EXHIBIT 99.1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS, QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA AND MANAGEMENT'S REPORT ON INTERNAL CONTROLS
OVER FINANCIAL REPORTING
Item 1. 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 December 31, 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 640 properties. At
December 31, 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.
As described below, the Company operates two business segments - real estate and
specialty finance.
o The real estate segment and its subsidiaries, operated through the
Company's wholly-owned subsidiary CNL Restaurant Investments, Inc.
("CNL-Investments"), 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 $488 million in affiliate real estate portfolios
and earns management fees related thereto. Revenues from
CNL-Investments (before elimination of inter-segment revenues)
represented approximately 75 percent, 74 percent and 26 percent of the
Company's total revenues from continuing operations for each of the
years ended December 31, 2004, 2003 and 2002, respectively. The
increase in 2003 and 2004, each as compared to 2002, is the result of
adopting accounting rules that require a component of the specialty
finance segment revenues to be treated as discontinued operations, as
described below in "Liquidity and Capital Resources - CNL-Capital -
Investment Property Sales Program".
o The specialty finance segment consists of CNL Restaurant Capital, LP
("CNL-Capital"), which, through December 31, 2004, was operated through
a partnership with the Company's wholly-owned subsidiary CNL Restaurant
Capital Corp ("CNL-Corp"), CNL/CAS Corp., an affiliate of the Company's
Chairman, and Bank of America ("the Bank"). Effective January 1, 2005,
the Bank and CNL/CAS Corp. each redeemed their remaining interest in
CNL-Capital. 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
(before elimination of inter-segment revenues) represented
approximately 28 percent, 29 percent and 75 percent of the Company's
total revenues from continuing operations for each of the years ended
December 31, 2004, 2003 and 2002, respectively. The decrease in 2003
and 2004, each as compared to 2002, is the result of adopting
accounting rules that require a component of the specialty finance
segment revenues to be treated as discontinued operations, as described
below in "Liquidity and Capital Resources - CNL Capital - Investment
Property Sales Program".
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 (the "Merger") with U.S.
Restaurant Properties, Inc. ("USRP"), a publicly traded real estate investment
trust. On February 25, 2005, the Company completed the transactions contemplated
by that agreement, including the merger of the Company into USRP and the change
of USRP's name to Trustreet Properties, Inc. On the same day, pursuant to merger
agreements between each of 18 public limited partnerships (the "CNL Income
Funds") and USRP, each CNL Income Fund merged with a separate wholly owned
subsidiary of the combined company's operating partnership. As a result of the
Merger, each share of Company common stock was 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 was not subject to change and there was no "collar" or minimum
trading price for the shares of the Company's common stock or USRP's common
stock. The Merger was structured to be tax-free to the stockholders of the
Company and USRP.
The Merger will be accounted for using the purchase method of accounting, and
the Company will be treated as the acquirer for accounting purposes. As a
result, the assets and liabilities of the Company will be recorded at historical
values without restatement to fair values. The assets and liabilities of USRP
and the CNL Income Funds will be recorded at their estimated fair values at the
date of the Merger, with the excess of the purchase price of USRP over the sum
of such fair values recorded as goodwill. The purchase price will be based upon
market capitalization of USRP using the trading price of USRP common stock and
traded preferred stock on February 25, 2005, as well as the estimated market
values for the existing Series B preferred stock plus certain merger related
costs. In subsequent periods, historical information of the combined company
will be that of the Company.
On January 18, 2005, Robert Lewis and Sutter Acquisition Fund, LLC, two limited
partners in several CNL Income Funds, filed Plaintiffs' Corrected Original
Petition for Class Action, Cause No. 05-00083-F, a purported class action
lawsuit on behalf of the limited partners of the 18 CNL Income Funds against the
Company, USRP, the 18 CNL Income Funds and the general partners (Mr. Seneff, Mr.
Bourne and CNL Realty Corporation) of the 18 CNL Income Funds, CNL-Investments
and CNL-Corp. in the District Court of Dallas County, Texas. The complaint
alleges that the general partners of the CNL Income Funds breached their
fiduciary duties in connection with the proposed mergers between the CNL Income
Funds and USRP and that the Company, CNL-Investments, CNL-Corp., and USRP aided
and abetted in the alleged breaches of fiduciary duties. The complaint further
alleges that the CNL Income Fund general partners violated provisions of the CNL
Income Fund partnership agreements and demands an accounting as to the affairs
of the CNL Income Funds. The plaintiffs are seeking unspecified compensatory and
exemplary damages and equitable relief, which also included an injunction
preventing the defendants from proceeding with the mergers. The injunction was
not successful in preventing the Merger that occurred on February 25, 2005.
Management of the Company believes that the lawsuit, including the request for
class certification, is without merit and intend to defend vigorously against
such claims.
On February 23, 2005, the Company awarded 26,500 shares of common stock to three
independent directors.
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. Following the Merger, the Company's management expects to meet short-term
liquidity requirements through earnings on real estate and loans, proceeds from
the sale of properties, interest and other income as well as an expanded line of
credit and warehouse credit facilities. Long-term liquidity requirements are
expected to be met through secured and unsecured debt issuances and sales of
common and/or preferred stock.
REIT Status. During 2004, the Company concluded that certain loans, which when
made by the Company in 1998 satisfied the REIT qualification requirements then
applicable, failed to meet subsequent REIT qualification requirements. To
eliminate any uncertainty, the Company sought assurance from the Internal
Revenue Service ("IRS") that the loans would not cause the Company to fail to
qualify as a REIT. The Company obtained such assurance in December 2004.
Contractual Obligations, Contingent Liabilities and Commitments. The following
table presents the Company's contractual cash obligations and related payment
periods as of December 31, 2004:
<s> <c>
Payments due by period (In millions)
Less
than one 2 to 3 4 to 5
Contractual cash obligations: year years years Thereafter Total
- ------------------------------------------- ---------- --------- ---------- ------------ ----------
Borrowings (1) $ 158.3 $ 307.3 $ 58.9 $ 188.0 $ 712.5
Leased office space (2) 1.1 2.4 2.5 6.8 12.8
Computer system financing 0.7 0.7 -- -- 1.4
Loans from an affiliate (3) 33.8 -- -- -- 33.8
---------- --------- ---------- ------------ ----------
Total contractual cash obligations $ 193.9 $ 310.4 $ 61.4 $ 194.8 $ 760.5
========== ========= ========== ============ ==========
The following table presents the Company's commitments, contingencies and
guarantees and related expiration periods as of December 31, 2004:
<s> <c>
Estimated payments due by period (In millions)
Less than
Commitments, contingencies one year 2 to 3 4 to 5
and guarantees years years Thereafter Total
- ---------------------------------------- ---------- ----------- ----------- ------------ ---------
Guaranty of unsecured promissory
note (2) $ 1.3 $ -- $ -- $ -- $ 1.3
Purchase commitments (4) 32.5 -- -- -- 32.5
---------- ----------- ----------- ------------ ---------
Total commitments, contingencies
and guarantees $ 33.8 $ -- $ -- $ -- $33.8
========== =========== =========== ============ =========
(1) The maturities on outstanding indebtedness assumes that loan repayments are
made on the mortgage warehouse facilities in accordance with the
contractual obligation and that bonds payable amortize in accordance with
estimated payment amounts. In February 2005, the Company renewed its $160
million warehouse facility with the Bank, resulting in $73.1 million shown
as maturing in 2005 in the above table now maturing in 2006. In the event
the mortgage warehouse lender continues to renew the other $100 million
facility as expected, $28.3 million of the amounts shown as maturing in
2005 in the above table would be renewed and would mature in 2006. The
maturities show $21.88 million relating to a senior subordinated note being
repaid over five years through 2008. As a result of new financing obtained
as part of the Merger, the Company anticipates repaying the $21.88 million
during 2005.
(2) In May 2002, the Company purchased a combined five percent partnership
interest in CNL Plaza, Ltd. and CNL Plaza Venture, Ltd. (the "Plaza") for
$0.2 million. Affiliates of James M. Seneff, Jr. and Robert A. Bourne, each
of which is a director of the Company, own the remaining partnership
interests. The Company has severally guaranteed 8.33 percent or $1.3
million of a $15.5 million unsecured promissory note on behalf of the
Plaza. The guaranty continues through the loan maturity which initially
matured in November 2004 and has been extended through May 31, 2005.
Further negotiations are underway to refinance this note. The Company has
not been required to fund any amounts under this guarantee. Management
believes that any required funding would be recoverable from operations of
the related assets or liquidation proceeds. Since November 1999, the
Company has leased its office space from the Plaza. Rental and other office
space expenses were $1.4 million, $1.4 million and $1.5 million for the
years ended December 31, 2004, 2003 and 2002, respectively. The Company's
lease expires in 2014 and provides for scheduled rent increases over the
term of the lease.
(3) Represents loans from an affiliate, as described in "Liquidity and Capital
Resources - Dividends". These loans are due on demand. As a result of new
financing obtained as part of the Merger, management of the Company
anticipates repaying these loans during 2005.
(4) Represents opportunities for net lease originations approved for funding
and accepted by the client.
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
declares and pays cash distributions to its common stockholders on a quarterly
basis. The current annualized distribution is $1.52 per share of common stock.
As a result of the Merger, the Company will declare and pay distributions to its
common stockholders on a monthly basis beginning in March 2005. USRP paid
distributions of $1.32 per share over the last twelve months on the USRP common
stock, which is equivalent to an annualized distribution of $1.02 on the .7742
shares of USRP common stock received by the CNLRP stockholder. The USRP Series C
preferred stock received by the CNLRP stockholder in the Merger provides for an
annual cumulative dividend of $1.875 per share, which is equivalent to an
annualized dividend of $0.30 on the 0.16 shares of Series C preferred stock
received for each share of CNLRP stock.
The Company has elected to distribute amounts in excess of that necessary to
qualify as a REIT. During the years ended December 31, 2004, 2003 and 2002, the
Company distributed $69.0 million, $69.0 million and $68.0 million,
respectively, or $1.52 per share each year, to its stockholders. For the year
2004, approximately 22 percent of the distributions received by stockholders
were considered to be ordinary income, 69 percent were considered a return of
capital, seven percent were qualified dividends and two percent were capital
gains for federal income tax purposes. During the years ended in 2003 and 2002,
approximately 39 percent and 0 percent, respectively, of the distributions
received by stockholders were considered to be ordinary income and approximately
61 percent and 100 percent, respectively, were considered a return of capital
for federal income tax purposes. The REIT's taxable income in 2003 and 2002 did
not include any of CNL-Capital's earnings since inception. Through the end of
the first quarter of 2004, distributions had been funded primarily by the
operations of CNL-Investments because the Company had elected to reinvest and
not distribute the earnings of CNL-Capital, as contemplated by the agreement
with its partner in CNL-Corp. Beginning in the second quarter of 2004 and
through December 31, 2004, CNL-Capital distributed $5 million to the Company.
The remainder of the distributions to date has been funded by sales of the
Company's common stock to the Company's Chairman through a private company
affiliate, CNL Financial Group, Inc. ("CFG"), and loans from CFG.
The Company's cash from operations for the years ended December 31, 2004, 2003
and 2002 were $39.1 million, $108.4 million, and $111.6 million, respectively.
Because increases in assets held for sale are primarily 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 (in 2003
and 2002), changes in the real estate portfolio and proceeds from the sale of
loans. Net cash provided by operating activities excluding changes in mortgage
loans held for sale and inventories of real estate held for sale were $58.9
million, $71.2 million, and $50.0 million in the years ended December 31, 2004,
2003 and 2002.
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, CFG
provided loans to and purchased common stock of the Company to enable the
Company to maintain its historical level of distributions during this period.
The loans are in the form of non-collateralized demand balloon promissory notes
which bear interest at LIBOR plus 2.5 percent or at the base rate, as defined in
the agreement, with interest payments and outstanding principal due upon demand.
During the years ended December 31, 2004, 2003 and 2002, CFG advanced $10.9
million, $18.7 million and $11.75 million, respectively. The principal amount
including accrued interest at December 31, 2004 was $35.8 million. As a result
of new financing obtained as part of the Merger, management of the Company
intends to pay off this balance during 2005. In addition, during 2002, the
Company converted $10.3 million of outstanding principal plus accrued interest
under the advances into 604,177 shares of stock. During 2002, the Company also
issued 569,177 additional shares to CFG in exchange for $9.75 million paid to
the Company in cash. The number of shares was determined using an estimated fair
value per share of $17.13. The value was determined by a third party firm, which
based its valuation on an analysis of comparable publicly traded real estate
investment trusts and a discounted cash flow analysis. The Company's Chairman
was not obligated to make loans or purchase shares and as a result of the
completion of the Merger, will not make any further loans or purchases of stock
to fund distributions. Should the Company not generate adequate cash flow from
other sources, the Company may have to reduce its distribution rate.
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 for new originations of real estate
properties during 2004, 2003 and 2002 was $247 million, $137 million and $204
million, respectively. Proceeds from the sales of properties through its
Investment Sales Program for the years ended December 31, 2004, 2003 and 2002
were $256 million, $194 million and $288 million, respectively. 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 accelerated principal payments of $5.8 million,
$10.1 million and $16.8 million during the years ended December 31, 2004, 2003
and 2002, respectively, 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 years ended December 31, 2004, 2003 and 2002, CNL-Capital derived its
primary cash flows from lease and interest income earned in excess of interest
expense paid ("net spread"), loan principal collections, net gains from the
Investment Property Sales Program, advisory services, referral 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 $8.4
million, $31.9 million and $10.4 million at December 31, 2004, 2003 and 2002,
respectively. The decrease during 2004, as compared to 2003, was primarily due
to paying down, over the course of 2004, approximately $21.88 million under its
Subordinated Note Payable, as described below in "Liquidity and Capital
Resources - Indebtedness - Subordinated Note Payable". The increase in cash in
2003 as compared to 2002 was due to larger inflows of cash from proceeds of
sales of properties then the outflows of cash for acquisitions or properties.
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.
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 franchise loans.
Rising delinquencies in securitized loan pools, low 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 described below in
"Liquidity and Capital Resources - New Financings", the Company priced a new net
lease securitization expected to close on March 4, 2005.
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 the 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 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 or 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.
Prior to 2002, all operating results generated within CNL-Capital, including the
results from the leasing and ultimate disposition of triple net lease properties
under its Investment Property Sales Program, were reported as income from
continuing operations. New accounting guidance issued in late 2001 required that
CNL-Capital reflect the operating results from its Investment Property Sales
Program for properties classified as held for sale beginning January 1, 2002, as
discontinued operations. The accounting guidance provided a carve out for
properties classified as held for sale prior to January 1, 2002 and permitted
the results from these properties to be reflected as income from continuing
operations. Due to the carve out during 2002, the Investment Property Sales
Program recorded a portion of its 2002 results as continuing operations and the
remaining portion as discontinued operations. This hybrid presentation during
2002, although in accordance with generally accepted accounting principles, did
not allow for comparability of results within CNL-Capital for each of the years
ended December 31, 2004, 2003 and 2002. The following table shows the results
within CNL-Capital without designation between continuing operations and
discontinued operations for purposes of showing comparability of results during
2004, 2003 and 2002 for presentation purposes only.
<s> <c>
(In Millions)
For the years ended December 31,
------------------------------------------------
2004 2003 2002
------------- -------------- -------------
Revenues:
Sale of real estate $ 256.2 $ 193.8 $ 287.6
Rental income 11.5 9.9 13.2
Other revenue items 29.6 32.3 35.1
------------- -------------- -------------
297.3 236.0 335.9
------------- -------------- -------------
Expenses:
Cost of real estate sold 221.0 169.2 263.0
Interest expense 21.8 25.9 29.6
Depreciation and amortization 1.1 1.2 1.2
Other expenses 29.7 31.1 29.5
------------- -------------- -------------
273.6 227.4 323.3
------------- -------------- -------------
Pre-tax income 23.7 8.6 12.6
Income tax (provision)/benefit (10.9) 6.3 --
------------- -------------- -------------
Net income $ 12.8 $ 14.9 $ 12.6
============= ============== =============
The chart below illustrates cash flows from Investment Property Sales proceeds
and the cost of properties sold as follows:
<s> <c>
(In Millions)
For the years ended December 31,
-------------------------------------------------
2004 2003 2002
------------- ------------- --------------
Sales of real estate $ 256.2 $ 193.8 $ 287.6
Cost of real estate 221.0 169.2 263.0
------------- ------------- --------------
Gain on sale $ 35.2 $ 24.6 $ 24.6
============= ============= ==============
Management expects continued demand for the Investment Property Sales Program.
The Company sold 128, 147 and 182 properties during the years ended December 31,
2004, 2003 and 2002. Despite the decrease in the number of properties sold in
2004 and 2003, each as compared to the previous year, gains on sales were higher
in 2004 as compared to 2003. Gains were higher in 2004 as a result of investing
and selling properties in the casual dining sector versus quick service sector.
