Captec Net Lease Realty (CRRR) 10-Q 2001 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended                June 30, 2001
	OR
	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __ to__

Commission file number:0-29650

CAPTEC NET LEASE REALTY, INC.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)

38-3368333
(IRS Employer Identification Number)

24 Frank Lloyd Wright Drive, Ann Arbor, Michigan 48106
(Address of principal executive offices, including zip code)

(734) 994-5505
(Registrant’s telephone number)

Not Applicable
(Former name, former address and former fiscal year, if changed since last year)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days. Yes No

      APPLICABLE ONLY TO CORPORATE ISSUERS:   Indicate the number of shares outstanding of each of the registrant’s classes of common equity, as of the latest practicable date.

9,508,108 shares of Common Stock, $.01 par value, outstanding as of August 14, 2001.

1

TABLE OF CONTENTS

Part I Financial Information
	Item 1. Financial Statements:
		Consolidated Balance Sheets
		Consolidated Statements of Operations
		Consolidated Statement of Changes in Stockholders’ Equity
		Consolidated Statements of Cash Flows
		Consolidated Notes to Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures about Market Risk
Part II Other Information
	Item 1. Legal Proceedings
	Item 2. Changes in Securities
	Item 3. Defaults upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits and Report on Form 8-K

CAPTEC NET LEASE REALTY, INC.
and SUBSIDIARIES

CONTENTS

Item No.		Page
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Balance Sheets		3
	Consolidated Statements of Operations		4
	Consolidated Statement of Changes in Stockholders’ Equity		5
	Consolidated Statements of Cash Flows		6
	Consolidated Notes to Financial Statements		7 – 9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		10 – 13
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		13
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings		14
Item 2.	Changes in Securities		14
Item 3.	Defaults upon Senior Securities		14
Item 4.	Submission of Matters to a Vote of Security Holders		14
Item 5.	Other Information		14
Item 6.	Exhibits and Report on Form 8-K		14

2

Part I. Financial Information
Item 1. Financial Statements

CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

			June 30,			December 31,
			2001			2000
ASSETS			(unaudited)
Cash and cash equivalents			$	2,729,592		$	665,408
Investments:
	Properties subject to operating leases, net			194,457,988			195,842,231
	Properties subject to financing leases, net			7,254,298			4,535,446
	Loans to affiliates, collateralized by mortgage loans			11,246,212			11,280,234
	Investment in joint venture			7,356,851			7,031,073
	Investment in affiliated limited partnerships, net			4,130,003			4,163,069
	Other loans			272,451			283,323
	Other loans, related party			364,847			373,799
		Total investments		225,082,650			223,509,175
Unbilled rent, net				7,476,307			6,840,646
Accounts receivable				673,245			693,101
Due from affiliates				937,445			1,856,950
Other assets				771,293			1,005,796
		Total assets	$	237,670,532		$	234,571,076
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
	Notes payable		$	102,495,158		$	98,365,915
	Accounts payable and accrued expenses			1,078,823			952,252
	Security deposits held on leases			207,527			225,612
		Total liabilities		103,781,508			99,543,779
Stockholders’ Equity:
	Common stock, ($.01 par value) authorized: 40,000,000 shares; issued and outstanding: 9,508,108			95,081			95,081
	Paid in capital			134,711,056			134,711,056
	Retained earnings (distributions in excess of earnings)			(917,113	)		221,160
		Total stockholders’ equity		133,889,024			135,027,297
		Total liabilities and stockholders’ equity	$	237,670,532		$	234,571,076

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

3

CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

			Three Months Ended				Six Months Ended
			June 30,				June 30,
			2001		2000		2001		2000
Revenue:
	Rental income from operating leases		$	5,491,129	$	6,066,499	$	10,973,040	$	12,205,248
	Earned income from financing leases			175,854		154,658		341,258		311,507
	Interest income on loans to affiliates			310,721		315,033		622,273		631,094
	Other income, principally affiliated ventures			360,199		507,499		730,510		1,527,204
		Total revenue		6,337,903		7,043,689		12,667,081		14,675,053
Expenses:
	Interest			2,398,393		2,567,252		4,588,440		5,113,444
	Management fees, affiliates, net			116,459		—		235,612		—
	General and administrative			408,304		388,268		792,023		730,864
	Depreciation and amortization			851,277		867,545		1,693,211		1,732,513
	Non-recurring merger and other costs			225,650		—		262,872		1,143,000
		Total expenses		4,000,083		3,823,065		7,572,158		8,719,821
		Income before equity in joint venture, gain on sale of properties and other non-recurring		2,337,820		3,220,624		5,094,923		5,955,232
Equity in net income of joint venture				235,597		144,535		413,359		295,077
Gain on sale of properties				198,608		985,574		579,607		1,611,221
Other non-recurring				—		706,421		—		706,421
		Net Income	$	2,772,025	$	5,057,154	$	6,087,889	$	8,567,951
		Income per common share:
		Basic	$	0.29	$	0.53	$	0.64	$	0.90
		Diluted	$	0.29	$	0.53	$	0.64	$	0.90
Weighted average number of common shares outstanding, basic and diluted				9,508,108		9,508,108		9,508,108		9,508,108

