EX-13 3 0003.txt ANNUAL REPORT TO SHAREHOLDERS 2000 ANNUAL REPORT - PAGE 4 [GRAPHIC 1] Design graphic depicting the Commercial Net Lease Realty, Inc. initials, "CNLR" Exhibit 13 Annual Report to Shareholders HISTORICAL FINANCIAL HIGHLIGHTS (dollars in thousands, except per share data)
-------------------------------------------------------------- 2000 1999 1998 1997 1996 ---------- ----------- ---------- ---------- ---------- Gross Revenues $ 80,891 $ 76,543 $ 64,773 $ 50,135 $ 33,369 Net Earnings $ 38,251 $ 35,311 $ 32,441 $ 30,385 $ 19,839 Total Assets $ 761,611 $ 749,789 $ 685,595 $ 537,014 $ 370,953 Total Long-Term Debt $ 360,381 $ 350,971 $ 292,907 $ 171,836 $ 116,956 Total Equity $ 393,901 $ 391,362 $ 383,890 $ 362,144 $ 252,574 Cash Dividends Paid to Stockholders $ 37,760 $ 37,495 $ 35,672 $ 28,381 $ 18,868 Weighted Average Shares Basic 30,387,371 30,331,327 29,169,371 24,070,697 16,798,918 Diluted 30,407,507 30,408,219 29,397,154 24,220,792 16,838,719 Per Share Information: Net Earnings Basic $ 1.26 $ 1.16 $ 1.11 $ 1.26 $ 1.18 Diluted $ 1.26 $ 1.16 $ 1.10 $ 1.25 $ 1.18 Dividends $ 1.245 $ 1.24 $ 1.23 $ 1.20 $ 1.18 Other Data: Funds from operations (1) $ 43,949 $ 46,044 $ 42,517 $ 34,230 $ 22,570 Cash flows provided by (used in): Operating activities $ 50,198 $ 47,876 $ 41,260 $ 34,010 $ 22,216 Investing activities $ (22,372) $ (64,436) $ (145,643) $ (167,002) $ (144,247) Financing activities $ (28,965) $ 18,447 $ 103,665 $ 133,742 $ 123,140 (1) Funds from operations are net earnings excluding depreciation, gains and losses on the sale of real estate and nonrecurring items of income and expense of the Company, and the Company's share of these items from the Company's unconsolidated partnership. For purposes of this table, funds from operations exclude $1,521, $9,824 and $5,501 of expenses incurred in acquiring CNL Realty Advisors, Inc. from a related party in 2000, 1999 and 1998, respectively, and a $367 cumulative effect of a change in accounting principle in 2000 because these transactions are considered to be non-recurring. Funds from operations are generally considered by industry analysts to be the most appropriate measure of performance and do not necessarily represent cash provided by operating activities in accordance with accounting principles generally accepted in the United States of America and are not necessarily indicative of cash available to meet cash needs. Management considers funds from operations an appropriate measure of performance of an equity REIT because it is predicated on cash flow analysis. The Company's computation of funds from operations may differ from the methodology for calculating funds from operations utilized by other equity REITs, and therefore, may not be comparable to such other REITs.
2000 ANNUAL REPORT - PAGE 17 [GRAPHIC 2] Design graphic depicting the Commercial Net Lease Realty, Inc. initials, "CNLR" MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS INTRODUCTION Commercial Net Lease Realty, Inc., a Maryland corporation, is a fully integrated, self-administered real estate investment trust ("REIT") formed in 1984 that acquires, owns, manages and indirectly develops high-quality, freestanding properties that are generally leased to major retail businesses under long-term commercial net leases. As of December 31, 2000, Commercial Net Lease Realty, Inc. and its subsidiaries (the "Company") owned 259 properties (the "Properties") that are leased to major retail businesses, including Academy, Barnes & Noble, Bed Bath & Beyond, Best Buy, Borders, Eckerd, Food 4 Less, Good Guys, Hi-Lo Automotive, OfficeMax, HomeLife and The Sports Authority. LIQUIDITY AND CAPITAL RESOURCES General. Historically, the Company's only demand for funds has been for the payment of operating expenses and dividends, for property acquisitions and development, either directly or through investment interests, for the payment of interest on its outstanding indebtedness and other investments. Generally, cash needs for items other than property acquisitions and development have been met from operations, and property acquisitions and development have been funded by equity and debt offerings, bank borrowings, the sale of Properties and, to a lesser extent, from internally generated funds. Potential future sources of capital include proceeds from the public or private offering of the Company's debt or equity securities, secured or unsecured borrowings from banks or other lenders, proceeds from the sale of Properties, as well as undistributed funds from operations. For the years ended December 31, 2000, 1999 and 1998, the Company generated $50,198,000, $47,876,000 and $41,260,000, respectively, in net cash provided by operating activities. The increase in cash from operations for each of the years ended December 31, 2000, 1999 and 1998, is primarily a result of changes in revenues and expenses as discussed in "Results of Operations." The Company's leases typically provide that the tenant bears responsibility for substantially all property costs and expenses associated with ongoing maintenance and operation, including utilities, property taxes and insurance. In addition, the Company's leases generally provide that the tenant is responsible for roof and structural repairs. Certain of the Company's Properties are subject to leases under which the Company retains responsibility for certain costs and expenses associated with the Property. Because many of the Properties which are subject to leases that place these responsibilities on the Company are recently constructed, management anticipates that capital demands to meet obligations with respect to these Properties will be minimal for the foreseeable future and can be met with funds from operations and working capital. The Company may be required to use bank borrowings or other sources of capital in the event of unforeseen significant capital expenditures. Indebtedness. In October 2000, the Company entered into an amended and restated loan agreement for a $200,000,000 revolving credit facility (the "Credit Facility") which amended the Company's existing loan agreement by (i) lowering the interest rates of the tiered rate structure to a maximum rate of 150 basis points above LIBOR (based upon the debt rating of the company), (ii) extending the expiration date to October 31, 2003, and (iii) amending certain of the financial covenants of the Company. In connection with the Credit Facility, the Company is required to pay a commitment fee of 20 basis points per annum. The principal balance is due in full upon expiration of the Credit Facility on October 31, 2003, which the Company may request to be extended for an additional 12 month period with the consent of the lender. As of December 31, 2000, $101,700,000 was outstanding and approximately $98,300,000 was available for future borrowings under the Credit Facility. The Company expects to use the Credit Facility primarily to invest in 2000 ANNUAL REPORT - PAGE 18 the acquisition and development of freestanding, retail properties, either directly or through investment interests. In December 1995, the Company entered into a long-term, fixed rate mortgage and security agreement for $13,150,000. Upon its maturity in December 1999, the Company repaid the outstanding principal balance of $13,150,000 using funds available from its Credit Facility. In January 1996, the Company entered into a long-term, fixed rate mortgage and security agreement for $39,450,000. The loan provides for a ten-year mortgage with principal and interest payable monthly, based on a 17-year amortization, with the balance due in February 2006 and bears interest at a rate of 7.435% per annum. The mortgage is collateralized by a first lien on and an assignment of rents and leases of certain of the Company's Properties. As of December 31, 2000, the outstanding principal balance was $31,535,000 and the aggregate carrying value of the Properties totaled $71,589,000. In June 1996, the Company acquired three Properties each subject to a mortgage totaling $6,864,000 (collectively the "Mortgages"). The Mortgages bear interest at a weighted average rate of 8.6% and have a weighted average maturity of 4.1 years. As of December 31, 2000, the outstanding principal balances for the Mortgages totaled $5,492,000 and the aggregate carrying value of these three properties totaled $7,886,000. Payments of principal on the mortgage debt and on advances outstanding under the Credit Facility are expected to be met from the proceeds of renewing or refinancing the Credit Facility, proceeds from public or private offerings of the Company's debt or equity securities, secured or unsecured borrowings from banks or other lenders or proceeds from the sale of one or more of its Properties. Debt and Equity Securities. During the year ended December 31, 1998, the Company issued a total of 988,172 shares of common stock pursuant to three prospectus supplements to its $300,000,000 shelf registration statement, and received gross proceeds totaling $16,962,000. In connection with the three offerings, the Company incurred stock issuance costs totaling $933,000 consisting primarily of underwriters' commissions and fees, legal and accounting fees and printing expenses. Proceeds from the offerings were used to pay down the Company's Credit Facility. During the year ended December 31, 1998, the Company received investment grade debt ratings from Standard and Poor's, Moody's Investor Service and Fitch IBCA on its senior, unsecured debt. In March 1998, the Company filed a prospectus supplement to its $300,000,000 shelf registration and issued $100,000,000 of 7.125% notes due 2008 (the "2008 Notes"). The 2008 Notes are senior obligations of the Company, ranked equally with the Company's other unsecured senior indebtedness and are subordinated to all of the Company's secured indebtedness. The 2008 Notes were sold at a discount for an aggregate purchase price of $99,729,000. In connection with the debt offering, the Company incurred debt issuance costs totaling $1,208,000, consisting primarily of underwriting discounts and commissions, legal and accounting fees, rating agency fees and printing expenses. The net proceeds from the debt offering were used to pay down outstanding indebtedness of the Company's Credit Facility. In September 1998, the Company filed a shelf registration statement with the Securities and Exchange Commission which permits the issuance by the Company of up to $300,000,000 in debt and equity securities (which includes approximately $112,000,000 of unissued debt and equity securities under the Company's previous $300,000,000 shelf registration statement). In June 1999, the Company filed a prospectus supplement to its $300,000,000 shelf registration statement and issued $100,000,000 of 8.125% notes due 2004 (the "2004 Notes"). The 2004 Notes are senior obligations of the Company, ranked equally with the Company's other unsecured senior indebtedness and are subordinated to all secured indebtedness of the Company. The 2004 Notes were sold at a discount for an aggregate purchase price of $99,608,000 with interest payable semi-annually commencing on December 15, 1999. The discount of $392,000 is being amortized as interest expense over the term of the debt obligation using the effective interest method. In connection with the debt offering, the Company 2000 ANNUAL REPORT - PAGE 19 entered into a treasury rate lock agreement which fixed a treasury rate of 5.1854% on a notional amount of $92,000,000. Upon issuance of the 2004 Notes, the Company terminated the treasury rate lock agreement resulting in a gain of $2,679,000. The gain has been deferred and is being amortized as an adjustment to interest expense over the term of the 2004 Notes using the effective interest method. The effective rate of the 2004 Notes, including the effects of the discount and the treasury rate lock gain, is 7.547%. In connection with the debt offering, the Company incurred debt issuance costs totaling $970,000, consisting primarily of underwriting discounts and commissions, legal and accounting fees, rating agency fees and printing expenses. Debt issuance costs have been deferred and are being amortized over the term of the 2004 Notes using the effective interest method. The net proceeds of the debt offering were used to pay down outstanding indebtedness of the Company's Credit Facility. In September 2000, the Company filed a prospectus supplement to its $300,000,000 shelf registration statement and issued $20,000,000 of 8.5% notes due 2010 (the "2010 Notes"). The 2010 Notes are senior, unsecured obligations of the Company and are subordinate to all secured indebtedness of the Company. The 2010 Notes were sold at a discount for an aggregate purchase price of $19,874,000 with interest payable semi-annually commencing on March 20, 2001. The discount of $126,000 is being amortized as interest expense over the term of the debt obligation using the effective interest method. In connection with the debt offering, the Company incurred debt issuance costs totaling $225,000 consisting primarily of underwriter discounts and commissions, legal and accounting fees, rating agency fees and printing expenses. Debt issuance costs have been deferred and are being amortized over the term of the 2010 Notes using the effective interest method. Net proceeds of the debt offering were used to pay down outstanding indebtedness of the Company's Credit Facility. In January 2001, the Company filed a shelf registration statement with the Securities and Exchange Commission which permits the issuance by the Company of up to $200,000,000 in debt and equity securities (which includes approximately $180,000,000 of unissued debt and equity securities under the Company's previous $300,000,000 shelf registration statement). During the year ended December 31, 1999, the Company announced the