Properties in the casual dining sector generally cost more per property but tend
to generate higher gains per property. In addition, during 2004, the Company
concentrated its efforts on using fewer external brokers to sell properties,
thereby reducing the costs incurred to sell the property, and therefore increase
the gain per property. Management anticipates that gains during 2005 generated
from the Company's inventory of properties held for sale at December 31, 2004
will approach the level achieved in 2004. At December 31, 2004, CNL-Capital had
$117.6 million in properties held for sale. If interest rates escalate, the
Company's interest costs could increase relative to the fixed rental revenues
reducing the margin and could result in lower gains on the subsequent sale. In
2005, management of the Company will manage concentrations on large net lease
financing transactions by selling a portion of the properties through the
Investment Property Sales platform and holding a portion of a transaction as a
long-term investment. Management anticipates that the majority of properties
purchased will be sold through the Investment Property Sales platform in 2005
but anticipates that over the next thirty-six months the ratio will shift to a
larger portion being held in the real estate portfolio versus sold in
CNL-Capital. Management's expectation is based on both the diversification of
contemplated future purchases and the achievement of returns that meet the
criteria of the Company.
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 year ended December 31, 2004, 2003 and
2002, CNL-Capital originated $247 million, $137 million and $204 million in net
leases respectively. Production during 2004 was primarily driven by the cut-back
in senior debt availability with large banks and the increase in leverage buy
out opportunities driven by private equity sponsors seeking real cash flow
returns. During 2002, originations included a portfolio of $117 million in
properties. CNL-Capital acquired this portfolio in September 2002 by purchasing
all of the limited and general partnership interests of CNL Net Lease Investors,
L.P., an affiliate of the Company's Chairman of the Board and Vice Chairman of
the Board, that until the acquisition, was a client of CNL-Investment's property
management group. Management expects continued demand for its core triple-net
lease financing in 2005. The Company acknowledges that the demand is impacted by
long-term low interest rates and the following factors:
o Identified lease transactions have been lost to competitors offering
mortgage debt financing. With continued 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.
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 and will continue to respond 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 benefits from the
rental income earned from the leases while holding them. At December 31, 2004,
CNL-Capital was involved in several opportunities for net lease originations
with $32.5 million approved for funding and accepted by the client (of which,
$5.6 million have been identified for CNL-Investments). 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.
The Company anticipates that the merger of the Company and USRP will provide
increased visibility to net-lease transactions in the restaurant marketplace.
Management believes that the Company's acquisition volume will predominantly be
comprised of restaurants although a portion of the net lease financings could be
in the form of other freestanding single tenant retail locations. The Company's
marketing platform was enhanced as of January 1, 2005 with the addition of two
new senior originators, increasing the direct marketing effort by forty percent.
Our existing team originated $247 million in new net-lease financings during
2004. As in 2004, the Company will continue to emphasize large public
transactions as well as those transactions where its net-lease financing is
packaged with senior debt financing provided by the Bank, the Company's alliance
partner. The ability to provide comprehensive capital solutions is augmented by
a revamped marketing plan which segments our opportunities both geographically
and by target market which is anticipated to result in an increased level of net
lease financings in 2005.
Indebtedness
CNL-Capital uses proceeds from sales of properties, its "net spread", servicing
and other revenues to pay operating expenses and uses borrowings on its
warehouse facilities to fund new real estate originations. CNL-Capital may be
subject to accelerated payments on its warehouse credit facilities. The Bank and
the other lenders monitor delinquency assumptions and may require accelerated
payments to reduce the level of warehouse financing. During the years ended
December 31, 2004, 2003 and 2002, CNL-Capital made $5.8 million, $10.1 million
and $16.8 million, respectively, in accelerated payments. 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 December 31, 2004, with the
stated total capacity and interest rate:
<s> <c>
In Millions
----------- Stated
Amount used Capacity Maturity interest rate (3)
----------------- ------------- --------------- -------------------
Note payable $ 161.9 $ 161.9 Jun 2007 2.70% (1)
Mortgage warehouse facilities 101.4 260.0 Annual 2.78%
Subordinated note payable 21.9 21.9 Dec 2008 7.00%
Series 2001-4 bonds payable (2) 29.8 29.8 2009 - 2013 8.90%
----------------- -------------
$ 315.0 $ 473.6
================= =============
(1) Stated rate excludes the impact of hedge transactions that bring the total
average rate to 5.83 percent.
(2) Balances include $1.4 million in bonds held by CNL-Investments eliminated
upon consolidation in the Company's consolidated financial statements.
(3) Excludes debt issuance and other related costs.
NotePayable. 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 $161.9 million and $182.0 million at December 31, 2004
and 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 accelerated payments 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 of debt,
resulting in losses on termination of cash flow hedge of $0.9 million and $0.5
million during 2004 and 2003, respectively.
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
December 31, 2004, CNL-Capital has two warehouse facilities. The first warehouse
facility is for $160 million with the Bank (the "Warehouse Credit Facility"). In
February 2005, the Company renewed the facility through February 2006. The
second mortgage warehouse credit facility has a current capacity of $100 million
with another lender and matures in June 2005. At December 31, 2004, CNL-Capital
had approximately $10.2 million in capital supporting its loan and lease
portfolio financed through its mortgage warehouse facilities. Amounts
outstanding under the mortgage warehouse facilities were $101.4 million and
$93.5 million at December 31, 2004, and 2003, respectively. The increase in the
balance outstanding resulted from 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 $21.88 million and $43.75 million at December 31, 2004
and 2003, respectively. In late December 2003, CNL-Capital removed some loans
previously held on a warehouse credit facility by selling them to
CNL-Investments, who in turn, 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. 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. 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 a result of new financing obtained as part of the Merger,
management of the Company expects to repay all of the outstanding balance during
2005.
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 $29.8 million
and $38.9 million at December 31, 2004 and 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
accelerated principal payments 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 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 December 31, 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 reduce the interest rate due on the outstanding debt over a twelve month
period on eight mortgage loans to provide debt service relief. Repayment terms
are scheduled to return to the original terms starting March 2005. 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 made advanced principal payments of approximately $5.3 million under its
Note Payable. The 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, had 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. CNL-Capital's interests in
these residual interests were $0.4 million at December 31, 2004 and appeared as
investments in the consolidated financial statements of the Company. The
following table shows the assets and the related bonds outstanding in each
securitization pool at December 31, 2004:
<s> <c>
(In Millions)
Mortgage loans Bonds outstanding
in pool at par at face value (1)
-----------------------------------------
Loans and debt supporting 1998-1 Certificates issued $ 169.5 $ 167.7
by CNL Funding 1998-1, LP
Loans and debt supporting 1999-1 Certificates issued
by CNL Funding 1999-1, LP 217.4 217.4
-----------------------------------------
$ 386.9 $ 385.1
=========================================
(1) CNL-Investments owns certain bonds in the 1998-1 pool with an aggregate net
carrying value of $16.0 million at December 31, 2004. These interests appear
as investments in the 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 stockholders of 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 an effort to reduce balance sheet
exposure to residual interests in securitizations, in September 2004, the
Company sold $11.1 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 $14.3 million,
$4.3 million and $5.3 million at December 31, 2004, 2003 and 2002, respectively.
The increase in cash in 2004 as compared to 2003 was due to CNL-Investments
collecting approximately $11 million in December 2004 in principal and interest
from a borrower who prepaid his mortgage note receivable balance. The borrower
obtained financing from an unrelated third party and satisfied the principal and
interest obligation to CNL-Investments.
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 proceeds from operating activities and from debt and equity
offerings.
Indebtedness
CNL-Investments has the following borrowing sources at December 31, 2004, with
the stated total capacity and interest rate:
<s> <c>
(In Millions)
Amount Stated
Used Capacity Maturity interest rate (1)
-------------- -------------- --------------- ------------------
Revolver $ 21.0 $ 40.0 July 2005 4.04%
Note payable 0.9 6.5 (2) 4.61%
Series 2000-A bonds payable 239.2 239.2 2009-2017 7.96%
Series 2001 bonds payable 111.6 111.6 Oct 2006 1.89%
Series 2003 bonds payable 26.2 26.2 2005-2011 6.02%
-------------- --------------
$ 398.9 $ 423.5
============== ==============
(1) Excludes debt issuance and other related costs.
(2) $0.3 million matures in 2005 and $0.6 million matures in 2011.
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 $21.0 million and $2.0 million at December 31, 2004 and 2003,
respectively. In February 2005, the Company amended the Revolver to increase the
capacity from $40 million to $60 million. All other material terms of the
Revolver remain unchanged.
Note Payable. At December 31, 2004 and 2003, the Company had $0.9 million and
$0.6 million, respectively, outstanding relating to loans from CNL Bank, an
affiliate. The loans have a total borrowing capacity of $6.5 million, were
established to finance the construction and acquisition of certain real estate
properties and were collateralized by mortgages on certain real property. A loan
in the amount of $0.3 million bears interest at LIBOR plus 325 basis points per
annum and requires monthly interest only payments until maturity in August 2005
at which point the unpaid principal balance will be due. The remaining loan of
$0.6 million bears interest at prime plus one-half percent per annum and
requires monthly interest only payments during the construction period with
monthly principal and interest payments beginning upon completion of the
construction period and through the maturity date in 2011.
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. During December 2004, a borrower on a
mortgage loan collateralizing the Series 2003 notes prepaid their mortgage note
balance of approximately $10.7 million. In January 2005, CNL-Investments paid
off approximately $10.7 million of the Series 2003 notes prior to their
scheduled maturity.
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. CNL-Investments continues to
monitor each tenant's situation carefully and will take appropriate action to
place CNL-Investments in a position to maximize the value of its investment. For
those tenants who have experienced financial difficulties or have defaulted
under their leases, management has estimated the loss or impairment on the
related properties and included such charge in earnings through December 31,
2004. Management believes it has recorded an appropriate impairment charge at
December 31, 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 March 4, 2005, Chevy's
had rejected the leases on 19 of the 23 sites. Management has recorded
impairments relating to some of these sites. Through March 4, 2005, management
has sold three 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 March 4, 2005, all
but two of the remaining 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. As of March 4, 2005,
Ground Round had rejected the leases on seven sites. Through March 4, 2005,
management has sold one site, re-leased one site and expects the remaining
rejected sites to be re-leased or sold. 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 all or a portion of rents during 2004 on ten sites to provide
rent relief. Under the forebearance agreement, commencing January 1, 2005 the
tenant will pay the amounts deferred under the forbearance agreement over five
years. This temporary forbearance on the rents had a $1.8 million negative
impact on cash flows of CNL-Investments during 2004 but the cash flows are
expected to be collected over the next five years.
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. 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. During 2003 and through December 2, 2004, the Company owned,
through a subsidiary, 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. In December 2004, the Company sold its interest in the
subsidiary engaged in the restaurant operations to CherryDen, LLC, an affiliate
of the Chairman and Vice Chairman of the Board of Directors. The Company
received $0.7 million in proceeds from the sale of this investment and for
satisfaction of loans to this subsidiary. CNL-Investments recognized a net gain
of $0.9 million, which included the recognition of $0.5 million in gains on
sales of real estate used in these restaurant operations, which were previously
deferred by CNL-Investments in accordance with generally accepted accounting
principles. CNL-Capital also recognized $0.3 million of such gains that it had
previously deferred.
CNL Investments, through a taxable-REIT subsidiary, focuses on acquisitions of
individual parcels or assemblages of land for development and subsequent sale or
lease. In addition, they work with developers and realty companies to partner in
the acquisition of realty for subsequent sale or lease. This provides access to
portions of the net lease market not presently served by the restaurant
originations team and efficiently levers the Company's resources. In 2004, the
subsidiary generated $3.7 million in gains on sale representing a pre-tax return
on investment of 35 percent. At December 31, 2004 CNL-Investments has invested
$22.7 million in properties they expect to profitably sell in 2005.
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 years ended December 31, 2004, 2003 and 2002,
the Company was required to make additional debt reductions of approximately
$2.4 million, $0.4 million and $0.9 million, respectively, 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 $386.9 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 assets with a fixed return by sometimes
financing a portion of them with variable rate debt. As of December 31, 2004,
the Company's variable rate debt includes the following:
o $21.0 million on its Revolver;
o $101.4 million on its mortgage warehouse facilities;
o $161.9 million on the June 2002 five-year financing, of which $125.1
million are subject to an interest-rate swap;
o $111.6 million outstanding on the Series 2001 bonds payable, all of
which is subject to an interest rate cap; and
o $26.2 million outstanding on the Series 2003 bonds payable, all of
which is subject to an interest rate cap.
The Company uses interest rate swaps and caps to hedge against fluctuations in
variable cash flows on a portion of its floating rate debt. Under interest rate
swaps, the Company agrees with other parties to exchange, at specified
intervals, the difference between fixed-rate and floating-rate interest amounts
calculated by reference to an agreed upon notional principal amount. Under a cap
purchase, a third party agrees to assume any interest costs above a stated rate.
Changes in the values of the Company's current interest rate swaps and caps that
qualify for hedge accounting are reflected in other comprehensive income (loss).
The Company also invests in financial instruments that are subject to various
forms of market risk such as interest rate fluctuations, credit risk and
prepayment risk. The value of its investments in residual interests from
previous securizations change as a result of fluctuating interest rates, credit
risk, market sentiment and other external forces, which could adversely affect
liquidity and capital resources.
The Company has entered into the following cash flow hedges and interest rate
caps that are outstanding as of December 31, 2004. The net value associated with
these hedges is reflected on the Company's Consolidated Balance Sheets:
<s> <c>
Estimated
Value
(Liability)
(in
millions)
Notional Cap Strike at
Amount (In Price or Trade Maturity December
Type of Hedge Millions) Swap Rate Date Date 31, 2004
----------------------------- -------------- ------------- ---------- ---------- -----------
Interest Rate Swap $ 125.1 6.590% 6/14/02 3/15/22 $ (8.7 )
Interest Rate Cap $ 113.3 4.500% 9/28/01 10/25/06 $ 0.1
Interest Rate Cap $ 26.0 3.500% 12/17/03 2/1/11 $ 0.5
Interest Rate Swap $ 110.0 4.354% 12/22/04 3/1/12 $ 0.0
In December 2004, the Company entered into an interest rate swap with a notional
amount of $110 in conjunction with the proposed $275 million net lease
securitization. The Company unwound this swap in February 2005, as discussed
below in "Liquidity and Capital Resources - New Financings".
Management estimates that a one-percentage point increase in short-term interest
rates for the year ended December 31, 2004 would have resulted in additional
interest costs of approximately $2.9 million. This sensitivity analysis contains
certain simplifying assumptions (for example, it does not consider the impact of
changes in prepayment risk or credit spread risk). Therefore, although it gives
an indication of the Company's exposure to interest rate change, it is not
intended to predict future results and the Company's actual results will likely
vary.
Inflation
Management believes inflation has not significantly affected the Company's
earnings because the inflation rate has remained low. During inflationary
periods, which generally are accompanied by rising interest rates, the Company's
ability to grow may be adversely affected because the yield on new investments
may increase at a slower rate than new borrowing costs. However, sustained low
inflation could lead to net lease pricing pressure as tenants request decreasing
rates for longer maturities.
New Financings
In December 2004, the Company and USRP each entered into a commitment letter
with the Bank and an affiliate of the Bank to obtain bridge financing in an
amount up to $775 million to finance the Merger, refinance the debt, and for
general corporate purposes until permanent financing could be put in place. The
bridge financing provided by the Bank consisted of a senior secured revolving
credit facility of up to $125 million and a senior secured term loan of up to
$650 million. The bridge financing bears interest at a floating rate of interest
and will mature, and be repayable in full, on the 90th day following its initial
funding. The Company anticipates raising approximately $875 million of new debt
capacity to replace the bridge financing and to refinance existing debt
following the Merger. These new financings are expected to consist of senior
unsecured notes, a new senior credit facility and a net lease securitization.
Net Lease Securitization. The Company priced a $275 million triple-net lease
financing on February 25, 2005 with an expected closing date of March 4, 2005.
Between December 2004 and February 2005, the Company entered into four interest
rate swaps with aggregate notional balances of $240 million in conjunction with
this financing in an attempt to lock in a portion of its cost of capital. The
Company unwound the interest rate swap contracts upon pricing these notes and
received $1.7 million. The notes are collateralized by approximately 324
properties originated by the Company, USRP and the 18 CNL Income Funds. Two
classes of mortgage notes were issued and will be amortized over twenty years
with a seven year balloon payment.
New Senior Credit Facility. The Company expects to enter into a senior credit
facility (the "Facility") consisting of a revolving credit facility and a term
loan with a syndicate of lenders, including the Bank. The size of the Facility
is expected to approximate $350 million and proceeds from the Facility will be
used to repay the bridge financing, refinance existing debt and for general
corporate purposes.
Senior Unsecured Notes. The Company expects to issue $250 million in senior
unsecured notes and together with the proceeds of the other financings described
above, expects to repay indebtedness incurred in connection with the merger and
related transactions. The notes will mature in March 2015. The notes will be
general unsecured senior obligations ranking equally with existing and future
unsecured senior debt, but will be effectively subordinated to all existing and
future secured debt an to all liabilities of subsidiaries.
The Company expects that the weighted average cost of the new financing will
approximate 6.25 percent to 7.0 percent.
Critical Accounting Policies
The Company accounts for many asset categories that require management to
exercise extensive judgment and make estimates. Listed below are the more
significant accounting policies that require management judgment and estimates
or are otherwise significant to the results of operations:
o The Company records the acquisition of land, buildings and equipment at
cost, including acquisition, closing and construction period interest
costs. Land and buildings are leased to restaurant operators generally
on a triple-net basis, which means that the tenant is responsible for
all operating expenses relating to the property, including property
taxes, insurance, maintenance and repairs. The property and secured
equipment leases held for investment are accounted for using either the
direct financing or the operating method unless the Company has
classified these properties pursuant to their intent to sell.
