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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2003
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 001-15581
CNL Restaurant Properties, Inc.
(Exact name of registrant as specified in its charter)
Maryland 59-3239115
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
450 South Orange Avenue
Orlando, Florida 32801
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (407) 540-2000
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 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 X No ___
Indicate by checkmark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes X No___
45,248,670 shares of common stock, $0.01 par value, outstanding as of
November 7, 2003.
CONTENTS
Part I Page
----
Item 1.Financial Statements:
Condensed Consolidated Balance Sheets 1
Condensed Consolidated Statements of Operations 2-3
Condensed Consolidated Statements of
Stockholders' Equity and Comprehensive
Income/(Loss) 4
Condensed Consolidated Statements of Cash Flows 5-6
Notes to Condensed Consolidated Financial
Statements 7-16
Item 2.Management's Discussion and Analysis of Financial
Condition and Results of Operations 17-33
Item 3.Quantitative and Qualitative Disclosures About
Market Risk 34
Item 4.Controls and Procedures 34
Part II
Other Information 35-38
Item 1. Financial Statements
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands except for share data)
September 30, December 31,
2003 2002
------------------ -----------------
ASSETS
Real estate investment properties $ 556,496 $ 568,102
Net investment in direct financing leases 105,750 110,926
Real estate held for sale 76,756 169,679
Mortgage loans held for sale 26,594 37,847
Mortgage, equipment and other notes receivable, net of allowance of
$11,318 and $12,062, respectively 313,125 334,149
Other investments 31,621 32,163
Cash and cash equivalents 28,940 16,584
Restricted cash 6,092 4,574
Receivables, less allowance for doubtful accounts
of $2,970 and $1,182, respectively 4,928 3,289
Accrued rental income 26,988 22,191
Goodwill 56,260 56,260
Other assets 32,769 30,500
------------------ -----------------
$ 1,266,319 $ 1,386,264
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Revolver $ 7,000 $ 14,000
Note payable 192,413 203,207
Mortgage warehouse facilities 63,159 145,758
Subordinated note payable 43,750 43,750
Bonds payable 409,937 424,508
Due to related parties 18,937 5,702
Other payables 38,698 36,326
------------------ -----------------
Total liabilities 773,894 873,251
------------------ -----------------
Minority interests, including redeemable partnership interest 6,804 18,862
Stockholders' equity:
Preferred stock, without par value. Authorized and unissued
3,000,000 shares -- --
Excess shares, $0.01 par value per share. Authorized and
unissued 78,000,000 shares -- --
Common stock, $0.01 par value per share. Authorized
62,500,000 shares, issued 45,286,297 shares, outstanding
45,248,670 shares 452 452
Capital in excess of par value 828,120 816,745
Accumulated other comprehensive loss (16,672 ) (16,862 )
Accumulated distributions in excess of net earnings (326,279 ) (306,184 )
------------------ -----------------
Total stockholders' equity 485,621 494,151
------------------ -----------------
$ 1,266,319 $ 1,386,264
================== =================
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands except for share data)
Quarter ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
--------------- ---------------- -------------- ---------------
Revenues:
Sale of real estate $ -- $ 39,467 $ -- $ 192,360
Rental income from operating leases 16,301 15,891 47,530 53,287
Earned income from direct financing leases 2,695 3,461 7,924 9,274
Interest income from mortgage, equipment and
other notes receivable 7,361 8,302 22,882 26,246
Investment and interest income 1,199 1,395 3,533 3,801
Food and beverage sales 3,391 -- 10,324 --
Other income 3,049 3,221 7,284 9,062
Net decrease in value of mortgage loans
held for sale, net of related hedge (483 ) (2,071 ) (2,734 ) (5,318 )
--------------- ---------------- -------------- ---------------
33,513 69,666 96,743 288,712
--------------- ---------------- -------------- ---------------
Expenses:
Cost of real estate sold -- 36,029 -- 177,483
General operating and administrative 6,136 7,133 21,145 22,520
Interest expense 12,662 13,989 38,233 44,730
Food and other restaurant costs 3,440 -- 10,077 --
Property expenses 530 476 948 2,113
State and other taxes 94 244 266 485
Depreciation and amortization 3,290 3,329 9,839 10,012
Provision for loss on loans 750 339 3,352 399
Impairment provisions 1,978 104 5,054 154
--------------- ---------------- -------------- ---------------
28,880 61,643 88,914 257,896
--------------- ---------------- -------------- ---------------
Earnings from continuing operations before minority
interest in income of consolidated joint ventures,
equity in earnings of unconsolidated joint
ventures and gain/(loss) on sale of assets 4,633 8,023 7,829 30,816
Minority interest in income of consolidated joint ventures (78 ) (469 ) (1,491 ) (1,564 )
Equity in earnings of unconsolidated joint ventures 30 28 89 76
Gain/(loss) on sale of assets (2 ) 22 (8 ) (352 )
--------------- ---------------- -------------- ---------------
Earnings from continuing operations 4,583 7,604 6,419 28,976
--------------- ---------------- -------------- ---------------
Discontinued operations
Earnings/(loss) from discontinued operations, net 1,045 (74 ) 3,737 (1,888 )
Gain on disposal of discontinued operations, net 7,420 3,713 21,501 5,629
--------------- ---------------- -------------- ---------------
8,465 3,639 25,238 3,741
--------------- ---------------- -------------- ---------------
Net Income $ 13,048 $ 11,243 $ 31,657 $ 32,717
=============== ================ ============== ===============
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS- CONTINUED
(In thousands except for share data)
Quarter ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
--------------- ---------------- -------------- ---------------
Earnings per share of common stock (basic and diluted):
From continuing operations $ 0.10 $ 0.17 $ 0.14 $ 0.65
From discontinued operations 0.19 0.08 0.56 0.09
--------------- ---------------- -------------- ---------------
Net income $ 0.29 $ 0.25 $ 0.70 $ 0.74
=============== ================ ============== ===============
Weighted average number of shares of common stock
outstanding 45,248,670 44,969,003 45,248,670 44,408,454
=============== ================ ============== ===============
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE
INCOME/(LOSS)
Nine Months Ended September 30, 2003 and Year Ended
December 31, 2002
(In thousands except for share data and per share data)
Accumulated
distributions Accumulated
Common stock Capital in in excess other
Number Par excess of of net comprehensive Comprehensive
of shares value par value earnings Income/(loss) Total Income/(loss)
------------ --------- ------------- -------------- -------------- ---------- --------------
Balance at December 31, 2001 44,075,641 $ 441 $ 798,154 $ (273,783 ) $ 1,370 $ 526,182
Shares issued 1,173,354 11 20,088 -- -- 20,099
Retirement of common stock (325 ) -- (4 ) -- -- (4 )
Stock issuance costs -- -- (1,493 ) -- -- (1,493 )
Net income -- -- -- 35,590 -- 35,590 $ 35,590
Other comprehensive loss,
market revaluation on
available for sale -- -- -- -- (775 ) (775 ) (775 )
securities
Current period adjustment to
recognize change in fair
value of cash flow hedges,
net of tax -- -- -- -- (17,457 ) (17,457 ) (17,457 )
----------
Total comprehensive income -- -- -- -- -- -- $ 17,358
==========
Distributions declared and
paid ($1.52 per share) -- -- -- (67,991 ) -- (67,991 )
------------ --------- ------------- -------------- ------------- ------------
Balance at December 31, 2002 45,248,670 $ 452 $ 816,745 $ (306,184 ) $ (16,862 ) $ 494,151
Acquisition of minority
interest -- -- 11,375 -- -- 11,375
Net income -- -- -- 31,657 -- 31,657 $ 31,657
Current period adjustment to
recognize change in fair
value of cash flow hedges,
net of tax -- -- -- -- 190 190 190
----------
Total comprehensive income -- -- -- -- -- -- $ 31,847
==========
Distributions declared and
paid ($1.14 per share) -- -- -- (51,752 ) -- (51,752 )
------------ --------- ------------- -------------- ------------- ------------
Balance at September 30, 2003 45,248,670 $ 452 $ 828,120 $ (326,279 ) $ (16,672 ) $ 485,621
============ ========= ============= ============== ============= ============
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine months ended
September 30,
2003 2002
------------------ -----------------
Cash flow from operating activities:
Net income $ 31,657 $ 32,717
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 9,995 11,181
Impairment provisions 7,933 4,823
Provision for loss on loans 3,352 399
Gain on sale of assets (1,282 ) (2,962 )
Investments in mortgage loans held for sale (112 ) (215 )
Collection on mortgage loans held for sale 6,166 14,805
Change in inventories of real estate held for sale 82,053 30,975
Changes in other operating assets and liabilities (553 ) (14,552 )
------------------ -----------------
Net cash provided by operating activities 139,209 77,171
------------------ -----------------
Cash flows from investing activities:
Additions to real estate investment properties -- (6,232 )
Proceeds from sale of assets 15,445 46,686
Decrease (increase) in restricted cash (1,518 ) 8,528
Investment in joint ventures -- (150 )
