UNITED STATESSECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended June 30, 2001OR[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from __________ to __________.Commission File Number 0-12989
COMMERCIAL NET LEASE REALTY, INC.(exact name of registrant as specified in its charter)
450 South Orange Avenue, Orlando, Florida 32801(Address of principal executive offices, including zip code)(407) 265-7348(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No X . Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.30,548,175 shares of Common Stock, $0.01 par value, outstanding as of August 14, 2001.COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESCONTENTSPart I Item 1.Financial Statements:Page Condensed Consolidated Balance Sheets1 Condensed Consolidated Statements of Earnings2 Condensed Consolidated Statements of Cash Flows3 Notes to Condensed Consolidated Financial Statements5 Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations12 Item 3. Quantitative and Qualitative Disclosures About Market Risk17 Part II Other Information 18COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(dollars in thousands, except per share data) ASSETSJune 30,2001December 31,2000Real estate: Accounted for using the operating method, net of accumulated depreciation and amortization of $28,982 and 27,438, respectively$505,784$514,962 Accounted for using the direct financing method111,202123,217Investment in unconsolidated affiliates6,0543,603Mortgages and accrued interest receivable12,70113,547Mortgages and other receivables from unconsolidated affiliates102,39677,798Cash and cash equivalents8,0992,190Receivables1,2782,070Accrued rental income, net of allowance 15,51215,285Debt costs, net of accumulated amortization of $3,985 and $3,587, respectively3,2853,668Other Assets5,1085,271 Total Assets$771,419$761,611 LIABILITIES AND STOCKHOLDERS' EQUITY Line of credit payable$107,800$101,700Mortgages payable36,30237,351Notes payable, net of unamortized discount of $572 and $625, respectively, and unamoritzed interest rate hedge gain of $1,702 and $1,955, respectively221,130221,330Accrued interest payable3,2013,214Accounts payable and accrued expenses1,7681,077Other liabilities3,5113,038 Total liabilities373,712367,710 Stockholders' equity: Preferred stock, $0.01 par value. Authorized 15,000,000 shares; none issued or outstanding-- Common stock, $0.01 par value. Authorized 90,000,000 shares; issued or outstanding 30,548,175 and 30,456,705 shares at June 30, 2001 and December 31, 2000, respectively305305 Excess stock, $0.01 par value. Authorized 105,000,000 shares; none issued or outstanding-- Capital in excess of par value399,478398,449 Accumulated dividends in excess of net earnings(2,076)(4,853) Total stockholders' equity397,707393,901$771,419$761,611See accompanying notes to condensed consolidated financial statements.1COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF EARNINGS(dollars in thousands, except per share data)Quarter EndedJune 30,Six Months EndedJune 30,2001200020012000Revenues: Rental income from operating leases$14,425$14,486$28,836$30,213 Earned income from direct financing leases3,0793,2996,3356,620 Contingent rental income122249784521 Development and asset management fees from related parties 10894200190 Interest from unconsolidated affiliate and other mortgages receivable2,1141,1744,2712,198 Other25628255542920,10419,58440,98140,171 Expenses: General operating and administrative 1,7241,2363,5772,486 Real estate expenses10192215192 Interest6,0526,23312,34612,879 Depreciation and amortization2,2062,2544,4144,542 Expenses incurred in acquiring advisor from related party35727569176610,44010,09021,24320,865 Earnings before equity in earnings of unconsolidated affiliates and gain on disposition of real estate9,6649,49419,73819,306 Equity in earnings of unconsolidated affiliates(865)(920)(2,209)(2,088) Gain on disposition of real estate1,586-4,450- Net earnings$10,385$8,574$21,979$17,218Net earnings per share of common stock: Basic$0.34$0.28$0.72$0.57 Diluted$0.34$0.28$0.72$0.57 Weighted average number of shares outstanding: Basic30,583,46330,353,34830,549,82030,339,649 Diluted30,707,44930,377,95730,625,86630,356,790 See accompanying notes to condensed consolidated financial statements.2COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(dollars in thousands)Six Months EndedJune 30,20012000Cash flows from operating activities: Net earnings$21,979$17,218 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization4,4144,542 Amortization of notes payable discount5344 Amortization of deferred interest rate hedge gain(253)(235) Gain on disposition of real estate(4,450)- Expenses incurred in acquiring advisor from related party691766 Equity in earnings of unconsolidated affiliates, net of deferred intercompany profits2,5482,564 Decrease in real estate leased to others using the direct financing method1,047995 Decrease in leasehold interests-1,455 Decrease (increase) in mortgages and accrued interest receivable(173)155 Decrease in receivables522127 Increase in accrued rental income(1,327)(1,585) Decrease in other assets46470 Increase (decrease) in accrued interest payable(13)356 Increase (decrease) in accounts payable and accrued expenses765(288) Increase in other liabilities52620 Net cash provided by operating activities26,37526,604 Cash flows from investing activities: Proceeds from the disposition of real estate35,285838 Additions to real estate accounted for using the operating method(13,262)(1,223) Contribution to unconsolidated affiliate(5,000)- Increase in mortgages receivable-(417) Mortgage payments received842653 Increase in mortgages and other receivable from unconsolidated affiliates(41,591)(19,404) Payments received from unconsolidated affiliates17,170- Increase in other assets(227)(395) Other270(53) Net cash used in investing activities(6,513)(20,001) Cash flows from financing activities: Proceeds from line of credit payable45,20025,600 Repayment of line of credit payable(39,100)(12,800) Repayment of mortgages payable(1,049)(2,069) Payment of debt costs(42)(14) Proceeds from issuance of common stock338279 Payment of dividends(19,202)(18,775) Other(98)(52) Net cash provided by financing activities(13,953)(7,831)See accompanying notes to condensed consolidated financial statements.3COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED(dollars in thousands)Six Months EndedJune 30,20012000 Net increase (decrease) in cash and cash equivalents5,909(1,228) Cash and cash equivalents at beginning of period2,1903,329 Cash and cash equivalents at end of period$8,099$2,101 Supplemental schedule of non-cash investing and financing activities: Issued 63,282 and 77,470 shares of common stock in 2001 and 2000, respectively, in connection with the acquisition of the Company's advisor$691$766 Mortgage note accepted in connection with the sale of real estate $-$1,425See accompanying notes to condensed consolidated financial statements.4COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSSix Months Ended June 30, 2001 and 20001. Basis of Presentation:The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles. The financial statements reflect all adjustments, consisting of normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Operating results for the quarter and six months ended June 30, 2001, may not be indicative of the results that may be expected for the year ending December 31, 2001. Amounts as of December 31, 2000, included in the financial statements, have been derived from the audited financial statements as of that date. These unaudited financial statements should be read in conjunction with the financial statements and notes thereto included in the Form 10-K of Commercial Net Lease Realty, Inc. for the year ended December 31, 2000. The condensed consolidated financial statements include the accounts of Commercial Net Lease Realty, Inc. and its wholly-owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation. In accordance with Statement of Financial Accounting Standard No. 128, “Earnings Per Share,” basic earnings per share are calculated based upon the weighted average number of common shares outstanding during each period and diluted earnings per share are calculated based upon weighted average number of common shares outstanding plus dilutive potential common shares. Certain items in the prior year’s financial statements have been reclassified to conform with the 2001 presentation. These reclassifications had no effect on Stockholders’ equity or net earnings. In June 2001, the Financial Accounting Standard Board (“FASB”) issued Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” This Statement addresses financial accounting and reporting for business combinations and supersedes Accounting Principles Board (“APB”) Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. The provisions of this Statement apply to all business combinations initiated after June 30, 2001. This Statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. The Company is currently evaluating this Statement to determine what impact it will have on the Company’s consolidated financial statements. In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” This Statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17,Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Adoption of this Statement is not expected to have a significant impact on the financial position or results of operations of the Company. 5COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUEDSix Months Ended June 30, 2001 and 20002. Leases:The Company generally leases its real estate to operators of major retail businesses. As of June 30, 2001, 157 of the leases have been classified as operating leases and 69 leases have been classified as direct financing leases. For the leases classified as direct financing leases, the building portions of the property leases are accounted for as direct financing leases while the land portions of 46 of these leases are accounted for as operating leases. Substantially all leases have initial terms of 10 to 20 years (expiring between 2001 and 2025) and provide for minimum rentals. In addition, the majority of the leases provide for contingent rentals and/or scheduled rent increases over the terms of the leases. The tenant is also generally required to pay all property taxes and assessments, substantially maintain the interior and exterior of the building and carry insurance coverage for public liability, property damage, fire and extended coverage. The lease options generally allow tenants to renew the leases for two to four successive five-year periods subject to substantially the same terms and conditions as the initial lease.3. Common Stock:In January 2001, the Company filed a shelf registration statement with the Securities and Exchange Commission which permits the issuance by the Company of up to $200,000,000 in debt and equity securities (which includes approximately $180,000,000 of unissued debt and equity securities under the Company’s previous $300,000,000 shelf registration statement).6COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUEDSix Months Ended June 30, 2001 and 20004. Earnings Per Share:The following represents the calculations of earnings per share and the weighted average number of shares of dilutive potential common stock for:Quarter EndedJune 30,Six Months EndedJune 30,2001200020012000Basic earnings per share: Net earnings$10,385,000$8,574,000$21,979,000$17,218,000 Weighted average number of shares outstanding 30,477,61030,271,50630,470,47930,264,824 Merger contingent shares105,85381,84279,34174,825 Weighted average number of shares outstanding used in basic earnings per share30,583,46330,353,34830,549,82030,339,649 Basic earnings per share$0.34$0.28$0.72$0.57 Diluted earnings per share: Net earnings$10,385,000$8,574,000$21,979,000$17,218,000 Weighted average number of shares outstanding30,477,61030,271,50630,470,47930,264,824 Effect of dilutive securities: Stock options55,0461,05236,349531 Merger contingent shares174,793105,399119,03891,435 Weighted average number of shares outstanding used in diluted earnings per share30,707,44930,377,95730,625,86630,356,790 Diluted earnings per share$0.34$0.28$0.72$0.57The following represents the number of options of common stock for which were not included in computing diluted earnings per share because their effects were antidilutive:Quarter EndedJune 30,Six Months EndedJune 30,2001200020012000 Antidilutive potential common stock:1,398,8921,658,6631,480,8921,662,2947COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUEDSix Months Ended June 30, 2001 and 20005. Related Party Transactions:In connection with the mortgages and other receivables from the Company’s unconsolidated subsidiary, Commercial Net Lease Realty Services, Inc. (“Services”) and its wholly-owned subsidiaries, the Company received $4,190,000 and $2,022,000 in interest and fees during the six months ended June 30, 2001 and 2000, respectively, $1,868,000 and $1,187,000 of which was earned during the quarters ended June 30, 2001 and 2000, respectively. In addition, Services paid the Company $339,000 and $204,000 in expense reimbursements for accounting services provided by the Company during the six months ended June 30, 2001 and 2000, respectively, $170,000 and $102,000 of which was earned during the quarters ended June 30, 2001 and 2000, respectively. In March 2001, Commercial Net Lease Realty Services, Inc., an unconsolidated subsidiary of the Company, filed an election to become a taxable REIT subsidiary, effective January 1, 2001. In April 2001, the Company modified its existing Amended and Restated Secured Revolving Line of Credit and Security Agreement (the “Security Agreement”) with Services to increase Services borrowing capacity from $65,000,000 to $85,000,000 and to modify certain provisions of the Security Agreement. In April 2001, the Company entered into two new Secured Revolving Lines of Credit and Security Agreements with wholly-owned subsidiaries of Services and modified an existing Secured Revolving Line of Credit and Security Agreement with another wholly-owned subsidiary of Services. In July 2001, the Company entered into a new Secured Revolving Line of Credit and Security Agreement with another wholly-owned subsidiary of Services. All Secured Revolving Line of Credit and Security Agreements between the Company and any wholly-owned subsidiaries of Services are collectively referred to as the “Subsidiary Agreements.” The Security Agreement and the Subsidiary Agreements provide an aggregate borrowing capacity of $140,500,000 to Services and its wholly-owned subsidiaries and each have expiration dates on October 31, 2003. In May 2001, Services and certain of its wholly owned subsidiaries became direct borrowers under the Company’s $200,000,000 revolving credit facility.8COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUEDSix Months Ended June 30, 2001 and 20006. Segment Information:Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. While the Company does not have more than one reportable segment, the Company has identified two primary sources of revenue: (i) rental and earned income from the triple net leases and (ii) fee income from development, property management and asset management services.The following tables represent the revenues, expenses and asset allocation for the two segments and the Company’s consolidated totals at (dollars in thousands):Rental andEarned IncomeFeeIncomeCorporateConsolidatedTotalsJune 30, 2001 and for the quarter then ended Revenues$18,081$2,023$-$20,104 General and administrative expenses1,1892263091,724 Real estate expenses101--101 Interest expense6,03121-6,052 Depreciation and amortization2,1792432,206 Expenses incurred in acquiring advisor from related party--357357 Equity in earnings of unconsolidated affiliates86(951)-(865) Gain on disposition of real estate1,586--1,586 Net earnings$10,253$801$(669)$10,385 Assets$771,276$60$83$771,419 Additions to long-lived assets: Real estate$13,194$-$-$13,194 Other $30$7$4$41 June 30, 2000 and for the quarter then ended Revenues$18,673$911$-$19,584 General and administrative expenses901442911,236 Real estate expenses92--92 Interest expense6,233--6,233 Depreciation and amortization2,2252542,254 Expenses incurred in acquiring advisor from related party--275275 Equity in earnings of unconsolidated affiliates95(1,015)-(920) Net earnings$9,317$(173)$(570)$8,574 Assets$761,325$83$82$761,490 Additions to long-lived assets: Real estate$1,089$-$-$1,089 Other$39$1$-$409COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUEDSix Months Ended June 30, 2001 and 20006. Segment Information - continued:Rental andEarned IncomeFeeIncomeCorporateConsolidatedTotalsJune 30, 2001 and for the six months then ended Revenues$36,887$4,094$-$40,981 General and administrative expenses2,3974677133,577 Real estate expenses215--215 Interest expense12,31432-12,346 Depreciation and amortization4,3703954,414 Expenses incurred in acquiring advisor from related party--691691 Equity in earnings of unconsolidated affiliates179(2,388)-(2,209) Gain on disposition of real estate4,450--4,450 Net earnings$22,220$1,168$(1,409)$21,979 Assets$771,276$60$83$771,419 Additions to long-lived assets: Real estate $13,262$-$-$13,262 Other$76$13$10$99June 30, 2000 and for the six months then ended Revenues$38,494$1,677$-$40,171 General and administrative expenses1,849925452,486 Real estate expenses 192--192 Interest expense12,879--12,879 Depreciation and amortization4,4854984,542 Expenses incurred in acquiring advisor from related party--766766 Equity in earnings of unconsolidated affiliates188(2,276)-(2,088) Net earnings$19,277$(740)$(1,319)$17,218 Assets$761,325$83$82 $761,490 Additions to long-lived assets: Real estate$1,223$-$-$1,223 Other$68$2$-$7010COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUEDSix Months Ended June 30, 2001 and 20007. Subsequent Events:In July 2001, the Company declared dividends to its shareholders of $9,623,000 or $0.315 per share of common stock, payable in August 2001.On July 2 2001, the Company announced that it had agreed to acquire Captec Net Lease Realty, Inc. (“Captec”), a publicly traded real estate investment trust, which owns 136 freestanding, net lease properties located in 26 states. Captec shareholders will receive