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Section 1: 10-Q (10-Q)

gty-10q_20190630.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2019

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 001-13777

 

GETTY REALTY CORP.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Maryland

11-3412575

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

Two Jericho Plaza, Suite 110

Jericho, New York 11753-1681

(Address of Principal Executive Offices) (Zip Code)

(516) 478-5400

(Registrant’s Telephone Number, Including Area Code)

Not Applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

Common Stock

 

GTY

 

New York Stock Exchange

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      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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  

The registrant had outstanding 41,120,045 shares of common stock as of July 25, 2019.

 

 

 


 

GETTY REALTY CORP.

FORM 10-Q

INDEX

 

 

 

 

  Page  

PART I—FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements (Unaudited)

 

1

 

Consolidated Balance Sheets as of June 30, 2019 and December 31, 2018

 

1

 

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2019 and 2018

 

2

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2019 and 2018

 

3

 

Notes to Consolidated Financial Statements

 

4

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

23

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

34

Item 4.

Controls and Procedures

 

35

 

 

 

PART II—OTHER INFORMATION

 

 

Item 1.

Legal Proceedings

 

36

Item 1A.

Risk Factors

 

36

Item 5.

Other Information

 

36

Item 6.

Exhibits

 

37

Signatures

 

 

38

 

 

 


 

PART I—FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

GETTY REALTY CORP.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except per share amounts)

 

 

 

June 30,

2019

 

 

December 31,

2018

 

ASSETS

 

 

 

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

Land

 

$

651,517

 

 

$

631,185

 

Buildings and improvements

 

 

413,505

 

 

 

409,753

 

Construction in progress

 

 

2,264

 

 

 

2,168

 

 

 

 

1,067,286

 

 

 

1,043,106

 

Less accumulated depreciation and amortization

 

 

(158,672

)

 

 

(150,691

)

Real estate, net

 

 

908,614

 

 

 

892,415

 

Investment in direct financing leases, net

 

 

84,197

 

 

 

85,892

 

Notes and mortgages receivable

 

 

32,154

 

 

 

33,519

 

Cash and cash equivalents

 

 

25,563

 

 

 

46,892

 

Restricted cash

 

 

1,942

 

 

 

1,850

 

Deferred rent receivable

 

 

39,506

 

 

 

37,722

 

Accounts receivable, net of allowance of $1,688 and $2,094, respectively

 

 

2,548

 

 

 

3,008

 

Right-of-use assets - operating

 

 

23,871

 

 

 

 

Right-of-use assets - finance

 

 

1,099

 

 

 

 

Prepaid expenses and other assets

 

 

57,856

 

 

 

57,877

 

Total assets

 

$

1,177,350

 

 

$

1,159,175

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

Borrowings under credit agreement, net

 

$

112,640

 

 

$

117,227

 

Senior unsecured notes, net

 

 

324,466

 

 

 

324,409

 

Environmental remediation obligations

 

 

58,760

 

 

 

59,821

 

Dividends payable

 

 

14,628

 

 

 

14,495

 

Lease liability - operating

 

 

24,463

 

 

 

 

Lease liability - finance

 

 

4,474

 

 

 

 

Accounts payable and accrued liabilities

 

 

53,408

 

 

 

62,059

 

Total liabilities

 

 

592,839

 

 

 

578,011

 

Commitments and contingencies

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

Preferred stock, $0.01 par value; 20,000,000 shares authorized; unissued

 

 

 

 

 

 

Common stock, $0.01 par value; 100,000,000 shares authorized; 41,108,192 and 40,854,491 shares issued and outstanding, respectively

 

 

411

 

 

 

409

 

Additional paid-in capital

 

 

646,581

 

 

 

638,178

 

Dividends paid in excess of earnings

 

 

(62,481

)

 

 

(57,423

)

Total stockholders’ equity

 

 

584,511

 

 

 

581,164

 

Total liabilities and stockholders’ equity

 

$

1,177,350

 

 

$

1,159,175

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

1


 

GETTY REALTY CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share amounts)

 

 

 

Three Months Ended

June 30,

 

 

Six Months Ended

June 30,

 

 

 

2019

 

 

2018

 

 

2019

 

 

2018

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues from rental properties

 

$

33,560

 

 

$

33,483

 

 

$

66,847

 

 

$

64,836

 

Interest on notes and mortgages receivable

 

 

728

 

 

 

759

 

 

 

1,490

 

 

 

1,522

 

Total revenues

 

 

34,288

 

 

 

34,242

 

 

 

68,337

 

 

 

66,358

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property costs

 

 

5,643

 

 

 

6,429

 

