Item 1. Business.
General
Trustreet Properties, Inc. (the “Company”) is the product of the February 25, 2005 Merger of CNL Restaurant Properties, Inc. (“CNLRP”) with and into U.S. Restaurant Properties, Inc. (“USRP”). Immediately following the Merger, USRP changed its name to Trustreet Properties, Inc. The Company is a Maryland corporation originally incorporated in 1997. Through its subsidiaries, the Company operates as a fully-integrated, self-administered real estate investment trust (a “REIT”) and has elected to be taxed as a REIT. Certain of the Company’s wholly owned subsidiaries have elected to be treated as taxable REIT subsidiaries which are subject to taxation at regular corporate rates. As a result of the Merger, the Company became the largest publicly traded REIT in the United States focused primarily on the restaurant industry.
At December 31, 2005, the Company owned approximately 2,100 properties diversified among more than 500 restaurant concepts in 49 states. The Company’s business is operated through two segments: real estate and specialty finance. The real estate segment focuses on ownership and portfolio management of restaurant properties leased to restaurant operators on long-term triple-net leases, under which the tenant is responsible for most property-related expenses, such as property taxes, maintenance and insurance. This segment also makes mortgage, equipment and other loans to restaurant operators. The specialty finance segment operates in the Company’s taxable REIT subsidiary (“TRS”) and includes the Company’s Investment Property Sales program (“IPS”), in which the Company purchases properties and resells them to third party investors. In addition, the specialty finance segment includes Trustreet Investment Banking, LLC, a wholly owned subsidiary of the Company that provides advisory services to national and regional restaurant operators.
USRP’s predecessors include U.S. Restaurant Properties Master L. P. and U.S. Restaurant Operating L.P., which were formed in 1985 by Burger King Corporation and QSV Properties, Inc., both of which were at the time wholly-owned subsidiaries of The Pillsbury Company. On October 15, 1997, U.S. Restaurant Properties Master L.P. was converted into a self-administered REIT and, on October 16, 1997, USRP’s common stock commenced trading on the New York Stock Exchange.
The Company’s executive offices are located at 450 South Orange Avenue, Orlando, Florida 32801 and its telephone number is (407) 540-2000. The Company has an Internet web site at www.trustreet.com where the Company’s filings with the Securities and Exchange Commission can be downloaded free of charge as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission. The Company’s common stock, Series A Cumulative Convertible Preferred Stock and 7.5 percent Series C Redeemable Convertible Preferred Stock are traded on the New York Stock Exchange, under the symbols “TSY”, “TSYPrA” and “TSYPrC”, respectively.
The Merger
On February 25, 2005, CNLRP merged with and into USRP and the combined company changed USRP’s name to Trustreet Properties, Inc. and acquired 18 Income Funds.
·
At the time of the Merger, USRP was a self-advised REIT focusing on acquiring, owning and leasing restaurant properties and, to a lesser extent, service station properties. At the time of the Merger, USRP’s portfolio consisted of approximately 766 properties, diversified among more than 81 restaurant concepts in 48 states.
·
CNLRP, a Maryland corporation founded in 1994, was a self-advised REIT focused on the restaurant industry. At the time of the Merger, CNLRP had financial interests in approximately 1,000 properties diversified among more than 116 restaurant concepts in 43 states, including total real estate holdings subject to lease of 640 properties.
·
The Income Funds, organized as Florida limited partnerships between 1986 and 1997, invested in triple-net leased restaurant properties. At the time of the Merger, the Income Funds owned, in the aggregate, approximately restaurant properties located in 38 states.
In the Merger, CNLRP stockholders received 0.7742 shares of USRP common stock and 0.16 shares of USRP 7.5 percent Series C Redeemable Convertible Preferred Stock (liquidation value $25 per share) for each share of CNLRP common stock. The aggregate dollar value of Merger consideration received by CNLRP stockholders was approximately $788 million based on the closing stock price of USRP common on February 24, 2005 and the liquidation value of the Series C Preferred Stock. As described in Note 2 to the financial statements included in Item 8, because CNLRP was considered the acquiror for accounting purposes, the purchase price used to account for the exchange of interests between USRP and CNLRP was $473 million before transaction costs. Income Fund limited partners received approximately 84 percent of their consideration in cash and the remainder in existing USRP Series A Cumulative Convertible Stock (liquidation preference $25 per share). Total consideration received by the Income Fund partners was approximately $538 million based on the February 24, 2005 trading price of the Series A preferred stock. As described in Note 2 to the financial statements included in Item 8, the Income Fund acquisitions were accounted for as a purchase with a price of $538 million.
Immediately following the Merger, 60.7 percent of the Company’s common stockholders were former CNLRP stockholders and 39.3 percent were former USRP stockholders. Former CNLRP directors constitute a majority of the Company’s board of directors and all of the Company’s executive officers are former CNLRP executive officers.
Segments
The Company’s business operations are divided into two business segments a real estate segment and a specialty finance segment. Its real estate segment has a strong capital base and stable cash flows, while its specialty finance segment growth business provides an additional source of earnings and liquidity.
·
The real estate segment oversees and manages a portfolio of primarily long-term triple-net lease properties, as well as mortgage and equipment loans. Its responsibilities include portfolio management, property management and dispositions.
·
The specialty finance segment includes the IPS program and delivers financial solutions principally in the forms of financing, advisory and other services, including investment banking services, to national and larger regional restaurant operators.
Please see note 17 of the Company’s Consolidated Financial Statements appearing in Item 8 of this report for certain financial information about these two business segments.
Real Estate Segment
As part of the Company’s ownership and management of its real estate portfolio, the Company’s real estate segment offers customers an integrated set of financial services. The lease financing provided by the Company’s real estate segment, often through sale/leaseback transactions, enables restaurant operators to monetize their on-balance sheet real estate, allowing them to devote a greater portion of their assets to their core business of restaurant operations. The real estate segment also provides mortgage, construction and equipment financing to these operators, making the Company a single source for their financial needs and offering the possibility of reduced transaction fees.
Following the Merger, the Company has undertaken the following initiatives with respect to its real estate segment:
·
Expansion and Diversification of Real Estate Portfolio. The Merger between CNLRP and USRP and the Mergers of the 18 Income Funds have created a real estate portfolio that is substantially larger and more diversified than either of the USRP or CNLRP portfolios. At December 31, 2005, the Company’s real estate portfolio consisted of approximately 2,005 properties diversified with 170 restaurant concepts in 49 states. Generally, the properties are leased to restaurant operators under long-term triple-net leases. At December 31, 2005, leases of the properties in the Company’s real estate portfolio aggregated $192.2 million in annualized base rent. Following the Merger, the Company acquired an aggregate of 274 properties for an aggregate purchase price of $267.7 million in 2005 to be held in its real estate portfolio. The Company has acquired an additional 14 properties with an aggregate purchase price of $14.4 million for its real estate portfolio in January and February of 2006. An additional $125 million was under commitment as of March 15, 2006.
·
Disposal or Re-Lease of Vacant Properties. As of December 31, 2005, the Company had 74 properties with a net carrying value of $46 million that are vacant with no lease. The Company intends to reduce the number of vacant properties by either locating suitable tenants to lease the properties from the Company or selling the vacant sites and reinvesting the sales proceeds in replacement properties.
·
Sale of Mortgage Loans. During July 2005, the Company sold mortgage loans receivable of approximately $194 million to a third party. The sale resulted in a gain of approximately $9.6 million and a related hedge loss of $8.6 million. At December 31, 2005, the Company had $79 million in aggregate outstanding loans secured by mortgages.
·
Sale of Service Station Properties. Prior to the Merger, USRP owned 81 service station properties. In September 2005, the Company sold eighteen gas station operating units and a percent interest in a bulk fuel loading terminal located in Hawaii. At December 31, 2005, the Company owned 54 service station properties.
Specialty Finance Segment
The Company’s specialty finance segment offers a diverse array of highly specialized services for customers. The IPS program purchases restaurant properties and resells them to investors who generally are seeking to defer taxes on commercial properties they have sold through the reinvestment of proceeds as permitted under the Internal Revenue Code. This segment also offers investment banking and development services.
The specialty finance segment engaged in the following significant lines of business in 2005 and expects to continue such business in 2006:
·
IPS Program. The IPS program generated $257 million in property sales proceeds in 2005 through the sale of 129 properties to investors. At December 31, 2005, the Company holds 122 properties for sale to investors through the IPS program, with an investment of $157.2 million, including 102 properties with an investment of $139.4 million that were recently purchased by the specialty finance segment.
·
Investment Banking Services. Through the Company’s wholly owned subsidiary, Trustreet Investment Banking, LLC, the specialty finance segment generated $0.3 million in fees for advisory services provided to restaurant operators in fiscal 2005. These services included strategic advice, mergers and acquisitions, divestitures, valuation opinions and debt and equity placement. In addition to the fees received for such services, the Company believes that the intellectual capital and relationships generated in this line of business enhance the Company’s other businesses.
·
Development. The Company’s Development and Redevelopment Group actively seeks to identify properties that are suitable for development as restaurants. Once a parcel is identified, the Development Group actively explores development opportunities including build to suit and leasing activities. Once developed, the properties are typically sold through the IPS program. At December 31, 2005, the Company had 38 properties with an investment of $48.7 million under development. Of the $48.7 million in properties held at December 31, 2005, $12.8 million represented undeveloped land, $13.6 million in projects were under construction and $11.1 million comprised completed projects. The remaining $11.2 million were acquired with an existing structure with the intent to redevelop at a future date.
Leases
Although there are variations in the specific terms of the Company’s leases, the following summarizes the general structure of the leases. The leases of the properties provide for initial terms typically of 15 to 20 years and expire between 2006 and 2025. Approximately 58 percent of the Company’s leases have terms that expire 2015 or later and the average remaining lease term of the Company’s portfolio is 11 years. The leases are on a triple-net basis which means the lessee is responsible for all repairs and maintenance, property taxes, insurance and utilities. The leases provide for minimum base annual rental payments (payable in monthly installments) ranging from approximately $0.005 million to $0.6 million. The majority of the leases also provide that, commencing in specified lease years (generally the sixth lease year), the annual base rent required under the terms of the lease will increase. In addition, certain leases provide for percentage rent based on sales in excess of a specified amount.
Generally, the leases provide for two to five, five-year or ten-year renewal options. The leases also generally provide that, in the event the Company wishes to sell the property subject to that lease, the Company first must offer the lessee the right to purchase the property on the same terms and conditions, and for the same price, as any offer which the Company has received for the sale of the property.
Major Tenants
At December 31, 2005, no single lessee, borrower (or affiliated groups of lessees or borrowers) or restaurant chain contributed more than ten percent of the Company’s total annualized base rent relating to its properties. In the event that certain lessees, borrowers or restaurant chains contribute more than ten percent of the Company’s rental, earned and interest income in future years, any failure of such lessees, borrowers or restaurant chains could materially affect the Company’s income. Additionally, as of December 31, 2005, no single lessee or borrower, or group of affiliated lessees or borrowers, leased properties or was the borrower under loans with an aggregate carrying value in excess of 20 percent of total assets of the Company.
Real Estate Held for Sale
The Company sells certain real estate properties to private investors as an alternative to either retaining the properties as a long-term investment or offering to sell net lease cash flows in the securitization marketplace. The accounting for these properties differs from that of similar properties without this designation as the Company does not record depreciation. In addition, the Company does not record accrued rent which is the aggregate difference between the scheduled rents which vary during the lease term and the income recognized on a straight-line basis. The properties held for sale are contemplated being sold within a year. The Company classifies its real estate held for sale as discontinued operations.
Mortgage, Equipment and Other Notes Receivable
Mortgage, equipment and other notes receivable are wholly or partially collateralized by first mortgages on the land and/or buildings, the equipment or other assets of franchised restaurant businesses. The loans are due in monthly installments with maturity dates ranging from 2006 to 2023.
Regulations
The Company, through its ownership interests in and management of real estate, is subject to various environmental, health, land-use and other regulations by federal, state and local governments that affect the development and regulation of restaurant and service station properties. The Company’s leases impose the primary obligation for regulatory compliance on the tenants.
Environmental Regulation. The Company’s operating results may be affected by the obligation to pay for the cost of complying with existing environmental laws, ordinances and regulations as well as the cost of complying with future legislation. Current laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of hazardous or toxic substances on its properties. Environmental laws also may impose restrictions on the manner in which a property may be used or transferred or in which businesses may be operated and may impose remedial or compliance costs.
In connection with the acquisition of a property, Phase I environmental assessments have been conducted by qualified, independent environmental engineers. A Phase I environmental assessment involves researching historical usages of a property, databases containing registered underground storage tanks and other matters, including an onsite inspection, to determine whether an environmental issue exists with respect to the property which needs to be addressed. If the results of a Phase I environmental assessment reveal potential issues, a Phase II environmental assessment, which may include testing, groundwater monitoring or borings to locate underground storage tanks, may, depending upon the circumstances, be ordered for further evaluation.
Phase I and Phase II environmental assessments of the Company’s properties have revealed potential environmental concerns. Specifically, the soils and groundwater beneath these properties may have been impacted by the presence of leaking underground storage tanks on, and the migration of contaminants from, the Company’s Properties and third-party locations adjacent to the Company’s properties. Where Phase I and Phase II environmental assessments have indicated a need for remedial action, the Company has taken all appropriate steps to remediate or mitigate environmental issues. Management is not aware of any environmental liability or compliance concern at any of the Company’s Properties that management believes would have a material adverse effect on the Company’s business, assets, results of operations or liquidity. Management generally places acquired Properties with potential environmental issues in special purpose limited liability companies to limit any future damages from claims concerning the Properties, and requires tenants to assume obligations relating to environmental issues.
It is possible that Phase I environmental assessments will not reveal all environmental liabilities or compliance concerns or that there will be material environmental liabilities or compliance concerns of which management is not aware. Management has not been notified by any governmental authority, and management has no knowledge, of any material non-compliance, liability or claim relating to hazardous or toxic substances or other environmental substances in connection with the Company’s properties.
Americans With Disabilities Act (“ADA”). Under the Americans with Disabilities Act of 1990 (the “ADA”), all public accommodations, including restaurants, are required to meet federal requirements relating to physical access and use by disabled persons. If it were determined that the Company was not in compliance with the ADA, the Company could be subject to fines, injunctive relief, damages or attorneys fees. The Company’s leases contemplate that compliance with the ADA is the responsibility of the tenants. The Company is not currently a party to any litigation or administrative proceeding with respect to a claim of violation of the ADA and it does not anticipate the occurrence of any action or proceeding under the ADA that would have a material adverse effect on the Company.
Land-use, Fire and Safety Regulations. The Company and its tenants are required to operate the Properties in compliance with various laws, land-use regulations, fire and safety regulations and building codes which may either be currently applicable or which may be adopted later by the governmental body or agency having jurisdiction over the location of the Property or the matter being regulated. The Company’s leases typically contemplate that compliance with land-use and fire and safety regulations is the responsibility of the tenants. The Company does not believe that the cost of compliance with such regulations and laws would have a material adverse effect on its financial position or results of operations.
Health Regulations. The restaurant industry is regulated by a variety of state and local departments and agencies concerned with the health and safety of restaurant customers. These regulations vary by restaurant location and type. The Company’s leases require the tenants to comply with all health regulations and inspections and require that the restaurant operators obtain insurance to cover liability for violation of such regulations or the interruption of business due to closure caused by failure to comply with such regulations. The Company is not currently a party to any litigation or administrative proceeding with respect to the compliance with health regulations of any property it finances, and does not anticipate any such action or proceeding would have a material adverse effect on its financial position or results of operations.
Insurance. The Company requires its tenants to maintain adequate comprehensive liability, fire, flood and extended loss insurance provided by reputable companies with commercially reasonable and customary deductibles. The Company also requires that it be named as an additional insured under such policies. Tenants are required to carry certain types and amounts of insurance under the leases with the Company and the Company actively monitors tenant compliance with this requirement. The Company intends to require tenants of subsequently acquired properties to obtain similar insurance coverage. There are, however, certain types of losses (generally of a catastrophic nature such as earthquakes and floods), that may be either uninsurable or not economically insurable, as to which the properties may be at risk depending on whether such events occur with any frequency in a property’s location. An uninsured loss could result in a loss to the Company of both its capital investment and anticipated profits from the affected property. In addition, because of coverage limits and deductibles, insurance coverage in the event of a substantial loss may not be sufficient to pay the full current market value or current replacement cost of the Company’s investment. Changes in building codes and ordinances, environmental considerations and other factors also might make using insurance proceeds to replace a facility after it has been damaged or destroyed unfeasible. Under such circumstances, the insurance proceeds received by the Company might be inadequate to restore its economic position with respect to the property. The Company’s policy with respect to vacant properties is to carry general liability insurance and, to the extent required by certain creditors, property coverage.
Competition
The fast-food, family-style and casual dining restaurant business is characterized by intense competition. The operators of the restaurants located on the Company's properties compete with independently owned restaurants, restaurants which are part of local or regional chains and restaurants in other well-known national chains, including those offering different types of food and service.
Local competition may enhance a restaurant’s success rather than detract from it. Many successful fast-food, family-style and casual dining restaurants are located in "eating islands", areas within which a variety of restaurants operate. This variety allows diners an opportunity to diversify their eating habits, giving them an incentive to return in the future. As a result, fast food, family style and casual dining restaurants frequently experience better operating results when there are other restaurants in the area.
The Company competes with other persons and entities in locating suitable properties to acquire and in locating purchasers for properties held for sale. The Company also competes with other financing sources such as banks, mortgage lenders, real estate brokers and sale/leaseback companies for suitable tenants for its properties and borrowers for its mortgage loans.
Employees
As of December 31, 2005, the Company had 144 associates.
Item 1A.
Item 1A. Risk Factors.
You should carefully consider the following risks and all of the other information set forth in this Annual Report on Form 10-K, including the consolidated financial statements and the notes thereto. If any of the events or developments described below were actually to occur, the Company’s business, financial condition or results of operations could be adversely affected.
Risks Relating to Our Business
The operations of CNLRP, USRP and the Income Funds may not be integrated successfully and intended benefits of the Mergers may not be realized, which could adversely affect our results of operations.
The continuing integration relating to the Mergers poses risks for our ongoing operations, including that:
• we may not achieve expected cost savings and operating efficiencies, such as the elimination of redundant administrative costs and property management costs;
• the diversion of management attention to the integration of the operations of CNLRP, USRP and the Income Funds could have an adverse effect on our revenues, expenses and operating results;
• the portfolios of the parties to the Mergers may not perform as well as anticipated due to various factors, including changes in general economic conditions and the performance of restaurant properties in markets in which the parties have a substantial presence;
• we may not effectively integrate the operations and portfolio management systems of CNLRP, USRP and the Income Funds, particularly since we hired very few USRP employees during the transition phase; and
• our internal accounting and finance staff and our financial and management controls, reporting systems and procedures may not meet the internal control and financial reporting needs of a much larger, more complicated combined company.
If we fail to integrate successfully CNLRP, USRP and the Income Funds and/or fail to realize the intended benefits of the Mergers, our results of operations could be adversely affected.
Our substantial debt could adversely affect our cash flow, limit our flexibility to raise additional capital and prevent us from making distributions on the outstanding shares of common stock.
We have a significant amount of debt. As of December 31, 2005, we had total consolidated debt of approximately $1.5 billion and stockholders’ equity of approximately $1.1 billion.
Our substantial amount of debt could have important consequences to you. For example, it could:
• require us to dedicate a substantial portion of our cash flow from operations to make payments on our debt, reducing the availability of our cash flow to fund future capital expenditures, working capital, execution of our growth strategy and other general corporate requirements;
• increase our vulnerability to general adverse economic and industry conditions and adverse changes in governmental regulations;
• limit our flexibility in planning for, or reacting to, changes in our business and the REIT industry, which may place us at a competitive disadvantage compared with our competitors;
• limit our ability to make distributions on our outstanding common and preferred stock;
• limit our ability to borrow additional funds, even when necessary to maintain adequate liquidity; and
• make us more vulnerable to increases in interest rates because of the variable interest rates on some of our borrowings.
The terms of our senior credit facilities, the indenture governing our 7½% Senior Notes due 2015 (the “Notes”) and our other existing financing arrangements allow us to incur substantial amounts of additional debt, subject to certain limitations. We may incur additional debt to execute our strategy. All such additional debt would increase the risks associated with our substantial leverage.
Our cash flow from operations and borrowings under our financing arrangements may not be sufficient to satisfy our debt service obligations or to fund our other liquidity needs or capital expenditures.
Our ability to make payments on or refinance our debt will depend largely upon our future operating performance, which is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. The operation of our business and the REIT distribution requirements require substantial capital resources. We do not anticipate generating sufficient amounts of cash from our operating activities to fund all of these capital needs. Consequently, in order to service our REIT distribution requirements and our debt obligations and to fund our development and other activities, we must rely on external sources of capital.
If we do not have sufficient cash flow or cash available to meet our debt service obligations, we may have to renegotiate the terms of our debt. In addition we would be required to repay or refinance substantially all of our debt. We cannot assure you that we will be able to repay or refinance any of our debt on commercially reasonable terms or at all. If we are unable to refinance our debt or obtain new financing under these circumstances, we would have to consider other options, such as:
• sales of certain assets to meet our debt service obligations;
• sales of equity; and
• negotiations with our lenders to restructure the applicable debt.
However, these options may not be adequate or feasible. Our financing arrangements and the indenture governing our Notes may restrict, or market or business conditions may limit, our ability to do some of these things. Moreover, if we are unable to obtain sufficient financing when we need it or on terms satisfactory to us, our development activities could have to be delayed, curtailed or eliminated and our financial results could be adversely affected.
We utilize an “UPREIT” structure and, as a result, we rely on the receipt of funds from our subsidiaries in order to meet our cash needs, service our indebtedness and make distributions on the outstanding shares of our common stock.
We are organized in an “UPREIT” structure and our principal assets consist of the shares of capital stock or other equity of our subsidiaries. Without independent means of generating operating revenues, we depend on dividends, distributions and other payments from our subsidiaries to fund our obligations and meet our cash needs. The payment of some of these dividends, distributions and other payments from our subsidiaries to us are subject to contractual restrictions and future agreements may impose more restrictions. We cannot assure you that the operating results of our subsidiaries at any given time will be sufficient to make distributions to us in order to allow us to make payments on our indebtedness and make distributions on the outstanding shares of our common stock.
The financing agreements governing our debt contain various covenants that limit our discretion in the operation of our business and could lead to acceleration of debt repayment.
Our existing and future financing agreements impose and will impose operating and financial restrictions on our activities. These restrictions require us to comply with or maintain certain financial tests and ratios, including a maximum consolidated leverage ratio, a maximum ratio of secured indebtedness to consolidated total tangible assets, a minimum consolidated tangible net worth test and minimum consolidated fixed charge and interest coverage ratios, and limit or prohibit our ability to, among other things:
• borrow money and guarantee debt;
• create liens;
• pay dividends on or redeem or repurchase stock;
• restrict dividends or other payments or distributions from material subsidiaries;
• make investments or acquisitions;
• enter into sale/leaseback transactions;
• enter into transactions with affiliates; and
• sell assets or merge with other companies.
These restrictions on our ability to operate our business could seriously harm our business by, among other things, limiting our ability to take advantage of financings, mergers, acquisitions and other corporate opportunities.
Various risks, uncertainties and events beyond our control could affect our ability to comply with these covenants and maintain the financial tests and ratios required by some of the instruments governing our financing arrangements. Failure to comply with any of the covenants in our existing or future financing agreements could result in a default under those agreements and under other agreements containing cross-default provisions. A default would permit lenders to accelerate the maturity of the debt under these agreements and to foreclose upon any collateral securing that debt. Under these circumstances, we might not have sufficient funds or other resources to satisfy all of our obligations. In addition, the limitations imposed by financing agreements on our ability to incur additional debt and to take other actions might significantly impair our ability to obtain other financing. We may not be able to obtain future waivers or amendments, if necessary.
We cannot assure you we will continue to make distributions at historical rates.
Our ability to continue to make distributions on our common stock at historical rates or to increase our common stock dividend rate, and our ability to make distributions on our preferred stock and to service our debt, will depend on a number of factors, including, among others, the following:
• our financial conditions and results of future operations;
• the performance of lease terms by tenants;
• the terms of our loan covenants; and
• our ability to acquire, finance and lease additional properties at attractive rates.
If we do not maintain or increase the dividend rate on our common stock, it could have an adverse effect on the market price of our common stock. Our outstanding preferred stock has a fixed dividend rate, and, with respect to the right of the payment of dividends, such stock ranks senior to our common stock. Any preferred stock that we may offer in the future may have similar provisions. In addition to being subject to payment in full of the dividends on our outstanding preferred stock, payment of dividends on our common stock also is subject to payment of interest on our existing debt or any debt we may incur in the future, and may be subject to payment in full of the dividends on any preferred stock we may offer in the future.
Our operations and financial condition could be adversely affected by a number of factors affecting the value of real estate.
Our investments will be subject to the risks generally associated with the ownership of real property, including:
• adverse changes in certain economic conditions;
• changes in the investment climate for real estate;
• increases in real estate tax rates and other operating expenses;
• adverse changes in governmental rules and fiscal policies, including zoning and land use;
• the relative illiquidity of real estate; and
• compliance with environmental and other ordinances, regulations and laws.
Any adverse changes in, or increased costs resulting from, these or other factors could adversely affect our results of operations.
We rely on a small number of tenants for a significant portion of our revenue, and rental payment defaults by these significant tenants could adversely affect our results of operations.