approximately $12.1 million in cash, 4.35 million newly issued Commercial Net Lease Realty common shares and two million newly issued shares of Commercial Net Lease Realty’s 9% Class A Preferred Stock. The merger, which has been unanimously approved by both the Company’s and Captec’s Board of Directors, is subject to the approval of the Securities and Exchange Commission and Captec’s shareholders. First Union Securities, Inc. served as a financial advisor to the Company and provided a fairness opinion in connection with the transaction. The Company and Captec may mutually agree to terminate the merger agreement under certain conditions; including if the merger is not approved by Captec’s shareholder’s or if the merger is not completed by January 31, 2002. If the merger agreement is terminated under certain circumstances, the Company and/or Captec would be obligated to pay certain termination fees. The Company’s potential liability would not exceed the lesser of $1.0 million or Captec’s actual out-of-pocket expenses and transaction costs incurred in connection with the merger agreement. On July 9, 2001, the Company filed a registration statement on Form S-8 with the Securities and Exchange Commission which permits the issuance by the Company of up to 2,900,000 shares of common stock pursuant to the Company’s 2000 Performance Incentive Plan. On July 25, 2001, the Company entered into Restricted Stock Award Agreements (“Agreements”), with four of the Company’s executive officers (“Officers”) and five members of the Board of Directors (“Directors”). The stock awards were granted under the Company’s 2000 Performance Incentive Plan in consideration of the mutual promises and covenants made in the Agreements. Pursuant to the Agreements, the Company issued restricted stock grants to the Officers and Directors totaling 234,000 and 5,000 shares, respectively. The terms of the Agreements with the Officers provide that the restricted stock will vest at a rate of 15%-30% over approximately a five-year period ending on January 1, 2006 and automatically upon a change in control. The terms of the Agreements with the Directors provide that the restricted stock will vest equally over approximately a two-year period ending on January 1, 2003 and automatically upon a change in control. 11ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSIntroductionCommercial Net Lease Realty, Inc., a Maryland corporation, is a fully integrated, self-administrated real estate investment trust that acquires, owns, manages and indirectly, through investment interests, develops high-quality, freestanding properties that are generally leased to major retail businesses under long-term commercial net leases. As of June 30, 2001, Commercial Net Lease Realty, Inc. and its subsidiaries (the “Company”) owned, either directly or through a partnership interest, 241 properties (the “Properties”) substantially all of which are leased to major retail businesses.Liquidity and Capital ResourcesGeneral. Historically, the Company’s only demand for funds has been for the payment of operating expenses and dividends, for property acquisitions and development, either directly or through investment interests, for the payment of interest on its outstanding indebtedness and for other investments. Generally, cash needs for items other than property acquisitions and development and other investments have been met from operations, and property acquisitions and development have been funded by equity and debt offerings, bank borrowings, the sale of Properties and, to a lesser extent, from internally generated funds. Potential future sources of capital include proceeds from the public or private offering of the Company’s debt or equity securities, secured or unsecured borrowings from banks or other lenders, proceeds from the sale of Properties, as well as undistributed funds from operations. For the six months ended June 30, 2001 and 2000, the Company generated $26,375,000 and $26,604,000, respectively, in net cash provided by operating activities. The decrease in cash from operations for the six months ended June 30, 2001, as compared to the six months ended June 30, 2000, is primarily the result of changes in revenues and expenses as discussed in “Results of Operations.”The Company’s leases typically provide that the tenant bears responsibility for substantially all property costs and expenses associated with ongoing maintenance and operation including utilities, property taxes and insurance. In addition, the Company’s leases generally provide that the tenant is responsible for roof and structural repairs. Certain of the Company’s Properties are subject to leases under which the Company retains responsibility for certain costs and expenses associated with the Property. Because many of these certain Properties are recently constructed, management anticipates that capital demands to meet obligations with respect to these Properties will be minimal for the foreseeable future and can be met with funds from operations and working capital. If required, the Company may use bank borrowings or other sources of capital in the event of unforeseen significant capital expenditures.Management believes that the Company’s current capital resources (including cash on hand), coupled with the Company’s borrowing capacity, are sufficient to meet its liquidity needs for the foreseeable future.Equity Securities. In January 2001, the Company filed a shelf registration statement with the Securities and Exchange Commission which permits the issuance by the Company of up to $200,000,000 in debt and equity securities (which includes approximately $180,000,000 of unissued debt and equity securities under the Company’s previous $300,000,000 shelf registration statement). In July 2001, the Company filed a registration statement on Form S-8 with the Securities and Exchange Commission which permits the issuance by the Company of up to 2,900,000 shares of common stock pursuant to the Company’s 2000 Performance Incentive Plan. On July 25, 2001, the Company entered into Restricted Stock Award Agreements (“Agreements”), with four of the Company’s executive officers (“Officers”) and five members of the Board of Directors (“Directors”). The stock awards were granted under the Company’s 2000 Performance Incentive Plan in consideration of the mutual promises and covenants made in the Agreements. Pursuant to the12Liquidity and Capital Resources – continued:Agreements, the Company issued restricted stock grants to the Officers and Directors totaling 234,000 and 5,000 shares, respectively. The terms of the Agreements with the Officers provide that the restricted stock will vest at a rate of 15%-30% over approximately a five-year period ending on January 1, 2006 and automatically upon a change in control. The terms of the Agreements with the Directors provide that the restricted stock will vest equally over approximately a two-year period ending on January 1, 2003 and automatically upon a change in control. Property Dispositions. During the six months ended June 30, 2001 the Company sold 28 of its Properties for a total of $35,722,000 and received net proceeds of $35,285,000. The Company recognized a net gain on the sale of these 28 Properties of $4,450,000. The Company intends to use the proceeds from the sale of 21 Properties to acquire additional Properties and to structure the transactions to qualify as tax-free exchange transactions for federal income tax purposes. The Company used the proceeds from the sale of seven properties to pay down the outstanding indebtedness of the Company. Investment in Unconsolidated Affiliates. Investment in Unconsolidated Affiliates. In March 2001, Commercial Net Lease Realty Services, Inc., an unconsolidated subsidiary of the Company, filed an election to become a taxable REIT subsidiary, effective January 1, 2001.In April 2001, the Company modified its existing Amended and Restated Secured Revolving Line of Credit and Security Agreement (the “Security Agreement”) with Services to increase Services borrowing capacity from $65,000,000 to $85,000,000 and to modify certain provisions of the Security Agreement. In April 2001, the Company entered into two new Secured Revolving Lines of Credit and Security Agreements with wholly-owned subsidiaries of Services and modified an existing Secured Revolving Line of Credit and Security Agreement with another wholly-owned subsidiary of Services. In July 2001, the Company entered into a new Secured Revolving Line of Credit and Security Agreement with another wholly-owned subsidiary of Services. All Secured Revolving Line of Credit and Security Agreements between the Company and any wholly-owned subsidiaries of Services are collectively referred to as the “Subsidiary Agreements.” The Security Agreement and the Subsidiary Agreements provide an aggregate borrowing capacity of $140,500,000 to Services and its wholly-owned subsidiaries and each have expiration dates on October 31, 2003. In May 2001, Services and certain of its wholly owned subsidiaries became direct borrowers under the Company’s $200,000,000 revolving credit facility.Dividends. One of the Company’s primary