UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.For the quarterly period ended June 30, 2003. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. 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 the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 day. Yes X No____.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No ____.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.
46,210,778 shares of Common Stock, $0.01 par value, outstanding as of August 1, 2003.
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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. These statements generally are characterized by the use of terms such as “believe,” “expect” and “may.” Although the management of Commercial Net Lease Realty, Inc. and its wholly-owned subsidiaries (collectively, 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: the loss of any member of the Company’s management team; changes in general economic conditions; changes in real estate market conditions; continued availability of proceeds from the Company’s debt or equity capital; the availability of other debt and equity financing alternatives; market conditions affecting the Company’s equity capital; 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 be in compliance with certain debt covenants; the ability of the Company to qualify as a real estate investment trust for federal income tax purposes; the ability of the Company to integrate acquired properties and operations into existing operations; 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 properties; the ability of tenants to make payments under their respective leases and the ability of the Company to re-lease properties that are currently vacant or that become vacant. Given these uncertainties, readers are cautioned not to place undue reliance on such statements.
Introduction
Commercial Net Lease Realty, Inc., a Maryland corporation, is a fully integrated, self-administrated real estate investment trust (“REIT”), formed in 1984 that acquires, owns, manages and indirectly, through investment interests, develops high quality, single-tenant retail, office and industrial properties that are generally leased to established corporate tenants under long-term commercial net leases. As of June 30, 2003, the Company owned 340 properties (the “Properties”) that are leased to established corporate tenants, including Academy, Barnes & Noble, Bennigan’s, Best Buy, Borders, Eckerd, Good Guys, Jared Jewelers, OfficeMax and The Sports Authority. Approximately 97 percent of the gross leasable area of the Company’s Property portfolio was leased at June 30, 2003.
Liquidity and Capital Resources
General. Historically, the Company’s only demand for funds has been for (i) payment of operating expenses and dividends, (ii) property acquisitions and development, either directly or through investment interests, (iii) payment of interest on its outstanding indebtedness and (iv) other investments. Generally, cash needs for items other than property acquisitions and development and for other investments have been met from operations, and property acquisitions and development and other investments 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, 2003 and 2002, the Company generated $25,935,000 and $29,555,000, respectively, of net cash from operating activities. The change in cash provided by operations for the six month ended June 30, 2003, as compared to the six months ended June 30, 2002, is primarily the result of changes in revenues and expenses as discussed in “Results of Operations.” Cash generated from operations could be expected to fluctuate in the future.
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
18
Liquidity and Capital Resources - continued:
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 modest for the foreseeable future and can be met with funds from operations and working capital. Management anticipates the costs associated with the Company’s vacant Properties or those Properties that become vacant will also be met with funds from operations and working capital. The Company may be required to use bank borrowings or other sources of capital in the event of unforeseen significant capital expenditures.
Indebtedness. In May 2003, the Company entered into an amended and restated loan agreement for a $225,000,000 revolving credit facility (the “Credit Facility”) which amended the Company’s existing loan agreement by (i) increasing the borrowing capacity to $225,000,000 from $200,000,000, (ii) lowering the interest rates of the tiered rate structure to a maximum rate of 135 basis points above LIBOR (based upon the debt rating of the company the current interest rate is 100 basis points above LIBOR), (iii) requiring the Company to pay a commitment fee based on a tiered rate structure to a maximum of 30 basis points per annum (based upon the debt rating of the company), (iv) providing for a competitive bid option for up to 50 percent of the facility amount, (v) extending the expiration date to May 9, 2006 and (vi) amending certain of the financial covenants of the Company. The principal balance is due in full upon expiration of the Credit Facility on May 9, 2006, which the Company may request to be extended for an additional 12-month period with the consent of the lender.
As of June 30, 2003, $95,800,000 was outstanding and approximately $129,200,000 was available for future borrowings under the Credit Facility. The Company expects to use the Credit Facility primarily to invest in the acquisition and development of freestanding properties generally leased to established corporate tenants, either directly or through investment interests.
Equity Securities. In March 2003, pursuant to the Company’s 2000 Performance Incentive Plan (“2000 Plan”), the Company granted and issued 70,407 shares of restricted common stock to certain officers of the Company and its affiliates. The vesting period for 40,407 shares of restricted stock vests in equal amounts each year over approximately a four-year period ending on January 1, 2007 and automatically upon a change in control of the Company. The remaining 30,000 shares of restricted stock vest in amounts equal to a rate of 15 percent to 30 percent each year over approximately a five-year period ending on January 1, 2008 and automatically upon a change in control of the Company.