authorization by the Company's board of directors to acquire up to $25,000,000 of the Company's outstanding common stock either through open market transactions or through privately negotiated transactions. As of December 31, 2000, the Company had acquired and retired 249,200 of such shares for a total cost of $2,379,000. The acquisition of these shares was funded primarily through asset disposition. Property Acquisitions, Dispositions and Commitments. During the year ended December 31, 2000, the Company invested $3,500,000 to complete construction of two buildings by the Company on previously acquired land parcels at a total cost of $3,724,000. Each of the properties is leased to Eckerd. The Company generally leases the Properties to major retail tenants and accounts for the leases under the provisions of the Statement of Financial Accounting Standards No. 13, "Accounting for Leases." Pursuant to the requirements of this Statement, one of the leases relating to the two buildings developed by the Company on land parcels owned by the Company has been classified as an operating lease and one has been classified as a direct financing lease. The Company owns one land parcel subject to a lease agreement with a tenant whereby the Company has agreed to construct a building on the land parcel for construction costs of approximately $2,216,000, of which $141,000 of costs had been incurred at December 31, 2000. Pursuant to the lease agreement, rent is to commence on the property upon completion of construction of the building. In addition to the one building under construction as of December 31, 2000, the Company may elect to acquire or develop additional properties, either directly or indirectly through investment interests, in the future. Such property acquisitions and development are expected to be the primary demand for additional capital in the future. The Company anticipates that it may engage in equity or debt financing, through either public or private offerings of its securities for cash, issuance of such securities in exchange for assets, 2000 ANNUAL REPORT - PAGE 20 disposition of assets or a combination of the foregoing. Subject to the constraints imposed by the Company's Credit Facility and long-term, fixed rate financing, the Company may enter into additional financing arrangements. During 1998, the Company sold six of its Properties for a total of $6,130,000 and received net sales proceeds of $5,947,000. The Company recognized a gain on the sale of these six Properties of $1,355,000 for financial reporting purposes. The Company reinvested the proceeds to acquire additional Properties and structured the transactions to qualify as tax-free like-kind exchange transactions for federal income tax purposes. During 1999, the Company sold 45 of its properties for a total of $50,541,000 and received net sales proceeds of $49,732,000. The Company recognized a net gain on the sale of these 45 properties of $6,724,000 for financial reporting purposes. The Company reinvested the proceeds from 41 of these properties to acquire additional Properties and structured the transactions to qualify as tax-free like-kind exchange transactions for federal income tax purposes. During 2000, the Company sold 13 of its properties for a total of $32,061,000 and received net sales proceeds of $31,257,000. The Company recognized a net gain on the sale of these 13 properties of $4,091,000 for financial reporting purposes. The Company used the proceeds to pay down outstanding indebtedness of the Company's Credit Facility. Investment in Unconsolidated Affiliates. In May 1999, the Company transferred its build-to-suit development operation to a 95 percent owned, taxable unconsolidated subsidiary ("Services"). The Company contributed $5.7 million of real estate and other assets to Services in exchange for 5,700 shares of non-voting common stock. In October 2000, the Company entered into the Second Modification of Amended and Restated Secured Revolving Line of Credit and Security Agreement with Services for $65,000,000 which amended Services existing credit agreement with the Company by (i) increasing its borrowing capacity from $50,000,000 to $65,000,000 and (ii) extending the expiration date to October 31, 2003. The credit facility is secured by a first mortgage on Services' properties. In October 2000, the Company entered into the Second Modification of Secured Revolving Line of Credit and Security Agreement the with a wholly-owned subsidiary of Services for $35,000,000, which amended its existing credit agreement with the Company by (i) increasing its borrowing capacity from $20,000,000 to $35,000,000 and (ii) extending the expiration date to October 31, 2003. During 2000, the Company borrowed $51,290,000 under its Credit Facility to fund the amounts drawn against under these revolving credit facilities. In September 1997, the Company entered into a partnership arrangement, Net Lease Institutional Realty, L.P. (the "Partnership"), with the Northern Trust Company, as Trustee of the Retirement Plan for the Chicago Transit Authority Employees ("CTA"). The Company is the sole general partner with a 20 percent interest in the Partnership and CTA is the sole limited partner with an 80 percent limited partnership interest. The Partnership owns and leases nine properties to major retail tenants under long-term commercial net leases. Net income and losses of the Partnership are to be allocated to the partners in accordance with their respective percentage interest in the Partnership. The Company accounts for its 20 percent interest in the Partnership under the equity method of accounting. Merger Transaction. On December 18, 1997, the Company's stockholders voted to approve an agreement and plan of merger with CNL Realty Advisors, Inc. (the "Advisor"), whereby the stockholders of the Advisor agreed to exchange 100 percent of the outstanding shares of common stock of the Advisor for up to 2,200,000 shares (the "Share Consideration") of the Company's common stock (the "Merger"). As a result, the Company became a fully integrated, self-administered REIT effective January 1, 1998. Ten percent of the Share Consideration (220,000 shares) was paid January 1, 1998, and the balance (the "Share Balance") of the Share Consideration is to be paid over time, within five years from the date of the merger, based upon the Company's completed property acquisitions and completed development projects in accordance with the Merger agreement. In the event of a change in control of the Company, any remaining Share Balance will be immediately issued and paid to stockholders of the Advisor. The market value of the common shares issued 2000 ANNUAL REPORT - PAGE 21 on January 1, 1998 was $3,933,000 of which $12,000 was allocated to the net tangible assets acquired and the difference of $3,921,000 was accounted for as expenses incurred in acquiring the Advisor from a related party. In addition, in connection with the Merger, the Company incurred costs totaling $771,000 consisting primarily of legal and accounting fees, directors' compensation and fairness opinions. For accounting purposes, the Advisor was not considered a "business" for purposes of applying APB Opinion No. 16, "Business Combinations," and therefore, the market value of the common shares issued in excess of the fair value of the net tangible assets acquired was charged to operations rather than capitalized as goodwill. Since the effective date of the Merger, the Company has issued 1,006,080 shares of the Share Balance. The market value of the Share Balance issued was $12,155,000, all of which was charged to operations. In addition, in connection with the completed development projects during the quarter ended December 31, 2000, on January 1, 2001, an additional 32,542 shares of the Share Balance became issuable to the stockholders of the Advisor. The market value of the 32,542 shares at the date the shares became issuable totaled $334,000, all of which is to be charged to operations during the year ended December 31, 2001. Pursuant to the agreement and plan of merger, the Company is required to issue the shares within 90 days after the shares become issuable. To the extent the remaining Share Balance is paid over time, the market value of the common shares issued will also be charged to operations. Management believes that the Company's current capital resources (including cash on hand), coupled with the Company's borrowing capacity, are sufficient to meet its liquidity needs for the foreseeable future. Dividends. One of the Company's primary objectives, consistent with its policy of retaining sufficient cash for reserves and working capital purposes and maintaining its status as a REIT, is to distribute a substantial portion of its funds available from operations to its stockholders in the form of dividends. During the years ended December 31, 2000, 1999 and 1998, the Company declared and paid dividends to its stockholders of $37,760,000, $37,495,000 and $35,672,000, respectively, or $1.245, $1.240 and $1.230 per share of common stock, respectively. The following presents the characterizations for tax purposes of such dividends for the years ended December 31: 2000 1999 1998 ------- ------- ------- Ordinary income 91.19% 90.54% 88.90% Capital gain 4.35% .55% - Unrecaptured Section 125 gain 4.46% 1.41% - Return of capital - 7.50% 11.10% ------- ------- ------- 100.00% 100.00% 100.00% ======= ======= ======= In January 2001, the Company declared dividends to its stockholders of $9,594,000 or $0.315 per share of common stock, payable in February 2001. 2000 ANNUAL REPORT - PAGE 22 RESULTS OF OPERATIONS Comparison of Year Ended December 31, 2000 to Year Ended December 31, 1999. As of December 31, 2000 and 1999, the Company owned 259 and 270 wholly-owned Properties, respectively, 257 and 267, respectively, of which were leased to operators of major retail businesses. In addition, during the year ended December 31, 2000 the Company sold 13 properties that were leased during 2000. During the year ended December 31, 1999, the Company sold 44 properties that were leased during 1999 and one property that was vacant. The Properties are leased on a long-term basis, generally 10 to 20 years, with renewal options for an additional 10 to 20 years. As of December 31, 2000, the weighted average remaining lease term of the Properties was approximately 13 years. During the years ended December 31, 2000 and 1999, the Company earned $73,776,000 and $72,525,000, respectively, in rental income from operating leases, earned income from direct financing leases and contingent rental income ("Rental Income"). The increase in Rental Income during 2000, as compared to 1999, was attributable to (i) the 36 Properties acquired and 15 buildings upon which construction was completed during 1999 were operational for a full fiscal year in 2000 and (ii) the Company received non-recurring additional rental income of $1,540,000 related to the termination of leases on several of its properties. The increase in Rental Income was partially offset by a decrease in Rental Income relating to the sale of the 13 properties during 2000 and a full year of Rental Income relating to the sale of the 45 properties during 1999. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. While the Company does not have more than one reportable segment, the Company has identified two primary sources of revenue: (i) rental and earned income from triple net leases and (ii) fee income from development, property management and asset management services. During the years ended December 31, 2000 and 1999, the Company generated $76,035,000 and $73,119,000, respectively, from its triple net lease segment. For the years ended December 31, 2000 and 1999, the Company generated revenues totaling $4,856,000 and $3,174,000, respectively, from its fee income segment. During 2000, one of the Company's lessees, Eckerd Corporation, accounted for more than ten percent of the Company's total rental income (including the Company's share of rental income from nine properties owned by the Company's unconsolidated partnership). As of December 31, 2000, Eckerd Corporation leased 50 Properties (including four properties under leases with the Company's unconsolidated partnership). It is anticipated that, based on the minimum rental payments required by the leases, Eckerd Corporation will continue to account for more than ten percent of the Company's total rental income in 2001. Any failure of this lessee to make its lease payments when they are due could materially affect the Company's earnings. During the years ended December 31, 2000 and 1999, the Company earned $457,000 and $1,883,000, respectively, in development and asset management fees from related parties. The decrease in fees earned during 2000 is attributable to the transfer of the Company's build-to-suit development operation to Services in May 1999. Development fees earned by Services during the years ended December 31, 2000 and 1999 are included in the Company's equity in earnings of unconsolidated affiliates. In addition, during 1999 the Company earned $506,000 of asset management fees from an affiliate of Services. During the years ended December 31, 2000 and 1999, operating expenses, excluding interest and including depreciation and amortization, were $15,856,000 and $25,070,000, respectively, (19.6% and 32.8%, respectively, of total revenues). The decrease in operating expenses for the year ended December 31, 2000, is attributable to the decrease in charges related to the costs incurred in acquiring the Company's external advisor from a related party and the decrease in general operating and administrative expenses as a result of the transfer of the Company's build-to-suit development operation to Services. The decrease in operating expenses was partially offset by an increase in depreciation