UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 COMMISSION FILE NUMBER 1-13561 ENTERTAINMENT PROPERTIES TRUST (Exact name of registrant as specified in its charter) MARYLAND 43-1790877 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 30 PERSHING ROAD, SUITE 201 KANSAS CITY, MISSOURI 64108 (Address of principal executive office) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (816) 472-1700 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 such filing requirements for the past 90 days. Yes [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. At October 14, 2004, there were 25,401,267 Common Shares of Beneficial Interest outstanding. 1 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ENTERTAINMENT PROPERTIES TRUST CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS) SEPTEMBER 30, 2004 DECEMBER 31, 2003 ------------------ ----------------- ASSETS (Unaudited) Rental properties, net $ 1,078,339 $ 887,143 Property under development 46,520 12,953 Investment in joint ventures 2,575 1,336 Cash and cash equivalents 10,252 29,284 Restricted cash 12,863 7,738 Intangible assets, net 10,624 693 Other assets 40,046 26,771 ----------- ----------- Total assets $ 1,201,219 $ 965,918 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable and accrued liabilities $ 7,759 $ 2,864 Common dividends payable 14,023 9,829 Preferred dividends payable 1,366 1,366 Unearned rents 641 895 Long-term debt 589,127 506,555 ----------- ----------- Total liabilities 612,916 521,509 Commitments and contingencies - - Minority interest in consolidated subsidiaries 6,144 21,630 Shareholders' equity: Common Shares, $.01 par value; 50,000,000 shares authorized; 25,401,267 and 20,129,749 shares issued at September 30, 2004 and December 31, 2003, respectively 254 201 Preferred Shares, $.01 par value; 5,000,000 shares authorized; 2,300,000 shares issued and outstanding 23 23 Additional paid-in-capital 615,735 454,195 Treasury shares at cost: 472,200 common shares (6,533) (6,533) Loans to shareholders (3,525) (3,525) Non-vested shares (2,686) (1,625) Accumulated other comprehensive income 3,615 - Distributions in excess of net income (24,724) (19,957) ----------- ----------- Shareholders' equity 582,159 422,779 ----------- ----------- Total liabilities and shareholders' equity $ 1,201,219 $ 965,918 =========== =========== 2 ENTERTAINMENT PROPERTIES TRUST CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA) THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, -------------------------------- ------------------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Rental revenue $ 32,308 $ 22,406 $ 91,273 $ 64,808 Other income 297 608 393 1,195 -------- -------- -------- -------- Total revenue 32,605 23,014 91,666 66,003 Property operating expense, net 465 220 1,590 398 General and administrative expense, excluding amortization of non-vested shares below 1,078 929 3,685 2,935 Costs associated with loan refinancing - - 1,134 - Interest expense, net 9,457 7,653 28,301 22,363 Depreciation and amortization 6,021 4,085 17,036 11,631 Amortization of non-vested shares 340 232 1,021 694 -------- -------- -------- -------- Income before income from joint ventures and minority interest 15,244 9,895 38,899 27,982 Equity in income from joint ventures 172 111 482 299 Minority interest (62) (375) (982) (1,125) -------- -------- -------- -------- Net income $ 15,354 $ 9,631 $ 38,399 $ 27,156 Preferred dividend requirements (1,366) (1,366) (4,097) (4,097) -------- -------- -------- -------- Net income available to common shareholders $ 13,988 $ 8,265 $ 34,302 $ 23,059 ======== ======== ======== ======== Net income per common share: Basic $ 0.58 $ 0.48 $ 1.56 $ 1.34 Diluted $ 0.57 $ 0.46 $ 1.51 $ 1.31 Shares used for computation (in thousands): Basic 24,031 17,353 21,997 17,189 Diluted 24,628 18,641 23,159 18,456 Dividends per common share $ 0.5625 $ 0.50 $ 1.6875 $ 1.50 ======== ======== ======== ======== 3 ENTERTAINMENT PROPERTIES TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED - IN THOUSANDS) NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2004 2003 --------- --------- OPERATING ACTIVITIES Net income $ 38,399 $ 27,156 Adjustments to reconcile net income to net cash provided by operating activities: Minority interest in net income 982 1,125 Equity in income from joint ventures (482) (299) Depreciation and amortization 17,036 11,631 Non-cash compensation expense to management and trustees 1,208 776 Costs associated with loan refinancing (non-cash portion) 729 - (Increase) decrease in other assets (6,142) 2,714 Decrease in receivable from joint venture - 8,438 Increase (decrease) in accounts payable and accrued liabilities 7,062 (441) Decrease in unearned rents (251) (3,659) --------- --------- Net cash provided by operating activities 58,541 47,441 --------- --------- INVESTING ACTIVITIES Acquisition of rental properties (230,995) (68,709) Additions to properties under development (39,708) (9,559) Distributions from joint ventures 606 362 Proceeds from sale of assets 3,100 - Proceeds from sale of equity interest in joint venture 8,240 - Investment in secured note receivable (5,000) - --------- --------- Net cash used in investing activities (263,757) (77,906) --------- --------- FINANCING ACTIVITIES Proceeds from long-term debt facilities 271,609 190,200 Principal payments on long-term debt (179,542) (97,665) Deferred financing fees paid (5,086) (7,414) Proceeds from issuance of common shares, net of costs 144,455 73,220 Distribution to minority interest (1,469) (1,125) Distribution to shareholders (38,974) (29,528) --------- --------- Net cash provided by financing activities 190,993 127,688 Effect of exchange rate changes on cash 316 - --------- --------- Net increase (decrease) in cash and cash equivalents (13,907) 97,223 Cash and cash equivalents at beginning of period 37,022 10,091 --------- --------- Cash and cash equivalents at end of period $ 23,115 $ 107,314 ========= ========= SUPPLEMENTAL SCHEDULE OF NON-CASH ACTIVITY Contribution of rental property and related debt to joint venture $ 9,603 $ - Transfer of property under development to rental property $ 6,858 $ 5,509 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the period for interest $ 28,017 $ 21,178 Issuance of non-vested stock grants to management and trustees $ 2,099 $ 1,304 4 ENTERTAINMENT PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. ORGANIZATION Entertainment Properties Trust (the Company) is a Maryland real estate investment trust (REIT) organized on August 29, 1997. The Company was formed to acquire and develop entertainment properties including megaplex theatres and entertainment retail centers. 2. SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. The consolidated balance sheet as of December 31, 2003 has been derived from the audited consolidated balance sheet at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2003. ACCOUNTING FOR ACQUISITIONS For rental property acquisitions completed after June 30, 2001 (the effective date of SFAS No. 141, "Business Combinations"), the Company considers the fair values of both tangible and intangible assets or liabilities when allocating the purchase price (plus any capitalized costs incurred during the acquisition). Tangible assets may include land, building, tenant improvements, furniture, fixtures and equipment. Intangible assets or liabilities may include values assigned to in-place leases (including the separate values that may be assigned to above-market and below-market in-place leases), the value of tenant relationships, and any assumed financing that is determined to be above or below market terms. Most of the Company's rental property acquisitions do not involve in-place leases. In such cases, the cost of the acquisition is allocated to the tangible assets based on recent independent appraisals and management judgment. Because the Company typically executes these leases simultaneously with the purchase of the real estate, no value has been ascribed to in-place leases in these transactions. For rental property acquisitions involving in-place leases, the fair value of the tangible assets is determined by valuing the property as if it were vacant based on management's determination of the relative fair values of the assets. Management determines the as if vacant fair value of a property using recent independent appraisals or methods similar to those used by independent appraisers. The aggregate value of intangible assets or liabilities is measured based on the difference between the stated price plus capitalized costs and the property as if vacant. 5 In determining the fair value of acquired in-place leases, the Company considers many factors. On a lease-by-lease basis, management considers the present value of the difference between the contractual amounts to be paid pursuant to the leases and management's estimate of fair market lease rates. For above market leases, management considers such differences over the remaining non-cancelable lease terms and for below market leases, management considers such differences over the remaining initial lease terms plus any fixed rate renewal periods. The capitalized above-market lease values are amortized as a reduction of rental income over the remaining non-cancelable terms of the respective leases. The capitalized below market lease values are amortized to income over the remaining initial lease terms plus any fixed rate renewal periods. Management considers several factors in determining the discount rate used in the present value calculations, including the credit risks associated with the respective tenants. If debt is assumed in the acquisition, the determination of whether it is above or below market is based upon a comparison of similar financing terms for similar rental properties. The fair value of acquired in-place leases also includes management's estimate, on a lease-by-lease basis, of the present value of the following amounts: (i) the value associated with avoiding the cost of originating the acquired in-place leases (i.e. the market cost to execute the leases, including leasing commissions, legal and other related costs); (ii) the value associated with lost revenue related to tenant reimbursable operating costs estimated to be incurred during the assumed re-leasing period, (i.e. real estate taxes, insurance and other operating expenses); (iii) the value associated with lost rental revenue from existing leases during the assumed re-leasing period; and (iv) the value associated with avoided tenant improvement costs or other inducements to secure a tenant lease. These values are amortized over the remaining initial lease term of the respective leases. The Company also determines the value, if any, associated with customer relationships considering factors such as the nature and extent of the Company's existing business relationship with the tenants, growth prospects for developing new business with the tenants and expectation of lease renewals. The value of customer relationship intangibles is amortized over the remaining initial lease terms plus any renewal periods. Management of the Company reviews the carrying value of intangible assets for impairment on an annual basis. Intangible assets consist of the following (in thousands): SEPTEMBER 30, 2004 DECEMBER 31,2003 ------------------ ---------------- In-place leases, net of accumulated amortization of $558 thousand and $0 $ 9,931 $ - Goodwill 693 693 ------- ------- Total intangible assets, net $10,624 $ 693 ======= ======= In-place leases, net at September 30, 2004 of approximately $9.9 million relate solely to four entertainment retail centers in Ontario, Canada that were purchased on March 1, 2004. Amortization expense related to in-place leases was $558 thousand for the nine months ended September 30, 2004. There was no amortization expense related to in-place leases for the nine months ended September 30, 2003. CONCENTRATION OF RISK American Multi-Cinema, Inc. (AMC) is the lessee of a substantial portion (65%) of the megaplex theatre rental properties held by the Company at September 30, 2004 as a result of a series of sale leaseback transactions pertaining to a number of AMC megaplex theatres. A substantial portion of the Company's revenues (approximately 60%) result from rental payments by AMC under the leases, or its parent, AMC Entertainment, Inc. (AMCE), as the guarantor of AMC's obligations under the leases. AMC Entertainment, Inc. is a publicly held company (AMEX:AEN) and accordingly, their financial information is publicly available. 