Pursuant to the 2000 Plan, in June 2003, the Company granted and issued 6,000 shares of restricted common stock to certain directors of the Company. The restricted stock issued to the directors vests in equal amounts each year over approximately a two-year period ending on January 1, 2005 and automatically upon a change in control in the Company.
In May 2003, the Company filed a shelf registration statement with the Securities and Exchange Commission, which permits the issuance by the Company of up to $600,000,000 in debt and equity securities (which includes approximately $89,637,000 of unissued debt and equity securities under the Company’s previous $200,000,000 shelf registration statement).
In July 2003, the Company issued 5,600,000 shares of common stock and received gross proceeds of $100,800,000. In addition, the Company has granted the underwriters an over-allotment option to purchase up to 840,000 additional shares of common stock. In connection with this offering, the Company incurred stock issuance costs totaling approximately $5,266,000, consisting primarily of underwriters’ commissions and fees, legal and accounting fees and printing expenses. Net proceeds from the offering will be used to fund a portion of the purchase price for two office buildings and a related parking garage in the Washington, D.C. metropolitan area.
19
Property Acquisitions and Commitments. On August 1, 2003, the Company acquired two office buildings and a related parking garage located in Arlington, Virginia (the Washington, D.C. metropolitan area) for $142,800,000. The Company used the net proceeds from the common stock offering to fund a portion of the purchase price. The remaining portion of the purchase price was funded through borrowings under the Company’s Credit Facility. In addition, the Company will fund an additional $28,900,000 for building and tenant improvements, and other costs related to the lease which will be funded through borrowings under the Company’s Credit Facility. The properties include two office buildings containing an aggregate of 541,000 rentable square feet (492,000 usable square feet for purposes of calculating rent) and a two-level garage with 1,079 parking spaces.
Investment in Unconsolidated Affiliates. In January 2003, the Company modified an existing secured revolving line of credit and security agreement with a wholly-owned subsidiary of Commercial Net Lease Realty Services, Inc. (“Services”) to increase the borrowing capacity from $5,000,000 to $15,000,000. In addition, the Company terminated an $11,000,000 secured revolving line of credit and security agreement with another wholly-owned subsidiary of Services. In May 2003, the Company modified an existing secured revolving line of credit and security agreement with a wholly-owned subsidiary of Services to increase the borrowing capacity from $15,000,000 to $45,000,000. In addition, the Company modified the existing secured revolving line of credit and existing security agreement with Services to decrease the borrowing capacity from $85,000,000 to $35,000,000. As of June 30, 2003, the secured revolving lines of credit and security agreements with Services and its wholly-owned subsidiaries provide for an aggregate borrowing capacity of $150,000,000. As of June 30, 2003, the aggregate outstanding balance of the secured revolving lines of credit and security agreements with Services and its wholly-owned subsidiaries was $71,799,000, resulting in $78,201,000 available for future borrowings under the line of credit.
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 common stockholders in the form of dividends. For the six months ended June 30, 2003 and 2002, the Company declared and paid dividends to its common stockholders of $25,884,000 and $25,339,000, respectively, or $0.64 and $0.63 per share of common stock, respectively. In July 2003, the Company declared dividends to its common shareholders of $14,787,000 or $0.320 per share of common stock, payable in August 2003.
Holders of the 9% Non-Voting Series A Preferred Stock issued in connection with the acquisition of Captec Net Lease Realty, Inc. (“Captec”) are entitled to receive, when and as authorized by the board of directors, cumulative preferential cash distributions at the rate of nine percent of the $25.00 liquidation preference per annum (equivalent to a fixed annual amount of $2.25 per share). For the six months ended June 30, 2003 and 2002, the Company declared and paid dividends to its preferred stockholders of $2,003,000 and $2,005,000, respectively, or $0.5625 per share of preferred stock.
Results of Operations
As of June 30, 2003 and 2002, the Company owned 340 and 346 Properties, respectively, 329 and 323, respectively, of which were leased generally to operators of established corporate tenants. During the six months ended June 30, 2003, the Company sold four properties with an aggregate gross leasable area of 33,000 square feet that were leased or partially leased during 2003. In addition, during the six months ended June 30, 2002, the Company sold five properties with an aggregate gross leasable area of 113,000 square feet that were leased or partially leased during 2002.
