UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 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
Securities registered pursuant to Section
12 (b) of the Act:
Title of each class: Name of exchange on which registered:
None Not Applicable
Securities registered pursuant to section
12(g) of the Act:
Common Stock, $0.01 par value per share
(Title of class)
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 check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [x]
Indicate by checkmark if the registrant is an accelerated filer (as
defined in Exchange Act Rules 12b2). Yes X No
Aggregate market value of the voting stock held by nonaffiliates of the
registrant: The registrant has made three offerings of Shares of common stock
(the "Shares") on Form S-11 under the Securities Act of 1933, as amended. The
number of Shares held by non-affiliates as of June 30, 2003 was 38,479,891.
Since no established market for such Shares exists, there is no market value for
such Shares. Each Share was originally sold at $20 per Share.
The number of Shares of common stock outstanding as of March 10, 2004
was 45,248,670.
DOCUMENTS INCORPORATED BY REFERENCE:
Registrant incorporates by reference portions of the CNL Restaurant Properties,
Inc. Definitive Proxy Statement for the 2004 Annual Meeting of Stockholders
(Items 10, 11, 12, 13 and 14 of Part III) to be filed no later than April 30,
2004.
PART I
Item 1. Business
CNL Restaurant Properties, Inc. ("CNL Properties") formerly CNL American
Properties, Inc., a Maryland corporation (the "Company"), is the nations largest
self-advised real estate investment trust ("REIT") focused on the restaurant
industry. The Company operates as a holding company for two primary subsidiary
operating companies, CNL Restaurant Investments, Inc ("CNL-Investments")
formerly CNL Restaurant Properties, Inc. and CNL Restaurant Capital Corp.
("CNL-Capital Corp.") formerly CNL Franchise Network Corp. Please see note 14 of
the Company's Consolidated Financial Statements appearing in Item 8 of this
report for certain financial information about these two business segments. The
Company was founded in 1994 and at December 31, 2003, has financial interests in
approximately 1,000 properties diversified among more than 120 restaurant
concepts in 43 states. The Company's total real estate holdings subject to lease
includes over 640 properties, of which 90 properties are classified as held for
sale. At December 31, 2003, the servicing portfolio of net lease properties and
mortgages includes approximately 2,200 units, of which over 1,200 are serviced
on behalf of third parties.
In June 2000 the Company divided its operations into two business segments, real
estate and specialty finance, in order to distinguish between its real estate
segment, an entity with a strong capital base and stable cash flows, and a
specialty finance growth business partnered with a large financial institution
to provide an additional source of earnings and liquidity.
o The real estate segment, operated principally through the Company's wholly
owned subsidiary CNL- Investments and its subsidiaries, is charged with
overseeing and maximizing value on a portfolio of primarily long-term
triple-net lease properties. Those responsibilities include portfolio
management, property management and dispositions. In addition,
CNL-Investments manages approximately $525 million in affiliate portfolios
and earns management fees related thereto.
o The specialty finance segment, operated through the Company's wholly-owned
subsidiary CNL-Capital Corp. is partnered with a financial institution,
Bank of America ("the Bank"), in owning CNL Restaurant Capital, LP
("CNL-Capital") formerly known as CNL Franchise Network, LP. CNL Capital,
through its subsidiaries, delivers financial solutions principally in the
forms of financing, advisory and other services to national and larger
regional restaurant operators. It does this primarily by acquiring
restaurant real estate properties, which have been subject to a triple-net
lease, utilizing short-term debt and generally selling such properties at
a profit.
In June 2000, the Company formed CNL-Capital and contributed certain assets and
operations in exchange for an 84.39 percent interest. The Bank contributed its
franchise finance originations group in exchange for a 9.18 percent non-voting
redeemable interest in the Partnership. The Bank also served as lender at the
time of the alliance on a $500 million warehouse credit facility and a $43.75
million subordinated debt facility (the "Subordinated Debt Facility"). The
strategic alliance with the Bank reduced the Company's reliance on public
markets to raise capital by broadening the Company's financial products and
offerings and enhancing the Company's securitization platform. The Company also
issued a 6.43 percent limited partnership interest in CNL-Capital to CNL
Financial Group, Inc., ("CFG") an affiliate of a director of the Company, in
exchange for the operations of CNL Advisory Services, Inc. ("CAS"). CAS
specializes in providing merger, acquisition and other advisory services to
restaurant operators and expands the Company's services to the sector. Effective
January 1, 2003 CNL-Capital modified certain terms relating to the alliance with
the Bank that resulted in the Bank reducing its ownership interest in
CNL-Capital. In exchange for the reduction, the Bank agreed to assume certain
costs of its portfolio operations and decreased the referral fees paid by the
bank to CNL-Capital under the referral program between the Bank and 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 on
January 1, 2003.
Effective January 1, 2001, CNL-Capital Corp elected to be treated as a taxable
REIT subsidiary ("TRS") pursuant to the provisions of the REIT Modernization
Act. 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. CNL-Capital Corp. also performs net lease
and loan servicing on behalf of third parties. Also, certain activities of
CNL-Investments are conducted in a subsidiary that has made a similar TRS
election.
In January 2004, the Company amended the Subordinated Debt Facility agreement
while at the same time making a $10 million prepayment reducing the balance to
$33.75 million. The Subordinated Debt Facility has a conversion feature to allow
the Bank, subsequent to a specified conversion date, to have the outstanding
note converted into a 10.11 percent of additional limited partnership interests
in CNL-Capital. This conversion feature was reduced from 13.1 percent when the
agreement was amended in January 2004. The Bank's interest in the Partnership on
a fully diluted basis after a conversion of the fully committed Subordinated
Debt Facility would be 12.85 percent. As of December 31, 2003, the Bank had not
exercised its conversion option.
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 actively monitor the public markets for
opportunities to satisfy the liquidity objectives of the Company. The Company's
board does not intend 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.
Leases
As of December 31, 2003, the Company's real estate segment, CNL-Investments,
owns, either directly or indirectly through joint venture arrangements, 544
properties, which are generally subject to long-term, triple-net leases.
Although there are variations in the specific terms of the leases, the following
summarizes the general structure of the Company's leases. The leases of the
properties provide for initial terms generally ranging from 10 to 25 years and
expire between 2004 and 2024. The leases are on a triple-net basis which means
the lessee is responsible for all repairs and maintenance, property taxes,
insurance and utilities. The leases provide for minimum base annual rental
payments (payable in monthly installments) ranging from approximately $41,000 to
$369,000. The majority of the leases also provide that, commencing in specified
lease years (generally the sixth lease year), the annual base rent required
under the terms of the lease will increase. In addition, certain leases provide
for percentage rent based on sales in excess of a specified amount.
Generally, the leases provide for two to five five-year or ten-year renewal
options. Lessees of 439 of the 544 properties also have been granted options to
purchase the property at the property's then fair market value after a specified
portion of the lease term has elapsed. Fair market value will be determined
through an appraisal by an independent appraisal firm. The option purchase price
may equal the Company's original cost to purchase the property plus a specified
percentage from the date of the lease or a specified percentage of the Company's
purchase price, if that amount is greater than the property's fair market value
at the time the purchase option is exercised. The leases also generally provide
that, in the event the Company wishes to sell the property subject to that
lease, the Company first must offer the lessee the right to purchase the
property on the same terms and conditions, and for the same price, as any offer
which the Company has received for the sale of the property.
Major Tenants
During 2003, no single lessee, borrower (or affiliated groups of lessees or
borrowers) or restaurant chain contributed more than ten percent of the
Company's revenues relating to its properties, loans and secured equipment
leases. In the event that certain lessees, borrowers or restaurant chains
contribute more than ten percent of the Company's rental, earned and interest
income in future years, any failure of such lessees, borrowers or restaurant
chains could materially affect the Company's income. Additionally, as of
December 31, 2003, no single lessee or borrower, or group of affiliated lessees
or borrowers, leased properties or was the borrower under loans with an
aggregate carrying value in excess of 20 percent of total assets of the Company.