Investment in mortgage, equipment and other notes
receivable -- (6,607 )
Collections on mortgage, equipment and other notes
receivable 14,484 11,994
------------------ -----------------
Net cash provided by investing activities 28,411 54,219
------------------ -----------------
Cash flows from financing activities:
Payment of stock issuance costs (1,493 ) (1,493 )
Proceeds from borrowing on revolver and note payable 29,892 235,333
Payment on revolver and note payable (47,686 ) (60,833 )
Proceeds from borrowing on mortgage warehouse facilities 56,040 154,235
Payments on mortgage warehouse facilities (138,639 ) (412,992 )
Retirement of bonds payable (14,571 ) (11,896 )
Payment of loan costs (150 ) --
Proceeds from sale of shares -- 9,750
Loan from stockholder 14,960 7,500
Distributions to minority interests (1,865 ) (1,075 )
Distributions to stockholders (51,752 ) (50,741 )
------------------ -----------------
Net cash used in financing activities $ (155,264 ) $ (132,212 )
-------------------- -----------------
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(In thousands)
Nine months ended
September 30,
2003 2002
------------------ ------------------
Net increase (decrease) in cash and cash equivalents $ 12,356 $ (822 )
Cash and cash equivalents at beginning of period, as restated 16,584 20,399
------------------ ------------------
Cash and cash equivalents at end of period $ 28,940 $ 19,577
================== ==================
Supplemental disclosures of cash flow information:
Interest paid $ 36,926 $ 44,131
================== ===================
Supplemental disclosures of non-cash investing and financing activities:
Mortgage notes accepted in exchange for sale of properties $ 400,000 $ --
================== ===================
Conversion of related party advances into shares of common
stock $ -- $ 10,350
================== ===================
Redemption of minority interest in lieu of payment on accounts
receivable $ 317 $ --
================== ===================
Acquisition of minority interest $ 11,375 $ --
================== ===================
Non-Cash Transaction:
During the nine months ended September 30, 2003, the Company foreclosed on seven
loans held for sale from three borrowers and accepted the underlying collateral
as settlement for the mortgage loans. The collateral received had a net
realizable value of $6.4 million and consisted of real estate.
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2003 and 2002
1. Organization and Nature of Business:
CNL Restaurant Properties, Inc. ("CNL Properties") formerly CNL American
Properties Fund, Inc. was organized in Maryland in May of 1994, and is a
self-administered real estate investment trust ("REIT"). The term "Company"
includes, unless the context otherwise requires, CNL Properties and its
majority owned and controlled subsidiaries. These subsidiaries include CNL
Restaurant Investments, Inc. ("CNL-Investments") formerly CNL Restaurant
Properties, Inc. and CNL Restaurant Capital Corp. ("CNL-Capital Corp.")
formerly CNL Franchise Network Corp. The Company's operations are divided
into two business segments, real estate and specialty finance. The real
estate segment, operated principally through the Company's wholly owned
subsidiary CNL-Investments and its subsidiaries, owns and manages a
portfolio of primarily long-term triple-net lease properties. Its
activities include portfolio management, property management and
dispositions. In addition, it services approximately $550 million in
affiliate portfolios and earns management fees related thereto. The
specialty finance segment, operated through the Company's wholly-owned
subsidiary CNL-Capital Corp. and a partnership with Bank of America, CNL
Restaurant Capital, LP ("CNL-Capital"), formerly known as CNL Franchise
Network, LP and its subsidiaries, delivers financial solutions in the form
of financing, servicing, development and advisory services to national and
regional restaurant operators.
Effective January 1, 2003, CNL-Capital modified certain terms relating to
the alliance with Bank of America allowing the bank to assume certain costs
of its portfolio operations, decreasing the referral fees paid by the bank
and decreasing the bank's ownership in the alliance accordingly. In
addition, CNL CAS/Corp. an affiliate of the Company's chairman, agreed to
reduce its interest in the alliance. As a result, the Company's effective
ownership interest in CNL-Capital increased from 84.39% to 96.26%. The
Company reduced the minority interest and increased stockholders' equity by
approximately $11.4 million to reflect this change in ownership.
2. Basis of Presentation:
The accompanying unaudited condensed financial statements have been
prepared in accordance with the instructions to Form 10-Q and do not
include all of the information and note disclosures required by generally
accepted accounting principles. The financial statements reflect all
adjustments consisting of normal recurring adjustments which, in the
opinion of management, are necessary to a fair statement of the results for
the interim periods presented. Operating results for the quarter and nine
months ended September 30, 2003 may not be indicative of the results that
may be expected for the year ending December 31, 2003. Amounts as of
December 31, 2002, included in the financial statements, have been derived
from audited financial statements as of that date. These unaudited
financial statements should be read in conjunction with the financial
statements and notes thereto included in the Company's Form 10-K for the
year ended December 31, 2002. Certain items in the prior year's financial
statements have been reclassified to conform with the 2003 presentation.
These reclassifications had no effect on stockholders' equity or net
income.
3. Adoption of New Accounting Standards:
In November 2002, the Financial Accounting Standards Board (the "FASB")
issued FASB Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others". FIN 45 clarifies the requirements relating to a
guarantor's accounting for, and disclosure of, the issuance of certain
types of guarantees. FIN 45 requires that upon issuance of a guarantee, the
guarantor must recognize a liability for the fair value of the obligation
it
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2003 and 2002
3. Adoption of New Accounting Standards - Continued:
assumes under that guarantee. FIN 45's provisions for initial recognition
and measurement are to be applied on a prospective basis to guarantees
issued or modified after December 31, 2002. The Company's previous
accounting for guarantees issued prior to January 1, 2003 is not required
to be revised or restated to reflect the effect of the recognition and
measurement provisions of FIN 45. The Company has not issued or modified
any guarantees since the adoption of FIN 45.
In January 2003, FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." FIN 46 requires that a
variable interest entity be consolidated by a company if that company is
subject to a majority risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual
returns or both. Prior to FIN 46, a company generally included another
entity in its consolidated financial statements only if it controlled the
entity through voting interests. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 31,
2003, and to older entities no later than the first fiscal year or interim
period ending after December 15, 2003. Management adopted this standard in
2003 which resulted in the consolidation of two of the Company's previously
unconsolidated subsidiaries. Adoption of this standard did not change the
Company's accounting for the Company's bankruptcy remote securitization
entities. The Company restated all prior periods presented to conform with
the 2003 presentation. The consolidation did not significantly impact the
Company's financial position or results of operations.
In May 2003, the FASB issued FASB Statement No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("FASB 150"). FASB 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics
of both liabilities and equity. FASB 150 will require issuers to classify
certain financial instruments as liabilities (or assets in some
circumstances) that previously were classified as equity. Some of the
examples of financial instruments covered by FASB 150 include shares that
are mandatorily redeemable, and other financial instruments that embody an
obligation to repurchase outstanding shares or a conditional obligation
that requires settlement by issuing a variable number of the entity's
shares. FASB 150 also requires that minority interests for majority owned
finite lived entities be classified as a liability and recorded at fair
market value. FASB 150 initially applied immediately to all financial
instruments entered into or modified after May 31, 2003, and otherwise was
effective at the beginning of the first interim period beginning after June
15, 2003. Effective October 29, 2003, the FASB deferred implementation of
FASB 150, as it applies to minority interests of finite lived Partnerships.
The deferral of these provisions is expected to remain in effect while
these interests are addressed in either Phase II of the FASB's Liabilities
and Equity project or Phase II of the FASB's Business Combinations Project;
therefore, no specific timing for the implementation of these provisions
has been stated. The implementation of the currently effective aspects of
FASB 150 did not have a material impact on the Company's results of
operations.