Management estimates residual values and collectable rents in
determining whether a lease is accounted for as either direct financing
or operating.
o The Company's real estate accounting differs for assets held by its two
operating segments based upon management's intention with respect to
such asset's disposition.
o Real estate held within CNL-Investments is generally acquired with an
intention to hold long-term. It is depreciated over its estimated
useful life and rent is recorded giving consideration to contractual
rent increases over the life of the lease. Some real estate held by
this segment may be designated so as to reflect management's intention
to dispose of the asset. In such case all operating income and expense,
including depreciation and accrued rent associated with future
contractual increases, is reflected as a component of discontinued
operations for all periods presented, even for periods prior to
management having stated its intention to sell. Management reviews its
properties for impairment whenever events or changes in circumstances
indicate that their carrying amount may not be recoverable through
operations or sale. Management determines whether impairment in value
has occurred by comparing the estimated future undiscounted cash flows,
including the residual value of the property, with the carrying cost of
the individual property. If impairment is indicated, the assets are
adjusted to estimated fair value.
o Real estate held within CNL-Capital is generally acquired with an
intention to sell within one year. It is therefore not depreciated, and
future contractual rent increases do not impact earnings. Management
reviews these properties for impairments and adjusts the asset to fair
value if necessary. Because of an accounting transition rule in 2002,
the properties within CNL-Capital were accounted for differently
depending on acquisition date. All properties acquired after December
31, 2001 are treated as discontinued operations, and operating income
and expense is reflected as a component of discontinued operations.
Management reviews the Company's ability and intent to hold these
assets for sale on a periodic basis to determine the proper
classification of these assets.
o "Mortgage notes receivable" differ from "mortgage loans held for sale"
primarily because of management's intention to hold the mortgage to its
maturity. These financial assets are recorded at the lower of cost or
market. Certain assets were reclassified in a prior year from "mortgage
loans held for sale" into the "mortgage notes receivable" category
when, in lieu of selling the mortgages, the Company elected to
refinance such mortgages using longer-term debt. In the case of such
reclassified mortgages, the Company recorded these at the value on the
refinance date. The value at such date differed from the par value of
the loan and such difference is being amortized to earnings over the
remaining life of the mortgage loans as a yield adjustment. Whenever it
appears that future collection on specific notes appears doubtful, a
valuation allowance is established. The allowance represents the
difference between the carrying amount and the amount management
expects to receive. Increases and decreases in the allowance due to
changes in the measurement of the impaired loans are included in
impairments and provisions on assets. Loans continue to be classified
as impaired unless they are brought fully current and the collection of
scheduled interest and principal is considered probable. When a loan or
portion of a loan, including an impaired loan, is determined to be
uncollectible, the portion deemed uncollectible is charged against the
allowance and subsequent recoveries, if any, are credited to the
allowance. Accrual of interest is discontinued when management
believes, after considering economic and business conditions and
collection efforts, that the borrowers' financial condition is such
that collection of interest is doubtful. Subsequent interest is
recorded as income.
o "Mortgage loans held for sale" were loans originated that the Company
intended to sell or securitize. They were recorded at fair market value
which was estimated using quoted prices, the present value of the
expected cash flows and the estimated impact of any defaults, and may
have been recorded at an amount greater than cost. In December 2003,
the Company re-designated the majority of these loans to reflect the
Company's intention to hold them to maturity and terminated the related
derivative instrument hedging these loans. In December 2004, the
remaining loans were reclassified to mortgage notes receivable to
reflect the Company's intention to hold them to maturity.
o Certain loans originated by the Company were sold to independent trusts
that, in turn, issued securities to investors backed by these assets.
The Company retains the servicing rights and participates in certain
cash flows from the trusts. The present value of expected excess of net
cash flows, after payment of principal and interest to bond or other
certificate holders, over the estimated cost of servicing is recorded
at the time of sale as a retained interest. Retained interests in
securitized assets are included in other investments. Accounting for
the retained interests requires that the Company estimate values using
market trends and historical experience, expected prepayments and
defaults. This information is considered, along with prevailing
discount rates and the terms of the bonds and certificates, to arrive
at an initial value and to periodically review the value for gains or
losses. Permanent impairments, representing the excess of carrying
value over estimated current fair value, are recorded as an expense.
o Management reviews its long-lived assets for impairment or potential
loss as events or circumstances indicate that the carrying amount of
the assets may not be recoverable. Management compares the estimated
future undiscounted cash flows, including the residual value of the
property or collateral, with the carrying cost of the individual asset.
If impairment is indicated, the assets are adjusted to the estimated
fair value. In addition, management evaluates the carrying value of
goodwill at least annually, to determine if an impairment is deemed
necessary. A discounted cash flow valuation approach and/or capital
market valuation approach is used to determine the fair market value of
the Company, which is compared to the Company's net book value.
Impairments resulting from this analysis are charged to results of
operations.
o The Company has also entered into certain derivative contracts in order
to hedge its exposure to fluctuations in interest rates on variable
rate debt qualifying for treatment as cash flow hedges. As long as the
criteria for hedge accounting are met the changes in fair value of
these contracts are reflected in other comprehensive income (loss) and
as a component of stockholders' equity. If the requirements are not
met, changes in the fair value of these contracts are reflected in
earnings.
o Valuation of deferred tax assets. The Company accounts for federal and
state income taxes with respect to its TRS subsidiaries using the asset
and liability method. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences
between the consolidated financial statements carrying amounts of
existing assets and liabilities and respective tax bases and operating
losses and tax-credit carry forwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. In the event that these
assumptions change the deferred taxes may change.
o Valuation allowances are established when necessary to reduce deferred
tax assets to the amount expected to be realized. The valuation
allowance is based on the Company's estimates of future taxable income
and ongoing prudent and feasible tax planning strategies. Should the
Company determine it would not be likely to realize in full the
deferred tax asset in the future, the Company would record a valuation
allowance to reduce the deferred tax asset to an amount that is more
likely than not to be realized. An adjustment to the deferred tax asset
would decrease income in the period the determination was made. The
Company reversed all valuation allowances in 2003 and 2004.
o In estimating future taxable income, the Company must estimate future
income using historical data, the expected growth rate of revenues and
expenses, the effect of capital expenditures, and future market and
economic conditions. Variability of these and other assumptions could
result in an inability to recover the carrying value of the deferred
tax assets.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 153, "Exchange of Non-Monetary
Assets" ("FAS 153"). FAS 153 addresses the measurement of exchanges of
non-monetary assets. It eliminates the exception from fair value measurement for
non-monetary exchange of similar productive assets under APB Opinion No. 29,
"Accounting for Non-Monetary Transactions", and replaces it with an exception
for exchanges that do not have commercial substance. A non-monetary exchange has
commercial substance if the entity's future cash flows are expected to
significantly change as a result of the exchange. The provisions of this
statement are effective for non-monetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005.
In December 2004, the FASB issued a revision to FAS 123 "Accounting for
Stock-Based Compensation" to expand the disclosure requirements in connection
with the entity's use of share-based compensation and share-based payment for
the acquisition of goods or services other than employee services. Historically,
the Company had not made any stock awards, and had not been subject to this
pronouncement. As a result of the Merger, in which the Company adopted USRP's
Incentive Plan, the Company will become subject to this pronouncement in 2005.
Results from Operations
The Company generated net income of $42.0 million, $42.4 million and $35.6
million for the years ended December 31, 2004, 2003 and 2002, respectively. Net
income in 2004 did not change significantly as compared to 2003. In 2004, higher
gains on sales of properties and lower impairments and provisions on assets in
the portfolio due to fewer financial difficulties and defaults by borrowers,
were offset by provisions for federal and state income taxes. No income tax
provision was recorded in 2003 because the 2003 provision was offset by the
recognition of deferred tax assets that had been previously subject to a
valuation allowance. The 19 percent increase in net income in 2003 as compared
to 2002 was the result of a combination of factors including lower general,
operating and administrative expense and decreased losses in the mortgage loans
held for sale. The Company undertook an initiative to reduce general operating
expenses by transferring certain functions out of the Company as described
below. In addition, property expenses were lower in 2003 as compared to 2002 due
to resolutions of 2002 bankruptcies and selling vacant properties that incurred
property expenses during 2002. The Company also benefited from a decrease in
interest expense resulting from low interest rates in the economy as well as
having lower amounts outstanding under its credit facilities than in 2002. The
decrease in amounts outstanding under its credit facilities during 2003 was the
result of paying down principal in accordance with loan repayment terms, selling
properties financed with debt under the Investment Sales Program and not having
to borrow as much due to low originations volume.
The following discussion of results from operations is by segment. All segment
results are before eliminating adjustments and operating results of the holding
company. As a result, the sum of amounts applicable to each segment will not, in
some cases, equal the Company total amount reflected in the consolidated
statements of income. Company earnings are as follows for each of the years
ended December 31:
<s> <c>
(In Millions)
% of % of % of
Net income by segment 2004 Total 2003 Total 2002 Total
---------- ------- ----------- -------- --------- --------
CNL-Investments $ 30.7 73% $ 27.7 65% $23.2 65%
CNL-Capital 12.8 31 14.9 35 12.6 35
Holding company results and
consolidating eliminations (1.5) (4) (0.2) -- (0.2 ) --
---------- ------- ----------- -------- --------- --------
Net income $ 42.0 100% $ 42.4 100% $35.6 100%
========== ======= =========== ======== ========= ========
o CNL-Investments reported a 11 percent increase in earnings in 2004 as a
result of higher gains on disposal of properties. It also posted a 19
percent increase in earnings in 2003 as compared to 2002. The improved
operating performance was due to incurring lower general, operating and
administrative expenses, interest expense and property expenses in 2003
as compared to 2002.
o CNL-Capital's earnings decreased during the year ended December 31,
2004 as compared to 2003. In 2004, higher gains on the Investment
Property Sales Program and lower impairments and provisions on assets
in the portfolio as a result of fewer financial difficulties and
defaults by borrowers, were offset by an income tax provision of $10.9
million. In addition, interest income from mortgage and other notes
receivable decreased in 2004 as compared to 2003 due to the 2003 sale
of $26.1 million in mortgage loans to CNL-Investments. This segment
reported an 18 percent increase in earnings in 2003 as compared to 2002
due to a one time benefit from income taxes amounting to $6.3 million.
The benefit resulted from the recognition of deferred tax assets that
had been subject to a valuation allowance in 2002 and prior years, as
further described below. Absent this one time benefit, operating
results would have decreased by 33 percent to $8.4 million in 2003, as
compared to $12.6 million in 2002. Despite a decrease in interest
expense, overall net income in 2003 was lowered by an increase in
provisions for loan losses and a decrease in the net spread between the
segment's rental and interest income and its interest expense. The
decrease in the spread was primarily due to a decrease in rental income
from lower originations volume and lower inventory levels available to
earn this spread income pending the sale of the properties under the
Investment Property Sales Program.
Revenues
<s> <c>
For the year ended December 31,
Total revenues by segment (in % of % of % of
millions) 2004 Total 2003 Total 2002 Total
-------- ------ -------- ------- -------- ------
CNL-Investments $ 78.9 75% $ 83.9 74% $ 86.8 26%
CNL-Capital 29.3 28 32.3 29 250.8 75
Holding company results and
consolidating eliminations (3.0) (3) (3.2) (3) (3.2 ) (1)
-------- ------ -------- ------- -------- ------
Total revenues* $ 105.2 100% $ 113.0 100% $ 334.4 100%
======== ====== ======== ======= ======== ======
* See discussion below for accounting treatment of sales of restaurant
properties as discontinued operations.
Revenues are discussed based on the individual segment results beginning with
the results of the real estate segment through CNL-Investments:
<s> <c>
For the year ended December 31,
CNL-Investments revenues by % of % of % of
line item (in millions) 2004 Total 2003 Total 2002 Total
-------- ------- --------- ------- ------- ------
Rental income from operating
leases and earned income from
direct financing leases $ 67.9 86% $70.8 85% $70.3 81%
Interest income from mortgage,
equipment and other notes
receivable 5.3 7 4.2 5 4.2 5
Investment and interest income 3.9 5 4.5 5 4.8 5
Other income 1.8 2 4.4 5 7.5 9
-------- ------- --------- ------- ------- ------
Total CNL-Investments
revenues $ 78.9 100% $ 83.9 100% $86.8 100%
======== ======= ========= ======= ======= ======
The rental revenue from vacant and other properties sold or held for sale at
December 31, 2004 was classified as a component of discontinued operations for
all periods presented and was not included in the segment revenues above. The
combined amount of rental income from operating leases and earned income from
direct financing leases from continuing operations decreased in 2004 as compared
to 2003 due to lower rental revenues resulting from tenant bankruptcies
including Chevy's and Ground Round, who filed for bankruptcy in 2003 and 2004,
respectively. The Company is actively seeking new tenants or buyers for the
properties affected by these bankruptcies. Rental revenues from continuing
operations for 2003 and 2002 remained fairly constant.
Interest income from mortgage, equipment and other notes receivable increased as
a result of the purchase of approximately $26.1 million in mortgage loans from
CNL-Capital in December 2003. CNL-Investments combined these mortgage loans with
other mortgage loans it previously owned and issued notes ("bonds payable")
collateralized by approximately $46.6 million of mortgage loans. The increase in
interest income from the new loans was partially offset by a decrease in
interest income earned on the declining balance of its original loan portfolio
resulting from the scheduled collections of principal and the lack of new loan
originations since 2000.
Investment and interest income decreased by 13 percent in 2004 as compared to
2003 due to the September 2004 sale of $11.1 million in franchise loan
investments relating to the 1999-1 retained interests in previous
securitizations. Investment and interest income are expected to be $1.5 million
lower in 2005 as a result of the sale of these investments.
Other income in CNL-Investments decreased consecutively in 2004 and 2003 as
compared to 2002 as a result of decreased billings of direct costs to third
parties using CNL-Investments for property management services. During 2003, the
Company transferred certain functions to CFG, an affiliate, thereby reducing
general and operating expenses, as well as reducing the billings of these
expenses collected from third parties. In 2004, CNL-Investments also transferred
its property management services to CNL-Capital further reducing its other
income generated from these services. In addition, other income was higher in
2002 as compared to each of 2003 and 2004 because during 2002, the Company
earned disposition fees and recorded as income the settlement proceeds collected
from one of its tenants who filed for bankruptcy. No such amounts were recorded
during 2003 or 2004.
The revenues of the specialty finance segment through CNL-Capital are more
variable than those of the real estate segment. The following table provides
additional information relating to the revenues of this segment:
<s> <c>
For the year ended December 31,
CNL-Capital revenues % of % of % of
by line item (in millions) 2004 Total 2003 Total 2002 Total
-------- ------- --------- ------- ------- ------
Sale of real estate $ -- --% $ -- --% $209.5 84%
Rental income from operating
leases -- -- -- -- 7.7 3
Interest income from mortgage
and other notes receivable 21.1 72 25.6 79 30.4 12
Investment and interest income 0.9 3 0.8 2 1.4 --
Net decrease in value of mortgage
loans held for sale, net of
related hedge -- -- (1.9) (5) (5.4 ) (2)
Other income 7.3 25 7.8 24 7.2 3
-------- ------- --------- ------- ------- ------
Total CNL-Capital
revenues $ 29.3 100% $ 32.3 100% $250.8 100%
======== ======= ========= ======= ======= ======
The comparability of CNL-Capital's revenues is significantly impacted by the
method of accounting for its sales of real estate that are recorded pursuant to
discontinued operations guidance. Gains from properties sold under the
Investment Property Sales Program are included as discontinued operations,
unless the gain was realized in 2002 for properties identified for sale before
January 1, 2002. The following information presents the Investment Property
Sales Program sales:
<s> <c>
CNL-Capital Investment Property Sales For the year ended December 31,
Program sales (in millions) 2004 2003 2002
------------ ------------- -----------
Sale of real estate, as reported (1) $ -- $ -- $ 209.5
Cost of real estate sold, as reported (1) -- -- (193.2 )
Gain on disposal of discontinued operations, net as
reported 35.2 24.6 8.3
------------ ------------- -----------
Total gains from Investment Property Sales
Program $ 35.2 $ 24.6 $ 24.6
============ ============= ===========
(1) Because of an accounting transition rule in 2002, the sales of properties
were accounted for differently depending on the date identified as held for
sale.
CNL-Capital sold 128, 147 and 182 properties under the Investment Property Sales
Program in 2004, 2003 and 2002, respectively. Gains from the Investment Property
Sales Program are described below in "Discontinued Operations." Additional
information on actual proceeds, purchases and related gains is located in
"Liquidity and Capital Resources - CNL-Capital - Investment Property Sales
Program."