 

 

11,138

 

 

 

11,363

 

Impairments

 

 

701

 

 

 

1,160

 

 

 

1,472

 

 

 

3,977

 

Environmental

 

 

855

 

 

 

1,396

 

 

 

1,758

 

 

 

2,384

 

General and administrative

 

 

3,798

 

 

 

3,855

 

 

 

7,775

 

 

 

7,442

 

Allowance for doubtful accounts

 

 

(113

)

 

 

(119

)

 

 

(28

)

 

 

7

 

Depreciation and amortization

 

 

6,151

 

 

 

5,907

 

 

 

12,250

 

 

 

11,501

 

Total operating expenses

 

 

17,035

 

 

 

18,628

 

 

 

34,365

 

 

 

36,674

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (loss) on dispositions of real estate

 

 

427

 

 

 

3,016

 

 

 

376

 

 

 

3,665

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

 

17,680

 

 

 

18,630

 

 

 

34,348

 

 

 

33,349

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense), net

 

 

1,504

 

 

 

224

 

 

 

1,709

 

 

 

588

 

Interest expense

 

 

(5,986

)

 

 

(5,314

)

 

 

(11,932

)

 

 

(10,365

)

Net earnings

 

$

13,198

 

 

$

13,540

 

 

$

24,125

 

 

$

23,572

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

0.32

 

 

$

0.33

 

 

$

0.58

 

 

$

0.58

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

0.32

 

 

$

0.33

 

 

$

0.58

 

 

$

0.58

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

41,024

 

 

 

39,901

 

 

 

40,949

 

 

 

39,806

 

Diluted

 

 

41,049

 

 

 

39,914

 

 

 

40,968

 

 

 

39,817

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

2


 

GETTY REALTY CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

 

 

Six Months Ended

June 30,

 

 

 

2019

 

 

2018

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

 

Net earnings

 

$

24,125

 

 

$

23,572

 

Adjustments to reconcile net earnings to net cash flow provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

12,250

 

 

 

11,501

 

Impairment charges

 

 

1,472

 

 

 

3,977

 

(Gain) loss on dispositions of real estate

 

 

(376

)

 

 

(3,665

)

Deferred rent receivable

 

 

(1,785

)

 

 

(2,243

)

Allowance for doubtful accounts

 

 

(28

)

 

 

7

 

Amortization of above-market and below-market leases

 

 

(342

)

 

 

(359

)

Amortization of debt issuance costs

 

 

470

 

 

 

403

 

Accretion expense

 

 

1,032

 

 

 

1,308

 

Stock-based compensation

 

 

1,139

 

 

 

848

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

219

 

 

 

94

 

Prepaid expenses and other assets

 

 

(612

)

 

 

(139

)

Environmental remediation obligations

 

 

(4,431

)

 

 

(5,153

)

Accounts payable and accrued liabilities

 

 

(1,573

)

 

 

599

 

Net cash flow provided by operating activities

 

 

31,560

 

 

 

30,750

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

 

Property acquisitions

 

 

(29,700

)

 

 

(55,308

)

Capital expenditures

 

 

 

 

 

(68

)

Addition to construction in progress

 

 

(430

)

 

 

(1,092

)

Proceeds from dispositions of real estate

 

 

592

 

 

 

1,576

 

Deposits for property acquisitions

 

 

27

 

 

 

(280

)

Amortization of investment in direct financing leases

 

 

1,695

 

 

 

1,448

 

(Issuance) of notes and mortgages receivable

 

 

(470

)

 

 

(140

)

Collection of notes and mortgages receivable

 

 

2,803

 

 

 

1,577

 

Net cash flow (used in) investing activities

 

 

(25,483

)

 

 

(52,287

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

 

Borrowings under credit agreement

 

 

35,000

 

 

 

50,000

 

Repayments under credit agreement

 

 

(40,000

)

 

 

(115,000

)

Proceeds from senior unsecured notes

 

 

 

 

 

100,000

 

Payment of debt issuance costs

 

 

 

 

 

(3,347

)

Payment of finance lease obligations

 

 

(259

)

 

 

(225

)

Security deposits received (refunded)

 

 

(271

)

 

 

(50

)

Payments of cash dividends

 

 

(28,332

)

 

 

(24,981

)

Payments in settlement of restricted stock units

 

 

(115

)

 

 

 

Proceeds from issuance of common stock, net - ATM

 

 

6,663

 

 

 

13,714

 

Net cash flow (used in) provided by financing activities

 

 

(27,314

)

 

 

20,111

 

Change in cash, cash equivalents and restricted cash

 

 

(21,237

)