4. Real estate investment properties:
During the nine months ended September 30, 2003 and 2002, the Company
recorded provisions for impairment of $5.0 million and $154,000,
respectively. The tenants of these properties experienced financial
difficulties and/or ceased payments of rents under the terms of their lease
agreements. The provisions represent the amount necessary to reduce the
carrying value to net realizable value of the properties at September 30,
2003 and 2002.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2003 and 2002
5. Real estate held for sale:
Real estate held for sale consists of the following:
(In thousands)
September 30, December 31,
2003 2002
----------------- -------------------
Land and buildings $ 76,756 $ 169,679
================= ===================
The Company's specialty finance business segment actively acquires real
estate assets subject to leases with the intent to sell them. All assets
are subject to the provisions of Statement of Financial Accounting
Standards No. 144 ("FAS 144"), "Accounting for the Impairment or Disposal
of Long-Lived Assets" consequently, the operating results and gains or
losses on dispositions of the assets are recorded as discontinued
operations.
The Company's real estate investment subsidiary, CNL-Investments, will
divest properties from time to time when strategic to its longer-term
goals. When CNL-Investments establishes its intent to sell a property, all
operating results relating to the properties and the ultimate gain or loss
on disposition of the assets are treated as discontinued operations for all
periods presented. These financial statements reflect certain
reclassifications of rental related income, interest expense and other
categories so as to conform with the requirements of FAS 144.
The operating results of the discontinued operations are as follows:
Quarters ended Nine months ended
September 30, September 30,
(In thousands) 2003 2002 2003 2002
--------------
----------- ----------- ----------- ------------
Rental income $ 2,280 $ 1,862 $ 8,903 $ 6,322
Interest expense (502 ) (145 ) (1,721 ) (1,254 )
Depreciation expense (36 ) (306 ) (156 ) (1,169 )
Impairment provisions (1,022 ) (1,523 ) (2,879 ) (4,669 )
Other income (expenses) 325 38 (410 ) (1,118 )
----------- ----------- ----------- ------------
Earnings/(loss) from discontinued
operations, net 1,045 (74 ) 3,737 (1,888 )
----------- ----------- ----------- ------------
Sales of real estate 59,260 54,718 179,758 84,651
Cost of real estate sold (51,840 ) (51,005 ) (158,257 ) (79,022)
----------- ----------- ----------- ------------
Gain on disposal of discontinued
operations, net 7,420 3,713 21,501 5,629
----------- ----------- ----------- ------------
Earnings from discontinued
operations, net $ 8,465 $ 3,639 $ 25,238 $ 3,741
=========== =========== =========== ============
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2003 and 2002
6. Borrowing:
As of December 31, 2002, the Company, through CNL-Capital, maintained a
$125 million and a $260 million mortgage warehouse facility. In June 2003,
the $125 million facility was renewed until June 2004, and the amended
agreement reduced the advances available under the mortgage warehouse
facility to $100 million. Advances under the mortgage warehouse facility
bear interest at the rate of LIBOR plus a price differential (0.90 percent
and 0.70 percent as of September 30, 2003 and December 2002, respectively).
In October 2003, the Company's $260 million mortgage warehouse facility was
extended to December 15, 2003. Management expects to renew this facility to
December 2004 with generally similar terms.
CNL-Investment's $30 million revolving line of credit (the "Revolver")
matured in October 2003 and at that time the Company exercised its one-year
renewal option.
7. Related Party Transactions:
During the nine months ended September 30, 2003, CNL Financial Group, Inc.,
an affiliate, advanced approximately $15.0 million to the Company in the
form of a demand balloon promissory note. The note is uncollateralized,
bears interest at LIBOR plus 2.5 percent with interest payments and
outstanding principal due upon demand. At September 30, 2003, $19.5 million
in total demand loans, including accrued interest, were outstanding and are
included in the due to related parties caption on the balance sheet.
In February 2003, Maple & Main Orlando, LLC, a subsidiary of
CNL-Investments, entered into a note payable with CNL Bank, an affiliate,
with an original maturity date of September 2003. The note is
collateralized by a mortgage on certain real property. In August 2003,
Maple & Main Orlando, LLC modified the note and extended the maturity date
to August 2005. The note bears interest at the rate of LIBOR plus 325 basis
points per annum and requires monthly interest only payments. The balance
at September 30, 2003 of $392,000 is included in notes payable.
8. Segment Information:
The Company has established CNL-Investments and CNL-Capital Corp. as
separate legal entities to operate and measure the real estate and
specialty finance segments, respectively.
CNL-Investments is the parent company of CNL APF Partners LP, a real estate
company that acquires and holds real estate, mortgage and equipment loans
generally until maturity. CNL-Capital Corp. is the parent of CNL-Capital, a
specialty finance company that offers financing, servicing, advisory and
other services to restaurant operators. CNL-Capital acquires restaurant
real estate properties subject to triple-net leases, utilizing short-term
debt, and then sells them generally within one year.
The following table summarizes the operating results for the quarters and
nine months ended September 30, 2003 and 2002 with segment information for
the two lines of business. Consolidating eliminations and other results of
the parent of CNL-Investments and CNL-Capital Corp. are reflected in the
"other" column.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2003 and 2002
8. Segment Information - Continued:
Quarter ended September 30, 2003
(In thousands)
CNL-Investments CNL-Capital Consolidated
Corp. Other Totals
------------- --------------- ------------- --------------
Revenues $ 25,466 $ 8,935 $ (888 ) $ 33,513
------------- --------------- ------------- --------------
General operating and administrative 1,455 5,374 (693 ) 6,136
Interest expense 6,857 5,932 (127 ) 12,662
Food and other restaurant costs 3,440 -- -- 3,440
Property expenses, state and other taxes 612 12 -- 624
Depreciation and amortization 2,987 303 -- 3,290
Provision for loss on loans -- 750 -- 750
Impairment provisions 1,978 -- -- 1,978
Minority interest net of equity in earnings 20 28 -- 48
(Gain)/loss on sale of assets (2 ) 4 -- 2
------------- --------------- ------------- --------------
17,347 12,403 (820 ) 28,930
------------- --------------- ------------- --------------
Discontinued operations:
Earnings/(loss) from discontinued
operations, net (900 ) 1,945 -- 1,045
Gain on disposal of discontinued
operations, net 825 6,595 -- 7,420
------------- --------------- ------------- --------------
(75 ) 8,540 -- 8,465
------------- --------------- ------------- --------------
Net income $ 8,044 $ 5,072 $ (68 ) $ 13,048
============= =============== ============= ==============
Assets at September 30, 2003 $ 803,018 $ 468,060 $ (4,759 ) $ 1,266,319
============= =============== ============= ==============
Investments accounted for under the
equity method at September 30, 2003 $ 1,079 $ -- $ -- $ 1,079
============= =============== ============= ==============
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2003 and 2002
8. Segment Information - Continued:
Quarter ended September 30, 2002
(In thousands)
CNL-Investments CNL-Capital Consolidated
Corp. Other Totals
------------- --------------- ------------ ----------------
Revenues $ 22,932 $ 47,625 $ (891 ) $ 69,666
------------- --------------- ------------ ----------------
Cost of real estate sold -- 36,029 -- 36,029
General operating and administrative 3,009 4,808 (684 ) 7,133
Interest expense 7,733 6,463 (207 ) 13,989
Property expenses, state and other taxes 672 48 -- 720
Depreciation and amortization 3,020 309 -- 3,329
Provision for loss on loans -- 339 -- 339
Impairment provisions 127 (23 ) -- 104
Minority interest net of equity in earnings (18 ) 459 -- 441
Gain on sale of assets (22 ) -- -- (22 )
------------- --------------- ------------ ----------------
14,521 48,432 (891 ) 62,062
------------- --------------- ------------ ----------------
Discontinued operations:
Earnings/(loss) from discontinued
operations, net (701 ) 627 -- (74 )
Gain on disposal of discontinued
operations, net 1,837 1,876 -- 3,713
------------- --------------- ------------ ----------------
1,136 2,503 -- 3,639
------------- --------------- ------------ ----------------
Net income $ 9,547 $ 1,696 $ -- $ 11,243
============= =============== ============ ================
Assets at September 30, 2002 $ 866,838 $ 583,639 $ (4,168 ) $ 1,446,309
============= =============== ============ ================
Investments accounted for under the
equity method at September 30, 2002 $ 1,181 $ -- $ -- $ 1,181
============= =============== ============ ================
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2003 and 2002
8. Segment Information - Continued:
Nine months ended September 30, 2003
(In thousands)
CNL-Investments CNL-Capital Consolidated
Corp. Other Totals
--------------- -------------- ---------- --------------
