UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended September 30, 2003

 

 

 

OR

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the transition period from                              to                              

 

Commission file number 1-13089

 

U.S. Restaurant Properties, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland

 

75-2687420

(State or other jurisdiction of incorporation
or organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

 

12240 Inwood Rd., Suite 300, Dallas, Texas 75244

(Address of principal executive offices)

(Zip Code)

 

 

 

(972) 387-1487

(Registrant’s telephone number, including area code)

 

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $0.001 per share

 

New York Stock Exchange

 

 

 

$1.93 Series A Cumulative Convertible Preferred Stock

 

New York Stock Exchange

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  ý

 

No  o

 

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes  ý  No  o

 

As of November 7, 2003, U.S. Restaurant Properties, Inc. had 22,514,689 shares of common stock $0.001 par value outstanding.

 

 



 

U.S. RESTAURANT PROPERTIES, INC.

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Unaudited Condensed Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2002

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Comprehensive Operations for the three and nine months ended September 30, 2003 and 2002

 

 

 

 

 

Unaudited Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2003

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002

 

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

Item 4.

Controls and Procedures

 

 

 

 

 

 

PART II.

 

OTHER INFORMATION

 

 

 

 

Item 6.

Exhibits and Reports on Form 8-K

 

2



 

PART I.    FINANCIAL INFORMATION

 

Item 1.           Financial Statements

 

U.S. Restaurant Properties, Inc.

Unaudited Condensed Consolidated Balance Sheets

(In thousands, except per share data)

 

 

 

September 30,
2003

 

December 31,
2002

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Property, net

 

 

 

 

 

Land

 

$

200,353

 

$

202,404

 

Building and leasehold improvements

 

359,322

 

372,191

 

Machinery and equipment

 

12,813

 

11,868

 

 

 

572,488

 

586,463

 

Less:  accumulated depreciation

 

(106,332

)

(100,002

)

 

 

466,156

 

486,461

 

 

 

 

 

 

 

Construction in progress

 

569

 

256

 

Cash and cash equivalents

 

4,648

 

4,392

 

Restricted cash and marketable securities

 

2,980

 

2,211

 

Rent and other receivables, net
(includes $1,253 and $2,531 allowance for doubtful accounts
at September 30, 2003 and December 31, 2002, respectively)

 

6,975

 

7,299

 

Straight line rent receivables, net
(includes $443 and $484 allowance for doubtful accounts
at September 30, 2003 and December 31, 2002, respectively, and $3,630 and $3,746 of remodel grants at September 30, 2003 and December 31, 2002, respectively)

 

15,093

 

15,600

 

Prepaid expenses and other assets

 

3,636

 

3,354

 

Inventories

 

2,640

 

1,289

 

Investments

 

2,908

 

3,025

 

Notes receivable, net
(includes $0 and $13 due from related parties, and $2,917
and $3,636 allowance for doubtful accounts at
September 30, 2003 and December 31, 2002, respectively)

 

6,637

 

10,268

 

Mortgage loans receivable, net
(includes $223 and $583 allowance for doubtful accounts
at September 30, 2003 and December 31, 2002, respectively)

 

11,340

 

34,469

 

Net investment in direct financing leases

 

278

 

518

 

Deferred financing costs and intangibles, net

 

8,019

 

9,935

 

Total assets

 

$

531,879

 

$

579,077

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

3



 

U.S. Restaurant Properties, Inc.

Unaudited Condensed Consolidated Balance Sheets

(In thousands, except per share data)

 

 

 

September 30,
2003

 

December 31,
2002

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

20,339

 

$

18,142

 

Accrued dividends and distributions

 

2,200

 

2,181

 

Unearned contingent rent

 

908

 

826

 

Deferred gain on sale of property

 

236

 

926

 

Line of credit

 

26,000

 

25,000

 

Interest rate derivatives at fair value

 

3,320

 

4,536

 

Notes payable

 

270,218

 

327,428

 

Mortgage note payable

 

919

 

946

 

Total liabilities

 

324,140

 

379,985

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Minority interests

 

53,957

 

52,845

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

Preferred stock, $0.001 par value per share:

 

 

 

 

 

Series A Cumulative Convertible Preferred Stock - 50,000 shares authorized, 3,680 shares issued and outstanding at September 30, 2003 and December 31, 2002 (aggregate liquidation value of $92,000)

 

4

 

4

 