and amortization expense as a result of the depreciation and amortization expense relating to the additional Properties acquired during 2000 and a full year of depreciation on the Properties acquired during 1999. The increase in depreciation and amortization 2000 ANNUAL REPORT - PAGE 23 expense was partially offset by a decrease in depreciation and amortization expense related to the sale of 13 properties during the year ended December 31, 2000 and a full year of depreciation and amortization of the 45 properties sold during the year ended December 31, 1999. In accordance with accounting principles generally accepted in the United States of America, certain costs relating to the development of Properties have been capitalized. The Company recognized $26,528,000 and $21,920,000 in interest expense for the years ended December 31, 2000 and 1999, respectively. Interest expense increased for the year ended December 31, 2000 primarily as a result of the higher average interest rate and borrowing levels on the Company's Credit Facility and the issuance of the 2004 Notes in June 1999 and the 2010 Notes in September 2000. During 2000, the Company sold 13 of its properties for a total of $32,061,000 and received net sales proceeds of $31,257,000. The Company recognized a gain on the sale of these 13 properties of $4,091,000 for financial reporting purposes. The Company used the proceeds to pay down outstanding indebtedness of the Company's Credit Facility. During 1999, the Company sold 45 of its properties for a total of $50,541,000 and received net sales proceeds of $49,732,000. The Company recognized a net gain on the sale of these 45 properties of $6,724,000 for financial reporting purposes. The Company reinvested the proceeds from 41 of these properties to acquire additional Properties and structured the transactions to qualify as tax-free like-kind exchange transactions for federal income tax purposes. Comparison of Year Ended December 31, 1999 to Year Ended December 31, 1998. As of December 31, 1999 and 1998, the Company owned 270 and 285 wholly-owned Properties, respectively, 267 and 281, respectively, of which were leased to operators of major retail businesses. In addition, during the year ended December 31, 1999, the Company sold 44 properties which were leased during 1999 and one property which was vacant. During the year ended December 31, 1998, the Company sold six properties which were leased during 1998. The Properties are leased on a long-term basis, generally 10 to 20 years, with renewal options for an additional 10 to 20 years. As of December 31, 1999, the weighted average remaining lease term of the Properties was approximately 14 years. During the years ended December 31, 1999 and 1998, the Company earned $72,525,000 and $61,750,000, respectively, in rental income from operating leases, earned income from direct financing leases and contingent rental income ("Rental Income"). The 17 percent increase in Rental Income during 1999, as compared to 1998, was attributable to income earned on the 36 Properties acquired and the 15 buildings upon which construction was completed during 1999. In addition, Rental Income increased during 1999 as a result of the fact that the 55 Properties acquired and 15 buildings upon which construction was completed during 1998 were operational for a full fiscal year in 1999. The increase in Rental Income was partially offset by a decrease in Rental Income relating to the sale of the 44 leased properties In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Statement requires that a public business enterprise report financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. While the Company does not have more than one reportable segment as defined by the Statement, the Company has identified two primary sources of revenue: (i) rental and earned income from triple net leases and (ii) fee income from development, property management and asset management services. During the years ended December 31, 1999 and 1998, the Company generated $73,119,000 and $62,067,000, respectively, from its triple net lease segment. For the years ended December 31, 1999 and 1998, the Company generated revenues totaling $3,174,000 and $2,706,000, respectively, from its fee income segment. 2000 ANNUAL REPORT - PAGE 24 During 1999, one of the Company's lessees, Eckerd Corporation, accounted for more than ten percent of the Company's total rental income (including the Company's share of rental income from nine properties owned by the Company's unconsolidated partnership). As of December 31, 1999, Eckerd Corporation leased 51 Properties (including four properties under leases with the Company's unconsolidated partnership). During the years ended December 31, 1999 and 1998, the Company earned $1,883,000 and $2,362,000, respectively, in development and asset management fees from related parties. The decrease in fees earned during 1999 is attributable to the transfer of the Company's build-to-suit development operation to Services in May 1999. During the years ended December 31, 1999 and 1998, the Company's operating expenses, excluding interest and including depreciation and amortization, were $25,070,000 and $20,594,000, respectively (32.8% and 31.8%, respectively, of total revenues). The increase in operating expenses for the year ended December 31, 1999, was primarily attributable to the increase in the charges related to the costs incurred in acquiring the Company's Advisor from a related party. Operating expenses for the years ended December 31, 1999 and 1998, excluding the costs relating to the acquisition of the Advisor, were $15,246,000 and $15,093,000, respectively, (19.9% and 23.3%, respectively, of total revenues). The increase in the dollar amount of operating expenses for the year ended December 31, 1999, as compared to the year ended December 31, 1998 is also attributable to the increase in depreciation expense as a result of the depreciation of the additional Properties acquired during 1999 and a full year of depreciation on the Properties acquired during 1998. The increase in depreciation expense was partially offset by a decrease in depreciation expense related to the sale of 45 properties during the year ended December 31, 1999. In addition, the increase in the dollar amount of operating expenses for the year ended December 31, 1999 was partially offset by a decrease in general operating and administrative expenses attributable to the transfer of the Company's build-to-suit development operation to Services. In accordance with generally accepted accounting principles, certain costs relating to the development of Properties for the Company's own use have been capitalized. The Company recognized $21,920,000 and $13,460,000, in interest expense for the years ended December 31, 1999 and 1998, respectively. Interest expense increased for the year ended December 31, 1999 primarily as a result of the higher average interest rate and borrowing levels on the Company's Credit Facility and the issuance of the 2008 Notes in March 1998 and the 2004 Notes in June 1999. During 1999, the Company sold 45 of its properties for a total of $50,541,000 and received net sales proceeds of $49,732,000. The Company recognized a net gain on the sale of these 45 properties of $6,724,000 for financial reporting purposes. The Company reinvested the proceeds from 41 of these properties to acquire additional Properties and structured the transactions to qualify as tax-free like-kind exchange transactions for federal income tax purposes. During 1998, the Company sold six of its properties for a total of $6,130,000 and received net sales proceeds of $5,947,000. The Company recognized a gain on the sale of these six properties of $1,355,000 for financial reporting purposes. The Company reinvested the proceeds to acquire additional properties and structured the transactions to qualify as tax-free like-kind exchange transactions for federal income tax purposes. Investment Considerations. Three of the Company's tenants, Levitz, Waccamaw/HomePlace and Heilig-Meyers (the "Tenants), have each filed voluntary petition for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. As a result, each of the Tenants has the right to reject or affirm its leases with the Company. In January 2001, Heilig-Meyers rejected one of its 17 leases with the Company, at which time Heilig-Meyers was no longer required to pay rent on this property. The Company is currently marketing the property for sale or lease. Levitz, Waccamaw/HomePlace and Heilig-Meyers continued to lease one, three and sixteen Properties, respectively, which combined, accounted for 7.9% percent of the Company's Rental Income for the year ended December 31, 2000. 2000 ANNUAL REPORT - PAGE 25 The Company had made an election to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, and related regulations. As a REIT, for federal income tax purposes, the Company generally will not be subject to federal income tax on income that it distributes to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost. Such an event could materially affect the Company's income. However, the Company believes that it was organized and operated in such a manner as to qualify for treatment as a REIT for the years ended December 31, 2000, 1999 and 1998, and intends to continue to operate the Company so as to remain qualified as a REIT for federal income tax purposes. Inflation has had a minimal effect on income from operations. Management expects that increases in retail sales volumes due to inflation and real sales growth should result in an increase in rental income over time. Continued inflation also may cause capital appreciation of the Company's Properties; however, inflation and changing prices also may have an adverse impact on the operating margins of retail businesses, on potential capital appreciation of the Properties and on operating expenses of the Company. Management of the Company currently knows of no trends that will have a material adverse effect on liquidity, capital resources or results of operations; however, certain factors exist that could contribute to trends that may adversely effect the Company in the future. Such factors include the following: changes in general economic conditions, changes in real estate market conditions, interest rate fluctuations, an increase in internet retailing, the ability of the Company to locate suitable tenants for its Properties and the ability of tenants to make payments under their respective leases. Investments in real property create a potential for environmental liability on the part of the owner of such property from the presence or discharge of hazardous substances on the property. It is the Company's policy, as a part of its acquisition due diligence process, to obtain a Phase I environmental site assessment for each property and where warranted, a Phase II environmental site assessment. Phase I assessments involve site reconnaissance and review of regulatory files identifying potential areas of concern, whereas Phase II assessments involve some degree of soil and/or groundwater testing. The Company may acquire a property whose environmental site assessment indicates that a problem or potential problem exists, subject to a determination of the level of risk and potential cost of remediation. In such cases, the Company requires the seller and/or tenant to (i) remediate the problem prior to the Company's acquiring the property, (ii) indemnify the Company for environmental liabilities or (iii) agree to other arrangements deemed appropriate by the Company to address environmental conditions at the property. The Company has 13 properties currently under some level of environmental remediation. The seller or the tenant is contractually responsible for the cost of the environmental remediation for each of these properties. Quantitative and Qualitative Disclosures About Market Risk. The Company is exposed to interest changes primarily as a result of its variable rate Credit Facility and its long term, fixed-rate debt used to finance the Company's development and acquisition activities and for general corporate purposes. The Company's interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve its objectives, the Company borrows at both fixed and variable rates on its long-term debt. The information in the table summarizes the Company's market risks associated with its debt obligations outstanding as of December 31, 2000 and 1999. The table presents principal cash flows and related interest rates by year of expected maturity for debt obligations outstanding as of December 31, 2000. The variable interest rates shown represent the weighted average rates for the Credit Facility at the end of the periods. As the table incorporates only those exposures that exist as of December 31, 2000 and 1999, it does not consider those exposures or positions which could arise after those dates. Moreover, because firm 2000 ANNUAL REPORT - PAGE 26 commitments are not presented in the table below, the information presented therein has limited predictive value. As a result, the Company's ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period, the Company's hedging strategies at that time and interest rates.
Maturity Date (dollars in thousands) There- 2001 2002 2003 2004 2005 after --------- -------- -------- -------- -------- -------- Variable rate credit facility $ - $ - $101,700 $ - $ - $ - Average interest rate - - (1) - - - Fixed rate mortgages $ 2,138 $2,308 $ 2,547 $ 2,780 $ 3,023 $ 24,555 Average interest rate 7.67% 7.67% 7.66% 7.65% 7.63% 7.87% Fixed rate notes $ - $ - $ - $100,000 $ - $120,000 Average interest rate - - - 7.547% - 7.402% (1) Interest rate varies based upon a tiered rate structure ranging from 80 basis points above LIBOR to 150 basis points above LIBOR based upon the debt rating of the Company.