As of December 31, 2005, our largest tenant represented 6.7 percent of our total annualized base rent and our ten largest tenants represented 34.9 percent of our total annualized base rent. As a result of the concentration of revenue generated from these few tenants, if any one of them were to cease paying rent or fulfilling their other monetary obligations, we could have significantly reduced rental revenues or higher expenses until the defaults were cured or the properties were leased to a new tenant or tenants. This could adversely affect our results of operations.
Changes in trends in the restaurant industry could adversely affect the sales, profitability and success of the chain restaurants that our tenants operate.
The chain restaurants operated by our tenants are generally within the quick service or casual dining segments of the restaurant industry, each of which is highly competitive. The success of these restaurants depends largely on the restaurant operators’ ability to adapt to trends and other factors affecting the restaurant industry including increased competition among restaurants (including competition for concept name recognition, products, price, value, quality, healthiness, service and convenience), the consolidation of restaurant chains, industry overbuilding, changing consumer habits, the introduction of new concepts and menu items, the increased costs of food products, the availability of labor and general economic conditions. Losses incurred by a particular chain restaurant as a result of these or other factors could adversely affect the income that is derived from our restaurant properties, which may impact our tenants’ ability to make payments to us, which would have an adverse affect on our revenues.
Tenant bankruptcy proceedings could negatively affect our income.
As the owner of the bankrupt tenants’ underlying real estate, we face no risk of loss of ownership of the property itself if the bankrupt tenant rejects any of our leases. However, tenant bankruptcies could adversely affect our income in the following ways:
• reduction, interruption or termination of lease payments related to tenants’ leases;
• reduction of revenue resulting from restructuring leases;
• increase in costs associated with the maintenance and financing of vacant properties;
• increase in costs associated with litigation and the protection of the properties; and
• increase in costs associated with improving and re-leasing the properties.
In connection with any tenant bankruptcy, we establish reserves relating to rent payments and other accounts receivable and take impairments to the book value of the underlying real estate, as appropriate, to reflect the difference between the net book value and the market value of the asset in cases where we do not believe the net book value will be recoverable through future operations and disposal of the asset. It may be necessary to take additional asset impairments and write-offs and/or establish additional reserves in the event of future tenant bankruptcies or if the current reserves and impairment charges prove to be inadequate. These factors may have a material adverse effect on our results of operations.
We may not be able to re-lease properties upon the termination, expiration or rejection of leases at comparable lease rates or at all.
The leases of the properties that comprise our portfolio expire on dates ranging from 2006 to 2025. As of December 31, 2005, leases due to expire thru 2010 represented approximately 23 percent of our total properties and approximately 15 percent of our total annualized base rent. Also, as of December 31, 2005, approximately four percent of our total properties representing two percent of the portfolio’s net carrying value were vacant (excluding unoccupied properties for which rent is currently being paid). Upon the termination or expiration of a lease, we might not be able to re-lease the related property. If we are able to re-lease, the lease rate might not be comparable to the expiring lease or additional expenses may be incurred because of, among other things, a downturn in the commercial leasing markets where we operate and the general performance of the restaurant industry or a specific property.
Our investment property sales program may be adversely affected by a significant reduction in or elimination of capital gains taxes or changes in interest rates.
The market for our investment property sales program is driven, in part, by demand created by property buyers seeking continued capital gains and/or tax deferrals. Any new proposal to significantly reduce or eliminate the capital gains tax or tax deferred opportunities could negatively impact demand for properties offered by our investment property sales program. In addition, an increase in general levels of interest rates could result in buyers requiring a higher yield, which may not be matched with higher yields from tenants. This could cause us to experience lower average gains or even losses on the future sales of investment property sales program. Conversely, if interest rates are low, we may lose potential lease transactions to competitors such as large national and regional banks who can offer less expensive mortgage financing that restaurant operators may find more attractive than our leases. This may reduce the pool of properties available for us to purchase under our investment property sales program.
We may be unable to sell properties when appropriate because real estate investments are illiquid.
Real estate investments generally cannot be sold quickly. Also, with the exception of our investment property sales program that takes place within a taxable REIT subsidiary, unless certain safe harbors for sales of property by REITs apply, if such property is deemed held primarily for sale in the ordinary course of business, sales of such property will be subject to a 100 percent “prohibited transaction” tax on any net income derived from such sales. Consequently, we may not be able to alter our portfolio promptly in response to changes in economic or other conditions. Our inability to respond quickly to adverse changes in the performance of our investments could have an adverse effect on our ability to meet our obligations.
We may not be able to acquire or sell properties on terms that are acceptable, or at all.
We routinely acquire and make strategic dispositions of our properties. There may not be opportunities for further acquisitions of properties or opportunities to finance the acquisition of properties on terms that meet our investment criteria, which may adversely affect our growth. In addition, we may not be able to sell properties for a gain, and may sustain a loss, on such sales relative to current net book value of such properties. In addition, if our cash flows were to significantly decrease for any reason, we may have to sell one or more properties to support our operations. In such event, we may incur losses on the disposition of such properties.
Our assets may decline in value and, as a result, may be subject to impairment charges.
We periodically, but no less frequently than annually, evaluate our real estate investments and other assets for impairment indicators. The judgment regarding the existence of impairment indicators is based on factors such as market conditions, operator performance and legal structure. If we determine that a significant impairment has occurred, we would be required to make an adjustment to the net carrying value of the asset, which could have a material adverse affect on our results of operations and funds from operations in the period in which the write-off occurs. In addition, to the extent we are unable to sell properties for book value, we may be required to take a non-cash impairment charge or loss on the sale, either of which would reduce our net income.
If we cannot obtain additional capital, our ability to grow will be limited.
Our growth strategy includes continuing to acquire properties leased to operators of national and regional restaurant chains. We will be unable to fund growth with cash from operating activities because, in addition to other requirements, we are required to distribute to our stockholders at least 90 percent of our taxable income each year to continue to qualify as a REIT for federal income tax purposes. As a result, we will have to rely primarily upon the availability of debt or equity capital, which may not be available on acceptable terms or at all. The debt could include unsecured or mortgage loans from lenders or the sale of debt securities. Equity capital could include common or preferred stock or units of limited partnership interest in our operating partnerships. We cannot assure you that additional financing, refinancing or other capital will be available in the required amounts or on acceptable terms. Our access to debt or equity capital will depend on a number of factors, including the market’s perception of our growth potential, our then current and potential future earnings, restrictions in our existing debt agreements and the actions of credit rating agencies, including rating watches or downgrades. Depending on these factors, we could experience delay or difficulty in implementing our growth strategy on satisfactory terms, or could be unable to implement this strategy.
Our securitizations could require replacement property contributions or accelerated principal paydowns and could be adversely affected by changes in rating agencies’ perceptions of the securitizations and the leases and loans underlying them.
As of December 31, 2005, we had $742 million of rated securities structured in private placement franchise loan and net lease securitization transactions. In the event of tenant defaults relating to pledged properties in our net lease securitizations, we may elect to contribute additional properties or substitute properties into these securitized pools from properties we own and that are not otherwise pledged as collateral. In addition, if certain ratios are exceeded or not maintained within the net lease securitizations, then principal paydown on the outstanding bonds is accelerated. For the years ended December 31, 2005, 2004 and 2003, CNLRP was required to make additional debt reductions of $2.1 million, $2.4 million and $0.4 million, respectively, as a result of exceeding certain ratios in the triple-net lease pools. There is no guaranty that we won’t be required to make additional debt reductions in the future. Upon the occurrence of a significant amount of delinquencies and/or defaults, one or more of the three rating agencies may choose to place a specific transaction on ratings watch or even downgrade one or more classes of securities to a lower rating. Should the loans or leases underlying the securities default, and the securities undergo a negative ratings action, we could experience material adverse consequences impacting our ability to continue earning income as servicer and our ability to engage in future desirable securitization transactions.
Severe weather conditions and other catastrophes may result in an increase in the number of defaults by our tenants.
Our business is exposed to the risk of severe weather conditions and other catastrophes. Catastrophes can be caused by various events, including natural events such as hurricanes, severe winter weather, tornadoes, windstorms, earthquakes, hailstorms, severe thunderstorms and fires, and other events such as explosions, terrorist attacks and riots. The incidence and severity of catastrophic and severe weather conditions are inherently unpredictable. Our properties are generally leased to tenants subject to triple net leases, meaning that the tenant is responsible for repairs and maintenance on the properties, and is required to pay the real estate taxes and maintain full property insurance coverage on the properties. In many cases, we also require the tenant to carry business interruption insurance which would provide for payment of rent while the property is closed. We anticipate that the tenant’s insurance would cover the damages from any such catastrophes. In the event the tenant’s insurance does not cover damage incurred, and the tenant does not have resources to cover the difference, we carry contingent property coverage that would generally pay for repairs when the tenant’s insurance is either insufficient or non-existent.
The development and redevelopment of properties presents risks not present in existing operating properties.
In connection with the development of new properties and the redevelopment of existing properties, we will be subject to risks, including:
• cost overruns;
• delays because of a number of factors, including unforeseen circumstances, strikes, labor disputes or supply disruptions, zoning, permitting and approval issues, and bad weather and other acts of God;
• design and construction defects;
• contractor and subcontractor disputes and mechanics’ liens; and
• lack of income-generating capacity until leasing.
Any of these factors could have a material adverse effect on our financial condition and results of operations.
Environmental laws and regulations could reduce the value of our properties or our tenants’ profitability.
All real property and the operations conducted on real property are subject to federal, state and local laws and regulations relating to hazardous materials, environmental protection and human health and safety. Under various federal, state and local laws, ordinances and regulations, we or our tenants may be required to investigate and clean up certain hazardous or toxic substances released on or in restaurant or service station properties we own, and also may be required to pay other costs relating to hazardous or toxic substances. This liability may be imposed without regard to whether we or our tenants knew about the release of these types of substances or were responsible for their release. The presence of contamination or the failure to remediate properly contamination at any properties or the migration of contaminants to or from our properties from or to adjacent third-party locations may adversely affect our ability to sell or lease those properties or to borrow using those properties as collateral.
The costs or liabilities could exceed the value of the affected real estate. The uses of any property prior to our acquisition and the building materials and products used at the property are among the property-specific factors that will affect how the environmental laws are applied to the properties. By the nature of their businesses, our tenants utilize cleaning agents and other potentially hazardous materials and, with regard to service station properties, maintain underground storage tanks. If we are subject to any material environmental liabilities, the liabilities could adversely affect our results of operations and ability to meet our obligations. We cannot predict what other environmental legislation or regulations will be enacted in the future, how existing or future laws or regulations will be administered or interpreted or what environmental conditions may be found to exist on the properties in the future. Compliance with existing and new laws and regulations may require us or the tenants to spend funds to remedy environmental problems. Our tenants, like many of our competitors, have incurred, and will continue to incur, capital and operating expenditures and other costs associated with complying with these laws and regulations, which will adversely affect their potential profitability, which could in turn impact their ability to make lease payments to us.
Generally, tenants must comply with environmental laws and meet remediation requirements. Our leases typically impose obligations on tenants to indemnify us from any compliance costs we may experience as a result of the environmental conditions on the property. If a lease does not require compliance by the tenant, however, or if a tenant fails to or cannot comply, we could be forced to pay these costs. In addition, in some cases we are responsible for adverse environmental conditions not caused by a tenant. If not addressed, environmental conditions could impair our ability to sell or re-lease the affected properties in the future or result in lower sales prices or rent payments.
The revenues generated by our tenants could be negatively affected by various federal, state and local laws and regulations to which they are subject.
We and our tenants will be subject to a wide range of federal, state and local laws and regulations, such as local licensing requirements, land use ordinances, consumer protection laws, and fire, life-safety and similar requirements which regulate the use of the properties. The leases typically require that each tenant comply with all laws and regulations. Failure to comply could result in fines by governmental authorities, awards of damages to private litigants, or restrictions on the ability to conduct business on such properties. This in turn could impair the ability of a tenant to pay rent, could require us to pay penalties or fines relating to any non-compliance, and could adversely affect our ability to re-sell or re-lease a property.
The loss of certain members of our management team could adversely affect our business.
We depend upon the services of Curtis B. McWilliams, as chief executive officer and president, and Steven D. Shackelford, as chief operating officer and chief financial officer. Loss of the services of either Mr. McWilliams or Mr. Shackelford could have a material adverse effect on our business and financial condition.
Tax Risks
Because we are a REIT, our distributions do not receive favorable tax treatment.
On May 28, 2003, the President signed into law the Jobs and Growth Tax Relief Reconciliation Act of 2003 (which we will refer to as the Act). Under the Act, the current maximum tax rate on the long-term capital gains of non-corporate taxpayers is reduced to 15 percent for tax years beginning on or before December 31, 2008. The Act also provides that the tax rate on “qualified dividend income” is the maximum capital gains rate rather than the tax rate that applies to ordinary income. Because we are a REIT, our distributions are not generally eligible for this new tax rate on dividends. As a result, our ordinary REIT distributions will be taxed to investors at the higher tax rates applicable to ordinary income. Certain earnings derived by our taxable REIT subsidiary are subjected to an income tax, and when distributed to us, can result in a portion of our distribution to our stockholders qualifying for the 15 percent rate. Without further legislation, in 2009 the maximum tax rate on long-term capital gains will revert to 20 percent, and all dividends will again be subject to tax at ordinary rates.
We will be subject to increased taxation if we fail to qualify as a REIT for federal income tax purposes.
We intend to continue to operate in a manner that will enable us to remain qualified as a REIT for federal income tax purposes. A REIT generally is not taxed at the corporate level on income it distributes to its stockholders, as long as it meets various complex organizational, asset, and income tests, and distributes annually at least 90 percent of its taxable income to its stockholders. While we continuously monitor our activities to make sure we are in compliance with the REIT qualification rules, these rules are complex and subject to change, and complying with them may depend on events which are not under our control. If we fail to qualify as a REIT, we generally would be subject to federal income tax at regular corporate rates subject to the relief provisions discussed under “Federal Income Tax Considerations-Requirements for REIT Qualification-Relief from Consequences of Failing to Meet Asset Tests” in the accompanying prospectus. In addition to these taxes, we may be subject to the federal alternative minimum tax. Furthermore, unless we are entitled to relief under specific statutory provisions, we could not elect to be taxed as a REIT for four taxable years following the year during which we are disqualified. Therefore, if we lose our REIT status, the funds available to satisfy our obligations for distribution to our stockholders or to service our debt obligations, including the notes, would be reduced substantially for each of the years involved. In addition, the failure to qualify as a REIT would also trigger a default under our existing revolving credit facility and other debt agreements.
While we continuously monitor our activities to make sure we are in compliance with the REIT qualification rules, these rules are subject to change and actions we may have taken in the past may no longer qualify us under the current rules. To the extent that the REIT qualification rules change in the future and as a result we no longer qualify as a REIT, this would substantially increase our income tax liability and would have a material adverse effect upon our results of operations, financial condition, and ability to make distributions.
Excessive non-real estate asset values may jeopardize our REIT status.
In order to qualify as a REIT, at least 75 percent of the value of our assets must consist of investments in real estate, investments in other REITs, cash and cash equivalents, and government securities. Therefore, the value of any property that is not considered a real estate asset for federal income tax purposes must represent in the aggregate less than 25 percent of our total assets. In addition, under federal income tax law, we generally will not be able to own securities in any one company (other than a REIT, a qualified REIT subsidiary or a taxable REIT subsidiary) which represent in excess of 10 percent of the voting securities or 10 percent of the value of all securities of any one company, or which have, in the aggregate, a value in excess of 5 percent of our total assets, and we may not own securities of one or more taxable REIT subsidiaries which have, in the aggregate, a value in excess of 20 percent of our total assets. The 25 percent, 20 percent, 10 percent and 5 percent tests are determined at the end of each calendar quarter. If we fail to meet any such test at the end of any calendar quarter, we may cease to qualify as a REIT subject to the relief provisions discussed under “Federal Income Tax Considerations-Requirements for REIT Qualification-Relief from Consequences of Failing to Meet Asset Tests” in the accompanying prospectus.
Certain of our leases may be recharacterized as financings, which would eliminate our depreciation deductions on our properties.
If any of our leases do not constitute a lease for federal income tax purposes, it will be treated as a financing arrangement. The recharacterization of a lease in this fashion may have adverse tax consequences for us. In particular, we would not be entitled to claim depreciation deductions with respect to any improvements on the property (although we should be entitled to treat part of the payments we would receive under the arrangement as the repayment of principal). In that event, in certain taxable years, our taxable income and the corresponding obligation to distribute 90 percent of that income would be increased. Any increase in our distribution requirements may limit our ability to operate our business, to invest in additional property or to service our debt obligations.
We may have to borrow funds or sell assets to meet our distribution requirements.
Subject to some adjustments that are unique to REITs, a REIT generally must annually distribute at least 90 percent of its otherwise taxable income. For the purpose of determining taxable income, we may be required to accrue interest, rent and other items treated as earned for tax purposes that we have not yet received. In addition, we may be required not to deduct certain expenses, or not to accrue as expenses for tax purposes some items which actually have been paid. As a result, we could have taxable income in excess of cash available for distribution. If this occurs, we may have to borrow funds or liquidate some of our assets in order to meet the distribution requirements applicable to a REIT.
We may be subject to other tax liabilities.
Even if we qualify as a REIT, we may be subject to some federal, state and local taxes on our income and property, such as franchise, sales and property taxes, that could reduce operating cash flow. Certain of our subsidiaries have elected to be taxable REIT subsidiaries, and therefore, are subject to taxation at regular corporation rates. These tax obligations may adversely affect our results of operations.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
As of December 31, 2005, the Company’s real estate segment owned 2,005 properties, either directly or indirectly through joint venture arrangements, located in all states, except Alaska, and including the District of Columbia.
As of December 31, 2005, 1,967 of the 2,005 properties represented fee simple ownership and 15 properties were owned through joint venture arrangements. As of December 31, 2005, 118 properties consisted of land only.
As of December 31, 2005, 99 properties consisted of building only. The Company does not own the underlying land. In connection with the acquisition of each of these properties, the Company entered into either a tri-party agreement with the tenant and the owner of the land or an assignment of interest in the ground lease with the landlord, as described in Item 1. Business-Leases.
As of December 31, 2005, the Company had pledged 951 properties as collateral related to bonds payable.
Description of Properties
Land. The Company's property lot sizes range from approximately 828 to 329,100 square feet depending upon building size and local demographic factors. Land owned is zoned for commercial use which, prior to acquisition, were reviewed for traffic patterns and volume.
The following table lists the properties owned as of December 31, 2005 by state.
Buildings. The buildings generally are rectangular and are constructed from various combinations of stucco, steel, wood, brick and tile. Building sizes range from approximately 100 to 45,000 square feet. Generally, buildings on properties owned are freestanding and are surrounded by paved parking areas. Buildings are suitable for conversion to various uses, although modifications may be required prior to use for other than restaurant operations. Depreciation expense is computed for buildings and improvements using the straight-line method using a depreciable life of 39 to 40 years for federal income tax purposes. As of December 31, 2005 the aggregate depreciated cost basis of the properties owned (including properties owned through consolidated joint ventures) for federal income tax purposes was $1,910 million.
The following table lists the properties owned as of December 31, 2005 by restaurant chain.
Management considers the properties to be well maintained and sufficient for the Company's operations and believes they are adequately covered by insurance. In addition, the Company has obtained contingent liability and property coverage. This insurance is intended to reduce the Company's exposure in the unlikely event a tenant's insurance policy lapses or is insufficient to cover a claim relating to the property.
Leases. The Company leases the properties to operators of selected national and regional fast-food restaurant chains. The leases are generally on a long-term "triple-net" basis, meaning that the tenant is responsible for repairs, maintenance, property taxes, utilities and insurance. Generally, a lessee is required, under the terms of its lease agreement, to make capital expenditures to refurbish restaurant buildings, premises, signs and equipment so as to comply with the lessee's obligations, if applicable, under the franchise agreement to reflect the current commercial image of its restaurant chain. These capital expenditures are required to be paid by the lessee during the term of the lease. The terms of the leases of the properties owned by the Company are described in Item 1. Business - Leases.
The following table lists properties as of December 31, 2005 by tenant and includes average age of buildings, annualized base rent and percent of total annualized base rent. Each lease has a monthly fixed lease payment (“base rent”) due each month. Base rent represents the monthly cash rent for December 2005 on an annualized basis. It does not represent a rent number in accordance with generally accepted accounting principles as it does not include the straight-line impact of any rent escalators or any contingent rent based on tenant sales exceeding a certain threshold. In 2005, those amounts collectively were $12.0 million. As a Real Estate Investment Trust is required to pay 90% of its taxable income in dividends, annual base rent is a key figure the Company reviews as it provides a proxy for the cash portion of rental revenues expected to be received.
The following table shows the aggregate number of leases which expire each calendar year through the year 2020, as well as the number of leases which expire after December 31, 2020. The table does not reflect the exercise of any of the renewal options provided to the tenant under the terms of such leases.
(1)
Excludes properties that were not leased at December 31, 2005 and properties that were leased on a month to month basis.
Item 3.
Item 3. Legal Proceedings.
The Company is not presently involved in any material litigation, nor to its knowledge is any material litigation threatened against the Company or its properties, other than routine litigation arising in the ordinary course of business. At this time, management does not believe there will be a material impact from the legal proceedings discussed below.
On January 18, 2005, Robert Lewis and Sutter Acquisition Fund, LLC, two limited partners in the Income Funds, filed a class action lawsuit on behalf of the limited partners of the Income Funds against the Company, CNLRP, the Income Funds, the general partners of the Income Funds, CNL Restaurant Investments, Inc. and CNL Restaurant Capital Corp. in the District Court of Dallas County, Texas (Cause No. 05-00083). The complaint alleged that the general partners of the Income Funds breached their fiduciary duties in connection with the proposed Mergers between the Income Funds and subsidiaries of the operating partnership of the Company and that the Company and CNLRP aided and abetted such alleged breaches of fiduciary duties. The complaint further alleged that the Income Funds’ general partners violated provisions of the Income Funds’ partnership agreements and demanded an accounting as to the affairs of the Income Funds. The plaintiffs are seeking unspecified compensatory and exemplary damages and equitable relief, including an injunction of the Mergers. On April 26, 2005, a supplemental plea to jurisdiction hearing was held with a ruling expected May 13, 2005. On May 2, 2005, the plaintiffs amended their lawsuit to add allegations that the general partners of the Income Funds, with CNLRP and USRP, prepared and distributed a false and misleading final proxy statement filing to the limited partners of the Income Funds and the shareholders of CNLRP and USRP. On May 26, 2005, the Court entered a Final Order Dismissing Action for lack of subject matter jurisdiction. On June 22, 2005, the plaintiffs filed a Notice of Appeal of the Order of Dismissal. On September 7, 2005, the plaintiffs filed an appellants’ brief. On November 7, 2005, the Company and the other defendants filed their Brief of Appellees’. On December 12, 2005, the plaintiffs filed their Appellants’ Reply Brief. The court has scheduled oral argument on the appeal for May 3, 2006. The management of the Company is evaluating the lawsuit, but believes that the likelihood of a material unfavorable outcome is remote. The management of the Company believes that the claims against the Company are without merit and intends to defend vigorously against such claims.
During 2004, Management Strategies, Inc. filed a lawsuit against USRP. The complaint alleges that the Company owes approximately $3 million in sales and fuel tax liabilities to the State of Georgia. The management of the Company believes the claims against the Company are without merit and intends to defend vigorously against such claims.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The common stock of the Company trades on the New York Stock Exchange (“NYSE”) under the symbol “TSY.” Prior to the Merger, the common stock of USRP traded on the New York Stock Exchange under the symbol “USV.” For each calendar quarter indicated, the following table reflects respective high, low and closing sales prices for the common stock of the Company, or , prior to Merger, USRP as quoted by the NYSE and the dividends paid per share in each such period.
CNLRP is treated as the acquirer for financial statement purposes while Trustreet Properties, Inc. formerly known as U.S. Restaurant Properties, Inc., is the legal and tax survivor. The following dividend information for common stockholders is based on taxable earnings and profits for the calendar year which includes the taxable activity of USRP for January 1, 2005 through February 24, 2005 and the taxable activity of the merged company from February 25, 2005 through December 31, 2005 and CNLRP for the year ended December 31, 2004.
Dividends paid to preferred stockholders in 2005 were 100% taxable.
The Company intends to pay regular monthly dividends to its stockholders. Future distributions will be declared and paid at the discretion of the board of directors and will depend upon cash generated by operating activities, the Company’s financial condition, capital requirements, annual distribution requirements under the REIT provisions of the Internal Revenue Code of 1986, as amended, and such other factors as the board of directors deems relevant.
On March 15, 2006, there were 9,068 stockholders of record of common stock.
Equity Compensation Plan Information
The only equity compensation plan that the Company has is its Flexible Incentive Plan, which was approved by the Company’s stockholders. Set forth below is certain information with respect to that plan.
(1)
Pursuant to the terms of the Company’s Flexible Incentive Plan, the maximum number of shares potentially available for issuance under the Plan equals 4.9 percent of the Company’s issued and outstanding shares of common stock. As of December 31, 2005, the Company had reserved for issuance under the Flexible Incentive Plan only the shares reported in the above table.
Item 6.
Item 6. Selected Financial Data.
You should read the selected financial data presented below in conjunction with the consolidated financial statements, the notes to the consolidated financial statements and with Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with Item 6. “Selected Financial Data,” and the consolidated financial statements and related notes contained in Item 6 of this report on Form 10-K, and the cautionary language relating to forward looking statements in italics before Item 1. “Business.”