objectives, consistent with its policy of retaining sufficient cash for reserves and working capital purposes and maintaining its status as a real estate investment trust, is to distribute a substantial portion of its funds available from operations to its stockholders in the form of dividends. For the six months ended June 30, 2001 and 2000, the Company declared and paid dividends to its stockholders of $19,202,000 and $18,775,000, respectively, or $0.62 and $0.62 per share of common stock, respectively. In July 2001, the Company declared dividends to its shareholders of $9,623,000 or $0.315 per share of common stock, payable in August 2001.Results of OperationsAs of June 30, 2001 and 2000, the Company owned 232 and 267 wholly-owned Properties, respectively, 226 and 262, of which were leased to operators of major retail businesses, respectively. During the six months ended June 30, 2001 and 2000, the Company earned $35,955,000 and $37,354,000, respectively, in rental income from operating leases, earned income from direct financing leases and contingent rental income (“Rental Income”), $17,626,000 and $18,034,000 of which was earned during the quarters ended June 30, 2001 and 2000, respectively. The decrease in Rental Income for the six months ended June 30, 2001 is primarily a result of the decrease in Rental Income relating to the 28 properties sold during the six13Results of Operations – continued:months ended June 30, 2001 which were operational for the full six months ended June 30, 2000. The decrease in Rental Income is partially offset as a result of non-recurring additional Rental Income received during the six months ended June 30, 2001 and 2000 of $1,503,000 and $1,059,000, respectively, related to the termination of leases on 27 and two properties, respectively. The decrease in Rental Income for the quarter ended June 30, 2001 is primarily a result of the decrease in Rental Income relating to the 38 properties sold subsequent to the quarter ended June 30, 2000. The decrease in Rental Income is partially offset as a result of non-recurring additional Rental Income received during the quarter ended June 30, 2001 of $1,103,000 related to the termination of leases on seven properties. The Company did not receive any lease termination fees during the quarter ended June 30, 2000. During the six months ended June 30, 2001 and 2000, the Company earned $784,000 and $521,000, respectively, in contingent rental income, $122,000 and $249,000 of which was earned during the quarters ended June 30, 2001 and 2000, respectively. The increase in contingent rental income in 2001 is attributable to the adoption of the Securities and Exchange Commission’s Staff Accounting Bulletin 101 “Revenue Recognition” (the “Bulletin”), which establishes accounting and reporting standards for the recognition of contingent rental income. Accordingly, the Company has modified its revenue recognition policy and recognizes contingent rental income based on the tenants’ actual gross quarterly or annual sales pursuant to the terms of the leases. Adoption of this Bulletin resulted in the recognition of an additional $367,000 of contingent rental income during the quarter ended March 31, 2001. During the six months ended June 30, 2001, the Company sold 28 properties for a total of $35,722,000 and received net sales proceeds of $35,285,000. The Company recognized a net gain on the sale of these 28 properties of $4,450,000 for financial reporting purposes. The Company intends to reinvest the proceeds from 21 of these properties to acquire additional properties and to structure the transactions to qualify as a tax-free like-kind exchange transactions for federal income tax purposes. The Company used the proceeds from the sale of seven properties to pay down the outstanding indebtedness of the Company.During the six months ended June 30, 2001 and 2000, the Company earned $4,271,000 and $2,198,000, respectively, in interest income, $2,114,000 and $1,174,000 of which was earned during the quarters ended June 30, 2001 and 2000, respectively. The increase in interest earned during 2001 is attributable to the interest earned on the mortgages receivable and the mortgages and other receivables from Services issued during 2000. During the six months ended June 30, 2001 and 2000, operating expenses, excluding interest and including depreciation and amortization, were $8,897,000 and $7,986,000, respectively, (21.7% and 19.9%, respectively, of total revenues), $4,388,000 and $3,857,000 (21.8% and 19.7%, respectively, of total revenues) of which was incurred during the quarters ended June 30, 2001 and 2000, respectively. The increase in operating expenses for the quarter ended June 30, 2001, as compared to the quarter ended June 30, 2000, is attributable to the increase in general operating and administrative expenses as a result of an increase in expenses related to technology, personnel related expenses and debt financing charges. The increase in operating expenses for the six months ended June 30, 2001, as compared to the six months ended June 30, 2000, is attributable to an increase in general operating and administrative expenses as a result of an increase in expenses related to technology, personnel related expenses, debt financing charges and professional services provided to the Company. However, the increase in general operating and administrative expenses for the six months ended June 30, 2001 is partially offset by a decrease in charges related to the costs incurred in acquiring the Company’s advisor from a related party. In addition, the increase in operating expenses for the quarter and six months ended June 30, 2001, as compared to the quarter and six months ended June 30, 2000, is partially offset by a decrease in deprecation expense related to the sale of 18 and nine properties during the six months ended June 30, 2001 and the quarter ended December 31, 2000, respectively.14Results of Operations - continued:The Company recognized $12,346,000 and $12,879,000 in interest expense for six months ended June 30, 2001 and 2000, respectively, $6,052,000 and $6,233,000 of which was incurred during the quarters ended June 30, 2001 and 2000, respectively. Interest expense decreased during the quarter and six months ended June 30, 2001, primarily as a result of the decline in the average interest rate on the Company’s credit facility. However, the decrease in interest expense was partially offset by an increase in the average borrowing levels of the Company’s Credit Facility and an increase in interest incurred related to the $20,000,000 of 8.5% notes payable issued in September 2000.In May 1999, Services was formed to enable the Company to perform additional development, leasing and disposition services. The Company accounts for its investment in Services under the equity method, and therefore, recognizes 95 percent of the income or loss of Services as equity in earnings of unconsolidated affiliate. The net losses incurred by Services for the six months ended June 30, 2001 are primarily due to the nature of the development, leasing and real estate disposition business which provides for revenue recognition upon completion of construction, leasing or disposition of the real estate, while many of the related expenses are recognized as incurred.Investment Considerations. Three of the Company’s tenants, Waccamaw/HomePlace, Heilig-Meyers and HomeLife (the “Tenants”), have each filed a voluntary petition for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. As a result, each of the Tenants has the right to reject or affirm its leases with the Company. As of July 2001, Waccamaw/HomePlace has rejected all five of its leases with the Company. Heilig-Meyers has rejected 12 of its 17 leases with the Company, and proposed that the lease for one of its Properties be assigned to a new tenant pursuant to the U.S. Bankruptcy Code procedures. HomeLife has filed a motion to reject all of five of its leases in the bankruptcy proceedings. Regardless of such election by HomeLife, Sears, Roebuck & Co., as assignor of the leases to HomeLife, will remain liable under the leases. As of the respective lease rejection dates, Waccamaw/HomePlace and Heilig-Meyers were no longer required to pay rent, real estate taxes or insurance on the Properties. Heilig-Meyers continues to lease five Properties. While the tenant has not rejected or affirmed the remaining five leases, there can be no assurance that some or all of the leases will not be rejected in the future. Combined Rental Income from the 27 leases accounted for 9.6% of the Company’s Rental Income for the six months ended June 30, 2001. The lost revenues and increased property expenses resulting from the rejection by any bankrupt tenant of any of their respective leases with the Company could have a material adverse effect on the liquidity and results of operations of the Company if the Company is unable to re-lease the Properties at comparable rental rates and in a timely manner. Currently, the Company is actively marketing the 22 closed Properties to existing and prospective clients. New Accounting Standards. In June 2001, the Financial Accounting Standard Board (“FASB”) issued Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” This Statement addresses financial accounting and reporting for business combinations and supersedes Accounting Principles Board (“APB”) Opinion No. 16, Business Combinations, and FASB Statement No. 38,Accounting for Preacquisition Contingencies of Purchased Enterprises. All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. The provisions of this Statement apply to all business combinations initiated after June 30, 2001. This Statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. The Company is currently evaluating this Statement to determine what impact it will have on the Company’s consolidated financial statements. In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” This Statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill15Results of Operations – continued:and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Adoption of this Statement is not expected to have a significant impact on the financial position or results of operations of the Company. This information contains 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. Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the Company’s actual results could differ materially from those set forth in the forward-looking statements. Certain factors that might cause a difference include the following: changes in general economic conditions, changes in real estate market conditions, continued availability of proceeds from the Company’s debt or equity capital, the ability of the Company to locate suitable tenants for its Properties and the ability of tenants to make payments under their respective leases. 16ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKThere have been no material changes in quantitative and qualitative disclosures about market risk as previously reported in the Form 10-K for the year ended December 31, 2000.17PART II. OTHER INFORMATIONItem 1.Legal Proceedings No material developments in legal proceedings as previously reported on the Form 10-K for the year ended December 31, 2000. Item 2.Changes in Securities and Use of Proceeds. Not applicable. Item 3.Defaults Upon Senior Securities. Not applicable. Item 4.Submission of Matters to a Vote of Security Holders. On May 31, 2001, the Company held its Annual Meeting of Shareholders (the "Annual Meeting"). At the Annual Meeting, the following nominees were elected to the Board of Directors of the Company: Messrs. Robert A. Bourne (26,519,529 for and 2,128,972 withheld), Edward Clark (26,500,091 for and 2,148,410 withheld), Kevin B. Habicht (26,754,737 for and 1,893,764 withheld), Clifford R. Hinkle (26,759,341 for and 1,889,161 withheld), Richard B. Jennings (26,728,345 for and 1,920,156 withheld), Ted B. Lanier (26,754,379 for and 1,894,123 withheld), Gary M. Ralston (26,759,037 for and 1,889,465 withheld) and James M. Seneff, Jr.,(26,758,329 for and 1,890,172 withheld). Item 5.Other Information. Not applicable. Item 6.Exhibits and Reports on Form 8-K. (a) The following exhibits are filed as a part of this report. 3.Articles of Incorporation and By-laws 3.1First Amended and Restated Articles of Incorporation of the Registrant (filed as Exhibit 3.1 to the Registrant's Registration Statement No. 333-64511 on Form S-3, and incorporated herein by reference). 3.2By-laws of the Registrant (filed as Exhibit 3.3(ii) to Amendment No. 2 to the Registrant's Registration Statement No. 1-11290 on Form 8-B, and incorporated herein by reference). 4.Instruments defining the rights of security holders, including indentures 4.1Specimen Certificate of Common Stock (filed as Exhibit 3.1 to the Registrant’s Registration Statement No. 333-64511 on Form S-3, and incorporated herein by reference). 4.2Form of Indenture dated March 25, 1998, by and among Registrant and First Union National Bank, Trustee, relating to $100,000,000 of 7.125% Notes due 2008 and $100,000,000 of 8.125% Notes due 2004 (filed as Exhibit 4.1 to the Registrant’s Current Report on Form 8-K dated March 20, 1998, and incorporated herein by reference).184.3Form of Supplemental Indenture No. 1 dated March 25, 1998, by and among Registrant and First Union National Bank, Trustee, relating to $100,000,000 of 7.125% Notes due 2008 (filed as Exhibit 4.2 to the Registrant’s Current Report on Form 8-K dated March 20, 1998, and incorporated herein by reference). 4.4Form of 7.125% Notes due 2008 (filed as Exhibit 4.3 to the Registrant’s Current Report on Form 8-K dated March 20, 1998, and incorporated herein by reference). 4.5Form of Supplemental Indenture No. 2 dated June 21, 1999, by and among Registrant and First Union National Bank, Trustee, relating to $100,000,000 of 8.125% Notes due 2004 (filed as Exhibit 4.2 to the Registrant’s Current Report on Form 8-K dated June 17, 1999, and incorporated herein by reference). 4.6Form of 8.125% Notes due 2004 (filed as Exhibit 4.3 to the Registrant’s Current Report on Form 8-K dated June 17, 1999, and incorporated herein by reference). 4.7 Form of Supplemental Indenture No. 3 dated September 20, 2000, by and among Registrant and First Union National Bank, Trustee, relating to $20,000,000 of 8.5% Notes due 2010 (filed as Exhibit 4.2 to the Registrant’s Current Report on Form 8-K dated September 20, 2000, and incorporated herein by reference). 4.8Form of 8.5% Notes due 2010 (filed as Exhibit 4.3 to the Registrant’s Current Report on Form 8-K dated September 20, 2000, and incorporated herein by reference). 10.Material Contracts 10.1Letter Agreement dated July 10, 1992, amending Stock Purchase Agreement dated January 23, 1992 (filed as Exhibit 10.34 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1992, and incorporated herein by reference) 10.2Advisory Agreement between Registrant and CNL Realty Advisors, Inc. effective as of April 1, 1993 and renewed January 1, 1997 (filed as Exhibit 10.04 to Amendment No. 1 to the Registrant's Registration Statement No. 33-61214 on Form S-2, and incorporated herein by reference). 10.31992 Commercial Net Lease Realty, Inc. Stock Option Plan (filed as Exhibit No. 10(x) to the Registrant's Registration Statement No. 33-83110 on Form S-3, and incorporated herein by reference). 10.4Secured Promissory Note, dated December 14, 1995, among Registrant and Principal Mutual Life Insurance Company relating to a $13,150,000 loan (filed as Exhibit 10.15 to the Registrant’s Current Report on Form 8-K dated January 18, 1996, and incorporated herein by reference).1910.5Mortgage and Security Agreement, dated December 14, 1995, among Registrant and Principal Mutual Life Insurance Company relating to a $13,150,000 loan (filed as Exhibit 10.16 to the Registrant’s Current Report on Form 8-K dated January 18, 1996, and incorporated herein by reference). 10.6Loan Agreement, dated January 19, 1996, among Registrant and Principal Mutual Life Insurance Company relating to a $39,450,000 loan (filed as Exhibit 10.12 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference). 10.7Secured Promissory Note, dated January 19, 1996 among Registrant and Principal Mutual Life Insurance Company relating to a $39,450,000 loan (filed as Exhibit 10.13 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference). 10.8Agreement and Plan of Merger dated May 15, 1997, by and among Commercial Net Lease Realty, Inc. and Net Lease Realty II, Inc. and CNL Realty Advisors, Inc. and the Stockholders of CNL Realty Advisors, Inc. (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated May 16, 1997, and incorporated herein by reference). 10.9Fourth Amended and Restated Line of Credit and Security Agreement, dated August 6, 1997, by and among Registrant, certain lenders and First Union National Bank, as the Agent, relating to a $200,000,000 loan (filed as Exhibit 10 to the Registrant’s Current Report on Form 8-K dated September 12, 1997, and incorporated herein by reference). 10.10Fifth Amended and Restated Line of Credit and Security Agreement, dated September 23, 1999, by and among Registrant, certain lenders and First Union National Bank, as the Agent, relating to a $200,000,000 loan (filed as Exhibit 10.13 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1999 and incorporated herein by reference). 10.11Sixth Amended and Restated Line of Credit and Security Agreement, dated October 26, 2000, by and among Registrant, certain lenders and First Union National Bank, as the Agent, relating to a $200,000,000 loan (filed as Exhibit 10.11 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended eptember 30, 2000 and incorporated herein by reference). (b)No reports on Form 8-K were filed during the quarter ended June 30, 2001.20SIGNATURESPursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.DATED this 14th day of August 2001.COMMERCIAL NET LEASE REALTY, INC.By: /s/Gary M. Ralston Gary M. Ralston President and DirectorBy: /s/Kevin B. Habicht Kevin B. Habicht Chief Financial Officer and Director21
COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESCONTENTS
COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(dollars in thousands, except per share data)
See accompanying notes to condensed consolidated financial statements.