During the six months ended June 30, 2003 and 2002, the Company earned $44,279,000 and $41,182,000, respectively, in rental income from operating leases, earned income from direct financing leases and contingent rental income from continuing operations (collectively, “Rental Income”). The increase in Rental Income during the six months ended June 30, 2003, is attributable to a decrease in
20
Results of Operations - continued:
Rental Income related to (i) the Rental Income resulting from the increased occupancy rate of the Company’s portfolio from 93 percent at June 30, 2002 to 97 percent at June 30, 2003 and (ii) the additional Rental Income generated from the acquisition of ten Properties with an aggregate gross leasable area of 316,000 subsequent to June 30, 2002. The increase in Rental Income was partially offset by (i) the disposition of eight properties subsequent to June 30, 2002 that were leased or partially leased with an aggregate gross leasable area of 199,000 square feet, (ii) the termination of leases on two properties subsequent to June 30, 2002 and (iii) a decrease in non-recurring additional Rental Income received during the six months ended June 30, 2003 compared to the six months ended June 30, 2002. The Company recognized $1,900,000 and $2,067,000 of non-recurring additional Rental Income related to lease terminations during the six months ended June 30, 2003 and 2002, respectively.
During the quarter ended June 30, 2003 and 2002, the Company earned $21,909,000 and $20,414,000, respectively, in Rental Income. The increase in Rental Income during the quarter ended June 30, 2003, is primarily a result of (i) the Rental Income resulting from the increased occupancy rate of the Company’s portfolio from 93 percent at June 30, 2002 to 97 percent at June 30, 2003, (ii) the additional Rental Income generated from the acquisition of ten properties with an aggregate gross leasable area of 316,000 subsequent to June 30, 2002 and (iii) the increase in Rental Income from non-recurring additional Rental Income received during the quarter ended June 30, 2003 of $650,000, related to the termination of a lease on one property in comparison to $600,000 during the quarter ended June 30, 2002, related to the termination of a lease on one property. However, the increase in Rental Income was partially offset as a result of (i) the eight properties that were disposed of subsequent to June 30, 2002 that had an aggregate gross leasable area of 199,000 square feet and (ii) the termination of leases on two properties subsequent to June 30, 2002.
During the six months ended June 30, 2003 and 2002, the Company earned $2,107,000 and $3,881,000, respectively, in interest income from unconsolidated affiliates and other mortgages receivable, of which $1,363,000 and $1,639,000 was earned during the quarters ended June 30, 2003 and 2003, respectively. The decrease in interest earned from unconsolidated affiliates and other mortgages receivable was primarily attributable to a decrease in the average borrowing levels on the lines of credit with Services and its wholly-owned subsidiaries and a decline in the average interest rate on the lines of credit.
During the six months ended June 30, 2003 and 2002, operating expenses from continuing operations, including general operating and administrative, real estate and depreciation and amortization expenses but excluding interest and the expense incurred in connection with dissenting shareholders’ settlement, were $11,781,000 and $11,331,000, respectively, (24.7% and 24.7%, respectively, of total revenues), of which $5,955,000 and $5,795,000, respectively, (24.7% and 25.8%, respectively, of total revenues) were incurred during the quarters ended June 30, 2003 and 2002, respectively. The increase in the dollar amount of operating expenses for the quarter and six months ended June 30, 2003, as compared to the quarter and six months ended June 30, 2002, is primarily attributable to the increase in depreciation and amortization expense related to (i) the acquisition of and tenant improvements on additional Properties since June 30, 2002, and (ii) the increase in amortization of debt financing fees related to the $50,000,000 notes payable issued in June 2002, partial repayment of the term note in June 2002 and the amended Credit Facility. In addition, the increase is attributable to an increase in general operating and administrative expenses during the quarter ended June 30, 2003, as a result of increases in office expenses, taxes and expenses related to professional services provided to the Company. The increase in operating expenses is partially offset by a (i) decrease in real estate expenses as a result of the increased occupancy rate of the Company’s portfolio from 93 percent at June 30, 2002 to 97 percent at June 30, 2003, and (ii) a decrease in expenses related to personnel.
The Company recognized $13,347,000 and $12,973,000 in interest expense for the six months ended June 30, 2003 and 2002, respectively, of which $6,838,000 and $6,406,000 was incurred during the quarters ended June 30, 2003 and 2002, respectively. Interest expense increased during the quarter and six months ended June 30, 2003, as a result of (i) the $50,000,000 notes payable issued in June 2002 and (ii) the
21
$21,000,000 fixed rate mortgage entered into in June 2002. However, the increase in interest expense was offset by a decrease in the average borrowing levels of the Company’s Credit Facility and the partial repayment of the term note payable in June 2002.