Overview of Management’s Discussion and Analysis
Trustreet Properties, Inc. is the new name we adopted upon the Merger of CNL Restaurant Properties, Inc. (“CNLRP”) and eighteen CNL Income Fund partnerships (“the Income Funds”) with and into U.S. Restaurant Properties, Inc. (“USRP”) on February 25, 2005 (the “Merger”). We are a Maryland corporation organized to operate as an equity real estate investment trust, or REIT.
The financial statements of Trustreet Properties, Inc. reflect the Merger of CNLRP, USRP and the Income Funds on February 25, 2005. Our officers are former CNLRP officers, and the majority of the Board of Directors are former CNLRP directors. The financial statements therefore present CNLRP as the acquiror for financial reporting purposes. Therefore, the financial results included in this Form 10-K include the historical financial results of only CNLRP for the years ended December 31, 2004 and 2003. In addition, the year ended December 31, 2005 includes the financial results of only CNLRP from January 1, 2005 through February 24, 2005 and the financial results of all the merged entities from February 25, 2005 through December 31, 2005. Accordingly, references to “we” or “us” in this Management’s Discussion and Analysis relate to CNLRP for periods prior to February 25, 2005 and to Trustreet Properties, Inc. for subsequent periods.
The assets and liabilities of CNLRP continue to be recorded at historical values. The asset and liabilities of USRP and the Income Funds were recorded at their estimated fair values on the date of the Merger, with the excess of the purchase price over the aggregate fair value of tangible and identifiable intangible assets recorded as goodwill. Our critical accounting policies continue to be those adopted by CNLRP, as modified to address the impact of the Merger.
For the past twenty years, we and our predecessors have financed real estate subject to triple-net leases to national and regional restaurant operators like Wendy’s, Burger King, Golden Corral, IHOP, Jack in the Box and Arby’s. Our key customers are:
1.
restaurant operators of major national and regional chains;
2.
restaurant property investors; and
3.
retail real estate developers.
Our business objective is to maximize stockholder returns by pursuing four complementary strategies that address the needs of our key customers. The four strategies are:
1.
financing free-standing restaurant and retail real estate;
2.
maximizing the potential of our real estate portfolio;
3.
sale of real estate to investors; and
4.
real estate development and redevelopment.
Strategy 1: Financing Free-standing Restaurant and Retail Real Estate
We own over 2,100 properties at December 31, 2005 with an investment of $2.1 billion, substantially all of which are leased to restaurant operators. Our real estate segment holds 2,005 of these properties as long term investments in the core REIT portfolio. The remaining properties are held in our taxable REIT subsidiary where our specialty finance segment operates. We are the largest provider of net-lease financing to the restaurant industry and we also offer investment banking and advisory services through our subsidiary, Trustreet Investment Banking, LLC. Beginning in 1995 through December 31, 2005, and not taking into account the volume generated by USRP prior to the Merger, our management team has provided financing solutions to restaurant operators in the form of:
·
$2.4 billion in properties purchased under sale leaseback terms including approximately $542 million, $247 million and $137 million during the years ended December 31, 2005, 2004 and 2003, respectively.
·
$3.4 billion in mortgage loans, including $2.3 billion referred to one of our lenders.
The combination of both net-lease and mortgage financing is attractive to restaurant operators because we provide them with a single source to assist in optimizing their capital structures. We experienced increasing competition in 2005 in the net lease sector, specifically on smaller transactions. This has resulted in compression on the acquisition cap rates in the marketplace. Regarding larger transactions, we believe that the financial returns expected by equity investors in the restaurant sector will cause public restaurant companies with large levels of on-balance sheet restaurant real estate to consider monetizing all or a portion of those amounts. We believe we are well positioned to acquire the restaurant operators’ real estate because of the following competitive advantages:
·
consistent source of financing dedicated almost exclusively to the restaurant industry for more than twenty years;
·
ability to execute transactions in excess of $100 million as committed, including properties with a single concept;
·
relationships with most of the major restaurant concepts and significant franchisees in those systems;
·
experience and expertise of our senior marketing representatives;
·
intellectual capital that resides in our investment banking services group; and
Before we purchase a property and enter into a long-term triple-net lease with a restaurant operator, the transaction undergoes a rigorous analysis. Our analysis includes:
·
credit underwriting of the restaurant concept;
·
credit underwriting of the potential tenant;
·
physical inspection of the real estate;
·
assessment of whether the properties should be held for long-term investment or held for sale; and
·
review and approval by our Investment Committee that includes senior executives, including the CEO and CFO, separate from the marketing team.
We expect that the properties we purchase for long-term investment in the next six months will earn rental income in the range of 8.5 - 9.75 percent including the impact of straight lining of rents. The term “straight lining of rent” refers to a requirement by generally accepted accounting principles that we average tenant rent payments over the life of the lease. In addition to $542 million in property acquisitions during the year ended December 31, 2005, we had $35 million in property acquisitions through the end of February 2006 and as of March 15, 2006, had $125 million under purchase commitment that we expect will close in the next six months. We expect over time to increase the designation of the number of properties held as long-term investment, as compared to properties held for sale to investors through the Investment Property Sales (“IPS”) program. While we will continue to make selected acquisitions in the convenience and gas station sector, we expect the predominant amount of our new property acquisitions will continue to be restaurants. We actively survey the market seeking to identify other asset classes where we believe we can compete effectively. Also, while we do not currently own any restaurants outside of the United States, we sometimes examine international financing opportunities for established restaurant customers.
Strategy 2: Maximizing the Potential of our Real Estate Portfolio
Our real estate portfolio consists of 2,005 properties with a net carrying value of $1.9 billion at December 31, 2005. We employ standard processes to evaluate the real estate within the portfolio and actively manage the risk profile. We examine the concept, tenant and geographic concentrations. We review the leases expiring in future periods to proactively manage that risk. Periodically, we will sell properties to realize appreciation on our original investment. In addition, we examine and evaluate alternatives for vacant properties. Those alternatives include re-leasing the property, selling the property and reinvesting the proceeds, or possibly redeveloping the real estate with a different restaurant or other retail concept to either continue to hold for investment or list for sale.
As of December 31, 2005, we had 58 properties with a net carrying value of $39.5 million with leases expiring in the next 12 months, and had 74 properties with a net carrying value of $46 million that are vacant with no lease. We will continue to manage these properties, and expect to reduce the number of vacant properties in the next 15 months either by locating suitable tenants to lease the properties or selling the vacant properties and reinvesting the sales proceeds in replacement properties. In addition, we had 42 properties representing $23 million in net carrying value classified as held for sale at December 31, 2005 in the core real estate portfolio.
The following tables illustrate as of December 31, 2005 the diversification in our real estate portfolio in terms of annualized base rent. Each lease has a monthly fixed lease payment (“base rent”) due each month. Base rent represents the monthly cash rent for December 2005 on an annualized basis. It does not represent a rent number in accordance with generally accepted accounting principles as it does not include the straight-line impact of any rent escalators or any contingent rent based on tenant sales exceeding a certain threshold. In 2005, those amounts collectively were $12 million. As a real estate investment trust is required to pay 90 percent of its taxable income in dividends, annual base rent is a key figure that we review as it provides a proxy for the cash portion of rental revenues expected to be received.
The tables show our top ten concepts, tenants, and states ranked as a percentage of total annualized base rent. We believe our diversification by concept, tenant and state enhances the stability of our cash flow by reducing exposure to a single concept, tenant or geographic area.
(*)
Includes estimated contingent rent for recently acquired units with leases where rent is based solely on actual store sales without a minimum threshold.
(**) Excludes one site leased by Jack in the Box, Inc. but operated as a different concept.
(*)
Includes estimated contingent rent for recently acquired units with leases where rent is based solely on actual store sales without a minimum threshold.
(*)
Includes estimated contingent rent for recently acquired units with leases where rent is based solely on actual store sales without a minimum threshold.
Approximately 58 percent of our leases have terms that expire in 2015 or later and the average remaining lease term of our portfolio is approximately 11 years. Our leases typically provide for initial terms of 15-20 years, plus renewal options. The triple-net lease is a long-term lease that requires the tenant to pay property expenses. This form of lease generally insulates us from significant cash outflows for maintenance, repair, real estate taxes or insurance. At December 31, 2005, our total annualized base rent on our real estate portfolio was approximately $192.2 million, without giving effect to any future rent escalations and without giving effect to any contingent rental income earned based on tenant restaurant sales in excess of thresholds as defined in the leases. Base rents include an estimate of rents that are based solely on restaurant sales.
One of the risks we face is that a tenant's financial condition could deteriorate, and rental payments could be interrupted. In the event of a tenant bankruptcy, we may be required to fund certain expenses in order to retain control or take possession of the property and its operations. This could expose us to successor liabilities and further affect liquidity. Also, we may determine that the property’s value has been impaired leading to a charge to earnings.
Strategy 3: Sale of Real Estate to Investors
Since 2001, we have sold more than $1.1 billion in properties through our IPS program, of which $257 million, $256 million and $194 million were sold during 2005, and 2003, respectively. At December 31, 2005, we held 122 properties for sale to investors through our IPS program with an investment of $157.2 million, including 102 properties with an investment of $139.4 million recently purchased by our specialty finance segment and funded by $122.7 million in mortgage warehouse debt. The 122 properties also include 20 properties with an investment of $18 million acquired through the Merger. When we purchase a property, we determine whether we want to hold it in our portfolio or sell the property through our IPS program. When determining if a property is to be held for investment or held for sale, we consider our existing portfolio profile. We examine attributes such as lease rate, concept, tenant concentration, geographic concentration and general real estate and economic market trends in the property’s location. We hold properties we believe will provide appreciation in excess of the general market over time and which contribute favorably to the weighted average term and yield of the portfolio.
Many buyers of our properties are those motivated to defer taxes on commercial properties they have sold through the reinvestment of the proceeds as permitted under the Internal Revenue Code. In addition, we find buyers who are attracted to our real estate because of its location, concept, tenant and income potential. Our properties typically sell in the $0.8 million to $3.0 million price range. We primarily employ direct marketing efforts to sell our properties and our website (Trustreet1031.com) lists our available properties for sale.
We expect our percentage net gain on the sale of real estate in 2006 to reflect the market as a whole, which suggests sell cap rates maintaining consistency or slightly increasing, and buy cap rates decreasing below levels experienced in 2005. This compression in acquisition cap rates is expected to reduce our net gain percentages in 2006. Overall, we expect gains for our properties held for sale to investors to perform well due to a continuing high demand for real estate but reflect a market exhibiting signs of greater efficiency.
Our IPS program complements our ability to offer sale leaseback financing, especially in securing and managing larger transactions. Our ability to commit to larger transactions allows our niche to be in areas of significantly reduced competition. Our strong alliances and business relationships also distinguish us from our competitors.
Strategy 4: Real Estate Development and Redevelopment
During 2004, we formed our Development Group that through our acquisition and due diligence process identifies properties that are suitable for development as restaurants. When the highest and best use of a parcel is outside of the restaurant industry, other retail uses are considered. Once a parcel is identified, we explore development opportunities including build-to-suit and leasing activities. These assets are then either held in our portfolio for long term appreciation or sold to enhance our profits. During 2005 and 2004, these activities generated $3.5 million and $4.9 million in pre-tax gains, respectively. Our Real Estate Development and Redevelopment Group portfolio held 38 properties with an investment of $48.7 million at December 31, 2005. Of the $48.7 million in properties held at December 31, 2005, $12.8 million represented undeveloped land, $13.6 million in projects were under construction and $11.1 million comprised completed projects. The remaining $11.2 million were acquired with an existing structure with the intent to redevelop at a future date.
Liquidity and Capital Resources
We intend to meet our short-term liquidity requirements through cash flows provided by operations, our line of credit, our warehouse lines, and other short-term borrowings. We expect our ability to generate cash will be sufficient to meet our short-term liquidity needs which include:
·
operating expenses;
·
current debt service requirements;
·
distributions on our common and preferred equity, as may be limited by performance covenants;
· initial funding of properties we intend to hold for investment;
·
initial funding of properties we intend to sell through our IPS program; and
·
federal and state taxes.
Merger Financing
On February 25, 2005, we completed the Mergers and CNLRP stockholders received 0.7742 shares of USRP common stock and 0.16 shares of newly issued USRP 7.5% Series C Redeemable Convertible Preferred Stock (“Preferred-C”) for each share of CNLRP stock. The Preferred-C has a liquidation preference of $25.00 per share. The aggregate dollar value of Merger consideration received by CNLRP stockholders was approximately $788 million based on the closing stock price of USRP common stock on February 24, 2005 and the liquidation value of Preferred-C. CNLRP was considered the acquiror for accounting purposes. The purchase price used to account for the exchange of interests between USRP and CNLRP was $473 million before transaction costs. Income Fund limited partners received approximately 84 percent of their consideration in cash and the remainder in existing USRP Series A Cumulative Convertible Stock (“Preferred-A”). The Preferred-A has a liquidation preference of $25.00 per share. Total consideration received by the Income Fund partners was approximately $545 million based on the February 24, 2005 trading price of the Preferred-A. The Income Fund acquisitions were accounted for as a purchase with a price of $538 million. The USRP common, Preferred-A, and Preferred-C shares are all traded on the New York Stock Exchange using our ticker symbol, TSY.
We restructured our debt in the six weeks immediately following the Merger. We initially entered into bridge facilities with an aggregate capacity of $775.0 million to fund the cash portion of the Merger and address impending debt maturities. During 2005, we obtained long-term financings to pay down the bridge facilities, repay the subordinated note payable outstanding during 2004, purchase properties, and improve capacity on our revolver. Those included a $275.0 million net lease securitization due in 2012, $300.0 million in senior unsecured registered notes due in 2015, a $275.0 million five-year term loan and a revolving credit facility with a maximum capacity of $175 million. As of December 31, 2005, the entire $175 million revolver capacity was available to us under the revolver, against which $55 million had been drawn.
We also issued 1.4 million shares of common stock through a controlled equity program and issued 8.05 million shares through a public offering totaling $129 million in proceeds, net of stock issuance costs to pay down debt and acquire properties held for investment.
Our debt structure at December 31, 2005 is as follows:
(a)
We have entered into hedging transactions to reduce our sensitivity to floating rate debt in the form of swaps and caps, as described further under “Market Risk”.
(b)
Balance includes a premium of $1.1 million at December 31, 2005.
(c)
We also pay exit fees to the lenders upon the sale of properties financed by the warehouse facilities which we record as interest expense. We paid exit fees of $1.2 million, $1.3 million and $1.3 million during 2005, 2004 and 2003, respectively.
(d)
The Revolver and Five Year Term Loan are subject to borrowing base asset requirements.
Our weighted average expected maturity of debt, excluding our revolving line of credit and the short-term mortgage warehouse facilities, was approximately 5.36 years, 5.20 years and 6.21 years at December 31, 2005, 2004 and 2003, respectively. We have two secured financings that total $223 million that mature in 2006. The 2006 maturities are collateralized by properties with a book value of $418 million at December 31, 2005. We are currently examining different structures and expect to refinance these maturing obligations with secured debt.
Our current capitalization structure is a combination of secured debt, senior unsecured debt, convertible preferred stock and common stock. Our total debt to total assets ratio at December 31, 2005 and 2004, were approximately 56 percent and 57 percent, respectively, and our collateralized debt to total assets (excluding the Revolver, Five Year Term Loan and the Senior Unsecured Notes) was approximately 32 percent and 56 percent, respectively. During 2005, we reduced the collateralized debt levels as compared to 2004 through equity issuances, the issuance of senior unsecured notes and the sale of certain non-core assets. We will seek to fund our pipeline of purchases in 2006 through a combination of our alternatives that may include mortgage warehouse facilities, secured debt, unsecured debt, sales of properties and issuance of equity. We continue to evaluate the mix of capital options as we seek to gradually reduce our total debt as a percentage of assets.
We had the following funds available to us at December 31, 2005:
Mortgage Warehouse Facilities. We maintain regular contact with our mortgage warehouse facility lenders and believe that the relatively low-cost, high-advance rate financing they provide has been integral to our success. As is typical of revolving debt facilities, these facilities carry a 364-day maturity and accordingly we are vulnerable to any changes in the terms of these facilities. The warehouse facilities currently advance between 95 and 97 percent of the original real estate cost. As of December 31, 2005, we had two mortgage warehouse facilities. The first mortgage warehouse facility permits borrowing up to a maximum of $160 million and was up for renewal in February 2006. The lender has extended the existing mortgage facility through March 31, 2006 and we are negotiating with the lender to renew the facility and modify the exit fee and other terms of the facility. The second mortgage warehouse facility has a current capacity of $100 million with another lender and matures in May 2006. We also intend to renew this facility and renegotiate the exit fees charged on this warehouse facility. At December 31, 2005, we had approximately $16.5 million in capital supporting our loan and lease portfolio financed through our mortgage warehouse facilities. Amounts outstanding under the mortgage warehouse facilities were $122.7 million and $101.4 million at December 31, 2005 and 2004, respectively. The increase in the balance outstanding resulted from new net lease originations funded by these facilities.
Bonds Payable. We have medium-term note and long-term bond financings, referred to collectively as bonds payable. We use rental income received on properties and interest income received on mortgage loans and equipment leases pledged as collateral on medium and long-term financing to make scheduled reductions in bond principal and interest. In February 2005, we acquired through the Merger the Triple Net Lease Mortgage Notes Series 2001-A. These notes bear interest at LIBOR plus 48 basis points and associated fees of approximately 50 basis points, amortize over fifteen years and have a scheduled final maturity date of August 2006. The notes are collateralized by 262 properties with a carrying value of $261 million at December 31, 2005. In March 2005, we completed a $275 million offering of Triple Net Lease Mortgage Notes, Series 2005 (the “Series 2005 Bonds”). The Series 2005 Bonds bear interest at a fixed rate plus other associated fees of approximately 39 basis points, amortize over twenty years and have expected final maturity date in 2012. The Series 2005 Bonds are collateralized by 326 properties with a carrying value of approximately $324 million at December 31, 2005.
Revolver. Through 2004, our short-term debt consisted of a $40 million revolving line of credit (the “Revolver”). We utilized the Revolver from time to time to manage the timing of inflows and outflows of cash from operating activities. During 2005, we entered into a new Revolver with a capacity of $175 million. The initial maturity date of the revolver is April 2008, with an optional one year extension.
Notes Payable. As part of the Merger financing, we entered into a term loan of $175 million which provided for an increase of up to $100 million at our option. In December 2005, we exercised our option and increased the term loan by $100 million under the same terms and conditions as the initial loan. During 2004, we had $161.9 million outstanding under a five year term loan which was due in 2007 and collateralized by a portfolio of mortgage loans receivable. In July 2005, we sold this portfolio of mortgage loans receivable and paid off the related loan. During 2005, we issued $300 million in senior uncollateralized notes at a premium of $1 million. Shortly after issuance, we exchanged all of the notes for registered notes. The notes pay interest semi-annually in arrears at the stated rate of 7.5 percent per annum and are due April 2015. The notes are subordinated to all of our existing and future collateralized debt. We can redeem the notes in whole or in part, at any time on or after April 1, 2010 at specified redemption prices.
Some sources of debt financing require that we maintain certain standards of financial performance, such as a fixed-charge coverage ratio, a tangible net worth requirement and certain levels of available cash and may restrict the amount or timing of common stock dividend payments. Any failure to comply with the terms of these covenants would constitute a default and could create an immediate need to find alternative borrowing sources. We were in compliance with all of our covenants at December 31, 2005.
Contractual Obligations, Contingent Liabilities and Commitments.
The following table presents contractual cash obligations and related payment periods as of December 31, 2005:
The following table presents commitments, contingencies and guarantees and related expiration periods as of December 31, 2005:
(1)
The maturities on outstanding indebtedness assumes loan repayments are made on the mortgage warehouse facilities in accordance with the contractual obligation even though these facilities are typically renewed each year. The maturities on outstanding indebtedness also assumes that bonds payable amortize in accordance with estimated payment amounts.
(2)
We own an interest in two limited partnerships and affiliates of two of our directors own the remaining partnership interests. We severally guaranteed $1.2 million of the limited partnerships’ $14 million unsecured promissory notes. The guaranty continues through December 31, 2010 when the note matures. We lease our office space from these limited partnerships for approximately $1.5 million per year, with scheduled rent increases. Our lease expires in 2014. As of March 15, 2006, we are discussing and evaluating the possible sale of the five percent interest.
(3)
Represents opportunities for net lease property purchases approved for funding and accepted by sellers as of December 31, 2005. Through the end of February 2006, we purchased $35 million in properties and as of March 15, 2006 had total commitments worth $125 million subject to a leaseback.
(4)
As part of the Merger, we assumed several products sales contracts that committed us to purchase a minimum quantity of fuel, at a predetermined margin over an index, at terms ranging from one to three years relating to certain gas station properties and fuel terminal operations. The contracts are customary in the retail petroleum industry and secure a readily available supply of fuel at competitive market prices. We are in the process of transferring the majority of these purchase commitments to the buyer of the fuel terminal operation. We intend to transfer or terminate, where possible, any remaining purchase commitment that it relates to properties or operations sold. In addition, in connection with certain gas station properties, we assumed certain agreements that obligate us to pay a release price should a gas station property change gas brands. The agreements are customary in the retail petroleum industry. Some, but not all, of the agreements release us from the aforementioned obligation upon the sale of the property to a third party.
(5)
We are subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are generally covered by insurance. While the resolution of these matters cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our consolidated financial statements. In addition:
a.
On January 18, 2005, Robert Lewis and Sutter Acquisition Fund, LLC, two limited partners in several of the Income Funds, filed a purported class action lawsuit on behalf of the limited partners against the general partners of the Income Funds, CNLRP and USRP. The complaint alleges that the general partners breached their fiduciary duties in connection with the Mergers and that the parties to the Merger aided and abetted in the alleged breaches of fiduciary duties. The complaint further alleges that the general partners violated provisions of the Income Fund partnership agreements and demands an accounting as to the affairs of the Income Funds. The plaintiffs are seeking unspecified compensatory and exemplary damages and equitable relief, which also included an injunction preventing the defendants from proceeding with the Mergers, which was unsuccessful. On April 26, 2005, a supplemental plea to jurisdiction hearing was held. On May 2, 2005, the plaintiffs amended their lawsuit to add allegations that the general partners of the Income Funds, with CNLRP and USRP, prepared and distributed a false and misleading final proxy statement filing to the limited partners of the Income Funds and the stockholders of CNLRP and USRP. On May 26, 2005, the Court entered a Final Order Dismissing Action for lack of subject matter jurisdiction. On June 22, 2005, the plaintiffs filed a Notice of Appeal of the Order of Dismissal. On September 7, 2005, the plaintiffs filed an appellants’ brief. On November 7, 2005, the Company and the other defendants filed their Brief of Appellees. On December 12, 2005, the plaintiffs filed their Appellant’s Reply Brief. The court has scheduled oral argument on the appeal for May 3, 2006. We believe the lawsuit, including the request for certification, is without merit and intend to defend vigorously against its claims.
b.
During 2004, Management Strategies, Inc. filed a lawsuit against USRP. The complaint alleges that we owe approximately $3 million in sales and fuel tax liabilities to the State of Georgia. We believe the claims against us are without merit and intend to defend vigorously against such claims.
(6)
Excludes amortization of deferred financing costs and uses the December 31, interest rate for all variable rate debt.
Cash Flows
Cash Flows Provided by/(Used in) Operating Activities
Our sources of cash from operations related to rental payments from our tenants, collections of interest on our portfolio of loans and investments in retained interests on previous securitizations, and net proceeds from the sales of property inventory from our IPS program. Our uses of cash from operations include payments of operating expenses, interest on our outstanding indebtedness and the acquisition of inventory for our IPS program. Our cash from operations for the years ended December 31, 2005, 2004 and 2003 were $48.4 million, $39.0 million, and $108.4 million, respectively. Because increases in assets held for sale are primarily funded through warehouse facilities, management believes that a better indicator of liquidity generated from operations would exclude the changes in the held for sale loans (in 2003) and changes in the real estate portfolio. Net cash provided by operating activities excluding changes in mortgage loans held for sale and inventories of real estate held for sale were $77.6 million, $58.9 million, and $71.2 million in the years ended December 31, 2005, 2004 and 2003, respectively. Other items impacting cash provided from operations are described below.
Our cash from operations increased during 2005 as compared to prior years as a result of increasing our real estate portfolio to approximately $1.9 billion as a result of the Merger in early 2005 and the origination of $542 million during 2005. Cash from operations during 2004 and 2003 were impacted by a reduction in rental income from the 2003 bankruptcy filings of Chevy’s Holding, Inc. and numerous operating subsidiaries (“Chevy’s”) and the 2004 bankruptcy filing of The Ground Round, Inc. (“Ground Round”). As of the bankruptcy filings, we owned 34 of these units with an initial investment of $69 million. As part of the Merger, we acquired five additional sites previously leased to these tenants. As of March 15, 2006, 28 sites had been rejected and 11 continued to pay rent under their leases. Of the 28 rejected sites, 11 had been re-leased, seven had been sold and we expect the remaining 10 sites rejected as part of the bankruptcy to be re-leased or sold. Cash flows from operations during 2004 decreased slightly due to granting temporary debt service and rent relief to a borrower/tenant who was experiencing financial difficulties.