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COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF EARNINGS(dollars in thousands, except per share data)
2
COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(dollars in thousands)
See accompanying notes to condensed consolidated financial statements.3
COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED(dollars in thousands)
See accompanying notes to condensed consolidated financial statements.4
COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSSix Months Ended June 30, 2001 and 2000
1. Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles. The financial statements reflect all adjustments, consisting of normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Operating results for the quarter and six months ended June 30, 2001, may not be indicative of the results that may be expected for the year ending December 31, 2001. Amounts as of December 31, 2000, included in the financial statements, have been derived from the audited financial statements as of that date. These unaudited financial statements should be read in conjunction with the financial statements and notes thereto included in the Form 10-K of Commercial Net Lease Realty, Inc. for the year ended December 31, 2000. The condensed consolidated financial statements include the accounts of Commercial Net Lease Realty, Inc. and its wholly-owned subsidiaries (the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation. In accordance with Statement of Financial Accounting Standard No. 128, “Earnings Per Share,” basic earnings per share are calculated based upon the weighted average number of common shares outstanding during each period and diluted earnings per share are calculated based upon weighted average number of common shares outstanding plus dilutive potential common shares. Certain items in the prior year’s financial statements have been reclassified to conform with the 2001 presentation. These reclassifications had no effect on Stockholders’ equity or net earnings. In June 2001, the Financial Accounting Standard Board (“FASB”) issued Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” This Statement addresses financial accounting and reporting for business combinations and supersedes Accounting Principles Board (“APB”) Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. The provisions of this Statement apply to all business combinations initiated after June 30, 2001. This Statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. The Company is currently evaluating this Statement to determine what impact it will have on the Company’s consolidated financial statements. In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” This Statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17,Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Adoption of this Statement is not expected to have a significant impact on the financial position or results of operations of the Company.
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COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUEDSix Months Ended June 30, 2001 and 2000
2. Leases:
The Company generally leases its real estate to operators of major retail businesses. As of June 30, 2001, 157 of the leases have been classified as operating leases and 69 leases have been classified as direct financing leases. For the leases classified as direct financing leases, the building portions of the property leases are accounted for as direct financing leases while the land portions of 46 of these leases are accounted for as operating leases. Substantially all leases have initial terms of 10 to 20 years (expiring between 2001 and 2025) and provide for minimum rentals. In addition, the majority of the leases provide for contingent rentals and/or scheduled rent increases over the terms of the leases. The tenant is also generally required to pay all property taxes and assessments, substantially maintain the interior and exterior of the building and carry insurance coverage for public liability, property damage, fire and extended coverage. The lease options generally allow tenants to renew the leases for two to four successive five-year periods subject to substantially the same terms and conditions as the initial lease.
3. Common Stock:
In January 2001, the Company filed a shelf registration statement with the Securities and Exchange Commission which permits the issuance by the Company of up to $200,000,000 in debt and equity securities (which includes approximately $180,000,000 of unissued debt and equity securities under the Company’s previous $300,000,000 shelf registration statement).
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4. Earnings Per Share:
The following represents the calculations of earnings per share and the weighted average number of shares of dilutive potential common stock for:
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COMMERCIAL NET LEASE REALTY, INC.and SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUEDSix Months Ended June 30, 2001 and 2000
5. Related Party Transactions:
In connection with the mortgages and other receivables from the Company’s unconsolidated subsidiary, Commercial Net Lease Realty Services, Inc. (“Services”) and its wholly-owned subsidiaries, the Company received $4,190,000 and $2,022,000 in interest and fees during the six months ended June 30, 2001 and 2000, respectively, $1,868,000 and $1,187,000 of which was earned during the quarters ended June 30, 2001 and 2000, respectively. In addition, Services paid the Company $339,000 and $204,000 in expense reimbursements for accounting services provided by the Company during the six months ended June 30, 2001 and 2000, respectively, $170,000 and $102,000 of which was earned during the quarters ended June 30, 2001 and 2000, respectively. In March 2001, Commercial Net Lease Realty Services, Inc., an unconsolidated subsidiary of the Company, filed an election to become a taxable REIT subsidiary, effective January 1, 2001. In April 2001, the Company modified its existing Amended and Restated Secured Revolving Line of Credit and Security Agreement (the “Security Agreement”) with Services to increase Services borrowing capacity from $65,000,000 to $85,000,000 and to modify certain provisions of the Security Agreement. In April 2001, the Company entered into two new Secured Revolving Lines of Credit and Security Agreements with wholly-owned subsidiaries of Services and modified an existing Secured Revolving Line of Credit and Security Agreement with another wholly-owned subsidiary of Services. In July 2001, the Company entered into a new Secured Revolving Line of Credit and Security Agreement with another wholly-owned subsidiary of Services. All Secured Revolving Line of Credit and Security Agreements between the Company and any wholly-owned subsidiaries of Services are collectively referred to as the “Subsidiary Agreements.” The Security Agreement and the Subsidiary Agreements provide an aggregate borrowing capacity of $140,500,000 to Services and its wholly-owned subsidiaries and each have expiration dates on October 31, 2003. In May 2001, Services and certain of its wholly owned subsidiaries became direct borrowers under the Company’s $200,000,000 revolving credit facility.