6 SHARE BASED COMPENSATION Share Options During 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 148 "Accounting for Stock-Based Compensation-Transition and Disclosure," which provides alternative methods of accounting for stock-based compensation and amends SFAS No. 123 "Accounting for Stock-Based Compensation." The Company adopted SFAS 148 as of January 1, 2003. Prior to 2003, the Company accounted for stock options issued under its share incentive plan under the recognition and measurement provisions of APB Opinion No. 25 "Accounting for Stock Issued to Employees," and related interpretations. Effective January 1, 2003, the Company adopted the fair value recognition provisions of SFAS No. 123 prospectively for all awards granted, modified, or settled after January 1, 2003. Awards under the Company's plan vest either immediately or up to a period of 5 years. Therefore the cost related to stock based compensation related to stock options included in the determination of net income for 2004 and 2003 is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS No. 123. The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards for each period (in thousands): NINE MONTHS ENDED SEPTEMBER 30, 2004 2003 ---------- ------------- Net income available to common shareholders, as reported $ 34,302 $ 23,059 Add: Stock-based compensation expense included in reported net income 87 19 Deduct: Total stock-based compensation expense determined under fair value based method for all awards (180) (115) ---------- ------------- Pro forma net income $ 34,209 $ 22,963 ========== ============= Basic earnings per share: As reported $ 1.56 $ 1.34 Pro forma $ 1.56 $ 1.34 Diluted earnings per share: As reported $ 1.51 $ 1.31 Pro forma $ 1.51 $ 1.31 Restricted Shares During the first quarter of 2004, the Company issued 55,650 restricted common shares as bonus compensation and long-term incentive to executives and other employees of the Company. Based upon the market price of the Company's common shares on the grant dates, approximately $2.1 million in non-vested shares were issued in the first quarter of 2004. During the first quarter of 2003, the Company issued 53,606 restricted common shares as bonus compensation and long-term incentive to executives and other employees of the Company. 7 During the second quarter of 2004, the Company issued 717 restricted common shares as retainers to Trustees of the Company. Based upon the market price of the Company's common shares on the grant dates, approximately $23,303 in non-vested shares were issued in the second quarter of 2004. RECLASSIFICATIONS Certain reclassifications have been made to the prior period amounts to conform to the current period presentation. 3. EARNINGS PER SHARE The following table summarizes the Company's common shares used for computation of basic and diluted earnings per share (in thousands): THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, 2004 ENDED SEPTEMBER 30, 2004 INCOME SHARES PER SHARE INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- ----------- ------------- --------- Basic earnings: Income available to common shareholders $ 13,988 4,031 $ 0.58 $ 34,302 21,997 $ 1.56 Effect of dilutive securities: Stock options - 466 (0.01) - 460 (0.03) Contingent shares from conversion of minority interest - - - 750 571 (0.01) Non-vested common share grants - 131 - - 131 (0.01) --------- ------ ------- -------- ------ ------- Diluted earnings $ 13,988 24,628 $ 0.57 $ 35,052 23,159 $ 1.51 ========= ====== ======= ======== ====== ======= THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, 2004 ENDED SEPTEMBER 30, 2004 INCOME SHARES PER SHARE INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- ----------- ------------- --------- Basic earnings: Income available to common shareholders $ 8,265 17,353 $ 0.48 $23,059 17,189 $ 1.34 Effect of dilutive securities: Stock options - 307 (0.01) - 286 (0.02) Contingent shares from conversion of minority interest 375 857 - 1,125 857 - Non-vested common share grants - 124 (0.01) - 124 (0.01) ------- ------ -------- ------- ------ -------- Diluted earnings $ 8,640 18,641 $ 0.46 $24,184 18,456 $ 1.31 ======= ====== ======== ======= ====== ======== 4. PROPERTY ACQUISITIONS On March 1, 2004, the Company acquired, through a wholly-owned subsidiary, four separate entertainment retail centers anchored by AMC megaplex theatres located in Ontario, Canada for total consideration of US $152 million. The properties are 8 the Mississauga Entertainment Centrum located in suburban Toronto, the Oakville Entertainment Centrum located in suburban Toronto, the Whitby Entertainment Centrum located in suburban Toronto, and the Kanata Centrum Walk located in suburban Ottawa. The fair value of the real properties acquired was approximately US $152 million. In accordance with Statement of Financial Accounting Standard (SFAS) No. 141 (described in Note 2), the Company allocated approximately $10 million of the purchase price to