Cash from operations was also impacted by the acquisition and sales activity in our IPS program. During 2005, 2004 and 2003, we received net sales proceeds of $257 million, $256 million and $194 million, respectively, from the sales of properties from our IPS program. We had a net use of cash during 2005 and 2004 as a result of acquiring properties at a faster rate than we sold them. The success of our IPS program and the growth of our property portfolio for long term hold is dependent on successfully originating new triple-net leases and the continued liquidity of the 1031 exchange marketplace. For the years ended December 31, 2005, 2004 and 2003, we originated $542 million, $247 million and $137 million in net leases respectively. Originations during 2005 included the acquisition of three large property portfolios. Production in 2005 was driven by three primary factors: (1) our ability to complete (and retain) large portfolio acquisitions of assets owned by franchisors; (2) operators’ continued interest in monetizing some or all of the value of their real estate holdings; and (3) a reorientation of our marketing strategies. We expect continued demand for our core triple-net lease financing in 2006. The demand is impacted by long-term low interest rates and the following other competitive factors:
· Identified lease transactions have been lost to competitors offering mortgage debt financing. With continued historically low prevailing long-term interest rates, large national and regional banks have offered less expensive mortgage financing that many restaurant operators find more attractive than leases. We do not currently originate mortgage financing due to the volatility and high cost of capital currently associated with our potential sources of financing these assets. Instead, we maintain a strategic alliance with a large financial institution, who through January 1, 2005, was a partner in the specialty finance segment. Under the strategic alliance, we provide the net lease financing and the financial institution provides the senior debt on those transactions requiring a combination of debt and net lease in the target capital structure.
· Various real estate brokerage firms compete against us and receive a brokerage fee upon the sale of the restaurant properties. Generally the brokers serve as an intermediary and do not have capital to ensure certainty of close for the restaurant operator. The threat exists more in the market for smaller transaction sizes than our typical prospect although new entrants (now commonly referred to as “flip shops”) continue to squeeze the margin between wholesale and retail cap rates. Through our borrowing capacity, we are able to provide that assurance which to date has mitigated this competitive threat, particularly on larger transactions.
We respond to these factors by adjusting net lease rates, identifying larger transactions and identifying efficiencies within the selling process to reduce costs. Net lease originations provide inventory necessary to execute the IPS Program. At December 31, 2005, we were involved in several opportunities for net lease originations with $134.2 million approved for funding and accepted by the client Our mortgage warehouse facilities provide advances for up to 97 percent of the real estate purchase value.
Investing Activities
The growth in our property portfolio was the result of the Merger in 2005 and the originations volume in 2005 described above. We funded this growth through a combination of equity issuances and borrowings from the Merger financings. During 2005 we paid $450.0 million for the Income Fund properties acquired through the various Merger and Merger-related financings and used $14 million to pay Merger related costs. We also used $302 million and $21 million during and 2004, respectively, to purchase properties designated as held for long term investment. During 2004 and 2003, properties purchased were virtually all designated as held for sale, and thus treated as an operating cash flow. Another source of funds was from the collection of principal from our borrowers on our loan portfolio (a non-core asset) and the sale of some non core assets as described below.
In June 2005, we received an unsolicited expression of interest from a third party to purchase mortgage loans held for investment. In July 2005, a purchase contract was entered into to sell the loans at a price of $194 million plus the actual cost to unwind the cash flow hedge. The transaction was consummated in July when we received sales proceeds of $203.8 million. We used the net proceeds from the sale, among other things, to pay $157.7 million in debt (due June 2007) that was collateralized by the mortgage loans receivable, pay $8.6 million to terminate the swap and pay $35 million of the outstanding balance on our Revolver.
As part of the Merger, we acquired several convenience, gas and restaurant operations which were under contract to sell as of the date of the Merger. In September 2005, we sold eighteen gas station operating units and a 50 percent interest in a bulk fuel loading terminal located in Hawaii. In accordance with purchase accounting rules, the values assigned to these assets at the Merger date were the expected net sales proceeds per the contract. As a result, the financial statements do not reflect any gain or loss on the sale of these assets. The sales proceeds of $10.2 million were deposited into an escrow account and as of March 15, 2006, all pending tax issues have been cleared, and the release of escrowed funds is pending certain administrative approvals.
Other sources of cash from investing activities during 2005, 2004 and 2003 include sales of some vacant and some performing properties and the collection of principal under our mortgage and notes receivables. During 2004, we received about $11.2 million in proceeds from the sale of our interest in loan certificates relating to previous securitizations.
Financing Activities
We recapitalized our company as a result of the Merger as described above under Merger Financing. This allowed us more access to capital and provided us the ability to increase originations in 2005. As part of the Merger we assumed the Series B (“Series B”) convertible preferred stock and used $32.5 million in cash to redeem this series of convertible preferred stock shortly after the Merger.
Proceeds from financing activities during 2005 came from bridge financing, our new Revolver, our term loan, the issuance of senior unsecured notes and the issuance of the Series 2005 Bonds. Proceeds during 2004 and 2003 came from the financings in place prior to the Merger, including issuance of bonds. Proceeds during also came from borrowings from our Chairman through a private company affiliate, CNL Financial Group, Inc. (“CFG”), as further described below. During 2005, we used the proceeds from financing activities to pay loan and bond issuance costs, to pay down the previous financings, including our old revolver and our senior subordinated debt, to pay distributions and to repay the loans from stockholders previously advanced through 2004. We used the proceeds from the sale of the mortgage loans to pay down the majority of our notes payable, the related hedge unwind and other items, as described above under “Investing Activities”. During 2005, 2004 and 2003 we used proceeds from our mortgage warehouse facilities to acquire properties to be held as inventory under our IPS program and repaid the mortgage warehouse facilities from the sales proceeds of these inventory properties. During these years we also repaid a portion of our bonds payable in accordance with their scheduled maturities and any required prepayments. In addition, we have $223 million in bonds maturing in 2006. Those bonds are collateralized by real estate with a net book value of $418 million. Those bonds will likely be refinanced through a secured financing collateralized by a portion of the current collateral as well as restaurant properties purchased in 2005 and 2006. We are examining a structure to facilitate the financing and anticipate freeing up a number of properties that are currently secured under the two series of bonds maturing in 2006.
We consider our long-term liquidity requirements to include the repayment of maturing debt, including borrowings under our revolving credit facilities used to fund properties held for investment. We intend to meet our long-term liquidity requirements by raising equity or debt capital, and by selling select properties. We expect to use the proceeds from property sales predominantly for reinvestment in new properties or for the reduction of debt. As of March 15, 2006, we have an effective shelf registration statement with the Securities and Exchange Commission to issue up to $700 million in debt, common stock or preferred shares. We issued 1.4 million shares of common stock between August and November 2005 through a controlled equity program and in December 2005, we issued 8.05 million shares through a public offering totaling $129.9 million in proceeds, net of stock issuance costs. We sold the shares of common stock at a range of $14.25 to $16.67 per share under the shelf registration. The proceeds of all equity issuances were used to pay down our Revolver and acquire properties held for investment. During 2004 and 2003 we paid stock issuance costs in the form of trailing commissions to brokers who had helped raise the initial equity of the company. This obligation ceased with the Merger in 2005.
Our ability to internally fund capital needs is limited since we must distribute at least 90 percent of our net taxable income (excluding net capital gains) to stockholders to qualify as a REIT. We intend to make distributions to stockholders in order to comply with REIT qualification requirements under the federal tax code. Effective with the Merger, we pay dividends to holders of Preferred stock. Preferred-A pays a quarterly dividend at an annualized rate of $1.93 per share and Preferred-C pays a quarterly dividend at an annualized rate of $1.875 per share. Common stock dividends are currently declared and paid monthly, currently at $0.11 per share, annualized at $1.32 per share. We intend to maintain a dividend rate on our common stock that is less than our funds from operations allocable to our common stockholders, with certain adjustments, in accordance with our debt agreements.
We have elected to distribute amounts in excess of that necessary to qualify as a REIT. During the years ended December 31, 2005, 2004 and 2003, we distributed $80.4 million, $69.0 million and $69.0 million, respectively, or an annualized rate of $1.32, $1.52 and $1.52 per share, respectively, to our common stockholders. During 2005, dividends on common shares for the first two months (prior to the Merger) were paid at a different rate than our current monthly rate of $0.11 per share. Should we experience a large level of tenant delinquencies and vacancies and/or not achieve the level of net gains anticipated for the IPS platform, it may require us to reduce the current common stock dividend level.
During 2005, we declared dividends to preferred stockholders of $24.5 million. As described above under “Merger Financing”, CNLRP was treated as the acquiror for financial statement purposes. However, Trustreet Properties, Inc. formerly known as U.S. Restaurant Properties, Inc. (USRP), was the legal and tax survivor. The following distribution information is based on taxable earnings and profits for the calendar year which included the taxable activity of USRP for January 1, 2005 through February 24, 2005 and the taxable activity of the merged company from February 25, 2005 through December 31, 2005.
In 2005, the distributions to common stockholders were considered to be 77.18 percent taxable income and 22.82 percent return of capital. The distribution to all classes of preferred stockholders was 100 percent taxable income.
The distributions were characterized as follows:
For the period from January 1, 2005 through February 25, 2005, 30 percent of the distributions received by CNLRP stockholders were considered to be ordinary income and 70 percent were considered to be return of capital.
For the year 2004, approximately 22 percent of the distributions received by CNLRP stockholders were considered to be ordinary income, 69 percent were considered a return of capital, seven percent were qualified dividends and two percent were capital gains for federal income tax purposes. During the year ended December 31, 2003, approximately 39 percent of the distributions received by CNLRP stockholders were considered to be ordinary income and approximately 61 percent were considered a return of capital for federal income tax purposes. Beginning in 2001, our Board of Directors made the determination that it was in the best interests of our stockholders to maintain our historical level of distributions during a period of volatility in the restaurant finance sector. While not necessary for REIT tax purposes, CNL Financial Group, Inc. (“CFG”), an affiliate of the Company’s Chairman, provided loans to and purchased common stock from us to enable us to maintain our historical level of distributions during this period. The loans were in the form of non-collateralized demand balloon promissory notes which bore interest at LIBOR plus 2.5 percent or at the base rate, as defined in the agreement, with interest payments and outstanding principal due upon demand. During the years ended December 31, 2004 and 2003, CFG advanced $10.9 million and $18.7 million, respectively. The principal amount including accrued interest at December 31, 2004 was $35.8 million. As a result of new financing obtained as part of the Merger, we paid off this balance during 2005. Our Chairman was not obligated to make loans or purchase shares and as a result of the completion of the Merger, will not make any further loans or purchases of stock to fund distributions.
There was no preferred stock outstanding during 2004 and 2003.
Liquidity Risks
In addition to the liquidity risks discussed above in connection with our IPS program, tenants or borrowers that are experiencing financial difficulties could impact our ability to generate adequate amounts of cash to meet our needs. In the event that financial difficulties persist, our collection of rental payments, and interest and principal payments on our small portfolio of mortgage loans held could be interrupted. At present, most of these tenants and borrowers continue to pay rent, principal and interest substantially in accordance with lease and loan terms. However, we continue to monitor each tenant’s and borrower’s situation carefully and will take appropriate action to maximize the value of our investment.
Most properties acquired with funds provided by the mortgage warehouse facilities are required to be sold within a certain time frame. Any delinquency, default or delay in the resale of these properties would generally require accelerated principal payments on the related debt and may restrict our ability to find alternative financing for these specific assets. Our debt, excluding bonds payable, generally includes cross-default provisions. A default under any debt facility could result in our other borrowings becoming immediately due and payable.
Liquidity risks also include the potential that a tenant’s financial condition could deteriorate, rendering it unable to make lease payments or payments of interest and principal on mortgage and equipment notes receivable. Generally, we use a triple-net lease to lease our properties to our tenants. The triple-net lease is a long-term lease that requires the tenant to pay expenses on the property. The lease somewhat insulates us from significant cash outflows for maintenance, repair, real estate taxes or insurance. However, if the tenant experiences financial problems, rental payments could be interrupted. In the event of tenant bankruptcy, we may be required to fund certain expenses in order to retain control or take possession of the property. This could expose us to successor liabilities and further affect liquidity.
Additional liquidity risks include the possible occurrence of economic events that could have a negative impact on the franchise securitization market and affect the quality or perception of the loans or leases underlying our previous securitization transactions. We conducted our previous securitizations using bankruptcy remote entities. These entities exist independent from the rest of our Company and their assets are not available to satisfy the claims of our creditors, any subsidiary or its affiliates. To date, the ratings on the loans underlying the securities issued in these transactions have been affirmed, unlike the ratings of many competitors’ loan pools that have been downgraded. Upon the occurrence of a significant amount of delinquencies and/or defaults, one or more of the three rating agencies may choose to place a securitized pool on ratings watch or even downgrade one or more classes of securities to a lower rating. Should the loans underlying the securities default, and the securities undergo a negative ratings action, we could experience material adverse consequences impacting our ability to continue earning income as servicer, renew our existing debt facilities and impact our ability to engage in future net lease securitization transactions. In addition, a negative ratings action against our securitized pools could cause our warehouse lenders to lower advance rates and increase the cost of financing.
Certain net lease properties are pledged as collateral for the triple-net lease bonds payable. In the event of a tenant default relating to pledged properties, we may elect to contribute additional properties or substitute properties into these securitized pools from properties we own not otherwise pledged as collateral. The Series 2000-A and Series 2001 pools contain properties impacted by the prior years’ bankruptcy filings of Chevy’s and Ground Round, and the financial difficulties of other restaurant operators. In the event that we have no suitable substitute property, the adverse performance of the pool might inhibit our future capital raising efforts including our ability to refinance the Series 2001 and Series 2001-A bonds payable maturing in 2006. The Series 2000-A and Series 2001 bonds payable include certain covenants relating to delinquency percentages and debt service coverage. If we fail to comply with certain financial ratio covenants, then principal payments on the outstanding bonds will be accelerated. We are currently exceeding certain required performance cash flow ratios within the Series 2000-A bonds payable due primarily to tenant defaults and bankruptcies in 2003 and 2004 from Chevy’s and Ground Round. As a result, cash flow remaining in excess of the scheduled principal and interest payments is required to be used for additional debt reduction. For the years ended December 31, 2005, 2004 and 2003, we were required to make additional debt reductions of approximately $2.1 million, $2.4 million and $0.4 million, respectively, as a result of exceeding certain ratios in the net lease pools. We are actively seeking new tenants or buyers for these properties to enable us to meet these ratios.
Hurricane Impact
During the year ended December 31, 2005, hurricanes Katrina, Rita and Wilma caused personal and property damage in Texas, Florida, Louisiana and Mississippi, which are states in which we owned properties. A total of 283 stores in our current real estate portfolio were located in FEMA designated disaster counties affected by these hurricanes. As of March 15, 2006, we were able to make contact with tenants and borrowers on all except two sites that are located in New Orleans and remain closed. Rents in those two stores are delinquent and are expected to be paid by insurance proceeds under business interruption coverage carried by the tenant. Our stores are generally leased to tenants subject to triple net leases, meaning that the tenant is responsible for repairs and maintenance on the properties, and is required to pay the real estate taxes and maintain full property insurance coverage on these properties. In many cases, we also require the tenant to carry business interruption insurance which would provide for payment of rent while the store is closed. We did not incur any losses nor did we have to pay out of pocket for any damage caused by the hurricanes because affected tenants’ insurance has covered this damage.
Financial Structure
Off-Balance Sheet Transactions
We currently hold residual interests in two securitizations, the assets and liabilities of which are not consolidated into our financial statements. The carrying value of our investment in the bond certificates was $16.0 million at December 31, 2005. Both are recorded as investments in the consolidated financial statements. The following table shows the assets and the related bonds outstanding in each securitization pool at December 31, 2005:
Quantitative and Qualitative Disclosures About Market Risk
We use fixed and floating rate debt to finance acquisitions, development and maturing debt. These transactions expose us to market risk related to changes in interest rates. We review our borrowings and attempt to mitigate interest rate exposure through the use of long-term debt maturities and derivative instruments, where appropriate. We do not use derivatives for trading or speculative purposes. As of December 31, 2005, we had the following derivative instruments outstanding:
In May 2005, we entered into an interest rate swap to hedge the $175 million five year term loan.
At December 31, 2005, we had fixed rate debt of $814 million and floating rate debt of $684 million. At December 31, 2005, the weighted average rate on the floating rate debt was 5.85 percent. We have entered into hedging transactions in response to the sensitivity that is inherent in floating rate debt, but certain of those hedging transactions have caps that cause the rate sensitivity to be reduced but not eliminated. The impact on net income available to common stockholders and on cash flows over the next twelve months that would result from a one percentage point variance in interest rates on $684 million in floating rate debt would be approximately $4.2 million (pre-tax), holding all other variables constant.
Management believes that the net carrying value of the debt approximates fair value, with the exception of the Series 2000-A Bonds and the Series 2005 Bonds which have an estimated fair value of approximately $304 million and $217 million, respectively. A one percentage point increase in interest rates would decrease the fair values to $259 million and $185 million, respectively. A one percentage point decrease in interest rates would increase the fair values to $368 million and $262 million, respectively.
Inflation
We believe inflation has not significantly affected our earnings because the inflation rate has remained low. During inflationary periods, which generally are accompanied by rising interest rates, our ability to grow may be adversely affected because the yield on new investments may increase at a slower rate than new borrowing costs. However, sustained low inflation could lead to net lease pricing pressure as tenants request decreasing rates for longer maturities.
Critical Accounting Policies
In response to SEC Release Numbers 33-8040, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies,” and 33-8056, “Commission Statement About Analysis of Financial Condition and Results of Operations,” we identified the following critical accounting policies that affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United states of America requires us to make estimates and judgments on assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments. A summary of our accounting policies and procedures are included in Note 1 of our consolidated financial statements. We believe the following critical accounting policies among others affect our more significant judgment of estimates used in the preparation of our consolidated financial statements.
·
We record the acquisition of land, buildings, equipment and lease intangibles at cost, including acquisition, closing and construction period interest costs. Land and buildings are leased to restaurant operators generally on a triple-net basis, which means that the tenant is responsible for all operating expenses relating to the property, including property taxes, insurance, maintenance and repairs. The property and secured equipment leases held for investment are accounted for using either the direct financing method for capital leases or the operating method unless we have classified these properties pursuant to their intent to sell. We estimate residual values and collectable rents in determining whether a lease is accounted for as either direct financing or operating.
·
For purchases of real estate held for investment that were consummated subsequent to June 30, 2001, the effective date of SFAS No. 141, “Business Combinations,” we allocate the fair value of the real estate acquired to the acquired tangible assets, consisting of land and building, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, other value of in-place leases and value of tenant relationships, based in each case on their relative fair values.
·
We determine the fair value of the tangible assets of an acquired property by valuing the property as if it were vacant, and we then allocate the “as-if-vacant” value to land and building based on the determination of the relative fair values of these assets. We use the as-if-vacant fair value of a property provided by a qualified appraiser for individual property acquisitions and use assumptions on portfolio acquisitions.
·
In allocating the fair value of the identified intangible assets and liabilities of an acquired property, we record above-market and below-market in-place lease values as other assets or other liabilities based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) our estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease.
·
The Company’s real estate accounting differs for assets held by its two operating segments based upon our intentions with respect to such asset’s disposition.
·
Real estate held within the real estate segment is generally acquired with an intention to hold long-term. It is depreciated over its estimated useful life and rent is recorded giving consideration to contractual rent increases over the life of the lease. Some real estate held by this segment may be designated so as to reflect our intention to dispose of the asset. In such case all operating income and expense, including depreciation and accrued rent associated with future contractual increases, is reflected as a component of discontinued operations for all periods presented, even for periods prior to our stating the intention to sell. We review our properties for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable through operations or sale. We determine whether impairment in value has occurred by comparing the estimated future undiscounted cash flows, including the residual value of the property, with the carrying cost of the individual property. If impairment is indicated, the assets are adjusted to estimated fair value.
·
Real estate held within the specialty finance segment is generally acquired with an intention to sell within one year. It is therefore not depreciated, and future contractual rent increases do not impact earnings. We review these properties for impairments and adjust the asset to fair value if necessary. All properties are treated as discontinued operations, and operating income and expense is reflected as a component of discontinued operations. We review our ability and intent to hold these assets for sale on a periodic basis to determine the proper classification of these assets.
·
Mortgage notes receivable are recorded at the lower of cost or market. Whenever future collection on specific notes appears doubtful, a valuation allowance is established. The allowance represents the difference between the carrying amount and the amount we expect to receive. Increases and decreases in the allowance due to changes in the measurement of the impaired loans are included in impairments and provisions on assets. Loans continue to be classified as impaired unless they are brought fully current and the collection of scheduled interest and principal is considered probable. When a loan or portion of a loan, including an impaired loan, is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance and subsequent recoveries, if any, are credited to the allowance. Accrual of interest is discontinued when we believe, after considering economic and business conditions and collection efforts, that a borrower’s financial condition is such that collection of interest is doubtful. Subsequent interest is recorded as income when collected.
·
Certain loans we originated were sold to independent trusts that, in turn, issued securities to investors backed by these assets. We retained the servicing rights and participate in certain cash flows from the trusts. The present value of expected excess of net cash flows, after payment of principal and interest to bond or other certificate holders, over the estimated cost of servicing is recorded at the time of sale as a retained interest. Retained interests in securitized assets are included in other investments. Accounting for the retained interests requires that we estimate values using market trends and historical experience, expected prepayments and defaults. This information is considered, along with prevailing discount rates and the terms of the bonds and certificates, to arrive at an initial value and to periodically review the value for gains or losses. Permanent impairments, representing the excess of carrying value over estimated current fair value, are recorded as an expense.
·
We review our long-lived assets for impairment or potential loss as events or circumstances indicate that the carrying amount of the assets may not be recoverable. We compare the estimated future undiscounted cash flows, including the residual value of the property or collateral, with the carrying cost of the individual asset. If impairment is indicated, the assets are adjusted to the estimated fair value. In addition, in accordance with SFAS No. 142, we are required to test goodwill for impairment at least annually. Changes in management’s judgments and estimates could significantly affect our analysis of the impairment of goodwill. Impairments resulting from this analysis are charged to results of operations.
·
We have also entered into certain derivative contracts in order to hedge our exposure to fluctuations in interest rates on variable rate debt, which contracts qualify for treatment as cash flow hedges. As long as the criteria for hedge accounting are met, the changes in fair value of these contracts are reflected in other comprehensive income (loss) and as a component of stockholders’ equity. If the requirements are not met, changes in the fair value of these contracts are reflected in earnings.
·
We accrue for losses associated with environmental remediation obligations when such losses are probable and reasonably estimable. Such accruals are adjusted as further information develops or circumstances change.
·
As a result of the Merger, we assumed retirement obligations for the removal of tanks, fuel lines and other required modifications to our gas stations, as well as estimated future costs to restore land leased under ground leases to its original condition. We recorded a liability based on expected future cash outlays in the period incurred, discounted to its present value based on our credit-adjusted risk-free rate. Over time, the liability is accreted for the change in present value, with this effect included in expenses.
·
We account for federal and state income taxes with respect to our TRS subsidiaries using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statements carrying amounts of existing assets and liabilities and respective tax bases and operating losses and tax-credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In the event that these assumptions change the deferred taxes may change.
·
Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The valuation allowance is based on our estimates of future taxable income and ongoing prudent and feasible tax planning strategies. Should we determine we are unlikely to realize in full a deferred tax asset, we would record a valuation allowance to reduce the deferred tax asset to an amount that is more likely than not to be realized. A reversal of the deferred tax asset would decrease income in the period the determination is made. The Company reversed all valuation allowances in 2003 and 2004.
·
In estimating future taxable income, we must estimate future income using historical data, the expected growth rate of revenues and expenses, the effect of capital expenditures, and future market and economic conditions. Variability of these and other assumptions could result in an inability to recover the carrying value of the deferred tax assets.
New Accounting Pronouncements
In December 2004, FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets.” This statement is effective for the fiscal years beginning after June 15, 2005. This statement addresses financial accounting and reporting obligations associated with the exchange of nonmonetary assets. The statement eliminates the exception to fair value for exchanges of similar productive assets issued in APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with a general exception for exchange transactions that do not have commercial substance, that is, transactions that are not expected to result in significant changes in the cash flows of the reporting entity. The adoption of this interpretation is not expected to have a significant impact on the financial position or results of operations of the Company.
As of March 31, 2005, the Company early adopted the provisions of SFAS No. 123(R), “Share−Based Payments” (“FAS 123(R)”), which establishes accounting standards for all transactions in which an entity exchanges its equity instruments for goods and services. FAS 123(R) focuses primarily on accounting for transactions with employees, and carries forward without change prior guidance for share−based payments for transactions with non−employees. FAS 123(R) eliminates the intrinsic value measurement objective in APB Opinion No. 25 and generally requires management of the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the date of the grant. The standard requires grant date fair value to be estimated using either an option−pricing model which is consistent with the terms of the award or a market observed price, if such a price exists. Such cost must be recognized over the period during which an employee is required to provide service in exchange for the award or the requisite service period (which is usually the vesting period). The standard also requires management of the Company to estimate the number of instruments that will ultimately be issued, rather than accounting for forfeitures as they occur. The Company elected to adopt the modified prospective application method as provided by FAS 123(R). Under the modified prospective method, compensation cost is recognized for all awards granted after adoption of this standard and for the unvested portion of previously granted awards that are outstanding on that date.
In May 2005, FASB issued SFAS No. 154, “Accounting Changes and Error Corrections (as amended)” This statement is effective for the fiscal years beginning after December 15, 2005. This Statement replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. Opinion previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The adoption of this interpretation is not expected to have a significant impact on the financial position or results of operations of the Company.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations”. This interpretation clarifies that the term conditional asset retirement obligation as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligation”, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. Thus, the timing and (or) method of settlement may be conditional on a future event. This interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. This interpretation is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of this interpretation does not have a significant impact on the financial position or results of operations of the Company.
