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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-15581
CNL Restaurant Properties, Inc.
(Exact name of registrant as specified in its charter)
Maryland 59-3239115
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
450 South Orange Avenue
Orlando, Florida 32801
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (407) 540-2000
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___
Indicate by checkmark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes X No___
45,248,670 shares of common stock, $0.01 par value, outstanding as of
November 9, 2004.
CONTENTS
Part I Page
----
Item 1.Financial Statements:
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Income 4
Condensed Consolidated Statements of
Stockholders' Equity and Comprehensive
Income/(Loss) 5
Condensed Consolidated Statements of Cash Flows 6-8
Notes to Condensed Consolidated Financial
Statements 9-18
Item 2.Management's Discussion and Analysis of Financial
Condition and Results of Operations 19-37
Item 3.Quantitative and Qualitative Disclosures About
Market Risk 37
Item 4.Controls and Procedures 37-38
Part II
Other Information 39-42
Item 1. Financial Statements
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands except for per share data)
September 30, December 31,
2004 2003
------------------ -----------------
ASSETS
Real estate investment properties $ 537,807 $ 530,692
Net investment in direct financing leases 101,200 103,662
Real estate and restaurant assets held for sale 171,647 143,589
Mortgage loans held for sale 537 1,490
Mortgage, equipment and other notes receivable, net of allowance of
$7,128 and $13,964, respectively 304,627 320,900
Other investments 18,566 29,671
Cash and cash equivalents 17,499 36,955
Restricted cash 12,641 12,462
Receivables, net of allowance for doubtful accounts
of $1,365 and $872, respectively 5,141 3,382
Accrued rental income 28,068 25,836
Goodwill 56,260 56,260
Other assets 32,042 33,217
------------------ -----------------
$ 1,286,035 $ 1,298,116
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Revolver $ 12,000 $ 2,000
Notes payable 164,942 182,560
Mortgage warehouse facilities 135,181 93,513
Subordinated note payable 21,875 43,750
Bonds payable 410,650 430,011
Due to related parties 35,216 25,038
Other payables 35,759 34,096
------------------ -----------------
Total liabilities 815,623 810,968
------------------ -----------------
Minority interests, including redeemable partnership interest 6,637 7,262
Stockholders' equity:
Preferred stock, without par value. Authorized and unissued
3,000 shares -- --
Excess shares, $0.01 par value per share. Authorized and
unissued 78,000 shares -- --
Common stock, $0.01 par value per share. Authorized
62,500 shares, issued 45,286 shares, outstanding
45,249 shares 452 452
Capital in excess of par value 826,627 826,627
Accumulated other comprehensive loss (13,793 ) (14,447 )
Accumulated distributions in excess of net earnings (349,511 ) (332,746 )
------------------ -----------------
Total stockholders' equity 463,775 479,886
------------------ -----------------
$ 1,286,035 $ 1,298,116
================== =================
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands except for per share data)
Quarter ended Nine months ended
September 30, September 30,
2004 2003 2004 2003
------------- ------------- --------------- -------------
Revenues:
Rental income from operating leases $ 14,600 $ 15,860 $ 43,468 $ 46,162
Earned income from direct financing leases 2,544 2,695 7,734 7,924
Interest income from mortgage, equipment and
other notes receivable 6,635 7,361 19,962 22,880
Investment and interest income 1,641 1,199 3,811 3,533
Other income 2,130 3,113 4,633 7,285
Net decrease in value of mortgage loans
held for sale, net of related hedge -- (483 ) -- (2,734 )
------------- ------------- --------------- -------------
27,550 29,745 79,608 85,050
------------- ------------- --------------- -------------
Expenses:
General operating and administrative 6,305 5,635 19,486 20,140
Interest expense 12,246 12,662 36,070 38,233
Property expenses, state and other taxes 219 536 450 1,002
Depreciation and amortization 3,067 3,170 8,822 9,441
Loss on termination of cash flow hedge -- -- 940 --
Impairments and provisions on assets 1,998 1,447 3,479 6,009
------------- ------------- --------------- -------------
23,835 23,450 69,247 74,825
------------- ------------- --------------- -------------
Income from continuing operations before minority interest
in income of consolidated joint ventures, equity in
earnings of unconsolidated joint ventures and
gain/(loss) on sale of assets 3,715 6,295 10,361 10,225
Minority interest in income of consolidated joint ventures (640 ) (78 ) (2,597 ) (1,491 )
Equity in earnings of unconsolidated joint ventures 32 30 97 89
Gain/(loss) on sale of assets 134 (2 ) 140 (8 )
------------- ------------- --------------- -------------
Income from continuing operations, net 3,241 6,245 8,001 8,815
Income from discontinued operations, net of income tax
provision 11,675 6,803 26,985 22,842
------------- ------------- --------------- -------------
Net income $ 14,916 $ 13,048 $ 34,986 $ 31,657
============= ============= =============== =============
Income per share of common stock (basic and diluted):
From continuing operations $ 0.07 $ 0.14 $ 0.18 $ 0.19
From discontinued operations 0.26 0.15 0.59 0.51
------------- ------------- --------------- -------------
Net income $ 0.33 $ 0.29 $ 0.77 $ 0.70
============= ============= =============== =============
Weighted average number of shares of common stock
outstanding 45,249 45,249 45,249 45,249
============= ============= =============== =============
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE
INCOME/(LOSS)
Nine months ended September 30, 2004 and year ended December 31, 2003
(UNAUDITED)
(In thousands except for per share data)
Accumulated
distributions Accumulated
Common stock Capital in in excess other
Number Par excess of of net comprehensive Comprehensive
of shares value par value earnings loss Total income
------------ --------- ------------- -------------- --------------- ----------- --------------
Balance at December 31, 2002 45,249 $ 452 $ 816,745 $ (306,184 ) $ (16,862 ) $ 494,151
Acquisition of minority
interest -- -- 11,375 -- -- 11,375
Stock issuance costs -- -- (1,493 ) -- -- (1,493 )
Net income -- -- -- 42,440 -- 42,440 $ 42,440
Reclassification of market
revaluation on available
for sale securities to
statement of income -- -- -- -- (78 ) (78 ) (78 )
Reclassification of cash flow
hedge losses to
statement of income -- -- -- -- 502 502 502
Current period adjustment to
recognize change in fair
value of cash flow
hedges, net of $1,750 in
tax benefit -- -- -- -- 1,991 1,991 1,991
---------------
Total comprehensive income -- -- -- -- -- -- $ 44,855
===============
Distributions declared and
paid ($1.52 per share) -- -- -- (69,002 ) -- (69,002 )
------------ --------- ------------- ------------- -------------- -----------
Balance at December 31, 2003 45,249 $ 452 $ 826,627 $ (332,746 ) $ (14,447 ) $ 479,886
============ ========= ============= ============= ============== ===========
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE
INCOME/(LOSS)
Nine months ended September 30, 2004 and year ended December 31, 2003
(UNAUDITED)
(In thousands except for per share data)
Accumulated
distributions Accumulated
Common stock Capital in in excess other
Number Par excess of of net comprehensive Comprehensive
of shares value par value earnings loss Total income
------------ --------- ------------- -------------- ---------------- ----------- --------------
Balance at December 31, 2003 45,249 $ 452 $ 826,627 $ (332,746 ) $ (14,447 ) $ 479,886
Net income -- -- -- 34,986 -- 34,986 $ 34,986
Other comprehensive income,
market revaluation on
available for sale
securities -- -- -- -- 3 3 3
Reclassification of cash
flow hedge losses to
statement of income -- -- -- -- 940 940 940
Current period adjustment to
recognize change in fair
value of cash flow
hedges, net of $431 in tax
provision -- -- -- -- (289 ) (289 ) (289 )
--------------
Total comprehensive income -- -- -- -- -- -- $ 35,640