Real Estate and Restaurant Assets Held for Sale
The Company sells certain real estate properties to private investors as an
alternative to either retaining the properties as a long-term investment or
offering to sell net lease cash flows in the securitization marketplace. The
accounting for these properties differs from that of similar properties without
this designation as the Company does not record depreciation or accrued rent on
these properties. The properties held for sale are contemplated being sold
within the next year.
During 2002 the Company purchased the operations of certain restaurants. In
December 2003, the Company decided to dispose of these restaurant operations and
as of December 31, 2003, had classified the restaurant assets as held for sale.
From time to time, certain properties classified as long-term investments may be
subsequently re-designated to held for sale classification. The company has
re-designated 30 and 83 properties during 2003 and 2002, respectively.
Mortgage Loans Held for Sale
Mortgage loans held for sale are wholly or partially collateralized by first
mortgages on the land and/or buildings of franchised restaurant businesses and
consist of fixed-rate loans at December 31, 2003. The loans carry a weighted
average interest rate of 8.33 percent. The mortgage loans are due in monthly
installments with maturity dates ranging from 2004 to 2022. The fixed-rate
mortgage loans generally prohibit prepayment for certain periods or include
prepayment penalties.
Mortgage, Equipment and Other Notes Receivable
Mortgage, equipment and other notes receivable are wholly or partially
collateralized by first mortgages on the land and/or buildings, the equipment or
other assets of franchised restaurant businesses. The loans are due in monthly
installments with maturity dates ranging from 2004 to 2023.
Available Information
The Company makes available free of charge on or through its Internet website
(http://www.cnlonline.com) the Company's Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable,
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") as
soon as reasonably practicable after the Company electronically files such
material with, or furnishes it to, the Securities and Exchange Commission.
Competition
The fast-food, family-style and casual dining restaurant business is
characterized by intense competition. The operators of the restaurants located
on the Company's properties compete with independently owned restaurants,
restaurants which are part of local or regional chains and restaurants in other
well-known national chains, including those offering different types of food and
service.
Local competition may enhance a restaurant's success rather than detract from
it. Many successful fast-food, family-style and casual dining restaurants are
located in "eating islands", areas within which a variety of restaurants
operate. This variety allows diners an opportunity to diversify their eating
habits, giving them an incentive to return in the future. As a result, fast
food, family style and casual dining restaurants frequently experience better
operating results when there are other restaurants in the area.
The Company competes with other persons and entities in locating suitable
properties to acquire and in locating purchasers for properties held for sale.
The Company also competes with other financing sources such as banks, mortgage
lenders, real estate brokers and sale/leaseback companies for suitable tenants
for its properties and borrowers for its mortgage loans.
The recessionary economy and historically low interest rates at which mortgage
financing can be obtained contributed to a decline in net lease volume in 2003
while the low interest rates made debt financing more attractive. Management
believes that the Company's volume levels may increase in the future due to the
projected rebound in the economy as well as the opportunities afforded by the
continued consolidation in the financing arena and the Company's ability to
provide an array of financial products. Competition in the financing arena
continues to be significant despite the exit of numerous competitors. Remaining
competitors provide meaningful competition.
Employees
As of December 31, 2003, the Company had 117 associates.
Item 2. Properties
As of December 31, 2003, the Company's real estate segment, CNL-Investments,
owned, either directly or indirectly through joint venture arrangements, 544
properties, located in 40 states. Reference is made to the Schedule of Real
Estate and Accumulated Depreciation filed with this report for a listing of the
properties and their respective costs.
As of December 31, 2003, the Company owned 469 of the 544 properties in fee
simple and ten properties through joint venture arrangements. As of December 31,
2003, 36 properties consisted of land only.
As of December 31, 2003, 39 properties consisted of building only. The Company
does not own the underlying land. In connection with the acquisition of each of
these properties, the Company entered into either a tri-party agreement with the
tenant and the owner of the land or an assignment of interest in the ground
lease with the landlord, as described in Item 1. Business-Leases.
As of December 31, 2003, the Company had pledged 379 properties as collateral
related to bonds payable.
Description of Properties
Land. The Company's property lot sizes range from approximately 6,000 to 199,000
square feet depending upon building size and local demographic factors. Land
owned is zoned for commercial use which, prior to acquisition, were reviewed for
traffic patterns and volume.
The following table lists the properties owned as of December 31, 2003 by state.
More detailed information regarding the location of the properties is contained
in the Schedule of Real Estate and Accumulated Depreciation filed with this
report.
Total Number of
State Restaurant Properties
Alabama 13
Arizona 13
California 30
Colorado 13
Connecticut 1
Delaware 1
Florida 75
Georgia 21
Idaho 3
Illinois 24
Indiana 8
Iowa 7
Kansas 5
Kentucky 6
Louisiana 10
Maryland 5
Michigan 12
Minnesota 8
Mississippi 5
Missouri 26
Nebraska 3
Nevada 3
New Hampshire 2
New Jersey 6
New Mexico 2
New York 4
North Carolina 19
Ohio 47
Oklahoma 4
Oregon 7
Pennsylvania 10
Rhode Island 1
South Carolina 9
Tennessee 26
Texas 70
Utah 4
Virginia 15
Washington 13
West Virginia 10
Wisconsin 3
------
TOTAL PROPERTIES 544
======
Buildings. The buildings generally are rectangular and are constructed from
various combinations of stucco, steel, wood, brick and tile. Building sizes
range from approximately 1,000 to 12,700 square feet. Generally, buildings on
properties owned are freestanding and are surrounded by paved parking areas.
Buildings are suitable for conversion to various uses, although modifications
may be required prior to use for other than restaurant operations. Depreciation
expense is computed for buildings and improvements using the straight-line
method using a depreciable life of 39 years for federal income tax purposes. As
of December 31, 2003 the aggregate depreciated cost basis of the properties
owned (including properties owned through joint ventures) for federal income tax
purposes was $621.5 million.
The following table lists the properties owned as of December 31, 2003 by
restaurant chain.
Restaurant Chain Number of Properties
Jack in the Box 54
International House of Pancakes 46
Pizza Hut 44
Golden Corral 36
Arby's 35
Bennigan's 26
Burger King 24
Chevy's Inc. 18
Ruby Tuesday 18
Steak & Ale 18
Baker's Square 17
Denny's 15
Applebee's 15
Boston Market 13
Wendy's 12
Other 153
-----
TOTAL: 544
=====
Management considers the properties to be well maintained and sufficient for the
Company's operations and believes they are adequately covered by insurance. In
addition, the Company has obtained contingent liability and property coverage.
This insurance is intended to reduce the Company's exposure in the unlikely
event a tenant's insurance policy lapses or is insufficient to cover a claim
relating to the property.
Leases. The Company leases the properties to operators of selected national and
regional fast-food restaurant chains. The leases are generally on a long-term
"triple-net" basis, meaning that the tenant is responsible for repairs,
maintenance, property taxes, utilities and insurance. Generally, a lessee is
required, under the terms of its lease agreement, to make capital expenditures
to refurbish restaurant buildings, premises, signs and equipment so as to comply
with the lessee's obligations, if applicable, under the franchise agreement to
reflect the current commercial image of its restaurant chain. These capital
expenditures are required to be paid by the lessee during the term of the lease.
The terms of the leases of the properties owned by the Company are described in
Item 1. Business - Leases.
The following is a schedule of the average rent per property for the years ended
December 31:
2003 2002 2001 2000 1999
-------------- -------------- --------------- -------------- -------------
Rental Revenues (1) $ 72,753,603 $ 74,504,692 $84,775,244 $91,520,103 $61,907,812
Properties (2) 515 552 644 725 642
Average Rent Per Property $ 141,269 $ 134,972 $ 131,639 $ 126,235 $ 96,430
Occupancy 95% 95% 92% 95% 97%
(1) Rental income includes the Company's share of rental income from the
properties owned through joint venture arrangements. Rental revenues have
been adjusted, as applicable, for any amounts for which the Company has
established an allowance for doubtful accounts. Rental revenues for all
periods presented include rental revenues relating to discontinued
operations for properties that were either disposed of or that were
classified as held for sale during the year ended December 31, 2003.