Series B Convertible Preferred Stock - 20 shares authorized, 16 shares issued and outstanding at September 30, 2003 (aggregate liquidation value of $16,000)

 

 

 

Common stock, $0.001 par value per share:

 

 

 

 

 

100,000 shares authorized, 19,924 and 19,832 shares issued and outstanding at September 30, 2003 and December 31, 2002, respectively

 

20

 

20

 

Additional paid-in capital

 

343,525

 

327,756

 

Excess stock, $0.001 par value per share
15,000 shares authorized, no shares issued

 

 

 

Accumulated other comprehensive loss

 

(3,320

)

(4,411

)

Loans to stockholders for common stock

 

(299

)

(299

)

Distributions in excess of net income

 

(186,148

)

(176,823

)

Total stockholders’ equity

 

153,782

 

146,247

 

Total liabilities and stockholders’ equity

 

$

531,879

 

$

579,077

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

4



 

U.S. Restaurant Properties, Inc.

Unaudited Condensed Consolidated Statement of Operations

(In thousands, except per share data)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

Revenues:

 

 

 

 

 

 

 

 

 

Real estate rental

 

$

15,099

 

$

14,926

 

$

45,312

 

$

45,398

 

Tenant expense reimbursements

 

864

 

722

 

2,552

 

2,368

 

Lease termination fees

 

29

 

 

1,660

 

92

 

Interest on mortgage loans

 

566

 

1,124

 

2,335

 

2,423

 

Retail operations

 

15,682

 

10,216

 

43,490

 

26,607

 

Total revenues

 

32,240

 

26,988

 

95,349

 

76,888

 

Expenses:

 

 

 

 

 

 

 

 

 

Ground rent

 

939

 

828

 

2,858

 

2,732

 

Property taxes

 

72

 

135

 

411

 

524

 

Other property

 

127

 

84

 

329

 

287

 

Legal

 

920

 

469

 

1,477

 

1,457

 

Depreciation and amortization

 

5,791

 

4,962

 

16,442

 

15,179

 

Impairment of long-lived assets

 

1,525

 

 

2,342

 

523

 

Recoveries of provision for doubtful accounts

 

(137

)

(229

)

(307

)

(234

)

General and administrative

 

2,784

 

2,531

 

9,472

 

7,637

 

Retail cost of sales

 

13,393

 

8,517

 

37,189

 

22,499

 

Total expenses

 

25,414

 

17,297

 

70,213

 

50,604

 

Income from continuing operations

 

6,826

 

9,691

 

25,136

 

26,284

 

Non-operating income

 

8

 

215

 

29

 

849

 

Interest expense

 

(4,615

)

(5,594

)

(15,707

)

(16,691

)

Minority interests

 

(1,205

)

(1,163

)

(3,542

)

(3,512

)

Net income from continuing operations before discontinued operations and cumulative effect of change in accounting principle

 

1,014

 

3,149

 

5,916

 

6,930

 

Income from discontinued operations

 

4,306

 

1,608

 

10,377

 

3,045

 

Cumulative effect of change in accounting principle

 

 

 

(270

)

 

Net income

 

5,320

 

4,757

 

16,023

 

9,975

 

Dividends on preferred stock

 

(2,185

)

(1,776

)

(5,736

)

(5,327

)

Net income allocable to common stockholders

 

$

3,135

 

$

2,981

 

$

10,287

 

$

4,648

 

 

 

 

 

 

 

 

 

 

 

Net income per share - basic and diluted:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations allocable to common stockholders

 

$

(0.06

)

$

0.07

 

$

0.01

 

$

0.08

 

Income from discontinued operations

 

0.22

 

0.08

 

0.52

 

0.16

 

Cumulative effect of change in accounting principle

 

 

 

(0.01

)

 

Net income per share

 

$

0.16

 

$

0.15

 

$

0.52

 

$

0.24

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

19,909

 

19,737

 

19,871

 

19,606

 

Diluted

 

20,024

 

19,824

 

19,955

 

19,741

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements

 

5



 

U.S. Restaurant Properties, Inc.

Unaudited Condensed Consolidated Statements of Other Comprehensive Operations

(In thousands)

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

5,320

 

$

4,757

 

$

16,023

 

$

9,975

 

Other comprehensive income (loss) -

 

 

 

 

 

 

 

 

 

Hedge settlement adjustment

 

707

 

710

 

2,292

 

2,652

 

Fair value adjustment for derivatives

 

(57

)

(2,504

)

(1,201

)

(4,324

)

Change in unrealized loss on investments

 

 

2,506

 

 

2,522

 

Comprehensive income

 

$

5,970

 

$

5,469

 

$

17,114

 

$

10,825

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

6



 

U.S. Restaurant Properties, Inc.