December 31, 2000 December 31, 1999 (dollars in thousands) (dollars in thousands) --------------------------------- --------------------------------- Weighted Weighted Average Average Interest Fair Interest Fair Total Rate Value Total Rate Value --------- --------- --------- --------- --------- --------- Variable rate credit facility $ 101,700 7.76% $ 101,700 $ 108,700 7.29% $ 108,700 Fixed rate mortgages $ 37,351 7.67% $ 37,351 $ 40,429 7.62% $ 40,429 Fixed rate notes $ 220,000 7.24% $ 216,159 $ 200,000 7.36% $ 185,840
This information contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the Company's actual results could differ materially from those set forth in the forward-looking statements. Certain factors that might cause such a difference include the following: changes in general economic conditions, changes in real estate market conditions, continued availability of proceeds from the Company's debt or equity capital, the ability of the Company to locate suitable tenants for its Properties and the ability of tenants to make payments under their respective leases. 2000 ANNUAL REPORT - PAGE 29 [GRAPHIC 3] Design graphic depicting the Commercial Net Lease Realty, Inc. initials "CNLR" INDEPENDENT AUDITORS' REPORT The Board of Directors Commercial Net Lease Realty, Inc.: We have audited the accompanying consolidated balance sheets of Commercial Net Lease Realty, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Commercial Net Lease Realty, Inc. and subsidiaries as of December 31, 2000 and 1999, and results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. Orlando, Florida January 12, 2001, except as to Note 19, which is as of January 16, 2001 2000 ANNUAL REPORT - PAGE 30 [GRAPHIC 4] Design graphic depicting the Commercial Net Lease Realty, Inc. initials "CNLR" COMMERCIAL NET LEASE REALTY, INC and SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (dollars in thousands, except per share data)
December 31, 2000 1999 --------- --------- ASSETS ------ Real estate: Accounted for using the operating method, net of accumulated depreciation and amortization $ 514,962 $ 546,193 Accounted for using the direct financing method 123,217 125,491 Investment in unconsolidated affiliates 3,603 8,346 Mortgages and accrued interest receivable 13,547 16,241 Mortgages and other receivables from unconsolidated affiliates 77,798 27,597 Cash and cash equivalents 2,190 3,329 Receivables 2,070 2,119 Accrued rental income, net of allowance 15,285 13,182 Debt costs, net of accumulated amortization of $3,587 and $2,894, respectively 3,668 2,964 Other assets 5,271 4,327 --------- --------- Total assets $ 761,611 $ 749,789 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Line of credit payable $ 101,700 $ 108,700 Mortgages payable 37,351 40,429 Notes payable, net of unamortized discount of $624 and $592, respectively, and unamortized interest rate hedge gain of $1,955 and $2,434, respectively 221,330 201,842 Accrued interest payable 3,214 2,744 Accounts payable and accrued expenses 1,077 1,717 Other liabilities 3,038 2,995 --------- --------- Total liabilities 367,710 358,427 --------- --------- Commitments and contingencies (Note 18) Stockholders' equity: Preferred stock, $0.01 par value. Authorized 15,000,000 shares; none issued or outstanding - - Common stock, $0.01 par value. Authorized 90,000,000 shares; issued and outstanding 30,456,705 and 30,255,939 shares at December 31, 2000 and 1999, respectively 305 303 Excess stock, $0.01 par value. Authorized 105,000,000 shares; none issued or outstanding - - Capital in excess of par value 398,449 396,403 Accumulated dividends in excess of net earnings (4,853) (5,344) --------- --------- Total stockholders' equity 393,901 391,362 --------- --------- $ 761,611 $ 749,789 ========= ========= See accompanying notes to consolidated financial statement.
2000 ANNUAL REPORT - PAGE 31 [GRAPHIC 5] Design graphic depicting the Commercial Net Lease Realty, Inc. initials "CNLR" COMMERCIAL NET LEASE REALTY, INC and SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (dollars in thousands, except per share data)
Year Ended December 31, 2000 1999 1998 ---------- ---------- ---------- Revenues: Rental income from operating leases $ 59,734 $ 57,764 $ 48,127 Earned income from direct financing leases 13,185 13,858 12,815 Contingent rental income 857 903 808 Development and asset management fees from related parties 457 1,883 2,362 Interest from unconsolidated affiliates and other mortgages receivable 5,962 1,809 241 Other 696 326 420 ---------- ---------- ---------- 80,891 76,543 64,773 ---------- ---------- ---------- Expenses: General operating and administrative 4,850 6,180 7,735 Real estate expenses 397 432 599 Interest 26,528 21,920 13,460 Depreciation and amortization 9,088 8,634 6,759 Expenses incurred in acquiring advisor from related party 1,521 9,824 5,501 ---------- ---------- ---------- 42,384 46,990 34,054 ---------- ---------- ---------- Earnings before equity in earnings of unconsolidated affiliates, gain on disposition of real estate and cumulative effect of change in accounting principle 38,507 29,553 30,719 Equity in earnings of unconsolidated affiliates (3,980) (966) 367 Gain on disposition of real estate 4,091 6,724 1,355 ---------- ---------- ---------- Earnings before cumulative effect of change in accounting principle 38,618 35,311 32,441 Cumulative effect of change in accounting principle (367) - - ---------- ---------- ---------- Net earnings $ 38,251 $ 35,311 $ 32,441 ========== ========== ========== See accompanying notes to consolidated financial statements. 2000 ANNUAL REPORT - PAGE 32 COMMERCIAL NET LEASE REALTY, INC and SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS - CONTINUED (dollars in thousands, except per share data) Net earnings per share of common stock: Basic: Earnings per share before cumulative effect of change in accounting principle $ 1.27 $ 1.16 $ 1.11 Cumulative effect of change in accounting principle (.01) - - ---------- ---------- ---------- Net earnings per share $ 1.26 $ 1.16 $ 1.11 ========== ========== --======== Diluted: Earnings per share before cumulative effect of change in accounting principle $ 1.27 $ 1.16 $ 1.10 Cumulative effect of change in accounting principle (.01) - - ---------- ---------- ---------- Net earnings per share $ 1.26 $ 1.16 $ 1.10 ========== ========== ========== Proforma amounts assuming retroactive application of accounting change Net earnings $ 38,632 $ 34,930 $ 32,441 ========== ========== ========== Basic earnings per share $ 1.27 $ 1.15 $ 1.11 ========== ========== ========== Diluted earnings per share $ 1.27 $ 1.15 $ 1.10 ========== ========== ========== Weighted average number of shares outstanding: Basic 30,387,371 30,331,327 29,169,371 ========== ========== ========== Diluted 30,407,507 30,408,219 29,397,154 ========== ========== ========== See accompanying notes to consolidated financial statements.
2000 ANNUAL REPORT - PAGE 33 [GRAPHIC 6] Design graphic depicting the Commercial Net Lease Realty, Inc. initials "CNLR" COMMERCIAL NET LEASE REALTY, INC. and SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 2000, 1999 and 1998 (dollars in thousands, except per share data)
Retained Earnings (Accumulated Capital in Dividends in Number of Common Excess of Excess of Net Shares Stock Par Value Earnings) Total ------------- ------------ ------------ ------------ ------------ Balances at December 31, 1997 27,953,627 $ 280 $ 361,793 $ 71 $ 362,144 Net earnings - - - 32,441 32,441 Dividends declared and paid ($1.23 per share of common stock) - - - (35,672) (35,672) Issuance of common stock in connection with acquisition of advisor 277,813 3 4,739 - 4,742 Issuance of common stock 1,289,649 12 21,171 - 21,183 Stock issuance costs - - (948) - (948) ------------- ------------ ------------ ------------ ------------ Balances at December 31, 1999 29,521,089 295 386,755 (3,160) 383,890 Net earnings - - - 35,311 35,311 Dividends declared and paid ($1.24 per share of common stock) - - - (37,495) (37,495) Issuance of common stock in connection with acquisition of advisor 798,109 8 9,816 - 9,824 Issuance of common stock 180,941 2 2,178 - 2,180 Purchase and retirement of common stock (244,200) (2) (2,329) - (2,331) Stock issuance costs - - (17) - (17) ------------- ------------ ------------ ------------ ------------ Balances at December 31, 1999 30,255,939 303 396,403 (5,344) 391,362 Net earnings - - - 38,251 38,251 Dividends declared and paid ($1.245 per share of common stock) - - - (37,760) (37,760) Issuance of common stock in connection with acquisition of advisor 150,158 2 1,519 - 1,521 Issuance of common stock 55,608 - 578 - 578 Purchase and retirement of common stock (5,000) - (48) - (48) Stock issuance costs - - (3) - (3) ------------- ------------ ------------ ------------ ------------ Balances at December 31, 2000 30,456,705 $ 305 $ 398,449 $ (4,853) $ 393,901 ============= ============ ============ ============ ============ See accompanying notes to consolidated financial statements.
2000 ANNUAL REPORT - PAGE 34 [GRAPHIC 7] Design graphic depicting the Commercial Net Lease Realty, Inc. initials "CNLR" COMMERCIAL NET LEASE REALTY, INC. and SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands)
Year Ended December 31, 2000 1999 1998 ---------- ---------- ---------- Cash flows from operating activities: Net earnings $ 38,251 $ 35,311 $ 32,441 Adjustments to reconcile net earnings to net cash provided by operating activities: Cumulative effect of change in accounting principle 367 - - Depreciation and amortization 9,088 8,634 6,759 Amortization of notes payable discount 93 56 15 Amortization of deferred interest rate hedge gain (479) (245) - Gain on disposition of real estate (4,091) (6,724) (1,355) Expenses incurred in acquiring advisor from related party 1,521 9,824 5,501 Equity in earnings of unconsolidated affiliates, net of deferred intercompany profits 4,740 1,202 9 Decrease in real estate leased to others using the direct financing method 2,048 1,805 1,393 Decrease in leasehold interests 1,454 - - Decrease in mortgages and accrued interest receivable 998 474 - Decrease (increase) in receivables (418) 1,508 (2,723) Increase in accrued rental income (3,081) (3,928) (3,346) Increase in other assets (336) (43) (2) Increase in accrued interest payable 470 98 1,881 Increase (decrease) in accounts payable and accrued expenses (536) 288 755 Increase (decrease) in other liabilities 109 (384) (68) ---------- ---------- ---------- Net cash provided by operating activities 50,198 47,876 41,260 ---------- ---------- ---------- Cash flows from investing activities: Proceeds from the sale of real estate 29,832 43,125 5,947 Additions to real estate accounted for using the operating method (2,015) (76,063) (117,943) Additions to real estate accounted for using the direct financing method (1,984) (1,901) (29,572) Increase in mortgages receivable (520) (3,952) - Mortgage payments received 4,730 1,191 - Increase in mortgages and other receivables from unconsolidated affiliate (70,967) (31,728) - Mortgage payments received from unconsolidated affiliate 19,677 4,859 - Increase in other assets (1,124) (148) (4,084) Other (1) 181 9 ---------- ---------- ---------- Net cash used in investing activities (22,372) (64,436) (145,643) ---------- ---------- ---------- Cash flows from financing activities: Proceeds from line of credit payable 71,200 87,000 143,600 Repayment of line of credit payable (78,200) (116,400) (120,600) Repayment of mortgages payable (3,078) (14,984) (1,673) Proceeds from notes payable 19,874 99,608 99,729 Proceeds from termination of interest rate hedge - 2,679 - Payment of debt costs (1,481) (1,365) (1,165) Proceeds from issuance of common stock 578 2,180 21,183 Payment of stock issuance costs (9) (54) (1,144) Repurchase of common stock (48) (2,331) - Payment of dividends (37,760) (37,495) (35,672) Other (41) (391) (593) ---------- ---------- ---------- Net cash provided by (used in) financing activities (28,965) 18,447 103,665 ---------- ---------- ---------- See accompanying notes to consolidated financial statements.