==============
Distributions declared and
paid ($1.14 per share) -- -- -- (51,751 ) -- (51,751 )
------------ --------- ------------- -------------- ---------------- -----------
Balance at September 30, 2004 45,249 $ 452 $ 826,627 $ (349,511 ) $ (13,793 ) $ 463,775
============ ========= ============= ============== ================ ===========
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Nine months ended
September 30,
2004 2003
------------------ -----------------
Cash flows from operating activities:
Net income $ 34,986 $ 31,657
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 9,390 9,995
Amortization of deferred financing costs 4,166 3,401
Impairments and provisions on assets 4,861 12,290
Gain on sales of assets (2,690 ) (1,282 )
Gain on investment in securities (495 ) --
Increase in income taxes payable 5,284 --
Investment in mortgage loans held for sale -- (112 )
Collection on mortgage loans held for sale -- 6,166
Changes in inventories of real estate held for sale (47,725 ) 82,053
Changes in other operating assets and liabilities (5,921 ) (4,687 )
------------------ -----------------
Net cash provided by operating activities 1,856 139,481
------------------ -----------------
Cash flows from investing activities:
Additions to real estate investment properties (13,997 ) --
Proceeds from sale of assets 15,826 15,445
Proceeds from sale of other investments 11,200 --
Increase in restricted cash (180 ) (1,518 )
Collection on mortgage, equipment and other notes
receivable 19,572 14,484
------------------ -----------------
Net cash provided by investing activities 32,421 28,411
------------------ -----------------
Cash flows from financing activities:
Payment of stock issuance costs (1,493 ) (1,493 )
Proceeds from borrowing on revolver 37,000 29,892
Payment on revolver, note payable and subordinated note
payable (66,493 ) (47,686 )
Proceeds from borrowing on mortgage warehouse facilities 185,044 56,040
Payments on mortgage warehouse facilities (143,376 ) (138,639 )
Proceeds from issuance of bonds 5,000 --
Retirement of bonds payable (24,547 ) (14,690 )
Payment of bond issuance and debt refinancing costs (920 ) (450 )
Loans from stockholder 10,900 14,960
Distributions to minority interest (2,339 ) (1,865 )
Distributions to stockholders (52,509 ) (51,752 )
------------------ ------------------
Net cash used in financing activities (53,733 ) (155,683 )
------------------ ------------------
Net (decrease)/increase in cash and cash equivalents (19,456 ) 12,209
Cash and cash equivalents at beginning of period 36,955 16,584
------------------ ------------------
Cash and cash equivalents at end of period $ 17,499 $ 28,793
================== ==================
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(UNAUDITED)
(In thousands)
Nine months ended
September 30,
2004 2003
------------------ -------------------
Supplemental disclosures of cash flow information:
Interest paid $ 33,495 $ 35,836
================== ===================
Interest capitalized $ 17 $ 73
================== ===================
Income taxes paid $ 2,343 $ 4,021
================== ===================
Supplemental disclosures of non-cash investing and financing activities:
Redemption of minority interest in lieu of payment on accounts
receivable $ 894 $ 317
================== ===================
Acquisition of minority interest $ -- $ 11,375
================== ===================
Foreclosure on mortgage notes receivable and acceptance of
underlying real estate collateral $ 452 $ --
================== ===================
Mortgage notes accepted in exchange for sale of properties $ -- $ 400
================== ===================
Notes receivable accepted in exchange for sale of properties $ 3,490 $ --
================== ===================
See accompanying notes to condensed consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and nine months ended September 30, 2004 and 2003
(UNAUDITED)
1. Organization and Nature of Business:
Organization - CNL Restaurant Properties, Inc. ("the Company") was
organized in Maryland in May of 1994, and is the nation's largest
self-advised real estate investment trust ("REIT") focused on the
restaurant industry. The term "Company" includes, unless the context
otherwise requires, CNL Restaurant Properties, Inc. and its majority
owned and controlled subsidiaries. These subsidiaries include CNL
Restaurant Investments, Inc. and CNL Restaurant Capital Corp. The
Company's operations are divided into two business segments. The real
estate segment, operated principally through CNL Restaurant
Investments, Inc. ("CNL-Investments"), owns and manages a portfolio of
primarily long-term triple-net lease properties. CNL-Investments
provides portfolio management, property management and dispositions,
and opportunistically acquires real estate investments for sale. In
addition, CNL-Investments services approximately $501 million in
affiliate real estate portfolios and earns management fees related
thereto. The specialty finance segment is operated through the
Company's wholly-owned subsidiary CNL Restaurant Capital Corp.
("CNL-Capital"), a partnership with Bank of America, N.A. (the "Bank")
and CNL/CAS Corp., an affiliate of the Company's Chairman. CNL-Capital
offers real estate financing, advisory and other services to national
and larger regional restaurant operators. It acquires restaurant real
estate properties, which are subject to triple-net lease, utilizing
short-term debt and generally sells the properties at a profit.
Effective January 1, 2004, the Bank redeemed a portion of its ownership
interest in CNL-Capital in lieu of payment of referral fees to the
Company. As a result, the Company's ownership interest in CNL-Capital
increased from 96.26 percent to 96.97 percent.
2. Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the instructions to Form 10-Q and
do not include all of the information and note disclosures required by
generally accepted accounting principles. The financial statements
reflect all adjustments consisting of normal recurring adjustments
which, in the opinion of management, are necessary to a fair statement
of the results for the interim periods presented. Operating results for
the quarter and nine months ended September 30, 2004 may not be
indicative of the results that may be expected for the year ending
December 31, 2004. Amounts as of December 31, 2003, included in the
financial statements, have been derived from audited financial
statements as of that date. These unaudited financial statements should
be read in conjunction with the financial statements and notes thereto
included in the Company's Form 10-K for the year ended December 31,
2003. Certain items in the prior period's financial statements have
been reclassified to conform with the 2004 presentation. These
reclassifications had no effect on stockholders' equity or net income.
3. Real Estate Investment Properties:
During the nine months ended September 30, 2004 and 2003, the Company
recorded provisions for impairments of $2.2 million and $1.6 million,
respectively. The tenants of these properties experienced financial
difficulties and/or ceased payments of rents under the terms of their
lease agreements. The provisions represent the amount necessary to
reduce the carrying value of the properties to their estimated fair
value.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and nine months ended September 30, 2004 and 2003
(UNAUDITED)
4. Real Estate and Restaurant Assets Held for Sale:
Real estate and restaurant assets held for sale consists of the
following:
(In thousands)
September 30, December 31,
2004 2003
----------------- -------------------
Land and buildings $ 170,605 $ 141,976
Restaurant assets 1,042 1,613
----------------- -------------------
$ 171,647 $ 143,589
================= ===================
CNL-Capital actively acquires real estate assets subject to leases with
the intent to sell. In accordance with Statement of Financial
Accounting Standard No. 144 "Accounting for the Impairment or Disposal
of Long-Lived Assets", the properties' operating results and the gains
or losses resulting from the disposition of properties are recorded as
discontinued operations.