 

 

(1,426

)

Cash, cash equivalents and restricted cash at beginning of period

 

 

48,742

 

 

 

20,813

 

Cash, cash equivalents and restricted cash at end of period

 

$

27,505

 

 

$

19,387

 

Supplemental disclosures of cash flow information

 

 

 

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

 

 

 

Interest

 

$

11,575

 

 

$

9,911

 

Income taxes

 

 

247

 

 

 

246

 

Environmental remediation obligations

 

 

3,872

 

 

 

4,545

 

Non-cash transactions:

 

 

 

 

 

 

 

 

Dividends declared but not yet paid

 

 

14,628

 

 

 

13,025

 

Issuance of notes and mortgages receivable related to property dispositions

 

$

926

 

 

$

3,313

 

 

The accompanying notes are an integral part of these consolidated financial statements.

3


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. — DESCRIPTION OF BUSINESS

Getty Realty Corp. (together with its subsidiaries, unless otherwise indicated or except where the context otherwise requires, “we,” “us” or “our”) is the leading publicly-traded real estate investment trust (“REIT”) in the United States specializing in the ownership, leasing and financing of convenience store and gasoline station properties. As of June 30, 2019, we owned 862 properties and leased 71 properties from third-party landlords. These 933 properties are located in 31 states across the United States and Washington, D.C. Our properties are operated under a variety of nationally recognized brands including 76, BP, Citgo, Conoco, Exxon, Getty, Gulf, Mobil, Shell, Sunoco and Valero. In addition, we lease approximately 8,900 square feet of office space, which is used for our corporate headquarters. Our company was originally founded in 1955 and is headquartered in Jericho, New York.

NOTE 2. — ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements include the accounts of Getty Realty Corp. and its wholly-owned subsidiaries. The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). We do not distinguish our principal business or our operations on a geographical basis for purposes of measuring performance. We manage and evaluate our operations as a single segment. All significant intercompany accounts and transactions have been eliminated.

Reclassifications

Changes in environmental estimates and impairments, which were recorded in prior periods, that were related to properties previously classified as discontinued operations are now included in operating expenses in environmental and impairments, respectively. These amounts have been reclassified to conform to the presentation of the current period financial statements. These reclassifications had no effect on the previously reported net earnings. Further, these amounts are now included with amounts related to properties that were sold subsequent to the change in the definition of discontinued operations, and therefore all impacts from previously disposed properties are within the same financial statement line items.

In connection with our adoption of Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), as described below, we adopted the practical expedient that alleviates the requirement to separately present lease and non-lease rental income. As a result, tenant reimbursements are now included within revenues from rental properties in our consolidated statements of operation. To facilitate comparability, we have reclassified prior period amounts related to tenant reimbursements to conform to the presentation of the current period financial statements.

Unaudited, Interim Consolidated Financial Statements

The consolidated financial statements are unaudited but, in our opinion, reflect all adjustments (consisting of normal recurring accruals) necessary for a fair statement of the results for the periods presented. These statements should be read in conjunction with the consolidated financial statements and related notes in our Annual Report on Form 10-K for the year ended December 31, 2018.

Use of Estimates, Judgments and Assumptions

The consolidated financial statements have been prepared in conformity with GAAP, which requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the period reported. Estimates, judgments and assumptions underlying the accompanying consolidated financial statements include, but are not limited to, real estate, receivables, deferred rent receivable, direct financing leases, depreciation and amortization, impairment of long-lived assets, environmental remediation costs, environmental remediation obligations, litigation, accrued liabilities, income taxes and the allocation of the purchase price of properties acquired to the assets acquired and liabilities assumed. Application of these estimates and assumptions requires exercise of judgment as to future uncertainties and, as a result, actual results could differ materially from these estimates.

Real Estate

Real estate assets are stated at cost less accumulated depreciation and amortization. For acquisitions of real estate which are accounted for as business combinations, we estimate the fair value of acquired tangible assets (consisting of land, buildings and improvements) “as if vacant” and identified intangible assets and liabilities (consisting of leasehold interests, above-market and below-market leases, in-place leases and tenant relationships) and assumed debt. Based on these estimates, we allocate the estimated fair value to the applicable assets and liabilities. Fair value is determined based on an exit price approach, which contemplates the

4


 

price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We expense transaction costs associated with business combinations in the period incurred. Acquisitions of real estate which do not meet the definition of a business are accounted for as asset acquisitions. The accounting model for asset acquisitions is similar to the accounting model for business combinations except that the acquisition costs are capitalized and allocated to the individual assets acquired and liabilities assumed on a relative fair value basis. For additional information regarding property acquisitions, see Note 11 – Property Acquisitions.