Results of Operations
Financial Reporting
Historically we have managed, operated and reported our business in two distinct segments. For the years ended December 31, 2005, 2004 and 2003, the results of each segment are discussed on a stand-alone basis below. Our consolidated financial statements reflect both segments, less amounts eliminated relating to transactions between segments.
Real estate segment: Generally, the majority of our earnings are derived from this segment, the assets of which include our properties subject to triple-net leases and mortgage, equipment and other loans to third parties. The segment’s earnings are from rental income, interest income on loans, proceeds from dispositions of properties sold to manage portfolio risk and income from retained interests in our prior loan securitizations.
Specialty finance segment: This segment includes our IPS program, our Real Estate Development and Redevelopment Group and our subsidiary Trustreet Investment Banking, LLC where we provide services to national and regional restaurant operators. This segment’s earnings are from lease income prior to sale, net gains from investment property sales, gains from the development and sale of restaurant/retail real estate and to a lesser extent, investment banking and other service revenues. This segment historically has earnings from interest income on mortgage loans as well. The majority of these loans were transferred to the real estate segment on March 31, 2005 and subsequently sold to an unrelated third party in July 2005.
The following table presents components of net income, including income from continuing and discontinued operations, by segment. It also reflects the elimination of transactions between segments used to prepare the consolidated financial statements.
* relates primarily to eliminations of transactions between segments
**
also includes the minority interest in earnings of consolidated joint ventures net of the equity in earnings of unconsolidated joint ventures
Revenues:
Revenues in the real estate segment were comprised of the following:
Real estate segment revenues primarily include rental income on operating and capital leases which increased during 2005 as a result of an increase in the number of properties held in our real estate portfolio. We added approximately $1 billion in properties through the Merger transaction on February 25, 2005 and added new properties through acquisitions of three property portfolios during the latter part of 2005, increasing the property portfolio to $1.9 billion. Rental income during 2005 increased 142 percent as compared to 2004 due to the increase in the number of properties generating rental income. Rental and earned income decreased in as compared to 2003 due to lower rental revenues resulting from tenant bankruptcies including Ground Round and Chevy’s, who filed for bankruptcy in 2004 and 2003, respectively. The portfolio from USRP included certain ground leases that were subleased to tenants but for which the lessor remained legally responsible for those liabilities in the event the tenant did not pay. The sublease rents received are recorded as rental revenues and the payments are recorded in property expenses. Portfolio acquisitions in late June, September and December 2005 also contributed to an increase in revenues in 2005 as compared to prior years. We expect an increase in rental revenues in 2006 as a result of the acquisition of these three portfolios.
Interest income in the real estate segment of $12.2 million, $9.2 million and $8.7 million in 2005, 2004 and 2003, respectively, is generated by our portfolio of mortgage, equipment and other notes receivable held by this segment as well as investment income earned on bonds held in mortgage loan securitizations. These increases were a result of adding $15 million in former USRP loans and $198.2 million in loans that were moved from the specialty finance segment on March 31, 2005. The real estate segment sold these loans in July 2005 and as a result of the sale, interest income is expected to continue to decrease relative to total revenues in the future. Interest income from mortgage, equipment and other notes receivable increased in 2004 as compared to 2003 as a result of the purchase of approximately $26.1 million in mortgage loans by our real estate segment from our specialty finance segment in December 2003. Our real estate segment combined these mortgage loans with other mortgage loans it previously owned and issued notes (“bonds payable”) collateralized by approximately $46.6 million of mortgage loans. The increase in interest income from the new loans was partially offset by a decrease in interest income earned on the declining balance of our original loan portfolio resulting from the scheduled collections of principal. Loan originations since 2000 have been minimal.
In July 2005, our real estate segment sold the mortgage loans receivable, for $203.8 million and recorded a gain on sale of loans of approximately $9.6 million. In July 2005, our real estate segment recognized as other income approximately $1.1 million in deferred loan origination fees that were being recorded as income over the term of the mortgage loans receivable. Upon the sale of the loans and the repayment of the related debt, our real estate segment recognized $10.6 million in hedge losses previously recorded in other comprehensive income (loss) in earnings. In addition, during the period from July 1, 2005 to July 18, 2005, the real estate segment recognized a gain of approximately $2 million relating to decreases in the cash flow hedge liability prior to the closing of the sale.
In addition to the $1.1 million described above, other income increased during as compared to 2004 as a result of earning and collecting $0.9 million in fees for providing due diligence and advisory services to one of our tenants and by $0.2 million for tenant reimbursements relating to real estate taxes for some properties acquired through the Merger. Certain properties assumed in the Merger require us to pay real estate taxes on behalf of the tenant. In these situations, we record the payment of the real estate taxes as an expense and then record the reimbursement from the tenant as tenant reimbursable within other income. Prior to the Merger, we did not have any leases that required us to pay taxes on behalf of the tenant. Other income decreased in 2004 as compared to 2003 as a result of decreased billings of direct costs to third parties using our real estate segment for property management services. During 2003, we transferred certain functions to CFG, an affiliate, thereby reducing general and operating expenses, as well as reducing the billings of these expenses collected from third parties. In 2004, our real estate segment also transferred its property management services to our specialty finance segment further reducing its other income generated from these services.
Revenues in the specialty finance segment were comprised of the following:
Specialty finance segment revenues decreased by 41 percent in 2005 as compared to 2004. Revenues associated with properties acquired with the intent to sell are recorded as revenue within discontinued operations and are not included here. This revenue consists primarily of interest income on a portfolio of mortgage loans receivable held by this segment. Most of the loans held by the specialty finance segment were moved to the real estate segment on March 31, 2005, causing a significant decrease in specialty finance segment revenues in 2005 as compared to 2004. Specialty finance revenues decreased by 9 percent in 2004 as compared to 2003. Interest income from mortgage and other notes receivable decreased during the year ended December 31, 2004 as compared to the same period in 2003 partially due to the sale of $26.1 million in mortgage loans to the real estate segment.
Other matters impacting the comparability of the various components of revenues during the three years ended December 31, 2005, 2004 and 2003 include:
·
During the year ended December 31, 2003, the specialty finance segment utilized a hedging strategy designed to address market volatility in the value of loans held for sale. In December 2003, the specialty finance segment sold its remaining mortgage loans held for sale to the real estate segment, which then re-designated these loans as held for investments purposes and issued bonds collateralized by the loans. In conjunction with this sale the fair value hedge was terminated.
·
Other income reflects, among other items, fees from advisory services, servicing income and referral fees for loans and other products from the Bank. The specialty finance segment experienced a decrease in other income in 2005 that is primarily due to no longer earning referral fees from the bank, combined with decreased advisory services revenues. This decrease is offset by an increase in servicing income caused by the increase in the number of properties serviced due to the Merger in 2005 and by recoveries of servicer advances that had been written off in previous years.
Operating expenses, excluding depreciation, amortization and interest:
Operating expenses, excluding interest, depreciation and amortization are presented in the following charts that detail the results by segment. The real estate segment portion of these costs consisted of the following:
General operating and administrative expenses in the real estate segment increased percent in 2005 as compared to 2004 as a result of having increased the rental portfolio to $1.9 billion with the February 25, 2005 Merger and the portfolio acquisitions during 2005. During 2005, these expenses include $0.7 million allocated to this segment as a result of the grant of stock and related cash compensation to members of our Board of Directors and employees during 2005. In addition, reflected in the specialty finance segment discussion of general operating and administrative below, various issues have increased the overall costs that are, in turn, allocated between segments. This increase was offset by a decrease in expenses resulting from the shift in the internal reporting of certain property development and redevelopment activities which, until 2005, reported through the real estate segment, as we view those activities as more appropriately aligned with the specialty finance segment. Direct and indirect payroll relating to these property development and redevelopment activities approximated $3.3 million during 2005. We experienced a decline in expenses in 2004 as compared to 2003 due to transferring certain financial and strategic functions, including transferring certain employees relating to the management of the external portfolios, to a subsidiary of CFG, an affiliate of our Chairman. However, this decrease was offset by an increase in additional professional fees as a result of compliance requirements with the Sarbanes-Oxley Act and increased expenses incurred in connection with the Merger with USRP.
Property expenses typically occur when tenants default on their obligations. Property expenses, state and other taxes increased compared to prior years primarily as a result of having increased the rental portfolio upon the Merger as discussed above. Property expenses also increased because as a result of the Merger, we assumed leasing arrangements where we are the tenant under some leases and are required to make rental payments of approximately $0.3 million per month and record these payments as rental expense. To the extent we have subleased these premises to another tenant, we have included the sublease rental income in rental revenues. Property expenses, which include real estate taxes, also increased due to a combination of a) acquiring approximately 77 vacant properties during the Merger for which we have to pay real estate taxes, insurance and repairs and maintenance and b) acquiring properties during the Merger that require us to pay real estate taxes directly on behalf of the tenants under the terms of the lease. To the extent we then bill the tenants for the real estate taxes, we have included the reimbursements from the tenants in other income. Property expenses were also higher in 2005 as a result of Chevy’s and Ground Round, two of our tenants, declaring bankruptcy in late 2003 and early 2004, respectively, rejecting several leases and causing us to incur legal fees, real estate taxes, insurance and repairs and maintenance on these vacant sites. Property expenses were higher in 2003 as compared to 2004 due to the higher number of vacant sites in 2003 as compared to 2004 resulting from the bankruptcies and lease rejections of three of our tenants, which included Phoenix Restaurant Group, Inc. and its subsidiaries, who filed for bankruptcy in 2001, and Roadhouse Grill, Inc. and Houlihan’s Restaurant Group who filed for bankruptcy in 2002.
Other expenses decreased during 2005 and 2004, each as compared to the prior year, due to a decrease in asset impairments related to properties held for investment and mortgage loans. Some expenses formerly presented in this category associated with properties treated as discontinued operations are incorporated in the earnings or losses from discontinued operations for all years presented.
Operating expenses, excluding interest, depreciation, and amortization in the specialty finance segment consisted of the following:
General operating and administrative expenses in the specialty finance segment increased 33 percent during 2005 as compared to 2004 and were relatively consistent in 2004 as compared to 2003. There are a number of items that have impacted the comparability between 2005 and 2004 that are summarized as follows:
·
Our expenses in this segment include a $2 million charge during 2005 resulting from a grant of stock and related cash compensation to members of our Board of Directors and employees.
·
The specialty finance segment provides lease and loan servicing to our real estate segment and to third parties. As servicer, we utilize property management software to account for leasing transactions and to capture other tenant and lease information. More than a year ago, we decided to upgrade our technology platform supporting this application. We incurred certain costs during 2005 necessary in the transition to the new application and the integration of USRP and Income Fund assets.
·
We have incurred additional expenses with the integration of the merged portfolios. While our servicing fee income in this segment for the management of the larger portfolio increased for the ten-month period after the Merger, we incurred various one-time setup expenses during to add new properties creating an excess of new expenses over new revenues that should stabilize in the future. The Income Fund portfolio had been previously serviced by the specialty finance segment and did not create significant additional integration costs.
·
Prior to 2005 certain services were purchased from affiliates of two of our Board members. These included human resources, tax planning and compliance, computer systems support, investor relations and other services. Throughout 2005, we brought substantially all of these functions on board in an initiative that began in November 2004. During this process, we incurred certain expenses such as recruitment and training of new employees and the separate licensure and maintenance of software previously leveraged among a wider enterprise affiliated with certain Board members.
·
We have shifted the internal reporting of certain property development and redevelopment activities previously reported through the real estate segment. Direct and indirect payroll relating to the property development and redevelopment activities approximated $3.3 million during 2005.
Property expenses in this segment represent activities in property development and redevelopment transitions from the real estate segment this year and costs associated with activities merged into this segment from USRP. The decrease in the line item for other expenses relates to impairments and a decrease in the minority interest in income of consolidated joint ventures. The specialty finance segment recorded provisions for loan losses of $0.1 million and $4.7 million in 2005 and 2003, respectively, associated with non-performing loans, and a recovery of $0.5 million due to improved performance on its loan portfolio during 2004. The segment also recorded write-offs of $1.0 million and $1.6 million during 2004 and 2003, respectively, relating to its 1998-1 and 1999-1 residual interests. The specialty finance segment recorded these amounts based on its determination that a permanent impairment in value had occurred as a result of certain borrower delinquencies within these securitized pools. The decrease in minority interest in income of consolidated joint ventures during 2005 was due to a decrease in activities of the consolidated joint venture. We sold the last remaining properties in 2005 and dissolved the joint venture in July 2005.
Interest Expense
Interest expense for each segment is illustrated in the following table:
Interest expense in the real estate segment increased approximately $51.2 million or percent, during 2005, as compared to 2004, due to the increased level of debt. Total debt at the real estate segment increased to $1.3 billion at December 31, 2005 versus $0.4 billion at December 31, 2004. The increase was a result of the Merger financings completed by April 2005, in addition to assuming existing debt as part of the Merger and from exercising our option to increase our term loan by $100 million. The weighted average interest rate on all borrowings was 5.99 percent at December 31, 2005 versus 5.92 percent at December 31, 2004. Included in interest expense within the real estate segment is amortization of deferred financing costs of $8.4 million, $4.3 million and $3.4 million for 2005, 2004 and 2003, respectively. The increase in deferred financing costs in 2005 was due to incurring costs to put the new Merger financing in place between February and April 2005.
The specialty finance segment experienced a 42 percent decrease in interest expense in 2005 as compared to 2004. The decrease was primarily due to the transfer of the pool of mortgage loans and related $161 million of debt to real estate segment on March 31, 2005 and the early extinguishment of the $22 million Subordinated Note Payable in April 2005. The specialty finance segment experienced a 23 percent decrease in interest expense in 2004 as compared to 2003. The decrease was partially the result of the $10 million pay down of the Subordinated Note Payable and the related decrease of the interest rate on this facility from 8.5 percent to 7.0 percent in January 2004. In September 2004, the specialty finance segment repaid an additional $11.875 million on the Subordinated Note Payable. Interest expense also decreased because the specialty finance segment paid down the existing mortgage warehouse facility by approximately $12.3 million in December 2003 when it sold mortgage loans receivable to the real estate segment, as described above. As a result of the sale of these mortgage loans receivable the specialty finance segment terminated the fair value hedge associated with mortgage loans receivable and eliminated the interest expense on the interest rate swap. Interest expense also decreased during 2004 because of a partial unwind of a cash flow hedge.
Depreciation and Amortization
Depreciation and amortization expense for each segment is illustrated in the following table:
The real estate segment experienced an increase in depreciation and amortization expense of $18.9 during 2005 as compared to 2004 million as the result of the Merger and portfolio acquisitions increasing the rental portfolio to $1.9 billion.
Loss on Termination of Cash Flow Hedge
During 2005 the real estate segment recorded a loss on termination of cash flow hedge of $8.6 million. In July 2005 the real estate segment sold a portfolio of mortgage loans, repaid the related debt and recorded a $10.6 million loss on termination of cash flow hedge that was previously recorded in other comprehensive income (loss). This amount was partially offset by approximately $2 million which represented the decrease during 2005 in the fair value of the hedge liability from the time hedge accounting was discontinued to the sale of the loans.
The specialty finance segment recorded a loss on termination of cash flow hedge of $0.9 million and $0.5 million during 2004 and 2003, respectively. In conjunction with our Note Payable pay down of approximately $5.8 million during 2004, we unwound a portion of our cash flow hedge to comply with our hedge agreement. The loss during 2003 relates to the prepayment of mortgage loans by a borrower causing the specialty finance segment to pay down a portion of the related debt collateralized by these mortgages and to also unwind a portion of the related swap.
Gain on Sale of Assets
During 2005, gain on sale of assets of $9.6 million was recorded by the real estate segment. This gain resulted from the July 2005 sale of approximately $194 million of mortgage loans to a third party.
Discontinued Operations
We break discontinued operations into two categories, real estate and retail. In the real estate category, under generally accepted accounting principles (“GAAP”), when a property is designated as held for sale, such as all of the properties purchased under our IPS program, all income and certain expenses relating to the property and the ultimate gain or loss realized upon its disposition are treated as discontinued operations for all periods presented. If an existing investment property is so designated, depreciation is discontinued. Revenues associated with these properties are not reflected in the “Revenues” line item in our income statement, but instead, along with expenses and any gain or loss from its sale, are presented separately under the “Income (loss) from discontinued operations”. In addition, only operating and administrative expenses that are directly attributable to acquiring or selling these properties are allocated to the “Income (loss) from discontinued operations” and all other general and operating and administrative expenses are allocated to “Income (loss) from continuing operations”.
The following table shows our results from discontinued operations:
Our real estate segment periodically sells properties in the portfolio. We may have a performing property and believe it to be an opportune time to sell the asset and realize value. Also, we believe the best strategy to resolve certain vacant properties is to sell them. We sold $61.1 million, $34.8 million and $32.4 million in properties during 2005, 2004 and 2003, respectively, generating gains of $9 million, $7.7 million and $3.7 million, respectively.
While GAAP requires us to disclose our investment property sales program as a discontinued operation, we do not manage it in that manner. It is a vital business operation that was developed over the last five years that allows us to compete on large transactions and appropriately mitigate risk and manage concentrations. Since 2001, in our specialty finance segment, we have sold approximately $1.1 billion in restaurant properties generating net pre-tax gains of $133.5 million. At December 31, 2005, we had approximately $206.5 million in real estate held for sale in our specialty finance segment.
Our specialty finance segment operated 18 convenience and gas stores in Hawaii. This business was previously operated by USRP and was acquired as part of the Merger. On February 24, 2005, the day before the Merger, USRP entered into a definitive agreement to sell the business to Aloha Petroleum, Ltd. ("Aloha"). The terms of that agreement resulted in us maintaining ownership of the real estate on eleven convenience and gas properties, which would be leased to Aloha. As described above in “Liquidity and Capital Resources”, we did not record any gain or loss on the sale of these assets. During 2005, the Hawaiian operations produced pre-tax income of approximately $0.4 million before consideration of indirect corporate overhead.
During 2003 and 2004, our real estate segment operated twelve restaurants in a subsidiary that was sold in the fourth quarter of 2004. While not our core expertise, we acquired the operations of the franchisee to preserve the value of our real estate investment because the franchisee was experiencing financial difficulties.
We are primarily treated as a REIT and generally record no tax expense. However, we have a taxable REIT subsidiary ("TRS”), where various business operations take place including the IPS program. The TRS recorded an income tax provision of approximately $10.0 million and $10.9 million for the years ended December 31, 2005 and 2004, respectively. The TRS recorded an income tax benefit of approximately $6.3 million for year ended December 31, 2003.
The $10.0 million income tax provision at December 31, 2005 includes a non-cash $3.2 million deferred tax charge resulting from the transfer of loans from the TRS to the REIT. The mortgage loans, with a principal balance of $185.7 million and a value of $194 million, were transferred to more appropriately align the holding of those mortgage loans with our objective of holding real estate properties as long-term investments. The transfer was executed by way of a purchase of a percent interest in the subsidiary that held the mortgage loans. We initially entered into an interest rate swap in 2002 to mitigate a portion of the variability related to the interest costs on our borrowings that financed the loans. The hedge met the definition of a cash flow hedge, and as a result, changes in its value period to period are reported in other comprehensive income ("OCI"). Valuation changes in the swap are required to be reflected net of applicable income taxes at the then applicable tax rate. The hedge liability generated a deferred tax asset in 2002 that was offset by a valuation allowance. In 2003, we met the criteria under GAAP to reverse the valuation allowance, and in effect realized the tax benefit through net income and not OCI. With this accounting treatment, all future valuation adjustments to the hedge liability impact both earnings and OCI. Had we not transferred the pool of loans to the real estate segment, the $2.7 million charge in 2005 would have continued to be amortized as a charge to earnings over the life of the hedge contract. These loans were subsequently sold to a third party as discussed above.
Item 7a.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
This information is described above in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Report of Independent Registered Certified Public Accounting Firm
To the Board of Directors and Stockholders of
Trustreet Properties, Inc.
We have completed integrated audits of Trustreet Properties, Inc.’s 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2005, and an audit of its 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements and financial statement schedules
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Trustreet Properties, Inc. and its subsidiaries at December 31, and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2005 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Orlando, Florida
March 16,
Item 8.
Item 8. Financial Statements and Supplementary Data.
TRUSTREET PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
See accompanying notes to consolidated financial statements.
TRUSTREET PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS - CONTINUED
(In thousands)
See accompanying notes to consolidated financial statements.
TRUSTREET PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except for per share data)
See accompanying notes to consolidated financial statements.
TRUSTREET PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME/(LOSS)
Years ended December 31, 2005, 2004 and 2003
(In thousands)
See accompanying notes to consolidated financial statements.
TRUSTREET PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME/(LOSS)
Years ended December 31, 2005, 2004 and 2003
(In thousands)
See accompanying notes to consolidated financial statements.
TRUSTREET PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME/(LOSS)
Years ended December 31, 2005, 2004 and 2003
(In thousands)
See accompanying notes to consolidated financial statements.
TRUSTREET PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See accompanying notes to consolidated financial statements.
TRUSTREET PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(In thousands)
See accompanying notes to consolidated financial statements.
Refer to Note 2 to the consolidated financial statements for the allocation of assets acquired and liabilities assumed as part of the Merger in February 2005.
During the year ended December 31, 2003, the Company designated approximately $23.7 million from mortgage loans held for sale to held for investment. The loans serve as collateral for bonds issued by the Company.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2005, 2004 and 2003
1.
Organization and Summary of Significant Accounting Policies:
Organization and Nature of Business - Trustreet Properties, Inc. (the “Company”) is the new name adopted upon the Merger (the “Merger”) of CNL Restaurant Properties, Inc. (“CNLRP”) and eighteen CNL Income Fund partnerships (“the Income Funds”) with and into U.S. Restaurant Properties, Inc. (“USRP”) on February 25, 2005.
The Company, a Maryland corporation, is a self-administered real estate investment trust (“REIT”). The Company’s operations are managed, operated and reported on two distinct segments, a real estate segment and a specialty finance segment. The real estate segment primarily acquires, owns, and manages a portfolio of single-tenant restaurant properties that are generally leased to established tenants under long-term triple-net leases and holds a small portfolio of mortgage loan receivables. The specialty finance segment provides financing, development and advisory services to national and regional restaurant operators. The specialty finance segment includes the Company’s investment property sales program, our real estate development and redevelopment group and to a lesser extent, investment banking services, to national and regional restaurant operators.
Beginning in June of 2000, the specialty finance segment was operated by a subsidiary of the Company through a partnership and alliance with Bank of America, N.A. (the “Bank”) and CNL/CAS Corp., an affiliate of the Company’s chairman. In 2003 and 2004, the Company modified certain terms relating to the alliance with the Bank that resulted in the Bank reducing its ownership interest in the specialty finance segment. Effective January 1, 2005, the Bank and CNL/CAS Corp agreed to redeem their remaining balance of their ownership interest in the specialty finance segment. The Company and the Bank agreed to continue the alliance for five years, but modified the referral fees program. As a result of these modifications, the Company’s ownership interest in the specialty finance segment increased to 100 percent.
Operating results for the year ended December 31, 2005 include the results of CNLRP from January 1, 2005 through February 24, 2005 and include the operating results of the merged Company from February 25, 2005 through December 31, 2005. Amounts prior to December 31, 2004 are those of CNLRP.
Principles of Consolidation - The consolidated financial statements of the Company include its majority owned and controlled affiliates and variable interest entities for which the Company is the primary beneficiary. The primary beneficiary of a variable interest entity is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both, as a result of holding a variable interest that changes with changes in the fair value of the entity’s net assets. All significant intercompany balances and transactions among consolidated affiliates and variable interest entities have been eliminated. The equity method of accounting is applied to those investments in non-controlled joint ventures that do not meet the variable interest entities criteria. The Company records investments in equity securities that are not readily marketable at cost. Minority interests represent the minority joint venture partners’ proportionate share of the equity in the Company’s consolidated joint ventures.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
1.
Organization and Summary of Significant Accounting Policies - Continued:
Use of Estimates - Preparation of the financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities. Significant estimates include provisions for impairment of real estate and loans, accruals, deferred tax assets, goodwill, useful lives of assets, franchise loan investments, asset retirement obligations and environmental liabilities. Actual results could differ from those estimates.
Real Estate and Lease Accounting - The Company records its properties comprised of land, buildings and equipment at cost. Management reviews its properties for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable through operations or sale. Management determines whether impairment in value has occurred by comparing the estimated future undiscounted cash flows, including the residual value of the property, with the carrying cost of the individual property. If impairment is indicated a loss will be recorded for the amount by which the carrying value of the asset exceeds its fair value.
Properties leased to restaurant operators are generally on a triple-net basis, whereby the tenant is responsible for all operating expenses relating to the property, including property taxes, insurance, maintenance and repairs. The leases are accounted for using either the direct financing method for capital leases or the operating method:
Operating method - Leases accounted for using the operating method are recorded at the cost of the asset. Revenue is recognized as rentals are earned and depreciation is charged to operations on a straight-line basis over seven years for equipment and over years for buildings. Contingent rent is recognized as revenue after the related lease sales targets are achieved. When scheduled rentals vary during the lease term, income is recognized on a straight-line basis so as to produce a constant periodic rent over the term of the lease. Accrued rental income is the aggregate difference between the scheduled rents which vary during the lease term and the income recognized on a straight-line basis.
