Welcome to the Realty Income's Second Quarter 2009 Earnings Call. (Operator instructions). I would now like to turn the conference over to Tom Lewis, CEO of Realty Income. Please go ahead.

The purpose, obviously, of this call is to go over our operations and results for the second quarter of 2009. With me in the room today is Gary Malino, our President and Chief Operating Officer; Paul Meurer, our Executive Vice President and Chief Financial Officer; and Tere Miller, our Vice President, Corporate Communications. As always, during this conference call, we will be making certain statements that may be 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. We will disclose in greater deal on the company's quarterly and Form 10-Q the factors that may cause such differences. With that out of the way, we'll start the way we normally do, with Paul reviewing the numbers in the quarter. Paul?

As usual, I'm going to comment on the financial statements briefly, provide a few highlights of our financial results for the quarter, starting with the income statement. Total revenue decreased slightly for the quarter from $82 million to $81.6 million. Rental revenue was slightly down for the comparative quarter, because we actually sold 30 properties over the past year and we have not acquired any new additional properties. We owned 2,367 properties at June 30 of last year, while we own only 2,338 properties now. Same-store rental revenue actually increased 0.5% for the quarterly period, and excluding Buffets, same-store rent growth was even healthier at 1.5% for the quarter. On the expense side, depreciation and amortization expense increased by $209,000 in the comparative quarterly period. Interest expense decreased for the quarter to $21.4 million, and of course, this reduction reflects the retirement of $120 million of our bonds over the past year. We had zero borrowings on our credit facility throughout the entire quarter, in fact, year-to-date. On a related note, our coverage ratios remained strong, with interest coverage at 3.5 times and fixed charge coverage at 2.7 times. General and administrative expenses in the second quarter decreased significantly by over $900,000. This is primarily due to lower overall compensation. We expect G&A expenses in 2009 to remain flat or lower as compared to 2008 at only about 6.5% of total revenues. Property expenses were about $1.9 million in the quarter. These expenses are primarily associated with the taxes, maintenance, and insurance expenses, which we become responsible for on properties that are available for lease. These expenses have increased somewhat. In addition, we did record additional bad debt expense in the second quarter of $585,000, although we do not expect bad debt expense to be as high in future quarters.…

As I run through all of these areas I guess I'll start by saying, like last quarter, it was a fairly quiet quarter, which in this environment I guess is a pretty good thing. I'll start with the portfolio which is doing pretty well right now, given the state of retail. The tenants in the portfolio that we are talking to have generally seen their business stabilize a bit in the second quarter. That's what we are hearing so far in the third quarter also, really not hearing much from them relative to additional declines in their businesses as we were late last year and earlier in the year. So things seem to have settled down a little bit. While we have worked with a few of the tenants to get through some issues, we are very fortunate we've dodged a lot of the failures that have occurred out there in retail, and in the few cases where we have had some situations with retailers, we've had either just a few properties or we have owned their more profitable properties. So we really weren't impacted or been able to lease a few properties and that's why occupancies remained fairly high. The other thing as always we talk about cash flow coverages of rent down at the store level, which kind of creates our margin of safety and when times get tough for retailers, allows us to do well with the properties we have. If you look at the top-15 tenants for the second quarter, they accounted for about 53.2% of our rent, and if you look at the EBITDA-to-rent coverage, at the end of the first quarter, it was about 2.39 times and ranged from a low of one tenant at 1.22 times upto about 3.75. At the end of…

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

Your restaurant exposure, relative to some other folks out there, is fairly high, and it's sort of above where it's been historically for you folks and clearly that industry has been under some degree of pressure. What's your thinking on the future about your exposure there as it relates to may be a buy/sell decision? The basis of this is really because unemployment is high, savings rates are up. It doesn't feel like there's a quick turn at hand for restaurant profitability.

Yes, at the end of '07, we had bought a fair amount of restaurants and at that time when we got over 20, said this is getting uncomfortable relative to size, and we're bringing it down. I don't think we've bought anything really in quite a long time in restaurants, and we've kind of put that on the list of not something we're considering. So, it's definitely our desire to bring it down and those numbers have been coming down now for a number of quarters. Relative to selling some properties, as we have been selling, a good number of those have been restaurants and so that's what's bringing down the percentage of the revenue in the portfolio. It's interesting also, Jeff, to look at it in restaurants, which is about 20%, 5% is Buffets, which coming out of their reorganization and with the adjustment of rents, we have pretty good cash flows on and kind of took a hit there, and that leaves us with about 15%. Out of that 15%, about half is fast food restaurants, and the fast food restaurant end has held up very well, as a matter of fact, has had some very good sales with people have been migrating down the price chart into restaurants and going for lower prices, they benefited. So if you take that out, that leaves us about 7% to 8% of casual dining. When we go through those, there has been a couple other little hits in there. So while there may be a little exposure, it's not up at 20% of the portfolio. I think it's down now to about 4% or 5% of the portfolio, where we look at it and say, “Okay, this is going to be a soft business, consumer's probably not coming back hard, and it is likely that spending will be moderated in the casual dining segment.” I think it's really down to about 4% or 5%, 6% that we keep an eye on now in restaurant.