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

4

CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2001
(unaudited)

				Common Stock									Retained Earnings			Accumulated Other			Total
								Paid-In		Comprehensive			(Distributions in excess			Comprehensive			Stockholders'
				Shares		Amount		Capital		Income			of earnings)			Income (Loss)			Equity
BALANCE, JANUARY 1, 2001					9,508,108	$	95,081	$	134,711,056	$	—		$	221,160		$	206,399		$	135,233,696
	Net Income				—		—		—		6,087,889			6,087,889			—			6,087,889
	Other comprehensive income:
		Net loss on derivatives			—		—		—		(206,399	)		—			(206,399	)		(206,399	)
			Comprehensive income								5,881,490
Common stock dividends ($0.76 per share)					—		—		—					(7,226,162	)		—			(7,226,162	)
BALANCE, JUNE 30, 2001					9,508,108	$	95,081	$	134,711,056				$	(917,113	)	$	—		$	133,889,024

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

5

CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

		Six Months Ended
		June 30,
		2001			2000
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	6,087,889		$	8,567,951
Adjustments to net income:
	Depreciation and amortization		1,693,211			1,732,513
	Amortization of debt issuance costs		729,220			509,193
	Equity in net income of joint venture		(413,359	)		(295,077	)
	Gain on sale of property, net		(579,607	)		(1,640,470	)
	Increase in unbilled rent		(635,661	)		(1,157,745	)
	Decrease (increase) in accounts receivable and other assets		404,457			(681,201	)
	Increase (decrease) in accounts payable and accrued expenses		126,571			(39,195	)
	Net cash provided by operating activities		7,412,721			6,995,969
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of properties subject to operating leases			(8,498,627	)		(6,187,101	)
Acquisition of properties subject to financing leases			(2,686,203	)		—
Advances on short-term loans to affiliates, net			—			(3,266,163	)
Proceeds from the disposition of properties			8,842,519			16,454,522
Collections on loans to affiliates, collateralized by mortgage loans			34,022			3,313,999
Collection of principal on other loans			19,824			8,169
Proceeds from joint venture distribution			87,581			361,600
Collection of principal on financing leases			(32,649	)		(68,508	)
Lease security deposits			(18,085	)		(10,082	)
	Net cash (used in) provided by investing activities		(2,251,618	)		10,606,436
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid on common stock			(7,226,162	)		(7,226,162	)
Borrowings of notes payable			14,000,000			4,500,000
Repayments of notes payable			(9,870,757	)		(14,941,528	)
	Net cash used in financing activities		(3,096,919	)		(17,667,690	)
NET CASH FLOWS			2,064,184			(65,285	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			665,408			1,035,607
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	2,729,592		$	970,322