We capitalize direct costs, including costs such as construction costs and professional services, and indirect costs associated with the development and construction of real estate assets while substantive activities are ongoing to prepare the assets for their intended use. The capitalization period begins when development activities are underway and ends when it is determined that the asset is substantially complete and ready for its intended use.

We evaluate the held for sale classification of our real estate as of the end of each quarter. Assets that are classified as held for sale are recorded at the lower of their carrying amount or fair value less costs to sell.

When real estate assets are sold or retired, the cost and related accumulated depreciation and amortization is eliminated from the respective accounts and any gain or loss is credited or charged to income. We evaluate real estate sale transactions where we provide seller financing to determine sale and gain recognition in accordance with GAAP. Expenditures for maintenance and repairs are charged to income when incurred.

Direct Financing Leases

Income under direct financing leases is included in revenues from rental properties and is recognized over the lease terms using the effective interest rate method which produces a constant periodic rate of return on the net investments in the leased properties. The investments in direct financing leases are increased for interest income earned and amortized over the life of the leases and reduced by the receipt of lease payments. We consider direct financing leases to be past-due or delinquent when a contractually required payment is not remitted in accordance with the provisions of the underlying agreement. We evaluate each account individually and set up an allowance when, based upon current information and events, it is probable that we will be unable to collect all amounts due according to the existing contractual terms and the amount can be reasonably estimated.

We review our direct financing leases at least annually to determine whether there has been an other-than-temporary decline in the current estimate of residual value of the property. The residual value is our estimate of what we could realize upon the sale of the property at the end of the lease term, based on market information and third-party estimates where available. If this review indicates that a decline in residual value has occurred that is other-than-temporary, we recognize an impairment charge. There were no impairments of any of our direct financing leases during the three and six months ended June 30, 2019 and 2018.

When we enter into a contract to sell properties that are recorded as direct financing leases, we evaluate whether we believe that it is probable that the disposition will occur. If we determine that the disposition is probable and therefore the property’s holding period is reduced, we record an allowance for credit losses to reflect the change in the estimate of the undiscounted future rents. Accordingly, the net investment balance is written down to fair value.

Notes and Mortgages Receivable

Notes and mortgages receivable consists of loans originated by us in conjunction with property dispositions and funding provided to tenants in conjunction with property acquisitions and capital improvements. Notes and mortgages receivable are recorded at stated principal amounts. We evaluate the collectability of both interest and principal on each loan to determine whether it is impaired. A loan is considered to be impaired when, based upon current information and events, it is probable that we will be unable to collect all amounts due under the existing contractual terms. When a loan is considered to be impaired, the amount of the loss is calculated by comparing the recorded investment to the fair value determined by discounting the expected future cash flows at the loan’s effective interest rate or to the fair value of the underlying collateral, if the loan is collateralized. Interest income on performing loans is accrued as earned. Interest income on impaired loans is recognized on a cash basis. We do not provide for an additional allowance for loan losses based on the grouping of loans, as we believe that the characteristics of the loans are not sufficiently similar to allow an evaluation of these loans as a group for a possible loan loss allowance. As such, all of our loans are evaluated individually for impairment purposes. There were no impairments related to our notes and mortgages receivable during the three and six months ended June 30, 2019 and 2018.

Revenue Recognition and Deferred Rent Receivable

On January 1, 2018, we adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), (“Topic 606”) using the modified retrospective method applying it to any open contracts as of January 1, 2018. The new guidance provides a unified model to determine how revenue is recognized. To determine the proper amount of revenue to be recognized, we perform the following steps: (i) identify the contract with the customer, (ii) identify the performance obligations within the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations and (v) recognize revenue when (or as) a performance

5


 

obligation is satisfied. Our primary source of revenue consists of revenue from rental properties and tenant reimbursements that is derived from leasing arrangements, which is specifically excluded from the standard, and thus had no material impact on our consolidated financial statements or notes to our consolidated financial statements as of June 30, 2019.

Lease payments from operating leases are recognized on a straight-line basis over the term of the leases. The cumulative difference between lease revenue recognized under this method and the contractual lease payment terms is recorded as deferred rent receivable on our consolidated balance sheets. We review our accounts receivable, including its deferred rent receivable, related to base rents, straight-line rents, tenant reimbursements and other revenues for collectability. Our evaluation of collectability primarily consists of reviewing past due account balances and considers such factors as the credit quality of our tenant, historical trends of the tenant, changes in tenant payment terms and current economic trends. In addition, with respect to tenants in bankruptcy, we estimate the probable recovery through bankruptcy claims. If a tenant’s accounts receivable balance is considered uncollectable, we will write off the related receivable balances and cease to recognize lease income, including straight-line rent unless cash is received. If the collectability assessment subsequently changes to probable, any difference between the lease income that would have been recognized if collectability had always been assessed as probable and the lease income recognized to date, is recognized as a current-period adjustment to revenues from rental properties. Our reported net earnings are directly affected by our estimate of the collectability of our accounts receivable.