In addition to its business of investing in restaurant properties
subject to triple-net leases, CNL-Investments will divest properties
from time to time when it is strategic to the Company's longer-term
goals. When CNL-Investments establishes its intent to sell a property,
all operating results relating to the properties and the ultimate gain
or loss on disposition of the properties are treated as discontinued
operations for all periods presented. During 2002, the Company
purchased the operations of certain restaurants. In December 2003, the
Company decided to dispose of these restaurant operations. As a result,
all operating results relating to these restaurant operations are
recorded as discontinued operations for all periods presented.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and nine months ended September 30, 2004 and 2003
(UNAUDITED)
4. Real Estate and Restaurant Assets Held for Sale - Continued:
Operating results of discontinued operations are as follows:
(In thousands)
Quarters ended Nine months ended
September 30, September 30,
2004 2003 2004 2003
------------ -------------- ------------- -------------
Rental income $ 3,905 $ 2,521 $ 9,324 $ 10,214
Food and beverage income 3,549 3,392 11,106 10,324
Food and beverage expenses (3,839 ) (3,144 ) (11,564 ) (10,077 )
Other property related expenses (302 ) (17 ) (664 ) (1,119 )
Interest expense (1,085 ) (503 ) (2,575 ) (1,721 )
Impairment and provisions on assets (603 ) (2,865 ) (1,382 ) (6,281 )
------------ -------------- ------------- -------------
Earnings/(loss) from discontinued
operations 1,625 (616 ) 4,245 1,340
------------ -------------- ------------- -------------
Sales of real estate 97,619 59,260 224,088 179,758
Cost of real estate sold (83,177 ) (51,841 ) (193,722 ) (158,256 )
------------ -------------- ------------- -------------
Gain on disposal of discontinued
operations 14,442 7,419 30,366 21,502
------------ -------------- ------------- -------------
Income tax provision (4,392 ) -- (7,626 ) --
------------ -------------- ------------- -------------
Income from discontinued operations,
net $ 11,675 $ 6,803 $ 26,985 $ 22,842
============ ============== ============= =============
5. Other Investments:
The Company holds franchise loan investments arising from
securitization transactions which were either purchased from affiliates
or retained in connection with a transaction executed by the Company.
Prior to the quarter ended September 30, 2004, the Company classified
these investments for which it had the positive intent and ability to
hold to maturity as held-to-maturity securities and recorded them at
amortized cost in other investments. Investments in these securities
not classified as either held-to-maturity or trading securities were
classified as available-for-sale securities. Available-for-sale
securities are recorded at fair value in other investments on the
balance sheet, with the change in fair value during the period excluded
from earnings and recorded as a component of other comprehensive
income.
During September 2004, the Company accepted an unsolicited offer to
sell certain franchise loan investments, originally classified as held
to maturity, to a third party for $11.2 million, resulting in a gain on
sale of approximately $0.1 million. As a result of the sale, the
Company redesignated the remaining $16.2 million in franchise loan
investments originally classified as investments held to maturity, to
investments available for sale. As a result of the redesignation, the
Company recorded the change in the fair value of these redesignated
franchise loan investments as a component of other comprehensive
income.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and nine months ended September 30, 2004 and 2003
(UNAUDITED)
5. Other Investments - Continued:
The carrying amounts of these investments, including accrued interest,
consist of the following:
(In thousands)
September 30, December 31,
2004 2003
----------------- -------------------
Held to maturity $ -- $ 27,442
Available-for-sale 18,566 2,229
----------------- -------------------
$ 18,566 $ 29,671
================= ===================
6. Borrowings:
In January 2004, the Company amended its subordinated note payable
agreement with the Bank, made a $10 million prepayment, reduced the
balance to $33.75 million, reduced the interest rate from 8.50 percent
to 7.00 percent per annum and reduced the Bank's ownership from the
conversion feature in CNL-Capital from 13.1 percent to 10.11 percent.
In September 2004, the Company repaid $11.88 million, which under the
amended terms was due by December 31, 2004, and further reduced the
Bank's potential ownership through the conversion feature in
CNL-Capital to 6.55 percent. The subordinated note will amortize over
five years beginning March 2005 with a balloon payment due on December
31, 2008.
As of December 31, 2003, the Company, through CNL-Capital, maintained a
$100 million and a $160 million mortgage warehouse facility. In March
2004, the $160 million mortgage warehouse facility was renewed with
similar terms until March 2005. Under this facility the Bank finances
property acquisitions at an advance rate of up to 97 percent of the
real estate purchase price. In May 2004, the $100 million warehouse
facility was renewed until June 2005. The amended agreement increased
the facility advance rate for real estate acquisitions from 90 percent
to 92 percent of the real estate purchase value. All other material
terms on this warehouse facility remained unchanged.
In May 2004, the Company issued an additional $5 million note from its
Series 2003 offering that had closed in December 2003. The note is
collateralized by a pool of mortgage notes, bears interest at LIBOR
plus 600 basis points and is expected to mature in 2011.
In June 2004, CNL-Investments amended the terms of the Revolver to
extend the maturity date to July 2005. In September 2004,
CNL-Investments amended the terms and increased the capacity from $30
million to $40 million. All other material terms of the Revolver
remained unchanged.
7. Related Party Transactions:
During the nine months ended September 30, 2004, CNL Financial Group,
Inc., a stockholder, advanced an aggregate of approximately $10.9
million to the Company in the form of demand balloon promissory notes.
The notes are uncollateralized, bear interest at LIBOR plus 2.5 percent
with interest payments and outstanding principal due upon demand. At
September 30, 2004, $35.4 million in total demand loans, including
accrued interest, are outstanding and included in the due to related
parties caption on the condensed consolidated balance sheet.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and nine months ended September 30, 2004 and 2003
(UNAUDITED)
7. Related Party Transactions - Continued:
During the nine months ended September 30, 2004, the Company paid real
estate brokerage fees of $0.1 million to CNL Commercial Net Lease
Realty, Inc., an affiliate of the Chairman and Vice Chairman of the
Company's Board of Directors in conjunction with the sale of a property
to an unrelated third party that resulted in a gain on sale of $1.5
million to the Company.
During the nine months ended September 30, 2004, the Company paid
environmental research and management fees of $0.1 million to Handex
Environmental, Inc. a member of a limited liability company affiliated
with the Company.