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

6

CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.	ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
	Organization:Captec Net Lease Realty, Inc. (the “Company”), which has operated as a REIT since November 1997, acquires, develops and owns freestanding properties which are leased on a long-term triple-net basis to operators of national and regional chain restaurants and national retailers. Triple-net leases generally impose on the lessee responsibility for all operating costs and expense of the property, including the costs of repairs, maintenance, real property taxes, assessments, utilities and insurance. The Company’s leases typically provide for minimum rent plus specified fixed periodic rent increases.
	Unaudited Interim Financial Information:The consolidated balance sheet as of June 30, 2001 and the consolidated statements of operations, stockholders’ equity and cash flows for the three and six months ended June 30, 2001 and 2000 have not been audited. In the opinion of management, all adjustments (including normal recurring adjustments) considered necessary for a fair presentation have been reflected therein. Results of operations for the interim periods are not necessarily indicative of results for the full year. These unaudited financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2000 filed with the United States Securities and Exchange Commission on March 30, 2001.
	Derivatives:In June 1998, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”). In June 2000, FASB issued SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities,” (“FAS 138”) which amends FAS 133. The statement requires that all derivative instruments be recorded at fair value on the balance sheet with changes in fair value recorded each period in current earnings and/or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. Any change in fair value resulting from ineffectiveness, as defined by FAS 133 is recognized immediately in current earnings. The Company adopted FAS 133, as amended, on January 1, 2001.
2.	PROPERTIES SUBJECT TO OPERATING LEASES:
	Properties subject to operating leases represent various properties leased to tenants under long-term net operating leases. The lease agreements generally provide for monthly rents based upon a percentage of the property’s cost. The initial term of the leases typically ranges from 15 to 20 years, although the Company in certain cases will enter into leases with terms that are shorter or longer. Most leases also provide for one or more five year renewal options. In addition, certain leases provide the tenant one or more options to purchase the properties at a predetermined price, generally only during stated periods during the fifth to seventh lease years.
	The Company’s investment in properties subject to operating leases includes capitalized acquisition and interest costs which have been allocated between land and buildings and improvements on a pro rata basis. The net investment in properties subject to operating leases is comprised of the following as of:

	June 30,			December 31,
	2001			2000
Land	$	78,848,674		$	79,432,815
Buildings and improvements		126,326,687			124,194,854
Construction draws on properties		—			1,698,032
		205,175,361			205,325,701
Less accumulated depreciation		(10,717,373	)		(9,483,470	)
Total	$	194,457,988		$	195,842,231

7

CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

	The Company sold 8 properties during the six months ended June 30, 2001, collecting total net proceeds of $8.8 million and reflected a net gain totaling approximately $580,000 on the sale of these properties.
3.	FINANCING LEASES:
	Properties subject to financing leases is comprised of six properties with respect to which the Company owns only the building and the land is subject to a ground lease between the tenant and an unrelated third party. The net investment in financing leases is comprised of the following as of:

		June 30,			December 31,
		2001			2000
Minimum lease payments to be received		$	15,643,319		$	9,703,037
Estimated residual value			—			—
	Gross investment in financing leases		15,643,319			9,703,037
Unearned income			(8,389,021	)		(5,167,591	)
	Net investment in financing leases	$	7,254,298		$	4,535,446

4.	INVESTMENT IN JOINT VENTURE:
	The Company has a 22.6% membership interest in FC Venture I, LLC (“FC Venture”). The investment is accounted for under the equity method. Summarized financial information of the Company’s joint venture investment as of and for the six months ended June 30, 2001 and 2000 is set forth below:

	2001		2000
Investment in properties subject to leases, net	$	49,870,025	$	45,714,093
Total assets		52,873,943		48,340,447
Notes payable		21,032,082		16,517,252
Total liabilities		31,603,756		17,256,521
Members’ equity		30,561,293		31,083,926
Revenues		2,904,492		2,255,126
Net income		1,829,022		1,305,649

5.	NOTES PAYABLE:
	The Company’s credit facility, as amended February 26, 2001, provides up to $105 million for the acquisition and development of properties and working capital. The credit facility expires on August 31, 2001 and is subject to certain borrowing base restrictions. The Company had approximately $100.6 million of aggregate outstanding borrowings under the credit facility at June 30, 2001. The Company also has an option to extend the maturity of the credit facility an additional three months.
	During 2000, the Company entered into three promissory notes for an aggregate amount of $1,945,000 with a lending institution. The notes are collateralized by certain properties in the Company’s property portfolio. The notes have terms ranging from 15 years to 20 years and bear interest at 9.0% per annum. As of June 30, 2001, the outstanding balance of the promissory notes is $1,861,035.