Other matters impacting the comparability of the various components of revenues
during the three years ended December 31, 2004, 2003 and 2002 include:
o In 2002, rental revenues associated with properties acquired after
December 31, 2001 were recorded as a component of income from
discontinued operations while properties acquired prior to January 1,
2002 and identified as held for sale were recorded in rental income
from continuing operations. Beginning January 1, 2003, these revenues
are recorded in discontinued operations regardless of the date of
acquisition. All properties owned by CNL-Capital are held with the
intent to be sold.
o Interest income from mortgage and other notes receivable decreased 18
percent for the year ended December 31, 2004, as compared to the same
period in 2003 partially due to the sale of $26.1 million in mortgage
loans to CNL-Investments in December 2003, as described above. The
remainder of the decrease was due to the declining balance of its loan
portfolio resulting from scheduled collections of principal. The 16
percent decrease in 2003 as compared to 2002, was a result of normal
principal repayments as well as foreclosure actions, the modification
of terms and other impacts of delinquent loans between years. The
Company has not originated new mortgage loans since May of 2001,
focusing instead on the opportunity to refer potential borrowers to the
Bank, CNL-Capital's financial institution partner.
o Despite a hedging strategy during 2003 and 2002 designed to address
market volatility in the value of loans held for sale, the loan
valuation increases associated with decreases in interest rates for
mortgage loans held for sale, net of related hedge, were more than
offset by estimated potential default losses and valuation decreases
(liability increases) in hedge contracts. The results improved in 2003
as compared to 2002 due to improvements in the hedge valuations
partially offset by increased potential default related loan reserves.
In December 2003, CNL-Capital sold its remaining mortgage loans held
for sale to CNL-Investments, which then re-designated these loans as
held for investments purposes and issued bonds collateralized by the
loans. In conjunction with this sale the fair value hedge was
terminated.
o Investment and interest income associated with retained interests in
the off balance sheet loan pools decreased by 43 percent in 2003 as a
result of certain pool defaults and prepayments in 2002 and 2003.
o Other income reflects, among other items, fees from advisory services,
servicing income and referral fees for loans and other products from
the Bank. Although other income did not change significantly during
2004 as compared to 2003, a decrease of $1.4 million in advisory
services fees was partially offset by a $0.6 million increase in
referral fees from loans and other products relating to the alliance
agreement with the Bank, resulting from a higher referral volume. In
addition, CNL-Investments transferred in 2004 its property management
services to CNL-Capital, which also partially offset the decrease in
other income. In 2003, advisory services fees were higher as compared
to 2004 and 2002 as a result of several key transactions closing during
the year.
Expenses
Excluding cost of real estate sold for 2002, expenses decreased during 2004 and
2003, each as compared to the previous year. General operating and
administrative expenses increased during 2004 as compared to 2003 due to
transactional costs arising from higher originations volume, compliance
requirements with the Sarbanes-Oxley Act and the merger with USRP. General
operating and administrative expenses were lower during 2003, as compared to the
previous year, due to the Company's initiative of outsourcing some functions to
reduce expenses. Interest expense was lower for each period presented due to
declining interest rates and having lower amounts outstanding under its
borrowings.
Cost of real estate sold is associated with the Investment Property Sales
Program of CNL-Capital and relates to properties held for sale at the end of
2001 that were sold by December 31, 2002. In 2002, costs associated with
properties acquired after 2001 were required to be included as a component of
the gain on disposal of discontinued operations, while in 2003 this treatment is
required regardless of acquisition date. A table and related discussion of the
comparative results is reported above under the discussion of related revenues.
General operating and administrative expenses consist primarily of
payroll-related and legal and other professional expenses. The following table
illustrates the comparative period expenses by segment:
<s> <c>
For the year ended December 31,
General operating and admini-
strative expenses by segment (in % of % of % of
millions) 2004 Total 2003 Total 2002 Total
-------- ------ -------- ------- ------ --------
CNL-Investments $ 8.9 32% $ 9.0 36% $11.8 42%
CNL-Capital 20.4 75 18.6 74 19.0 67
Holding company results and
consolidating eliminations (2.0) (7) (2.4) (10) (2.4 ) (9)
-------- ------ -------- ------- -------- ------
Total general operating and
administrative expenses $ 27.3 100% $ 25.2 100% $ 28.4 100%
======== ====== ======== ======= ======== ======
o CNL-Investments' general operating and administrative expenses remained
constant between 2004 and 2003, while in 2003 this segment reported a
24 percent decrease over the comparable period in 2002. The decline in
expenses in 2003 as compared to 2002 was the result of transferring
certain financial and strategic functions, including transferring
certain employees relating to the management of the external
portfolios, to a subsidiary of CFG, an affiliate. The decrease in
general operating and administrative expenses in 2004 resulting from
the transfer of certain strategic functions to CFG during 2003 was
offset by an increase in additional professional fees as a result of
compliance requirements with the Sarbanes-Oxley Act and increased
expenses incurred in connection with the merger with USRP.
o General operating and administrative expenses in CNL-Capital increased
during 2004 as compared to 2003 due to several factors. The Company
incurred additional professional fees as a result of compliance
requirements with the Sarbanes-Oxley Act, and increased expenses in
connection with the merger with USRP. CNL-Capital's general operating
and administrative expenses were fairly constant between 2003 and 2002.
Interest expense constitutes one of the most significant operating expenses. The
interest expense incurred in connection with the Investment Property Sales
Program is included in operating results from discontinued operations.
Components of interest expense from continuing operations are as follows:
<s> <c>
For the year ended December 31,
Interest expense by segment (in % of % of % of
millions) 2004 Total 2003 Total 2002 Total
-------- ------ -------- ------- ------ --------
CNL-Investments $ 29.3 61% $ 27.5 54% $30.6 52%
CNL-Capital 18.3 38 23.7 47 28.5 49
Holding company results and
consolidating eliminations 0.4 1 (0.6) (1) (0.7 ) (1)
-------- ------ -------- ------- -------- ------
Total interest expense $ 48.0 100% $ 50.6 100% $58.4 100%
======== ====== ======== ======= ======== ======
o CNL-Investments had an increase in interest expense in 2004 as compared
to 2003 due to CNL-Investments issuing bonds payable in December 2003
and May 2004, collateralized by approximately $46.6 million of mortgage
loans. The segment realized a decrease of 10 percent in interest
expense in 2003 as compared to the previous year. CNL-Investments
decreased its level of debt throughout most of 2003 and 2002 through
the sales of real estate. As a result, interest expense decreased due
to a decline in weighted average balances outstanding on its borrowings
during 2003 as compared to 2002.
o CNL-Capital experienced a 23 percent decrease in interest expense in
2004 as compared to 2003. The decrease was partially the result of the
$10 million pay down of the Subordinated Note Payable and the related
decrease of the interest rate on this facility from 8.5 percent to 7.0
percent in January 2004. In September 2004, CNL-Capital repaid an
additional $11.875 million on the Subordinated Note Payable. Interest
expense also decreased because CNL-Capital paid down the Mortgage
Warehouse Facility by approximately $12.3 million in December 2003 when
it sold the mortgage loans receivable to CNL-Investments, as described
above. As a result of the sale of these mortgage loans receivable
CNL-Capital terminated the fair value hedge associated with the
mortgage loans receivable and eliminated the interest expense on the
interest rate swap. Interest expense also decreased because CNL-Capital
unwound a portion of a cash flow hedge this year, as further described
below. During 2003, CNL-Capital reduced its interest-bearing debt,
partly due to holding lower average inventory levels of properties held
for sale. The reduction in available inventory occurred because
CNL-Capital generated $194 million in sales proceeds from the
Investment Property Sales Program throughout 2003 while acquiring only
$169 million in new properties. Declining interest rates also
contributed to lower interest expense in 2003 as compared to the
previous year. The weighted average interest rate on the mortgage
warehouse facilities to fund property acquisitions decreased from 4.07
percent to 3.41 percent in 2002 and 2003, respectively. The decrease in
the weighted average rates charged on borrowings from the mortgage
warehouse facilities was partially offset by higher weighted average
interest rate charged by the five-year financing of over $225 million
entered into in June 2002. Although interest expense increased due to
the five-year financing, CNL-Capital complied with the terms of the
loan warehouse facility and was also able to preserve net spread
resulting from the excess of the interest income received over the
interest expense paid.
Property expenses typically occur when tenants default on their obligations in
the real estate segment. The Company recognized $0.3 million, $0.7 million and
$3.0 million in property expenses during 2004, 2003 and 2002, respectively. In
2004 and 2003, fewer vacant properties were on hand incurring these expenses as
opposed to 2002. Property expenses were higher in 2002 due to three major
tenants declaring bankruptcy and rejecting numerous leases that resulted in the
Company incurring real estate taxes, insurance, repairs and maintenance and
legal fees related to dealing with resolution of the assets within bankruptcies.
Phoenix Restaurant Group, Inc. and its subsidiaries, (collectively referred to
as "PRG") filed for bankruptcy in 2001, and Roadhouse Grill, Inc. ("Roadhouse
Grill") and Houlihan's Restaurant Group ("Houlihan's") filed for bankruptcy in
2002. Some expenses formerly presented in this category associated with
properties treated as discontinued operations are incorporated in the earnings
or losses from discontinued operations for all years presented.
Depreciation and amortization expenses reflect the level of assets invested in
leased properties held by CNL-Investments. Once a property is designated as held
for sale or sold, the related depreciation is reflected as a component of
discontinued operations. The specialty finance segment does not depreciate its
properties held for sale, but along with CNL-Investments, CNL-Capital has
recorded depreciation on office and computer equipment during 2004, 2003 and
2002, respectively.
CNL-Capital recorded a loss on termination of cash flow hedge of $0.9 million
and $0.5 million in 2004 and 2003, respectively. In conjunction with the Company
paying approximately $5.8 million during 2004, as described above in "Liquidity
and Capital Resources -- CNL Capital -- Indebtedness -- Note Payable," the
Company unwound a portion of its cash flow hedge to comply with its hedge
agreement. The loss during 2003 relates to the prepayment of mortgage loans by a
borrower causing CNL-Capital to pay down a portion of the related debt
collateralized by these mortgage loans and to also unwind a portion of the
related swap.
Impairments and provisions on assets consist of bad debt expense relating to
receivables that management deemed uncollectible, provisions for loan losses
associated with non-performing loans, valuation allowances associated with
investments in the 1998-1 and 1999-1 residual interests and impairment
provisions on properties (excluding impairments on properties treated as
discontinued operations as described below). The following table illustrates the
comparative period expenses by segment:
<s> <c>
For the year ended December 31,
Impairments and provisions on % of % of % of
assets (in millions) 2004 Total 2003 Total 2002 Total
-------- ------ -------- ------- ------- -------
CNL-Investments $ 3.0 65% $ 4.1 32% $ 4.3 45%
CNL-Capital 1.6 35 8.8 68 5.2 55
-------- ------ -------- ------- -------- ------
Total impairments and
provisions on assets $ 4.6 100% $ 12.9 100% $ 9.5 100%
======== ====== ======== ======= ======== ======
CNL-Investments recorded provisions for loan losses of $0.6 million and $0.8
million during 2004 and 2003, respectively, associated with non-performing
loans. The provisions for loan losses during 2004 related primarily to loans
from American Restaurant Group ("ARG"), which declared bankruptcy in October
2004. Management evaluates its loan portfolio and records a reserve as potential
losses become evident. CNL-Investments recorded impairment provisions of $2.4
million, $3.3 million and $4.3 million during 2004, 2003 and 2002, respectively,
excluding impairments on properties treated as discontinued operations as
described below. The impairments related to properties from defaulted tenants,
including properties previously leased to Roadhouse Grill, Houlihan's, Chevy's
and Ground Round, all of which declared bankruptcy during 2002 through 2004. The
impairments represented the difference between the net carrying value of the
properties and the estimated fair value of the properties.
CNL-Capital recorded provisions for loan losses of $4.7 million and $3.2 million
in 2003 and 2002, respectively, associated with non-performing loans, and a
recovery of $0.5 million due to improved performance on its loan portfolio
during 2004. CNL-Capital also recorded write-offs of $1.0 million, $1.6 million
and $2.0 million during 2004, 2003 and 2002, respectively, relating to its
1998-1 and 1999-1 residual interests. CNL-Capital recorded these amounts based
on its determination that a permanent impairment in value had occurred as a
result of certain borrower delinquencies within these securitized pools.
CNL-Capital also recorded bad debt expense of $1.1 million and $2.5 million
during 2004 and 2003, respectively, relating to receivables that management
elected to reserve or write-off.
Discontinued Operations
The Company accounts for certain of its revenues and expenses as originating
from discontinued operations pursuant to generally accepted accounting
principles requiring that sales of real estate, or the designation of a real
estate asset as held for sale, be treated as discontinued operations if certain
criteria are met. Any gain or loss from such disposition, and any income or
expenses associated with these real estate assets, are included in the income
statement as discontinued operations. CNL-Capital's Investment Property Sales
program, a vital piece of its ongoing operating strategy, falls within this
guidance. Therefore, gains from properties sold under the Investment Property
Sales program are included as discontinued operations, unless the gain was
realized in 2002 for properties identified as held for sale before January 1,
2002. Income and expenses associated with Investment Property Sales program
assets are also included in discontinued operations, except for 2002 income and
expenses associated with properties acquired before January 1, 2002 and sold by
December 31, 2002. In addition, CNL-Investments has designated certain real
estate assets as held for sale and has included income and expenses associated
with the assets as well as the gain or loss from any dispositions of these
assets 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 and
sold them in December 2004 to an affiliated entity, as described above in
"Liquidity and Capital Resources - CNL-Investments - Liquidity Risks". All
operating results relating to these restaurant operations have been recorded as
discontinued operations for all periods presented. The table below illustrates
the treatment of discontinued operations by segment for each of the years ended
December 31:
<s> <c>
Income from discontinued operations
by segment (in millions) 2004 2003 2002
------------- ------------ -----------
CNL-Investments discontinued operations:
Losses from operations $ (3.4 ) $ (6.8 ) $ (5.5 )
Gains on disposal 7.7 3.7 3.3
CNL-Capital discontinued operations:
Earnings from operations 4.9 5.9 3.2
Gains on disposal 35.2 24.6 8.3
Income tax (provision)/benefit (10.9 ) 6.3 --
------------- ------------ -----------
Total income from discontinued
operations $ 33.5 $ 33.7 $ 9.3
============= ============ ===========
o Losses from discontinued operations of CNL-Investments include
impairment provisions of $2.4 million, $8.2 million and $9.0 million in
2004, 2003 and 2002, respectively. The earnings from discontinued
operations of CNL-Capital include impairment provisions of $2.3
million, $1.4 million and $0.7 million in 2004, 2003 and 2002,
respectively. Impairments related primarily to properties or restaurant
assets designated as held for sale or sold through March 31, 2005.
o In December 2004, the Company sold its interest in a subsidiary engaged
in restaurant operations to Cherry Den LLC, as described above in
"Liquidity and Capital Resources - CNL-Investments - Liquidity Risks."
The Company received $0.7 million in proceeds from the sale and
recognized a net gain of $1.2 million on this sale including the
recognition of $0.8 million in gains on sales of real estate used in
its restaurant operations, which were previously deferred in accordance
with generally accepted accounting principles.
o Gains on disposal of properties of CNL-Investments were higher during
2004 as compared to the same periods in 2003 and 2002. During 2004,
CNL-Investments sold three properties with gains exceeding $1.0 million
per property. Although CNL-Capital sold 128, 147 and 182 properties in
2004, 2003 and 2002, respectively, gains in 2004 were higher because
CNL-Capital reduced its reliance on outside brokers to sell its
properties increasing the average gain per property. The increase in
gains is also due to better originations market penetration that
resulted in favorable spread between the acquisition price and the
sales price.
Income Tax (Provision)/Benefit
The Company is a REIT and REITs generally are not subject to income tax if
certain distributions and other requirements are met. However, effective January
1, 2001, the Company began engaging in certain activities that are taxable
through its TRSs.
o At the time of the TRS election, differences existed between the tax
and the financial reporting treatment of certain items such as loan
loss reserves and reserves for impairment and depreciation. In the
aggregate, these differences served to defer deductions and accelerate
income reported for tax purposes prior to the TRS election, with the
benefit of the reversal of such differences attributed to the TRS. This
benefit gave rise to a deferred tax asset. Management did not believe
that the realization of the deferred tax asset was more likely than
not. Therefore the deferred tax asset was completely offset by a
valuation allowance, and no benefit was recognized January 1, 2001.
o During 2002, the Company reflected no tax benefit or expense. While
taxable activities were profitable, sufficient benefit of future
deductions existed to offset expense for the year. As of December 31,
2003, CNL-Capital reversed the valuation allowance of $7.0 million
previously recorded by the CNL-Capital TRS against its deferred tax
asset. CNL-Capital determined that is was more likely than not that
this deferred tax asset will be realized based on historical earnings
and projected future income of CNL-Capital.
o During 2004, CNL-Capital recognized $10.9 million in tax expenses
consisting of $8.4 million in current federal and state taxes and $2.5
million in deferred federal and state taxes. The deferred tax expense
includes $0.9 million associated with the reversal of deferred tax
benefit recorded in 2003 relating to the cash flow hedge that is
recognized as a component of other comprehensive income. The Company
accounts for partial hedge terminations designed to offset reductions
in the mortgage note receivable balances as removing an applicable
portion of the previously recorded tax effect from other comprehensive
income. Also, during 2004, the Company reversed the remaining valuation
allowance that had been recorded at December 31, 2003.