During the six months ended June 30, 2003, the Company recorded a non-recurring dissenting shareholders’ settlement expense of $2,413,000 related to the appraisal rights litigation disclosed in Item 3 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002, that arose as a result of the merger with Captec Net Lease Realty, Inc. in December 2001. The Company entered into a settlement agreement dated as of February 7, 2003 with the beneficial owners of the alleged 1,037,946 dissenting shares (including the petitioners in the Appraisal Action) which required the Company to pay $15,569,000, which approximated the value of the original merger consideration (which included cash, common shares and preferred shares) at the time of the litigation settlement plus the dividends that would have been paid if the shares had been issued at the time of the merger. On February 13, 2003, the parties filed a stipulation and order of dismissal and the Court entered the order of dismissal, dismissing the Appraisal Action with prejudice.
During the six months ended June 30, 2003 and 2002, the Company recognized equity in earnings of unconsolidated affiliates of $1,955,000 and $1,777,000, respectively, of which $1,191,000 and $1,137,000 was recognized during the quarters ended June 30, 2003 and 2002, respectively. The increase in equity in earnings of unconsolidated affiliates was primarily attributable to the income generated from the investments in mortgage loans. However, the increase in equity in earnings from unconsolidated affiliates was partially offset by a decrease in the income generated by Services and its wholly-owned subsidiaries, which was attributable to the timing of real estate dispositions by Services and its subsidiaries.
In accordance with Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company has classified the operations of the nine and 19 properties sold during 2003 and 2002, respectively, as discontinued operations. Accordingly, the results of operations for 2003 and 2002 related to these 28 properties have been reclassified to earnings from discontinued operations. During the six months ended June 30, 2003 and 2002, the Company recognized earnings from discontinued operations of $423,000 and $2,930,000, respectively, of which a loss of $148,000 and earnings of $2,145,000 was recognized during the quarters ended June 30, 2003 and 2002, respectively. The Company occasionally sells properties and may reinvest the proceeds of the sales to purchase new properties, the Company evaluates its ability to fund distributions to stockholders by considering the combined effect of income from continuing and discontinued operations.
During the six months ended June 30, 2003, the Company sold nine properties for net sales proceeds of $12,830,000 and recognized a net loss of $409,000 for financial reporting purposes. This loss is included in earnings from discontinued operations. The Company used the proceeds to pay down outstanding indebtedness of the Company’s Credit Facility.
During the six months ended June 30, 2002, the Company sold 12 properties for net sales proceeds of $21,430,000 and recognized a net gain of $859,000 for financial reporting purposes. This gain is included in earnings from discontinued operations. The Company reinvested the proceeds from three of these properties to acquire additional properties and structured the transactions to qualify as tax-free like-kind exchange transactions for federal income tax purposes. The Company used the remaining proceeds to pay down outstanding indebtedness of the Company’s Credit Facility.
During the quarter ended June 30, 2003, the Company sold two properties for net sales proceeds of $688,000 and recognized a net loss of $477,000 for financial reporting purposes. This loss is included in earnings from discontinued operations. The Company used the proceeds to pay down outstanding indebtedness of the Company’s Credit Facility.
22
During the quarter ended June 30, 2002, the Company sold nine properties for net sales proceeds of $17,817,000 and recognized a net gain of $768,000 for financial reporting purposes. This gain is included in earnings from discontinued operations. The Company reinvested the proceeds from three of these properties to acquire additional properties and structured the transactions to qualify as tax-free like-kind exchange transactions for federal income tax purposes. The Company used the remaining proceeds to pay down outstanding indebtedness of the Company’s Credit Facility.
Investment Considerations. As of July 2003, the Company owns eight vacant, unleased Properties, which accounts for three percent of the total gross leasable area of the Company’s portfolio; the Company is actively marketing these Properties for sale or re-lease. Additionally, three percent of the total gross leasable area of the Company’s portfolio is leased to four tenants that 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. 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.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There 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, 2002.
24
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains a set of disclosure controls and procedures designed to ensure that information required to be disclosed in the Company’s filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. The principal executive and financial officers of the Company have evaluated the Company’s disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q and have determined that such disclosure controls and procedures are effective.
There was no change in internal control over financial reporting that occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.
25