in-place leases and is amortizing this value over the remaining non-cancelable lease terms ranging from 5 to 19 years. Approximately US $27 million of the purchase price consisted of 747,243 restricted common shares of EPR valued at US $36.25 per share. The cash portion of the purchase price was paid in Canadian dollars and financed in part through Canadian-dollar non-recourse fixed-rate mortgage loans provided by GMAC Commercial Mortgage of Canada, Limited of approximately US $97 million. The following unaudited pro forma results of operations reflects the Company's acquisition as if it had occurred as of the beginning of the period: PRO FORMA NINE MONTHS ENDED SEPTEMBER 30, ----------------------------------------- 2004 2003 -------- ------ Total revenue $ 93,866 75,130 Net income available to common shareholders $ 34,860 25,430 Basic net income per common share $ 1.58 1.42 Diluted net income per common share $ 1.53 1.38 During the third quarter of 2004, the Company completed two megaplex theatre acquisitions totaling approximately $19.5 million, consisting of the Grand Prairie Theatre located in Peoria, Illinois, leased to Rave Motion Pictures, and the Palace Theatre in Lafayette, Louisiana leased to Southern Theatres. Lease terms for both theatres include a 20 year base term with optional extension periods all on a triple-net basis. 5. CONVERSION OF PREFERRED INTEREST IN EPT GULF STATES, LLC On September 20, 2004, 100% of the preferred interest in EPT Gulf States, LLC was converted to 857,145 restricted common shares of the Company. As a result, $15 million of minority interest in a consolidated subsidiary was converted to common shares and additional paid-in-capital. The shares were subsequently registered with the SEC under the Securities Act of 1933. 6. COMMITMENTS As of September 30, 2004, the Company has $46.5 million invested in property under development. The Company has outstanding commitments to fund an additional $33.3 million in improvements on certain of these properties. ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in this quarterly report on Form 10-Q. The forward-looking statements included in this discussion and elsewhere in this Form 10-Q involve risks and uncertainties, including anticipated financial performance, business prospects, industry trends, shareholder returns, performance of leases by tenants and other matters, which reflect management's best judgment based on factors currently known. Actual results and experience could differ materially from the anticipated results and other 9 expectations expressed in our forward-looking statements as a result of a number of factors including but not limited to those discussed in this Item and in Item I "Business - Risk Factors", in our annual report on Form 10-K for the year ended December 31, 2003 and those discussed in "Risk Factors" in our prospectus filed under Rule 424(b) of the SEC on October 14, 2004. OVERVIEW Our primary business strategy is to purchase real estate (land, buildings and other improvements) that we lease to operators of destination based entertainment and entertainment related properties. As of September 30, 2004, we had invested approximately $1.2 billion (before accumulated depreciation) in 54 megaplex theatre properties and various restaurant, retail and other properties located in 21 states and Ontario, Canada. As of September 30, 2004, we had invested approximately $46.5 million in development land and construction in progress for theatre and theatre-related developments. A majority of our properties are leased pursuant to long-term, triple-net leases, under which the tenants typically pay all operating expenses of a property, including, but not limited to, all real estate taxes, assessments and other government charges, insurance, utilities, repairs and maintenance. A majority of our revenues are derived from rents received or accrued under long-term, triple-net leases. We also own multi-tenant properties in which we lease space to operating tenants. We incur general and administrative expenses including compensation expense for our executive officers and other employees, professional fees and various expenses incurred in the process of identifying, evaluating and acquiring additional properties. We are self-administered and managed by our trustees, executive officers and other employees. Our primary non-cash expense is the depreciation of our properties. We depreciate buildings and improvements on our properties over a seven-year to 40-year period for tax and financial reporting purposes. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related notes. In preparing these financial statements, management has made its best estimates and assumptions that affect the reported assets and liabilities. The most significant assumptions and estimates relate to revenue recognition, depreciable lives of the real estate, the valuation of real estate and accounting for real estate acquisitions. Application of these assumptions requires the exercise of judgment as to future uncertainties and, as a result, actual results could differ materially from these estimates. Revenue Recognition Rents that are fixed and determinable are recognized on a straight-line basis over the term of the lease. Base rent escalation in most of our leases is dependent upon increases in the Consumer Price Index (CPI) and accordingly, management does not include any future base rent escalation amounts on these leases in current revenue. Most of our leases provide for percentage rents based upon the level of sales achieved by the tenant. These percentage rents are recognized once the required sales level is achieved. Real Estate Useful Lives We are required to make subjective assessments as to the useful lives of our properties for the purpose of determining the amount of depreciation to reflect on