Item 2. Quantitative and Qualitative Disclosures About Market Risk
This information is described above in Item 1. Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Item 3. Financial Statements and Supplementary Data
Report of Independent Registered Certified Public Accounting Firm
To The Board of Directors and Shareholders:
We have completed an integrated audit of CNL Restaurant Properties, Inc.'s 2004
consolidated financial statements and of its internal control over financial
reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Our opinions, based on our audits,
are presented below.
Consolidated financial statements
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, stockholders' equity and comprehensive income
(loss) and cash flows present fairly, in all material respects, the financial
position of CNL Restaurant Properties, inc. and its subsidiaries at December 31,
2004 and 2003, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2004 in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit of financial statements includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management's assessment, included in Management's Report
on Internal Control Over Financial Reporting appearing in Item 4, that the
Company maintained effective internal control over financial reporting as of
December 31, 2004 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2004, based on criteria established in Internal Control - Integrated Framework
issued by the COSO. The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
/s/ PRICEWATERHOUSECOOPERS LLP
Orlando, Florida
March 4, 2005, except for Note 4, as to which the date is June 10, 2005
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except for per share data)
<s> <c>
December 31,
2004 2003
---------------- ----------------
ASSETS
Real estate investment properties $ 535,588 $ 524,681
Net investment in direct financing leases 98,972 101,755
Real estate and restaurant assets held for sale 146,136 151,879
Mortgage, equipment and other notes receivable, net of
allowance of $7,261 and $13,964, respectively 290,140 320,900
Mortgage loans held for sale -- 1,490
Other investments 16,495 29,671
Cash and cash equivalents 22,744 36,955
Restricted cash 7,402 12,462
Receivables, less allowance for doubtful accounts
of $2,136 and $872, respectively 7,391 3,382
Accrued rental income 28,546 25,464
Goodwill 56,260 56,260
Other assets 33,975 33,217
------------------ ------------------
$ 1,243,649 $ 1,298,116
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Revolver $ 21,000 $ 2,000
Notes payable 162,810 182,560
Mortgage warehouse facilities 101,394 93,513
Subordinated note payable 21,875 43,750
Bonds payable 405,421 430,011
Due to related parties 37,172 25,038
Other payables 33,736 34,096
------------------ ------------------
Total liabilities 783,408 810,968
------------------ ------------------
Minority interests, including redeemable partnership interest 6,819 7,262
Commitments and contingencies (Note 14)
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 outstanding 45,249 452 452
Capital in excess of par value 825,134 826,627
Accumulated other comprehensive loss (12,434 ) (14,447 )
Accumulated distributions in excess of net income (359,730 ) (332,746 )
------------------ ------------------
Total stockholders' equity 453,422 479,886
------------------ ------------------
$ 1,243,649 $ 1,298,116
================== ==================
See accompanying notes to consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except for per share data)
<s> <c>
Year Ended December 31,
2004 2003 2002
-------------- ------------- -------------
Revenues:
Sale of real estate $ -- $ -- $ 209,498
Rental income from operating leases 57,728 60,161 66,440
Earned income from direct financing leases 10,221 10,687 11,629
Interest income from mortgage, equipment and other
notes receivables 26,394 29,807 34,552
Investment and interest income 3,770 4,586 5,347
Net decrease in value of mortgage loans
held for sale, net of related hedge -- (1,853 ) (5,368 )
Other income 7,107 9,610 12,308
--------------- --------------- --------------
105,220 112,998 334,406
--------------- --------------- --------------
Expenses:
Cost of real estate sold -- -- 193,179
General operating and administrative 27,346 25,208 28,433
Interest expense 47,999 50,576 58,401
Property expenses 312 746 3,036
State and other taxes 337 212 88
Depreciation and amortization 11,775 12,228 12,784
Loss on termination of cash flow hedges 940 502 --
Impairments and provisions on assets 4,551 12,864 9,510
--------------- -------------- ---------------
93,260 102,336 305,431
--------------- --------------- --------------
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 11,960 10,662 28,975
Minority interest in income of consolidated joint ventures (3,718 ) (1,913 ) (2,409 )
Equity in earnings of unconsolidated joint ventures 105 108 101
Gain/(loss) on sale of assets 135 (157 ) (347 )
--------------- --------------- --------------
Income from continuing operations 8,482 8,700 26,320
Income from discontinued operations, after income taxes 33,536 33,740 9,270
--------------- --------------- --------------
Net income $ 42,018 $ 42,440 $ 35,590
=============== =============== ==============
See accompanying notes to consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME - CONTINUED
(In thousands except for per share data)
<s> <c>
Year Ended December 31,
2004 2003 2002
--------------- --------------- --------------
Earnings per share of common stock (basic and diluted):
From continuing operations $ 0.19 $ 0.19 $ 0.59
From discontinued operations 0.74 0.75 0.21
--------------- --------------- --------------
Net income $ 0.93 $ 0.94 $ 0.80
=============== =============== ==============
Weighted average number of shares
of common stock outstanding 45,249 45,249 44,620
=============== =============== ==============
See accompanying notes to consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME/(LOSS)
Years Ended December 31, 2004, 2003 and 2002
(In thousands except for per share data)
<s> <c>
Accumulated Accumlated
Common stock distributions other Compre-
----------------------- Capital in in excess compre- hensive
Number Par excess of of net hensive income/
of shares value par value income income/(loss) Total (loss)
----------- ---------- -------------- ------------- ------------- ------------- ----------
Balance at December 31, 2001 44,076 441 798,154 (273,783) 1,370 526,182
Shares issued, net of
retirement of common stock 1,173 11 20,084 -- -- 20,095
Stock issuance costs -- -- (1,493 ) -- -- (1,493 )
Net income -- -- -- 35,590 -- 35,590 $35,590
Other comprehensive loss,
market revaluation on
available for sale securities -- -- -- -- (775 ) (775 ) (775)
Current period adjustment to
recognize change in fair
value of cash flow hedges, net
of tax -- -- -- -- (17,457 ) (17,457 ) (17,457 )
----------
Total comprehensive income -- -- -- -- -- -- $ 17,358
==========
Distributions declared and
paid ($1.52 per share) -- -- -- (67,991) -- (67,991 )
----------- ---------- -------------- ------------- ------------- -------------
Balance at December 31, 2002 45,249 452 816,745 (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 consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME/(LOSS)
Years Ended December 31, 2004, 2003 and 2002
(In thousands except for per share data)
<s> <c>
Accumulated Accumulated
Common stock distributions other Compre-
----------------------- Capital in in excess compre- hensive
Number Par excess of of net hensive income/
of shares value par value income income/(loss) Total (loss)
----------- ---------- -------------- ------------- ------------- ------------- ----------
Balance at December 31, 2003 45,249 $ 452 $ 826,627 $ (332,746 ) $ (14,447 ) $ 479,886
Stock issuance costs -- -- (1,493 ) -- -- (1,493 )
Net income -- -- -- 42,018 -- 42,018 $ 42,018
Other comprehensive loss,
market revaluation on
available for sale securities -- -- -- -- (340 ) (340 ) (340)
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 $100 in tax benefit -- -- -- -- 1,413 1,413 1,413
----------
Total comprehensive income -- -- -- -- -- -- $ 44,031
==========
Distributions declared and
paid ($1.52 per share) -- -- -- (69,002 ) -- (69,002 )
----------- ---------- -------------- ------------- ------------- -------------
Balance at December 31, 2004 45,249 $ 452 $ 825,134 $ (359,730 ) $ (12,434 ) $ 453,422
=========== ========== ============== ============= ============= =============
See accompanying notes to consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<s> <c>
Year Ended December 31,
2004 2003 2002
-------------- ------------- -------------
Cash flows from operating activities:
Net income $ 42,018 $ 42,440 $ 35,590
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 12,677 13,466 14,826
Amortization of deferred financing costs 5,535 4,023 4,273
Impairments and provisions on assets 9,299 22,405 19,165
Gain on sales of assets (4,943 ) (3,475 ) (2,947 )
Increase in income tax payable 658 -- --
Decrease/(increase) in deferred tax asset 2,494 (7,754 ) --
Increase in prepaid income tax (723 ) (2,610 ) --
Increase in accrued rental income (3,533 ) (5,728 ) (5,561 )
Amortization of investment in direct financing leases 2,164 1,810 1,119
Net decrease in value of mortgage loans held for sale,
net of related hedge -- 1,853 5,368
Investment in mortgage loans held for sale -- (112 ) (226 )
Collection on mortgage loans held for sale -- 7,635 16,356
Changes in inventories of real estate held for sale (19,854 ) 29,618 45,471
Changes in other operating assets and liabilities (6,707 ) 4,801 (21,847 )
-------------- -------------- --------------
Net cash provided by operating activities 39,085 108,372 111,587
-------------- -------------- --------------
Cash flows from investing activities:
Additions to real estate investment properties (20,726 ) -- (7,212 )
Proceeds from sale of assets 20,562 25,312 67,085
Decrease/(increase) in restricted cash 5,060 (7,888 ) 6,357
Investment in joint venture -- -- (150 )
Investment in mortgage, equipment and other notes receivable -- -- (6,607 )
Collection on mortgage, equipment and other notes receivable 34,789 29,075 15,481
Proceeds from sale of other investments 11,195 19 --
-------------- -------------- --------------
Net cash provided by investing activities 50,880 46,518 74,954
-------------- -------------- --------------
See accompanying notes to condensed financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(In thousands)
<s> <c>
Year Ended December 31,
2004 2003 2002
--------------- --------------- ---------------
Cash flows from financing activities:
Payment of stock issuance costs $ (1,493 ) $ (1,493 ) $ (1,493 )
Proceeds from borrowings on revolver and note payable 61,552 34,104 249,334
Payment on revolver, note payable and subordinated note
payable (84,177 ) (66,751 ) (90,874 )
Proceeds from borrowings on mortgage warehouse facilities 196,335 124,127 189,901
Payments on mortgage warehouse facilities (188,454 ) (176,372 ) (474,312 )
Proceeds from issuance of bonds 5,000 24,906 --
Retirement of bonds payable (29,844 ) (19,403 ) (16,436 )
Payment of bond issuance and debt refinancing costs (908 ) (2,231 ) (27 )
Proceeds from sale of shares, net of retirement of
common stock -- -- 9,746
Loan from stockholder 10,900 18,710 11,750
Distributions to minority interest (3,327 ) (1,867 ) (1,484 )
Distributions to stockholders (69,760 ) (68,244 ) (67,991 )
--------------- -------------- --------------
Net cash used in financing activities (104,176 ) (134,514 ) (191,886 )
--------------- -------------- --------------
Net increase (decrease) in cash and cash equivalents (14,211 ) 20,376 (5,345 )
Cash and cash equivalents at beginning of year 36,955 16,579 21,924
--------------- -------------- --------------
Cash and cash equivalents at end of year $ 22,744 $ 36,955 $ 16,579
=============== ============== ==============
Supplemental disclosures of cash flow information:
Interest paid $ 44,541 $ 48,114 $ 52,704
=============== ============== ==============
Interest capitalized $ 23 $ 95 $ 113
=============== ============== ==============
Income taxes paid $ 8,508 $ 4,019 $ 193
=============== ============== ==============
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 notes receivable and acceptance of
underlying real estate collateral $ 452 $ 4,632 $ 3,788
=============== ============== ==============
Notes receivable accepted in exchange for sale of properties $ 3,490 $ 1,394 $ --
=============== ============== ==============
Financing of computer software acquisition $ -- $ 1,788 $ --
=============== ============== ==============
Distributions declared and unpaid at December 31 $ -- $ 758 $ --
=============== ============== ==============
Conversion of related party advances into shares of
common stock $ -- $ -- $ 10,350
=============== ============== ==============
See accompanying notes to consolidated financial statements.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
1. Significant Accounting Policies:
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
$488 million in affiliate real estate portfolios and earns management fees
related thereto. Through December 31, 2004, the specialty finance segment
was 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.
In 2003, CNL-Capital modified certain terms relating to the alliance with
the Bank that resulted in the Bank reducing its ownership interest in
CNL-Capital. In conjunction with the ownership reduction, the Bank agreed
to assume certain costs of its portfolio operations and decreased the
referral fees paid by the Bank to CNL-Capital under the referral program
between the Bank and CNL-Capital. In addition, CNL CAS/Corp. agreed to
reduce its interest in CNL-Capital. Effective January 1, 2005, the Bank
agreed to redeem the remaining balance of its ownership interest in
CNL-Capital. The Company and the Bank agreed to continue the alliance for
five years, but modified the referral fees program between the parties
whereby only CNL-Capital will pay referral fees when the resulting net
amount is a payable to the Bank. In addition, this agreement eliminated the
conversion feature in the Subordinated Note Payable that allowed the Bank
to convert the note into additional ownership of CNL-Capital. Also
effective January 1, 2005, CNL-Capital reached an agreement to purchase
CNL/CAS Corp's one percent interest at its carrying value. As a result of
these agreements, the Company's ownership interest in CNL-Capital increased
to 100 percent.
Merger - On August 9, 2004, the Company announced that it had entered into
a definitive agreement and plan of merger (the "Merger") with U.S.
Restaurant Properties, Inc. ("USRP"), a publicly traded real estate
investment trust, and on February 25, 2005, completed the transactions
contemplated by the agreement, including the Merger of the Company into
USRP and the change of USRP's name to Trustreet Properties, Inc. On the
same day, pursuant to merger agreements between each of the 18 public
limited partnerships (the "CNL Income Funds") and USRP, each CNL Income
Fund merged with a separate wholly owned subsidiary of the combined
company's operating partnership. As a result of the Merger, each share of
Company common stock was 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 was not subject to change and there was no "collar" or minimum
trading price for the shares of the Company's common stock or USRP's common
stock. The Merger was structured to be tax-free to the stockholders of the
Company and USRP.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
1. Significant Accounting Policies:
The Merger will be accounted for using the purchase method of accounting,
and the Company will be treated as the acquirer for accounting purposes. As
a result, the assets and liabilities of the Company will be recorded at
historical values without restatement to fair values. The assets and
liabilities of USRP and the CNL Income Funds will be recorded at their
estimated fair values at the date of the Merger, with the excess of the
purchase price of USRP over the sum of such fair values recorded as
goodwill. The purchase price will be based upon market capitalization of
USRP using the trading price of USRP common stock and traded preferred
stock as of the date the merger was announced as well as the estimated
market values for the existing Series B preferred stock plus certain merger
related costs. In subsequent periods, historical information of the
combined company will be that of the Company.
On January 18, 2005, Robert Lewis and Sutter Acquisition Fund, LLC, two
limited partners in several CNL Income Funds, filed Plaintiffs' Corrected
Original Petition for Class Action, Cause No. 05-00083-F, a purported class
action lawsuit on behalf of the limited partners of the 18 CNL Income Funds
against the Company, USRP, the 18 CNL Income Funds and the general partners
(Mr. Seneff, Mr. Bourne and CNL Realty Corporation) of the 18 CNL Income
Funds, CNL-Investments and CNL-Corp. in the District Court of Dallas
County, Texas. The complaint alleges that the general partners of the CNL
Income Funds breached their fiduciary duties in connection with the
proposed mergers between the CNL Income Funds and USRP and that the
Company, CNL-Investments, CNL-Corp., and USRP aided and abetted in the
alleged breaches of fiduciary duties. The complaint further alleges that
the CNL Income Fund general partners violated provisions of the CNL Income
Fund partnership agreements and demands an accounting as to the affairs of
the CNL Income Funds. The plaintiffs are seeking unspecified compensatory
and exemplary damages and equitable relief, which also included an
injunction preventing the defendants from proceeding with the mergers. The
injunction was not successful in preventing the Merger that occurred on
February 25, 2005.
Management of the Company believes that the lawsuit, including the request
for class certification, is without merit and intends to defend vigorously
against such claims.
In December 2004, the Company and USRP each entered into a commitment
letter with the Bank and an affiliate of the Bank to obtain bridge
financing in an amount up to $775 million to finance the Merger, refinance
the debt, and for general corporate purposes until permanent financing
could be put in place. The bridge financing provided by the Bank consisted
of a senior secured revolving credit facility of up to $125 million and a
senior secured term loan of up to $650 million. The bridge financing bears
interest at a floating rate of interest and will mature, and be repayable
in full, on the 90th day following its initial funding. The Company
anticipates raising approximately $875 million of new debt capacity to
replace the bridge financing and to refinance existing debt following the
Merger. These new financings are expected to consist of senior unsecured
notes, a new senior credit facility and a net lease securitization.
Net Lease Securitization. The Company priced a $275 million triple-net
lease financing on February 25, 2005 with an expected closing date of March
4, 2005. Between December 2004 and February 2005, the Company entered into
four interest rate swaps with aggregate notional balance of $240 million in
conjunction with this financing in an attempt to lock in a portion of its
cost of capital. The Company unwound the interest rate swap contracts upon
pricing these notes and received $1.7 million. The notes are collateralized
by approximately 324 properties originated by the Company, USRP and the 18
CNL Income Funds. Two classes of mortgage notes were issued and will be
amortized over twenty-years with a seven year balloon payment.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
1. Significant Accounting Policies - Continued:
New Senior Credit Facility. The Company expects to enter into a senior
credit facility (the "Facility") consisting of a revolving credit facility
and a term loan with a syndicate of lenders, including the Bank. The size
of the Facility is expected to approximate $350 million and proceeds from
the Facility will be used to repay the bridge financing, refinance existing
debt and for general corporate purposes.