Unaudited Condensed Consolidated Statement of Stockholders’ Equity

Nine Months Ended September 30, 2003

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated
Other
Comprehensive
Income (Loss)

 

 

 

 

 

 

 

 

 

Series A
Preferred Stock

 

Series B
Preferred Stock

 

 

 

 

 

Additional
Paid-in
Capital

 

 

Loans
To-
Shareholders

 

Distributions
In Excess of
Net Income

 

Total
Stockholders’
Equity

 

 

 

 

 

Common Stock

 

 

 

 

 

 

 

 

Shares

 

Par Value

 

Shares

 

Par Value

 

Shares

 

Par Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2003

 

3,680

 

$

4

 

 

$

 

19,832

 

$

20

 

$

327,756

 

$

(4,411

)

$

(299

)

$

(176,823

)

$

146,247

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

16,023

 

16,023

 

Preferred stock - Series B issuance

 

 

 

 

 

16

 

 

 

 

 

 

14,406

 

 

 

 

 

 

 

14,406

 

Preferred stock - Series B warrants

 

 

 

 

 

 

 

 

 

 

 

 

 

253

 

 

 

 

 

 

 

253

 

Preferred stock - Series B warrants accretion

 

 

 

 

 

 

 

 

 

 

 

 

 

89

 

 

 

 

 

(89

)

 

Proceeds from exercised stock options

 

 

 

 

 

 

 

 

 

92

 

 

 

1,012

 

 

 

 

 

 

 

1,012

 

Stock-based compensation to employees

 

 

 

 

 

 

 

 

 

 

 

 

 

9

 

 

 

 

 

 

 

9

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedge settlement adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,292

 

 

 

 

 

2,292

 

Fair value adjustment for derivatives

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,201

)

 

 

 

 

(1,201

)

Distributions declared on common stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(19,680

)

(19,680

)

Distributions declared on preferred stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(5,579

)

(5,579

)

Balance at September 30, 2003

 

3,680

 

$

4

 

16

 

$

 

19,924

 

$

20

 

$

343,525

 

$

(3,320

)

$

(299

)

$

(186,148

)

$

153,782

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

7



 

U.S. Restaurant Properties, Inc.

Unaudited Condensed Consolidated Statements of Cash Flows

(In thousands)

 

 

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

16,023

 

$

9,975

 

Adjustments to reconcile net income to net cash flows from operating activities:

 

 

 

 

 

Depreciation and amortization

 

16,971

 

16,595

 

Cumulative effect of change in accounting principle

 

270

 

 

Amortization of deferred financing costs and discounts

 

1,317

 

1,452

 

Impairment of long-lived assets

 

3,872

 

1,851

 

Accretion of interest income

 

 

(444

)

Fair value adjustment for interest rate derivatives

 

(125

)

(402

)

Minority interests

 

3,542

 

3,512

 

Gain on sale of property

 

(10,275

)

(2,253

)

Gain on disposal of asset retirement obligation

 

(64

)

 

Change in rent and other receivables, net

 

296

 

(267

)

Change in straight line rent, net

 

(265

)

(1,638

)

Change in prepaid expenses

 

(282

)

(632

)

Change in inventories

 

(1,571

)

(746

)

Change in net investment in direct financing leases

 

144

 

406

 

Change in accounts payable and accrued liabilities

 

2,811

 

(2,360

)

Change in unearned contingent rent

 

82

 

(128

)

Other increases

 

(298

)

(302

)

Cash flows provided by operating activities

 

32,448

 

24,619

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

 

Proceeds from sale of property and equipment

 

35,100

 

16,300

 

Purchase of property

 

(7,863

)

(10,387

)

Purchase of machinery and equipment

 

(3,300

)

(259

)

Purchase of investments

 

 

(3,014

)

Proceeds from sale of investments

 

 

4,838

 

Change in restricted cash

 

(769

)

5,395

 

Mortgage loans receivable acquired

 

(11

)

(26,583

)

Mortgage loans receivable principal payments

 

11,676

 

4,120

 

Notes receivable issued

 

(63

)

(1,275

)

Notes receivable principal payments

 

2,239

 

959

 

Other increases

 

260

 

345

 

Cash flows provided by (used in) investing activities

 