(2) Excludes properties that were vacant at December 31 and that did not
generate rental revenues during the year.
The following table lists properties as of December 31, 2003 by tenant and
includes average age of buildings, annualized total rental revenue and percent
of total revenue. To calculate annualized total rental revenue, the monthly
rental revenue for each restaurant property owned and leased at December 31,
2003 was multiplied by 12 to present annualized rental revenues for a 12 month
period. Contingent rental income was excluded in the calculation of annualized
total rental revenue.
Total
Number of Average Age
Restaurant of Buildings Annualized Percent of
Properties (years) Total Rental Total Rental
Tenant (1) Revenue (2) Revenue
------------- -------------- -------------- --------------
S&A Properties Corporation 35 22.1 $ 6,019,849 9.31%
IHOP Properties, Inc. 46 6.4 5,426,195 8.39%
Golden Corral Corporation 30 5.1 4,989,411 7.72%
Jack in the Box, Inc. 26 5.2 3,224,498 4.99%
Jack in the Box Eastern Division, L.P. 29 5.1 3,024,450 4.68%
Vicorp Restaurant, Inc. 18 21.7 2,418,886 3.74%
Boston Market Corp. 13 6.8 1,628,959 2.52%
Pollo Operations, Inc. 10 8.9 1,446,120 2.24%
Woodland Group, Inc. 10 8.4 1,403,350 2.17%
Other 298 8.8 35,087,731 54.26%
------ ------------- ------------
Total 515 $64,669,449 100.00%
------ ------------- ------------
(1) Excludes properties that were vacant at December 31, 2003 and that did not
generate rental revenues during the year.
(2) The Company has straight-lined the contractual increases in rental income
over the life of each of the leases in order to calculate rental revenue in
accordance with generally accepted accounting principles.
The following table shows the aggregate number of leases which expire each
calendar year through the year 2018, as well as the number of leases which
expire after December 31, 2018. The table does not reflect the exercise of any
of the renewal options provided to the tenant under the terms of such leases.
Base Rent
--------------------------------------------
Year Number (1) Amount (2) Percent
------------------ ------------------ -------------------
2004 1 $ 100,935 0.16%
2005 4 427,799 0.66%
2006 3 311,337 0.48%
2007 1 109,811 0.17%
2008 1 117,297 0.18%
2009 1 84,059 0.13%
2010 12 1,224,173 1.89%
2011 16 2,210,272 3.42%
2012 26 4,033,945 6.24%
2013 22 3,272,302 5.06%
2014 69 9,320,587 14.41%
2015 34 4,528,935 7.00%
2016 61 4,357,442 6.74%
2017 51 6,561,902 10.15%
2018 117 15,923,362 24.62%
Thereafter 96 12,085,291 18.69%
--------- --------------- ----------
Total 515 64,669,449 100.00%
========= =============== ==========
(1) Excludes properties for which the leases have been terminated and excludes
properties leased on a month to month basis.
(2) The Company has straight-lined the contractual increases in rental income
over the life of each of the leases in order to calculate rental revenue in
accordance with generally accepted accounting principles.
Item 3. Legal Proceedings
As of December 31, 2003, neither the Company nor any of its properties was a
party to or the subject of any material pending legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
As of March 1, 2004, there were 32,378 stockholders of record of common stock.
There is no public trading market for the Company Shares, and even though the
Company intends to list the Company Shares on the New York Stock Exchange or
other national securities exchange or over-the-counter market no later than
December 31, 2005, there is no assurance that listing will occur. If listing
occurs, there is no assurance that a public market for the Company Shares will
develop. In October 1998, the Board of Directors elected to implement the
Company's redemption plan. Under the redemption plan, the Company elected to
redeem Company Shares, subject to certain conditions and limitations. During
1999, the Company terminated the redemption plan. As of December 31, 2003, the
estimated fair value per share is $17.20. (For Florida intangible tax purposes,
this is the equivalent of the Just Value per share.) The Company obtained this
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. Because the Company Shares are not publicly traded, investors are
cautioned that the estimated fair value of the shares may not be realized upon
sale of the shares.
Stockholders of the Company sold and purchased shares of common stock subject to
negotiation by the purchaser and the selling stockholder. The following table
reflects the high, low and average sales prices for transfers of shares of
common stock for each calendar quarter during 2003 and 2002, other than pursuant
to the plan, net of commissions.
2003 (1) 2002 (1)
--------------------------------------- --------------------------------------
High Low Average High Low Average
---------- ---------- ---------- ---------- ---------- ----------
First Quarter $19.00 $10.24 $15.28 $20.00 $11.20 $14.15
Second Quarter 20.00 12.81 16.04 19.00 12.94 14.54
Third Quarter 20.00 10.00 16.18 19.00 11.88 15.00
Fourth Quarter 21.29 13.10 15.73 19.00 7.00 12.87
(1) A total of 207,184 and 239,692 shares were transferred for the years ended
December 31, 2003 and 2002, respectively.
The Company expects to make distributions to the stockholders pursuant to the
provisions of the Articles of Incorporation. For the years ended December 31,
2003 and 2002, the Company declared cash distributions of $69.0 million and
$68.0 million, respectively, to stockholders. For federal income tax purposes,
39 percent and 0 percent of distributions paid in 2003 and 2002, respectively,
were considered to be ordinary income and 61 percent and 100 percent,
respectively, were considered to be a return of capital.
The following table presents total distributions and distributions per Company
Share:
(In Thousands, except for per share data)
First Second Third Fourth Year
----------- ----------- ----------- ----------- -----------
2003 Quarter
------------
Total distributions
declared $17,251 $17,250 $ 17,251 $ 17,250 $69,002
Distributions per
share 0.38 0.38 0.38 0.38 1.52
2002 Quarter
------------
Total distributions
declared $16,803 $16,803 $ 17,134 $ 17,251 $67,991
Distributions per
share 0.38 0.38 0.38 0.38 1.52
In March 2004, the Company declared distributions to stockholders of $17.251
million ($0.38124 per Share) payable in March 2004.
The Company intends to continue to declare distributions of cash to the
stockholders.
Equity Compensation Plan Information
Number of securities
Number of securities remaining available for
to be issued upon future issuance under
exercise of Weighted-average equity compensation
outstanding options, exercise price of plans excluding
warrants and rights outstanding options, securities reflected in
Plan Category (a) warrants and rights column (a)
-------------------------- ----------------------- ------------------------ ------------------------
Equity compensation
plans approved by
security holders -- (1) $ 4,500,000 (2)
Equity compensation
plans not approved
by security holders (3) (3) (3)
----------------------- ------------------------
Total -- $ 4,500,000
======================= ========================
(1) During 1999, the stockholders approved a performance incentive plan (the
"Plan") which became effective as of February 23, 1999. As of December 31,
2003, the Company has not granted any awards under the Plan.
(2) The Plan authorizes the issuance of up to 4,500,000 shares of the Company's
common stock upon the exercise of stock options (both incentive and
nonqualified), stock appreciation rights and the award of restricted stock
("Stock Award") provided that the aggregate number of shares of Common
Stock that may be issued pursuant to Options, stock appreciation rights
("SARs"), and Stock Awards granted under the Plan increases automatically
to 9,000,000 shares and 12,000,000 shares, respectively, when the Company
has issued and outstanding 150,000,000 shares and 200,000,000 shares,
respectively, of common stock. The Plan terminates on February 23, 2009.
Key employees, officers, directors and persons performing consulting or
advisory services for the Company or its affiliates, as defined in the
Plan, who are designated by the committee administering the Plan, are
eligible to receive awards under the Plan. Awards may be made in the form
of stock options, stock awards, SARs, Phantom Stock Awards, Performance
Awards and Leveraged Stock Purchase Awards as defined further in the Plan.
As of December 31, 2003, the Company had not made any awards related to the
Plan.
(3) As of December 31, 2003, the Company does not maintain any equity
compensation plans not approved by security holders.