The present value of the difference between the fair market rent and the contractual rent for above-market and below-market leases at the time properties are acquired is amortized into revenues from rental properties over the remaining terms of the in-place leases. Lease termination fees are recognized as other income when earned upon the termination of a tenant’s lease and relinquishment of space in which we have no further obligation to the tenant.

The sales of nonfinancial assets, such as real estate, are to be recognized when control of the asset transfers to the buyer, which will occur when the buyer has the ability to direct the use of or obtain substantially all of the remaining benefits from the asset. This generally occurs when the transaction closes and consideration is exchanged for control of the property.

Impairment of Long-Lived Assets

Assets are written down to fair value when events and circumstances indicate that the assets might be impaired and the projected undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those assets. Assets held for disposal are written down to fair value less estimated disposition costs.

We recorded impairment charges aggregating $701,000 and $1,472,000 for the three and six months ended June 30, 2019, respectively, and $1,160,000 and $3,977,000 for the three and six months ended June 30, 2018, respectively. Our estimated fair values, as they relate to property carrying values, were primarily based upon (i) estimated sales prices from third-party offers based on signed contracts, letters of intent or indicative bids, for which we do not have access to the unobservable inputs used to determine these estimated fair values, and/or consideration of the amount that currently would be required to replace the asset, as adjusted for obsolescence (this method was used to determine $58,000 of the $1,472,000 in impairments recognized during the six months ended June 30, 2019) and (ii) discounted cash flow models (this method was used to determine that there were no impairments during the six months ended June 30, 2019). During the six months ended June 30, 2019, we recorded $1,414,000 of the $1,472,000 in impairments recognized due to the accumulation of asset retirement costs as a result of changes in estimates associated with our estimated environmental liabilities which increased the carrying values of certain properties in excess of their fair values. For the six months ended June 30, 2019 and 2018, impairment charges aggregating $361,000 and $718,000, respectively, were related to properties that were previously disposed of by us.

The estimated fair value of real estate is based on the price that would be received from the sale of the property in an orderly transaction between market participants at the measurement date. In general, we consider multiple internal valuation techniques when measuring the fair value of a property, all of which are based on unobservable inputs and assumptions that are classified within Level 3 of the Fair Value Hierarchy. These unobservable inputs include assumed holding periods ranging up to 15 years, assumed average rent increases of 2.0% annually, income capitalized at a rate of 8.0% and cash flows discounted at a rate of 7.0%. These assessments have a direct impact on our net income because recording an impairment loss results in an immediate negative adjustment to net income. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future rental rates and operating expenses that could differ materially from actual results in future periods. Where properties held for use have been identified as having a potential for sale, additional judgments are required related to the determination as to the appropriate period over which the projected undiscounted cash flows should include the operating cash flows and the amount included as the estimated residual value. This requires significant judgment. In some cases, the results of whether impairment is indicated are sensitive to changes in assumptions input into the estimates, including the holding period until expected sale.

Fair Value of Financial Instruments

All of our financial instruments are reflected in the accompanying consolidated balance sheets at amounts which, in our estimation based upon an interpretation of available market information and valuation methodologies, reasonably approximate their fair values, except those separately disclosed in the notes below.

6


 

The preparation of consolidated financial statements in accordance with GAAP requires management to make estimates of fair value that affect the reported amounts of assets and liabilities and disclosure of assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the period reported using a hierarchy (the “Fair Value Hierarchy”) that prioritizes the inputs to valuation techniques used to measure the fair value. The Fair Value Hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The levels of the Fair Value Hierarchy are as follows: “Level 1” – inputs that reflect unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date; “Level 2” – inputs other than quoted prices that are observable for the asset or liability either directly or indirectly, including inputs in markets that are not considered to be active; and “Level 3” – inputs that are unobservable. Certain types of assets and liabilities are recorded at fair value either on a recurring or non-recurring basis. Assets required or elected to be marked-to-market and reported at fair value every reporting period are valued on a recurring basis. Other assets not required to be recorded at fair value every period may be recorded at fair value if a specific provision or other impairment is recorded within the period to mark the carrying value of the asset to market as of the reporting date. Such assets are valued on a non-recurring basis.