Revenues $ 75,780 $ 23,361 $(2,398 ) $ 96,743
--------------- -------------- ---------- --------------
General operating and administrative 7,368 15,591 (1,814 ) 21,145
Interest expense 20,712 18,018 (497 ) 38,233
Food and other restaurant costs 10,077 -- -- 10,077
Property expenses, state and other taxes 1,214 -- -- 1,214
Depreciation and amortization 9,051 788 -- 9,839
Provision for loss on loans -- 3,352 -- 3,352
Impairment provisions 5,054 -- -- 5,054
Minority interest net of equity in earnings 74 1,328 -- 1,402
Loss on sale of assets -- 8 -- 8
--------------- -------------- ---------- --------------
53,550 39,085 (2,311 ) 90,324
--------------- -------------- ---------- --------------
Discontinued operations:
Earnings/(loss) from discontinued
operations, net (1,419 ) 5,156 -- 3,737
Gain on disposal of discontinued
operations, net 1,738 19,763 -- 21,501
--------------- -------------- ---------- --------------
319 24,919 -- 25,238
--------------- -------------- ---------- --------------
Net income $ 22,549 $ 9,195 $ (87 ) $ 31,657
=============== ============== ========== ==============
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2003 and 2002
8. Segment Information - Continued:
Nine months ended September 30, 2002
(In thousands)
CNL-Investments CNL-Capital Consolidated
Corp. Other Totals
---------------- -------------- ----------- --------------
Revenues $ 66,722 $ 224,363 $ (2,373 ) $ 288,712
---------------- -------------- ----------- --------------
Cost of real estate sold -- 177,483 -- 177,483
General operating and administrative 8,589 15,684 (1,753 ) 22,520
Interest expense 23,425 21,783 (478 ) 44,730
Property expenses, state and other taxes 2,355 243 -- 2,598
Depreciation and amortization 9,086 926 -- 10,012
Provision for loss on loans -- 399 -- 399
Impairment provisions 154 -- -- 154
Minority interest net of equity in earnings (38 ) 1,526 -- 1,488
Loss on sale of assets 335 17 -- 352
---------------- -------------- ----------- --------------
43,906 218,061 (2,231 ) 259,736
---------------- -------------- ----------- --------------
Discontinued operations:
Earnings/(loss) from discontinued
operations, net (2,541 ) 653 -- (1,888 )
Gain on disposal of discontinued
operations, net 3,314 2,315 -- 5,629
---------------- -------------- ----------- --------------
773 2,968 -- 3,741
---------------- -------------- ----------- --------------
Net income $ 23,589 $ 9,270 $ (142 ) $ 32,717
================ ============== =========== ==============
9. Income Tax:
The Company elected to be taxed as a REIT under the Internal Revenue Code.
To qualify as a REIT, the Company must meet a number of organizational and
operational requirements, including a current requirement that it
distribute at least 90 percent of its taxable income to its stockholders.
As a REIT the Company generally will not be subject to corporate level
federal income tax on net income it distributes to its stockholders, except
taxes applicable to its taxable REIT subsidiaries ("TRSs") as described
below. This benefit allows earnings from a REIT to be subject to federal
taxation at the stockholder level, and avoids the typical double taxation
applicable to most corporations. If the Company fails to qualify as a REIT
in any taxable year, it will be subject to federal income taxes at regular
corporate rates (including any alternative minimum tax) and may not be able
to qualify as a REIT for four subsequent tax years. Even if the Company
qualifies for taxation as a REIT, the Company may be subject to state and
local taxes on its income and property, and to federal income and excise
taxes on its undistributed taxable income.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2003 and 2002
9. Income Tax - Continued:
Stockholder distributions that are characterized as return of capital are
generally non-taxable to the stockholder and the amount reduces the
stockholder's basis in Company stock. Through December 31, 2002 the Company
has distributed approximately $4.17 per share of an investor's original
purchase price since December 31, 1995 as a non-taxable return of capital
for tax purposes. The taxability of the distribution made in 2003 will not
be determined until January 2004, but is likely that a portion will be
considered a return of capital for income tax purposes. Each stockholder
must maintain records of the purchase price, distributions received, and
the applicable tax treatment of such distributions in order to determine
the gain or loss upon sale of Company stock.
The Company has two TRSs in which activities of the specialty finance
segment and select activities of the real estate segment are conducted.
Prior to January 1, 2001, Company subsidiaries were not subject to federal
income tax.
Loan valuation adjustments, loss reserves, loan fees, and depreciation,
among other items, are treated differently for tax than for financial
reporting purposes. In the aggregate, the Company's TRSs have an excess of
available future deductible items over future taxable items and as such may
more fully benefit from these items when the related subsidiaries produce a
greater level of taxable income. The subsidiaries involved do not have
sufficient historical earnings on which to expect a full potential future
benefit of these future deductions. Therefore the Company has recorded an
allowance against a portion of the deferred tax asset associated with the
future deductible items.
The consolidated provision for federal income taxes differs from the amount
computed by applying the statutory federal income tax rate to the earnings
of the CNL-Capital Corp segment and the earnings of the real estate segment
TRS as follows:
Nine months ended September 30:
----------------------------------------------------------------
2003 2002
---------------------------- ----------------------------
Amount Amount
(In thousands) Rate (In thousands) Rate
----------------- ------ ---------------- ------
Expected tax at US statutory rate $ 2,911 34% $ 3,152 34%
Adjustments:
Other (314) (4) 195 2
Change in valuation allowances (2,597 ) (30) (3,347 ) (36 )
----------------- ------- ---------------- ------
Provision for income taxes $ -- --% $ -- --%
================= ======= ================ ======
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2003 and 2002
9. Income Tax - Continued:
Components of the net deferred tax asset are as follows:
(In thousands)
September 30, December 31,
2003 2002
----------------- ----------------
Deferred tax asset:
Cash flow hedge related difference $ 5,477 $ 5,789
Loan valuation and related hedge differences 241 1,899
Loan origination fees 559 619
Real estate loss reserves 1,175 300
Reserve for investment losses 839 736
Unconsolidated affiliates difference (665) --
Net operating losses 292 250
Book vs Tax Allocation of Earnings 239 --
Other 548 (19 )
----------------- ----------------
Total 8,705 9,574
Valuation allowance (5,447 ) (7,846)
----------------- ----------------
Net recorded deferred tax asset $ 3,258 $ 1,728
================= ================
The income tax provision consists of the following:
Nine months ending
September 30
(In thousands)
2003 2002*
------------ ------------
Current:
Federal $ 2,804 $ --
State 454 --
------------ ------------
3,258 --
------------ ------------
Deferred:
Federal (2,804 ) --
State (454 ) --
------------ ------------
(3,258 ) --
------------ ------------
Total Provision $ -- ) $ --
============ ============
* The TRS returns filed for the year ended December 31, 2001 reflected
a net operating loss and through September 30, 2002 no current taxes
were payable. For reasons stated above, there was no tax benefit
recorded for the loss or other future deductible items.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following information, including, without limitation, the Quantitative and
Qualitative Disclosures About Market Risk that are not historical facts, may be
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These
statements generally are characterized by the use of terms such as "believe,"
"expect" and "may." Although the Company believes that the expectations
reflected in such forward-looking statements are based upon reasonable
assumptions, the Company's actual results could differ materially from those set
forth in the forward-looking statements. Factors that might cause such a
difference include: changes in general economic conditions, changes in real
estate conditions, availability of capital from borrowings under the Company's
credit facilities, the availability of other debt and equity financing
alternatives, changes in interest rates under the Company's current credit
facilities and under any additional variable rate debt arrangements that the
Company may enter into in the future, the ability of the Company to refinance
amounts outstanding under its credit facilities at maturity on terms favorable
to the Company, the ability of the Company to locate suitable tenants for its
restaurant properties and borrowers for its mortgage loans, the ability of
tenants and borrowers to make payments under their respective leases, secured
equipment leases or mortgage loans, the ability of the Company to re-lease
properties that are currently vacant or that may become vacant and the ability
of the Company to securitize or sell mortgage loans or net lease properties on a
favorable and timely basis. Given these uncertainties, readers are cautioned not
to place undue reliance on such statements.