Direct financing method - All of the Company’s capital leases are accounted for using the direct financing method and are recorded at the net investment that, at the inception of the lease, generally represents the cost of the asset. Unearned income is deferred and amortized into income over the lease terms so as to produce a constant periodic rate of return on the Company’s net investment in the capital leases.
Purchase Accounting for Acquisition of Real Estate - For purchases of real estate held for investment that were consummated subsequent to June 30, 2001, the effective date of SFAS No. 141, “Business Combinations,” the fair value of the real estate acquired is allocated to the acquired tangible assets, consisting of land and building, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, the value of in-place leases, and the value of tenant relationships, based in each case on their relative fair values.
The fair value of the tangible assets of an acquired property is determined by valuing the property’s land and building as if it were vacant. Management uses several methodologies to determine fair market value for assets including qualified appraisals.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
1.
Organization and Summary of Significant Accounting Policies - Continued:
In allocating the fair value of the identified intangible assets and liabilities of an acquired property, above-market and below-market in-place lease values are recorded at the present value (using a discount rate reflective of the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above-market lease values are amortized as a reduction of rental income over the remaining non-cancelable terms of the respective leases and the capitalized below-market lease values are amortized as an increase to rental income over the remaining non-cancelable terms of the respective leases.
The value of the in-place lease is measured as the present value of the estimated value of the theoretical unrealized lease rental income over a construction period. The value of the tenant relationship is calculated as the present value of the lease income during an estimated vacancy period not incurred at the end of the lease term if a lease is projected to be renewed by the tenant. The value of in-place leases and tenant relationships, exclusive of the value of above-market and below-market in-place leases, is amortized to expense over the remaining non-cancelable periods of the respective leases. If a lease were to be terminated prior to its stated expiration, all unamortized amounts relating to that lease would be written off.
When real estate is disposed, the related cost, accumulated depreciation, identified intangible assets and liabilities, the related accumulated amortization of intangibles and any accrued rental income for operating leases and the net investment for capital leases are removed from the accounts and gains and losses from the dispositions are reflected in income. Income from disposition of real estate is recognized in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 66 “Accounting for Real Estate Sales.”
Real Estate Held for Sale - The Company acquires, develops and currently owns properties that it intends to sell. The properties that are classified as held for sale primarily consist of properties that have been acquired in the marketplace with the intent to resell. Rental income is recognized without regard to potential future rent increases and the asset is not depreciated. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company classifies its real estate held for sale as discontinued operations for each property in which rental revenues are generated. When real estate held for sale is disposed, the related costs are removed from the accounts and gains and losses from the dispositions are reflected in income from discontinued operations.
Notes Receivable - The Company originated loans to restaurant operators prior to May 2001 and acquired through the Merger, notes and mortgage notes that are generally collateralized by real estate, equipment and business enterprise value. The Company expects these loans to be held until maturity. The loans are recorded at cost and are reduced for any estimated future loss. Whenever it appears that future collection on specific loans appears doubtful, a provision for loan losses is established. The provision for loan losses represents the difference between the carrying amount and the amount management expects to receive. Increases and decreases in the allowance due to changes in the measurement of the impaired loans are included in impairment provisions on assets. Loans continue to be classified as impaired unless they are brought fully current and the collection of scheduled interest and principal is considered probable. Accrual of interest is discontinued when management believes, after considering economic and business conditions and collection efforts, that the borrowers’ financial condition is such that collection of interest is doubtful. Subsequent interest is recorded as income upon receipt.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
1.
Organization and Summary of Significant Accounting Policies - Continued:
Cash and Cash Equivalents - The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. These amounts may exceed federally insured levels, however, the Company has not experienced any losses in such accounts.
Restricted Cash - Restricted cash relates to cash held in escrow, subject to certain restrictions and cash received in connection with assets held as collateral for certain debt and is subject to restrictions until released by the trustee.
Derivative Financial Instruments - The Company utilizes derivative instruments to partially offset the effect of fluctuating interest rates on the cash flows associated with a portion of its variable-rate debt. All derivative instruments are recorded on the balance sheet at fair value. Accounting for the changes in the fair value of derivatives associated with hedge transactions is dependent upon the intended use of the derivative and their resulting designation as follows:
Fair-value hedge transactions - When the Company hedges changes in the fair value of an asset or liability, the effective changes in the value of the derivative instrument are offset in the income statement by changes in the value of the hedged item.
Cash-flow hedge transactions - When the Company hedges variability of cash flows related to a variable-rate asset or liability or a forecasted transaction, effective changes in the value of the derivative instrument are reported in other comprehensive income and subsequently recognized in operations in the periods in which earnings are impacted by the variability of the cash flows of the hedged item or forecasted transaction.
The ineffective portion of all hedges are reflected in earnings.
Securitizations - Between 1999 and 2001, certain loans were originated and sold to entities that, in turn, issued securities to investors backed by these assets. The Company retained the servicing rights and participates in cash flows from the retained equity positions and lower rated securities. The present value of the expected cash flows for each retained security, after payment of principal and interest to third-party bond or certificate holders, over the estimated cost of servicing was recorded at the time of sale as a retained interest. The Company’s investments in the residual interest in these securitization transactions and an interest-only strip are classified as available-for-sale securities and are included in other assets. Available-for-sale securities are recorded at fair value in other assets on the balance sheet, with the change in fair value during the period excluded from earnings and recorded as a component of other comprehensive income. Accounting for the retained interests requires the Company to estimate their value using market trends and historical experience, expected prepayments and defaults. This information is considered, along with prevailing discount rates and the terms of the bonds and certificates, to arrive at current fair value amounts and determine whether a permanent impairment in value has occurred. The fair value of these investments, including accrued interest, were $16.0 million and $16.5 million at December 31, 2005 and 2004, respectively.
Loan Costs - Loan costs incurred in connection with debt have been deferred and are being amortized over the term of the related debt using the effective interest method. Loan costs are included in other assets in the financial statements. As of December 31, 2005 and 2004, the Company had capitalized loan costs of $50.8 million and $24.3 million, respectively and recorded accumulated amortization of $17.6 million and $11.6 million, respectively.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
1.
Organization and Summary of Significant Accounting Policies - Continued:
Goodwill - The excess of the cost of an acquired business over the net of the amounts assigned to assets acquired (including identified intangible assets) and liabilities assumed is recorded as goodwill. Goodwill is not amortized but is tested for impairment at a level of reporting referred to as a reporting unit on an annual basis, or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairments resulting from this analysis are charged to results of operations in the period in which any impairment is determined. Goodwill attributable to the real estate segment and specialty finance segment was $179.6 million and $56.3 million, respectively. No impairment was required at December 31, 2005 or 2004.
Income Taxes - The Company elected to be taxed as a REIT for federal income tax purposes. The Company generally will not be subject to federal corporate income taxes on amounts distributed to stockholders, providing it distributes at least 90 percent of its taxable income and meets certain other requirements for qualifying as a REIT. Earnings and profits, which determine the taxability of dividends to stockholders, differ from reported net income as a result of differing treatment of items for financial versus tax reporting, such as different lives and methods used to depreciate investment properties. Notwithstanding qualification as a REIT for tax purposes, the Company is subject to certain state taxes on its income and property.
Effective January 1, 2001, the Company's subsidiary, CNL-Restaurant Capital Corp., has elected to be treated as a taxable REIT subsidiary (“TRS”) pursuant to the provisions of the REIT Modernization Act. As a TRS, its operating Partnership, CNL-Restaurant Capital, is able to engage in activities resulting in income that previously would have been disqualified from being eligible REIT income under the federal income tax statute and regulations. Certain activities reside within CNL-Restaurant Capital Corp. that are therefore subject to federal income taxes. A second less significant TRS began operations during 2002 and is also subject to federal income taxes. Effective with the Merger, the TRS activities of USRP and CNLRP’s smaller TRS combined to form a single consolidated TRS.
Environmental Remediation Costs - The Company accrues for losses associated with environmental remediation obligations when such losses are probable and reasonably estimable. As part of the Merger, the Company acquired some properties relating to gas stations and convenience stores that had some existing known environmental conditions being handled by third parties. The Company estimated approximately $4.6 million in losses from environmental remediation obligations as of the Merger date. Through December 31, 2005, the Company had paid approximately $0.6 million relating to these environmental matters.
Asset Retirement Obligations - As a result of the Merger, the Company assumed retirement obligations for the removal of tanks, fuel lines and other required modifications to the Company’s gas stations, as well as estimated future costs to restore land leased under ground leases to its original condition. The fair value of asset retirement obligations assumed on the Merger Date was $0.62 million and was recorded as a liability based on expected future cash outlays, discounted to its present value based on the Company’s credit-adjusted risk-free rate. Over time, the liability is accreted for the change in present value, with this effect included in expenses. The Company recorded accretion expense of $0.04 million and had a balance of $0.66 million at December 31, 2005.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
1.
Organization and Summary of Significant Accounting Policies - Continued:
Earnings Per Share - Prior to the Merger, CNLRP stockholders owned 45.2 million shares of CNLRP common stock. As a result of the Merger, CNLRP stockholders received 0.7742 shares of USRP common stock for each CNLRP share and an additional 7.2 million shares of Series C preferred. The Company has restated the weighted average shares outstanding calculation for all periods presented to show the effect of the exchange of the shares as a result of the Merger.
The Company reports both basic and diluted earnings per share. Basic earnings per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share reflects the dilutive effect of stock options, restricted stock and convertible preferred stock. Diluted earnings per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares and common share equivalents outstanding during the period, which are computed using the treasury stock method for outstanding stock options. Common share equivalents are excluded from the computations in periods in which they have an anti-dilutive effect.
Equity Compensation Plan - As a result of the Merger, the Company adopted USRP’s Flexible Incentive Plan (“Incentive Plan”). Under the Incentive Plan, the Company may grant shares of restricted common stock or options to purchase common stock. Pursuant to this Incentive Plan, stock options may be granted at any time and the aggregate outstanding options that can be granted shall be at an amount equal to or less than 4.9% of the Company’s issued and outstanding shares of common stock at the date of grant. Options may be exercised through either the payment of cash or the transfer of shares of the Company’s common stock owned by the optionee.
Reclassifications - Certain items in the prior years’ financial statements have been reclassified to conform to the 2005 presentation. These reclassifications had no effect on stockholders’ equity or net income.
New Accounting Standards -In December 2004, FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets.” This statement is effective for the fiscal years beginning after June 15, 2005. This statement addresses financial accounting and reporting obligations associated with the exchange of nonmonetary assets. The statement eliminates the exception to fair value for exchanges of similar productive assets issued in APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” and replaces it with a general exception for exchange transactions that do not have commercial substance, that is, transactions that are not expected to result in significant changes in the cash flows of the reporting entity. The adoption of this interpretation is not expected to have a significant impact on the financial position or results of operations of the Company.
As of March 31, 2005, the Company early adopted the provisions of SFAS No. 123(R), “Share−Based Payments” (“FAS 123(R)”), which establishes accounting standards for all transactions in which an entity exchanges its equity instruments for goods and services. FAS 123(R) focuses primarily on accounting for transactions with employees, and carries forward without change prior guidance for share−based payments for transactions with non−employees. FAS 123(R) eliminates the intrinsic value measurement objective in APB Opinion No. 25 and generally requires management of the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the date of the grant. The standard requires grant date fair value to be estimated using either an option−pricing model which is consistent with the terms of the award or a market observed price, if such a price exists. Such cost must be recognized over the period during which an employee is required to provide service in exchange for the award or the requisite service period (which is usually the vesting period). The standard also requires management of the Company to estimate the number of instruments that will ultimately be issued, rather than accounting for forfeitures as they occur. The Company elected to adopt
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
1.
Organization and Summary of Significant Accounting Policies - Continued:
the modified prospective application method as provided by FAS 123(R). Under the modified prospective method, compensation cost is recognized for all awards granted after adoption of this standard and for the unvested portion of previously granted awards that are outstanding on that date.
In May 2005, FASB issued SFAS No. 154, “Accounting Changes and Error Corrections (as amended)” This statement is effective for the fiscal years beginning after December 15, 2005. This Statement replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. Opinion previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This Statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The adoption of this interpretation is not expected to have a significant impact on the financial position or results of operations of the Company.
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations”. This interpretation clarifies that the term conditional asset retirement obligation as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligation”, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. Thus, the timing and (or) method of settlement may be conditional on a future event. This interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. This interpretation is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of this interpretation does not have a significant impact on the financial position or results of operations of the Company.
2.
Merger:
On August 9, 2004, CNLRP announced that it had entered into a definitive agreement and plan of Merger with USRP, a publicly traded real estate investment trust, and on February 25, 2005, completed the transactions contemplated by the agreement, including the Merger of CNLRP into USRP, the change of USRP’s name to Trustreet Properties, Inc. and the acquisition of the Income Funds. CNLRP previously managed the real estate portfolios of the Income Funds under agreements that terminated effective with the Merger. The Merger was structured to be tax-free to the stockholders of CNLRP and USRP but taxable with respect to the Income Funds. In order to effect the Merger, the Company entered into several new financing transactions. As a result of the Merger, the Company became the largest publicly traded REIT in the United States focused primarily on the restaurant industry and further diversified the Company’s real estate portfolio.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
2.
Merger - Continued:
The Merger of CNLRP into USRP through an exchange of equity interests was accounted for using the purchase method of accounting, and CNLRP was treated as the acquiror for accounting purposes since the former common stockholders of CNLRP owned approximately 60.7% and the former common stockholders of USRP own approximately 39.3% of the outstanding common stock of the combined company on a fully diluted basis. In addition, the former directors of CNLRP make up a majority of the current board of directors and the former executive officers of CNLRP manage the Company. As a result of CNLRP being treated as the acquiror for accounting purposes, the assets and liabilities of CNLRP continue to be recorded at historical values. The assets and liabilities of USRP and the Income Funds were recorded at their estimated fair values at the date of the Merger, with the excess of the purchase price of USRP over the sum of tangible and identifiable intangible fair values of USRP recorded as goodwill.
In connection with the allocation of the purchase price to real estate finalized during the fourth quarter of 2005, the following methodology was utilized:
·
The fair value of land and buildings was estimated as if the properties were vacant. The land value was estimated and the buildings were valued at estimated replacement cost less depreciation.
·
For properties currently under lease, an analysis was performed to determine whether the current lease terms were above or below market rate and an asset or liability, respectively, was determined using discounted cash flows.
·
For properties currently under lease, the value associated with having a lease in place was estimated by evaluating the present value of the lost rents for each property that would have resulted if the properties had to be constructed and the costs related to executing the lease.
·
The benefit of having a tenant in each specific property with a high likelihood of renewing the lease at the end of the current term was evaluated and a value was determined using the present value of rents during a standard re-lease period.
The purchase price relating to the exchange of interests between USRP and CNLRP was based upon the market capitalization of USRP using an average trading price of USRP common stock and traded Series A Preferred Stock for the day before and the day of the announcement of the proposed Merger on August 9, 2004, as well as the estimated market values for the Series B Convertible Preferred Stock (“the Series B Preferred Stock”) of USRP plus certain Merger related costs incurred by CNLRP.
(a) Includes a $7.5 million premium as a result of the Merger triggering the redemption provisions of the Series B Preferred Stock.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
2.
Merger - Continued:
As a result of the exchange of interests between CNLRP and USRP, 45.2 million shares of CNLRP common shares were converted into (i) 35.2 million USRP common shares and (ii) 7.2 million newly issued shares of USRP’s Series C Preferred Stock, using an exchange rate of (i) 0.7742 for common shares and (ii) 0.16 per preferred shares. The Company recorded goodwill of approximately $179.6 million which represented the excess of the fair value of the USRP common stock over the fair value of its tangible and identifiable intangible net assets.
The acquisition of each of the Income Funds by USRP through a combination of cash and USRP Series A Preferred Stock interests was also accounted for using the purchase method of accounting and the assets and liabilities of the Income Funds were recorded at their estimated fair values at the date of the Mergers. The purchase price for the Income Funds was determined as follows:
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
2.
Merger - Continued:
The following table shows the allocation of the purchase consideration:
(1) The goodwill was assigned to the real estate segment.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
2.
Merger - Continued:
In order to gauge the estimated cost of soil and groundwater contamination from the accidental loss of petroleum and other solvents from the Company’s underground storage tanks during the first quarter of 2005, the Company performed a number of site investigations of the acquired USRP properties. Based upon the most recent environmental site assessments by its environmental consultants, the Company accrued its best estimate of $4.6 million, on a non-discounted basis, for the remediation and post-monitoring expenses. This amount is included in environmental and exit costs liability in the table above. It is reasonably possible that the Company’s recorded estimate of its obligation may change in the near term.
The following unaudited pro forma condensed consolidated financial information has been prepared utilizing the historical financial statements of CNLRP, USRP and the historical combined financial information of the Income Funds. The unaudited pro forma condensed consolidated statements of earnings assume that the Mergers had occurred as of the beginning of each of the periods presented, after giving effect to certain adjustments including a) rental income adjustments resulting from the straight-lining of scheduled rent increases as if the real estate had been acquired as of the beginning of each of the periods presented, b) the amortization of the intangible assets relating to above market leases and liabilities relating to below market leases over the remaining lease terms, c) the amortization of below market lease liabilities over the remaining lease terms plus renewal options, as applicable, d) elimination of intercompany fees and expenses between CNLRP and the Income Funds, e) adjustments to depreciate real estate assets over the depreciable lives and f) the amortization of identifiable leases in place intangibles and tenant relationship intangibles over the remaining lease terms. The following information also gives effect to the additional interest expense and amortization of loan costs resulting from entering into a series of financings as part of the Merger consisting of a $275 million net lease securitization, the issuance of $250 million in senior unsecured notes, and a $175 million term loan, net of the effect of eliminating the interest expense and amortization of loan costs relating to the repayment of $213 million of indebtedness. The unaudited proforma condensed financial information is not indicative of the results of operations that would have been achieved had the Mergers reflected herein been consummated on the dates indicated or that will be achieved in the future.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2005, 2004 and 2003
2.
Merger - Continued:
The proforma amounts for the year ended December 31, 2005, includes a non-cash tax charge of $3.2 million and $8.7 million of Merger expenses.
3.
Real Estate Investment Properties:
Real estate investment properties consist of the following at:
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2005, 2004 and 2003
3.
Real Estate Investment Properties - Continued:
In 2005, 2004 and 2003 the Company recorded provisions for impairment of $0.1 million, $1.2 million and $2.1 million, respectively. The tenants of these properties experienced financial difficulties and/or ceased payment of rents under the terms of their lease agreements. The provisions represent the amount necessary to reduce the properties’ carrying value to estimated fair value.
For the years ended December 31, 2005, 2004 and 2003 tenants paid or are expected to pay directly to real estate taxing authorities approximately $31.3 million, $10.1 million and $10.3 million, respectively, in real estate taxes in accordance with the terms of their triple-net leases.
Substantially all property leases have initial terms of 15 to 20 years (most expiring between 2006 and 2025) and provide for scheduled rent increases, and in some cases, contingent rent. The leases generally allow the tenant to purchase the property at the greater of the Company's purchase price plus a specified percentage or fair market value at specified times. Fixed and determinable lease revenues are recognized on a straight-line basis over the terms of the leases. For the years ended December 31, 2005, 2004 and 2003, the Company recognized $7.7 million, $3.3 million and $5.4 million, respectively, of accrued rental income. The Company recognized contingent rent revenues of $4.0 million, $0.7 million and $0.3 million for the years ended December 31, 2005, 2004 and 2003, respectively, of which $0.2 million, $0.09 million and $0.08 million are reflected as “Income from discontinued operations,” respectively, in the Company’s Consolidated Statements of Income.
Future minimum contractual lease payments to be received under noncancellable operating leases at December 31, 2005 are as follows:
4. Net Investment in Capital Leases:
The components of net investment in capital leases consist of the following at:
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years Ended December 31, 2005, 2004 and 2003
4. Net Investment in Capital Leases - Continued:
The following is a schedule of future minimum lease payments to be received on capital leases at December 31, 2005:
The Company’s real estate segment recorded provisions for losses on capital leases totaling $0.3 million during the year ended December 31, 2004. The tenants of these properties experienced financial difficulties and ceased payment of rents. The provisions represent the amount necessary to reduce the carrying values of the capital leases to their estimated fair value.
5.
Real Estate Held for Sale:
Real estate held for sale consists of the following at December 31:
As part of the Merger, the Company acquired several convenience, gas and restaurant operations which were under contract to sell as of the date of the Merger. In September 2005, the Company sold eighteen gas station operating units and a percent interest in a bulk fuel loading terminal located in Hawaii. The values assigned to these assets at the Merger date were the expected net sales proceeds, as a result of which, the Company did not record any gain or loss on the sale of these assets. The sales proceeds of $10.2 million were deposited into an escrow account and as of March 15, 2006, all pending tax issues have been cleared and the release of escrowed funds is pending certain administrative approvals.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
5.
Real Estate Held for Sale - Continued:
Operating results of discontinued operations are as follows:
6.
Mortgage, Equipment and Other Notes Receivable:
Mortgage, equipment and other notes receivable consist of the following at December 31:
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
6.
Mortgage, Equipment and Other Notes Receivable - Continued:
Approximately $79 million and $273 million of the outstanding principal balance as of December 31, 2005 and 2004, respectively, is secured by mortgages. The remaining principal is secured by franchise restaurant equipment and other collateral. The loans carry interest rates ranging from 2.4 percent to 12.5 percent. The loans are due in monthly installments with maturity dates ranging from 2006 to 2023 and generally prohibit prepayment for certain periods or include prepayment penalties. As of December 31, 2005 and 2004, approximately $16.1 million and $15.0 million in notes receivable are considered impaired and approximately $3.5 million and $2 million are non-accrual status with regard to recognition of interest. The Company recognized $0.3 million and $0.5 million of interest income as of December 31, 2005 and 2004, respectively, on impaired loans.
During July 2005, the Company sold mortgage loans receivable of approximately $194 million to a third party. The sale resulted in a gain of approximately $9.6 million and a related hedge loss of $8.6 million. The gain is reflected in gain on sale of assets in the accompanying statement of income.
Changes in the allowance for loan losses for 2005 and 2004 are summarized as follows:
7. Securitized Portfolios:
The following table represents the securitized portfolio and all managed loans as of December 31:
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
7. Securitized Portfolios - Continued:
The total loan portfolio managed by the Company, including the loan portfolio managed for others, had net charge-offs during the years ended December 31, 2005, 2004 and 2003 of $3.8 million, $7.5 million and $14.5 million, respectively.
The following table summarizes cash flows received from and paid to securitization trusts for the years ended December 31:
8.
Intangible Lease Costs:
Intangible lease costs consists of the following at December 31:
Above market lease values are amortized to rental income over the remaining terms of the leases acquired in connection with each applicable property. The weighted average amortization period for above market leases is 10.5 years. Leases in place and tenant relationships are amortized over the remaining terms of the leases acquired in connection with each applicable property and the amortization is included in depreciation and amortization expense. The weighted average amortization period for leases in place and tenant relationships are 12.8 years and 8.3 years, respectively. The weighted average amortization period for all intangible assets is 10.2 years.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
8.
Intangible Lease Costs - Continued:
The Company recognized aggregate amortization expense on intangible assets of approximately $9.8 million for 2005. Based on the balance of intangible assets at December 31, 2005, subject to amortization, the estimated aggregate amortization expense for each of the succeeding five years and thereafter is as follows:
9.
Borrowings:
Borrowings consist of the following at December 31:
(a)
Assumed debt as a result of the Merger described in Note 2.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
9.
Borrowings - Continued:
Revolver and Term Loan. Through December 2004, CNLRP’s short term debt consisted of a $40 million revolving line of credit (the “Revolver”). In February 2005, CNLRP amended the Revolver to increase the capacity from $40 million to $60 million. In February 2005 the Company obtained bridge financing with the lender consisting of a senior collateralized revolving credit facility of up to $125 million and a senior collateralized term loan of up to $650 million. The new revolving facility replaced the Company’s previous revolving line of credit. The bridge financing bore interest at a floating rate of the London Interbank Offer Rate, or LIBOR, plus three percent. In March 2005, the Company reduced the capacity to $385 million on the senior collateralized term loan when it paid off $265 million of the outstanding balance and terminated that portion of the bridge financing. In April 2005, the Company entered into a senior credit facility (the “Facility”) with available capacity of $350 million with a syndicate of lenders. The Company paid approximately $4.5 million in fees to the lenders for lending and administrative services related to the financing. In April 2005, the Company drew on the Facility to pay off the outstanding balance and terminate the bridge Revolver and term loan. The Facility consists of a revolving credit facility in an initial amount of $175 million and a term loan of $175 million. This revolver bears interest at LIBOR plus 2.25 percent per annum, and the interest rate for the term loan facility is LIBOR plus two percent per annum. The initial maturity date of the revolver is April 2008, with an available one year extension, and the maturity date of the term loan is April 2010. The Company’s obligations under the Facility are guaranteed by substantially all of the Company’s subsidiaries and are collateralized by a pledge of the ownership interests in certain of its direct and indirect subsidiaries. The Facility provided for an increase of up to $100 million at the option of the borrower to be allocated between the revolver and the term loan. In December 2005, the Company exercised its option and increased the term loan by $100 million under the same terms and conditions as the initial borrowing.
The Company uses fixed and floating rate debt to finance acquisitions, development and maturing debt. These transactions expose the Company to market risk related to changes in interest rates. The Company reviews its borrowing and attempts to mitigate interest rate exposure through the use of long-term debt maturities and derivative instruments, where appropriate. As of December 31, 2005, the Company had the following derivative instruments outstanding:
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
9.