37,269

 

(9,561

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

 

Proceeds from line of credit

 

$

34,950

 

$

17,700

 

Payments on line of credit

 

(33,950

)

(2,500

)

Proceeds from issuance of Series B preferred stock

 

14,406

 

 

Proceeds from issuance of Series B preferred stock warrants

 

253

 

 

Distributions to minority interest shareholders

 

(3,576

)

(3,593

)

Payment of common stock dividends

 

(19,680

)

(19,420

)

Payment of preferred stock dividends

 

(5,579

)

(5,327

)

Proceeds from sale of stock and exercised stock options

 

1,012

 

1,516

 

Payments on notes/mortgage note payable

 

(57,026

)

(7,540

)

Financing costs

 

(271

)

(650

)

Cash flows used in financing activities

 

(69,461

)

(19,814

)

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

256

 

(4,756

)

Cash and cash equivalents at beginning of period

 

4,392

 

10,346

 

Cash and cash equivalents at end of period

 

$

4,648

 

$

5,590

 

 

 

 

 

 

 

Supplemental disclosure:

 

 

 

 

 

Interest paid during the period

 

$

11,498

 

$

12,097

 

Taxes paid during the period

 

$

358

 

$

238

 

 

 

 

 

 

 

Non-cash investing and financing activities:

 

 

 

 

 

Mortgage loans receivable tendered for property acquisitions

 

$

12,000

 

$

11,547

 

Security deposit and note receivable written off

 

1,037

 

 

Decrease in common and preferred stock dividends accrued

 

 

3,932

 

Notes received on sale of property

 

 

294

 

Operating Partnership Units exchanged for common stock

 

 

1,411

 

Property received in exchange for Operating Partnership Units and Note Receivable

 

2,265

 

 

Reclassification of notes receivable to loans to stockholders for common stock

 

 

475

 

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

8



 

U.S. Restaurant Properties, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 

1.                                      Interim Unaudited Financial Information

 

U.S. Restaurant Properties, Inc. (“USRP” and, collectively with its subsidiaries, the “Company”) is a fully integrated, self-administered and self-managed Real Estate Investment Trust (a “REIT”), as defined under the Internal Revenue Code of 1986, as amended.  The Company owns, acquires and manages branded chain restaurants and selected service retail properties.  Additionally, from time to time, the Company makes opportunistic investments in mortgage loans, secured by leasehold interests in restaurants or real estate.  The business and operations of the Company are conducted primarily through USRP’s wholly-owned and controlled subsidiary, U.S. Restaurant Properties Operating L.P., USRP’s operating partnership (“OP”).  As of September 30, 2003, the Company owned 785 properties in 48 states.

 

In June 2003, the Company formed a new taxable REIT subsidiary (“TRS”), USRP Holding Corp. (“Holding”).  Holding was formed as an owned and controlled subsidiary of OP.   The change in the Company’s structure was made to ensure continued compliance by the Company with Internal Revenue Service rules regarding qualification as a REIT with regard to related party transactions between the Company’s subsidiaries.  As a result of the change in organizational structure, rental income from the Company’s Shoney’s and Captain D’s real estate, as well as the net operations from the gasoline stations and restaurants operated by the Company affiliates, will become subject to Federal and State income taxes.

 

Holding has three wholly-owned subsidiaries, Fuel Supply, Inc. (“FSI”), USRP (Hawaii), LLC, and USRP (S&C), LLC.  FSI, which was organized in April 2001, operates various retail businesses located on certain Company properties in order to transition the operations from one tenant to another.  USRP (Hawaii), LLC was formed in June 2003 and owns the Company’s Hawaii service stations.  USRP (S&C), LLC was formed in June 2003 and owns 65 of the Company’s Shoney’s and Captain D’s restaurants, as well as the partnership interest of USRP (Sho) 1, L.P.    Holding owns the Company-operated non-Hawaii service stations.  Subsequent to September 30, 2003, Holding owns the unpledged Shoney’s and Captain D’s properties.

 

Basis of Presentation and Estimates

 

The accompanying interim unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2002 and the Form 8-K, as amended, filed August 18, 2003 with the Securities and Exchange Commission (“SEC”).  Operating results for the three and nine months ended September 30, 2003 are not necessarily indicative of the results to be expected for the year ending December 31, 2003.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted in this report on Form 10-Q pursuant to the Rules and Regulations of the SEC.  In the opinion of management, the disclosures contained in this report are adequate to make the information presented not misleading.