Senior Unsecured Notes. The Company expects to issue $250 million in senior
unsecured notes and together with the proceeds of the other financings
described above, expects to repay indebtedness incurred in connection with
the Merger and related transactions. The notes will mature in March 2015.
The notes will be general unsecured debt, but will be effectively
subordinated to all existing and future secured debt and to all liabilities
of subsidiaries.
Equity Compensation Plan - During 1999, the stockholders approved a
performance incentive plan and through December 31, 2004, the Company had
not made any awards related to this plan. As a result of the Merger, this
performance incentive plan ceased to exist, and the Company adopted USRP's
Flexible Incentive Plan ("Incentive Plan"). Under the Incentive Plan, the
Company may grant shares of restricted common stock or stock options to
purchase common stock. Pursuant to this Incentive Plan, stock options may
be granted at any time and the aggregate outstanding options that can be
granted shall be at an amount equal to or less than 4.9% of the Company's
issued and outstanding shares of common stock at the date of grant. Options
may be exercised through either the payment of cash or the transfer of
shares of the Company's common stock owned by the optionee.
Principles of Consolidation - The consolidated financial statements of the
Company include its majority owned and controlled affiliates and variable
interest entities for which the Company is the primary beneficiary. The
primary beneficiary of a variable interest entity is the party that absorbs
a majority of the entity's expected losses, receives a majority of its
expected residual returns, or both, as a result of holding a variable
interest that change with changes in the fair value of the entity's net
assets. All significant intercompany balances and transactions among
consolidated affiliates and variable interest entities have been
eliminated. The equity method of accounting is applied to those investments
in joint ventures that do not meet the variable interest entities criteria.
Use of Estimates - Preparation of the financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions relating to the reporting of assets and
liabilities and the disclosure of contingent assets and liabilities.
Significant estimates include provisions for impairment of real estate and
loans, valuation of loans held for sale, deferred tax assets, goodwill,
long lived assets and franchise loan investments. Actual results could
differ from those estimates.
Real Estate and Lease Accounting - The Company records its properties
comprised of land, buildings and equipment at cost. Management reviews its
properties for impairment whenever events or changes in circumstances
indicate that their carrying amount may not be recoverable through
operations or sale. Management determines whether impairment in value has
occurred by comparing the estimated future undiscounted cash flows,
including the residual value of the property, with the carrying cost of the
individual property. If impairment is indicated, the assets are adjusted to
estimated fair value.
Properties leased to restaurant operators are generally on a triple-net
basis, which means the tenant is responsible for all operating expenses
relating to the property, including property taxes, insurance, maintenance
and repairs. The leases are accounted for using either the direct financing
or the operating method.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
1. Significant Accounting Policies - Continued:
Direct financing method - The leases accounted for using the direct
financing method are recorded at the net investment that, at the
inception of the lease, generally represents the cost of the asset.
Unearned income is deferred and amortized to income over the lease
terms so as to produce a constant periodic rate of return on net
investment in the leases.
Operating method - Land, building and secured equipment leases are
accounted for using the operating method. Revenue is recognized as
rentals are earned and depreciation is charged to operations on a
straight-line basis over the life of the related assets. Rental
income is recognized on a straight-line basis over the lease term.
Buildings and equipment are depreciated on the straight-line method
over their estimated useful lives of 30 and seven years,
respectively.
Properties acquired that the Company intends to sell within one year of
acquisition are recorded at cost. Rental income is recognized without
regard to potential future rent increases and the asset is not depreciated.
Revenue from sale of real estate is recognized at the time of closing when
collectibility of the sales price is reasonably assured and the earnings
process is substantially complete.
Loans - The Company originated loans to restaurant operators prior to May
2001 that were generally collateralized by real estate, equipment and
business enterprise value. The Company has accounted for these loans
depending on the following classification:
Mortgage loans held for sale - Loans originated that the Company
intended to sell or securitize generally within one year of
origination were recorded at cost and adjusted for changes in market
value under the Company's hedging strategy. Quoted prices for similar
loans and the present value of the expected cash flows net of the
estimated impact of any defaults were used to determine fair value.
In December 2004, the remaining loans previously held for sale were
reclassified to mortgage notes receivable to reflect the Company's
intention to hold them to maturity.
Mortgage, equipment and other notes receivable - These loans are
expected to be held until maturity, are recorded at cost and are
reduced for any estimated future loss. Whenever it appears that
future collection on specific notes appears doubtful, a valuation
allowance is established. The allowance represents the difference
between the carrying amount and the amount management expects to
receive. Increases and decreases in the allowance due to changes in
the measurement of the impaired loans are included in impairments and
provisions on assets. Loans continue to be classified as impaired
unless they are brought fully current and the collection of scheduled
interest and principal is considered probable. When a loan or portion
of a loan, including an impaired loan, is determined to be
uncollectible, the portion deemed uncollectible is charged against
the allowance and subsequent recoveries, if any, are credited to the
allowance. Accrual of interest is discontinued when management
believes, after considering economic and business conditions and
collection efforts, that the borrowers' financial condition is such
that collection of interest is doubtful. Subsequent interest is
recorded as income.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
1. Significant Accounting Policies - Continued:
Securitizations - Between 1999 and 2001, certain loans were originated and
sold to entities that, in turn, issued securities to investors backed by
these assets. The Company retained the servicing rights and participates in
cash flows from the retained equity positions and lower rated securities.
The present value of the expected cash flows for each retained security,
after payment of principal and interest to third-party bond or certificate
holders, over the estimated cost of servicing was recorded at the time of
sale as a retained interest. Retained interests in securitized assets are
included in other investments. Accounting for the retained interests
requires the Company to estimate their value using market trends and
historical experience, expected prepayments and defaults. This information
is considered, along with prevailing discount rates and the terms of the
bonds and certificates, to arrive at current fair value amounts and
determine whether a permanent impairment in value has occurred.
Restricted Cash - Restricted cash relates to cash received in connection
with assets held as collateral for certain debt and is subject to
restrictions until released by the trustee.
Cash and Cash Equivalents - The Company considers all highly liquid
investments with a maturity of three months or less when purchased to be
cash equivalents. These amounts may exceed federally insured levels,
however, the Company has not experienced any losses in such accounts.
Derivative Financial Instruments - The Company utilizes derivative
instruments to partially offset the effect of fluctuating interest rates on
the cash flows associated with a portion of its variable-rate debt. All
derivative instruments are recorded on the balance sheet at fair value.
Changes in the value of derivatives associated with hedge transactions are
recorded either in current earnings or in other comprehensive income
depending on the type.
Fair-value hedge transactions - During 2003 and 2002, when the
Company hedged changes in the fair value of an asset or liability,
the effective changes in the value of the derivative instrument were
generally offset in the income statement by changes in the value of
the hedged item.
Cash-flow hedge transactions - When the Company hedges variability of
cash flows related to a variable-rate asset or liability or a
forecasted transaction, effective changes in the value of the
derivative instrument are reported in other comprehensive income and
subsequently recognized in operations in the periods in which
earnings are impacted by the variability of the cash flows of the
hedged item or forecasted transaction.
The ineffective portion of all hedges are reflected in earnings.
Goodwill - Management evaluates the carrying value of goodwill on a
periodic basis, and at least annually, to determine if an impairment is
deemed necessary. A discounted cash flow valuation approach and/or capital
market valuation approach is used to determine the fair market value of the
Company, which is compared to the Company's net book value. Impairments
resulting from this analysis are charged to results of operations. No
impairment was required at December 31, 2004.
Loan Costs - Loan costs incurred in connection with debt have been
capitalized and are being amortized over the term of the related debt using
the effective interest method. Loan costs are included in other assets in
the financial statements. As of December 31, 2004 and 2003, the Company had
capitalized loan costs of $24.3 million and $26.0 million, respectively and
recorded accumulated amortization of $11.6 million and $6.9 million,
respectively.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
1. Significant Accounting Policies - Continued:
Income Taxes - The Company elected to be taxed as a REIT for federal income
tax purposes. The Company generally will not be subject to federal
corporate income taxes on amounts distributed to stockholders, providing it
distributes at least 90 percent of its taxable income and meets certain
other requirements for qualifying as a REIT. Earnings and profits, which
determine the taxability of dividends to stockholders, differ from reported
net income as a result of differing treatment of items for financial
reporting versus tax purposes, such as different lives and methods used to
depreciate investment properties. Notwithstanding qualification as a REIT
for tax purposes, the Company is subject to certain state taxes on its
income and property.
Effective January 1, 2001, the Company's subsidiary, CNL-Capital Corp.,
elected to be treated as a taxable REIT subsidiary ("TRS") pursuant to the
provisions of the REIT Modernization Act. As a TRS, its operating
Partnership, CNL-Capital, is able to engage in activities resulting in
income that previously would have been disqualified from being eligible
REIT income under the federal income tax regulations. Certain activities
reside within CNL-Capital Corp. that are therefore subject to federal
income taxes. A second less significant TRS began operations during 2002
and is also subject to federal income taxes.
Earnings Per Share - Basic earnings per share are calculated based upon net
earnings (income available to common stockholders) divided by the weighted
average number of shares of common stock outstanding during the reporting
period.
Consolidated Statement of Cash Flows - Supplemental Disclosure - During the
year ended December 31, 2003, the Company re-designated approximately $23.7
million from mortgage loans held for sale to held for investment. The loans
serve as collateral for bonds issued by the Company. In June 2002, the
Company redesignated approximately $225 million from mortgage loans held
for sale to held for investment. The loans serve as collateral for a five
year borrowing facility.
During the year ended December 31, 2002, the Company converted $10.3
million of outstanding loans payable plus accrued interest payable under
the loans into 604,177 shares of Company stock (see Note 11).
During the year ended December 31, 2002, a tenant and borrower of the
Company assigned loans in the amount of $7.5 million to an affiliate. The
Company agreed to the assignment in exchange for an interest in a loan from
the affiliate (see Note 11).
New Accounting Standards - In December 2004, the Financial Accounting
Standards Board (the "FASB") issued Statement of Financial Accounting
Standards No. 153, "Exchange of Non-Monetary Assets" ("FAS 153"). FAS 153
addresses the measurement of exchanges of non-monetary assets. It
eliminates the exception from fair value measurement for non-monetary
exchange of similar productive assets under APB Opinion No. 29, "Accounting
for Non-Monetary Transactions", and replaces it with an exception for
exchanges that do not have commercial substance. A non-monetary exchange
has commercial substance if the entity's future cash flows are expected to
significantly change as a result of the exchange. The provisions of this
statement are effective for non-monetary asset exchanges occurring in
fiscal periods beginning after June 15, 2005.
In December 2004, the FASB issued a revision to FAS 123 "Accounting for
Stock-Based Compensation" to expand the disclosure requirements in
connection with the entity's use of share-based compensation and
share-based payment for the acquisition of goods or services other than
employee services. Historically, the Company has not made any stock awards,
and had not been subject to this pronouncement. As a result of the Merger
in which the Company adopted USRP's Incentive Plan, the Company will become
subject to this pronouncement in 2005.
CNL RESTAURANT PROPERTIES, INC. AND
SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended
December 31, 2004, 2003 and 2002
2. Real Estate Investment Properties:
Reclassification - Certain items in the prior years' financial statements
have been reclassified to conform to the 2004 presentation. These
reclassifications had no effect on stockholders' equity or net income.
Real estate investment properties consist of the following at December 31:
<s> <c>
(In thousands)
2004 2003
------------------ -----------------
Land $ 281,777 $ 271,670
Buildings 313,928 302,153
Equipment 1,251 1,673
------------------ -----------------
596,956 575,496
Less accumulated depreciation (61,368 ) (50,815 )
------------------ -----------------
$ 535,588 $ 524,681
================== =================
During 2002, the Company sold properties and equipment that were subject to
operating leases and received net proceeds of $0.9 million and recorded a
net loss of $0.3 million.
In 2004, 2003 and 2002 the Company recorded provisions for impairment of
$2.0 million, $3.3 million and $3.4 million, respectively. The tenants of
these properties experienced financial difficulties and/or ceased payment
of rents under the terms of their lease agreements. The provisions
represent the amount necessary to reduce the properties' carrying value to
estimated fair value.
For the years ended December 31, 2004, 2003 and 2002 tenants paid or are
expected to pay directly to real estate taxing authorities approximately
$10.1 million, $10.3 million and $9.4 million, respectively, in real estate
taxes in accordance with the terms of their triple-net leases.
Substantially all property leases have initial terms of 10 to 20 years
(most expiring between 2005 and 2024) and provide for scheduled rent
increases, and in some cases, contingent rent. The leases generally allow
the tenant to purchase the property at the greater of the Company's
purchase price plus a specified percentage or fair market value at
specified times. Fixed and determinable lease revenues are recognized on a
straight-line basis over the terms of the leases. For the years ended
December 31, 2004, 2003 and 2002, the Company recognized $4.0 million, $6.2
million and $5.6 million, respectively, of such accrued rental income.
Future minimum contractual lease payments to be received under
noncancellable operating leases at December 31, 2004 are as follows:
<s> <c>
(In thousands)
--------------------
2005 $ 54,344
2006 54,495
2007 55,070
2008 56,135
2009 57,743
Thereafter 411,915
--------------------
$ 689,702
====================
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
3. Net Investment in Direct Financing Leases:
The components of net investment in direct financing leases consist of the
following at December 31:
<s> <c>
(In thousands)
2004 2003
------------ -------------
Minimum lease payments
receivable $ 177,109 $ 190,738
Estimated residual values 25,261 25,510
Interest receivable from
secured equipment leases 7 6
Less unearned income (103,405 ) (114,499 )
------------ -------------
Net investment in direct financing
leases $ 98,972 $ 101,755
============ =============
The following is a schedule of future minimum lease payments to be received
on direct financing leases at December 31, 2004:
(In thousands)
----------------
2005 $ 12,184
2006 12,155
2007 12,208
2008 12,249
2009 12,433
Thereafter 115,880
----------------
$ 177,109
================
The Company's real estate segment recorded provisions for losses on direct
financing leases totaling $0.3 million and $0.9 million during the year
ended December 31, 2004 and 2002, respectively. The tenants of these
properties experienced financial difficulties and ceased payment of rents.
The provisions represent the amount necessary to reduce the carrying values
of the direct financing leases to their estimated fair value.
4. Real Estate and Restaurant Assets Held for Sale:
Real estate and restaurant assets held for sale consist of the following at
December 31:
(In thousands)
2004 2003
-------------- ---------------
Land and buildings $ 146,136 $ 150,266
Restaurant assets -- 1,613
-------------- ---------------
$ 146,136 $ 151,879
============== ===============
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
4. Real Estate and Restaurant Assets Held for Sale - Continued:
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 and the gain or loss on disposition of the property is treated as
discontinued operations for all periods presented. These financial
statements reflect reclassifications of rental related income, interest
expense and other categories so as to conform with the requirements of FAS
144 including two properties identified as held for sale during the three
months ended March 31, 2005. During 2002, the Company purchased the
operations of certain restaurants. In December 2004, the restaurant
operations were sold to an affiliated entity. All operating results
relating to these restaurant operations were recorded as discontinued
operations for all periods presented.
The operating results of the discontinued operations were as follows for
the years ended December 31:
<s> <c>
(In thousands)
2004 2003 2002
------------ ----------- ------------
Rental, earned and other income $ 12,430 $ 13,023 $ 13,807
Food and beverage income 13,471 13,728 2,428
Interest expense (3,534 ) (2,267 ) (2,348 )
Other property related expense (1,838 ) (2,023 ) (3,706 )
Impairment provisions (4,748 ) (9,541 ) (9,654 )
Food and beverage expenses (14,257 ) (13,856 ) (2,836 )
------------ ----------- ------------
Gain/(loss) from discontinued operations 1,524 (936 ) (2,309 )
------------ ----------- ------------
Sales of real estate and restaurant operations 290,977 226,250 148,875
Cost of real estate and restaurant operations (248,027 ) (197,920 ) (137,296 )
sold
------------ ----------- ------------
Gain on disposal of discontinued operations 42,950 28,330 11,579
------------ ----------- ------------
Income tax (provision)/ benefit (10,938 ) 6,346 --
------------ ----------- ------------
Income from discontinued operations, net $ 33,536 $ 33,740 $ 9,270
============ =========== ============
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
5. Mortgage, Equipment and Other Notes Receivable:
Mortgage, equipment and other notes receivable consist of the following at
December 31:
<s> <c>
(In thousands)
2004 2003
-------------- -------------
Outstanding principal $ 296,412 $ 332,924
Accrued interest income 2,277 3,377
Deferred financing income (1,321 ) (1,530 )
Unamortized deferred costs 33 93
Allowance for uncollectible notes (7,261 ) (13,964 )
-------------- -------------
$ 290,140 $ 320,900
============== =============
Approximately $273 million and $308 million of the outstanding principal
balance as of December 31, 2004 and 2003, respectively, is secured by
mortgages. The remaining principal is secured by franchised restaurant
equipment and other collateral. As of December 31, 2004 and 2003,
approximately $15 million and $8 million in notes receivable are considered
impaired and approximately $2 million and $3 million are non-accrual status
with regard to recognition of interest. The Company recognized $0.5 million
and $0.4 million of interest income as of December 31, 2004 and 2003,
respectively, on impaired loans.