an annual basis with respect to those properties. These assessments have a direct impact on our net income. Depreciation and amortization are provided on the straight-line method over the useful lives of the assets, as follows: 10 Buildings 40 years Tenant improvements Base term of lease or useful life, whichever is shorter Equipment 3 to 7 years Impairment of Real Estate Values We are required to make subjective assessments as to whether there are impairments in the value of our rental properties. These estimates of impairment may have a direct impact on our consolidated financial statements. We apply the provisions of Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. We assess the carrying value of our rental properties whenever events or changes in circumstances indicate that the carrying amount of a property may not be recoverable. Certain factors that may occur and indicate that impairments may exist include, but are not limited to: underperformance relative to projected future operating results, tenant difficulties and significant adverse industry or market economic trends. No such indicators existed during 2003 or the first nine months of 2004. If an indicator of possible impairment exists, a property is evaluated for impairment by comparing the carrying amount of the property to the estimated undiscounted future cash flows expected to be generated by the property. If the carrying amount of a property exceeds its estimated future cash flows on an undiscounted basis, an impairment charge is recognized in the amount by which the carrying amount of the property exceeds the fair value of the property. Management estimates fair value of our rental properties based on projected discounted cash flows using a discount rate determined by management to be commensurate with the risk inherent in the Company. Management did not record any impairment charges for 2003 or the first nine months of 2004. Real Estate Acquisitions Upon acquisitions of real estate properties, we make subjective estimates of the fair value of acquired tangible assets (consisting of land, building, tenant improvements, and furniture, fixtures and equipment) and identified intangible assets and liabilities (consisting of above and below market leases, in-place leases, tenant relationships and assumed financing that is determined to be above or below market terms) in accordance with Statement of Financial Accounting Standards (SFAS) No.141, Business Combinations. We utilize methods similar to those used by independent appraisers in making these estimates. Based on these estimates, we allocate purchase price to the applicable assets and liabilities. These estimates have a direct impact on our net income. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2003 Revenue from property rentals was $32.3 million for the three months ended September 30, 2004 compared to $22.4 million for the three months ended September 30, 2003. The $9.9 million increase resulted primarily from the property acquisitions completed in 2003 and 2004 and from base rent increases and percentage rents on existing properties. Percentage rents of $520 thousand and $265 thousand were recognized during the three months ended September 30, 2004 and 2003, respectively, and straight-line rents were $665 thousand for the three months ended September 30, 2004 compared to no straight-line rents in the prior year. Our property operating expenses, net totaled $465 thousand for the three months ended September 30, 2004 compared to $220 thousand for the three months ended September 30, 2003. These expenses, net of tenant reimbursements, arise from the operations of our retail centers in Greenville, SC, Westminster, CO, Southfield, MI, Suffolk, VA, Tampa, FL, New Rochelle, NY, and Ontario, Canada. 11 Our general and administrative expenses totaled $1.1 million for the three months ended September 30, 2004 compared to $0.9 million for the same period in 2003. The increase in operating expenses is due primarily to: - Increases in insurance expense, including premiums for both Director and Officer insurance and property and casualty insurance due to an overall increase in premiums in the insurance market and increases in the size of our real estate portfolio. - An increase in payroll and related expenses attributable to increases in base compensation, bonus awards, and payroll taxes related to the vesting of stock grants and stock bonuses, and the addition of employees. Our net interest expense increased by $1.8 million to $9.5 million for the three months ended September 30, 2004 from $7.7 million for the three months ended September 30, 2003. The increase in net interest expense primarily resulted from increases in long-term debt used to finance real estate acquisitions. Depreciation and amortization expense, including amortization of non-vested shares, totaled $6.3 million for the three months ended September 30, 2004 compared to $4.3 million for the same period in 2003. The $2 million increase resulted from the property acquisitions completed in 2003 and 2004 and recent grants of restricted shares to management. Income from joint ventures totaled $172 thousand for the three months ended September 30, 2004 compared to $111 thousand for the same period in 2003. The increase is due to the addition of the Atlantic-EPR II joint venture as of March 1, 2004. For the three months ended September 30, 2004 minority interest in net income was $62 thousand as compared to $375 thousand for the three months ended September 30, 2003. The decrease is due to the conversion of the preferred interest in EPT Gulf States, LLC as of September 20, 2004 to 857,145 common shares of the Company. The minority interest for third quarter 2004 relates solely to the minority interest in New Roc Associates, L.P. which was acquired as of October 27, 