Item 6. Selected Financial Data
(In Thousands, except for share and per share data)
Year Ended Year Ended Year Ended Year Ended Year Ended
December 31, December 31, December 31, December 31, December 31,
2003 2002 2001 2000 1999
---------------- -------------- -------------- --------------- ----------------
Continuing Operations:
Revenues (1) $ 114,337 $ 336,163 $ 274,413 $ 113,413 $ 70,764
================ ============== ============== =============== ================
Earnings/(loss) from
continuing operations, net (1) $ 8,176 $ 27,407 $ (15,739 ) $ (6,409 ) $ (52,571 )
Discontinued Operations:
Earnings/(loss) and gains from
discontinued operations,
net (1) 34,264 8,183 (4,872 ) 9,336 2,734
---------------- -------------- -------------- --------------- ----------------
Earnings/(loss) before
cumulative effect if
accounting change 42,440 35,590 (20,611 ) 2,927 (49,837 )
Cumulative effect of accounting
change -- -- (3,841 ) -- --
---------------- -------------- -------------- --------------- ----------------
Net income/(loss) $ 42,440 $ 35,590 $ (24,452 ) $ 2,927 $ (49,837 )
================ ============== ============== =============== ================
Earnings/(loss) per share (1):
Continuing operations (1) $ 0.18 $ 0.61 $ (0.36 ) $ (0.15 ) $ (1.33 )
Discontinued operations (1) 0.76 0.19 (0.11 ) 0.22 0.07
Cumulative effect of
accounting change -- -- (0.09 ) -- --
---------------- -------------- -------------- --------------- ----------------
Net income/(loss) per share $ 0.94 $ 0.80 $ (0.56 ) $ 0.07 $ (1.26 )
================ ============== ============== =============== ================
Funds from operations (2) $ 49,504 $ 44,710 $ (6,029 ) $ 16,007 $ 35,956
================ ============== ============== =============== ================
Cash distributions declared $ 69,002 $ 67,991 $ 66,466 $ 66,329 $ 60,079
================ ============== ============== =============== ================
Cash distributions declared
per share $ 1.52 $ 1.52 $ 1.52 $ 1.52 $ 1.52
================ ============== ============== =============== ================
Weighted average shares
outstanding:
Basic 45,248,670 44,620,235 43,589,985 43,495,919 39,402,941
================ ============== ============== =============== ================
Diluted 45,248,670 44,620,235 43,589,985 43,495,919 39,402,941
================ ============== ============== =============== ================
At December 31:
Total assets $ 1,298,116 $ 1,383,450 $ 1,560,117 $ 1,605,944 $ 1,138,193
================ ============== ============== =============== ================
Long-term obligations $ 656,321 $ 671,465 $ 484,815 $ 398,100 $ 140,504
================ ============== ============== =============== ================
Total stockholders' equity $ 479,886 $ 494,151 $ 526,182 $ 607,738 $ 672,214
(3) ================ ============== ============== =============== ================
For a discussion of material events affecting the comparability of the
information reflected in the selected financial data, refer to the section
captioned "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in Item 7.
(1) The results of operations relating to properties that were either disposed
of or that were classified as held for sale during the year ended December
31, 2003 are reported as discontinued operations for all periods presented.
(2) Funds from operations ("FFO"), based on the revised definition adopted by
the Board of Governors of the National Association of Real Estate
Investment Trusts ("NAREIT") and as used herein, except for the add back of
the advisor acquisition expense of $76.3 million during 1999, means net
income/(loss) determined in accordance with Generally Accepted Accounting
Principles ("GAAP"), excluding gains (losses) from sales of depreciable
operating property, excluding extraordinary items (as defined by GAAP),
including depreciation and amortization of real estate assets and after
adjusting for unconsolidated partnerships and joint venture. As a result of
the restatement, FFO does not include add backs for impairment provisions
or capital lease principal components. These amounts for the years ended
December 31, 2003, 2002, 2001, 2000 and 1999 (in thousands) were $11,542,
$13,335, $26,018, $2,576 and $0, respectively, for the impairment
provisions and $1,725, $1,852, $2,384, $2,242 and $1,629, respectively, for
capital lease principal components. Funds from operations are generally
considered by industry analysts to be the most appropriate measure of
performance. FFO (i) does not represent cash generated from operating
activities determined in accordance with GAAP (which, unlike FFO, generally
reflects all cash effects of transactions and other events that enter into
the determination of net earnings), (ii) is not necessarily indicative of
cash flow available to fund cash needs and (iii) should not be considered
as an alternative to net earnings determined in accordance with GAAP as an
indication of the Company's operating performance, or to cash flow from
operating activities determined in accordance with GAAP as a measure of
either liquidity or the Company's ability to make distributions.
Accordingly, the Company believes that in order to facilitate a clear
understanding of the consolidated historical operating results of the
Company, FFO should be considered in conjunction with the Company's net
earnings and cash flows as reported in the accompanying consolidated
financial statements and notes thereto. However, the Company's measure of
FFO may not be comparable to similarly titled measures of other REITS
because these REITS may not apply the definition of FFO in the same manner
as the Company.
(3) Includes subscriptions received of $0.2 million during 1999 and includes
$1.5 million of stock issuance costs during each of the years ended
December 31, 2003, 2002, 2001 and 2000 and $1.7 million during the year
ended December 31, 1999. Stock issuance costs consists of selling
commissions, marketing support and due diligence expense reimbursement fees
during 1999 and organizational and offering expenses. Stock issuance costs
for 2003, 2002, 2001 and 2000 consist of soliciting dealer servicing fees.
The following is a reconciliation of net earnings to FFO:
(In Thousands)
2003 2002 2001 2000 1999
------------- ------------- -------------- ------------- --------------
Net income/(loss) $ 42,440 $ 35,590 $ (24,452 ) $ 2,927 $ (49,837 )
Depreciation
Continuing operations 9,997 10,512 11,483 12,198 7,460
Discontinued operations 665 1,693 1,931 149 1,210
Loss/(Gain) on sale of property
Continuing operations 5 181 1,141 721 781
Discontinued operations (3,633 ) (3,295 ) -- -- --
Amortization of joint venture costs 30 29 27 12 9
Advisor acquisition expense -- -- -- -- 76,333
Cumulative effect of accounting
change -- -- 3,841 -- --
------------- ------------- -------------- ------------- --------------
FFO (*) $ 49,504 $ 44,710 $ (6,029 ) $ 16,007 $ 35,956
============= ============= ============== ============= ==============
(*) - The Company restated FFO for the years ended December 31, 2002, 2001,
2000 and 1999 to conform to 2003 presentation that conforms to the NAREIT
definition of FFO, except for the add back by the Company of the advisor
acquisition expense of $76.3 million during 1999.
Item 7. 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 December
31, 2003, has financial interests in approximately 1,000 properties diversified
among more than 120 restaurant concepts in 43 states. The Company's total real
estate holdings subject to lease include over 640 properties, of which 90
properties are classified as held for sale. At December 31, 2003, the servicing
portfolio of net lease properties and mortgages consists of approximately 2,200
units, of which over 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, dispositions and the
opportunistic acquisition and profitable sale of real estate investments.
In addition, CNL-Investments services approximately $525 million in
affiliate real estate portfolios and earns management fees related
thereto. Revenues from the real estate segment represented approximately
75 percent, 26 percent and 32 percent of the Company's total revenues in
2003, 2002 and 2001, respectively. The increase in 2003 is the result of
adopting accounting rules that require a component of the specialty
finance revenues to be treated as discontinued operations, as described
below.
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 ("the Bank"), in owning CNL Restaurant
Capital, LP ("CNL-Capital"). CNL-Capital, through its subsidiaries,
delivers financial solutions principally in the forms of financing,
advisory and other services to national and larger regional restaurant
operators. It does this primarily by acquiring restaurant real estate
properties, which are subject to a triple-net lease, utilizing short-term
debt and generally selling such properties at a profit. Revenues from the
specialty finance segment represented approximately 25 percent, 74 percent
and 68 percent of the Company's total revenues in 2003, 2002 and 2002,
respectively. The decrease in 2003 was due to classifying components of
revenues into discontinued operations in accordance with new accounting
requirements.