8

CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

6.	DERIVATIVE INSTRUMENTS:
	At June 30, 2001, the Company had two derivative instruments, an interest rate cap agreement and an interest rate swap agreement. These instruments have been entered into to meet the Company’s risk management objective, which is to manage the interest rate exposure associated with borrowings under its floating rate credit facility. The Company has designated these instruments as cash flow hedges as they are used to hedge fluctuations in interest payments. In accordance with the provisions of FAS 133, on January 1, 2001 the Company recorded a cumulative-effect-type transition adjustment of $206,399 in accumulated other comprehensive income to recognize at fair value the two derivatives that are designated as cash-flow hedging instruments. At June 30, 2001, the fair value of these instruments was $0. During the six months ended June 30, 2001, the Company recorded a loss on the interest rate instruments of $206,399, which has been recognized in accumulated other comprehensive loss. The termination date of the two derivative instruments is July 2, 2001. The cash flow hedges had no ineffectiveness for the period and accordingly, no amounts were recorded in the statement of operations.
7.	EARNINGS PER SHARE:
	Stock options currently outstanding were excluded from the computation of diluted earnings per share because their exercise price was in excess of the average market price of the Company’s common stock during the six months ended June 30, 2001 and 2000.
8.	NON-RECURRING ITEMS:
	On May, 1, 2000, the Company terminated a merger agreement that resulted in the Company recognizing expense of $1.1 million in non-recurring merger costs during the six months ended June 30, 2000. During the six months ended June 30, 2001, the Company incurred approximately $263,000 in costs associated with the planned sale of the Company (see Note 10).
9.	RELATED PARTY TRANSACTIONS:
	The Company is party to an advisory agreement, as amended, with Captec Net Lease Realty Advisors, Inc. (“Captec Advisors”), an affiliate, whereby the Company pays to Captec Advisors a management fee. During the six months ended June 30, 2001, the Company incurred approximately $636,000 in management fees to Captec Advisors, of which $400,000 was paid by Family Realty II, Inc., an affiliate of the Company.
	During the six months ended June 30, 2001, the Company purchased three properties from Family Realty II, Inc., an affiliate, for an aggregated purchase price of $6,285,400. In addition, during the six months ended June 30, 2001, the Company purchased one property from FC Venture, an affiliate, for $1,156,203.
10.	SUBSEQUENT EVENTS:
	In July 2001, the Company declared dividends to its shareholders of $3,613,081, or $0.38 per share of common stock, which was paid on July 18, 2001.
	On July 2, 2001, the Company announced it has entered into a merger agreement with Commercial Net Lease Realty, Inc. (“CNL”). CNL will acquire all of the outstanding shares of common stock of the Company for a combination of cash and stock. The merger is subject to approval by the Company’s stockholders and other conditions set forth in the merger agreement, and is expected to close in the fourth quarter of 2001.

9

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

The Company, which operates as a REIT, acquires, develops and owns freestanding properties which are leased on a long-term triple-net basis to operators of national and regional chain restaurants and retailers. The Company’s triple-net leases generally impose on the lessee responsibility for all operating costs and expenses of the property, including the costs of repairs, maintenance, real property taxes, assessments, utilities and insurance. The Company’s leases typically provide for minimum rent plus specified fixed periodic rent. The Company’s long-term leases with creditworthy lessees mitigate short-term fluctuations in the general economy, thereby reducing the impact these fluctuations have on its operations. Other revenues are derived primarily from fee income earned from affiliates and interest income on loans to affiliates.

As of June 30, 2001, the Company owned 136 properties, located in 26 states, subject to long-term net leases with 56 different lessees under major restaurant and retail concepts including Bennigan’s, Applebee’s, Denny’s, Best Buy, Blockbuster Video, and Jared Jewelers.

On July 2, 2001, the Company announced it has entered into a merger agreement with Commercial Net Lease Realty, Inc. (“CNL”). CNL will acquire all of the outstanding shares of common stock of the Company for a combination of cash and stock. The merger is subject to approval by the Company’s stockholders and other conditions set forth in the merger agreement, and is expected to close in the fourth quarter of 2001.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2001.   During the three months ended June 30, 2001 total revenue decreased 10.0% to $6.3 million as compared to $7.0 million for the three months ended June 30, 2000. Rental revenue from operating leases for the three months ended June 30, 2001 decreased 9.4% to $5.5 million as compared to $6.1 million for the three months ended June 30, 2000, due to the reduction of the Company’s property portfolio as a result of property sales. Earned income from financing leases for the three months ended June 30, 2001 increased 13.7% to approximately $176,000 as compared to approximately $155,000 for the three months ended June 30, 2000. The increase is the result of the addition of two properties subject to financing leases in the first quarter of 2001. Other income decreased 29.0% to approximately $360,000 for the three months ended June 30, 2001 as compared to $507,000 for the three months ended June 30, 2000. The decrease is due to reduced one-time acquisition related fees from affiliated ventures. The amount of fees earned for the acquisition, development and management of properties on behalf of affiliated ventures are subject to variations, principally by the amount of new properties identified and acquired by the affiliated ventures.