Organization and Business
CNL Restaurant Properties, Inc. ("CNL-Properties" or the "Company"), formerly
CNL American Properties Fund, Inc., is the nation's largest self-advised real
estate investment trust ("REIT") focused on the restaurant industry. The Company
has two primary subsidiary operating companies, CNL Restaurant Investments, Inc.
and CNL Restaurant Capital Corp. The Company was founded in 1994 and at
September 30, 2003, has financial interests in approximately 1,000 properties
diversified among more than 127 restaurant concepts in 47 states. The Company's
total real estate holdings subject to lease include over 600 properties, of
which approximately 60 properties are classified as held for sale. At September
30, 2003, the servicing portfolio of net lease properties and mortgages consists
of approximately 2,200 units, of which approximately 1,200 are serviced on
behalf of third parties.
The Company operates two business segments - real estate and specialty finance.
o The real estate segment, operated principally through the Company's
wholly owned subsidiary CNL Restaurant Investments, Inc.
("CNL-Investments"), formerly known as CNL Restaurant Properties,
Inc. (a name used by the Company effective June 27, 2003), and its
subsidiaries, manage a portfolio of primarily long-term triple-net
lease properties. Those responsibilities include portfolio
management, property management and dispositions. In addition,
CNL-Investments services approximately $550 million in affiliate
real estate portfolios and earns management fees related thereto.
o The specialty finance segment, operated through the Company's
wholly-owned subsidiary CNL Restaurant Capital Corp. ("CNL-Capital
Corp"), formerly known as CNL Franchise Network Corp., is partnered
with a financial institution, Bank of America, in owning CNL
Restaurant Capital, LP ("CNL-Capital"). With its subsidiaries,
CNL-Capital delivers financial solutions principally in the forms of
financing, advisory and other services to national and larger
regional restaurant operators primarily by acquiring restaurant real
estate properties, which are subject to a triple-net lease,
utilizing short-term debt and selling such properties at a profit.
Effective January 1, 2003 CNL-Capital modified certain terms
relating to the alliance with the financial institution allowing the
bank to assume certain costs of its portfolio operations and
decreasing the referral fees paid by the bank, and decreasing the
bank's ownership interest in CNL-Capital. In addition, an affiliate
of the Company's chairman agreed to reduce its interest in
CNL-Capital. As a result, the Company's effective interest in the
specialty finance operations increased from 84.39 percent to 96.26
percent.
CNL-Capital Corp is treated as a taxable REIT subsidiary ("TRS"). As a TRS,
CNL-Capital Corp engages in activities that would previously have caused income
to the Company from CNL-Capital to be disqualified from being eligible REIT
income under the federal income tax rules. Now CNL-Capital earnings are subject
to tax, but management can control the timing of distributions to the Company.
CNL-Capital Corp originates triple-net lease properties for sale to third
parties and, when market conditions may allow, securitization. CNL-Capital Corp
also performs net lease and loan servicing on behalf of non-Company owners.
Also, certain activities of CNL-Investments are conducted in a subsidiary that
has made a similar TRS election.
When the Company was created in 1994, the intent was to provide stockholders
liquidity by December 31, 2005 through either listing on a national exchange,
merging with another public company or liquidating its assets. The Company's
officers and directors continue to monitor the public markets for opportunities.
The Company's board presently has no intention to liquidate the Company. To
comply with certain tax guidelines governing the significance of taxable REIT
subsidiaries, the Company may pursue other alternatives relative to CNL-Capital
Corp that would provide stockholder liquidity for all or a portion of the
Company's investment.
Liquidity and Capital Resources
The Company is a self-advised real estate investment trust that reflects the
earnings of its two primary segment subsidiaries, CNL-Investments and
CNL-Capital Corp. The Company elected to reinvest the earnings of the specialty
finance business to date, as contemplated by the agreement with its financial
institution partner. The Company will continue to reinvest earnings into this
subsidiary if the subsidiary is able to generate acceptable returns.
CNL-Properties has continued to declare and pay distributions to its
stockholders that are primarily funded by CNL-Investments activities. The
remainder of the distributions to date have been funded by sales of its common
stock to the Company's Chairman through a private company affiliate, CNL
Financial Group, Inc. ("CNL Financial Group"), and loans from CNL Financial
Group.
The Company's ability to internally fund capital needs is limited since it must
distribute at least 90 percent of its net taxable income (excluding net capital
gains) to stockholders to qualify as a REIT. The Company has elected to
distribute amounts in excess of that required. In the nine months ended
September 30, 2003 and 2002 the Company distributed $51.8 million and $50.7
million, respectively, or $0.38125 per share each quarter, to its stockholders.
For 2002, these distributions constituted a return of capital for tax purposes
and were generally not taxable to the shareholders, but did reflect tax
deductions associated with impairments and loan loss reserves recorded in 2001
and differences in non-cash charges including depreciation and amortization. The
REIT's taxable income in 2002 did not include any of CNL-Capital Corp's $12.6
million in earnings. Through December 31, 2002 the Company has distributed
approximately $4.17 per share of an investor's original purchase price since
December 31, 1995 as a non-taxable return of capital for tax purposes. The
characterization for income tax purposes of the distribution made in 2003 will
not be determined until January 2004, but is likely that a portion will be
considered a return of capital.
In order to ensure that the Company maintained its historical level of
distributions to its stockholders, the Company's Chairman, through CNL Financial
Group, advanced to the Company $15.0 million during the nine months ended
September 30, 2003. Throughout 2002, the Chairman received 1,173,354 shares of
the Company's stock in exchange for $20.1 million in cash, including the
conversion of amounts previously treated as advances. Similar stock purchases
occurred in 2001. This provided capital that allowed the Company to reinvest the
earnings generated by the specialty finance business. The number of shares were
determined using an estimated fair value per share of $17.13 as concluded in an
early 2002 valuation from a third party firm, which based its valuation on an
analysis of comparable publicly traded real estate investment trusts and a
discounted cash flow analysis. Also, the Chairman advanced $4.2 million to the
Company in December 2002. The Company's Chairman was under no obligation to do
so. Should the Company's Chairman determine not to purchase additional shares or
loan additional funds to the Company, and the Company does not generate adequate
cash flow from other sources, the Company may have to reduce its distribution
rate.
As described above, during the nine months ended September 30, 2003, CNL
Financial Group, an affiliate, advanced approximately $15.0 million to the
Company in the form of a demand balloon promissory note. The note is
non-collateralized, bears interest at LIBOR plus 2.5 percent with interest
payments and outstanding principal due upon demand. At September 30, 2003, the
principal amount of such loans outstanding was $19.2 million.
The Company's management expects to continue meeting short-term and long-term
liquidity requirements through distributions from CNL-Investments, issuance of
debt and sales of common or preferred stock. To date CNL-Capital Corp has
reinvested its earnings in ongoing operations. Management expects distributions
from CNL-Capital Corp to begin within the next two years.
The Company is currently exploring interest in an offering of the Company's
preferred stock. The proceeds of any sale of preferred stock would be used for
general corporate purposes and potentially to retire existing debt.
The Company may continue selling additional shares of its common stock and
borrowing additional funds in order to satisfy future distribution requirements.
The Company's Chairman is under no obligation to purchase additional shares of
the Company's common stock or loan additional funds to the Company in order to
guarantee that the Company maintains its historical distribution level to
stockholders.
Selling additional shares of the Company's stock may dilute a shareholder's
investment, affecting its future value. However, selling stock to enable
CNL-Capital to reinvest earnings may be accretive to the extent that the value
of the specialty finance segment increases. In connection with maintaining its
historical distribution level, the Company may sell additional shares of its
common stock to CNL Financial Group or to third party purchasers. Such sales may
reduce the value a shareholder receives for his or her investment upon a future
liquidity event.
o Specialty Finance Segment (CNL Restaurant Capital Corp)
CNL-Capital originates triple-net leases, temporarily financing those assets
with warehouse credit facilities and periodically selling or refinancing those
assets. CNL-Capital generates income by earning a spread on assets with a return
greater than its cost of borrowings, and by selling assets at gains. A
triple-net lease is a long-term lease with periodic rents that require the
lessee to pay expenses on the property including maintenance, repair, real
estate taxes or insurance. In a securitization refinancing, the Company sells or
transfers a pool of loans or properties with triple-net leases to a special
purpose entity which, in turn, issues to investors securities backed by an
interest in the revenue originating from the loans or triple-net leases. These
transactions generate cash that is used for additional acquisitions.