Borrowings - Continued:
In May 2005, the Company entered into an interest rate swap agreement, for notional borrowings of $175 million which applies to the term loan described above, to protect the Company against fluctuation in the LIBOR rate. Under the interest rate swap agreement, the Company pays a fixed rate of 4.20 percent and receives a floating rate. The floating rate is based on LIBOR. This agreement matures April 1, 2010. The net payments or receipts are recognized as an adjustment to interest expense. The agreement was entered into with a major financial institution, and the Company anticipates that the financial institution will satisfy its obligations under the agreement.
Senior Unsecured Notes. In March 2005, the Company issued $250 million in senior uncollateralized notes. In September 2005, the Company issued an additional $50 million notes at a premium. The notes pay interest semi-annually in arrears at the stated rate of 7.5 percent per annum and are due April 2015. The notes are subordinated to all of the Company’s existing and future collateralized debt. The Company can redeem the notes in whole or in part, at any time on or after April 1, 2010 at specified redemption prices.
Notes Payable. In July 2005, the Company sold a portfolio of mortgage loans receivable at a gain of $9.6 million and paid off $157.7 million in Notes Payable that financed the mortgage loans. Upon the sale of the loans and repayment of the related debt, the Company recognized $10.6 million in hedge losses previously recorded in other comprehensive income (loss) to earnings. In addition, during the period from July 1, 2005 to July 18, 2005, the Company recognized a gain of approximately $2 million relating to decreases in the fair value hedge liability prior to the closing of the sale, resulting in a net loss on termination of the hedge of $8.6 million.
Mortgage Note Payable. In February 2005, the Company acquired through the Merger, a mortgage note payable that USRP had assumed as part of an office building acquisition. The mortgage bears interest at a stated rate of 8.0 percent per annum with payments of principal and interest due monthly through June 2007.
Mortgage Warehouse Facilities. As of December 31, 2004, the Company maintained a $100 million and a $160 million mortgage warehouse facility for the short-term financing of properties purchased with an intent to sell. In February 2005, the $160 million mortgage warehouse facility was renewed with similar terms until February 2006 and was then extended until March 2006 with similar terms. In May 2005, the $100 million warehouse facility was renewed until May 2006, and the amended agreement increased the facility advance rate for real estate acquisitions. The Company pays the warehouse facilities a fee of up to one percent of an individual borrowing upon the repayment of the borrowing, depending upon how long the loan was outstanding.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
9.
Borrowings - Continued:
Subordinated Note Payable. In April 2005, the Company paid in full the $21.875 million subordinated note payable using proceeds from the new senior credit facility described above.
Bonds Payable. Collateral for the Series 2000-A bonds consist of 248 commercial real estate properties operated as restaurants leased to tenants, with a carrying value of $284.1 million at December 31, 2005. The Series 2000-A bonds bear interest at a weighted average fixed rate of 7.9 percent per annum. The bond indenture provides for an optional redemption at their remaining principal balance when remaining rents due under the leases that serve as collateral are less than ten percent of the aggregate initial rents due under the leases.
In February 2005, the Company acquired through the Merger, Triple Net Lease Mortgage Notes Series 2001-A. The notes bear interest at LIBOR plus 48 basis points plus associated fees of approximately 50 basis points, amortize over fifteen years and have a scheduled final maturity date of August 2006. The notes are collateralized by 262 properties with a carrying value of $260.7 million at December 31, 2005. The notes include covenants relating to delinquency percentages or debt service coverage. If the Company fails to comply with certain financial covenants then principal payments may be accelerated. The Company maintains an interest rate cap agreement with a strike rate of 6.0 percent to reduce sensitivity to increases in LIBOR.
Collateral for the Series 2001-4 bonds consists of 45 mortgage loans that had a carrying value of approximately $38.6 million as of December 31, 2005. The Series 2001-4 bonds bear interest at a rate of 8.90 percent per annum. The bond indenture requires monthly principal and interest payments received from mortgage loan borrowers to be applied to the bonds. The bond indenture also provides for an optional redemption of the bonds at their remaining principal balance when the remaining amounts due under the loans that serve as collateral for the bonds are less than ten percent of the aggregate amounts due under the loans at the time of issuance.
Collateral for the Series 2001 bonds consists of 115 commercial real estate properties operated as restaurant units which have a carrying value of approximately $157.1 million as of December 31, 2005. The bonds are scheduled to amortize over a 15-year period with a balloon payment in 2006. The 2001 bonds bear interest at a rate of LIBOR plus 48 basis points per annum plus associated costs of 45.75 basis points. The Company entered into an interest rate cap agreement with a strike rate of 4.50 percent to reduce sensitivity to increases in LIBOR.
Collateral for the Series 2003 bonds consists of eight mortgage loans and one equipment lease, with a combined carrying value of $20.2 million at December 31, 2005. The bond indenture requires monthly principal and interest payments received from borrowers to be applied to the bonds. The Company entered into an interest rate cap agreement with a strike rate of 3.5 percent to reduce sensitivity to increases in LIBOR. In May 2004, the Company issued an additional $5 million note from the Series 2003. The note bears interest at LIBOR plus 600 basis points.
In March 2005, the Company completed a $275 million offering of Triple Net Lease Mortgage Notes, Series 2005 (the “Series 2005 Bonds”). The notes bear interest at a fixed rate plus associated fees of approximately 39 basis points, amortize over twenty years and have an expected final maturity date in 2012. The notes are collateralized by 326 properties with a combined carrying value of approximately $323.9 million at December 31, 2005. The notes include covenants relating to delinquency percentages or debt service coverage. If certain ratios are exceeded or not maintained, then principal payments may be accelerated.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
9.
Borrowings - Continued:
The Series 2000-A and Series 2001 bonds also include certain covenants relating to delinquency percentages or debt service coverage. If certain ratios are exceeded or not maintained, then principal payment may be accelerated. Due primarily to tenant defaults and bankruptcies in 2003 and 2004, the Company has made accelerated principal payments on the Series 2000-A bonds. As a result, certain cash flow normally remaining in excess of the scheduled principal and interest payments is required to be used for additional debt reduction. During the years ended December 31, 2005, 2004 and 2003, the Company was required to make additional debt reductions of approximately $2.1 million, $2.4 million and $0.4 million, respectively, as a result of exceeding certain ratios in the net lease pools.
Through March 2005, the Company entered into four interest rate swaps which were designated as hedges for the Series 2005 Bonds, and recorded other comprehensive income of $1.7 million relating to these instruments. The Company terminated these four interest rate swaps in March 2005 when the Company completed its offering of the Series 2005 Bonds and received $1.7 million in proceeds. The Company will amortize the $1.7 million recorded in comprehensive income into earnings over seven years, the expected maturity of the Series 2005 Bonds. The Company expects to recognize approximately $0.4 million of that amount in earnings during 2006.
Series B Preferred Stock. The Merger triggered a redemption provision of the USRP Series B Preferred Stock, as a result of which, the Company recorded this preferred stock as an obligation. A $32.5 million obligation was recorded and included a redemption premium of $7.5 million. The holders of the preferred stock exercised their redemption options in March 2005.
Some sources of debt financing require that the Company maintains certain standards of financial performance, such as a fixed-charge coverage ratio, a tangible net worth requirement and a restriction on the level of secured debt, and may restrict the amount or timing of common stock dividend payments. Any failure to comply with the terms of these debt covenants would constitute a default and could create an immediate need to find alternative borrowing sources. The Company is in compliance with all of our covenants at December 31, 2005.
The following schedule of future principal payments on outstanding indebtedness at December 31, 2005 reflects the annual maturities of the warehouse facilities and assumes that bonds payable amortize in accordance with estimated payment amounts.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
10. Fair Value of Financial Instruments:
The Company believes that the carrying value of its cash and cash equivalents, accounts receivables, accounts payable and other accruals approximate fair value because of their short term maturities. The Company believes that the carrying amount of mortgage and other notes receivables approximate fair value based on current rates which similar loans would be made to borrowers with similar credit and for similar maturities. The Company’s other investments are recorded at fair value which was derived based on a discounted cash flow analysis applying assumptions regarding the amount and timing of future cash flows. At December 31, 2005, the fair value of the Company’s Series 2005 bonds payable was $217 million based upon secondary market activity. At December 31, 2005 and 2004, the fair value of the Company’s Series 2000-A bonds payable was $304 million and $261 million, respectively, based upon secondary market trading. The Company believes that the carrying amount of the Company’s other debt approximates fair value based upon current valuation for similar bond issuances.
11.
Income Tax:
The Company elected to be taxed as a REIT under the Internal Revenue Code. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including a current requirement that it distribute at least 90 percent of its taxable income to its stockholders. As a REIT, the Company generally is not subject to corporate level federal and state income tax on net income it distributes to its stockholders, except for taxes applicable to its taxable REIT subsidiaries (“TRS”).
The Company has a TRS in which certain activities, including primarily the purchase of real property with the intent to resell have been conducted since 2001. A second, smaller TRS, in which certain activities involving the property improvement and redevelopment of real property were conducted, was reorganized to join in the filing of a consolidated return with the first TRS effective January 1, 2005. As a result of the Merger with USRP, a TRS organized by USRP was similarly reorganized such that the retail convenience, gas, and restaurant operations are similarly consolidated into the primary TRS. These reorganizations have simplified the tax reporting structure into a single TRS.
The purchase of real property with the intent to resell; the property improvement and redevelopment of real property; and the operations of convenience and gas stations and restaurants, all of which, among other activities, are conducted within the TRS, are treated as discontinued operations.
On March 31, 2005, other subsidiaries within the REIT purchased from the TRS a 100 percent interest in a partnership that held a pool of mortgage loans collateralizing a $160.8 million note payable carrying a variable interest rate (the “Loan Transfer”). A portion of this variable interest rate was fixed through the initiation of a hedge transaction. This hedge met the definition of a cash flow hedge, and as a result, changes in its value were reported in other comprehensive income (“OCI”), net of applicable income taxes at the then applicable effective tax rate.
As a result of the Loan Transfer, the items of income and expense associated with the mortgage loans and related note payable are no longer reflected in the TRS income tax returns. Accordingly, any deferred tax asset or liability, and any tax effect of the hedge will not be realized. The tax provision for the year ended December 31, 2005, includes a $3.2 million non-cash charge related to the Loan Transfer.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
11.
Income Tax - Continued:
The components of the net deferred tax asset which is included in other assets consist of the following at December 31:
The income tax provision/(benefit) of $10.0 million, $10.9 million and $(6.3) million for the years ended December 31, 2005, 2004 and 2003, respectively, have been allocated to discontinued operations. The consolidated provision for income taxes from continuing operations differs from the amount computed by applying the federal statutory rate of 35 percent for 2005 and 34 percent for 2004 and 2003 to income before taxes for each of the three years ended December 31:
12. Distributions:
As discussed in Notes 1 and 2, CNLRP was treated as the acquiror for financial statement purposes while Trustreet Properties, formerly known as U.S. Restaurant Properties, Inc. (USRP), is the legal and tax survivor. The following unaudited distribution information is based on taxable earnings and profits for the calendar year which includes the taxable activity of USRP for January 1, 2005 through February 24, 2005 and the taxable activity of the merged company from February 25, 2005 through December 31, 2005.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
12. Distributions - Continued:
The distributions to the common stockholders in 2005 were deemed to be 77.18 percent taxable income and 22.82 percent return of capital. The 2005 distribution to all classes of preferred shareholders was 100 percent taxable income. Specifically, the distributions were characterized as follows:
For the period from January 1, 2005 through February 25, 2005, 30 percent of the distributions received by CNLRP stockholders were considered to be ordinary income and 70 percent were considered to be return of capital.
For the year ended December 31, 2004, 22 percent of the distributions received by CNLRP stockholders were considered to be ordinary income, 69 percent were considered a return of capital, seven percent were qualified dividends and two percent were capital gains for federal income tax purposes. During the year ended December 31, 2003, 39 percent of the distributions received by CNLRP stockholders were considered to be ordinary income, and 61 percent were considered a return of capital. There was no preferred stock outstanding during 2004 and 2003.
13. Related Party Transactions:
The following table and disclosures summarize related party transactions with affiliated entities for the years ended December 31:
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
13.
Related Party Transactions - Continued:
(1)
Services purchased from affiliates include human resources, tax planning and compliance, computer systems support, investor relations and other services. Post Merger, the Company performed substantially all of these functions internally.
(2)
In May 2002, the Company purchased a combined five percent partnership interest in CNL Plaza, Ltd. and CNL Plaza Venture, Ltd. (the “Plaza”) which owns and operates the office tower in which the Company headquarters are located, for $0.2 million. Affiliates of two members of the Board of Directors, including the Chairman, own the remaining partnership interests. The Company has severally guaranteed 8.33 percent of an unsecured promissory note on behalf of the Plaza. The guaranty, after a refinancing during 2005 by the Plaza, equated to $1.2 million of the $14 million unsecured promissory note. The guaranty continues through December 31, 2010. The Company received distributions of $0.10 million, $0.07 million and $0.07 million during the years ended December 31, 2005, and 2003, respectively, from the Plaza. Since November 1999, the Company has leased its office space from CNL Plaza, Ltd., an affiliate of a member of the Company’s board of directors. As of March 15, 2006, the Company is currently discussing and evaluating the possible sale of the five percent interest. As a result of the Merger, the Company is incurring the rental expenses under these leases in 2005. The Company’s leases expire in 2014 and provide for scheduled rent increases over the term of the lease. Rental and other expenses for the years ended December 31, 2005, 2004 and 2003 include accrued rental expense (the additional rent expense resulting from the straight-lining of scheduled rent increases over the term of the lease) and executory costs. Future commitments due under the office space operating leases are as follows at December 31, 2005:
(3)
Soliciting dealer servicing fee paid to an affiliate in connection with the Company’s previous common stock offerings. During 2005, the Company received a refund of approximately $1.7 million from the affiliate and began paying an outside stock transfer agent for stock and investor servicing fees.
(4)
Property management and other administrative services provided to affiliates investing in restaurant net lease properties and loans. During 2005, these affiliates became part of the Company as a result of the Merger.
(5)
During the years ended December 31, 2004 and 2003, the Company received referral fees paid by the Bank, a partner in the specialty finance segment through January 1, 2005, under a business referral program between the Company and the Bank. The Company did not receive any referral fees from the Bank in 2005.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
13.
Related Party Transactions - Continued:
During 2004 and 2003, CNL Financial Group (“CFG”), an affiliate, advanced $10.9 million and $18.7 million, respectively, to the Company in the form of a demand balloon promissory note. The loan bore interest at a rate of LIBOR plus 2.5 percent or at the base rate as defined in the agreement. The balance outstanding as of December 31, 2004 was $35.8 million, which included accrued interest. In April 2005, the Company paid the demand balloon promissory note in full to CFG in the amount of $36.4 million, including accrued interest.
During the year ended December 31, 2002 the specialty finance segment acquired a portfolio of 109 real estate properties, which have been classified as held for sale, for approximately $117 million by acquiring all of the limited partner and general partner interests in CNL Net Lease Investors, LP, (“NLI”). Eight of the properties acquired were vacant and the remaining 101 properties were leased to restaurant operators under triple-net leases. The Chairman of the Board and Vice Chairman of the Board of Directors of the Company, through an affiliate, owned the 0.1 percent general partner interest in NLI prior to the acquisition by the specialty finance segment and agreed to waive their rights to benefit from the transaction. Of the original 109 properties, 107 have been sold to third parties as of December 31, 2005. The Company has recognized approximately $11.6 million in net gains on the sales of these properties through December 2005.
During the year ended December 31, 2002, a tenant and borrower of the Company assigned loans in the amount of $7.5 million to Restaurants Acquisitions I, LLC, an affiliate of the Chairman. The Company agreed to the assignment and advanced an additional $3.6 million to the affiliate in exchange for an $11.1 million participating note. The note was amended during 2004 to remove the participating feature and change the maturity date from May 2014 to December 2007. The note bears interest at a rate of ten percent per annum. The Company earned $1.1 million in interest income from the affiliate during each of the years 2005, 2004 and 2003.
During the year ended December 2003, OrangeDen, LLC, a subsidiary engaged in restaurant operations, entered into a collateral contribution agreement (‘the Agreement”) with two separate affiliates, CFG and Cherry Den, LLC, to provide collateral for a letter of credit to an insurance company for worker’s compensation and general liability coverage relating to employees leased to the restaurant operations within the real estate segment. The collateral consisted of certificates of deposit with one-year terms amounting to $353,000 and were included in real estate and restaurant assets held for sale at December 31, 2003 relating to this Agreement. In December 2004, the Company sold its interest in OrangeDen, LLC, to Cherry Den, LLC, an affiliate of the Chairman and Vice Chairman of the Board of Directors. The Company received $0.7 million in proceeds from the sale and recognized a net gain of $1.2 million, which included the recognition of $0.8 million in gains on the sales of real estate used in it restaurant operations, which had previously been deferred.
14.
Stock Options and Restricted Shares:
The Company adopted USRP’s Flexible Incentive Plan (the “Plan”). Under the Plan, the Company may grant shares of restricted common stock or stock options to purchase common stock. Pursuant to this Plan, stock options may be granted at any time and the aggregate outstanding options that can be granted shall be at an amount equal to or less than 4.9% of the Company’s issued and outstanding shares of common stock at the date of grant. Options may be exercised through either the payment of cash or the transfer of shares of the Company’s common stock owned by the optionee, at the Company’s discretion.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
14.
Stock Options and Restricted Shares - Continued:
No stock options were issued during the year ended December 31, 2005, and previously granted options were fully vested as of the date of the Merger. As a result, no compensation cost was recognized relating to stock options during the year ended December 31, 2005. Early adoption of FAS 123(R), and the change from applying the original provisions of SFAS No. 123, did not have an impact on income from continuing operations, net income, cash flow from operations, cash flow from financing activities, and basic and diluted earnings per share for the year ended December 31, 2005.
The following is a summary of options outstanding by range of exercise price as of December 31, 2005:
The following is a summary of stock option activity for the year ended December 31, 2005:
In March 2005, the Company granted approximately 0.1 million shares of non-vested common stock to members of its board of directors and certain employees. The non-vested shares had a fair market value of approximately $2.3 million based on the Company’s stock price on the date of grant. The Company records compensation expense over the vesting period.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
14.
Stock Options and Restricted Shares - Continued:
The following is a summary of the status of the Company’s non-vested shares as of December 31, 2005, and changes during the year ended December 31, 2005:
As of December 31, 2005, there was $1.2 million of total unrecognized compensation costs related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of approximately 3.5 years.
15.
Stockholders’ Equity:
On February 25, 2005, in accordance with the terms of the Merger, approximately 45.2 million shares of CNLRP common stock were converted into 35.2 million shares of the Company’s common stock and 7.2 million newly issued shares of the Company’s Series C Preferred Stock.
Outstanding Warrants - At December 31, 2005, two investors had outstanding Series B warrants to purchase 0.4 million shares of the Company’s common stock at an exercise price of $16.39 per share. The warrants became exercisable on October 10, 2003 and expire between 2010 and 2011. At December 31, 2005, 0.4 million shares of common stock were reserved for that purpose.
During the year ended December 31, 2005, the Company issued 1.4 million shares of common stock through a controlled equity program and issued 8.05 million shares through a public offering totaling $129.9 million in proceeds, net of stock issuance costs. The Company sold the shares of common stock at a range of $14.25 to $16.67.
Redeemable Preferred Stock
Series A Preferred Stock - The Series A Preferred Stock has a liquidation preference of $25.00 per share. The Series A Preferred Stock is redeemable, in whole or in part, at the option of the Company, (i) for such number of shares of Company common stock as are issuable at a conversion rate of 0.9384 shares of Company common stock for each share of Series A Preferred Stock, provided that for 20 trading days within any period of 30 consecutive trading days, including the last trading day of such period, the closing price of the common stock on the New York Stock Exchange equals or exceeds the conversion price, subject to adjustment in certain circumstances, plus cash in the amount of any accrued and unpaid dividends, or (ii) for cash at a redemption price equal to $25.00 per share of Series A Preferred Stock, plus any accrued and unpaid dividends. The Series A Preferred Stock has no stated maturity and is not subject to a sinking fund provision. Shares of Series A Preferred Stock are convertible, in whole or in part, at the option of the holder at any time, unless previously redeemed, into shares of common stock at a conversion
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
15.
Stockholders’ Equity - Continued:
price of $26.64 per share of common stock (equivalent to a conversion rate of 0.9384 shares of common stock). Distributions on Series A Preferred Stock are cumulative and are equal to the greater of (i) $1.93 per annum or (ii) the cash distribution paid or payable on the number of shares of common stock into which a share of Series A Preferred Stock is convertible. Holders of Series A Preferred Stock are entitled to receive dividends in parity with holders of Series C Preferred Stock and in preference to any dividends to common stockholders. Upon liquidation, holders of Series A Preferred Stock are entitled to receive distributions in parity with holders of Series C Preferred Stock and in preference to any distributions to common stockholders.
Series C Preferred Stock - The Company’s 7.5 percent Series C Preferred Stock has a liquidation preference of $25.00 per share. The Series C Preferred Stock is not redeemable prior to February 25, 2009, unless the Board of Directors determines that such a redemption is necessary or advisable to preserve the status of the Company as a REIT. On and after February 25, 2009, and with appropriate notice, the Series C Preferred Stock is redeemable, in whole or in part, at the option of the Company for cash at a redemption price of $25.00 per share, plus all accrued and unpaid dividends thereon to and including the date fixed for redemption, without interest. If fewer than all of the outstanding shares of Series C Preferred Stock are to be redeemed, the Series C Preferred Stock to be redeemed shall be redeemed pro rata (as nearly as may be practicable without creating fractional shares), by lot or by any other equitable method determined by the Company that will not result in a violation of the Ownership Limit, provided that such method satisfies any applicable requirements of any securities exchange on which the Series C Preferred Stock are then listed or any national quotation system on which the Series C Preferred Stock are then quoted. If such redemption is to be by lot and, as a result of such redemption, any holder of a number of shares of Series C Preferred Stock would become a holder of a number of shares of Series C Preferred Stock in excess of the Ownership Limit because such holders of shares of Series C Preferred Stock were not redeemed, or were redeemed only in part, then, except as otherwise provided in the Articles of Incorporation, the Company will redeem the requisite number of Series C Preferred Stock of such holder such that such holder will not violate the Ownership Limit subsequent to such redemption. Shares of Series C Preferred Stock are convertible, in whole or in part, at the option of the holder at any time, unless previously redeemed, into shares of common stock at an initial conversion price of $19.50 (equivalent to a conversion rate of 1.28205 shares of common stock for each share of Series C Preferred Stock). Distributions on Series C Preferred Stock are cumulative and are equal to $1.875 per share per annum. Holders of Series C Preferred Stock are entitled to receive dividends in parity with holders of Series A Preferred Stock and in preference to any dividends to common stockholders. Upon liquidation, holders of Series C Preferred Stock are entitled to receive distributions in parity with holders of Series A Preferred Stock and in preference to any distributions to common stockholders.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
15.
Stockholders’ Equity - Continued:
Computation of Earnings Per Common Share - For the years ended December 31, 2005, 2004 and 2003, basic and diluted earnings per common share for income (loss) from continuing operations available to common stockholders has been computed as follows:
(1)
For the year ended December 31, 2005, the potential dilution from the Company’s outstanding Common Stock Equivalents was anti-dilutive to the loss from continuing operations per share calculation. As such, the Company excluded stock options to purchase approximately 0.012 million shares of common stock, warrants to purchase 0.4 million shares of common stock, restricted stock of approximately 0.1 million shares and the conversion of Series A and Series C Preferred Stock into 16.6 million shares of common stock from the computation of diluted earnings per share as these Common Stock Equivalents were anti-dilutive.
(2)
For the years ended December 31, 2004 and 2003, the Company did not have any Common Stock Equivalents.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
15.
Stockholders’ Equity - Continued:
The following unaudited presentation assumes that the Series C Preferred Stock issued to the CNLRP stockholders in connection with the Merger was outstanding for all periods presented.
16. Concentration of Credit Risk:
No individual lessee or borrower (or affiliated groups of lessees or borrowers) or restaurant chain represented more than ten percent of the Company's revenues relating to its properties, loans and secured equipment leases during the years ended December 31, 2005, 2004 or 2003.
Although the Company's properties are geographically diverse throughout the United States and lessees and borrowers operate a variety of restaurant concepts, 25 restaurant chains constitute 75 percent of the Company’s properties. Failure of any one of these restaurant chains or any significant lessees or borrowers could significantly impact results of operations if the Company is not able to timely protect its interest.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
17.
Segment Information:
The Company has established separate legal entities to operate and measure the real estate and specialty finance segments.
The real estate segment primarily acquires and holds real estate. It also holds certain mortgage and equipment loans generally until maturity. The specialty finance segment includes the Company’s investment property sales program, our Real Estate Development and Redevelopment Group and investment banking services to national and regional restaurant operators. The specialty finance segment’s earnings are from lease income prior to sale, net gains from investment property sales, gains from development and sale of restaurant/retail real estate and to a lesser extent, advisory services and servicing activities.
The following tables summarize the results for the real estate and specialty finance segments. Consolidating eliminations and results of the parent company are reflected in the “other” column.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
17.
Segment Information - (Continued):
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
17.
Segment Information - (Continued):
18.
Commitments and Contingencies:
As a result of the Merger, the Company acquired properties subject to leases where the Company was the lessee under these leases. During the year ended December 31, 2005, the Company incurred $3.3 million in ground rent expense related to such leases, with such amounts recorded as property expenses. The remaining lease terms (excluding renewal option terms) expire between 2006 and 2024. Minimum future lease obligations at December 31, 2005 are as follows:
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
18.