I'm curious now as you're looking forward then 2 or 3 years and you talk about acquisitions coming back, are there segments or sectors that you'd like to see be more represented in your portfolio? If we're going to have a soft consumer market, has that caused you to think more about goods versus services or different geographies? How do you think about that mix?

Yes. First on goods versus services, we're about 22% just pure services and about 55%, I think, that is goods that have some type of service with it and we like the service component. It seems to hold up a little better for us, and so there's a theme there. Outside of that, I think it's where two-thirds of the portfolio is already, which was kind of staying at the basic human needs which was stuff people buy every day and at relatively low price points, and that's served us pretty well. I think that this is a theme that we'll be playing out for quite a while and that means staying away from durable goods, kind of consumer discretionary. While I don't have specific industries, I think you just want to keep within that theme and as we're looking at things kind of come across, if it's restaurant, then we just move it right to the side and I'm not going to consider it today but anything outside of that we'll take a good look at, but basic human needs and low price point. The last point on it, if you look through the portfolio, while we don't have a lot of big box, small box has been easier to lease this year than the big box has been. So I think we'll continue to work in that space too.

I'm curious and normally I wouldn't ask this question of a retail landlord, but I think you guys pay particular attention to tenant credit. When you step back and look at what you see among the retailers and the service providers you have relationships with and what you hear from them, do you have a feel, Tom, I'm curious as to what, I guess I'll call it, what inning you think we're in? Do you think there is more pain, whether it's net store closures or bankruptcies, behind us than ahead of us? Or how do you think about that right now?

It's like in the 12-step program. I think it starts with first you have to admit you have a problem, and trying to see the future is not something that is really clear right now. I think you have to sit down and do some scenario planning which is you kind of say, okay, I think we'll slowly move up from here. The worst is over, and most of the retailers will be okay, but if it comes back too fast, you probably worry about the Fed tightening up a bit and a lot of people still have balance sheet as their primary problem and they'll have to refinance. So under that situation, while it'd be better, I think it'd just be okay. Kind of a middle scenario is what a lot of people are talking about, which is an L-shaped or (inaudible) and then you have to say, it's just going to go sideways for a while and people will be looking at their balance sheets and there still are maturities, so you've got some issues to look at right there. Then the other scenario, obviously, is we take another leg down, and then I think some people could have some problems. If we just go sideways, what we're hearing from our retailers is, generally, their business has stopped declining and generally they feel better about life, but I think you have to go a few years out and look at maturities on people's balance sheet. The other thing is, again, really scrubbing the portfolio. It's interesting because I had a research department four or five weeks ago through and run some numbers for me, and I said, go back and look at the first quarter of '09 retail sales versus first quarter '08, and what was it? The…

And just last question, I'll yield the floor, is as it relates to acquisitions, what do you think is causing folks or causing the market to become a little bit more liquid now and causing people to sell? Is it that you're seeing financing come back or folks under pressure to let assets go? You really haven't seen many transactions occur in other property types. It's starting, but given the cap rates that you're thrown out in the past, where you'd like to be a buyer, what's causing people to sell at those levels?

Yes. I think it's the same thing I just said before, which is most of it is balance sheet generated, where people have been sitting around for a year. They've had a big bid/ask spread. Now they're at the point where they have some financings coming up and really while credit's become a little more available, it hasn't gotten into a range where they think they can solve their problem, and they're saying, okay, I need to do something here, and as always, that's what closes the bid/ask spread. We live in Escondido and one of the areas is ground zero for decline in homes, and you saw at the end of 2006 it peaked, and then there were just no transactions for about a year to 18 months and then all of a sudden, people have to start selling, and the bid/ask spread closes. I think that's what's starting in our area. It could always be offset a bit if financing rates really came down. So there were some alternatives in the high-yield market and while that's gotten better, it hadn't gotten far enough for them. But I think it's just times gone by. Some people have some overall balance sheet issues they have to deal with, and now that the property is sitting on their portfolio, it's worthwhile for them to consider moving right up and getting them off the books.