Total expenses increased 4.6% to $4.0 million for the three months ended June 30, 2001 as compared to $3.8 million for the three months ended June 30, 2000. Interest expense decreased 6.6% to $2.4 million for the three months ended June 30, 2001 as compared to $2.6 million for the three months ended June 30, 2000. The decrease was due to a 14 basis point decrease in the weighted average interest rate and a $14.8 million decrease in the average outstanding borrowings under the Company’s credit facility used to fund the acquisition and development of properties, slightly offset by an increase of approximately $100,000 in amortization of deferred financing costs. Management fees were approximately $116,000 during the three months ended June 30, 2001. The increase is the result of reduced acquisition levels for the affiliated ventures, which provide for a reduction in the management fee paid by the Company to Captec Advisors, an affiliate. During the three months ended June 30, 2000, the acquisition levels of the affiliated ventures fully supported the management fee paid by the Company. The management fee paid and reductions received are subject to variations, principally changes in the Company’s property portfolio balance caused by property acquisitions and dispositions, and the amount of new properties identified and acquired by the affiliated ventures. General and administrative expenses increased 5.2% to approximately $408,000 for the three months ended June 30, 2001 as compared to approximately $388,000 for the three months ended June 30, 2000 as a result of increases in payroll related costs and property taxes paid on vacant properties. Depreciation and amortization decreased 1.9% to approximately $851,000 for the three months ended June 30, 2001 as compared to approximately $868,000 for the three months ended June 30, 2000. The decrease is due to the reduction of the Company’s property portfolio as a result of property sales. Non-recurring items for the three months ended June 30, 2001 were approximately $226,000. The costs incurred during the three months ended June 30, 2001 represent costs related to the proposed merger of the Company.

10

The Company holds a 22.6% membership interest in FC Venture I, LLC. During the three months ended June 30, 2001, the Company recorded approximately $236,000 as its portion of FC Venture’s equity earnings as compared to approximately $146,000 for the three months ended June 30, 2000. The increase is primarily due to the growth of FC Venture’s property portfolio.

The Company sold 3 properties during the three months ended June 30, 2001, collecting total net proceeds of $3.5 million and reflected a net gain totaling approximately $199,000 on the sale of these properties.

During the three months ended June 30, 2000 an IRS audit of periods prior to the Company’s initial public offering was completed resulting in no additional tax payment. As a result of the completed audit the Company recorded other non-recurring income of approximately $706,000 representing a reversal of a previously provided allowance for an estimated tax obligation.

As a result of the foregoing, the Company’s net income decreased 45.2% to $2.8 million for the three months ended June 30, 2001 as compared to $5.1 million for the three months ended June 30, 2000.

Six Months Ended June 30, 2001.   During the six months ended June 30, 2001 total revenue decreased 13.7% to $12.7 million as compared to $14.7 million for the six months ended June 30, 2000. Rental revenue from operating leases for the six months ended June 30, 2001 decreased 10.1% to $10.9 million as compared to $12.2 million for the six months ended June 30, 2000. The decrease is due to the reduction in the Company’s property portfolio as a result of property sales. Earned income from financing leases for the six months ended June 30, 2001 increased 9.6% to approximately $341,000 as compared to approximately $312,000 for the six months ended June 30, 2000. The increase is the result of the addition of two properties subject to financing leases in the first quarter of 2001. Other income decreased 52.2% to approximately $731,000 for the six months ended June 30, 2001 as compared to $1.5 million for the six months ended June 30, 2000. The decrease is the due to reduced one-time acquisition related fees from affiliated ventures. The amount of fees earned for the acquisition, development and management of properties on behalf of affiliated ventures are subject to variations, principally by the amount of new properties identified and acquired by the affiliated ventures.