Changes in the allowance for loan losses for 2004 and 2003 are summarized
as follows:
<s> <c>
(In thousands)
2004 2003
-------------- ------------
Balance at beginning of year $ 13,964 $ 12,062
Provision for loan losses 112 5,463
Recoveries on loans previously charged off (683 ) (944 )
Interest income reserves 311 964
Loans charged off (6,443 ) (3,581 )
-------------- ------------
Balance at end of year $ 7,261 $ 13,964
============== ============
Management believes the net carrying value of the notes approximates fair
value based on current rates at which similar loans would be made to
borrowers with similar credit and for similar maturities.
6. Mortgage Loans Held for Sale:
Mortgage loans held for sale were wholly or partially collateralized by
first mortgages on land and/or buildings of franchised restaurant
businesses. The loans carried a weighted average interest rate of 8.33
percent, and were due in monthly installments with maturity dates ranging
from 2004 to 2022. The loans generally prohibited prepayment for certain
periods or included prepayment penalties.
At December 31, 2003, the Company had approximately $1.5 million classified
as mortgage loans held for sale. In 2004, these loans were reclassified to
mortgage notes receivable to reflect the Company's intention to hold them
to maturity.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
7. Other Investments:
The Company holds certificated franchise loan investments arising from
securitization transactions. Prior to September 2004, the Company
classified these investments as held-to-maturity securities and recorded
them at amortized cost in other investments on the balance sheet. The
Company's investments in the residual interest in these securitization
transactions and an interest only strip are 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.
The fair value of these investments, including accrued interest, consist of
the following at December 31:
<s> <c>
(In thousands)
2004 2003
------------- --------------
Held to maturity $ -- $ 27,442
Available for sale (1) 16,495 2,229
------------- --------------
$ 16,495 $ 29,671
============= ==============
(1) Maturities ranging from 2012-2018.
In 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 investments originally classified as investments
held to maturity, to investments available for sale. As a result of the
redesignation, the Company records the change in the fair value of these
redesignated franchise loan investments as a component of other
comprehensive income. Other comprehensive income for 2004 includes
unrealized holding losses on available-for-sale securities of $0.3 million.
The key assumptions used in calculating the current value of these
investments are based on normal market assumptions as follows:
o five percent prepayment penalty computed after taking into consideration
the period of time covered by yield maintenance and lockout prepayment
penalties;
o a cumulative default ratio (CDR) of zero; and
o prevailing market discount rates
During the years ended December 31, 2004, 2003 and 2002, the Company
recorded write-offs amounting to $1.0 million, $1.6 million and $2.0
million, respectively, relating to its 1999-1 and 1998-1 residual
interests. The Company recorded these amounts based on its determination
that a permanent impairment in value had occurred as a result of certain
borrower delinquencies. As of December 31, 2004 the carrying value of these
interests was approximately $400,000.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
7. Other Investments - Continued:
The following table shows the effects on an individual key assumption
affecting the current fair value of the retained certificates under two
negative scenarios by altering the current assumptions being used to value
the certificates.
<s> <c>
1998-1
Certificates
(in millions)
------------------
Fair value of retained certificates $ 16.0
Discount rate for retained certificates (annual):
Impact on fair value of 100 bp adverse change $(0.88)
Impact on fair value of 200 bp adverse change $(1.70)
Expected credit losses (annual rate):
Impact on fair value of 2 percent adverse change $(0.17)
Impact on fair value of 3 percent adverse change $(2.66)
These sensitivities are hypothetical and should be used with caution.
Changes in fair value based on a percentage variation in assumptions
generally cannot be extrapolated because the relationship of the change in
assumption to the change in fair value may not be linear. Also, the effect
of a variation in a particular assumption on the original fair values of
the retained certificates is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in
another (for example, increases in market interest rates may result in
lower prepayments and increased credit losses), which might magnify or
counteract the sensitivities.
The following table represents the securitized portfolio and all managed
loans as of December 31:
<s> <c>
Principal amount > 60
days
Total principal amount past due
(In thousands) (In thousands)
--------------------------- --------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Mortgage loans $ 660,712 $ 735,517 $ 9,315 $ 16,011
Equipment and other loans 22,597 23,783 -- 199
------------ ------------ ------------ ------------
Total loans managed or securitized 683,309 759,300 9,315 16,210
Less:
Loans securitized (386,897) (421,845) (8,717 ) (3,599 )
Loans held for sale or securitization -- (4,531) -- (1,969 )
------------ ------------ ------------ ------------
Loans held in portfolio (Note 5) $ 296,412 $ 332,924 $ 598 $ 10,642
============ ============ ============ ============
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
7. Other Investments - Continued:
The total loan portfolio managed by the Company had net charge-offs during
the years ended December 31, 2004, 2003 and 2002 of $7.5 million, $14.5
million and $24.9 million, respectively.
The following table summarizes cash flows received from and paid to
securitization trusts for the years ended December 31:
<s> <c>
(In thousands)
2004 2003 2002
------------ ----------- ------------
Servicing fees received $ 1,387 $ 1,597 $ 1,625
Other cash flows received on retained interests $ 3,820 $ 4,332 $ 5,272
Servicing advances paid $ (3,949 ) $ (4,128 ) $ (6,253 )
Collection of servicing advances $ 3,041 $ 3,603 $ 5,115
8. Borrowings:
Borrowings consist of the following at December 31:
<s> <c>
2004 2003
------------------------------- ----------------------------
Amount Average Amount Average
(In thousands) rate (In thousands) rate
------------------------------- ----------------------------
Revolver $ 21,000 4.04% $ 2,000 3.62%
Notes payable 162,810 5.83% 182,560 6.13%
Mortgage warehouse facilities 101,394 2.78% 93,513 3.41%
Subordinated note payable 21,875 7.00% 43,750 8.50%
Series 2000-A bonds payable 239,165 7.96% 252,477 7.94%
Series 2001-4 bonds payable 28,489 8.90% 33,938 8.90%
Series 2001 bonds payable 111,577 1.89% 118,690 1.70%
Series 2003 bonds payable 26,190 6.02% 24,906 5.67%
----------------- ----------------
$ 712,500 $ 751,834
================= ================
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
8. Borrowings - Continued:
Borrowing resources at December 31, 2004 include:
<s> <c>
Expected
maturity/
(In thousands) retirement date
--------------------------------- ------------------
Balance
outstanding Capacity
--------------- ------------- ------------------
Revolver $ 21,000 $ 40,000 July 2005
Notes payable 162,810 168,408 (1)
Mortgage warehouse facilities 101,394 260,000 Annual
Subordinated note payable 21,875 21,875 December 2008
Series 2000-A bonds payable 239,165 239,165 2009-2017
Series 2001-4 bonds payable 28,489 28,489 2009-2013
Series 2001 bonds payable 111,577 111,577 October 2006
Series 2003 bonds payable 26,190 26,190 2005-2011
--------------- -------------
$ 712,500 $ 895,704
=============== =============
(1) $0.3 million matures in 2005, $162 million matures in 2007 and $0.6
million matures in 2011.
Revolver. The Revolver bears interest at a rate of LIBOR plus 225 basis
points per annum, plus an unused fee of 25 basis points per annum, on any
unused capacity, and includes financial covenants that provide for the
maintenance of certain financial ratios. During 2004, the Revolver was
amended to extend the maturity date to July 2005 and to increase the
capacity from $30 million to $40 million. All other material terms of the
Revolver remain unchanged. The Company was in compliance with all covenants
as of December 31, 2004. In February 2005, the Company amended the Revolver
to increase the capacity from $40 million to $60 million. All other
material terms of the Revolver remain unchanged.
Notes Payable. The Company has financing that consists of a five-year term
financing that carries a variable interest rate tied to the weighted
average rate of commercial paper plus 1.25 percent per annum (the "Note
Payable"). Collateral for the Note Payable balance of approximately $162
million and $182 million at December 31, 2004 and 2003, respectively,
consists of 161 mortgage loans that had a carrying value of $199 million at
December 31, 2004. The Note Payable has a renewal provision based on the
Company's request and the lender's consent. The Company has loans with CNL
Bank, an affiliate, to finance the construction and acquisition of certain
real estate properties. These balances were $0.9 million and $0.6 million
at December 31, 2004 and 2003, respectively, were collateralized by
mortgages and bore interest at the prime rate plus one-half percent and
LIBOR plus 325 basis points. At December 31, 2004, the borrowing capacity
with CNL Bank was $6.15 million.
Mortgage Warehouse Facilities. CNL-Capital maintains mortgage warehouse
facilities which have a total borrowing capacity of $260.0 million at
December 31, 2004 and bear interest at a weighted average rate of 2.78
percent. The $160 million warehouse credit facility has been extended until
February 2006. Under this facility the Bank finances property acquisitions
at an advance rate of up to 97 percent of the real estate purchase price.
The $100 million mortgage warehouse facility matures in June 2005. In May
2004, the facility advance rate for real estate acquisitions was increased
from 90 percent to 92 percent of the real estate purchase value. Management
believes the lender will grant a one-year extension to the Company on this
facility.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
8. Borrowings - Continued:
The Company is obligated under the provisions of its mortgage warehouse
facilities and its Note Payable to pay down certain debt associated with
borrower delinquencies or defaults within a required time frame. Most
properties acquired on the mortgage warehouse facilities are required to be
sold within a certain time frame. Any delinquency, default or delay in the
resale of properties financed through one of these facilities would
generally result in an immediate pay-down of the related debt. In 2004 and
2003, the Company recorded a loss on termination of cash flow hedges of
$0.9 million and $0.5 million, respectively, because the Company unwound a
portion of its cash flow hedge to comply with its hedge agreement.
Subordinated Note Payable. In January 2004, CNL-Capital amended the $43.75
million subordinated note payable agreement to reduce the interest rate
from 8.50 percent to 7.00 percent per annum and made a $10 million
prepayment reducing the balance to $33.75 million. In September 2004, the
Company made a mandatory prepayment of $11.875 million reducing the
principal to $21.875 million. As a result of these prepayments, the Bank's
ownership from the conversion feature in CNL-Capital was reduced from 13.1
percent to 6.55 percent at December 31, 2004. Effective January 1, 2005,
the conversion feature was eliminated (see Note 1). The subordinated note
is being amortized over five years with a balloon payment due December 31,
2008.
Bonds Payable. Collateral for the Series 2000-A bonds consist of 253
commercial real estate properties operated as restaurants leased to
tenants, with a carrying value of $316.9 million at December 31, 2004. The
Series 2000-A bonds bear interest at a weighted average fixed rate of 7.9
percent per annum. The bond indenture provides for an optional redemption
at their remaining principal balance when remaining rents due under the
leases that serve as collateral are less than ten percent of the aggregate
initial rents due under the leases.
Collateral for the Series 2001-4 bonds consists of 47 mortgage loans that
had a carrying value of approximately $41.7 million as of December 31,
2004. The Series 2001-4 bonds bear interest at a rate of 8.90 percent per
annum. The bond indenture requires monthly principal and interest payments
received from borrowers to be applied to the bonds. The bond indenture also
provides for an optional redemption of the bonds at their remaining
principal balance when the remaining amounts due under the loans that serve
as collateral for the bonds are less than ten percent of the aggregate
amounts due under the loans at the time of issuance.
Collateral for the Series 2001 bonds consist of 120 commercial real estate
properties operated as restaurant units which have a carrying value of
approximately $179.6 million as of December 31, 2004. The bonds are
scheduled to amortize over a 15-year period with a balloon payment in 2006.
The 2001 bonds bear interest at a rate of LIBOR plus 48 basis points per
annum plus associated costs of 45.75 basis points. The Company entered into
an interest rate cap agreement with a strike rate of 4.50 percent to
protect against future increases in LIBOR.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
8. Borrowings - Continued:
The Series 2000-A and Series 2001 bonds 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 and bankruptcies. As a result, cash flow
normally exceeding the scheduled principal and interest payments is
required to be directed toward additional debt reduction. During the years
ended December 31, 2004, 2003 and 2002, the Company was required to make
additional debt reductions of approximately $2.4 million, $0.4 million and
$0.9 million, respectively, as a result of exceeding certain ratios in the
net lease pools.
In December 2003, the Company issued notes collateralized by a pool of
mortgage loans, Series 2003. The proceeds of $25 million were applied to
pay down short-term and medium term debt. The Company applied 34 mortgage
loans and four equipment leases as collateral for the bonds, which had a
carrying value of approximately $32.0 million as of December 31, 2004. The
offering resulted in an initial weighted average maturity of approximately
3.8 years and rate of interest of approximately 5.67 percent per annum. The
bond indenture requires monthly principal and interest payments received
from borrowers to be applied to the bonds. The Company entered into an
interest rate cap agreement with a strike rate of 3.5 percent to protect
against future increases in LIBOR. In May 2004, the Company issued an
additional $5 million note from the Series 2003. The note bears interest at
LIBOR plus 600 basis points and is expected to mature in 2011.
In December 2004, the Company entered into an interest rate swap agreement
with a notional amount of $110 million in conjunction with a net lease
securitization expected to close in March 2005. The Company unwound this
swap in February 2005 when it priced the net lease securitization (see Note
1).
The following schedule of maturities on outstanding indebtedness does not
reflect the annual extensions on the warehouse facilities, assumes that
bonds payable amortize in accordance with estimated payment amounts and
also assumes there will be no accelerated pay-down of debt in conjunction
with the Merger:
(In thousands)
-----------------
2005 $ 158,326
2006 134,600
2007 172,682
2008 32,383
2009 26,520
Thereafter 187,989
-----------------
$ 712,500
=================
Management believes that net carrying value of the debt approximates fair
value with the exception of the Series 2000-A Bonds which have an estimated
fair value of approximately $261 million based on recent secondary market
activity.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
9. Income Tax:
The Company has elected to be taxed as a REIT under the Internal Revenue
Code. To qualify as a REIT, the Company must meet a number of
organizational and operational requirements, including a current
requirement that it distribute at least 90 percent of its taxable income to
its stockholders. As a REIT the Company generally will not be subject to
corporate level federal income tax on net income it distributes to its
stockholders, except taxes applicable to its taxable REIT subsidiaries
("TRSs").
For income tax purposes the Company has two TRSs in which activities of
CNL-Capital and select activities of CNL-Investments are conducted. Prior
to January 1, 2001, Company subsidiaries were not subject to federal income
tax.
Loan valuation adjustments, loss reserves, loan fees, and depreciation,
among other items, are treated differently for tax than for financial
reporting purposes. In the aggregate, the Company's TRSs have an excess of
available future deductible items over future taxable items.
The consolidated provision for federal income taxes differs from the amount
computed by applying the statutory federal income tax rate to the income
from continuing operations as follows for each of the three years ended
December 31:
<s> <c>
(In thousands)
2004 2003 2002
------------ ------------- -------------
Expected tax at U.S. statutory rate $ 2,619 $ 3,050 $ 9,010
REIT income not subject to U.S.
income tax (8,200 ) (10,508 ) (8,645 )
Loss benefit attributed to discontinued
operations 5,581 454 --
Change in valuation allowance -- 7,004 (365 )
------------ ------------- -------------
Provision for income taxes $ -- $ -- $ --
------------ ------------- -------------
As of December 31, 2003, the Company reversed the valuation allowance of
approximately $7 million previously recorded in the CNL-Capital TRS. The
$0.8 million valuation allowance then remaining was reversed during the
year ended December 31, 2004. The Company determined that it is more likely
than not that all deferred tax assets will be realized based on historical
earnings and projected future income.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
9. Income Tax - Continued:
The components of the net deferred tax asset consists of the following at
December 31:
<s> <c>
(In thousands)
2004 2003
---------- -----------
Deferred tax asset:
Cash flow hedge related difference $ $ 4,039
3,355
Loan valuation and related hedge differences (1,668) (155)
Loan origination fees 535 646
Real estate loss reserves 846 1,303
Reserve for investment losses 1,906 1,200
Losses relating to value creation activities 407 1,092
Other (42) 449
---------- -----------
---------- -----------
Total 5,339 8,574
Valuation allowance -- (842)
---------- -----------
Net recorded deferred tax asset $ 5,339 $ 7,732
========== ===========
The income tax provision (benefit) consists of the following components for
each of the years ended December 31:
<s> <c>
(In thousands)
2004 2003 2002
------------ ----------- -------------
Current:
Federal $ 6,675 $ 2,678 $ 1,487
State 1,724 458 241
------------ ----------- -------------
8,399 3,136 1,728
------------ ----------- -------------
Deferred:
Federal 2,168 (8,466 ) (1,487 )
State 371 (1,016 ) (241 )
------------ ----------- -------------
2,539 (9,482 ) (1,728 )
------------ ----------- -------------
Total provision/(benefit) $ 10,938 $ (6,346 ) $ --
============ =========== =============
The income tax provision/benefit has been allocated as follows:
<s> <c>
(In thousands)
2004 2003 2002
------------ ----------- ------------
Continuing operations $ -- $ -- $ --
Discontinued operations 10,938 (6,346) --
------------ ----------- ------------
Total income tax provision/benefit $ 10,938 $ (6,346 ) $ --
============ =========== ============
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
10. Distributions:
For the year ended December 31, 2004, 22 percent of the distributions
received by stockholders were considered to be ordinary income, 69 percent
were considered a return of capital, seven percent were qualified dividends
and two percent were capital gains for federal income tax purposes. During
the years ended in 2003 and 2002, 39 percent and 0 percent, respectively,
of the distributions received by stockholders were considered to be
ordinary income, and 61 percent and 100 percent, respectively, were
considered a return of capital.