As of September 30, 2004 the Company was in the process of negotiating
a sale of its interest in a subsidiary engaged in restaurant operations
to CherryDen, LLC, an affiliate of the Chairman and Vice Chairman of
the Board of Directors. The Company originally acquired the operations
upon a tenant experiencing financial difficulties in an effort to
preserve the value of the underlying restaurant real estate. The
proceeds from the sale are anticipated to be approximately $0.7
million. The subsidiary has experienced cumulative operating losses
since acquisition and the Company has recorded a loss of approximately
$0.4 million relating to the difference between the estimated sale
proceeds and the carrying value of its investment in and loans to the
subsidiary. Upon the sale of the subsidiary, the Company will recognize
approximately $0.9 million in gains on the previous sales of real
estate used in its restaurant operations. In anticipation of the
proposed sale, CherryDen, LLC, paid a refundable deposit of $0.2
million to the subsidiary.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and nine months ended September 30, 2004 and 2003
(UNAUDITED)
8. Segment Information:
The following tables summarize the operating results for the Company's
two business segments. Consolidating eliminations and other results of
the parent of CNL-Investments and CNL-Capital are reflected in the
"other" column.
Quarter ended September 30, 2004
(In thousands)
CNL- Consolidated
Investments CNL-Capital Other Totals
------------- --------------- ------------- --------------
Revenues $ 20,345 $ 8,133 $ (928 ) $ 27,550
------------- --------------- ------------- --------------
General operating and administrative 1,705 5,070 (470 ) 6,305
Interest expense 7,441 4,657 148 12,246
Property expenses, state and other taxes 219 -- -- 219
Depreciation and amortization 2,821 246 -- 3,067
Impairments and provisions on assets 1,696 302 -- 1,998
Minority interest net of equity in
earnings 2 606 -- 608
Gain on sale of assets (134 ) -- -- (134 )
------------- --------------- ------------- --------------
13,750 10,881 (322 ) 24,309
------------- --------------- ------------- --------------
Discontinued operations:
Income from discontinued
operations, net of income tax 1,946 9,729 -- 11,675
------------- --------------- ------------- --------------
Net income $ 8,541 $ 6,981 $ (606 ) $ 14,916
============= =============== ============= ==============
Assets at September 30, 2004 $ 788,998 $ 499,731 $ (2,694 ) $ 1,286,035
============= =============== ============= ==============
Investments accounted for under the
equity method at September 30, 2004 $ 995 $ -- $ -- $ 995
============= =============== ============= ==============
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and nine months ended September 30, 2004 and 2003
(UNAUDITED)
8. Segment Information - Continued:
Quarter ended September 30, 2003
(In thousands)
CNL- Consolidated
Investments CNL-Capital Other Totals
------------- --------------- ------------ ----------------
Revenues $ 21,636 $ 8,935 $ (826 ) $ 29,745
------------- --------------- ------------ ----------------
General operating and administrative 1,705 4,561 (631 ) 5,635
Interest expense 6,857 5,932 (127 ) 12,662
Property expenses, state and other taxes 524 12 -- 536
Depreciation and amortization 2,867 303 -- 3,170
Impairments and provisions on assets (115 ) 1,562 -- 1,447
Minority interest net of equity in
earnings 20 28 -- 48
Loss/(Gain) on sale of assets (2 ) 4 -- 2
------------- --------------- ------------ ----------------
11,856 12,402 (758 ) 23,500
------------- --------------- ------------ ----------------
Discontinued operations:
Income/(loss) from discontinued
operations, net of income tax (1,736 ) 8,539 -- 6,803
------------- --------------- ------------ ----------------
Net income $ 8,044 $ 5,072 $ (68 ) $ 13,048
============= =============== ============ ================
Assets at September 30, 2003 $ 802,177 $ 468,060 $ (4,759 ) $ 1,265,478
============= =============== ============ ================
Investments accounted for under the
Equity method at September 30, 2003 $ 1,079 $ -- $ -- $ 1,079
============= =============== ============ ================
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and nine months ended September 30, 2004 and 2003
(UNAUDITED)
8. Segment Information - Continued:
Nine months ended September 30, 2004
(In thousands)
CNL- Consolidated
Investments CNL-Capital Other Totals
------------- --------------- ------------ ----------------
Revenues $ 59,890 $ 22,061 $ (2,343 ) $ 79,608
------------- --------------- ------------ ----------------
General operating and administrative 6,079 14,918 (1,511 ) 19,486
Interest expense 21,805 14,067 198 36,070
Property expenses, state and other taxes 450 -- -- 450
Depreciation and amortization 8,204 618 -- 8,822
Loss on termination of cash flow hedge -- 940 -- 940
Impairments and provisions on assets 2,819 660 -- 3,479
Minority interest net of equity in
earnings 33 2,467 -- 2,500
Gain on sale of assets (140 ) -- -- (140 )
------------- --------------- ------------ ----------------
39,250 33,670 (1,313 ) 71,607
------------- --------------- ------------ ----------------
Discontinued operations:
Income from discontinued
operations, net of income tax 3,256 23,729 -- 26,985
------------- --------------- ------------ ----------------
Net income $ 23,896 $ 12,120 $ (1,030 ) $ 34,986
============= =============== ============ ================
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and nine months ended September 30, 2004 and 2003
(UNAUDITED)
8. Segment Information - Continued:
Nine months ended September 30, 2003
(In thousands)
CNL- Consolidated
Investments CNL-Capital Other Totals
------------- --------------- ------------ ----------------
Revenues $ 64,087 $ 23,361 $ (2,398 ) $ 85,050
------------- --------------- ------------ ----------------
General operating and administrative 7,616 14,338 (1,814 ) 20,140
Interest expense 20,712 18,018 (497 ) 38,233
Property expenses, state and other taxes 1,002 -- -- 1,002
Depreciation and amortization 8,653 788 -- 9,441
Impairments and provisions on assets 1,403 4,606 -- 6,009
Minority interest net of equity in
earnings 74 1,328 -- 1,402
Loss on sale of assets -- 8 -- 8
------------- --------------- ------------ ----------------
39,460 39,086 (2,311 ) 76,235
------------- --------------- ------------ ----------------
Discontinued operations:
Income/(loss) from discontinued
operations, net of income tax (2,078 ) 24,920 -- 22,842
------------- --------------- ------------ ----------------
Net income $ 22,549 $ 9,195 $ (87 ) $ 31,657
============= =============== ============ ================
9. Income Tax:
The Company elected to be taxed as a REIT under the Internal Revenue
Code. To qualify as a REIT, the Company must meet a number of
organizational and operational requirements, including a current
requirement that it distribute at least 90 percent of its taxable
income to its stockholders. As a REIT, the Company generally is not
subject to corporate level federal income tax on net income it
distributes to its stockholders, except for taxes applicable to its
taxable REIT subsidiaries ("TRSs").
The Company has two TRSs for income tax purposes, in which activities
of CNL-Capital and select activities of CNL-Investments are conducted.
The CNL-Capital TRS recorded a current income tax provision of $4.4
million and $7.6 million during the quarter and nine months ended
September 30, 2004, respectively, all of which was allocated to
discontinued operations. The effective tax rate used by CNL-Capital
approximated the statutory rate. No income tax provision was recorded
during the quarter and nine months ended September 30, 2003 as a result
of the recognition of deferred tax assets previously subject to
valuation allowances.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and nine months ended September 30, 2004 and 2003
(UNAUDITED)
9. Income Tax: - Continued:
As of September 30, 2004, the CNL-Investments TRS had a deferred tax
asset of $0.6 million. This TRS has not yet consistently generated any
taxable income. Therefore, CNL-Investments has established a valuation
allowance to completely offset its deferred tax asset.