2000 ANNUAL REPORT - PAGE 35 COMMERCIAL NET LEASE REALTY, INC. and SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED (dollars in thousands)
Year Ended December 31, 2000 1999 1998 ---------- ---------- ---------- Net increase (decrease) in cash and cash equivalents (1,139) 1,887 (718) Cash and cash equivalents at beginning of year 3,329 1,442 2,160 ---------- ---------- ---------- Cash and cash equivalents at end of year $ 2,190 $ 3,329 $ 1,442 ========== ========== ========== Supplemental disclosure of cash flow information: Interest paid, net of amount capitalized $ 26,957 $ 22,553 $ 11,478 ========== ========== ========== Supplemental schedule of non-cash investing and financing activities: Issued 150,158, 798,109 and 277,813 shares of common stock in 2000, 1999 and 1998, respectively, in connection with the acquisition of the Company's advisor $ 1,521 $ 9,824 $ 4,742 ========== ========== ========== Net assets acquired in connection with the acquisition of the Company's advisor $ - $ - $ 12 ========== ========== ========== Mortgage notes accepted in connection with the disposition of real estate $ 1,425 $ 6,618 $ - ========== ========== ========== Mortgage notes accepted as payment for mortgage receivable from unconsolidated affiliate $ - $ 6,755 $ - ========== ========== ========== Mortgage note issued in connection with the acquisition of real estate $ - $ 350 $ - ========== ========== ========== Real estate and other assets contributed to unconsolidated affiliate in exchange for: Non-voting common stock $ - $ 5,700 $ - ========== ========== ========== Mortgage receivable $ - $ 8,064 $ - ========== ========== ========== Capital lease obligation incurred for the lease of the Company's office space $ - $ 2,570 $ - ========== ========== ========== See accompanying notes to consolidated financial statements.
2000 ANNUAL REPORT - PAGE 36 [GRAPHIC 8] Design graphic depicting the Commercial Net Lease Realty, Inc. initials "CNLR" COMMERCIAL NET LEASE REALTY, INC. and SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 2000, 1999 and 1998 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: ORGANIZATION AND NATURE OF BUSINESS - Commercial Net Lease Realty, Inc., a Maryland corporation, is a fully integrated real estate investment trust formed in 1984. Commercial Net Lease Realty, Inc. acquires, owns, manages and indirectly, through an investment in an unconsolidated subsidiary, develops high-quality, freestanding properties that are generally leased to major retail businesses under long-term commercial net leases. PRINCIPLES OF CONSOLIDATION -The consolidated financial statements include the accounts of Commercial Net Lease Realty, Inc. and its seven wholly-owned subsidiaries (the "Company"). Each of the subsidiaries is a qualified real estate investment trust subsidiary as defined in the Internal Revenue Code section 856(i)(2). All significant intercompany accounts and transactions have been eliminated in consolidation. REAL ESTATE AND LEASE ACCOUNTING - The Company records the acquisition of real estate at cost, including acquisition and closing costs. The cost of properties developed by the Company includes direct and indirect costs of construction, property taxes, interest and other miscellaneous costs incurred during the development period until the project is substantially complete and available for occupancy. Real estate is generally leased to others on a net lease 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 or the operating method. Such methods are described below: Direct financing method - Leases accounted for using the direct financing method are recorded at their net investment (which at the inception of the lease generally represents the cost of the property) (Note 3). 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 leases. Operating method - Leases accounted for using the operating method are recorded at the cost of the real estate. Revenue is recognized as rentals are earned and expenses (including depreciation) are charged to operations as incurred. Buildings are depreciated on the straight-line method over their estimated useful lives (generally 35 to 40 years). Leasehold interests are amortized on the straight-line method over the terms of their respective leases. 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. 2000 ANNUAL REPORT - PAGE 37 Effective in October 2000, the Company adopted the Securities and Exchange Commission's Staff Accounting Bulletin 101, "Revenue Recognition," which establishes accounting and reporting standards for the recognition of contingent rental income. Accordingly, the Company has modified its revenue recognition policy and recognizes contingent rental income based on the tenants' actual gross quarterly or annual sales pursuant to the terms of the leases. Adoption of this Bulletin resulted in a cumulative effect of $367,000 which reduced net earnings for the year ended December 31, 2000. When real estate is disposed of, the related cost, accumulated depreciation or amortization and any accrued rental income for operating leases and the net investment for direct financing leases are removed from the accounts and gains and losses from the dispositions are reflected in income. Management reviews its real estate for impairment whenever events or changes in circumstances indicate that the carrying value of the assets, including accrued rental income, may not be recoverable through operations. Management determines whether an impairment in value occurred by comparing the estimated future cash flows (undiscounted and without interest charges), including the residual value of the real estate, with the carrying cost of the individual real estate. If an impairment is indicated, a loss will be recorded for the amount by which the carrying value of the asset exceeds its fair value. INVESTMENT IN UNCONSOLIDATED AFFILIATES - In May 1999, the Company contributed real estate and other assets to Commercial Net Lease Realty Services, Inc. ("Services"), an unconsolidated subsidiary whose officers and directors consist of certain officers and directors of the Company. In connection with the contribution, the Company received a 95 percent, non-controlling interest in Services. The Company accounts for its 95 percent interest in Services under the equity method of accounting. The Company is entitled to receive 95 percent of the dividends paid by Services. In September 1997, the Company contributed cash and real estate to Net Lease Institutional Realty, L.P. (the "Partnership") for a 20 percent interest in the Partnership. The Company is the sole general partner of the Partnership and accounts for its 20 percent interest in the Partnership under the equity method of accounting. 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. Cash and cash equivalents consist of cash and money market accounts. Cash equivalents are stated at cost plus accrued interest, which approximates fair value. Cash accounts maintained on behalf of the Company in demand deposits at commercial banks and money market funds may exceed federally insured levels; however, the Company has not experienced any losses in such accounts. The Company limits investment of temporary cash investments to financial institutions with high credit standing; therefore, management believes it is not exposed to any significant credit risk on cash and cash equivalents. DEBT COSTS - Debt costs incurred in connection with the Company's $200,000,000 line of credit and mortgages payable have been deferred and are being amortized over the terms of the loan commitments using the straight-line method which approximates the effective interest method. Debt costs incurred in connection with the issuance of the Company's notes payable have been deferred and are being amortized over the term of the debt obligations using the effective interest method. 2000 ANNUAL REPORT - PAGE 38 INCOME TAXES - The Company has made an election to be taxed as a real estate investment trust under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, and related regulations. The Company generally will not be subject to federal income taxes on amounts distributed to stockholders, providing it distributes at least 95 percent of its real estate investment trust taxable income, 90 percent effective January 1, 2001, and meets certain other requirements for qualifying as a real estate investment trust. For each of the years in the three-year period ended December 31, 2000, the Company believes it has qualified as a real estate investment trust; accordingly, no provisions have been made for federal income taxes in the accompanying consolidated financial statements. Not withstanding the Company's qualification for taxation as a real estate investment trust, the Company is subject to certain state taxes on its income and real estate. EARNINGS PER SHARE - In accordance with Statement of Financial Accounting Standard No. 128, "Earnings Per Share," basic earnings per share are calculated based upon the weighted average number of common shares outstanding during each year and diluted earnings per share are calculated based upon weighted average number of common shares outstanding plus dilutive potential common shares. (See Note 11). NEW ACCOUNTING STANDARDS - In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activity, an Amendment for SFAS 133." The Statements establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. The Statements require that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, an Amendment of FASB Statement No. 133." Statement No. 137 defers the effective date of Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" for one year. Statement No. 133, as amended, is now effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. The Company has reviewed the Statement, as amended, and has determined that it will not have any impact on the Company's consolidated financial statements. USE OF ESTIMATES - Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from those estimates. RECLASSIFICATION - Certain items in prior years' financial statements have been reclassified to conform with the 2000 presentation. These reclassifications had no effect on stockholders' equity or net earnings. 2000 ANNUAL REPORT - PAGE 39 2. LEASES: The Company generally leases its real estate to operators of major retail businesses. As of December 31, 2000, 174 of the leases have been classified as operating leases and 83 leases have been classified as direct financing leases. For the leases classified as direct financing leases, the building portions of the property leases are accounted for as direct financing leases while the land portions of 46 of these leases are accounted for as operating leases. Substantially all leases have initial terms of 10 to 20 years (expiring between 2001 and 2020) and provide for minimum rentals. In addition, the majority of the leases provide for contingent rentals and/or scheduled rent increases over the terms of the leases. The tenant is also generally required to pay all property taxes and assessments, substantially maintain the interior and exterior of the building and carry insurance coverage for public liability, property damage, fire and extended coverage. The lease options generally allow tenants to renew the leases for two to four successive five-year periods subject to substantially the same terms and conditions as the initial lease. 