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 actively monitor the public markets for
opportunities to satisfy the liquidity objectives of the Company. 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
General. Historically, the Company's demand for funds has been for payment of
operating expenses and dividends, for payment of principal and interest on its
outstanding indebtedness, and in the case of CNL-Capital, for acquisitions of
properties with the intent to sell. 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, the Company has not received distributions from CNL-Capital because
this subsidiary has reinvested its earnings in ongoing operations. Management
expects that distributions from CNL-Capital will begin within the next two
years.
Contractual Obligations, Contingent Liabilities and Commitments. The following
table presents the Company's contractual cash obligations and related payment
periods as of December 31, 2003:
Payments due by period (In millions)
------------------------------------
Less
than one 2 to 3 4 to 5
Contractual cash obligations: year years years Thereafter Total
- ------------------------------------------- ---------- --------- ---------- ------------ ----------
Borrowings (1) $ 146.0 $ 175.5 $ 68.9 $ 361.4 $ 751.8
Leased office space (2) 1.1 2.4 2.4 8.0 13.9
---------- --------- ---------- ------------ ----------
Total contractual cash obligations $ 147.1 $ 177.9 $ 71.3 $ 369.4 $ 765.7
========== ========= ========== ============ ==========
The following table presents the Company's commitments, contingencies and
guarantees and related expiration periods as of December 31, 2003:
Estimated payments due by period (In millions)
----------------------------------------------
Less
Commitments, contingencies than one 2 to 3 4 to 5
and guarantees year years years Thereafter Total
- ---------------------------------------- ---------- ----------- ----------- ------------ ---------
Guaranty of unsecured promissory
note (2) $ 1.3 $ -- $ -- $ -- $ 1.3
Purchase commitments 82.0 -- -- -- 82.0
---------- ----------- ----------- ------------ ---------
Total commitments, contingencies
and guarantees $ 83.3 $ -- $ -- $ -- $83.3
========== =========== =========== ============ =========
(1) The maturities on outstanding indebtedness assumes that loan repayments are
made on the mortgage warehouse facilities in accordance with the
contractual obligation and that bonds payable amortize in accordance with
estimated payment amounts. In the event the mortgage warehouse lenders
continue to renew the facilities as expected, $146 million of the 2004
amounts would likely mature in a later year. In January 2004, the Company
renegotiated the Subordinated Debt Facility. Under the renegotiated terms,
the Company will make a mandatory repayment of $11.875 million by December
31, 2004. This repayment of $11.875 million was reflected in the
"Thereafter" column in this table as of December 31, 2003.
(2) In May 2002, the Company purchased a combined five percent partnership
interest in CNL Plaza, Ltd. and CNL Plaza Venture, Ltd. (the "Plaza") for
$0.2 million. Affiliates of James M. Seneff, Jr. and Robert A. Bourne, each
of which is a director of the Company, own the remaining partnership
interests. The Company has severally guaranteed 8.33 percent or $1.3
million of a $15.5 million unsecured promissory note on behalf of the
Plaza. The guaranty continues through the loan maturity in November 2004.
Since November 1999, the Company has leased its office space from CNL
Plaza, Ltd., an affiliate of a member of the Company's board of directors.
The Company's lease expires in 2014 and provides for scheduled rent
increases over the term of the lease. Rental and other expenses in
connection with the lease for the years ended December 31, 2003, 2002 and
2001 totaled $1.4 million, $1.5 million and $1.2 million, respectively.
Dividends. 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
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 has continued to declare and pay distributions to its stockholders.
These distributions have been primarily funded by CNL-Investments' activities
because the Company has elected to reinvest the earnings of CNL-Capital, its
specialty finance business, to date as contemplated by the agreement with the
partners of CNL-Capital. The Company will continue to reinvest earnings into
this subsidiary if the subsidiary is able to generate acceptable returns. The
remainder of the distributions to date has been funded by sales of the Company's
common stock to the Company's Chairman through a private company affiliate, CNL
Financial Group, Inc. ("CFG"), and loans from CFG.
The Company has elected to distribute amounts in excess of that necessary to
qualify as a REIT. During the years ended December 31, 2003, 2002 and 2001, the
Company distributed $69.0 million, $68.0 million and $66.5 million,
respectively, or $1.52 per share each year, to its stockholders. During 2003,
2002 and 2001, approximately 39 percent, 0 percent and 21 percent, respectively,
of the distributions received by stockholders were considered to be ordinary
income and approximately 61 percent, 100 percent and 79 percent, respectively,
were considered a return of capital for federal income tax purposes. The REIT's
taxable income in 2003, 2002 and 2001 has not included any of CNL-Capital's
earnings since inception. The Company's cash from operations for the years ended
December 31, 2003, 2002 and 2001 were $108.4 million, $111.6 million and $48.7
million. Management believes that a better indicator of cash from operations
would exclude the changes in the held for sale loans and real estate portfolio
and proceeds from the sale of loans. Net cash provided by operating activities
excluding changes in mortgage loans and inventories of real estate held for sale
is $71.2 million, $50.0 million and $59.4 million in the years ended December
31, 2003, 2002 and 2001.
In order to ensure that the Company maintained its historical level of
distributions to its stockholders, the Company's Chairman, through CFG, made
advances to the Company in the amount of $18.7 million, $11.75 million and $8.7
million during the years ended December 31, 2003, 2002 and 2001, respectively,
in the form of demand balloon promissory notes. The notes are
non-collateralized, bear interest at LIBOR plus 2.5 percent or at the base rate,
as defined in the agreement, with interest payments and outstanding principal
due upon demand. The principal amount including accrued interest at December 31,
2003 was $23.5 million. In addition, during 2002 and 2001, the Chairman, through
CFG, received 1,173,354 shares and 579,722 shares, respectively, of the
Company's stock in exchange for $20.1 million and $9.7 million, respectively, in
cash, including the conversion of amounts previously treated as advances. This
provided capital that allowed the Company to reinvest the earnings generated by
the specialty finance business. The number of shares was determined using an
estimated fair value per share of $16.78 and $17.13 during 2001 and 2002,
respectively. The value per share for 2001 and 2002 was determined by 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. The
Company's Chairman is under no obligation to purchase additional shares or make
advances to the Company. 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.
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. 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 and may reduce the value a
shareholder would receive in a future liquidity event. 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.
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, meeting existing payment demands and potentially, to
retire existing debt.
o Specialty Finance Segment (CNL-Capital).
CNL-Capital current demand for funds include (i) payment of operating expenses,
(ii) funds necessary for net lease originations to be sold in its Investment
Property Sales Program (as defined below) and (iii) payment of principal and
interest on its outstanding indebtedness. Demands for funds diminished at
CNL-Capital during 2003 due to a decline in new originations of real estate
properties and a decrease in interest expense, and due to CNL-Capital not
distributing to the Company any cash resulting from the "net spread" earned and
not distributing any of the gains realized from the sale of properties under the
Investment Property Sales Program, as described below.
During the years ended December 31, 2003, 2002 and 2001, 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, advisory services 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 had cash and cash equivalents of $31.9 million, $10.4
million and $10.8 million at December 31, 2003, 2002 and 2001, respectively.
CNL-Capital's longer-term liquidity requirements (beyond one year) are expected
to be met through successful renewal of its warehouse credit facilities and
gains from the Company's Investment Property Sales Program. 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.
Investment Property Sales Program
As described above, the improvement in liquidity has been primarily due to
Investment Property Sales, further described below, outpacing new originations.