2003. NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2003 Revenue from property rentals was $91.3 million for the nine months ended September 30, 2004 compared to $64.8 million for the nine months ended September 30, 2003. The $26.5 million increase resulted primarily from the property acquisitions completed in 2003 and 2004 and from base rent increases and percentage rents on existing properties. Percentage rents of $1.7 million and $872 thousand were recognized during the nine months ended September 30, 2004 and 2003, respectively, and straight-line rents were $1.6 million for the nine months ended September 30, 2004 compared to no straight-line rents in the prior year. Our property operating expenses, net totaled $1.6 million for the nine months ended September 30, 2004 compared to $398 thousand for the nine months ended September 30, 2003. These expenses, net of tenant reimbursements, arise from the operations of our retail centers in Greenville, SC, Westminster, CO, Southfield, MI, Suffolk, VA, Tampa, FL, New Rochelle, NY, and Ontario, Canada. General and administrative expenses totaled $3.7 million for the nine months ended September 30, 2004 compared to $2.9 million for the same period in 2003. The increase in operating expenses is due primarily to: - Increases in insurance expense, including premiums for both Director and Officer insurance and property and casualty insurance due to an overall increase in premiums in the insurance market and increases in the size of our real estate portfolio. 12 - A $99 thousand expense incurred for professional fees on a project that was ultimately not executed. - An increase in payroll and related expenses attributable to increases in base compensation, bonus awards, and payroll taxes related to the vesting of stock grants and stock bonuses, and the addition of employees. - Increases in franchise and other miscellaneous taxes paid. Costs associated with loan refinancing for the nine months ended September 30, 2004 were $1.1 million. These costs related to the termination of our iStar Credit Facility and consisted of a prepayment penalty of $405 thousand and the write-off of $729 thousand of remaining unamortized financing fees. No such costs were incurred for the nine months ended September 30, 2003. Net interest expense increased to $28.3 million for the nine months ended September 30, 2004 from $22.4 million for the nine months ended September 30, 2003. The $5.9 million increase in net interest expense resulted primarily from increases in long-term debt used to finance real estate acquisitions. Our depreciation and amortization expense, including amortization of non-vested shares, totaled $18.1 million for the nine months ended September 30, 2004 compared to $12.3 million for the same period in 2003. The $5.8 million increase resulted primarily from the property acquisitions completed in 2003 and 2004 and recent grants of restricted shares to management. Income from joint ventures totaled $482 thousand for the nine months ended September 30, 2004 compared to $299 thousand for the same period in 2003. The increase is due to the addition of the Atlantic-EPR II joint venture as of March 1, 2004. For the nine months ended September 30, 2004 minority interest in net income was $982 thousand as compared to $1.1 million in the prior year period. The decrease is due to the conversion of the preferred interest in EPT Gulf States, LLC as of September 20, 2004 to 857,145 common shares of the Company. The minority interest for third quarter 2004 relates solely to the minority interest in New Roc Associates, L.P. which was acquired as of October 27, 2003. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents were $10.3 million at September 30, 2004. In addition, we had restricted cash of $12.9 million at September 30, 2004 to be used only for payment of certain property taxes and capital improvements. Mortgage Debt and Credit Facilities As of September 30, 2004, we had total debt outstanding of $589.1 million. All of our debt is mortgage debt secured by a substantial portion of our rental properties. As of September 30, 2004, $564.1 million of debt outstanding was fixed rated debt with a weighted average interest rate of approximately 6.5%. As of September 30, 2004, we had $25 million in debt outstanding under our $150 million Revolving Bank Credit Facility that bears interest at a floating rate and is secured by eleven rental properties. Liquidity Requirements Short-term liquidity requirements consist primarily of normal recurring corporate operating expenses, debt service requirements and distributions to shareholders. We meet these requirements primarily through cash provided by operating activities. Cash provided by operating activities was $58.5 million for the nine months ended September 30, 2004 and $47.4 million for the nine months ended September 30, 2003. We anticipate that our cash on hand, cash from operations, and funds available under our revolving debt facility will provide adequate liquidity to fund our operations, make interest and principal payments on our debt, 13 and allow distributions to our shareholders and avoidance of corporate level federal income or excise tax in accordance with Internal Revenue Code requirements for qualification as a REIT. We make real estate acquisitions and fund development primarily with funds generated by debt financings and/or equity offerings. EPR had six theatre projects under construction at September 30, 2004. The properties are being developed by and have been pre-leased to the prospective tenants. The cost of development is paid by us either in periodic draws or upon successful completion of construction. These theatres will have a total of 96 screens and their total development costs (including land) will be approximately $70.9 million. Through September 30, 2004, we have invested $37.6 million in these projects (including land), and have commitments to fund an additional $33.3 million in improvements. Upon successful completion of construction, we have agreed to lease these theatres to the theatre operators under long-term triple-net leases. Off Balance Sheet Arrangements At September 30, 2004, we had a 20% investment interest in two non-consolidated real estate joint ventures, Atlantic-EPR I and Atlantic-EPR II, which are accounted for under the equity method of accounting. We do not anticipate any material impact on our liquidity as a result of any commitments that may arise involving those joint ventures. The following is a brief description of the joint ventures: On May 11, 2000, we completed the formation of a joint venture partnership, Atlantic-EPR I, a Delaware general partnership, with Atlantic of Hamburg, Germany (Atlantic), whereby we contributed the AMC Cantera 30 theatre with a carrying value of $33.5 million in exchange for cash proceeds from mortgage financing of $17.8 million and a 100% interest in Atlantic-EPR I. During 2000 through 2002, we sold to Atlantic a total of an 80% interest in Atlantic-EPR I in exchange for $14.3 million in cash. The final payment by Atlantic of $8.4 million was paid to us in January 2003. The joint venture agreement allows Atlantic to exchange up to a maximum of 10% of its ownership interest in Atlantic-EPR I per year, beginning in 2005, for common shares of EPR or, at our discretion, cash. We account for our investment in Atlantic-EPR I under the equity method of accounting. We recognized income of $307 thousand and $299 thousand from our investment in this joint venture during the first nine months of 2004 and 2003, respectively. On March 1, 2004, we completed the formation of the second joint venture partnership, Atlantic-EPR II, a Delaware general partnership, with Atlantic, whereby we contributed the AMC Tampa Veterans 24 theatre with a carrying value of $24.2 million and related mortgage debt of $14.6 million for a 100% interest in Atlantic-EPR II. Simultaneously on March 1, 2004, we sold to Atlantic an 80% interest in Atlantic-EPR II in exchange for $8.2 million in cash. The joint venture agreement allows Atlantic to exchange up to a maximum of 10% of its ownership interest in Atlantic-EPR II per year, beginning in 2007, for common shares of EPR or, at our discretion, cash. We account for our investment in Atlantic-EPR II under the equity method of accounting. We recognized income of $175 thousand from our investment in this joint venture during the first nine months of 2004. FUNDS FROM OPERATIONS (FFO) The National Association of Real Estate Investment Trusts (NAREIT) developed FFO as a relative non-GAAP financial measure of performance and liquidity of an equity REIT in order to recognize that income-producing real estate historically has not depreciated on the basis determined under GAAP. FFO is a widely used measure of the operating performance of real estate companies and is provided here as a supplemental measure to Generally Accepted Accounting Principles (GAAP) net income available to common shareholders and earnings per share. FFO, as defined under the revised NAREIT definition and presented 14 by us, is net income, computed in accordance with GAAP, excluding gains and losses from sales of depreciable operating properties, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships, joint ventures and other affiliates. Adjustments for unconsolidated partnerships, joint ventures and other affiliates are calculated to reflect FFO on the same basis. FFO is a non-GAAP financial measure. FFO does not represent cash flows from operations as defined by GAAP and is not indicative that cash flows are adequate to fund all cash needs and is not to be considered an alternative to net income or any other GAAP measure as a measurement of the results of our operations or our cash flows or liquidity as defined by GAAP. The following tables summarize our FFO for the three and nine month periods ended September 30, 2004 and September 30, 2003 (in thousands): THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, 2004 2003 2004 2003 ------- ------- ------- ------- Net income available to common shareholders $13,988 $ 8,265 $34,302 $23,059 Add: Real estate depreciation and amortization 5,778 4,042 16,347 11,496 Add: Allocated share of joint venture depreciation 59 33 163 97 ------- ------- ------- ------- Basic Funds From Operations 19,825 12,340 50,812 34,652 ------- ------- ------- ------- Add: minority interest in net income - 375 750 1,125 ------- ------- ------- ------- Diluted Funds From Operations $19,825 $12,715 $51,562 $35,777 ------- ------- ------- ------- FFO per common share: Basic $ 0.82 $ 0.71 $ 2.31 $ 2.02 Diluted $ 0.80 $ 0.68 $ 2.23 $ 1.94 Shares used for computation (in thousands): Basic 24,031 17,353 21,997 17,189 Diluted 24,628 18,641 23,159 18,456 Other financial information: Straight-lined rental revenue $ 665 $ - $ 1,635 $ - IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In December 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaced FASB Interpretation No. 46, Consolidation of Variable Interest Entities, which was issued in January 2003. We adopted FIN 46R on March 31, 2004. The adoption did not have any effect on our 2004 interim financial statements. FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, was issued in May 2003. This Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The Statement also includes required disclosures for financial instruments within its scope. For EPR, the Statement was effective for instruments entered into or modified after May 31, 2003 and otherwise was effective as of January 1, 2004, except for mandatory redeemable financial instruments. For certain mandatory redeemable financial instruments, the Statement will be effective