3. REAL ESTATE: ACCOUNTED FOR USING THE OPERATING METHOD - Real estate on operating leases consisted of the following at December 31 (dollars in thousands): 2000 1999 --------- --------- Land $ 254,720 $ 267,479 Buildings and improvements 285,448 296,219 Leasehold interests 2,091 4,409 --------- --------- 542,259 568,107 Less accumulated depreciation and amortization (27,438) (22,023) --------- --------- 514,821 546,084 Construction in progress 141 109 --------- --------- $ 514,962 $ 546,193 ========= ========= Some leases provide for scheduled rent increases throughout the lease term. Such amounts are recognized on a straight-line basis over the terms of the leases. For the years ended December 31, 2000, 1999 and 1998, the Company recognized $3,162,000, $3,985,000 and $3,403,000, respectively, of such income. At December 31, 2000 and 1999, the balance of accrued rental income was $15,285,000, net of an allowance of $1,311,000, and $13,182,000, net of an allowance of $957,000, respectively. The following is a schedule of future minimum lease payments to be received on noncancellable operating leases at December 31, 2000 (dollars in thousands): 2001 $ 53,866 2002 54,019 2003 54,251 2004 54,019 2005 54,227 Thereafter 453,220 -------- $723,602 ======== 2000 ANNUAL REPORT - PAGE 40 Since lease renewal periods are exercisable at the option of the tenant, the above table only presents future minimum lease payments due during the initial lease terms. In addition, this table does not include any amounts for future contingent rentals which may be received on the leases based on a percentage of the tenant's gross sales. ACCOUNTED FOR USING THE DIRECT FINANCING METHOD - The following lists the components of net investment in direct financing leases at December 31 (dollars in thousands): 2000 1999 --------- --------- Minimum lease payments to be received $ 230,712 $ 245,306 Estimated residual values 39,552 39,644 Less unearned income (147,047) (159,459) --------- --------- Net investment in direct financing leases $ 123,217 $ 125,491 ========= ========= The following is a schedule of future minimum lease payments to be received on direct financing leases at December 31, 2000 (dollars in thousands): 2001 $ 15,297 2002 15,358 2003 15,371 2004 15,549 2005 15,666 Thereafter 153,471 --------- $ 230,712 ========= The above table does not include future minimum lease payments for renewal periods or for contingent rental payments that may become due in future periods (See Real Estate - Accounted for Using the Operating Method). 2000 ANNUAL REPORT - PAGE 41 4. INVESTMENT IN UNCONSOLIDATED AFFILIATES: In May 1999, the Company transferred its build-to-suit development operation to a 95 percent owned, taxable unconsolidated subsidiary, Commercial Net Lease Realty Services, Inc. The Company contributed $5.7 million of real estate and other assets to Services in exchange for 5,700 shares of non-voting common stock. In connection with the contribution, the Company received a 95 percent non-controlling interest in Services. The Company accounts for its investment in Services using the equity method. The Company is entitled to received 95 percent of the dividends paid by Services. In October 2000, the Company entered into the Second Modification of Amended and Restated Secured Revolving Line of Credit and Security Agreement with Services for $65,000,000, which amended Services existing credit agreement with the Company by (i) increasing its borrowing capacity from $50,000,000 to $65,000,000 and (ii) extending the expiration date to October 31, 2003. The credit facility is secured by a first mortgage on Services' properties and bears interest at prime rate plus 0.25%. The outstanding principal balance of the mortgage at December 31, 2000 and 1999 was $56,407,000 and $19,978,000, respectively. In October 2000, the Company entered into the Second Modification of Secured Revolving Line of Credit and Security Agreement the with a wholly-owned subsidiary of Services for $35,000,000, which amended its existing credit agreement with the Company by (i) increasing its borrowing capacity from $20,000,000 to $35,000,000 and (ii) extending the expiration date to October 31, 2003. The line of credit bears interest at prime rate plus 0.25%. The outstanding principal balance of the line of credit at December 31, 2000 and 1999 was $21,391,000 and $7,619,000, respectively. The following presents Services' condensed financial information (dollars in thousands): December 31, 2000 1999 -------- -------- Real estate, net of accumulated depreciation $ 55,015 $ 30,251 Investment in unconsolidated affiliates 4,369 5,531 Cash and cash equivalents 5,353 1,396 Notes receivable from related parties 11,608 - Other assets 10,759 3,576 -------- -------- Total assets $ 87,104 $ 40,754 ======== ======== Mortgage and other payables $ 83,006 $ 20,456 Other liabilities 4,174 15,705 -------- -------- Total liabilities 87,180 36,161 -------- -------- Stockholders' equity (deficit) (76) 4,593 -------- -------- Total liabilities and stockholders' equity (deficit) $ 87,104 $ 40,754 ======== ======== Period May 1, 1999 For The (Date of Inception) Year Ended Through December 31, 2000 December 31,1999 ----------------- ---------------- Revenues $ 4,120 $ 660 Net earnings $ (4,669) $ (1,407) 2000 ANNUAL REPORT - PAGE 42 For the years ended December 31, 2000 and 1999, the Company recognized a loss of $4,435,000 and $1,337,000, respectively, from Services. In September 1997, the Company entered into a Partnership arrangement, Net Lease Institutional Realty, L.P. (the "Partnership"), with the Northern Trust Company, as Trustee of the Retirement Plan for Chicago Transit Authority Employees ("CTA"). The Company is the sole general partner with a 20 percent interest in the Partnership and CTA is the sole limited partner with an 80 percent interest in the Partnership. The Partnership owns and leases nine properties to major retail tenants under long-term, commercial net leases. The following presents the Partnership's condensed financial information (dollars in thousands): December 31, 2000 1999 --------- -------- Real estate leased to others: Accounted for using the operating method, net of accumulated depreciation $ 24,425 $ 24,742 Accounted for using the direct financing method 4,957 5,030 Other assets 1,145 698 -------- -------- Total assets $ 30,527 $ 30,470 ======== ======== Note payable $ 10,699 $ 11,133 Other liabilities 84 132 -------- -------- Total liabilities 10,783 11,265 -------- --------- Partners' capital 19,744 19,205 -------- -------- Total liabilities and partners' capital $ 30,527 $ 30,470 ======== ======== For the Year Ended December 31, 2000 1999 1998 ------- ------- ------- Revenues $ 3,707 $ 3,279 $ 3,276 Net earnings $ 2,273 $ 1,857 $ 1,834 For the years ended December 31, 2000, 1999 and 1998, the Company recognized income of $455,000, $371,000 and $367,000, respectively, from the Partnership. 2000 ANNUAL REPORT - PAGE 43 5. LINE OF CREDIT PAYABLE: In October 2000, the Company entered into an amended and restated loan agreement for a $200,000,000 revolving credit facility (the "Credit Facility") which amended the Company's existing credit facility by (i) lowering the interest rates of the tiered rate structure to a maximum rate of 150 basis points above LIBOR (based upon the debt rating of the Company), (ii) extending the expiration date to October 31, 2003, and (iii) amending certain of the financial covenants of the Company's existing loan agreement. In connection with the Credit Facility, the Company is required to pay a commitment fee of 20 basis points per annum on the commitment. The principal balance is due in full upon termination of the Credit Facility on October 31, 2003, which the Company may request to be extended for an additional 12 month period with the consent of the lender. Interest incurred on prime rate advances on the Credit Facility is payable quarterly. LIBOR rate advances have maturity periods of one week, one, two, three or six months, whichever the Company selects, with interest payable at the end of the selected maturity period. All unpaid interest is due in full upon termination of the Credit Facility. As of December 31, 2000 and 1999, the outstanding principal balance was $101,700,000 and $108,700,000, respectively. The terms of the Credit Facility include financial covenants which provide for the maintenance of certain financial ratios. The Company was in compliance with such covenants as of December 31, 2000. The cost of buildings constructed by the Company for its own use includes capitalized interest on the Credit Facility. For the years ended December 31, 2000, 1999 and 1998, interest cost incurred was $9,027,000, $7,740,000 and $4,886,000, respectively, of which $134,000, $487,000 and $1,112,000, respectively, was capitalized, and $8,380,000, $6,619,000 and $3,774,000, respectively, was charged to operations. 6. MORTGAGES PAYABLE: In January 1996, the Company entered into a long-term, fixed rate mortgage and security agreement for $39,450,000. The loan provides for a ten-year mortgage with principal and interest payable monthly, based on a 17-year amortization, with the balance due in February 2006 and bears interest at a rate of 7.435% per annum. The mortgage is collateralized by a first lien on and assignments of rents and leases of certain of the Company's properties. As of December 31, 2000, the aggregate carrying value of these properties totaled $71,589,000. The outstanding principal balance as of December 31, 2000 and 1999, was $31,535,000 and $34,189,000, respectively. In June 1996, the Company acquired three properties each subject to a mortgage totaling $6,864,000 (collectively, the "Mortgages"). The Mortgages bear interest at a weighted average rate of 8.6% and have a weighted average maturity of 4.1 years, with principal and interest payable monthly. As of December 31, 2000 and 1999, the outstanding balances for the Mortgages totaled $5,492,000 and $5,890,000, respectively. As of December 31, 2000, the aggregate carrying value of these three properties totaled $7,886,000. In December 1999, the Company acquired a property subject to a mortgage of $350,000. The mortgage bears interest at a rate of 8.5% per annum with principal and interest payable monthly and the balance due in December 2009. As of December 31, 2000 and 1999, the outstanding principal balance of the mortgage was $324,000 and $350,000, respectively. As of December 31, 2000, the carrying value of this property was $3,566,000. 2000 ANNUAL REPORT - PAGE 44 The following is a schedule of the annual maturities of the Company's mortgages payable for each of the next five years (dollars in thousands): 2001 $ 2,138 2002 2,308 2003 2,547 2004 2,780 2005 3,023 -------- $ 12,796 ======== 7. NOTES PAYABLE: In March 1998, the Company filed a prospectus supplement to its $300,000,000 shelf registration statement and issued $100,000,000 of 7.125% notes due 2008 (the "2008 Notes"). The 2008 Notes are senior obligations of the Company and are ranked equally with the Company's other unsecured senior indebtedness and are subordinated to all secured indebtedness of the Company. The 2008 Notes were sold at a discount for an aggregate purchase price of $99,729,000 with interest payable semiannually commencing on September 15, 1998 (effective interest rate of 7.163%). The discount of $271,000 is being amortized as interest expense over the term of the debt obligation using the effective interest method. The 2008 Notes are redeemable at the option of the Company, in whole or in part, at a redemption price equal to the sum of (i) the principal amount of the 2008 Notes being redeemed plus accrued interest thereon through the redemption date and (ii) the Make-Whole Amount, as defined in the Supplemental Indenture No. 1 dated March 25, 1998 for the 2008 Notes. The terms of the indenture include financial covenants which provide for the maintenance of certain financial ratios. The Company was in compliance with such covenants as of December 31, 2000. In connection with the debt offering, the Company incurred debt issuance costs totaling $1,208,000, consisting primarily of underwriting discounts and commissions, legal and accounting fees, rating agency fees and printing expenses. Debt issuance costs have been deferred and are being amortized over the term of the 2008 Notes using the effective interest method. The net proceeds from the debt offering were used to pay down outstanding indebtedness of the Company's Credit Facility. In June 1999, the Company filed a prospectus supplement to its $300,000,000 shelf registration statement and issued $100,000,000 of 8.125% notes due 2004 (the "2004 Notes"). The 2004 Notes are senior obligations of the Company and are ranked equally with the Company's other unsecured senior indebtedness and are subordinated to all secured indebtedness of the Company. The 2004 Notes were sold at a discount for an aggregate purchase price of $99,608,000 with interest payable semi-annually commencing on December 15, 1999. The discount of $392,000 is being amortized as interest expense over the term of the debt obligation using the effective interest method. In connection with the debt offering, the Company entered into a treasury rate lock agreement which fixed a treasury rate of 5.1854% on a notional amount of $92,000,000. Upon issuance of the 2004 Notes, the Company terminated the treasury rate lock agreement resulting in a gain of $2,679,000. The gain has been deferred and is being amortized as an adjustment to interest expense over the term of the 2004 Notes using the effective interest method. The effective rate of the 2004 Notes, including the effects of the discount and the treasury rate lock gain, is 7.547%. The 2004 Notes are redeemable at the option of the Company, in whole or in part, at a redemption price equal to the sum of (i) the principal amount of the 2004 Notes being redeemed plus accrued interest thereon through the redemption date and (ii) the Make-Whole Amount, as defined in the Supplemental Indenture No. 2 dated June 21, 1999 for the 2004 Notes. The terms of the indenture include financial covenants which provide for the maintenance of certain financial ratios. The Company was in compliance with such covenants as of December 31, 2000. 