Interest expense for the six months ended June 30, 2001 decreased 10.3% to $4.6 million as compared to $5.1 million for the six months ended June 30, 2000. The decrease was due to a 22 basis point decrease in the weighted average interest rate as well a $17.0 million decrease in the average outstanding borrowings under the Company’s credit facility used to fund the acquisition and development of properties, slightly offset by an increase of approximately $220,000 in amortization of deferred financing costs. Management fees were approximately $236,000 during the six months ended June 30, 2001. The increase is the result of reduced acquisition levels for the affiliated ventures, which provide for a reduction in the management fee paid by the Company to Captec Advisors, an affiliate. During the six months ended June 30, 2000, the acquisition levels of the affiliated ventures fully supported the management fee paid by the Company. The management fee paid and reductions received are subject to variations, principally changes in the Company’s property portfolio balance caused by property acquisitions and dispositions, and the amount of new properties identified and acquired by the affiliated ventures. General and administrative expenses increased 8.4% to approximately $792,000 for the six months ended June 30, 2001 as compared to approximately $731,000 for the six months ended June 30, 2000 as a result of increases in payroll related costs and property taxes paid on vacant properties. Depreciation and amortization decreased 2.3% for the six months ended June 30, 2001 as compared to the six months ended June 30, 2000. The decrease is due to the reduction of the Company’s property portfolio as a result of property sales. Non-recurring items decreased 77.0% to approximately $263,000 for the six months ended June 30, 2001 as compared to $1.1 million for the six months ended June 30, 2000. The costs incurred during the six months ended June 30, 2001 represent costs related to the proposed merger of the Company. The $1.1 million expensed during the six months ended June 30, 2000 relates to the termination of a previous merger agreement that was announced on May 1, 2000.

The Company sold 8 properties during the six months ended June 30, 2001, collecting total net proceeds of $8.8 million and reflecting a net gain of approximately $580,000 on the sale of these properties.

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During the six months ended June 30, 2001 the Company recorded approximately $413,000 as its portion of FC Venture’s equity earnings. The increase is primarily due to the growth of FC Venture’s property portfolio.

During the six months ended June 30, 2000 an IRS audit of periods prior to the Company’s initial public offering was completed resulting in no additional tax payment. As a result of the completed audit the Company recorded other non-recurring income of approximately $706,000 representing a reversal of a previously provided allowance for an estimated tax obligation.

As a result of the foregoing, the Company’s net income decreased 29.0% to $6.1 million for the six months ended June 30, 2001 as compared to $8.6 million for the six months ended June 30, 2000.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s principal use of funds is for property development and acquisition, payment of interest on its outstanding indebtedness, and payment of operating expenses and dividends. Historically, interest expense, operating expenses and dividends have been paid out of cash flows from operations. Property acquisition and development have been typically funded out of proceeds from borrowings. The Company expects to meet its liquidity requirements, which are principally property acquisition and development and scheduled debt maturities, through a variety of future sources of capital, including long-term collateralized and uncollateralized indebtedness, the issuance of additional equity or debt securities and “off-balance sheet” financing through the formation of joint ventures.

The Company’s leases generally provide for specified periodic rent increases. In addition, most of the Company’s leases require the lessee to pay all operating costs and expenses including repairs, maintenance, real property taxes, assessments, utilities and insurance, thereby substantially reducing the Company’s exposure to increases in costs and operating expenses. Based upon these factors, the Company does not anticipate significant capital demands related to the management of its properties.

At June 30, 2001, the Company had cash and cash equivalents of $2.7 million. For the six months ended June 30, 2001, the Company generated cash from operations of $7.4 million as compared to $7.0 million for the six months ended June 30, 2000. Cash generated from operations provides funds for dividends. Any excess cash from operations may also be used for investment in properties. For the six months ended June 30, 2001 the Company utilized $2.3 million in investing activities as compared to generating $10.6 million during the six months ended June 30, 2000. The Company used $3.1 million in financing activities during the six months ended June 30, 2001 as compared to using $17.7 million during the six months ended June 30, 2000.

CREDIT FACILITY.   In February 2001, the Company amended and extended the maturity of its credit facility with First Union National Bank. The effect of the amendment was to extend the maturity to August 31, 2001. The amendment also resulted in an increased interest rate spread over LIBOR to a range of 2.25% to 2.50%, dependent upon the ratio of debt to asset value, and reduced the facility borrowing capacity to $105.0 million. The Company also intends to extend the maturity of the credit facility an additional three months pursuant to the agreement. The extension of the credit facility has been designed to be short-term in nature to enable the Company to continue to operate with a flexible capital structure. Upon expiration of the credit facility, the Company intends to refinance its indebtedness under the credit facility through a new facility or loan with an institutional lender and/or through the issuance of debt securities. The terms of the Company’s obligations with respect to any indebtedness incurred in refinancing the credit facility will be based on market conditions applicable to such form of indebtedness at the time, which may cause the terms of any such indebtedness to vary materially from the terms of the credit facility. No assurances can be made that the Company will be able to refinance such debt. At June 30, 2001, the Company had $100.6 million outstanding under the credit facility. Notwithstanding the above, pursuant to the merger agreement with CNL, the Company’s entire outstanding principal balance under the credit facility will be repaid by CNL upon completion of the merger which remains subject to stockholder approval and other conditions set forth in the merger agreement.