Our next question comes from the line of Michael Bilerman with Citigroup.

Hi. It's Greg Schweitzer with Michael. On the increase in bad debt, could you talk a bit about the drivers of that increase?

Sure. We had a little bit larger number in the first quarter, you may recall me talking about, and then a little bit larger number the second quarter than expected. Those were receivables that were on the books that we chose to essentially write-off after what we do as sort of monthly review of those to determine whether they're collectible or not. There were a couple of big situations that made that a larger number year-to-date than we expect as a run rate going forward. One was one where we had a judgment where we thought we would collect a fair amount of the receivables from something that happened, say, a year ago or so, and that didn't come to fruition, as it turned out. So we’ve scrubbed them pretty hard to make sure that we're comfortable with what we believe to be the collectibility of all the receivables we have. One thing I'll point is our accounts receivable have not gone up. There's been no change in that. You can see that in our balance sheet. So we don't have a lot of those kind of sitting on the books. I mentioned in my upfront remarks that we expect the run rate to be less on a go-forward basis. Bad debt expense was $585,000 in the second quarter. Our current expectation is less than half of that for the next quarter and the quarter after that. So really that 585 may be for the balance of the year, if you will, is our current estimate. So we suspect we're going to continue to have some, more than we've had in years past, but that the bulk of it happened in the first half of this year.

And how do you get comfortable with sort of the tenant health for the retailers that report their sales to you annually? Is there any other ways that you monitor that health when you're looking at that receivables balance or as part of your watch list?

We do get their financials. More often that, it's the property-level stuff that we tend to get once a year on some of the tenants and we do get their financials. So we are able to watch their overall operations which then allows us to infer whether somebody is having a problem, but mostly what we do is pick up the phone and talk to them and have ongoing conversations. As Paul said, there's not huge receivables there. If there is a receivable from the tenant, then we'll tend to be on the phone with them a lot or if we've seen the trends go down or if the last time we were in cash flow coverages we thought that they were getting closer, there might be an issue. And, generally, we have really good discussions with the retailers. They're pretty open. We generally have confidentiality agreements with each other and good relationships. So we're able to keep on top of them casually; if not, within the lease, they're required to report every quarter.

How much of the portfolio as a percent of revenue, say, gives you that property-level detail only once a year?

I don't know off the top of my head. Of the whole portfolio, if you get to the top-15 tenants, it's probably 10 of them that we get it quarterly, and it's probably 3 or 4 annually and 1 or 2 that we get sales and impute backwards.

Okay. And then just a couple more on tenants. Vicorp filed for Chapter 11 last year and about three months ago it was sold to American Blue Ribbon and (inaudible) Bakers Squares with Realty Income as landlord. Were any of the locations that you have and are they under closure risk or are there any that you're monitoring?

We have none that are under closure risk or are monitoring. The Chapter 11 filing Vicorp pact was in April of last year, so that is a concluded event as of a number of quarters ago. So I don't think we have any exposure coming on Vicorp.

And then on the (inaudible) deal exposure, I know there was a question last quarter on it. A similar search comes up with the numerous (inaudible) locations with Realty Income as landlord. Are you able to give us the cash flow coverage of this tenant?

We, under no circumstances, comment on the cash flow coverage into the operations of companies in the portfolio unless they're in Chapter 11. So, no, we don't report their financials. We let them do it.

How about on an industry basis, say, for the auto, RV dealer industry cash flow coverage?

Yes. Well, we do have other tenants in there and that is the one that's on the lower end and this quarter improved from a 1.22 up into the 1.55 area.

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

There was some talk that there might be more Chapter 11 filings when DIP financing returned. Have you guys seen anything like that? Is that something you're hearing maybe a greater possibility for some of your tenants?

No. Right now, we have no tenants that we have in Chapter 11 in our top-25 tenants which gets down about 1% of rent, and we've had nobody call us up and say they're going to go or that we think is imminent. So dip financing has widened out a little bit, which has been actually good for those situations, but the answer is just no.

Then thinking about the spaces that you try to lease, the 79 that you have that are available to be leased, are those leasable spaces or are these things that you can actually get someone in there or do you think they're kind of terminal in a sense in that you're just not going to find a tenant in the near term?