CNL-Capital has the following borrowing sources as of September 30, 2003, with
the stated total capacity and interest rate:
In thousands
Amount used Capacity Maturity Interest rate (4)
---------------- ------------- --------------- -------------------
Note payable (medium term financing) (1) $ 192,020 $ 192,020 Jun 2007 2.36%
Mortgage warehouse facilities (1)(2) 63,159 360,000 Annual 2.57%
Subordinated note payable 43,750 43,750 Jun 2007 8.50%
Series 2001-4 bonds payable (3) 39,294 39,294 2009 - 2013 8.90%
---------------- -------------
$ 338,223 $ 635,064
================ =============
(1) Average rate excludes the impact of hedge transactions that bring
the total average rate to 5.76 percent on the medium term financing
and 4.11 percent on financing the warehouse facilities.
(2) The $260 million mortgage warehouse facility was recently extended
to December 15, 2003. Management does not anticipate CNL-Capital
will require the full current capacity, and will likely decrease its
capacity. Management expects renewal of this facility to December
2004 with generally similar terms. The second mortgage warehouse
facility of $100 million matures in June 2004.
(3) Includes $4,892 in bonds held by CNL-Investments eliminated upon
consolidation in Company financial statements.
(4) Excludes debt issuance and other related costs.
In forming the alliance with Bank of America, the Company invested certain
assets and operations into CNL-Capital and Bank of America provided CNL-Capital
with a $43.75 million subordinated debt facility (the "Subordinated Debt
Facility") and a warehouse credit facility (the "Warehouse Credit Facility")
with an initial capacity of $500 million.
The securitization market experienced considerable volatility in late 2000 as a
result of rising delinquencies in securitized loan pools, falling treasury
rates, macroeconomic uncertainties and sluggish restaurant sales. Investors
demanded higher interest rates on the securities backed by the underlying loans
issued in securitizations while ratings agencies downgraded many of the
securities. In response to the market conditions, management used private market
sales channels to either refinance or sell existing mortgage loans and halted
the origination of new loans.
Company warehouse borrowings were initially designed to provide interim
financing until periodic securitizations could occur. The instability of this
market led to renegotiated terms of the relationship with Bank of America by
October 2001, including the need to remove certain loans held as collateral on
the Warehouse Credit Facility and the requirement that CNL-Investments guarantee
the repayments. The guaranty has since been reduced from $15 million to $2
million. Management is seeking resolution to the last remaining $2 million in
loans and may bundle them with other mortgage loans in a medium-term financing
in the fourth quarter of 2003. Bank of America agreed to finance the remaining
loans held as collateral on the Warehouse Credit Facility until December 2003.
The mirror credit facility expired in October 2003.
In June 2002, in order to repay warehouse financing, the Company entered into a
five-year term $207 million financing collateralized with $225 million in
mortgage loans re-designated to reflect the Company's intention to hold them to
maturity. This five-year term financing carries a variable interest rate tied to
the weighted average rate of commercial paper plus 1.25 percent with a portion
of such interest fixed through the initiation of a hedge transaction. The
transaction provides CNL-Capital ongoing earnings on the excess of interest
income over interest expense.
Most sources of debt financing require that CNL-Capital maintain certain
standards of financial performance such as a fixed-charge coverage ratio, a
tangible net worth requirement and certain levels of available cash. Any failure
to comply with the terms of these covenants would constitute a default and may
create an immediate need to find alternate borrowing sources.
In 2001, CNL-Capital commenced selling investment properties to third parties
(the "Investment Property Sales" program) adding diversity to its original
securitization model. These leased properties can be sold and may qualify the
buyer for special tax treatment under Section 1031 of the Internal Revenue Code
(a "Section 1031 Exchange"). Generally, Section 1031 Exchanges allow an investor
who realizes a gain from selling appreciated real estate to defer paying taxes
on such gain by reinvesting the sales proceeds in like-kind real estate. During
the nine months ended September 30, 2003 and 2002, CNL-Capital has generated
gains of $19.8 million and $17.2 million respectively. The success of this
program is dependent upon achieving an optimal balance of cash flows from lease
income earned in excess of holding costs versus a maximum gain on the sale. The
chart below illustrates cash flows from Investment Property Sales proceeds and
purchases of properties in the comparative nine-month periods:
(In thousands)
Nine months ended Nine months ended
September 30, 2003 September 30, 2002
--------------------- -----------------------
Proceeds from Investment Property Sales program sales $ 161,469 $ 211,527
===================== =======================
Purchases of properties to be sold under the Investment $ 56,603 $ 158,729
Property Sales program
===================== =======================
CNL-Capital's earnings depend on its continued origination and holding of new
real estate inventory in order to sustain the level of earnings and sales
achieved in the initial nine months of 2003. By selling more properties than are
originated during a period, CNL-Capital will have fewer properties on which to
earn income in a future period. At September 30, 2003, CNL-Capital had $65.5
million in properties held for sale, an amount that management believes is
significantly below the desirable level of inventory to sustain continued
earnings. Purchases of new properties have been challenging. Management expects
continued strong demand for Investment Property Sales assets but demand could
diminish if interest rates increase. Management continues to investigate other
sales channels in which to market net lease assets and to monitor the
securitization market for potential re-entry in the future.
During the nine months ended September 30, 2003, CNL-Capital Corp derived its
primary cash flows from lease and interest income earned in excess of interest
expense paid ("net spread"), net gains from the Investment Property Sales
program and servicing revenues. Significant cash outflows consist of operating
expenses, real property purchases and capital enhancements in the loan portfolio
(excess of investment over related borrowings). CNL-Capital has taken steps to
reduce its credit capacity in its warehouse credit facilities of $360 million at
September 30, 2003. Management has and may continue to decrease the mortgage
warehouse facility capacity from its present level in order to economize on its
cost, provided that there continue to be costs associated with excess capacity.
CNL-Capital may also be subject to margin calls on its warehouse credit
facilities. The lenders monitor asset securitization market conditions,
performance of the Company's derivatives and delinquencies and based on changes
in market conditions, may require a margin call to reduce the level of warehouse
financing. During the nine months ended September 30, 2003 CNL-Capital made $1.4
million in margin calls, with another $2.2 million made in October 2003. During
the nine-month period in 2002, CNL-Capital funded approximately $16 million in
net margin calls on its warehouse credit facilities. CNL-Capital's medium term
financing that provides $192 million in financing secured by Company mortgage
notes receivables also contains provisions that obligate the Company to make
margin calls in the event of certain borrower non-payments. Significant cash
outflows could result from all such margin call provisions.
Management originally contemplated stronger demand for its core triple-net lease
financing in 2003. The slight rise in interest rates has spurred recent demand
for the net lease financing product, but originations year to date have trailed
expectations. Management attributes the slow-down to two competitive factors:
o A large number of identified leases have been lost to competitors
offering mortgage debt financing. With the low prevailing interest
rates, large national and regional banks have offered inexpensive
mortgage financing that many premier restaurant operators find more
attractive than leases. CNL-Capital does not currently offer debt
financing to its clients due to the volatility and high cost of
capital currently associated with the securitization market.
CNL-Capital instead earns a fee for the referral of such
opportunities to its financial institution partner pursuant to the
terms of that alliance. While debt financing represents a threat to
the net lease finance product and, as a result, the success of the
Investment Property Sales program, management of CNL-Capital is
convinced that a debt product is not currently in the best interest
of CNL-Capital. Management continues to monitor the potential
reemergence of a mortgage loan product, but does not expect this
market to be viable in the foreseeable future.
o CNL-Capital has also lost a few transactions as new competitors have
emerged with a net lease program styled after CNL-Capital's
Investment Property Sales program. Competitors have met mixed
success at offering this product, and management believes it can
recapture this piece of the market through differentiating its
Investment Property Sales program as a highly efficient, turnkey
program that brings value to our restaurant clients.
For the nine months ended September 30, 2003, CNL-Capital purchased $56.6
million in net lease properties as compared with $53.1 million in the nine-month
period last year. In both years these originations were low compared with the
$119.9 million closed in the nine-month period in 2001. These originations
provide inventory necessary to execute the Investment Property Sales program and
CNL-Capital typically profits from the leases while holding them. At September
30, 2003, CNL-Capital is involved in several large opportunities for net lease
originations with $108.4 million approved for funding and accepted by the
client, and an additional $90.2 million approved with client acceptance pending.
CNL-Capital's warehouse facilities provide advances for up to 97 percent of the
real estate purchase value. The Company is reinvesting its operating profits to
fund the amounts not advanced by the mortgage warehouse facilities.