11. Related Party Transactions:
The following table and disclosures summarize related party transactions
with affiliated entities for the years ended December 31:
(In thousands)
---------------------------------------
Amounts received (paid): 2004 2003 2002
------------ ------------ ------------
Services purchased from affiliates (1) $ (2,268) $ (3,094) $ (3,954)
Rental and other expenses to affiliates
for office space (2) $ (1,411) $ (1,445) (1,479)
Dealer servicing fee (3) $ (1,493) $ (1,493) $ (1,493)
Servicing fees from affiliates (4) $ 2,884 $ 4,612 $ 5,938
Referral fees from the Bank $ 1,657 $ 1,109 $ 734
Sale of properties to an affiliate (5) $ -- $ -- $ 25,857
(1) Services purchased from affiliates include human resources, tax
planning and compliance, computer systems support, investor relations
and other services.
(2) In May 2002, the Company purchased a combined five percent partnership
interest in CNL Plaza, Ltd. and CNL Plaza Venture, Ltd. (the "Plaza")
for $0.2 million. Affiliates of James M. Seneff, Jr. and Robert A.
Bourne, each of which is a director of the Company, own the remaining
partnership interests. The Company has severally guaranteed 8.33
percent or $1.3 million of a $15.5 million unsecured promissory note on
behalf of the Plaza. The guaranty continues through the loan maturity
which initially matured in November 2004 and has been extended through
May 31, 2005. Further negotiations are underway to refinance this note.
The Company received distributions of $0.07 million, $0.07 million and
$0.10 million during the years ended December 31, 2004, 2003 and 2002,
respectively, from the Plaza. Since November 1999, the Company has
leased its office space from CNL Plaza, Ltd., an affiliate of a member
of the Company's board of directors. The Company's lease expires in
2014 and provides for scheduled rent increases over the term of the
lease. Rental and other expenses for the years ended December 31, 2004,
2003 and 2002 include accrued rental expense (the additional rent
expense resulting from the straight-lining of scheduled rent increases
over the term of the lease) and executory costs. Future commitments due
under the office space operating lease are as follows:
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
11. Related Party Transactions - Continued:
(In thousands)
-------------------
2005 $ 1,139
2006 1,173
2007 1,209
2008 1,245
2009 1,282
Thereafter 6,760
-------------------
$ 12,808
===================
(3) Soliciting dealer servicing fee paid to an affiliate in connection with
the Company's previous common stock offerings.
(4) Property management and other administrative services provided to
affiliates investing in restaurant net lease properties and loans.
(5) Proceeds received from affiliates from the sale of 22 properties during
2002 for which the Company recorded losses of $0.9 million.
During 2002, CNL Financial Group ("CFG"), an affiliate, advanced $7.5
million to the Company in the form of a demand balloon promissory note. The
loan bore interest at a rate of LIBOR plus 2.5 percent or at the base rate
as defined in the agreement. In June 2002, the Company converted $10.3
million of outstanding principal plus accrued interest (including advances
received in prior years) into 604,177 shares of Company stock. During
September 2002 the Company also issued 569,177 additional shares to CFG in
exchange for $9.75 million paid to the Company in cash. During 2004, 2003
and 2002, CFG advanced an additional $10.9 million, $18.7 million and $4.25
million, respectively, to the Company under the same terms as the previous
advances. The balance outstanding as of December 31, 2004 was $35.8
million, which included accrued interest.
During the year ended December 31, 2002 CNL-Capital acquired a portfolio of
109 real estate properties, which have been classified as held for sale,
for approximately $117 million by acquiring all of the limited partner and
general partners interests in CNL Net Lease Investors, LP, ("NLI"). Eight
of the properties acquired were vacant and the remaining 101 properties
were leased to restaurant operators under triple-net leases. The Chairman
of the Board and Vice Chairman of the Board of Directors of the Company,
through an affiliate, owned the 0.1 percent general partner interest in NLI
prior to the acquisition by CNL-Capital and agreed to waive their rights to
benefit from the transaction. Of the original 109 properties, 107 have been
sold as of December 31, 2004. The Company has recognized approximately
$11.6 million in net gains on the sales of these properties through
December 2004.
During the year ended December 31, 2002, a tenant and borrower of the
Company assigned loans in the amount of $7.5 million to Restaurants
Acquisitions I, LLC, an affiliate of the Company. The Company agreed to the
assignment and advanced an additional $3.6 million to the affiliate in
exchange for an $11.1 million participating note. The note was amended
during 2004 to remove the participating feature and change the maturity
date from May 2014 to December 2007. The note bears interest at a rate of
ten percent per annum. The Company earned $1.1 million, $1.1 million and
$0.7 million in interest income from the affiliate during 2004, 2003 and
2002, respectively.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
11. Related Party Transactions - Continued:
During the year ended December 2003, OrangeDen, LLC, a subsidiary engaged
in restaurant operations, entered into a collateral contribution agreement
(`the Agreement") with two separate affiliates, CFG and Cherry Den, LLC, to
provide collateral for a letter of credit to an insurance company for
worker's compensation and general liability coverage relating to employees
leased to the restaurant operations within CNL-Investments. The collateral
consisted of certificates of deposit with one-year terms amounting to
$353,000 and were included in real estate and restaurant assets held for
sale at December 31, 2003 relating to this Agreement. In December 2004, the
Company sold its interest in OrangeDen, LLC, to Cherry Den, LLC, an
affiliate of the Chairman and Vice Chairman of the Board of Directors. The
Company received $0.7 million in proceeds from the sale and recognized a
net gain of $1.2 million, which included the recognition of $0.8 million in
gains on the sales of real estate used in it restaurant operations, which
were previously deferred.
During the year ended December 31, 2004, the Company paid real estate
brokerage fees of $0.1 million to CNL Commercial Net Lease Realty, Inc.,
("CNLR"), 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. In addition, during 2004, the Company paid CNLR $0.1 million
for real estate development fees.
During the year ended December 31, 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.
During 2004 and 2003, the Company entered into loan agreements with CNL
Bank, an affiliate. The Company paid $0.03 million and $0.01 million in
interest to CNL Bank during 2004 and 2003, respectively.
12. Concentration of Credit Risk:
No individual lessee or borrower (or affiliated groups of lessees or
borrowers) or restaurant chains represented more than ten percent of the
Company's revenues relating to its properties, loans and secured equipment
leases during the years ended December 31, 2004, 2003 or 2002.
Although the Company's properties are geographically diverse throughout the
United States and lessees and borrowers operate a variety of restaurant
concepts, 15 restaurant chains constitute 72 percent of the Company's
properties. Failure of any one of these restaurant chains or any
significant lessees or borrowers could significantly impact results of
operations if the Company is not able to timely protect its interest.
13. Segment Information:
The Company has established CNL-Investments and CNL-Capital Corp. as
separate legal entities to operate and measure the real estate and
specialty finance segments, respectively.
CNL-Investments is the parent company of CNL APF Partners LP, a real estate
company that acquires and holds real estate, mortgage and equipment loans
generally until maturity. CNL-Capital Corp. is the parent of CNL-Capital, a
specialty finance company that offers financing, servicing, advisory and
other services to restaurant operators. CNL-Capital acquires restaurant
real estate properties subject to triple-net leases, utilizing short-term
debt, and then sells them generally within one year.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
13. Segment Information - Continued:
The following tables summarize the results for the years 2004, 2003 and
2002 for CNL-Investments and CNL-Capital Corp. Consolidating eliminations
and results of the parent of CNL-Investments and CNL-Capital Corp. are
reflected in the "other" column.
<s> <c>
Year ended December 31, 2004
(In thousands)
CNL- CNL-Capital Consolidated
Investments Corp. Other Totals
------------- -------------- ------------- ---------------
Revenues $ 78,893 $ 29,337 $ (3,010 ) $ 105,220
------------- -------------- ------------- ---------------
General operating and administrative 8,868 20,453 (1,975 ) 27,346
Interest expense 29,262 18,314 423 47,999
Property expenses, state and other taxes 649 -- -- 649
Depreciation and amortization 10,901 874 -- 11,775
Loss on termination of cash flow hedges -- 940 -- 940
Impairments and provisions on assets 2,935 1,616 -- 4,551
Minority interest net of equity in 61 3,552 -- 3,613
earnings
Gain on sale of assets (135 ) -- -- (135 )
------------- -------------- ------------- ---------------
52,541 45,749 (1,552 ) 96,738
------------- -------------- ------------- ---------------
Discontinued operations:
Income from discontinued operations,
net of income tax provision 4,367 29,169 -- 33,536
------------- -------------- ------------- ---------------
Net income $ 30,719 $ 12,757 $ (1,458 ) $ 42,018
============= ============== ============= ===============
Assets at December 31, 2004 $ 795,125 $ 451,237 $ (2,713 ) $ 1,243,649
============= ============== ============= ===============
Investments accounted for under the
equity method at December 31, 2004 $ 947 $ -- $ -- $ 947
============= ============== ============= ===============
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
13. Segment Information - Continued:
<s> <c>
Year ended December 31, 2003
(In thousands)
CNL- CNL-Capital Consolidated
Investments Corp. Other Totals
-------------- -------------- ----------- ---------------
Revenues $ 83,924 $ 32,254 $ (3,180 ) $ 112,998
-------------- -------------- ----------- ---------------
General operating and administrative 8,980 18,645 (2,417 ) 25,208
Interest expense 27,481 23,653 (558 ) 50,576
Property expenses, state and other taxes 958 -- -- 958
Depreciation and amortization 11,294 934 -- 12,228
Loss on termination of cash flow hedges -- 502 -- 502
Impairments and provisions on assets 4,108 8,756 -- 12,864
Minority interest net of equity in earnings 114 1,691 -- 1,805
Loss on sale of assets 148 9 -- 157
-------------- -------------- ----------- ---------------
53,083 54,190 (2,975 ) 104,298
-------------- -------------- ----------- ---------------
Discontinued operations:
Income/(loss) from discontinued
operations, net of income tax
benefit (3,074 ) 36,814 -- 33,740
-------------- -------------- ----------- ---------------
Net income $ 27,767 $ 14,878 $ (205 ) $ 42,440
============== ============== =========== ===============
Assets at December 31, 2003 $ 811,203 $ 491,923 $ (5,010 ) $ 1,298,116
============== ============== =========== ===============
Investments accounted for under the
equity method at December 31, 2003 $ 1,038 $ -- $ -- $ 1,038
============== ============== =========== ===============
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
13. Segment Information - Continued:
<s> <c>
Year ended December 31, 2002
(In thousands)
CNL- CNL-Capital Consolidated
Investments Corp. Other Totals
------------- --------------- ----------- ---------------
Revenues $ 86,843 $ 250,784 $ (3,221 ) $ 334,406
------------- --------------- ----------- ---------------
Cost of real estate sold -- 193,179 -- 193,179
General operating and administrative 11,764 19,064 (2,395 ) 28,433
Interest expense 30,590 28,490 (679 ) 58,401
Property expenses, state and other taxes 2,734 390 -- 3,124
Depreciation and amortization 11,541 1,243 -- 12,784
Impairments and provisions on assets 4,360 5,150 -- 9,510
Minority interest net of equity in 128 2,180 -- 2,308
earnings
Loss on sale of assets 330 17 -- 347
------------- --------------- ----------- ---------------
61,447 249,713 (3,074 ) 308,086
------------- --------------- ----------- ---------------
Discontinued operations:
Income/(loss) from discontinued
operations (2,226 ) 11,496 -- 9,270
------------- --------------- ----------- ---------------
Net income $ 23,170 $ 12,567 $ (147 ) $ 35,590
============= =============== =========== ===============
Assets at December 31, 2002 $ 831,491 $ 555,971 $ (4,012 ) $ 1,383,450
============= =============== =========== ===============
Investments accounted for under the
equity method at December 31, 2002 $ 1,121 $ -- $ -- $ 1,121
============= =============== =========== ===============
14. Commitments and Contingencies:
In the ordinary course of business, the Company has outstanding commitments
to qualified borrowers and tenants. These commitments, including
development agreements, if accepted by the potential borrowers, obligate
the Company to provide funding. At December 31, 2004, the Company had
committed to fund $29.7 million to qualified tenants. In addition, the
Company has commitments to purchase real estate properties at December 31,
2004 totaling $2.8 million.
Certain operating leases relating to real estate held for sale provide
that, in the event the Company sells the leased property before the fifth
lease year, the annual rent will increase to the fifth year annual rent
effective on the day of the sale, and that the Company will compensate the
tenant for the increase.
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
15. Selected Quarterly Financial Data:
The following table presents selected unaudited quarterly financial data
for each fiscal quarter during the years ended December 31, 2004 and 2003:
<s> <c>
(In thousands except for per share data)
2004 Quarter First Second Third Fourth Year
--------------------------------- ----------- ----------- ------------ ------------ -----------
Continuing operations:
Revenues (1) $ 26,203 $ 25,575 $ 27,473 $ 25,969 $ 105,220
=========== =========== ============ ============ ===========
Earnings from continuing
operations, net (1)(2) $ 3,631 $ 1,842 $ 3,478 $ (469 ) $ 8,482
Discontinued operations:
Earnings and gains
from discontinued
operations, net (1) 7,217 7,378 11,438 7,503 33,536
----------- ----------- ------------ ------------ -----------
Net Income $ 10,848 $ 9,220 $ 14,916 $ 7,034 $ 42,018
=========== =========== ============ ============ ===========
Earnings per share of common stock (basic and diluted):
Continuing operations (1) $ 0.08 $ 0.04 $ 0.08 $ (0.01 ) $ 0.19
=========== =========== ============ ============ ===========
Discontinued operations (1) $ 0.16 $ 0.16 $ 0.25 $ 0.17 $ 0.74
=========== =========== ============ ============ ===========
CNL RESTAURANT PROPERTIES, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2004, 2003 and 2002
15. Selected Quarterly Financial Data - Continued:
<s> <c>
(In thousands except for per share data)
2003 Quarter First Second Third Fourth Year
------------------------------------ ---------- ----------- ---------- ----------- -----------
Continuing operations:
Revenues (1) $26,921 $ 28,071 $29,586 $28,420 $ 112,998
========== =========== ========== =========== ===========
Earnings from continuing
operations, net (1) $ 758 $ 1,712 $ 6,139 $ 91 $ 8,700
Discontinued operations:
Earnings and gains
from discontinued
operations, net (1) 7,261 8,879 6,909 10,691 33,740
---------- ----------- ---------- ----------- -----------
Net Income $8,019 $ 10,591 $13,048 $10,782 $ 42,440
========== =========== ========== =========== ===========
Earnings per share of common stock (basic and diluted):
Continuing operations (1) $ 0.02 $ 0.03 $ 0.14 $ 0.00 $ 0.19
========== =========== ========== =========== ===========
Discontinued operations (1) $ 0.16 $ 0.20 $ 0.15 $ 0.24 $ 0.75
========== =========== ========== =========== ===========
(1) The results of operations relating to properties that were either
disposed of or that were classified as held for sale through March 31,
2005 are reported as discontinued operations for all periods presented.
(2) During the fourth quarter, the Company recorded additional commission
expense upon achieving certain origination volume threshold, and also
incurred increased operating expenses in connection with the Merger and
compliance requirements with the Sarbanes-Oxley Act.
16. Subsequent Events:
During December 2004, a borrower on a mortgage loan collateralizing the
Series 2003 notes prepaid their mortgage note balance of approximately
$10.7 million. In January 2005, the Company paid off approximately $10.7
million of the Series 2003 notes prior to their scheduled maturity.
On February 23, 2005, the Company awarded 26,500 shares of common stock to
three independent directors. On February 25, 2005, the Company merged with
USRP and the 18 CNL Income Funds. The Company obtained financing to execute
the merger transaction (see Note 1).
Item 4. Management's Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting, as such term is defined in
Exchange Act Rules 13a-15(f). The Company's internal control system was designed
to provide reasonable assurance to the Company's management and board of
directors regarding the preparation and fair presentation of published financial
statements. All internal control systems, no matter how well designed, have
inherent limitations. Therefore, even those systems determined to be effective
can provide only reasonable assurance with respect to financial statement
preparation and presentation. Under the supervision and with the participation
of management, including the principal executive officer and principal financial
officer, management conducted an evaluation of the effectiveness of the
Company's internal control over financial reporting based on the framework in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on management's evaluation under
the framework in Internal Control - Integrated Framework, management of the
Company concluded that the Company's internal control over financial reporting
was effective as of December 31, 2004. Management's assessment of the
effectiveness of the Company's internal control over financial reporting as of
December 31, 2004 has been audited by PricewaterhouseCoopers LLP, an independent
registered certified public accounting firm. PricewaterhouseCoopers LLP has
issued an attestation report on management's assessment of the Company's
internal control report over financial reporting which is in "Item 3 - Financial
Statements and Supplementary Data".