Recently, the Company concluded that certain loans, which when made by
the Company in 1998 satisfied the REIT qualification requirements then
applicable, may fail to meet subsequent REIT qualification
requirements. To eliminate any uncertainty, the Company is in the
process of seeking assurance from the Internal Revenue Service ("IRS")
that the loans would not cause the Company to fail to qualify as a
REIT. Although action by the IRS is discretionary, the Company, after
consulting with its outside tax counsel and based upon current
discussions with the IRS and upon actions taken by the IRS in similar
circumstances, believes that such assurance will be granted.
10. Merger Agreement:
On August 9, 2004, the Company announced that it had entered into a
definitive Agreement and Plan of Merger with U.S. Restaurant
Properties, Inc. ("USRP"), a publicly traded real estate investment
trust, which as of August 9, 2004 owned or financed 789 freestanding,
net lease properties located in 48 states (the "Merger"). In the
Merger, each share of Company common stock will be converted into
0.7742 shares of USRP common stock and 0.16 newly issued shares of
USRP's 7.5 percent Series C Redeemable Convertible Preferred Stock ($25
liquidation preference). The exchange ratio is not subject to change
and there is no "collar" or minimum trading price for the shares of the
Company's common stock or USRP's common stock. The Merger is structured
to be tax-free to the stockholders of the Company and USRP.
The Merger is subject to certain conditions including approval by a
majority of the stockholders of the Company and USRP, and the
consummation of a minimum number of mergers between USRP and 18
affiliated limited partnerships representing at least 75 percent of the
aggregate purchase price for all of the limited partnerships. The
general partners of the 18 affiliated limited partnerships are
directors of the Company. The transaction is expected to be consummated
in the first quarter of 2005, but there can be no assurance that the
merger will be consummated by such time or at all.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following information, including, without limitation, the Quantitative and
Qualitative Disclosures About Market Risk that are not historical facts, may be
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These
statements generally are characterized by the use of terms such as "believe,"
"expect" and "may." Although the Company (as defined below) 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 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. (the "Company"), is the nation's largest
self-advised real estate investment trust ("REIT") focused on the restaurant
industry. The Company has two primary subsidiary operating companies, CNL
Restaurant Investments, Inc. and CNL Restaurant Capital Corp. The Company was
founded in 1994 and at September 30, 2004, had financial interests in
approximately 1,000 properties diversified among more than 116 restaurant
concepts in 43 states. The Company's total real estate holdings subject to lease
(including properties classified as held for sale) include over 653 properties.
At September 30, 2004, the servicing portfolio of net lease properties and
mortgages consists of approximately 2,100 units, of which over 1,100 are
serviced on behalf of third parties.
The Company operates two business segments - real estate and specialty finance
o The real estate segment ("CNL-Investments"), operated through the
Company's wholly-owned subsidiary CNL Restaurant Investments,
Inc., manages a portfolio of primarily long-term triple-net lease
properties. CNL-Investments provides portfolio management,
property management and dispositions, and opportunistically
acquires real estate investments for sale. In addition,
CNL-Investments services approximately $501 million in affiliate
real estate portfolios and earns management fees related thereto.
Revenues from CNL-Investments represented approximately 75 percent
of the Company's total revenues from continuing operations for
each of the nine months ended September 30, 2004 and 2003,
respectively.
o The specialty finance segment consists of CNL Restaurant Capital,
LP ("CNL-Capital"), which is operated through a partnership with
the Company's wholly-owned subsidiary CNL Restaurant Capital
Corp., CNL/CAS Corp., an affiliate of the Company's Chairman, and
Bank of America ("the Bank"). CNL-Capital offers real estate
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 CNL-Capital from its
loan portfolio, advisory and other services represented
approximately 25 percent of the Company's total revenues from
continuing operations for each of the nine months ended September
30, 2004 and 2003, respectively.
When the Company was created in 1994, the intent was to provide stockholders
with liquidity by December 31, 2005 through either listing on a national
exchange, merging with another public company or liquidating its assets. In
furtherance of this goal, on August 9, 2004, the Company announced that it had
entered into a definitive Agreement and Plan of Merger with U.S. Restaurant
Properties, Inc. ("USRP"), a publicly traded real estate investment trust, which
as of August 9, 2004, owned 789 freestanding, net lease properties located in 48
states (the "Merger"). In the Merger, each share of Company common stock will be
converted into 0.7742 shares of USRP common stock and 0.16 newly issued shares
of USRP's 7.5 percent Series C Redeemable Convertible Preferred Stock ($25
liquidation preference). The exchange ratio is not subject to change and there
is no "collar" or minimum trading price for the shares of the Company's common
stock or USRP's common stock. The Merger is expected to be tax-free to the
stockholders of the Company and USRP.
The Merger is subject to certain conditions including approval by a majority of
the stockholders of the Company and USRP, and the consummation of a minimum
number of mergers between USRP and 18 affiliated limited partnerships
representing at least 75 percent of the aggregate purchase price for all of the
limited partnerships. The general partners of the 18 affiliated limited
partnership are directors of the Company. The transaction is expected to be
consummated in the first quarter of 2005, but there can be no assurance that the
merger will be consummated by such time or at all.
The Company has received opinions from Bank of America Securities and Legg Mason
Wood Walker, Incorporated that, as of August 9, 2004, the merger consideration
to be received by the stockholders of the Company is fair from a financial point
of view.
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 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 and
CNL-Capital, issuance of debt and sales of common and/or preferred stock.
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. Through the
end of the first quarter of 2004, distributions had been primarily funded by
CNL-Investments' activities because the Company and the others Partners of
CNL-Capital had elected to reinvest the earnings of CNL-Capital, with the
remainder being funded by the Company's Chairman through a privately held
affiliate. CNL-Capital began making distributions to the Company in the second
quarter of 2004.
The Company has elected to distribute amounts in excess of that necessary to
qualify as a REIT. The Company declared distributions of $51.8 million or $1.14
per share to its stockholders for each of the nine months ended September 30,
2004 and 2003. The Company's cash provided by operations was $1.9 million and
$139.5 million for the nine months ended September 30, 2004 and 2003,
respectively. Because increases in assets held for sale are funded through
warehouse facilities, management believes that a better indicator of liquidity
generated from operations would exclude the changes in the held for sale loans
and real estate portfolio. Net cash provided by operating activities excluding
changes in mortgage loans and inventories of real estate held for sale was $49.6
million and $51.4 million for the nine months ended September 30, 2004 and 2003,
respectively.
Beginning in 2001, the Board of Directors of the Company made the determination
that it was in the best interests of the Company's stockholders to maintain its
historical level of distributions during a period of volatility in the
restaurant finance sector. While not necessary for REIT tax purposes, to enable
the Company to maintain its historical level during this period, CNL Financial
Group, Inc., a stockholder controlled by James M. Seneff, Jr., the Company's
Chairman, provided loans to and purchased common stock of the Company. During
the nine months ended September 30, 2004 and 2003, these loans totaled $10.9
million and $15.0 million, respectively. The principal amount including accrued
interest at September 30, 2004 was $35.4 million. In addition, during 2002 and
2001, Mr. Seneff, through CNL Financial Group, Inc., purchased 1,173,354 shares
and 579,722 shares, respectively, of CNLRP stock in exchange for $20.1 million
and $9.7 million, respectively, in cash, including the conversion of amounts
previously treated as advances. The Company's Chairman was not obligated to make
loans or purchase shares and will not make any further loans or purchases of
stock to fund distributions once the Merger is completed. 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.