2000 ANNUAL REPORT - PAGE 45 In connection with the debt offering, the Company incurred debt issuance costs totaling $970,000, consisting primarily of underwriting discounts and commissions, legal and accounting fees, rating agency fees and printing expenses. Debt issuance costs have been deferred and are being amortized over the term of the 2004 Notes using the effective interest method. The net proceeds of the debt offering were used to pay down outstanding indebtedness of the Company's Credit Facility. In September 2000, the Company filed a prospectus supplement to its $300,000,000 shelf registration statement and issued $20,000,000 of 8.5% notes due 2010 (the "2010 Notes"). The 2010 Notes are senior, unsecured obligations of the Company and are subordinated to all secured indebtedness of the Company. The 2010 Notes were sold at a discount for an aggregate purchase price of $19,874,000 with interest payable semi-annually commencing on March 20, 2001 (effective interest rate of 8.595%). The discount of $126,000 is being amortized as interest expense over the term of the debt obligation using the effective interest method. The 2010 Notes are redeemable at the option of the Company, in whole or in part, at a redemption price equal to the sum of (i) the principal amount of the 2010 Notes being redeemed plus accrued interest thereon through the redemption date and (ii) the Make-Whole Amount, as defined in the Supplemental Indenture No. 3 dated September 20, 2000 for the 2010 Notes. The terms of the indenture include financial covenants which provide for the maintenance of certain financial ratios. The Company was in compliance with such covenants as of December 31, 2000. In connection with the debt offering, the Company incurred debt issuance costs totaling $225,000 consisting primarily of underwriting discounts and commissions, legal and accounting fees and rating agency fees. Debt issuance costs have been deferred and are being amortized over the term of the 2010 Notes using the effective interest method. The net proceeds from the debt offering were used to pay down outstanding indebtedness of the Company's Credit Facility. 8. COMMON STOCK: In November 1999, the Company announced the authorization by the Company's board of directors to acquire up to $25,000,000 of the Company's outstanding common stock either through open market transactions or through privately negotiated transactions. As of December 31, 2000, the Company had acquired and retired 249,200 of such shares for a total cost of $2,379,000. 9. EMPLOYEE BENEFIT PLAN: Effective January 1, 1998, the Company adopted a defined contribution retirement plan (the "Retirement Plan") covering substantially all of the employees of the Company. The Retirement Plan permits participants to defer up to a maximum of 15 percent of their compensation, as defined in the Retirement Plan, subject to limits established by the Internal Revenue Code. The Company matches 50 percent of the participants' contributions up to a maximum of six percent of a participant's annual compensation. The Company's contributions to the Retirement plan for the years ended December 31, 2000, 1999 and 1998 totaled $36,000, $52,000 and $60,000, respectively. 2000 ANNUAL REPORT - PAGE 46 10. DIVIDENDS: The following presents the characterization for tax purposes of dividends paid to stockholders for the years ended December 31: 2000 1999 1998 ------ ------ ------ Ordinary income $1.135 $1.120 $1.090 Capital gain .054 .010 - Unrecaptured Section 1250 Gain .056 .020 - Return of capital - .090 .140 ------ ------ ------ $1.245 $1.240 $1.230 ====== ====== ====== On January 16, 2001, the Company declared dividends of $9,594,000 or 31.5 cents per share of common stock, payable on February 15, 2001 to stockholders of record on January 31, 2000. 11. EARNINGS PER SHARE: The following represents the calculations of earnings per share and the weighted average number of shares of dilutive potential common stock for the years ended December 31: 2000 1999 1998 ----------- ----------- ----------- Basic Earnings Per Share: Net earnings $38,251,000 $35,311,000 $32,441,000 =========== =========== =========== Weighted average number of shares outstanding 30,278,209 29,650,912 29,124,583 Merger contingent shares 109,162 680,415 44,788 ----------- ----------- ----------- Weighted average number of shares used in basic earnings per share 30,387,371 30,331,327 29,169,371 =========== =========== =========== Basic earnings per share $ 1.26 $ 1.16 $ 1.11 =========== =========== =========== Diluted Earnings Per Share: Net earnings $38,251,000 $35,311,000 $32,441,000 =========== =========== =========== Weighted average number of shares outstanding 30,278,209 29,650,912 29,124,583 Effect of dilutive securities: Stock options 366 - 150,679 Merger contingent shares 128,932 757,307 121,892 ----------- ----------- ----------- Weighted average number of shares used in diluted earnings per share 30,407,507 30,408,219 29,397,154 =========== =========== =========== Diluted earnings per share $ 1.26 $ 1.16 $ 1.10 =========== =========== =========== For the years ended December 31, 2000, 1999 and 1998, options on 1,665,925, 1,668,659 and 1,145,700 shares of common stock, respectively, were not included in computing diluted earnings per share because their effects were antidilutive. 2000 ANNUAL REPORT - PAGE 47 12. STOCK OPTION PLAN: The Company's stock option plan (the "Plan") provides compensation and incentive to persons ("Key Employees" and "Outside Directors of the Company") whose services are considered essential to the Company's continued growth and success. As of December 31, 2000, the Plan had 2,000,000 shares of common stock reserved for issuance. The following summarizes transactions in the Plan for the years ended December 31:
2000 1999 1998 --------------------- --------------------- --------------------- Weighted Weighted Weighted Number Average Number Average Number Average Of Exercise Of Exercise Of Exercise Shares Price Shares Price Shares Price --------- --------- --------- --------- --------- --------- Outstanding, January 1 1,665,925 $ 14.83 1,710,600 $ 14.89 1,145,100 $ 13.52 Granted 292,900 10.61 10,000 13.69 654,000 17.38 Exercised - - - - (14,500) 12.88 Surrendered (77,733) 14.11 (54,675) 16.55 (74,000) 16.03 --------- --------- --------- Outstanding, December 31 1,881,092 14.20 1,665,925 14.83 1,710,600 14.89 ========= ========= ========= Exercisable, December 31 1,401,859 14.50 1,208,725 14.03 855,933 13.38 ========= ========= ========= Available for grant, December 3, 92,908 308,075 167,900 ========= ========= =========
The weighted-average remaining contractual life of the 1,881,092 options outstanding at December 31, 2000 was 6.1 years, 1,149,025 options which had exercise prices ranging from $10.1875 to $14.125 and 732,067 options which had exercise prices ranging from $14.875 to $17.875. One third of the grant to each individual becomes exercisable at the end of each of the first three years of service following the date of the grant and the options' maximum term is ten years. The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations in accounting for the Plan. Accordingly, no compensation expense has been recorded with respect to the options in the accompanying consolidated financial statements. Had compensation cost for the Plan been determined based upon the fair value at the grant dates for options granted after December 31, 1994 under the Plan consistent with the method of Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation," the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below for the years ended December 31 (dollars in thousands, except per share data): 2000 1999 1998 --------- -------- -------- Net earnings as reported $38,251 $35,311 $32,441 ======= ======= ======= Pro forma net earnings $38,018 $35,019 $32,187 ======= ======= ======= Earnings per share as reported: Basic $ 1.26 $ 1.16 $ 1.11 ======= ======= ======= Diluted $ 1.26 $ 1.16 $ 1.10 ======= ======= ======= Pro forma earnings per share: Basic $ 1.25 $ 1.15 $ 1.10 ======= ======= ======= Diluted $ 1.25 $ 1.15 $ 1.09 ======= ======= ======= 2000 ANNUAL REPORT - PAGE 48 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 2000, 1999 and 1998 : (i) risk free rates of 6.7% and 6.2% for the 2000 grants, 5.1% for the 1999 grant and 5.7% and 5.9% for 1998 grants, (ii) expected volatility of 11.1%, 24.6% and 17.4%, respectively, (iii) dividend yields of 10.5%, 10.5% and , 7.9%, respectively, and (iv) expected lives of ten years for grants in 2000, 1999 and 1998. 13. MERGER TRANSACTION: On December 18, 1997, the Company's stockholders voted to approve an agreement and plan of merger with CNL Realty Advisors, Inc. (the "Advisor"), whereby the stockholders of the Advisor agreed to exchange 100 percent of the outstanding shares of common stock of the Advisor for up to 2,200,000 shares (the "Share Consideration") of the Company's common stock (the "Merger"). As a result, the Company became a fully integrated, self-administered real estate investment trust effective January 1, 1998. Ten percent of the Share Consideration (220,000 shares) was paid January 1, 1998, and the balance (the "Share Balance") of the Share Consideration is to be paid over time, within five years from the date of the Merger, based on the Company's completed property acquisitions and completed development projects in accordance with the Merger agreement. The market value of the common shares issued on January 1, 1998 was $3,933,000, of which $12,000 was allocated to the net tangible assets acquired and the difference of $3,921,000 was accounted for as expenses incurred in acquiring the Advisor from a related party. In addition, in connection with the Merger, the Company incurred costs totaling $771,000 consisting primarily of legal and accounting fees, directors' compensation and fairness opinions. For accounting purposes, the Advisor was not considered a "business" for purposes of applying APB Opinion No. 16, "Business Combinations," and therefore, the market value of the common shares issued in excess of the fair value of the net tangible assets acquired was charged to operations rather than capitalized as goodwill. Since the effective date of the Merger, the Company has issued 1,006,080 shares of the Share Balance. The market value of the Share Balance issued was $12,155,000, all of which was charged to operations. On January 1, 2001, in connection with the completed development projects during the quarter ended December 31, 2000, an additional 32,542 shares of the Share Balance became issuable to the stockholders of the Advisor. The market value of the 32,542 shares at the date the shares became issuable totaled $334,000, all of which is to be charged to operations during the year ended December 31, 2001. Pursuant to the agreement and the plan of merger, the Company is required to issue the shares within 90 days after the shares become issuable. To the extent the remaining Share Balance is paid over time, the market value of the common shares issued will also be charged to operations. 14. FAIR VALUE OF FINANCIAL INSTRUMENTS: The Company believes the carrying values of its line of credit payable and the lines of credit receivable from Services and a wholly-owned subsidiary of Services approximate fair value based upon their nature, terms and variable interest rates. The Company believes that the carrying value of its mortgages payable and mortgages receivable and other receivables at December 31, 2000 approximate fair value, based upon current market prices of similar issues. At December 31, 2000, the fair value of the Company's notes payable was $216,159,000 based upon the quoted market price. 