Environmental Remediation Obligations

We record the fair value of a liability for an environmental remediation obligation as an asset and liability when there is a legal obligation associated with the retirement of a tangible long-lived asset and the liability can be reasonably estimated. Environmental remediation obligations are estimated based on the level and impact of contamination at each property. The accrued liability is the aggregate of our estimate of the fair value of cost for each component of the liability. The accrued liability is net of estimated recoveries from state underground storage tank (“UST”) remediation funds considering estimated recovery rates developed from prior experience with the funds. Net environmental liabilities are currently measured based on their expected future cash flows which have been adjusted for inflation and discounted to present value. We accrue for environmental liabilities that we believe are allocable to other potentially responsible parties if it becomes probable that the other parties will not pay their environmental remediation obligations.

Income Taxes

We and our subsidiaries file a consolidated federal income tax return. Effective January 1, 2001, we elected to qualify, and believe that we are operating so as to qualify, as a REIT for federal income tax purposes. Accordingly, we generally will not be subject to federal income tax on qualifying REIT income, provided that distributions to our stockholders equal at least the amount of our taxable income as defined under the Internal Revenue Code. We accrue for uncertain tax matters when appropriate. The accrual for uncertain tax positions is adjusted as circumstances change and as the uncertainties become more clearly defined, such as when audits are settled or exposures expire. Tax returns for the years 2015, 2016 and 2017, and tax returns which will be filed for the year ended 2018, remain open to examination by federal and state tax jurisdictions under the respective statutes of limitations.

New Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets. Under ASU 2016-02 lessor accounting will remain similar to lessor accounting under previous GAAP, while aligning with the FASB’s new revenue recognition guidance. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, to clarify how to apply certain aspects of the new standard. In July 2018, the FASB also issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, to give entities another option for transition and to provide lessors with a practical expedient to reduce the cost and complexity of implementing the new standard. The transition option allows entities to not apply the new leases standard in the comparative periods in their financial statements in the year of adoption. In December 2018, the FASB issued ASU 2018-20, which clarifies lessor treatment of sales taxes and other similar taxes collected from lessees, lessor costs paid directly by lessees and recognition of variable payments for contracts with lease and non-lease components. We elected the package of practical expedients and the lease and non-lease component practical expedient. We elected to apply the transition requirements at the January 1, 2019, effective date rather than at the beginning of the earliest comparative period presented. The consolidated financial statements for the quarter ended June 30, 2019, are presented under the new standard, while the comparative period presented was not adjusted and continues to be reported in accordance with our historical accounting policy. For additional information regarding the new lease accounting standard, see Note 3 – Leases.

On June 16, 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurements of Credit Losses on Financial Instruments (“ASU 2016-13”) to amend the accounting for credit losses for certain financial instruments. Under the new guidance, an entity recognizes its estimate of expected credit losses as an allowance, which the FASB believes will result in more timely recognition of such losses. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are currently evaluating the impact the adoption of ASU 2016-13 will have on our consolidated financial statements.

7


 

NOTE 3. — LEASES

As of June 30, 2019, we owned 862 properties and leased 71 properties from third-party landlords. These 933 properties are located in 31 states across the United States and Washington, D.C. Substantially all of our properties are leased on a triple-net basis primarily to petroleum distributors, convenience store retailers and, to a lesser extent, individual operators. Generally, our tenants supply fuel and either operate our properties directly or sublet our properties to operators who operate their convenience stores, gasoline stations, automotive repair service facilities or other businesses at our properties. Our triple-net lease tenants are responsible for the payment of all taxes, maintenance, repairs, insurance and other operating expenses relating to our properties, and are also responsible for environmental contamination occurring during the terms of their leases and in certain cases also for environmental contamination that existed before their leases commenced. For additional information regarding environmental obligations, see Note 6 – Environmental Obligations.

Substantially all of our tenants’ financial results depend on the sale of refined petroleum products, convenience store sales or rental income from their subtenants. As a result, our tenants’ financial results are highly dependent on the performance of the petroleum marketing industry, which is highly competitive and subject to volatility. During the terms of our leases, we monitor the credit quality of our triple-net lease tenants by reviewing their published credit rating, if available, reviewing publicly available financial statements, or reviewing financial or other operating statements which are delivered to us pursuant to applicable lease agreements, monitoring news reports regarding our tenants and their respective businesses, and monitoring the timeliness of lease payments and the performance of other financial covenants under their leases.

We adopted ASU 2016-02 as of January 1, 2019. ASU 2016-02 amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets. Under ASU 2016-02, lessor accounting will remain similar to lessor accounting under previous GAAP, while aligning with the FASB’s new revenue recognition guidance.