PROPERTY SALES.   The Company periodically has explored the marketability of certain properties in its portfolio that would contribute to greater diversification levels in tenants, geography, property type and property size thereby increasing the strength of its current portfolio. At June 30, 2001, no properties in the Company’s portfolio are being

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actively marketed.

DIVIDENDS.   During the six months ended June 30, 2001 the Company paid dividends of $7,226,162. In July 2001, the Company declared a second quarter dividend on its common stock in the amount of $0.38 per share or $3,613,081. The dividend was payable to stockholders of record on July 11, 2001 and was paid on July 18, 2001. The Company expects to pay future dividends from cash available for distribution. The Company believes that cash from operations will be sufficient to allow the Company to make distributions necessary to enable the Company to continue to qualify as a REIT.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents a risk of loss arising from adverse changes in market prices and interest rates. The Company’s market risk arises from interest rate risk inherent in its financial instruments. The Company is not subject to foreign currency exchange rate risk or commodity price risk.

The Company monitors and manages interest rate exposure as an integral part of its overall risk management program, which recognizes the unpredictability of financial markets and seeks to reduce the potentially adverse effect on its results. At June 30, 2001, approximately 98% of the Company’s debt bore interest at variable rates of LIBOR plus 2.25% to 2.50%.

The following table presents certain information on the Company’s assets and liabilities which are sensitive to interest rate changes at June 30, 2001:

		Maturity
		0 to 6
		Months			Total
Assets:
	Cash and cash equivalents	$	2,729,592		$	2,729,592
Liabilities:
	Notes payable	$	100,634,123		$	100,634,123
	Reprice difference	$	(97,904,531	)
	Cumulative gap	$	(97,904,531	)

A 1.0% increase in the variable interest rate for the six months ended June 30, 2001 would have resulted in additional interest expense of approximately $249,000.

The Company uses derivative financial instruments in the normal course of business to manage its exposure to fluctuations in interest rates. Those instruments involve, to varying degrees, market risk, as the instruments are subject to rate and price fluctuations, and elements of credit risk in the event the counterparty should default. The Company does not enter into derivative transactions for trading purposes. At June 30, 2001, the Company had an interest rate swap contract outstanding with a total notional amount of $50 million, and an interest rate cap contract outstanding with a total notional amount of $25 million. The notional amounts serve solely as a basis for the calculation of payments to be exchanged and are not a measure of the exposure of the Company through the use of derivatives. Under the interest rate swap contract, the Company agrees to pay a fixed rate of 5.8% and the counterparty agrees to make payments based on 3-month LIBOR. Under the interest rate cap agreement the counterparty agrees to make payments to the Company if LIBOR exceeds 7.5%. Both the interest rate swap contract and interest rate cap contract terminated on July 2, 2001 and were replaced with an interest rate cap contract with a total notional amount of $68.3 million. Under the new interest rate cap contract the counterparty agrees to make payments to the Company if LIBOR exceeds 5.0%.

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PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.None.

ITEM 2. CHANGES IN SECURITIES. None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None.

ITEM 5. OTHER INFORMATION. None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a)	Reports on Form 8-K
	No reports on Form 8-K were filed during the quarter ended June 30, 2001.

FORWARD-LOOKING STATEMENTS

This Form 10-Q contains certain “forward-looking statements” which represent the Company’s expectations or beliefs, including, but not limited to, statements concerning industry performance and the Company’s operations, performance, financial condition, plans, growth and strategies. Any statements contained in this Form 10-Q which are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the generality of the foregoing, words such as “may,” “will,” “expect,” “anticipate,” “intend,” “could,” “estimate” or “continue” or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, certain of which are beyond the Company’s control, and actual results may differ materially depending on a variety of important factors many of which are beyond the control of the Company.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	CAPTEC NET LEASE REALTY, INC.
August 14, 2001	By: /s/ Patrick L. Beach
	Patrick L. Beach Chief Executive Officer and President
August 14, 2001	By: /s/ W. Ross Martin
	W. Ross Martin Chief Financial Officer and Executive Vice President

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