At September 30, 2003, CNL-Capital had approximately $73 million in capital
supporting its loan and lease portfolio. CNL-Capital management maintains
regular contact with its mortgage warehouse facility lenders and believes that
the relatively low-cost, high-advance rate financing they provide has been
integral to CNL-Capital's success. As is typical of revolving debt facilities,
these facilities carry a 364-day maturity and accordingly CNL-Capital is
vulnerable to any changes in the terms of these facilities. The warehouse
facilities currently advance an average of 89.0 percent of the original real
estate value, a decline in the current quarter from 95.1 percent at June 30,
2003. This decline resulted from special terms relating to the disposition of
the remaining amounts of the $117 million portfolio of properties acquired in
September 2002 and from the renewed terms of one mortgage warehouse facility
lender. Management believes that the average advance rates offered by lenders
could decline further as warehouse lenders continue to manage their respective
risk. A five percent decrease in advance rates, for example, would create a $2.7
million cash requirement for CNL-Capital, based on the outstanding net lease
properties in the warehouse credit facilities at September 30, 2003. With the
expected increase in the level of net lease properties on the warehouse, that
cash requirement would similarly increase. While management expects its mortgage
warehouse facilities to renew, any non-renewal would create an immediate need to
find alternate borrowing sources.
Additional liquidity risks include the possible occurrence of economic events
that could have a negative impact on the franchise asset-backed securitization
market and affect the quality or perception of the loans or leases underlying
CNL-Capital's securitization transactions. The Company conducted its previous
securitizations using bankruptcy remote entities. These entities exist
independent from the Company and their assets are not available to satisfy the
claims of creditors of the Company, any subsidiary or its affiliates. To date,
the ratings on the loans underlying the securities issued in these transactions
have been affirmed unlike the ratings of many competitors' loan pools that have
been downgraded. Upon the occurrence of a significant amount of delinquencies
and/or defaults, one or more of the three rating agencies may choose to place a
specific transaction on ratings watch or even downgrade one or more classes of
securities to a lower rating. Should the loans underlying the securities
default, and the securities undergo a negative ratings action, CNL-Capital could
experience material adverse consequences impacting its ability to continue
earning income as servicer, and its ability to engage in future profitable
securitization transactions. To potentially avoid those consequences,
CNL-Capital could choose to contribute capital to serve as additional collateral
supporting one or more of the bankruptcy remote entities used to facilitate a
securitization. CNL-Capital holds an interest in the following securitizations,
the assets and liabilities of which are not consolidated in the Company
financial statements:
September 30, 2003
------------------------------------------
(In thousands)
Mortgage loans in Bonds outstanding
pool at par at face value(1)
-------------------- ---------------------
Loans and debt supporting 1998-1 Certificates issued by CNL
Funding 1998-1, LP $ 198,851 $ 196,501
Loans and debt supporting 1999-1 Certificates issued by CNL
Funding 1999-1, LP $ 230,656 $ 230,656
-------------------- ---------------------
$ 429,507 $ 427,157
==================== =====================
(1) Certain bonds in both the 1998-1 and 1999-1 pools are owned by
CNL-Investments; the aggregate amount of these bonds of $27,824 appears
as investments in the consolidated financial statements of the Company.
Liquidity risk also exists from the possibility of borrower delinquencies on the
mortgage loans held for sale or held to maturity. In the event of a borrower
delinquency, the Company could suffer not only shortfalls on scheduled payments
but also margin calls by the lenders that provide the warehouse facilities and
the five-year note, subjecting the Company to unanticipated cash outflows. The
Company is obligated under the provisions of its mortgage warehouse facilities
and its five-year refinancing to pay down certain debt associated with borrower
delinquencies or defaults within a required time frame. Most properties acquired
on the mortgage warehouse facilities are required to be sold within a certain
time frame. Any delinquency, default or delay in the resale of properties
financed through one of these facilities would generally result in an immediate
pay-down of the related debt and may restrict the Company's ability to find
alternative financing. The Company's debt, excluding bonds payable, generally
provides for cross-default triggers. A default of a mortgage warehouse facility,
for example from a failure to make a margin call, could result in other Company
borrowings becoming immediately due and payable.
Management believes the Investment Property Sales program will continue to be
successful, but not without risk:
o Management believes that the recent tax law changes decreasing, but
not eliminating capital gains taxes are not significant enough to
dissuade demand created by property buyers seeking continued tax
deferrals. However any sweeping new proposal to eliminate the
capital gains tax could negatively impact demand.
o The program has also benefited from a loss of confidence in the
stock market. Nonetheless, our property buyers can choose
investments other than real estate for future purchases.
o An increase in general levels of interest rates could result in
buyers requiring a higher yield. Neither the rate of return on
leased properties nor the rate of return required by a buyer
correlate directly with prevailing interest rates. Net lease
properties acquired in anticipation of sales through the Investment
Property Sales program can typically be leased to tenants at a rate
that exceeds the rate a buyer is willing to accept. CNL-Capital is
at risk, however, that any interest rate increases causing buyers to
demand higher yields may not be matched with higher yields from
tenants. This risk could cause CNL-Capital to experience lower
average gains or even losses on the future sales of Investment
Property Sales properties.
CNL-Capital's longer-term liquidity requirements (beyond one year) are expected
to be met through successful renewal of its warehouse credit facilities, gains
from the Company's Investment Property Sales program, and fees from portfolio
debt referrals. In addition, management believes CNL-Capital's longer term
liquidity requirements will be satisfied in part by operating cash flows
provided by servicing and advisory services. CNL-Capital may also seek
additional debt or equity financing. Any decision to pursue additional debt or
equity capital will depend on a number of factors, such as compliance with the
terms of existing credit agreements, the Company's financial performance,
industry or market trends and the general availability of attractive financing
transactions. However, there can be no assurance that future expansion will be
successful due to competitive, regulatory, market, economic and other factors.
o Real Estate Segment (CNL Restaurant Investments, Inc.)
CNL-Investments cash flows primarily consist of rental income from tenants on
restaurant properties owned, interest income on mortgage loans, dispositions of
properties and income from holding interests in prior loan securitizations
including those originated by predecessor entities of CNL-Capital.
CNL-Investments' cash outflows are predominantly interest expense, operating
expenses, reinvestment of disposition proceeds and distributions to
CNL-Properties. Borrowing resources at September 30, 2003 for CNL-Investments
include:
(In thousands)
Amount Used Capacity Maturity Interest Rate (1)
--------------- -------------- -------------- ------------------
Revolver $ 7,000 $ 30,000 Oct 2004 3.62%
Series 2000-A bonds payable 255,322 255,322 2009-2017 7.94%
Series 2001 bonds payable 120,212 120,212 Oct 2006 1.59%
--------------- --------------
$ 382,534 $ 405,534
=============== ==============
(1) Excludes debt issuance and other related costs.
CNL-Investments provides a guaranty of $2 million of CNL-Capital's mortgage
warehouse facility debt and also provides a guaranty of up to ten percent of
CNL-Capital's five year term financing.
CNL-Investments short-term debt consists of the $30 million revolving line of
credit (the "Revolver") entered into in October 2001. The Company utilizes the
Revolver from time to time to manage the timing of inflows and outflows of cash
from operating activities. The Company's Revolver matured in October 2003, and
at that time the Company exercised its one-year renewal option.
CNL-Investments also has medium-term and long-term bond financing. Rental income
received on the 379 properties pledged as collateral on medium and long-term
financing is used to make scheduled reductions in bond principal and interest.
Liquidity risks within the real estate business include the potential that a
tenant's financial condition could deteriorate, rendering it unable to make
lease payments. Generally, CNL-Investments uses a triple-net lease to lease its
properties to its tenants. The triple-net lease is a long-term lease that
requires the tenant to pay expenses on the property. The lease somewhat
insulates CNL-Investments from significant cash outflows for maintenance,
repair, real estate taxes or insurance. However, if the tenant experiences
financial problems, rental payments could be interrupted and in the event of
tenant bankruptcy the Company may be required to fund certain expenses in order
to retain control or take possession of the property and its operations. This
could expose the Company to successor liabilities and further affect liquidity.
Such events may adversely affect the Company's revenue and operating cash flow.