For leases in which we are the lessor, we are (i) retaining classification of our historical leases as we are not required to reassess classification upon adoption of the new standard, (ii) expensing indirect leasing costs in connection with new or extended tenant leases, the recognition of which would have been deferred under prior accounting guidance and (iii) aggregating revenue from our lease components and non-lease components (comprised of tenant reimbursements) into revenue from rental properties. We reclassified prior periods for these changes in presentation.

Revenues from rental properties were $33,560,000 and $66,847,000 for the three and six months ended June 30, 2019, respectively, and $33,483,000 and $64,836,000 for the three and six months ended June 30, 2018, respectively. Rental income contractually due from our tenants included in revenues from rental properties was $29,378,000 and $58,586,000 for the three and six months ended June 30, 2019, respectively, and $28,424,000 and $55,927,000 for the three and six months ended June 30, 2018, respectively.

In accordance with GAAP, we recognize rental revenue in amounts which vary from the amount of rent contractually due during the periods presented. As a result, revenues from rental properties include non-cash adjustments recorded for deferred rental revenue due to the recognition of rental income on a straight-line basis over the current lease term, the net amortization of above-market and below-market leases, rental income recorded under direct financing leases using the effective interest method which produces a constant periodic rate of return on the net investments in the leased properties and the amortization of deferred lease incentives (the “Revenue Recognition Adjustments”). Revenue Recognition Adjustments included in revenues from rental properties were $235,000 and $614,000 for the three and six months ended June 30, 2019, respectively, and $598,000 and $1,380,000 for the three and six months ended June 30, 2018, respectively.

Tenant reimbursements, which consist of real estate taxes and other municipal charges paid by us which were reimbursable by our tenants pursuant to the terms of triple-net lease agreements, were $3,947,000 and $7,647,000 for the three and six months ended June 30, 2019, respectively, and $4,461,000 and $7,529,000 for the three and six months ended June 30, 2018, respectively.

We incurred $93,000 and $228,000 of lease origination costs for the six months ended June 30, 2019 and 2018, respectively. This deferred expense is recognized on a straight-line basis as amortization expense in our consolidated statements of operations over the terms of the various leases.

The components of the $84,197,000 investment in direct financing leases as of June 30, 2019, are lease payments receivable of $132,868,000 plus unguaranteed estimated residual value of $13,928,000 less unearned income of $62,599,000. The components of the $85,892,000 investment in direct financing leases as of December 31, 2018, are lease payments receivable of $139,276,000 plus unguaranteed estimated residual value of $13,928,000 less unearned income of $67,312,000.

8


 

As of June 30, 2019, future contractual annual rentals receivable from our tenants, which have terms in excess of one year are as follows (in thousands):

 

 

Operating

Leases

 

 

Direct

Financing Leases

 

2019

 

$

52,524

 

 

$

6,456

 

2020

 

 

104,903

 

 

 

13,156

 

2021

 

 

101,933

 

 

 

13,339

 

2022

 

 

101,571

 

 

 

13,420

 

2023

 

 

101,634

 

 

 

13,467

 

Thereafter

 

 

702,108

 

 

 

73,030

 

Total

 

$

1,164,673

 

 

$

132,868

 

As previously disclosed in our 2018 Annual Report on Form 10-K and under the previous lease accounting standard, future contractual minimum annual rentals receivable from our tenants, which have terms in excess of one year as of December 31, 2018, would have been as follows (in thousands):

 

 

Operating

Leases

 

 

Direct

Financing Leases

 

2019

 

$

102,928

 

 

$

12,864

 

2020

 

 

102,693

 

 

 

13,156

 

2021

 

 

99,593

 

 

 

13,339

 

2022

 

 

99,184

 

 

 

13,420

 

2023

 

 

99,223

 

 

 

13,467

 

Thereafter

 

 

678,106

 

 

 

73,030

 

Total

 

$

1,181,727

 

 

$

139,276

 

For leases in which we are the lessee, ASU 2016-02 requires leases with durations greater than twelve months to be recognized on the balance sheet. We elected the package of transition provisions available for expired or existing contracts, which allowed us to carryforward our historical assessments of (i) whether contracts are or contain leases, (ii) lease classification and (iii) initial direct costs.