The Company's Investment Property Sales Program came into being as a reaction to
uncertainty in the franchise asset-backed securitization market. CNL-Capital was
formed in June of 2000 through an alliance between the Company and the Bank. The
original vision of CNL-Capital was centered on securitization. This business
model was predicated upon the origination of pools of loans or triple-net leases
and the subsequent issuance of bonds collateralized by real estate and other
restaurant assets underlying the loan or lease. The securitization market
experienced considerable volatility in late 2000 that continued through 2003
virtually shutting down that securitization financing channel for the franchise
asset class. Rising delinquencies in securitized loan pools, falling treasury
rates, macroeconomic uncertainties combined with the sluggish restaurant sales
within certain concepts all contributed to the volatility. Investors required
higher interest rates on securities issued in securitizations while ratings
agencies downgraded the quality of the loans underlying the securities. While
many of the Company's competitors experienced downgrades or ratings actions on
bonds previously issued, the Company's prior loan or lease securitizations to
date have not been subject to any such ratings action.
In 2001, CNL-Capital changed its business focus to the private market sales
channels to either refinance or sell existing mortgage loans, and halted the
origination of new loans. In October 2001, the Company renegotiated certain
terms of its alliance with the Bank. Over the course of 2001 through 2003, the
Company sold or refinanced the loans described above over a longer term.
The uncertainty in the franchise asset-backed securitization market led
management to focus the originations effort toward new long-term, triple-net
leases on real estate with the intent of selling these properties to third
parties. In 2001, CNL-Capital began selling investment properties to third
parties (the "Investment Property Sales Program") adding diversity to its
original securitization model. These leased properties 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. 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 years ended December 31:
(In thousands)
2003 2002 2001
------------- ------------- --------------
Proceeds from Investment Property Sales program sales $ 193,850 $ 287,622 $ 128,480
============= ============= ==============
Purchases of properties to be sold under the Investment
Property Sales program $ 168,965 $ 263,019 $ 118,372
============= ============= ==============
For properties acquired subsequent to December 31, 2001, generally accepted
accounting principles require that the sale of these investment properties be
designated as discontinued operations. A significant element of the ongoing
activities of the specialty finance segment is the Investment Property Sales
Program that consists of the origination of new triple-net lease financing on
properties and the subsequent disposition of those properties. The following
table shows the combined results of the Investment Property Sales Program and
the rest of the operations of the specialty finance segment (without treating
the Investment Property Sales Program as discontinued operations) for each of
the three years ended December 31:
(In thousands)
2003 2002 2001
------------- -------------- -------------
Revenues:
Sale of real estate $ 193,850 $ 287,622 $ 128,480
Rental income 9,983 13,165 16,212
Other revenue items 32,020 35,116 46,271
------------- -------------- -------------
235,853 335,903 190,963
------------- -------------- -------------
Expenses:
Cost of real estate sold 168,965 263,019 118,372
Interest expense 25,920 29,608 32,176
Depreciation and amortization 1,216 1,243 5,519
Other expenses 31,220 29,466 30,653
------------- -------------- -------------
227,321 323,336 186,720
------------- -------------- -------------
Income tax benefit 6,346 -- --
Cumulative effect of accounting change -- -- (3,841 )
------------- -------------- -------------
Net income $ 14,878 $ 12,567 $ 402
============= ============== =============
Management expects continued demand for Investment Property Sales Program
properties but continues to study other sales channels to market net lease
assets. The success of the Investment Property Sales business is dependent on
successfully originating new triple-net leases. For the years ended December 31,
2003, 2002 and 2001, CNL-Capital originated $137 million, $204 million and $182
million in net leases respectively. During 2002, originations included a
portfolio of $117 million in properties. CNL-Capital acquired this portfolio in
September 2002 by purchasing all of the limited and general partnership
interests of CNL Net Lease Investors, L.P., an affiliate of the Company's
Chairman of the Board and Vice Chairman of the Board, that until the
acquisition, was a client of CNL-Investment's property management group.
Management had contemplated stronger demand for its core triple-net lease
financing in 2003 and attributes the slow-down to two competitive factors:
o A 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 restaurant operators find more attractive than leases.
CNL-Capital does not currently originate debt financing 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 the Bank, 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 believes that a
securitized 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 near term.
o CNL-Capital has 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.
Management has responded to this slowdown by adjusting net lease rates,
identifying larger transactions like the September 2002 portfolio acquisition of
$117 million in properties and by identifying new areas to reduce costs. These
originations provide inventory necessary to execute the Investment Property
Sales Program and CNL-Capital typically profits from the leases while holding
them. At December 31, 2003, CNL-Capital is involved in several opportunities for
net lease originations with $82 million approved for funding and accepted by the
client, and an additional $30 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.
Indebtedness.
During 2003, CNL-Capital used the "net spread" earned to pay operating expenses
and used borrowings on its warehouse facilities to fund new real estate
originations. CNL-Capital has continued to reduce its warehouse credit capacity
to align triple-net lease financing opportunities to its financing capacity
requirements and to reduce its overall financing costs. The Company reduced its
warehouse credit capacity from $385 million at December 31, 2002 to $260 million
at December 31, 2003 thereby realizing economies from the reduced capacity.
CNL-Capital may be subject to margin calls on its warehouse credit facilities.
The Bank and the other lenders monitor delinquency assumptions and may require
one or more margin calls to reduce the level of warehouse financing. During the
years ended December 31, 2003, 2002 and 2001, CNL-Capital made $10.1 million,
$16.8 million and $21.3 million in margin calls.
CNL-Capital has the following borrowing sources at December 31, 2003, with the
stated total capacity and interest rate:
In thousands
Amount used Capacity Maturity Interest rate (4)
----------------- ------------- --------------- -------------------
Note payable (medium term financing) (1) $ 181,955 $ 181,955 Jun 2007 2.53%
Mortgage warehouse facilities (1)(2) 93,513 260,000 Annual 2.53%
Subordinated note payable 43,750 43,750 June 2007 8.50%
Series 2001-4 bonds payable (3) 38,921 38,921 2009 - 2013 8.90%
----------------- -------------
$ 358,139 $ 524,626
================= =============
(1) Average rate excludes the impact of hedge transactions that bring the total
average rate to 6.13 percent on the medium term financing and 3.41 percent
on the warehouse facilities.
(2) In December 2003, CNL-Capital lowered the borrowing capacity on one of its
mortgage warehouse facilities from $260 million to $160 million because it
did not require the full capacity and extended the maturity date on this
facility to March 2004 pending further negotiations with the Bank. In March
2004, CNL-Capital renewed this facility through March 2005. The second
mortgage warehouse facility of $100 million matures in June 2004.
(3) Includes $4,983 in bonds held by CNL-Investments eliminated upon
consolidation in Company financial statements.
(4) Excludes debt issuance and other related costs.
Note Payable. In June 2002, in order to repay warehouse financing, CNL-Capital
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. The transaction provides CNL-Capital earnings on the
excess of interest income over interest expense. 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.
Mortgage Warehouse Facilities. 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 92.2 percent of the original real estate value.
Company warehouse borrowings were initially designed to provide interim
financing until periodic securitizations could occur. In forming the alliance
with the Bank in 2000, the Bank provided a warehouse credit facility (the
"Warehouse Credit Facility") with an initial capacity of $500 million. The
instability of the securitization markets led to renegotiated terms of the
relationship with the Bank in October 2001, including the need to remove certain
loans held as collateral on the Warehouse Credit Facility and the requirement
that CNL-Investments guarantee a portion of the repayments. As part of the
renegotiations, the Bank agreed to finance the remaining loans held as
collateral on the Warehouse Credit Facility until December 2003.
In December 2003, CNL-Capital removed the remaining loans on the Warehouse
Credit Facility by selling them to CNL-Investments, the real estate segment of
the Company. CNL-Investments combined these loans with loans it previously owned
and issued $24.9 million of notes collateralized by approximately $46.6 million
of mortgage loans. The Company re-designated the loans previously held in the
Warehouse Credit Facility to reflect the Company's intention to hold them to
maturity and terminated the swap hedging these loans. This financing carries a
variable interest rate of LIBOR plus 4.50 percent. This transaction enabled
CNL-Capital to repay the warehouse financing and eliminated a $2 million
guaranty previously provided by CNL-Investments on the mortgage loans. The
transaction also provides the Company ongoing earnings on the excess of interest
income over interest expense under the refinancing.