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6. Segment Information:
Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. While the Company does not have more than one reportable segment, the Company has identified two primary sources of revenue: (i) rental and earned income from the triple net leases and (ii) fee income from development, property management and asset management services.The following tables represent the revenues, expenses and asset allocation for the two segments and the Company’s consolidated totals at (dollars in thousands):
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6. Segment Information - continued:
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7. Subsequent Events:
In July 2001, the Company declared dividends to its shareholders of $9,623,000 or $0.315 per share of common stock, payable in August 2001.On July 2 2001, the Company announced that it had agreed to acquire Captec Net Lease Realty, Inc. (“Captec”), a publicly traded real estate investment trust, which owns 136 freestanding, net lease properties located in 26 states. Captec shareholders will receive approximately $12.1 million in cash, 4.35 million newly issued Commercial Net Lease Realty common shares and two million newly issued shares of Commercial Net Lease Realty’s 9% Class A Preferred Stock. The merger, which has been unanimously approved by both the Company’s and Captec’s Board of Directors, is subject to the approval of the Securities and Exchange Commission and Captec’s shareholders. First Union Securities, Inc. served as a financial advisor to the Company and provided a fairness opinion in connection with the transaction. The Company and Captec may mutually agree to terminate the merger agreement under certain conditions; including if the merger is not approved by Captec’s shareholder’s or if the merger is not completed by January 31, 2002. If the merger agreement is terminated under certain circumstances, the Company and/or Captec would be obligated to pay certain termination fees. The Company’s potential liability would not exceed the lesser of $1.0 million or Captec’s actual out-of-pocket expenses and transaction costs incurred in connection with the merger agreement. On July 9, 2001, the Company filed a registration statement on Form S-8 with the Securities and Exchange Commission which permits the issuance by the Company of up to 2,900,000 shares of common stock pursuant to the Company’s 2000 Performance Incentive Plan. On July 25, 2001, the Company entered into Restricted Stock Award Agreements (“Agreements”), with four of the Company’s executive officers (“Officers”) and five members of the Board of Directors (“Directors”). The stock awards were granted under the Company’s 2000 Performance Incentive Plan in consideration of the mutual promises and covenants made in the Agreements. Pursuant to the Agreements, the Company issued restricted stock grants to the Officers and Directors totaling 234,000 and 5,000 shares, respectively. The terms of the Agreements with the Officers provide that the restricted stock will vest at a rate of 15%-30% over approximately a five-year period ending on January 1, 2006 and automatically upon a change in control. The terms of the Agreements with the Directors provide that the restricted stock will vest equally over approximately a two-year period ending on January 1, 2003 and automatically upon a change in control.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
IntroductionCommercial Net Lease Realty, Inc., a Maryland corporation, is a fully integrated, self-administrated real estate investment trust that acquires, owns, manages and indirectly, through investment interests, develops high-quality, freestanding properties that are generally leased to major retail businesses under long-term commercial net leases. As of June 30, 2001, Commercial Net Lease Realty, Inc. and its subsidiaries (the “Company”) owned, either directly or through a partnership interest, 241 properties (the “Properties”) substantially all of which are leased to major retail businesses.Liquidity and Capital ResourcesGeneral. Historically, the Company’s only demand for funds has been for the payment of operating expenses and dividends, for property acquisitions and development, either directly or through investment interests, for the payment of interest on its outstanding indebtedness and for other investments. Generally, cash needs for items other than property acquisitions and development and other investments have been met from operations, and property acquisitions and development have been funded by equity and debt offerings, bank borrowings, the sale of Properties and, to a lesser extent, from internally generated funds. Potential future sources of capital include proceeds from the public or private offering of the Company’s debt or equity securities, secured or unsecured borrowings from banks or other lenders, proceeds from the sale of Properties, as well as undistributed funds from operations. For the six months ended June 30, 2001 and 2000, the Company generated $26,375,000 and $26,604,000, respectively, in net cash provided by operating activities. The decrease in cash from operations for the six months ended June 30, 2001, as compared to the six months ended June 30, 2000, is primarily the result of changes in revenues and expenses as discussed in “Results of Operations.”The Company’s leases typically provide that the tenant bears responsibility for substantially all property costs and expenses associated with ongoing maintenance and operation including utilities, property taxes and insurance. In addition, the Company’s leases generally provide that the tenant is responsible for roof and structural repairs. Certain of the Company’s Properties are subject to leases under which the Company retains responsibility for certain costs and expenses associated with the Property. Because many of these certain Properties are recently constructed, management anticipates that capital demands to meet obligations with respect to these Properties will be minimal for the foreseeable future and can be met with funds from operations and working capital. If required, the Company may use bank borrowings or other sources of capital in the event of unforeseen significant capital expenditures.Management believes that the Company’s current capital resources (including cash on hand), coupled with the Company’s borrowing capacity, are sufficient to meet its liquidity needs for the foreseeable future.Equity Securities. In January 2001, the Company filed a shelf registration statement with the Securities and Exchange Commission which permits the issuance by the Company of up to $200,000,000 in debt and equity securities (which includes approximately $180,000,000 of unissued debt and equity securities under the Company’s previous $300,000,000 shelf registration statement). In July 2001, the Company filed a registration statement on Form S-8 with the Securities and Exchange Commission which permits the issuance by the Company of up to 2,900,000 shares of common stock pursuant to the Company’s 2000 Performance Incentive Plan. On July 25, 2001, the Company entered into Restricted Stock Award Agreements (“Agreements”), with four of the Company’s executive officers (“Officers”) and five members of the Board of Directors (“Directors”). The stock awards were granted under the Company’s 2000 Performance Incentive Plan in consideration of the mutual promises and covenants made in the Agreements. Pursuant to the
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Liquidity and Capital Resources – continued:Agreements, the Company issued restricted stock grants to the Officers and Directors totaling 234,000 and 5,000 shares, respectively. The terms of the Agreements with the Officers provide that the restricted stock will vest at a rate of 15%-30% over approximately a five-year period ending on January 1, 2006 and automatically upon a change in control. The terms of the Agreements with the Directors provide that the restricted stock will vest equally over approximately a two-year period ending on January 1, 2003 and automatically upon a change in control. Property Dispositions. During the six months ended June 30, 2001 the Company sold 28 of its Properties for a total of $35,722,000 and received net proceeds of $35,285,000. The Company recognized a net gain on the sale of these 28 Properties of $4,450,000. The Company intends to use the proceeds from the sale of 21 Properties to acquire additional Properties and to structure the transactions to qualify as tax-free exchange transactions for federal income tax purposes. The Company used the proceeds from the sale of seven properties to pay down the outstanding indebtedness of the Company. Investment in Unconsolidated Affiliates. Investment in Unconsolidated Affiliates. In March 2001, Commercial Net Lease Realty Services, Inc., an unconsolidated subsidiary of the Company, filed an election to become a taxable REIT subsidiary, effective January 1, 2001.In April 2001, the Company modified its existing Amended and Restated Secured Revolving Line of Credit and Security Agreement (the “Security Agreement”) with Services to increase Services borrowing capacity from $65,000,000 to $85,000,000 and to modify certain provisions of the Security Agreement. In April 2001, the Company entered into two new Secured Revolving Lines of Credit and Security Agreements with wholly-owned subsidiaries of Services and modified an existing Secured Revolving Line of Credit and Security Agreement with another wholly-owned subsidiary of Services. In July 2001, the Company entered into a new Secured Revolving Line of Credit and Security Agreement with another wholly-owned subsidiary of Services. All Secured Revolving Line of Credit and Security Agreements between the Company and any wholly-owned subsidiaries of Services are collectively referred to as the “Subsidiary Agreements.” The Security Agreement and the Subsidiary Agreements provide an aggregate borrowing capacity of $140,500,000 to Services and its wholly-owned subsidiaries and each have expiration dates on October 31, 2003. In May 2001, Services and certain of its wholly owned subsidiaries became direct borrowers under the Company’s $200,000,000 revolving credit facility.Dividends. One of the Company’s primary objectives, consistent with its policy of retaining sufficient cash for reserves and working capital purposes and maintaining its status as a real estate investment trust, is to distribute a substantial portion of its funds available from operations to its stockholders in the form of dividends. For the six months ended June 30, 2001 and 2000, the Company declared and paid dividends to its stockholders of $19,202,000 and $18,775,000, respectively, or $0.62 and $0.62 per share of common stock, respectively. In July 2001, the Company declared dividends to its shareholders of $9,623,000 or $0.315 per share of common stock, payable in August 2001.Results of OperationsAs of June 30, 2001 and 2000, the Company owned 232 and 267 wholly-owned Properties, respectively, 226 and 262, of which were leased to operators of major retail businesses, respectively. During the six months ended June 30, 2001 and 2000, the Company earned $35,955,000 and $37,354,000, respectively, in rental income from operating leases, earned income from direct financing leases and contingent rental income (“Rental Income”), $17,626,000 and $18,034,000 of which was earned during the quarters ended June 30, 2001 and 2000, respectively. The decrease in Rental Income for the six months ended June 30, 2001 is primarily a result of the decrease in Rental Income relating to the 28 properties sold during the six