As of January 1, 2019, we recognized operating lease right-of-use assets of $25,561,000 (net of deferred rent expense) and operating lease liabilities of $26,087,000, which were presented on our consolidated financial statements. The right-of-use assets and lease liabilities are carried at the present value of the remaining expected future lease payments. When available, we use the rate implicit in the lease to discount lease payments to present value; however, our current leases did not provide a readily determinable implicit rate. Therefore, we estimated our incremental borrowing rate to discount the lease payments based on information available and considered factors such as interest rates available to us on a fully-collateralized basis and terms of the leases. ASU 2016-02 had a material impact on our consolidated balance sheets, but did not have an impact on our consolidated statements of operations. The most significant impact was the recognition of right-of-use assets and lease liabilities for operating leases, while our accounting for finance leases remained substantially unchanged.

The following presents the lease-related assets and liabilities (in thousands):

 

 

June 30,

2019

 

Assets

 

 

 

 

Right-of-use assets - operating

 

$

23,871

 

Right-of-use assets - finance

 

 

1,099

 

Total lease assets

 

$

24,970

 

Liabilities

 

 

 

 

Lease liability - operating

 

$

24,463

 

Lease liability - finance

 

 

4,474

 

Total lease liabilities

 

$

28,937

 

9


 

The following presents the weighted average lease terms and discount rates of our leases:

Weighted-average remaining lease term (years)

 

 

 

 

Operating leases

 

4.3

 

Finance leases

 

11.9

 

Weighted-average discount rate

 

 

 

 

Operating leases (1)

 

 

5.30

%

Finance leases

 

 

17.06

%

 

(1)

Upon adoption of the new lease standard, discount rates used for existing leases were established at January 1, 2019.

The following presents our total lease costs (in thousands):

 

 

Three Months Ended

June 30, 2019

 

 

Six Months Ended

June 30, 2019

 

Operating lease cost

 

$

1,141

 

 

$

2,279

 

Finance lease cost

 

 

 

 

 

 

 

 

Amortization of leased assets

 

 

133

 

 

 

259

 

Interest on lease liabilities

 

 

206

 

 

 

416

 

Short-term lease cost

 

 

33

 

 

 

90

 

Total lease cost

 

$

1,513

 

 

$

3,044

 

The following presents supplemental cash flow information related to our leases (in thousands):

 

 

Three Months Ended

June 30, 2019

 

 

Six Months Ended

June 30, 2019

 

Cash paid for amounts included in the measurement of lease liabilities

 

 

 

 

 

 

 

 

Operating cash flows for operating leases

 

$

1,134

 

 

$

2,303

 

Operating cash flows for finance leases

 

 

206

 

 

 

416

 

Financing cash flows for finance leases

 

$

133

 

 

$

259

 

As of June 30, 2019, scheduled lease liabilities mature as follows (in thousands):

 

 

Operating

Leases

 

 

Direct

Financing Leases

 

2019

 

$

2,214

 

 

$

740

 

2020

 

 

4,209

 

 

 

1,446

 

2021

 

 

3,797

 

 

 

1,288

 

2022

 

 

3,055

 

 

 

1,022

 

2023

 

 

2,934

 

 

 

846

 

Thereafter

 

 

16,111

 

 

 

3,199

 

Total lease payments

 

 

32,320

 

 

 

8,541

 

Less: amount representing interest

 

 

(7,857

)

 

 

(4,067

)

Present value of lease payments

 

$

24,463

 

 

$

4,474

 

As previously disclosed in our 2018 Annual Report on Form 10-K and under the previous lease accounting standard, future minimum annual rentals payable under such leases, excluding renewal options, as of December 31, 2018, would have been as follows: 2019 – $6,016,000, 2020 – $5,284,000, 2021 – $4,371,000, 2022 – $2,766,000, 2023 – $2,021,000 and $2,754,000 thereafter.

Major Tenants

As of June 30, 2019, we had three significant tenants by revenue:

 

We leased 155 convenience store and gasoline station properties in three separate unitary leases and three stand-alone leases to subsidiaries of Global Partners LP (NYSE: GLP) (“Global”). In the aggregate, our leases with subsidiaries of Global represented 18% of our total revenues for the six months ended June 30, 2019 and 2018. All of our unitary leases with subsidiaries of Global are guaranteed by the parent company.

 

We leased 77 convenience store and gasoline station properties pursuant to three separate unitary leases to Apro, LLC (d/b/a “United Oil”). In the aggregate, our leases with United Oil represented 13% of our total revenues for the six months ended June 30, 2019 and 2018.

10


 

 

We leased 75 convenience store and gasoline station properties pursuant to two separate unitary leases to subsidiaries of Chestnut Petroleum Dist., Inc. (“Chestnut”). In the aggregate, our leases with subsidiaries of Chestnut represented 11% of our total revenues for the six months ended June 30, 2019 and 2018. The largest of these unitary leases, co