Recently, the Company concluded that certain loans, which when made by the
Company in 1998 satisfied the REIT qualification requirements then applicable,
may fail to meet subsequent REIT qualification requirements. To eliminate any
uncertainty, the Company is in the process of seeking assurance from the
Internal Revenue Service ("IRS") that the loans would not cause the Company to
fail to qualify as a REIT. A failure by the Company to qualify as a REIT would
substantially increase the Company's federal income tax liability and,
therefore, would have a material adverse effect upon the Company's results of
operations, its financial condition, and its ability to pay dividends. Although
action by the IRS is discretionary, the Company, after consulting with its
outside tax counsel and based upon current discussions with the IRS and upon
actions taken by the IRS in similar circumstances, believes that such assurance
will be granted.
CNL-Capital
CNL-Capital's current demand for funds includes payment of operating expenses,
funds necessary for net lease originations to be sold in its Investment Property
Sales Program (as defined below) and payment of principal and interest on its
outstanding indebtedness. Demand for funds increased during 2004 to cover the
$224.4 million of new originations of real estate properties that exceeded the
$197.4 million received from the sales of properties. In addition, CNL-Capital
utilized $10 million in January 2004 to pay down a portion of the Subordinated
Note Payable (as defined below) and modify the existing terms, and in September
2004 paid the $11.88 million due by December 31, 2004 under the modified terms.
CNL-Capital also paid margin calls of $5.8 million during the nine months ended
September 30, 2004 to reduce the level of debt financing as required by the
lenders due to delinquency levels or restructures of mortgage loan payments from
borrowers.
During the nine months ended September 30, 2004 and 2003, CNL-Capital 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 $12.0 million and
$31.9 million at September 30, 2004 and December 31, 2003, respectively.
CNL-Capital's long-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 long-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
The Company's Investment Property Sales Program originated 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 has continued to date
severely limiting the securitization financing channel for the franchise asset
class. Rising delinquencies in securitized loan pools, falling treasury rates,
macroeconomic uncertainties combined with sluggish restaurant sales within
certain concepts all contributed to the volatility. Investors required higher
interest rates on securities issued in securitizations while rating agencies
downgraded the quality of many 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 and lease securitizations to
date have not been subject to any such ratings action.
As a result of the volatility in the securitization market beginning in 2000,
CNL-Capital changed its business focus in 2001 and halted the origination of new
loans. Uncertainty in the franchise asset-backed securitization market led
management to focus originations on its traditional core product of 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 borrowing costs, combined with a
maximum gain on the sale.
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. Restaurant properties acquired
in anticipation of sales through the Investment Property Sales program typically
are leased to tenants at a rate that exceeds the rate a buyer is willing to
accept. However, the Company could experience lower average gains or even losses
on future sales due to declining tenant performance prior to the sale of one of
more properties, a shift in the demand for real estate properties in a
particular region or nationwide or because of other factors that alter the
perceived value of a given property between the time the Company purchases the
property and the time of actual sale. An unexpected rise in interest rates could
increase the yields available on alternative non-real estate investments and may
cause real estate investors to require higher lease rates from tenants. If the
Company is holding a large inventory of properties for sale at such time, the
value of these properties may be impacted. Such a reduction in value could cause
the Company's mortgage warehouse facilities to require more equity enhancement
from the Company. This additional capital requirement along with lower than
expected gains from property sales could adversely affect the Company's
liquidity.
The chart below illustrates cash flows from Investment Property Sales proceeds
and the cost of properties sold as follows:
(In millions)
For the nine months ended
September 30,
2004 2003
-------------- ----------------
Proceeds from Investment Property Sales $ 197.4 $ 161.5
============== ================
Cost of properties sold under the Investment Property
Sales program $ 171.9 $ 141.7
============== ================
Generally accepted accounting principles require that investment properties held
for sale be accounted for as discontinued operations when the operations and
cash flows of the properties will be eliminated from the ongoing operations of
the company as a result of the disposal transaction, and when the company will
not have any significant continuing involvement in the operations of the
properties after the disposal transaction. A significant element of the ongoing
activities of CNL-Capital 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 CNL-Capital (without treating the Investment Property Sales
Program as discontinued operations) for each of the periods presented:
(In millions)
For the quarters ended For the nine months ended
September 30, September 30,
2004 2003 2004 2003
------------- ------------- --------------- ----------------
Revenues:
Sale of real estate $ 89.9 $ 50.0 $ 197.4 $ 161.5
Rental income 3.8 2.0 8.9 7.9
Other revenue items 8.1 9.0 22.3 23.5
------------- ------------- --------------- ----------------
101.8 61.0 228.6 192.9
------------- ------------- --------------- ----------------
Expenses:
Cost of real estate sold 78.4 43.4 171.9 141.7
Interest expense 5.7 6.4 16.6 19.7
Depreciation and amortization 0.3 0.3 0.8 0.8
Other expenses 6.0 5.8 19.6 21.5
------------- ------------- --------------- ----------------
90.4 55.9 208.9 183.7
------------- ------------- --------------- ----------------
Pre-tax income 11.4 5.1 19.7 9.2
Income tax provision (4.4) -- (7.6 ) --
------------- ------------- --------------- ----------------
Net income $ 7.0 $ 5.1 $ 12.1 $ 9.2
============= ============= =============== ================
Management expects continued demand for the Investment Property Sales Program.
Despite selling 101 properties versus 126 properties during the nine months
ended September 30, 2004 and 2003, respectively, gains per property sold were
higher in 2004 versus 2003. The success of the Investment Property Sales
business is dependent on successfully originating new triple-net leases and the
continued liquidity of the 1031 exchange marketplace. For the nine months ended
September 30, 2004 and 2003, CNL-Capital originated $224.4 million and $56.6
million in net leases respectively. Management expects continued demand for its
core triple-net lease financing during the rest of 2004 and into 2005 but
acknowledges that the demand is impacted by low interest rates and the following
factors:
o Identified lease transactions have been lost to competitors
offering mortgage debt financing. With low prevailing interest
rates, large national and regional banks have offered less
expensive 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 provides referrals of mortgage debt
transactions to the Bank and earns a fee for these referrals.
Management continues to monitor the potential re-emergence of a
mortgage loan product, but does not expect this market to be
viable in the near term.
o Various real estate brokerage firms compete against CNL-Capital
and receive a brokerage fee upon the sale of the restaurant
properties. Generally the brokers serve as an intermediary and do
not have capital to ensure certainty of close for the restaurant
operator. CNL-Capital, through its warehouse facilities, is able
to provide that assurance which to date has mitigated this
competitive threat, particularly on the larger transactions. The
threat exists more in the market for smaller transaction sizes
than the typical CNL-Capital prospect.