In mid December 2003, CNL-Capital renewed the December 2003 maturity date on the
Warehouse Credit Facility through March 2004, pending further negotiations with
the Bank. As part of the renewal, CNL-Capital reduced the $260 million capacity
to $160 million and agreed to a 15 basis point unused fee on this facility, and
the Bank agreed to finance the remaining loans until March 2004. In March 2004,
CNL-Capital renewed this facility through March 2005. The second mortgage
warehouse facility of $100 million with another lender matures in June 2004.
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. At December 31,
2003, CNL-Capital had approximately $94 million in capital supporting its loan
and lease portfolio.
Subordinated Note Payable. In forming the alliance with the Bank during 2000,
the Bank provided CNL-Capital with a $43.75 million subordinated debt facility
(the "Subordinated Debt Facility"). In late December 2003, CNL-Capital removed
the remaining loans on the Warehouse Credit Facility by selling them to
CNL-Investments. In January 2004, CNL-Capital used these proceeds along with
additional funds, to repay the Bank $10 million on the Subordinated Debt
Facility. As part of the repayment, CNL-Capital and the Bank modified the terms
of the Subordinated Debt Facility. CNL-Capital extended the maturity date on the
Subordinated Debt Facility from June 2007 to December 2008 and reduced the
interest rate from 8.50 percent to 7.00 percent per annum. Under the new terms,
CNL-Capital will make a mandatory repayment of $11.875 million on this facility
by December 31, 2004. CNL-Capital will then make quarterly payments of principal
and interest to the Bank using a five-year amortization schedule beginning March
2005 with a balloon payment due on December 31, 2008. As part of the
negotiations, the Bank eliminated a previous restriction on CNL-Capital to pay
down the Subordinated Debt Facility for every dollar distributed by CNL-Capital
to the Company. In addition, the Company agreed to provide a guaranty on the
entire amount outstanding under the Subordinated Debt Facility as part of the
renegotiations. Prior to the renegotiations, only CNL-Capital had provided a
guaranty on the Subordinated Debt Facility.
Bonds Payable. In May 2001, CNL-Capital issued bonds collateralized by a pool of
mortgages (the "Series 2001-4 Bonds). The proceeds of $42.1 million were applied
to pay down short-term debt. At December 31, 2003, 60 mortgage loans served as
collateral for the bonds which had a carrying value of approximately $45.8
million as of December 31, 2003. The offering resulted in an initial weighted
average life of approximately 7.8 years and a rate of interest of approximately
8.90 percent per annum. The bond indenture requires monthly principal and
interest payments received from borrowers to be applied to the bonds. The bond
indenture also provides for an optional redemption of the bonds at their
remaining principal balance when the remaining amounts due under the loans that
serve as collateral for the bonds are less than 10 percent of the aggregate
amounts due under the loans at the time of issuance.
Some 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.
Liquidity Risks.
Tenants or borrowers that are experiencing financial difficulties could impact
CNL-Capital's ability to generate adequate amounts of cash to meet its needs. In
the event the financial difficulties persist, CNL-Capital's collection of
interest and principal payments could be interrupted. At present, most of these
borrowers continue to pay principal and interest substantially in accordance
with loan terms. However, CNL-Capital continues to monitor each borrower's
situation carefully and will take appropriate action to place CNL-Capital in a
position to maximize the value of its investment.
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 note 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 for these specific assets. 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.
For those borrowers who have experienced financial difficulties or who have
defaulted under their loans, management has estimated the loss or impairment on
the related investments and included such charge in earnings through December
31, 2003. However, management 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 appropriate
reserves at December 31, 2003 based on an assessment of specific borrowers'
financial difficulties, facts may develop in future periods that may suggest the
need for larger reserve charges.
As of March 12, 2004, CNL-Capital is under negotiations to provide temporary
debt service relief to a borrower/tenant who is experiencing liquidity
difficulties. CNL-Capital anticipates lowering the interest rate over the next
twelve months on eight mortgage loans to provide the necessary debt service
relief to the borrower/tenant. Repayment terms would go back to the original
terms starting with the thirteenth month. This temporary debt service relief
will have a $1.5 million negative impact to cash flows of CNL-Capital over the
next twelve months. Management does not believe that this temporary decline in
cash flows will have a material adverse effect on the overall liquidity of the
Company.
Additional liquidity risks include the possible occurrence of economic events
that could have a negative impact on the franchise securitization market and
affect the quality or perception of the loans or leases underlying CNL-Capital's
previous 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. CNL-Capital holds an interest in the following
securitizations (referred to as the 1998-1 and 1999-1 residual interests), the
assets and liabilities of which are not consolidated in the Company financial
statements:
December 31, 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 $ 192,801 $ 191,144
Loans and debt supporting 1999-1 Certificates issued by CNL
Funding 1999-1, LP $ 229,044 $ 229,044
-----------------------------------------
$ 421,845 $ 420,188
=========================================
(1) Certain bonds in both the 1998-1 and 1999-1 pools are owned by
CNL-Investments; the aggregate amount of these bonds of $27,563 appears as
investments in the consolidated financial statements of the Company.
Management believes that the Investment Property Sales Program will continue to
be successful, but not without risks. 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. 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.
o Real Estate Segment (CNL-Investments)
CNL-Investments' demand for funds are predominantly interest expense, operating
expenses, reinvestment of disposition proceeds and distributions to the Company.
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 had cash and cash equivalents of $4.4 million, $5.3 million and
$10.2 million at December 31, 2003, 2002 and 2001, respectively.
CNL-Investments' management believes the availability on its line of credit 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 high-yielding investments and cash from
operating activities.
Indebtedness
From time to time, CNL-Investments will borrow amounts available under its
Revolver to fund operating expenses. Borrowing resources at December 31, 2003
for CNL-Investments include:
(In thousands)
Amount Used Capacity Maturity Interest Rate (1)
-------------- -------------- --------------- ------------------
Revolver $ 2,000 $ 30,000 Oct 2004 3.62%
Note payable (2) 605 5,000 2005 4.40%
Series 2000-A bonds payable 252,477 252,477 2009-2017 7.94%
Series 2001 bonds payable 118,690 118,690 Oct 2006 1.70%
Series 2003 bonds payable 24,906 24,906 2005-2010 5.67%
-------------- --------------
$ 398,678 $ 431,073
============== ==============
(1) Excludes debt issuance and other related costs.
(2) CNL-Investments did not renew the remaining $4.4 million available under the
note payable when it matured in January 2004.
CNL-Investments provides a guaranty of up to ten percent of CNL-Capital's five
year term financing. CNL Investments also provides a 100 percent guaranty on
CNL-Capital's Subordinated Debt Facility.
CNL-Investments' short-term debt consists of a $30 million revolving line of
credit (the "Revolver") entered into in October 2001 with the Bank.
CNL-Investments utilizes the Revolver from time to time to manage the timing of
inflows and outflows of cash from operating activities. The Revolver matured in
October 2003, and at that time CNL-Investments exercised its one-year renewal
option.
In January 2003, a subsidiary of CNL-Investments, entered into a Master Credit
Facility Agreement ("the Note Payable") with CNL Bank, an affiliate. The Note
Payable had a total borrowing capacity of $5 million and was established for the
purpose of financing the acquisition and redevelopment of real estate
properties. At December 31, 2003, the Company had $0.6 million outstanding
relating to this Note Payable. Amounts outstanding are collateralized by
mortgages on certain real property, bear interest at LIBOR plus 325 basis points
per annum and require monthly interest only payments until maturity in 2005. The
unused portion of $4.4 million on the credit facility expired in January 2004
and management of CNL-Investment elected not to extend the available capacity.
CNL-Investments also has medium-term note and long-term bond financing, referred
to collectively as bonds payable, that was used to restructure the Company's
indebtedness. Rental income received on 379 properties and interest income
received on 34 mortgage loans and four equipment leases pledged as collateral on
medium and long-term financing is used to make scheduled reductions in bond
principal and interest.
Some 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 could constitute a default and may create an immediate need to find
alternate borrowing sources.
Liquidity Risks
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, CNL-Investments may be required to fund certain expenses in
order to retain control or take possession of the property and its operations.