for EPR on January 1, 2005. The effective date has 15 been deferred indefinitely for certain other types of mandatory redeemable financial instruments. As of September 30, 2004, our financial statements have not been impacted by the issuance of FASB Statement No. 150. INFLATION Investments by EPR are financed with a combination of equity and secured mortgage indebtedness. During inflationary periods, which are generally accompanied by rising interest rates, our ability to grow may be adversely affected because the yield on new investments may increase at a slower rate than new borrowing costs. All of our megaplex theatre leases provide for base and participating rent features. To the extent inflation causes tenant revenues at our properties to increase over baseline amounts, we would participate in those revenue increases through our right to receive annual percentage rent. Our leases also generally provide for escalation in base rents in the event of increases in the Consumer Price Index, with a limit of 2% per annum, or fixed periodic increases. Our theatre leases are triple-net leases requiring the tenants to pay substantially all expenses associated with the operation of the properties, thereby minimizing our exposure to increases in costs and operating expenses resulting from inflation. A portion of our retail and restaurant leases are non-triple-net leases. These retail leases represent less than 15% of our total real estate square footage. To the extent any of those leases contain fixed expense reimbursement provisions or limitations, we may be subject to increases in costs resulting from inflation that are not fully passed through to tenants. FORWARD LOOKING INFORMATION CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION WITH THE EXCEPTION OF HISTORICAL INFORMATION, THIS REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS AS DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND IDENTIFIED BY SUCH WORDS AS "WILL BE," "INTEND," "CONTINUE," "BELIEVE," "MAY," "EXPECT," "HOPE," "ANTICIPATE," "GOAL," "FORECAST," OR OTHER COMPARABLE TERMS. OUR ACTUAL FINANCIAL CONDITION, RESULTS OF OPERATIONS OR BUSINESS MAY VARY MATERIALLY FROM THOSE CONTEMPLATED BY SUCH FORWARD- LOOKING STATEMENTS AND INVOLVE VARIOUS RISKS AND UNCERTAINTIES, INCLUDING BUT NOT LIMITED TO THOSE DISCUSSED UNDER "RISK FACTORS" IN OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2003 AND OUR PROSPECTUS FILED UNDER RULE 424(b) OF THE SEC ON OCTOBER 14, 2004. INVESTORS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON ANY FORWARD-LOOKING STATEMENTS. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risks, primarily relating to potential losses due to changes in interest rates. We seek to mitigate the effects of fluctuations in interest rates by matching the term of new investments with new long-term fixed rate borrowings whenever possible. We also have a $150 million line of credit that bears interest at a floating rate that we use to acquire properties. We are subject to risks associated with debt financing, including the risk that existing indebtedness may not be refinanced or that the terms of such refinancing may not be as favorable as the terms of current indebtedness. The majority of our borrowings are subject to mortgages or contractual agreements which limit the amount of indebtedness we may incur. Accordingly, if we are unable to raise additional equity or borrow money due to these limitations, our ability to acquire additional properties may be limited. ITEM 4. CONTROLS AND PROCEDURES A review and evaluation was performed by our management, including our Chief Executive Officer (the "CEO") and Chief Financial Officer (the "CFO"), of the effectiveness of the design and operation of our disclosure controls and procedures as of 16 September 30, 2004, the end of the period covered by this report. Based on that review and evaluation, the CEO and CFO have concluded that our current disclosure controls and procedures, as designed and implemented, were effective. There have been no significant changes in our internal controls subsequent to the date of their evaluation. There were no significant material weaknesses identified in the course of such review and evaluation and, therefore, no corrective measures were taken by us in our internal control over financial reporting. PART II - OTHER INFORMATION ITEM 1 . LEGAL PROCEEDINGS Other than routine litigation and administrative proceedings arising in the ordinary course of business, we are not presently involved in any litigation nor, to our knowledge, is any litigation threatened against us or our properties, which is reasonably likely to have a material adverse effect on our liquidity or results of operations. ITEM 2 . UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS See Note 5 to the financial statements included in Part I, Item 1 of this report. 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. Exhibits. 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act 32 Certifications furnished pursuant to Section 906 of the Sarbanes-Oxley Act. b. Reports on Form 8-K. 8-K current report item 7, filed on July 27, 2004 in connection with the release of the Company's earnings for the quarter ended June 30, 2004 8-K, current report item 7, filed on September 27, 2004 in order to file as an exhibit the opinion of Sonnenschein Nath & Rosenthal LLP as to the legality of the shares registered under the Registrant's Registration Statement on Form S-3, Registration No. 333-119160. 17 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. ENTERTAINMENT PROPERTIES TRUST Dated: October 29, 2004 By /s/ David M. Brain ------------------------ David M. Brain, President - Chief Executive Officer and Trustee Dated: October 29, 2004 By /s/ Fred L. Kennon ------------------------ Fred L. Kennon, Vice President - Chief Financial Officer 18