2000 ANNUAL REPORT - PAGE 49 15. RELATED PARTY TRANSACTIONS: During the years ended December 31, 1999 and 1998, the Company provided certain development services for an affiliate of a member of the Company's board of directors. In connection therewith, the Company earned $1,351,000 and $2,144,000, respectively, in development fees relating to these services. The Company's receivables balance at December 31, 2000 and 1999 includes $134,000 and $634,000, respectively, of these development fees. During the year ended December 31, 2000, the Company did not directly provide development services (See Note 4). In March 1999, the Company sold 38 of its properties to an affiliate of a member of the Company's board of directors for a total of $36,568,000 and received net proceeds of $36,173,000, resulting in a gain of $5,363,000 for financial reporting purposes. In November 1999, the Company entered into a lease agreement for its office space (the "Lease") with an affiliate of a member of the Company's board of directors. The Lease provides for rent in the amount of $390,000 per year, expiring in October 2014. In May 2000, the Company subleased a portion of its office space to affiliates of a member of the Company's board of directors. During the year ended December 31, 2000, the Company earned $248,000 in rental income and recognized $143,000 in accrued rental income related to these subleases. The Company manages Net Lease Institutional Realty, L.P. (the "Partnership"), in which the Company holds a 20 percent equity interest. Pursuant to a management agreement, the Partnership paid the Company $273,000, $218,000 and $218,000 in asset management fees during the years ended December 31, 2000, 1999 and 1998, respectively. A wholly-owned subsidiary of Services holds a 33 1/3 percent equity interest in WXI/SMC Real Estate LLC (the "LLC"). The Company provided certain management services for the LLC on behalf of Services pursuant to the LLC's Limited Liability Company Agreement and Property Management and Development Agreement. The LLC paid the Company $183,000 and $314,000 in fees during the years ended December 31, 2000 and 1999, respectively, and $200,000 in expense reimbursements during the year ended December 31, 1999 relating to these services. As of December 31, 2000, the Company held two mortgages totaling $6,755,000 with affiliates of certain members of the Company's board of directors. In connection with the revolving credit facilities between the Company and Services and the Company and a wholly-owned subsidiary of Services, the Company received $5,078,000 and $1,530,000 in interest and fees during the years ended December 31, 2000 and 1999, respectively. In addition, Services paid the Company $407,000 and $177,000 in expense reimbursements for accounting services provided by the Company during the years ended December 31, 2000 and 1999, respectively. During the years ended December 31, 2000, 1999 and 1998, an affiliate of a member of the Company's board of directors provided certain administrative, tax and technology services to the Company. In connection therewith, the Company paid $398,000, $50,000 and $41,000 in fees relating to these services. In September 2000, a wholly-owned subsidiary of Services entered into a $6,000,000 loan agreement and a $15,000,000 line of credit agreement with affiliates in which certain officers of the Company own an equity interest. The loan and line of credit are collateralized by substantially all of the assets of the respective affiliate. 2000 ANNUAL REPORT - PAGE 50 The Company has guaranteed bank loans made to certain of the Company's officers totaling $4,898,000. Each of the loans is full recourse to the respective officer and is collateralized by the common shares of the Company that were purchased with the proceeds from the loans. 16. SEGMENT INFORMATION: Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. While the Company does not have more than one reportable segment, the Company has identified two primary sources of revenue: (i) rental and earned income from the triple net leases and (ii) fee income from development, property management and asset management services. The following table represents the revenues, expenses and asset allocation for the two segments and the Company's consolidated totals at December 31, 2000, 1999 and 1998, and for the years then ended:
Rental and Fee Earned Income Income Corporate Consolidated ------------ ------------ ------------ ------------ 2000 ----------------------------------- Revenues $ 76,035 $ 4,856 $ - $ 80,891 General operating and administrative expenses 2,962 823 1,065 4,850 Real estate expenses 397 - - 397 Interest expense 26,528 - - 26,528 Depreciation and amortization 8,949 134 5 9,088 Expenses incurred in acquiring advisor from related party - - 1,521 1,521 Equity in earnings of unconsolidated affiliates 455 (4,435) - (3,980) Gain on disposition of real estate 4,091 - - 4,091 Cumulative change in accounting principle (367) - - (367) ------------ ------------ ------------ ------------ Net earnings $ 41,378 $ (536) $ (2,591) $ 38,251 ============ ============ ============ ============ Assets $ 761,503 $ 41 $ 67 $ 761,611 ============ ============ ============ ============ Additions to long-lived assets: Real estate $ 3,999 $ - $ - $ 3,999 ============ ============ ============ ============ Other $ 667 $ 220 $ 52 $ 939 ============ ============ ============ ============ 2000 ANNUAL REPORT - PAGE 51 1999 ------------------------------------ Revenues $ 73,119 $ 3,174 $ 250 $ 76,543 General operating and administrative expenses 4,630 1,345 205 6,180 Real estate expenses 432 - - 432 Interest expense 21,920 - - 21,920 Depreciation and amortization 8,419 185 30 8,634 Expenses incurred in acquiring advisor from related party - - 9,824 9,824 Equity in earnings of unconsolidated affiliates 371 (1,337) - (966) Gain on disposition of real estate 6,724 - - 6,724 ------------ ------------ ------------ ------------ Net earnings $ 44,813 $ 307 $ (9,809) $ 35,311 ============ ============ ============ ============ Assets $ 749,626 $ 81 $ 82 $ 749,789 ============ ============ ============ ============ Additions to long-lived assets: Real estate $ 77,964 $ - $ - $ 77,964 ============ ============ ============ ============ Other $ 218 $ 192 $ 37 $ 447 ============ ============ ============ ============ 1998 ------------------------------------ Revenues $ 62,067 $ 2,706 $ - $ 64,773 General operating and administrative expenses 5,558 1,137 1,040 7,735 Real estate expenses 599 - - 599 Interest expense 13,460 - - 13,460 Depreciation and amortization 6,730 19 10 6,759 Expenses incurred in acquiring advisor from related party - - 5,501 5,501 Equity in earnings of unconsolidated affiliates 367 - - 367 Gain on disposition of real estate 1,355 - - 1,355 ------------ ------------ ------------ ------------ Net earnings $ 37,442 $ 1,550 $ (6,551) $ 32,441 ============ ============ ============ ============ Assets $ 685,432 $ 108 $ 55 $ 685,595 ============ ============ ============ ============ Additions to long-lived assets: Real estate $ 150,730 $ - $ - $ 150,730 ============ ============ ============ ============ Other $ 1,133 $ 108 $ 55 $ 1,296 ============ ============ ============ ============
2000 ANNUAL REPORT - PAGE 52 17. MAJOR TENANTS: For the years ended December 31, 2000, 1999 and 1998, the Company recorded rental and earned income from one of the Company's tenants, Eckerd Corporation, of $8,674,000, $9,048,000 and $7,170,000, respectively. The rental and earned income from Eckerd Corporation represents more than ten percent of the Company's rental and earned income for each of the respective years. 18. COMMITMENTS AND CONTINGENCIES: During the year ended December 31, 1999, the Company entered into a purchase and sale agreement whereby the Company acquired ten land parcels leased to major retailers and has agreed to acquire the buildings on each of the respective land parcels at the expiration of the initial term of the ground lease for an aggregate amount of approximately $23 million. The seller of the buildings holds a security interest in each of the land parcels which secures the Company's obligation to purchase the buildings under the purchase and sale agreement. As of December 31, 2000, the Company owned one land parcel subject to lease agreement with a tenant whereby the Company has agreed to construct a building on the land parcel for construction costs of approximately $2,216,000, of which $141,000 of costs had been incurred at December 31, 2000. Pursuant to the lease agreement, rent is to commence on the property upon completion of construction of the building. The Company is a co-defendant in a lawsuit filed by a property owner for alleged breach of a ground lease. The suit asks for damages of $7,500,000 and/or specific performance of the ground lease. The Company believes, in the unlikely event that the Company were to be held liable, the relief granted by the court would be specific performance of the ground lease or damages in an amount far less than the amount sought by the plaintiff and would not materially affect the Company's operations or financial condition. In the ordinary course of its business, the Company is a party to various other legal actions which the Company believes are routine in nature and incidental to the operation of the business of the Company. The Company believes that the outcome of the proceedings will not have a material adverse effect upon its operations or financial condition. 19. SUBSEQUENT EVENT: On January 16, 2001, the Company filed a shelf registration statement with the Securities and Exchange Commission which permits the issuance by the Company of up to $200,000,000 in debt and equity securities (which includes approximately $180,000,000 of unissued debt and equity securities under the Company's previous $300,000,000 shelf registration statement). 2000 ANNUAL REPORT - PAGE 53 [GRAPHIC 9] Design graphic depicting the Commercial Net Lease Realty, Inc. initials "CNLR" CONSOLIDATED QUARTERLY FINANCIAL DATA (dollars in thousands, except per share data)
First Second Third Fourth 2000 Quarter Quarter Quarter Quarter Year --------------------------------- -------- -------- -------- -------- -------- Rent and other revenue $ 20,587 $ 19,584 $ 20,168 $ 20,552 $ 80,891 Depreciation and amortization expense 2,288 2,254 2,204 2,342 9,088 Interest expense 6,646 6,233 6,768 6,881 26,528 Advisor acquisition expense 491 275 297 458 1,521 Other expenses 1,350 1,328 1,343 1,226 5,247 Earnings before cumulative change in accounting principle 8,644 8,574 8,555 12,845 38,618 Net earnings 8,644 8,574 8,555 12,478 38,251 Earnings per share before cumulative change in accounting principle (1): Basic 0.29 0.28 0.28 0.42 1.27 Diluted 0.28 0.28 0.28 0.42 1.27 Net earnings per share (1): Basic 0.29 0.28 0.28 0.41 1.26 Diluted 0.28 0.28 0.28 0.41 1.26 1999 --------------------------------- Rent and other revenue $ 18,830 $ 19,152 $ 18,983 $ 19,578 $ 76,543 Depreciation and amortization expense 1,993 2,060 2,230 2,351 8,634 Interest expense 4,777 5,357 5,663 6,123 21,920 Advisor acquisition expense 4,928 3,239 794 863 9,824 Other expenses 2,437 1,943 1,294 938 6,612 Net earnings 9,830 7,135 8,796 9,550 35,311 Net earnings per share (1): Basic 0.33 0.24 0.29 0.31 1.16 Diluted 0.32 0.23 0.29 0.31 1.16 (1) Calculated independently for each period, and consequently, the sum of the quarters may differ from the annual amount. 2000 ANNUAL REPORT - PAGE 54 [GRAPHIC 10] Design graphic depicting the Commercial Net Lease Realty, Inc. initials "CNLR"
SHARE PRICE AND DIVIDEND DATA The common stock of the Company currently is traded on the New York Stock Exchange ("NYSE") under the symbol "NNN." For each calendar quarter indicated, the following table reflects respective high, low and closing sales prices for the common stock as quoted by the NYSE and the dividends paid per share in each such period.
First Second Third Fourth 2000 Quarter Quarter Quarter Quarter Year ------------------------ --------- --------- --------- --------- --------- High $ 10.8125 $ 11.5000 $ 11.0625 $ 11.1667 $ 11.5000 Low 9.5000 10.1667 10.2500 9.8125 9.5000 Close 10.4375 10.5156 10.3750 10.1875 10.1875 Dividends paid per share 0.310 0.310 0.310 0.315 1.245 1999 ------------------------ High $ 13.9375 $ 13.8125 $ 13.1875 $ 11.5625 $ 13.9375 Low 11.1250 11.0625 10.4375 9.4375 9.4375 Close 11.1875 12.8750 10.6250 9.9375 9.9375 Dividends paid per share 0.310 0.310 0.310 0.310 1.240
For federal income tax purposes, 7.5% of dividends paid in 1999 was treated as a non-taxable return of capital and 8.81% and 1.96% of dividends paid in 2000 and 1999, respectively, was considered capital gain (representing 4.35% and 0.55% of capital gain - 20%, respectively, and 4.46% and 1.41%, respectively, of unrecaptured Section 1250 gain). The Company intends to pay regular quarterly dividends 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 and such other factors as the board of directors deems relevant. On February 15, 2001, there were approximately 1,290 shareholders of record of common stock.