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Results of Operations – continued:months ended June 30, 2001 which were operational for the full six months ended June 30, 2000. The decrease in Rental Income is partially offset as a result of non-recurring additional Rental Income received during the six months ended June 30, 2001 and 2000 of $1,503,000 and $1,059,000, respectively, related to the termination of leases on 27 and two properties, respectively. The decrease in Rental Income for the quarter ended June 30, 2001 is primarily a result of the decrease in Rental Income relating to the 38 properties sold subsequent to the quarter ended June 30, 2000. The decrease in Rental Income is partially offset as a result of non-recurring additional Rental Income received during the quarter ended June 30, 2001 of $1,103,000 related to the termination of leases on seven properties. The Company did not receive any lease termination fees during the quarter ended June 30, 2000. During the six months ended June 30, 2001 and 2000, the Company earned $784,000 and $521,000, respectively, in contingent rental income, $122,000 and $249,000 of which was earned during the quarters ended June 30, 2001 and 2000, respectively. The increase in contingent rental income in 2001 is attributable to the adoption of the Securities and Exchange Commission’s Staff Accounting Bulletin 101 “Revenue Recognition” (the “Bulletin”), which establishes accounting and reporting standards for the recognition of contingent rental income. Accordingly, the Company has modified its revenue recognition policy and recognizes contingent rental income based on the tenants’ actual gross quarterly or annual sales pursuant to the terms of the leases. Adoption of this Bulletin resulted in the recognition of an additional $367,000 of contingent rental income during the quarter ended March 31, 2001. During the six months ended June 30, 2001, the Company sold 28 properties for a total of $35,722,000 and received net sales proceeds of $35,285,000. The Company recognized a net gain on the sale of these 28 properties of $4,450,000 for financial reporting purposes. The Company intends to reinvest the proceeds from 21 of these properties to acquire additional properties and to structure the transactions to qualify as a tax-free like-kind exchange transactions for federal income tax purposes. The Company used the proceeds from the sale of seven properties to pay down the outstanding indebtedness of the Company.During the six months ended June 30, 2001 and 2000, the Company earned $4,271,000 and $2,198,000, respectively, in interest income, $2,114,000 and $1,174,000 of which was earned during the quarters ended June 30, 2001 and 2000, respectively. The increase in interest earned during 2001 is attributable to the interest earned on the mortgages receivable and the mortgages and other receivables from Services issued during 2000. During the six months ended June 30, 2001 and 2000, operating expenses, excluding interest and including depreciation and amortization, were $8,897,000 and $7,986,000, respectively, (21.7% and 19.9%, respectively, of total revenues), $4,388,000 and $3,857,000 (21.8% and 19.7%, respectively, of total revenues) of which was incurred during the quarters ended June 30, 2001 and 2000, respectively. The increase in operating expenses for the quarter ended June 30, 2001, as compared to the quarter ended June 30, 2000, is attributable to the increase in general operating and administrative expenses as a result of an increase in expenses related to technology, personnel related expenses and debt financing charges. The increase in operating expenses for the six months ended June 30, 2001, as compared to the six months ended June 30, 2000, is attributable to an increase in general operating and administrative expenses as a result of an increase in expenses related to technology, personnel related expenses, debt financing charges and professional services provided to the Company. However, the increase in general operating and administrative expenses for the six months ended June 30, 2001 is partially offset by a decrease in charges related to the costs incurred in acquiring the Company’s advisor from a related party. In addition, the increase in operating expenses for the quarter and six months ended June 30, 2001, as compared to the quarter and six months ended June 30, 2000, is partially offset by a decrease in deprecation expense related to the sale of 18 and nine properties during the six months ended June 30, 2001 and the quarter ended December 31, 2000, respectively.
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Results of Operations - continued:
The Company recognized $12,346,000 and $12,879,000 in interest expense for six months ended June 30, 2001 and 2000, respectively, $6,052,000 and $6,233,000 of which was incurred during the quarters ended June 30, 2001 and 2000, respectively. Interest expense decreased during the quarter and six months ended June 30, 2001, primarily as a result of the decline in the average interest rate on the Company’s credit facility. However, the decrease in interest expense was partially offset by an increase in the average borrowing levels of the Company’s Credit Facility and an increase in interest incurred related to the $20,000,000 of 8.5% notes payable issued in September 2000.In May 1999, Services was formed to enable the Company to perform additional development, leasing and disposition services. The Company accounts for its investment in Services under the equity method, and therefore, recognizes 95 percent of the income or loss of Services as equity in earnings of unconsolidated affiliate. The net losses incurred by Services for the six months ended June 30, 2001 are primarily due to the nature of the development, leasing and real estate disposition business which provides for revenue recognition upon completion of construction, leasing or disposition of the real estate, while many of the related expenses are recognized as incurred.Investment Considerations. Three of the Company’s tenants, Waccamaw/HomePlace, Heilig-Meyers and HomeLife (the “Tenants”), have each filed a voluntary petition for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. As a result, each of the Tenants has the right to reject or affirm its leases with the Company. As of July 2001, Waccamaw/HomePlace has rejected all five of its leases with the Company. Heilig-Meyers has rejected 12 of its 17 leases with the Company, and proposed that the lease for one of its Properties be assigned to a new tenant pursuant to the U.S. Bankruptcy Code procedures. HomeLife has filed a motion to reject all of five of its leases in the bankruptcy proceedings. Regardless of such election by HomeLife, Sears, Roebuck & Co., as assignor of the leases to HomeLife, will remain liable under the leases. As of the respective lease rejection dates, Waccamaw/HomePlace and Heilig-Meyers were no longer required to pay rent, real estate taxes or insurance on the Properties. Heilig-Meyers continues to lease five Properties. While the tenant has not rejected or affirmed the remaining five leases, there can be no assurance that some or all of the leases will not be rejected in the future. Combined Rental Income from the 27 leases accounted for 9.6% of the Company’s Rental Income for the six months ended June 30, 2001. The lost revenues and increased property expenses resulting from the rejection by any bankrupt tenant of any of their respective leases with the Company could have a material adverse effect on the liquidity and results of operations of the Company if the Company is unable to re-lease the Properties at comparable rental rates and in a timely manner. Currently, the Company is actively marketing the 22 closed Properties to existing and prospective clients. New Accounting Standards. In June 2001, the Financial Accounting Standard Board (“FASB”) issued Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” This Statement addresses financial accounting and reporting for business combinations and supersedes Accounting Principles Board (“APB”) Opinion No. 16, Business Combinations, and FASB Statement No. 38,Accounting for Preacquisition Contingencies of Purchased Enterprises. All business combinations in the scope of this Statement are to be accounted for using one method, the purchase method. The provisions of this Statement apply to all business combinations initiated after June 30, 2001. This Statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. The Company is currently evaluating this Statement to determine what impact it will have on the Company’s consolidated financial statements. In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” This Statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill
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Results of Operations – continued:
and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Adoption of this Statement is not expected to have a significant impact on the financial position or results of operations of the Company. This information contains 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. Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the Company’s actual results could differ materially from those set forth in the forward-looking statements. Certain factors that might cause a difference include the following: changes in general economic conditions, changes in real estate market conditions, continued availability of proceeds from the Company’s debt or equity capital, the ability of the Company to locate suitable tenants for its Properties and the ability of tenants to make payments under their respective leases.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKThere have been no material changes in quantitative and qualitative disclosures about market risk as previously reported in the Form 10-K for the year ended December 31, 2000.
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PART II. OTHER INFORMATION
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20SIGNATURESPursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.DATED this 14th day of August 2001.COMMERCIAL NET LEASE REALTY, INC.By: /s/Gary M. Ralston Gary M. Ralston President and DirectorBy: /s/Kevin B. Habicht Kevin B. Habicht Chief Financial Officer and Director21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.DATED this 14th day of August 2001.COMMERCIAL NET LEASE REALTY, INC.By: /s/Gary M. Ralston Gary M. Ralston President and DirectorBy: /s/Kevin B. Habicht Kevin B. Habicht Chief Financial Officer and Director
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