Well, we don't think they're terminal. We've had a lot of leasing going on this year and we've been able to keep occupancy very high. And if you just look at the lease rollover list, we've had a number coming off there and then a number coming back from tenants, but thus far this year, our portfolio management group has been able to lease them as fast or faster as they come off. It has really been an advantage to have smaller boxes, and in the smaller boxes being able to find tenants that are regional if a national goes out or a local if a regional goes out that want to go in there and then the property sales that you've seen this year, a lot of the times are letting those people know that maybe an appropriate way for them to operate that property is to own it themselves so that we stay with most of our tenants being larger chains. So, no. They're not terminal. We have been able to lease them and I think the portfolio management group this year has done a great job and more than stayed even.

Yes, one of our trends, Rich, that we pointed out over the past two years has been while historically we used to say it takes about 6 months to release a vacant space, but that timeframe has widened a bit to 9 to 12 months. However, this past quarter, it went pretty fast on a handful of them. It was a nice little trend to have that be a little faster and that's why you saw that tick up in occupancy because we're always going to have a handful that are vacant, but as a general comment, over the past two years, it's taken a little bit longer to release space. Therefore, our carrying costs have gone up and, therefore, our property expenses went up a bit over the past year, but this past quarter, we actually saw a fair amount of momentum, which was nice.

Okay. Yes, Paul, you were heading in the same direction I was going to ask. I mean is that something we should extrapolate a bit? Do you think that's something that's a signal maybe the economy's improving a bit or the situation's getting better? Or was that maybe just a blip in the second quarter?

I don't know.

Is that a good answer?

Yes, that's fair. That's fair. I'm hopeful here and I was hoping maybe you guys were hopeful, as well. Then one more thing.

Rich, let me just say this. We have modeled it such that it is not going to continue to improve in that manner. How's that?

Yes, that's fair. That's conservative. I like that.

No, but that's important that we point out again that our projections include real conservative assumptions relative to the existing portfolio.

And the last thing I had, guys, I know when you buy things, you tend to issue equity post the acquisition. With the markets as crazy as they are, when we have move-up in the equity markets, are you tempted to issue equity ahead of what might be some transactions? Is that a possibility, or you just wouldn't do that?

I would if I knew there were a number of transactions and they were about to close, which means I had accretive use for the funds on a fairly short-term basis. Absent that, we prefer to find things to buy before we go get a bunch of equity to buy it, and plus we're very lucky we have on cash on hand, but I'll give you the circumstances. We have $35 million here. If we went out and bought $35 million worth of stuff and it's a few months from now and we were sitting around and an opportunity comes in and it's $75 million or $100 million, as we got down very close to closing, where we've checked all the boxes and we're relatively sure it's going to close, under those circumstances, we would. Then depending on size, you have some disclosure risks relative to the acquisitions if it's just one. So I'd do it if the timing was fairly close, but if the timing wasn't close, we'd prefer to wait.

The next question comes from the line of [Ben Rosenshwank] with TFM.

This is actually [Ryan Levinson] sitting in with Ben. I was just wondering on the 9 properties sold in the second quarter how many were occupied?

9 properties sold during the second quarter how many were occupied when they were sold? That's one of those questions where I'll give you two answers, and the first answer is I'm not exactly sure, but that's only because generally when we sell them and they're unoccupied, it is we have found somebody who would like to occupy them, and we make the choice rather than to sign a lease, to sell it to them. So it's technically unoccupied, but we do have somebody that wants it, and that's a function of when we find somebody who wants to lease it, deciding whether we'd like maintain them in the portfolio or not. There hadn't been a lot of sales of just vacant properties to somebody --

I think most of them were occupied.

Yes.

I'm just thinking through our vacancy list, Ryan, and where we're always analyzing for sale or lease, and I think only one of them was a vacant property being sold but not exactly sure.

At roughly $600,000 per property, I think it was about $5.5 million of gross proceeds, if I assume an average NOI per store, doesn't that equate to like a 20 something percent cap rate on each one of those locations if they were occupied?

I can't do the math with you right now, but I am absolutely positive that wasn't the cap rate on our sales.

The other thing is Rite Aid announced that they're seeking rent relief on 500 stores in the second quarter. Of the 24 Rite Aids that are in your portfolio, do you have any exposure? It's obviously not their entire store base. It's just a fraction of their system. I'm just wondering if you have any exposure to that.

Yes, it's not our policy to comment on our individual tenants and what they're doing, so we can sit here all day. We have 118 tenants. A lot of times on these calls, people get mentioned who aren't our tenants, so that's the policy we'll maintain. We are not looking currently at any substantial downside in our drugstore portfolio and other areas and if there is some minor, we'd put it in the guidance but that's where we are there.

One other occupancy question. The two rejected leases in the Big 10 bankruptcy and the two rejected leases in the Bally's bankruptcy, I'm just wondering if those are included in the 79 vacant properties that you have?