Management has responded to this slow-down by adjusting net lease rates,
identifying larger transactions and identifying new areas within the selling
process to reduce costs. Net lease originations provide inventory necessary to
execute the Investment Property Sales Program and CNL-Capital typically profits
from the leases while holding them. At September 30, 2004, CNL-Capital was
involved in several opportunities for net lease originations with $38 million
approved for funding and accepted by the client. 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 the nine months ended September 30, 2004, CNL-Capital used proceeds from
sales of properties, its "net spread", servicing and other revenues to pay
operating expenses and used borrowings on its warehouse facilities to fund new
real estate originations. 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 nine months ended September 30, 2004 and 2003,
CNL-Capital made $5.8 million and $1.4 million in margin calls, respectively. Of
the $5.8 million payment in 2004, $5.3 million was required by a lender when
CNL-Capital provided debt service relief to a borrower/tenant who was
experiencing financial difficulties, as described below in "Liquidity Risks."
CNL-Capital has the following borrowing sources at September 30, 2004, with the
stated total capacity and interest rate:
In thousands
Amount used Capacity Maturity Interest rate (3)
----------------- ------------- --------------- -------------------
Note payable (1) $ 164,550 $ 164,550 Jun 2007 2.50%
Mortgage warehouse facilities 135,181 260,000 Annual 2.61%
Subordinated note payable 21,875 21,875 Dec 2008 7.00%
Series 2001-4 bonds payable (2) 30,236 30,236 2009 - 2013 8.90%
----------------- -------------
$ 351,842 $ 476,661
================= =============
(1) Average rate excludes the impact of hedge transactions that bring the
total average rate to 5.78 percent.
(2) Balances include $1.3 million in bonds held by CNL-Investments
eliminated upon consolidation in Company's condensed consolidated
financial statements.
(3) Excludes debt issuance and other related costs.
Note Payable. 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.
Amounts outstanding were $164.6 million and $182.0 million as of September 30,
2004 and December 31, 2003, respectively. The decrease was partially due to
payments of principal in accordance with the debt agreement. The decrease was
also due to the lender requiring the payment of $5.8 million in the form of
margin calls to reduce the level of financing as a result of delinquency levels
or restructures of payments due from borrowers on the underlying collateral. In
accordance with the terms of the Note Payable and related hedging agreements,
CNL-Capital unwound portions of the hedge instrument as a result of the pay
downs from the margin calls, resulting in losses on termination of cash flow
hedge of $0.9 million during 2004.
Mortgage Warehouse Facilities. CNL-Capital's 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 91 percent of the original real estate cost. As of
September 30, 2004, CNL-Capital has two warehouse facilities. The first
warehouse facility is for $160 million with the Bank and matures in March 2005
(the "Warehouse Credit Facility"). The second mortgage warehouse facility of
$100 million with another lender, matures in June 2005. At September 30, 2004,
CNL-Capital had approximately $13.0 million in capital supporting its loan and
lease portfolio financed through its mortgage warehouse facilities. Amounts
outstanding under the mortgage warehouse facilities were $135.2 million and
$93.5 million as of September 30, 2004 and December 31, 2003, respectively. The
increase in the balance outstanding resulted from the new net lease originations
funded by these facilities.
Subordinated Note Payable. During 2000, the Bank provided CNL-Capital with a
$43.75 million subordinated note payable (the "Subordinated Note Payable").
Amounts outstanding were $21.875 million and $43.75 million at September 30,
2004 and December 31, 2003, respectively. In late December 2003, CNL-Capital
removed the remaining loans on the Warehouse Credit Facility by selling them to
CNL-Investments. CNL-Investments then executed a bond offering supported, in
part, by this collateral. In January 2004, CNL-Capital used these proceeds along
with additional funds, to repay the Bank $10 million on the Subordinated Note
Payable. As part of the repayment, CNL-Capital and the Bank modified the terms
of the Subordinated Note Payable. The Bank extended the maturity date on the
Subordinated Note Payable from June 2007 to December 2008 and reduced the
interest rate from 8.50 percent to 7.00 percent per annum. In September 2004,
CNL-Capital repaid $11.88 million on this facility, which under the amended
terms agreed to in January 2004 was due by December 31, 2004. CNL-Capital is
scheduled to 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 requirement for CNL-Capital to pay down the Subordinated Note Payable
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 Note Payable as part of the renegotiations. Prior to the
renegotiations, only CNL-Capital had provided a guaranty on the Subordinated
Note Payable.
Bonds Payable. In May 2001, CNL-Capital issued bonds collateralized by a pool of
mortgages. 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 ten percent of the aggregate amounts due under the
loans at the time of issuance. In September 2004, CNL-Capital retired $3.6
million of these bonds that had been held by CNL-Investments. No gain/loss was
recorded upon retirement of these bonds. Amounts outstanding were $30.2 million
and $38.9 million at September 30, 2004 and December 31, 2003, respectively.
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 alternative borrowing sources.
Liquidity Risks
In addition to the liquidity risks discussed above in connection with the
Investment Property Sales Program, 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 rental payments, and interest and principal
payments could be interrupted. At present, most of these tenants and borrowers
continue to pay rent, principal and interest substantially in accordance with
lease and 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 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 five-year note and its warehouse
facilities 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 require a pay-down in accordance with the
terms of the respective agreements 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 reflected such charge in
the statement of income through September 30, 2004. However, impairment charges
may be required in future periods based upon changing circumstances.
In March 2004, CNL-Capital provided temporary debt service relief to a
borrower/tenant who was experiencing liquidity difficulties. CNL-Capital agreed
to modify the interest rate due on the outstanding debt over the next twelve
months on eight mortgage loans to provide debt service relief. Repayment terms
are scheduled to return to the original terms starting with the thirteenth
month. The mortgage loans receivable from this borrower/tenant serve as
collateral on the Note Payable. As a result of the restructure, and as required
by the lender, the Company paid down approximately $5.3 million under its Note
Payable. This reduction in cash flows from the temporary debt service relief
provided to the borrower/tenant, after consideration of the $5.3 million
reduction in debt outstanding under the Note Payable, is scheduled to have an
approximate $1 million negative impact to cash flows over the twelve month
period ending March 2005. Management does not believe that this temporary
decline in cash flows will have a material adverse effect on overall liquidity.
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, renew its warehouse credit facilities and impact its
ability to engage in future net lease securitization transactions. In addition,
a negative ratings action against the Company's securitized pools could cause
the Company's warehouse lenders to lower the advance rates and increase the cost
of financing.
CNL-Capital holds an interest in two securitizations (referred to as the 1998-1
and 1999-1 residual interests), the assets and liabilities of which are not
consolidated in the Company's financial statements. The following table shows
the assets and the related bonds outstanding in each securitization pool at
September 30, 2004:
(In thousands)
Mortgage loans Bonds outstanding
in pool at par at face value (1)
------------------- ----------------------
Loans and debt supporting 1998-1 Certificates issued
by CNL Funding 1998-1, LP $ 172,926 $ 171,083
Loans and debt supporting 1999-1 Certificates issued
by CNL Funding 1999-1, LP 219,945 219,945
------------------- ----------------------
$ 392,871 $ 391,028
=================== ======================
(1) Certain bonds in the 1998-1 pool are owned by CNL-Investments; the
aggregate net carrying value of $16.3 million appears as investments in
the condensed consolidated financial statements of the Company.