Most sources of debt financing require that CNL-Investments maintain certain
standards of financial performance such as a fixed-charge coverage ratio, and
impose a limitation on the distributions from CNL-Investments to the Company
tied to funds from operations. Any failure to comply with the terms of these
covenants would constitute a default and may create an immediate need to find
alternate borrowing sources.
On October 10, 2003, a tenant of CNL-Investments, Chevy's Holding, Inc. and
numerous operating subsidiaries, ("Chevy's") filed for voluntary bankruptcy
under the provisions of Chapter 11. Chevy's operates the Chevy's, Rio Bravo and
Fuzio concepts. CNL-Investment owns 22 Chevy's units, with a total investment of
$54.1 million. As of September 30, 2003 the rental payments on the leases were
current, however Chevy's has rejected 16 of the 22 leases. Rent for the month of
October 2003 is currently unpaid on all 22 sites and will be included in the
lease rejection claim for the closed sites. Management expects the 16 rejected
sites to be re-leased or sold with no additional resulting impairment.
Management expects Chevy's to pay rent on the six remaining sites, beginning
with November 2003 rent, for so long as Chevy's actively operates those sites.
Payment of October rent on these six sites would be made generally upon
completion of the plan of reorganization.
Management is aware of other multi-unit tenants that are also experiencing
financial difficulties. In the event the financial difficulties continue, the
Company's collection of rental payments could be interrupted. At present, most
of these tenants continue to pay rent substantially in accordance with lease
terms. However, the Company continues to monitor each tenant's situation
carefully and will take appropriate action to place the Company in a position to
maximize the value of its investment. Management has estimated the loss or
impairment on the related properties and included such charge in earnings
through September 30, 2003, but acknowledges that the estimation process is
challenging due to the number of possible outcomes that may result from a
default situation. While management believes it has recorded an appropriate
impairment charge at September 30, 2003, based on its assessment of the tenants'
financial difficulties and its knowledge of the properties, facts may develop in
future periods that may suggest the need for a larger impairment charge.
The Company has experienced tenant bankruptcies and may commit further resources
in seeking resolution to these properties including funding restaurant
businesses directly or on behalf of successor tenants. For example, where the
value of the leased real estate is linked to the financial performance of the
tenant, CNL-Investments may allocate capital to invest in turnaround
opportunities.
Certain net lease properties are pledged as collateral for the Series 2000-A and
Series 2001 triple-net lease mortgage bonds payable. In the event of a tenant
default relating to pledged properties, the Company may elect to contribute
additional properties or substitute properties into these securitized pools from
properties it owns not otherwise pledged as collateral. These pools contain
properties potentially impacted by the recent bankruptcy filing of Chevy's and
the financial difficulties of other restaurant operators; management is
evaluating the impact to the pools, including any need to identify substitute
properties. In the event that the Company has no suitable substitute property,
the adverse performance of the pool might inhibit the Company's future capital
raising efforts, including the ability to refinance the Series 2001 bonds
maturing in 2006.
CNL-Investments management believes the combination of availability on its line
of credit and the projected disposition volume in 2003 will permit it to meet
its short-term liquidity objectives. Long-term liquidity requirements will be
met through a combination of selectively disposing assets and reinvesting the
proceeds in higher-yielding investments and cash from operating activities.
Off-Balance Sheet Transactions
The Company holds a retained interest in approximately $450 million in loans
transferred to unconsolidated trusts that provide the collateral for long-term
bonds as discussed in the specialty finance segment liquidity section above.
While the Company is not contractually obligated to guarantee the repayment of
the bonds, in the event borrower repayments of principal and interest are not
adequate to repay the bondholders, the Company may elect to contribute
additional assets into these unconsolidated entities to supplement cash flows
and maintain attractive ratings on these pools. Recent accounting pronouncements
have not required the consolidation of these trusts.
The Company is a partner in several joint ventures that are accounted for under
the equity method. Recent accounting pronouncements requiring the Company to
fully consolidate certain joint ventures have been implemented, and the
Company's financial results in the accompanying financial statements reflect
such consolidation. Those joint ventures not required by recent accounting
pronouncements to be fully consolidated are not significant to the presentation
of the Company's financial position or results of operations.
Interest Rate Risk
The Company generally invests in assets with a fixed return by financing a
portion of them with variable rate debt. Floating interest rates on variable
rate debt expose the Company to interest rate risk. As of September 30, 2003,
the Company's variable rate debt includes the following:
o $7 million on its Revolver;
o $63 million on its mortgage warehouse facilities;
o $192 million on the June 2002 five-year financing; and
o $120 million outstanding on the Series 2001 bonds.
Generally, the Company uses derivative financial instruments (primarily interest
rate swap contracts) to hedge against fluctuations in interest rates from the
time it originates fixed-rate mortgage loans until the time they are sold. The
Company generally terminates certain of these contracts upon the sale of the
loans, and both the gain or loss on the sale of the loans and the additional
gain or loss on the termination of the interest rate swap contracts is
recognized in the consolidated statement of operations.
Additionally, the Company uses interest rate swaps and caps to hedge against
fluctuations in interest rates on a portion of its floating rate debt. Under
interest rate swaps, the Company agrees with other parties to exchange, at
specified intervals, the difference between fixed-rate and floating-rate
interest amounts calculated by reference to an agreed upon notional principal
amount. Under a cap, a third party agrees to assume any interest costs above a
stated rate. Changes in the values of these interest rate swaps and caps are
reflected in other comprehensive income.
The Company also invests in financial instruments that are subject to various
forms of market risk such as interest rate fluctuations, credit risk and
prepayment risk. The value of its mortgage loans held for sale and its
investments change as a result of fluctuating interest rates, credit risk,
market sentiment and other external forces, which could materially adversely
affect liquidity and capital resources.
Management estimates that a one-percentage point increase in long-term interest
rates as of September 30, 2003 would have resulted in a decrease in the fair
value of its fixed-rate loans held for sale of $1.0 million. This decline in
fair value would have been offset by an increase in the fair value of certain
interest rate swap positions of $1.3 million. In addition, a one-percentage
point increase in short-term interest rates for the nine months ended September
30, 2003 would have resulted in additional interest costs of approximately $1.3
million. This sensitivity analysis contains certain simplifying assumptions (for
example, it does not consider the impact of changes in prepayment risk or credit
spread risk). Therefore, although it gives an indication of the Company's
exposure to interest rate change, it is not intended to predict future results
and the Company's actual results will likely vary.
Management believes inflation has not significantly affected the Company's
earnings because the inflation rate has remained low. During inflationary
periods, which generally are accompanied by rising interest rates, the Company's
ability to grow may be adversely affected because the yield on new investments
may increase at a slower rate than new borrowing costs. However, sustained low
inflation could lead to net lease pricing pressure as tenants request decreasing
rates for longer maturities.
Results from Operations
The following discussion of results from operations is by segment. All segment
results are before eliminating adjustments and results of the holding company.
As a result, the sum of amounts applicable to each segment will not, in some
cases, equal the Company total amount reflected in the condensed consolidated
statement of operations. Company earnings by segment for comparative three-month
and nine-month periods are reflected in the following table:
Three months ended Nine months ended
September 30, September 30,
Net income by segment (in millions) 2003 2002 2003 2002
------------ -------------- -------------- -------------
Real estate segment $ 8.0 $ 9.5 $ 22.5 $ 23.6
Specialty finance segment 5.1 1.7 9.2 9.3
Other holding company results
and consolidating eliminations (0.1 ) -- -- (0.2 )
------------ -------------- -------------- -------------
Net income $ 13.0 $ 11.2 $ 31.7 $ 32.7
============ ============== ============== =============
o The real estate segment posted comparable earnings in three-month
and nine-month periods ended September 30, 2003 compared with the
same periods in 2002. Impairment charges, including amounts
attributed to discontinued operations, have increased from $4.1
million to $6.9 million in the nine months ended September 30, 2002
and 2003 respectively. These additional costs are offset in part by
a reduction in general and administrative expenses, decreased
property expenses and decreased interest costs. A significant tenant
default led to increased property expenses in early 2002 that have
not been repeated to date in 2003.
o The specialty finance business segment posted its strongest
quarterly earnings this year, and has approximately the same
year-to-date net income as the same period in 2002. Gains from the
Investment Sales Program are approximately $19.8 million and $17.2
million in the nine months ended September 30, 2003 and 2002,
respectively, and $6.6 million and $5.3 million in the quarters
ended September 30, 2003 and 2002, respectively. This is offset
somewhat by the narrowing of the net spread between the segment's
rental and interest i