This could expose CNL-Investments to successor liabilities and further affect
liquidity.
Management is aware of multi-unit tenants that are also experiencing financial
difficulties. In the event the financial difficulties continue, CNL-Investments'
collection of rental payments could be interrupted. At present, most of these
tenants continue to pay rent substantially in accordance with lease terms.
However, CNL-Investments continues to monitor each tenant's situation carefully
and will take appropriate action to place CNL-Investments in a position to
maximize the value of its investment. For those tenants who have experienced
financial difficulties or have defaulted under their leases, management has
estimated the loss or impairment on the related properties and included such
charge in earnings through December 31, 2003. However, management 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 December 31, 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.
In October 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 $56.6
million. As of December 31, 2003, Chevy's has rejected 16 of the 22 leases.
Management has recorded impairments relating to some of these sites and expects
these rejected sites to be re-leased or sold. Chevy's has paid rent on the six
remaining sites since filing bankruptcy in October 2003.
In February 2004, The Ground Round, Inc. ("Ground Round"), a tenant of
CNL-Investments, filed for voluntary bankruptcy under the provisions of Chapter
11. Ground Round operates the Ground Round and Tin Alley Grills concepts.
CNL-Investments owns 12 units, with a total investment of $12.9 million. Ground
Round had closed eight of these sites as of the bankruptcy filing.
CNL-Investments did not collect the February rents but anticipates collecting
the March rents in accordance with bankruptcy provisions. As of March 12, 2004,
Ground Round had neither affirmed nor rejected the 12 leases and CNL-Investments
had determined that no impairment provisions were deemed necessary. Management
will continue to monitor developments surrounding the bankruptcy, including the
potential rejection of some or all of these leases.
As of March 12, 2004, CNL-Investments is under negotiations to provide temporary
rent forbearance to a tenant who is experiencing liquidity difficulties.
CNL-Investments anticipates forbearing the collection of partial rents over the
next twelve months on ten sites to provide the necessary rent relief. Under the
proposed negotiations, the tenant will pay the amounts deferred under the
forbearance agreement over five years. This temporary forbearance on the rents
will have a $1.8 million negative impact to cash flows of CNL-Investments over
the next twelve months but will be collected between months 13 through 72.
CNL-Investments 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. As of December 31, 2003 the Company owned, through an investment
of $1.8 million, the business restaurant operations of twelve Denny's
restaurants that represented a strategic move to preserve the Company's real
estate investment when the franchisee of the restaurants experienced severe
financial difficulties. CNL-Investment has since successfully disposed of the
real estate and plans to sell its investment in the business by the end of 2004.
This activity is not a core operation or competency of the Company and is only
undertaken in situations where management believes the course of action best
preserves the Company's position in the real estate or loan investment.
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 CNL-Investments 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. The Series 2000-A and Series 2001 financings include
certain triggers relating to delinquency percentages or debt service coverage.
If certain ratios are exceeded or not maintained, then principal pay down on the
outstanding bonds is accelerated.
Off-Balance Sheet Transactions
The Company is not dependent on the use of any off-balance sheet financing
arrangements for liquidity. The Company holds a residual interest in
approximately $422 million in loans transferred to unconsolidated trusts that
serve as collateral for the long-term bonds discussed in "Liquidity and Capital
Resources - Specialty Finance Segment (CNL-Capital). Recent accounting
pronouncements have not required the consolidation of these trusts.
Interest Rate Risk
Floating interest rates on variable rate debt expose the Company to interest
rate risk. The Company invests in assets with a fixed return by sometimes
financing a portion of them with variable rate debt. As of December 31, 2003,
the Company's variable rate debt includes the following:
o $2 million on its Revolver;
o $94 million on its mortgage warehouse facilities;
o $182 million on the June 2002 five-year financing;
o $119 million outstanding on the Series 2001 bonds; and
o $25 million outstanding on the Series 2003 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 and leases until the time they are
sold. The Company generally terminates certain of these contracts upon the sale
of the loans or properties, 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 variable cash flows 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 purchase, a third party agrees to assume any interest costs
above a stated rate. Changes in the values of the Company's current 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.
The Company has entered into the following cash flow hedges and interest rate
caps that are outstanding as of December 31, 2003. The net value associated with
these hedges is reflected on the Company's Consolidated Balance Sheets:
Estimated
Value
(Liability)
(in
thousands)
Notional Cap Strike at
Amount (In Price or Trade Maturity December
Type of Hedge Thousands) Swap Rate Date Date 31, 2003
----------------------------- -------------- ------------- ---------- ---------- -----------
Pay Fixed Rate - Receive
Floating Rate Swap $ 144,418 6.590% 6/14/02 3/15/22 $ (10,772 )
Interest Rate Cap 132,000 4.500% 9/28/01 12/25/06 730
Interest Rate Cap 30,000 3.500% 12/17/03 2/1/11 953
Management estimates that a one-percentage point increase in short-term interest
rates for the year ended December 31, 2003 would have resulted in additional
interest costs of approximately $2.7 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.
Critical Accounting Policies
The Company accounts for many asset categories that require management to
exercise extensive judgment and make estimates. Listed below are the more
significant accounting policies that require management judgment and estimates
or are otherwise significant to the results of operations:
o The Company records the acquisition of land, buildings and equipment at
cost, including acquisition, closing and construction period interest
costs. Land and buildings are leased to restaurant operators generally on
a triple-net basis, which means that the tenant is responsible for all
operating expenses relating to the property, including property taxes,
insurance, maintenance and repairs. The property and secured equipment
leases held for investment are accounted for using either the direct
financing or the operating method unless the Company has classified these
properties pursuant to their intent to sell. Management estimates residual
values and collectable rents in determining whether a lease is accounted
for as either direct financing or operating.
o The Company's real estate accounting differs for assets held by its two
operating segments based upon management's intention with respect to such
asset's disposition.
o Real estate held within the real estate segment is generally acquired
with an intention to hold long-term. It is depreciated over its
estimated useful life and rent is recorded giving consideration to
contractual rent increases over the life of the lease. Some real estate
held by this segment may be designated so as to reflect management's
intention to dispose of the asset. In such case all operating income
and expense, including depreciation and accrued rent associated with
future contractual increases, is reflected as a component of
discontinued operations for all periods presented, even for periods
prior to management having stated its intention to sell.
o Real estate held within the specialty finance segment is generally
acquired with an intention to sell within one year. It is therefore not
depreciated, and future contractual rent increases do not impact
earnings. Because of a transition rule, the specialty finance
properties are accounted for differently depending on acquisition date.
All such properties acquired after December 31, 2001 are treated as
discontinued operations, and operating income and expense is reflected
as a component of discontinued operations.
o "Mortgage loans held for sale" were loans originated that the Company
intended to sell or securitize. They were recorded at fair market value
which was estimated using quoted prices, the present value of the expected
cash flows and the estimated impact of any defaults, and may have been
recorded at an amount greater than cost. In December 2003, the Company
re-designated the majority of these loans to reflect the Company's
intention to hold them to maturity and terminated the related derivative
instrument hedging these loans.
o "Mortgage notes receivable" differ from "mortgage loans held for sale"
primarily because of management's intention to hold the mortgage to its
maturity. These financial assets are recorded at the lower of cost or
market. Certain assets have been reclassified from "mortgage loans held
for sale" into the "mortgage notes receivable" category when, in lieu of
selling the mortgages, the Company elects to refinance such mortgages
using longer-term debt. In the case of such reclassified mortgages, the
Company records these at the value on the refinance date. The value at
such date may differ from the par value of the loan with any such
difference being amortized to earnings over the remaining life of the
mortgage loans as a yield adjustment.
o Certain loans originated by the Company were sold to independent trusts
that, in turn, issued securities to investors backed by these assets. The
Company retains the servicing rights and participates in certain cash
flows from the trusts. The present value of expected excess of net cash
flows, after payment of principal and interest to bond or other
certificate holders, over the estimated cost of servicing is recorded at
the time of sale as a retained i