CNL-Investments
CNL-Investments' demand for funds are predominantly principal and interest
payments, operating expenses, acquisitions of properties 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,
proceeds from dispositions of properties and income from holding interests in
prior loan securitizations including those originated by predecessor entities of
CNL-Capital. In September 2004, the Company sold $11.2 million of franchise loan
investments. As a result of this investment sale, the Company will recognize
reduced investment interest income in the future. CNL-Investments had cash and
cash equivalents of $5.4 million and $4.3 million at September 30, 2004 and
December 31, 2003, respectively.
CNL-Investments' management believes the availability on its revolver will
permit it to meet its short-term liquidity objectives. Long-term liquidity
requirements will be met through a combination of selectively disposing of
assets and reinvesting the proceeds from cash from operating activities and from
debt and equity offerings.
Indebtedness
CNL-Investments has the following borrowing sources at September 30, 2004, with
the stated total capacity and interest rate:
(In thousands)
Amount Used Capacity Maturity Interest Rate (1)
-------------- -------------- --------------- ------------------
Revolver $ 12,000 $ 40,000 July 2005 3.82%
Note payable 392 392 2005 4.92%
Series 2000-A bonds payable 241,472 241,472 2009-2017 7.95%
Series 2001 bonds payable 113,210 113,210 Oct 2006 1.70%
Series 2003 bonds payable 27,038 27,038 2005-2010 5.67%
-------------- --------------
$ 394,112 $ 422,112
============== ==============
(1) Excludes debt issuance and other related costs.
Revolver. Through August 2004, CNL-Investments' short-term debt consisted of a
$30 million revolving line of credit (the "Revolver") 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. In June 2004, CNL
Investments amended the terms of the Revolver to extend the maturity date to
July 2005 and in September 2004, increased the capacity to $40 million. Amounts
outstanding were $12.0 million and $2.0 million at September 30, 2004 and
December 31, 2003, respectively.
Note Payable. At September 30, 2004, the Company had $0.4 million outstanding
relating to a Note Payable to CNL Bank, an affiliate. Amounts outstanding are
collateralized by a mortgage on certain real property, bears interest at LIBOR
plus 325 basis points per annum and requires monthly interest only payments
until maturity in December 2005.
Bonds Payable. CNL-Investments has medium-term note and long-term bond
financing, referred to collectively as bonds payable. Rental income received on
properties and interest income received on mortgage loans and equipment leases
pledged as collateral on medium and long-term financing is used to make
scheduled reductions in bond principal and interest. In May 2004,
CNL-Investments issued an additional $5 million note from its Series 2003
offering that had closed in December 2003. The note is collateralized by a pool
of mortgage notes, bears interest at LIBOR plus 600 basis points and is expected
to mature in 2011. The $5 million in proceeds from the issuance of the notes
were used to pay down short-term debt.
CNL-Investments provides a guaranty of up to ten percent of CNL-Capital's Note
Payable and on the $160 million Warehouse Credit Facility with the Bank. The
Company also provides a 100 percent guaranty on CNL-Capital's Subordinated Note
Payable.
Some sources of debt financing require that CNL-Investments maintain certain
standards of financial performance such as fixed-charge coverage ratios and
tangible net worth requirements, 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 alternative borrowing sources.
Liquidity Risks
Liquidity risks within CNL-Investments include the potential that a tenant's or
borrower's financial condition could deteriorate, rendering it unable to make
lease payments or payments of interest and principal on mortgage and equipment
notes receivable. 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. 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. This could expose
CNL-Investments to successor liabilities and further affect liquidity.
Management is aware of multi-unit tenants that are 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 September 30, 2004. Management believes it has
recorded an appropriate impairment charge at September 30, 2004, based on its
assessment of each tenants' financial difficulties and its knowledge of the
properties. However, impairment charges may be required in future periods based
upon changing circumstances.
In October 2003, Chevy's Holding, Inc. and numerous operating subsidiaries
("Chevy's"), a tenant of CNL-Investments, filed for voluntary bankruptcy under
the provisions of Chapter 11. Chevy's operates the Chevy's, Rio Bravo and Fuzio
concepts. As of the bankruptcy filing, CNL-Investments owned 23 Chevy's units
with a total initial investment of $56.6 million. Through November 9, 2004,
Chevy's had rejected the leases on 19 of the 23 sites. Management has recorded
impairments relating to some of these sites. Through November 9, 2004 management
has sold four sites, re-leased three sites and expects the remaining rejected
sites to be re-leased or sold. Chevy's has paid rent on the four sites whose
leases have not been rejected since filing bankruptcy. As of November 9, 2004
all but one of the properties were pledged as collateral for the Series 2000-A
and Series 2001 triple net lease bonds payable.
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. As of
the bankruptcy filing, CNL-Investments owned 12 units, with a total initial
investment of $12.9 million. All twelve properties were pledged as collateral
for the Series 2000-A triple net lease bonds payable and as of November 9, 2004,
Ground Round had closed 7 of these sites. As of November 9, 2004, Ground Round
had rejected the leases on 7 sites. The remaining five leases have been assumed
by the new owner of Ground Round. Management has recorded impairments relating
to some of these sites.
In March 2004, CNL-Investments provided temporary rent forbearance to a tenant
who was experiencing liquidity difficulties. CNL-Investments agreed to forebear
the collection of partial rents over the next twelve months on ten sites to
provide 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 on cash flows
of CNL-Investments over the next twelve months but the cash flows are expected
to 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 temporarily
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 September 30, 2004 the Company owned, through an
investment of $0.7 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-Investments 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. As of
September 30, 2004 the Company was in the process of negotiating a sale of its
interest in a subsidiary engaged in restaurant operations to CherryDen, LLC, an
affiliate of the Chairman and Vice Chairman of the Board of Directors. The
Company originally acquired the operations upon a tenant experiencing financial
difficulties in an effort to preserve the value of the underlying restaurant
real estate. The proceeds from the sale are anticipated to be approximately $0.7
million. The subsidiary has experienced cumulative operating losses since
acquisition and the Company has recorded a loss of approximately $0.4 million
relating to the difference between the estimated sale proceeds and the carrying
value of its investment in and loans to the subsidiary. Upon the sale of the
subsidiary, the Company will recognize approximately $0.9 million in gains on
the previous sales of real estate used in its restaurant operations. In
anticipation of the proposed sale, CherryDen, LLC, paid a refundable deposit of
$0.2 million to the subsidiary. As of November 9, 2004, the sale of these
restaurant operations had not occurred.
Certain net lease properties are pledged as collateral for the Series 2000-A and
Series 2001 triple-net lease 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 bankruptcy filings of Chevy's and Ground Round, 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
payable maturing in 2006. The Series 2000-A and Series 2001 bonds payable
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. The Company is currently exceeding
certain required performance cash flow ratios within the Series 2000-A bonds
payable due primarily to tenant defaults from the Chevy's and Ground Round
bankruptcies described above. As a result, cash flow normally exceeding the
scheduled principal and interest payments is required to be directed toward
additional debt reduction. For the nine months ended September 30, 2004, the
Company was required to make additional debt reductions of approximately $1.8
million as a result of exceeding certain ratios in the net lease pools. The
Company is actively seeking new tenants or buyers for these properties that will
result in improved performance under these ratios.
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 $392.9 million in loans transferred to unconsolidated trusts that
serve as collateral for the long-term bonds discussed in "Liquidity and Capital
Resources - CNL-Capital - Indebtedness". 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 a