Your information is incorrect.

Okay. What's incorrect about it?

I'm not going to comment individually on tenants, which we don't, but it's not correct that I have those units that have been vacated or in a bankruptcy.

I'm sorry? On Bally's or Big, Big 10, there was a withdrawal of their rejection on Friday, and [Bear] wrote a note about this, which indicated that they had some sort of commentary from you.

On Big 10, I will comment. Big 10 went through a Chapter 11. They're out. We have 50 leases with them, 48 leases were accepted, which is exactly what we anticipated in the bankruptcy, and the other two we have and they're released out of the 79.

Okay. Those are in the 79. Can you give us an indication on what the rank concession was on the other 48?

It's very typical of what we reported in all the other ones. It's right around the mid-80s is what they come in at.

Mid-8?

Mid-80s, 84, 85, 86 generally when we go through a bankruptcy, and any of the ones that we've had in the last year, last 6 months have been relatively consistent with that.

Okay. And so I take it then that you're saying that the Bally's information is incorrect?

Again, I'm not going to comment individually on all the tenants. We don't think we have exposure to any down side in rent in the health and fitness area right now.

Okay. But there's a Bally Total Fitness of Greater New York, there's 7 stores that you're listed as landlord.

If you think we have some down side in that, I do not believe we do.

Okay. So you're not debating whether you're the landlord; it's just --

I'm debating whether we think we have any down side in the tenant that you have mentioned.

Okay, okay. One other one just about working capital; why does your working capital fluctuate so wildly from quarter-to-quarter, I think it was a provider of about roughly $25 million of cash in the quarter?

It doesn't vary widely from quarter-to-quarter. I'm not going to debate your math with you, but for example, we used $20 million of it in the first quarter to pay off the bonds that we had coming due then. More broadly speaking, when the bond payment dates are due, March 15 and September 15, and the cash gets used at those times to pay off those bonds when they're due.

And the quarter in between, it doesn't.

Right.

I'll follow up with you, Paul. Lastly, Tom, you mentioned in your prepared remarks that there were a couple of other hits. I was just wondering if you could elaborate on that a little bit?

Nothing that I see coming right now, nothing going on that I know of in the top 25. So, no. Looking forward, there's nothing imminent right now that I'm aware of. Anything that has happened, we had in the guidance and we have a little extra put in there, but that's basically just an assumption something small will happen. So, nothing imminent that I'm aware of.

So you don't think that some of the LBOs where you were the financier of the real estate, (inaudible), nothing imminent there?

Not that I'm aware of.

Our next question comes from the line of Andrew DiZio with Janney Montgomery Scott.

First in relation to your expert lease expirations that are coming up in the second half of '09, are those centered around any particular industry, or, although you wouldn't give us a name, any particular tenant?

You know, we're kind of at the end of the child care era because we bought those about the same time. So a high number of our lease rollovers really for the last 4 or 5 years have come out of child care and there's some child care in there. And then I just think it was a smattering of a bunch of stuff. I think that's the only theme in there.

Paul, I think you mentioned that your cost to carry had gone up in relation to the vacant properties. When you said that, did you mean on just an overall total basis because there's more vacancy, or did you mean like a per-square-foot basis? I think you mentioned before that your cost to carry is usually about 20%, $0.20 on the dollar?

Correct. I meant it in two different ways. One is that the carry time has increased a bit typically. Like I said, this past quarter, we had some real good success in terms of time, but for the most part over the last two years, let's call it, net time of vacancy has increased from about 6 months to more like 9 or 12 months in some of the properties. So the time of the carry, which increases the overall carry cost. That's the main cause of it, if you will. The second way is, yes, our vacancy, we've had a few more properties over the past two years, as opposed to the years just prior to that, and so as such, you're going to have a little bit higher carry cost.

Sure, okay. So you just meant in the aggregate. Got you.

Correct.

And last question. With respect to the narrowing of the bid/ask that you're seeing, are you seeing any particular industry that's adjusted faster, or is it just overall?

Again, I think it's balance sheet driven, so it really kind of comes across the board.

And that concludes the question-and-answer session. Mr. Lewis, please go ahead with any closing remarks.

Okay. Well, I'd like to thank everybody for joining us today, and hopefully, we'll talk again in about another 90 days and see what has unfolded during that period of time. Thank you very much.

Ladies and gentlemen, this concludes the Realty Income second quarter 2009 earnings conference call. If you would like to listen to a replay of today's conference, please dial 303-590-3030 or 800-406-7325 with the passcode 4117045. ACT would like to thank you for your participation. You may now disconnect.