Commitments and Contingencies - Continued:
In the ordinary course of business, the Company has outstanding commitments to qualified borrowers and tenants. These commitments, including development agreements, if accepted by the potential tenants, obligate the Company to purchase sale leaseback properties. At December 31, 2005, the Company had committed to purchase $134 million in real estate properties.
As of December 31, 2005, the Company had entered into operating leases relating to real estate held for sale which provide that, in the event the Company sells the leased property before the fifth lease year, the annual rent will increase to the fifth year contractual rate effective on the day of the sale, and that the Company will compensate the tenant for the increase.
As part of the Merger, the Company assumed certain agreements in connection with certain gas station properties, that obligate the Company to pay a release price should a gas station property change gas brands. The agreements are customary in the retail petroleum industry. Some, but not all, of the agreements release the Company from the aforementioned obligation upon the sale of the property to a third party.
On January 18, 2005, Robert Lewis and Sutter Acquisition Fund, LLC, two limited partners in several Income Funds, filed Plaintiffs’ Corrected Original Petition for Class Action, Cause No. 05-00083-F, a purported class action lawsuit on behalf of the limited partners of the Income Funds against the Company, USRP, the Income Funds and the general partners (Mr. Seneff, Mr. Bourne and CNL Realty Corporation) of the Income Funds, and subsidiaries of the Company in the District Court of Dallas County, Texas (the “Court”). The complaint alleged that the general partners of the Income Funds breached their fiduciary duties in connection with the proposed Mergers between the Income Funds and USRP and that the Company, subsidiaries of the Company and USRP aided and abetted in the alleged breaches of fiduciary duties. The complaint further alleged that the Income Fund general partners violated provisions of the Income Fund partnership agreements and demanded an accounting as to the affairs of the Income Funds. On April 26, 2005, a supplemental plea to jurisdiction was held. On May 2, 2005, the plaintiffs filed their First Amended Petition for Class Action. In the Amended Petition the plaintiffs did not add any parties or claims, but they did add allegations that the general partners of the Income Funds, with CNLRP and USRP, prepared and distributed a false and misleading final proxy statement filing to the limited partners of the Income Funds and the shareholders of CNLRP and USRP. The plaintiffs are seeking unspecified compensatory and exemplary damages and equitable relief, which also included an injunction preventing the defendants from proceeding with the Mergers. On May 26, 2005, the Court entered a Final Order Dismissing Action for lack of subject matter jurisdiction. On June 22, 2005, the plaintiffs filed a Notice of Appeal of the Order of Dismissal. On September 7, 2005, the plaintiffs filed an appellants’ brief. On November 7, 2005, the Company and the other defendants filed on appellees’ brief. On December 12, 2005, the plaintiffs filed their Appellants’ Replying Brief. The Court has scheduled oral argument on the appeal for May 3, 2006. Management of the Company believes the claims against the Company are without merit and intends to vigorously defend against such claims.
During 2004, Management Strategies, Inc. filed a lawsuit against USRP. The complaint alleges that the Company owes approximately $3 million in sales and fuel tax liabilities to the State of Georgia. The management of the Company believes the claims against the Company are without merit and intends to defend vigorously against such claims.
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
18.
Commitments and Contingencies - Continued:
The Company may be subject to claims or litigation in the ordinary course of business. At December 31, 2005, there were no outstanding claims against the Company in the ordinary course of business that are expected to have a material adverse effect on the Company’s financial position or results of operations.
19. Selected Quarterly Financial Data (Unaudited):
The following table presents selected unaudited quarterly financial data for each fiscal quarter during the years ended December 31, 2005 and 2004:
TRUSTREET PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Years ended December 31, 2005, 2004 and 2003
19. Selected Quarterly Financial Data (Unaudited) - Continued:
(1)
The results of operations relating to properties that were either disposed of or that were classified as held for sale during the year ended December 31, 2005 and 2004 are reported as discontinued operations.
(2)
Earnings/(loss) from continuing operations allocable to common stockholders includes income from continuing operations and gain/(loss) on sale of assets, net of dividends to preferred stockholders.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Management, including our Chief Executive Officer and Chief Financial Officer, carried out an evaluation as of December 31, 2005 of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in the Company’s reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to management to allow timely decisions regarding required disclosures. Based upon the evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2005, the Company’s disclosure controls and procedures are effective.
Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
·
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the Company’s assets;
·
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that the Company’s receipts and expenditures are being made only in accordance with authorizations of the Company’s management and directors; and
·
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
For the three months ended December 31, 2005, our Chief Executive Officer and Chief Financial Officer also concluded that there were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, including changes that would have resulted from the merger of CNLRP and the Income Funds with and into USRP on February 25, 2005.
It should be noted that a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are certain resource constraints, and the benefits of controls must be considered relative to their costs. The design of any system of controls is also based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Management’s Report on Internal Control Over Financial Reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in the report entitled “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO” Report).
Based on our evaluation and the criteria set forth in the COSO report, management concluded that our internal control over financial reporting was effective as of December 31, 2005. Management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2005 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, who also audited our consolidated financial statements, as stated in their report, which is included herein.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
The information required by this Item is incorporated by reference to the Company's Definitive Proxy Statement to be filed with the Commission no later than April 28, 2006.
Item 11.
Item 11. Executive Compensation.
The information required by this Item is incorporated by reference to the Company's Definitive Proxy Statement to be filed with the Commission no later than April 28, 2006.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this Item is incorporated by reference to the Company's Definitive Proxy Statement to be filed with the Commission no later than April 28, 2006.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The information required by this Item is incorporated by reference to the Company's Definitive Proxy Statement to be filed with the Commission no later than April 28, 2006.
Item 14.
Item 14. Principal Accountant Fees and Services.
The information required by this Item is incorporated by reference to the Company's Definitive Proxy Statement to be filed with the Commission no later than April 28, 2006.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a) The following documents are filed as part of this report.
1. Consolidated Financial Statements
Report of Independent Registered Certified Public Accounting Firm.
Consolidated Balance Sheets at December 31, 2005 and 2004.
Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003.
Consolidated Statements of Stockholders' Equity and Comprehensive Income/(Loss) for the years ended December 31, 2005, 2004 and 2003.
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003.
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts for the years ended December 31, 2005, 2004 and 2003.
Schedule III - Real Estate and Accumulated Depreciation at December 31, 2005.
Notes to Schedule III - Real Estate and Accumulated Depreciation at December 31, 2005.
Schedule IV - Mortgage Loans on Real Estate at December 31, 2005.
All other Schedules are omitted as the required information is inapplicable or is presented in the financial statements or notes thereto.
3. Exhibits
2.1
Agreement and Plan of Merger by and between the Registrant and CNL Restaurant Properties, Inc., dated as of August 9, 2004 (previously filed as Exhibit 2.1 to the Registrant’s current report on Form 8-K filed on August 10, 2004 and incorporated herein by reference).
2.2
Agreements and Plans of Merger by and among the Registrant, a separate, wholly-owned subsidiary of the operating partnership of the Registrant and each of the 18 Income Funds (previously filed as Exhibits 2.2 - 2.19 to the Registrant’s current report on Form 8-K filed on August 10, 2004 and incorporated herein by reference).
3.1
Restated Articles of Incorporation of the Registrant dated November 11, 1997, as amended by the Articles of Amendment to the Articles of Restatement of the Registrant dated February 24, 2005 and the Articles of Amendment to the Articles of Restatement of the Registrant dated February 24, 2005 (previously filed as Exhibit 3.1 to the Registrant’s quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2005 and incorporated herein by reference).
3.2
Third Amended and Restated Bylaws (previously filed as Exhibit 3.1 on the Company’s current report on Form 8-K filed on August 15, 2005 and incorporated herein by reference).
4.1
Specimen of Common Stock Certificate (previously filed as Exhibit 4.1 to the Registrant’s Registration Statement on Form S-4 (File No. 333-21403) and incorporated herein by reference).
4.2
Articles Supplementary Classifying and Designating a Series of Preferred Stock as Series A Cumulative Convertible Preferred Stock (previously filed as Exhibit 3.2 to the Registrant’s current report on Form 8-K filed on November 14, 1997 and incorporated herein by reference).
4.3
Amendment to Articles Supplementary Classifying and Designating a Series of Preferred Stock as Series A Cumulative Convertible Preferred Stock (previously filed as Exhibit 3.2 to the Registrant’s current report on Form 8-K filed on February 25, 2005 and incorporated herein by reference).
4.4
Articles Supplementary Classifying and Designating a Series of Preferred Stock as 8% Series B Convertible Preferred Stock (previously filed as Exhibit 4.01 to the Registrant’s Form 10-Q for the fiscal quarter ended June 30, 2003 and incorporated herein by reference).
4.5
Articles Supplementary Classifying and Designating a Series of Preferred Stock as 8% Series B-1 Convertible Preferred Stock (previously filed as Exhibit 99.5 to the Registrant’s current report on Form 8-K filed on September 16, 2004 and incorporated herein by reference).
4.6
Articles Supplementary Establishing and Fixing The Rights and Preferences of 7.5% Series C Redeemable Convertible Preferred Stock (previously filed as Exhibit 4.1 to the Registrant’s registration statement on Form 8-A (File No. 001-13089) and incorporated herein by reference).
4.7
Specimen of 7.5% Series C Redeemable Convertible Preferred Stock Certificate (previously filed as Exhibit 4.2 to the Registrant’s registration statement on Form 8-A (File No. 001-13089) and incorporated herein by reference).
4.8
Indenture dated as of March 4, 2005, among Net Lease Funding 2005, LP, MBIA Insurance Corporation and Wells Fargo Bank, N.A., as indenture trustee relating to $275,000,000 Triple Net Lease Mortgage Notes, Series (previously filed as Exhibit 99.1 to the Registrant’s current report on Form 8-K filed on March 10, 2005 and incorporated herein by reference).
4.9
Securities Purchase Agreement relating to the Series B Preferred Stock (previously filed as Exhibit 4.02 to the Registrant’s Form 10-Q for the fiscal quarter ended June 30, 2003 and incorporated herein by reference).
4.10
Registration Rights Agreement relating to Series B Preferred Stock (previously filed as Exhibit 4.03 to the Registrant’s Form 10-Q for the fiscal quarter ended June 30, 2003 and incorporated herein by reference).
4.11
Stock Purchase Warrant - Omnicron Master Trust (previously filed as Exhibit 4.04 to the Registrant’s Form 10-Q for the fiscal quarter ended June 30, 2003 and incorporated herein by reference).
4.12
Stock Purchase Warrant - The Riverview Group, LLC (previously filed as Exhibit 4.05 to the Registrant’s Form 10-Q for the fiscal quarter ended June 30, 2003 and incorporated herein by reference).
4.13
Registration Rights Agreement by and between the Registrant, LSF3 Capital Investments I, LLC and LSF3 Capital Investments II, LLC dated as of March 9, (previously filed as Exhibit 10.5 to the Schedule 13D filed by LSF3 Capital Investments I, LLC, and the other reporting persons named therein, on March 19, 2001 and incorporated herein by reference).
4.14
Indenture, dated as of March 23, 2005, between the Registrant and Wells Fargo Bank, National Association, as trustee, relating to the Registrant’s 7 ½% Senior Noted due 2015 (previously filed as Exhibit 4.1 to the Registrant’s current report on Form 8-K filed on March 28, 2005 and incorporated herein by reference).
4*
Pursuant to Regulation S-K Item 601(b)(4)(iii), the Registrant by this filing agrees, upon request, to furnish to the Securities and Exchange Commission a copy of instruments defining the rights of holders of long-term debt of the Registrant.
10.6
Registrant Flexible Incentive Plan (previously filed as Exhibit 10.1 to the Registrant’s Form 10-Q for the fiscal quarter ended March 31, 2003 and incorporated herein by reference).
10.7
Bridge Credit Agreement dated as of February 25, 2005, by and among the Registrant, as borrower, certain subsidiaries of the Registrant, as guarantors, Bank of America, N.A., as Administrative Agent, L/C Issuer and Swing Line Lender, and certain other lenders party thereto, and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book Manager (previously filed as Exhibit 10.1 to the Registrant’s current report on Form 8-K filed on March 3, 2005 and incorporated herein by reference).
10.8
Bridge Credit Agreement dated as of February 25, 2005, by and among Net Lease Funding 2005, LP, as borrower, Bank of America, as Administrative Agent, and certain other lenders party thereto, and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book Manager (previously filed as Exhibit 10.2 to the Registrant’s current report on Form 8-K filed on March 3, 2005 and incorporated herein by reference).
10.9
Credit Agreement, dated as of April 8, 2005, by and among the Registrant, as borrower, certain subsidiaries of the Registrant, as guarantors, Bank of America, N.A., as Administrative Agent, L/C Issuer and Swing Line Lender, Bank of America Securities LLC, as Sole Lead Arranger and Sole Book Manager, Key Bank, National Association, as Syndication Agent, Credit Suisse First Boston, Societe Generale, and Wachovia Bank National Association, as Co-Documentation Agents, and the lenders party thereto (previously filed as Exhibit 10.1 to the Registrant’s current report on Form 8-K filed on April 13, 2005 and incorporated herein by reference).
10.10
Pledge Agreement, dated as of April 8, 2005, by substantially all of the Borrower’s domestic subsidiaries, in favor of Bank of America, N.A., in its capacity as Administrative Agent (previously filed as Exhibit 10.2 to the Registrant’s current report on Form 8-K filed on April 13, 2005 and incorporated herein by reference).
12.1
Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends
Subsidiaries of Registrant
23.1
Consent of PricewaterhouseCoopers LLP
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on the 16th day of March, 2006.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ CURTIS B. MCWILLIAMS
Chief Executive Officer
March 16, 2006
Curtis B. McWilliams
(Principal Executive Officer)
/S/ STEVEN D. SHACKELFORD
Chief Financial Officer
March 16, 2006
Steven D. Shackelford
(Principal Financial and Accounting
Officer)
/S/ JAMES M. SENEFF, JR.
Director, Chairman of the Board
March 16, 2006
James M. Seneff, Jr.
/S/ ROBERT A. BOURNE
Director
March 16, 2006
Robert A. Bourne
/S/ G. RICHARD HOSTETTER
Director
March 16, 2006
G. Richard Hostetter
/S/ J. JOSEPH KRUSE
Director
March 16, 2006
J. Joseph Kruse
/s/ RICHARD C. HUSEMAN
Director
March 16, 2006
Richard C. Huseman
/s/ JAMES H. KROPP
Director
March 16, 2006
James H. Kropp
/s/ G. STEVEN DAWSON
Director
March 16, 2006
G. Steven Dawson
TRUSTREET PROPERTIES, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2005, 2004 and 2003
(In thousands)
(a) Deducted from receivables and accrued rental income on the balance sheet.
(b) Reduction of rental, earned, interest and other income.
(c) Deducted from mortgage, equipment and other notes receivable on the balance sheet.
TRUSTREET ROPERTIES, INC.
NOTES TO SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(a)
Transactions in real estate and accumulated depreciation during 2005, 2004 and 2003 are summarized below. The balances in 2005, 2004 and 2003 have been adjusted to reflect the reclassification of properties accounted for as discontinued operations.
TRUSTREET PROPERTIES, INC.
NOTES TO SCHEDULE III - REAL ESTATE AND ACCUMULATED
DEPRECIATION - CONTINUED
December 31, 2005
(b)
As of December 31, 2005, 2004 and 2003, the aggregate depreciated cost of the properties owned by the Company and its consolidated joint ventures for federal income tax purposes was $1,910.1 million, $689.1 million and $621.5 million, respectively. Substantially all of the leases are treated as operating leases for federal income tax purposes.
(c)
Depreciation expense is computed for buildings and improvements based upon estimated lives of 30 years.
(d)
The building portion of this property is owned by the tenant; therefore, depreciation is not applicable.
(e)
For financial reporting purposes, certain components of the lease relating to land and/or building have been recorded as a capital lease. Accordingly, costs relating to these components have been included in capital leases and depreciation is not applicable.
(f)
The Company owns the building only relating to this property. This property is subject to a ground lease between the tenant and an unaffiliated third party. In connection therewith, the Company entered into either a tri-party agreement with the tenant and the owner of the land or an assignment of interest in the ground lease with the landlord of the land. The tri-party agreement or assignment of interest each provide that the tenant is responsible for all obligations under the ground lease and provide certain rights to the Company to help protect its interest in the building in the event of a default by the tenant under the terms of the ground lease.
(g)
The property(ies) is/are encumbered at December 31, 2005.
(h)
Included as “other” are some properties for which the land and/or building have been recorded as a capital lease, and some properties where the Company owns the building only, as described above. Dates of construction for the properties included as “other” range from 1955 to 2001 and dates acquired range from 1997 to 2005.
(i)
For financial reporting purposes, the undepreciated cost of the following properties was written down to its net realizable value due to an anticipated impairment in value. The Company recognized the impairments by recording an allowance for loss on land and/or building or net investment in capital lease in the amounts listed below for each property as of December 31, 2005. The impairments at December 31, 2005 represent the difference between the properties' carrying values and managements estimate of the net realizable value of the properties based upon anticipated sales prices to interested third parties. The cost of the properties presented on this schedule is the gross amount at which the properties were carried at December 31, 2005, excluding the allowances for loss.
TRUSTREET PROPERTIES, INC.
NOTES TO SCHEDULE III - REAL ESTATE AND ACCUMULATED
DEPRECIATION - CONTINUED
December 31, 2005
(j) (continued)
The following is a list of properties and the related impairment at December 31, 2005:
Trustreet Properties, Inc.
Schedule IV - Mortgage Loans on Real Estate
December 31, 2005
(In thousands except for number of shares)
EXHIBITS
EXHIBIT INDEX
Exhibit Number
2.1
Agreement and Plan of Merger by and between the Registrant and CNL Restaurant Properties, Inc., dated as of August 9, 2004 (previously filed as Exhibit 2.1 to the Registrant’s current report on Form 8-K filed on August 10, 2004 and incorporated herein by reference).
2.2
Agreements and Plans of Merger by and among the Registrant, a separate, wholly-owned subsidiary of the operating partnership of the Registrant and each of the 18 Income Funds (previously filed as Exhibits 2.2 - 2.19 to the Registrant’s current report on Form 8-K filed on August 10, 2004 and incorporated herein by reference).
3.1
Restated Articles of Incorporation of the Registrant dated November 11, 1997, as amended by the Articles of Amendment to the Articles of Restatement of the Registrant dated February 24, 2005 and the Articles of Amendment to the Articles of Restatement of the Registrant dated February 24, 2005 (previously filed as Exhibit 3.1 to the Registrant’s quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2005 and incorporated herein by reference).
3.2
Third Amended and Restated Bylaws (previously filed as Exhibit 3.1 on the Company’s current report on Form 8-K filed on August 15, 2005 and incorporated herein by reference).
4.1
Specimen of Common Stock Certificate (previously filed as Exhibit 4.1 to the Registrant’s Registration Statement on Form S-4 (File No. 333-21403) and incorporated herein by reference).
4.2
Articles Supplementary Classifying and Designating a Series of Preferred Stock as Series A Cumulative Convertible Preferred Stock (previously filed as Exhibit 3.2 to the Registrant’s current report on Form 8-K filed on November 14, 1997 and incorporated herein by reference).
4.3
Amendment to Articles Supplementary Classifying and Designating a Series of Preferred Stock as Series A Cumulative Convertible Preferred Stock (previously filed as Exhibit 3.2 to the Registrant’s current report on Form 8-K filed on February 25, 2005 and incorporated herein by reference).
4.4
Articles Supplementary Classifying and Designating a Series of Preferred Stock as 8% Series B Convertible Preferred Stock (previously filed as Exhibit 4.01 to the Registrant’s Form 10-Q for the fiscal quarter ended June 30, 2003 and incorporated herein by reference).
4.5
Articles Supplementary Classifying and Designating a Series of Preferred Stock as 8% Series B-1 Convertible Preferred Stock (previously filed as Exhibit 99.5 to the Registrant’s current report on Form 8-K filed on September 16, 2004 and incorporated herein by reference).
4.6
Articles Supplementary Establishing and Fixing The Rights and Preferences of 7.5% Series C Redeemable Convertible Preferred Stock (previously filed as Exhibit 4.1 to the Registrant’s registration statement on Form 8-A (File No. 001-13089) and incorporated herein by reference).
4.7
Specimen of 7.5% Series C Redeemable Convertible Preferred Stock Certificate (previously filed as Exhibit 4.2 to the Registrant’s registration statement on Form 8-A (File No. 001-13089) and incorporated herein by reference).
4.8
Indenture dated as of March 4, 2005, among Net Lease Funding 2005, LP, MBIA Insurance Corporation and Wells Fargo Bank, N.A., as indenture trustee relating to $275,000,000 Triple Net Lease Mortgage Notes, Series (previously filed as Exhibit 99.1 to the Registrant’s current report on Form 8-K filed on March 10, 2005 and incorporated herein by reference).
4.9
Securities Purchase Agreement relating to the Series B Preferred Stock (previously filed as Exhibit 4.02 to the Registrant’s Form 10-Q for the fiscal quarter ended June 30, 2003 and incorporated herein by reference).
4.10
Registration Rights Agreement relating to Series B Preferred Stock (previously filed as Exhibit 4.03 to the Registrant’s Form 10-Q for the fiscal quarter ended June 30, 2003 and incorporated herein by reference).
4.11
Stock Purchase Warrant - Omnicron Master Trust (previously filed as Exhibit 4.04 to the Registrant’s Form 10-Q for the fiscal quarter ended June 30, 2003 and incorporated herein by reference).
4.12
Stock Purchase Warrant - The Riverview Group, LLC (previously filed as Exhibit 4.05 to the Registrant’s Form 10-Q for the fiscal quarter ended June 30, 2003 and incorporated herein by reference).
4.13
Registration Rights Agreement by and between the Registrant, LSF3 Capital Investments I, LLC and LSF3 Capital Investments II, LLC dated as of March 9, (previously filed as Exhibit 10.5 to the Schedule 13D filed by LSF3 Capital Investments I, LLC, and the other reporting persons named therein, on March 19, 2001 and incorporated herein by reference).
4.14
Indenture, dated as of March 23, 2005, between the Registrant and Wells Fargo Bank, National Association, as trustee, relating to the Registrant’s 7 ½% Senior Noted due 2015 (previously filed as Exhibit 4.1 to the Registrant’s current report on Form 8-K filed on March 28, 2005 and incorporated herein by reference).
4*
Pursuant to Regulation S-K Item 601(b)(4)(iii), the Registrant by this filing agrees, upon request, to furnish to the Securities and Exchange Commission a copy of instruments defining the rights of holders of long-term debt of the Registrant.
10.6
Registrant Flexible Incentive Plan (previously filed as Exhibit 10.1 to the Registrant’s Form 10-Q for the fiscal quarter ended March 31, 2003 and incorporated herein by reference).
10.7
Bridge Credit Agreement dated as of February 25, 2005, by and among the Registrant, as borrower, certain subsidiaries of the Registrant, as guarantors, Bank of America, N.A., as Administrative Agent, L/C Issuer and Swing Line Lender, and certain other lenders party thereto, and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book Manager (previously filed as Exhibit 10.1 to the Registrant’s current report on Form 8-K filed on March 3, 2005 and incorporated herein by reference).
10.8
Bridge Credit Agreement dated as of February 25, 2005, by and among Net Lease Funding 2005, LP, as borrower, Bank of America, as Administrative Agent, and certain other lenders party thereto, and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book Manager (previously filed as Exhibit 10.2 to the Registrant’s current report on Form 8-K filed on March 3, 2005 and incorporated herein by reference).
10.9
Credit Agreement, dated as of April 8, 2005, by and among the Registrant, as borrower, certain subsidiaries of the Registrant, as guarantors, Bank of America, N.A., as Administrative Agent, L/C Issuer and Swing Line Lender, Bank of America Securities LLC, as Sole Lead Arranger and Sole Book Manager, Key Bank, National Association, as Syndication Agent, Credit Suisse First Boston, Societe Generale, and Wachovia Bank National Association, as Co-Documentation Agents, and the lenders party thereto (previously filed as Exhibit 10.1 to the Registrant’s current report on Form 8-K filed on April 13, 2005 and incorporated herein by reference).
10.10
Pledge Agreement, dated as of April 8, 2005, by substantially all of the Borrower’s domestic subsidiaries, in favor of Bank of America, N.A., in its capacity as Administrative Agent (previously filed as Exhibit 10.2 to the Registrant’s current report on Form 8-K filed on April 13, 2005 and incorporated herein by reference).
12.1
Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends
Subsidiaries of Registrant
23.1
Consent of PricewaterhouseCoopers LLP
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
EXHIBIT 12.1
RATIO OF EARNINGS TO FIXED CHARGES
EXHIBIT 12.2
RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND
PERFERRED STOCK DIVIDENDS
EXHIBIT
SUBSIDIARIES OF THE REGISTRANT
EXHIBIT 23.1
CONSENT OF PRICEWATERHOUSECOOPERS LLP
EXHIBIT 31.1
RULE 13a-14(a) CERTIFICATION OF CHIEF EXECUTIVE OFFICER
EXHIBIT 31.2
RULE 13a-14(a) CERTIFICATION OF CHIEF FINANCIAL OFFICER
EXHIBIT 32.1
SECTION 1350 CERTIFICATION OF CHIEF EXECUTIVE OFFICER
EXHIBIT 32.2
SECTION 1350 CERTIFICATION OF CHIEF FINANCIAL OFFICER