 

Accounting measurements at interim dates inherently involve greater reliance on estimates than at year end and the results of operations for the interim periods shown in the report are not necessarily indicative of results to be expected for the fiscal year.  In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments (of a normal recurring nature) necessary to present fairly the consolidated financial position of the Company as of September 30, 2003, the consolidated results of its operations and comprehensive operations for the three and nine months ended September 30, 2003 and 2002, and the consolidated statements of cash flows and stockholders’ equity for the nine months ended September 30, 2003.

 

9



 

The preparation of consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect reported amounts of certain assets, liabilities, contingent assets and liabilities, revenues and expenses as of and for the reporting periods.  Actual results may differ from such estimates.  Any differences from those estimates are recorded in the period in which they are identified.

 

Amounts in previous periods have been reclassified to conform to current period presentation.

 

SIGNIFICANT ACCOUNTING POLICIES

 

This section should be read in conjunction with the more detailed information regarding the Company’s significant accounting policies contained in the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2002 and Form 8-K, as amended, filed August 18, 2003.

 

New Accounting Standards

 

Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation —Transition and Disclosure,” amends SFAS No. 123, “Accounting for Stock-Based Compensation,” and provides new transition methods if an entity adopts the fair value based method of valuing stock-based compensation as well as requiring additional disclosures in interim and annual financial statements.  At this time, the Company intends to continue to utilize the intrinsic value model of accounting for stock option grants which results in compensation costs equal to the excess, if any, of the fair value of the Company’s stock at the measurement date above the stock options strike price.  Pro-forma disclosures are as follows (in thousands, except per share data):

 

Pro-forma Stock-Based Compensation Cost

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

Net income allocable to common stockholders,
as reported

 

$

3,135

 

$

2,981

 

$

10,287

 

$

4,648

 

Stock-based compensation recognized, net

 

 

 

9

 

86

 

 

 

3,135

 

2,981

 

10,296

 

4,734

 

Pro-forma stock-based compensation

 

(2

)

(40

)

(27

)

(120

)

Pro-forma net income allocable to common
stockholders

 

$

3,133

 

$

2,941

 

$

10,269

 

$

4,614

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted income per share:

 

 

 

 

 

 

 

 

 

As reported - basic and diluted

 

$

0.16

 

$

0.15

 

$

0.52

 

$

0.24

 

Pro-forma - basic

 

$

0.16

 

$

0.15

 

$

0.52

 

$

0.24

 

Pro-forma - diluted

 

$

0.16

 

$

0.15

 

$

0.51

 

$

0.23

 

 

 

 

 

 

 

 

 

 

 

Stock options:

 

 

 

 

 

 

 

 

 

Pro-forma estimated compensation value per
options granted

 

$

2.06

 

$

2.50

 

$

2.10

 

$

2.01

 

 

10



 

SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” was issued in April 2003 and was adopted by the Company on July 1, 2003.  This Statement is to be applied prospectively and is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003.  This Statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133.  The Company has no new derivative instruments effective during 2003.  Management will evaluate all future derivative instruments under the provisions of SFAS No. 149 to determine whether there is an impact on the Company’s consolidated financial statements.

 

SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” was adopted by and effective for the Company on July 1, 2003.  This Statement addresses how an issuer classifies and measures financial instruments with characteristics of both liabilities and equity. The Series B Preferred is neither mandatorily redeemable, as defined in SFAS No. 150, nor does it embody an unconditional obligation to transfer equity shares of the Company.  The Series B Preferred does contain conditional obligations to redeem in cash or shares, but the conditions or events are not certain to occur at September 30, 2003.  Accordingly, the Series B Preferred does not fall under the scope of SFAS No. 150 at this time. EITF D-98, “Classification and Measurement of Preferred Securities,” provides guidance to determine if preferred securities should be classified as permanent equity.  As none of the redemption requirements of the securities are outside the control of the Company, management concluded that the Series B Preferred is appropriately classified as equity as of September 30, 2003.

 

Management also examined its classification of its minority interests under the guidance of SFAS No. 150. At this time, management believes the current classification of its minority interests in the Company’s Condensed Consolidated Balance Sheets as of September 30, 2003 is appropriate.  See Note 11, “Subsequent Events,” for information regarding the redemption of the USRP/HCI Partnership 1, L.P. ("HJV") minority interest.  The Company will continue to monitor its remaining financial instruments which have characteristics of both debt and equity for appropriate classification under SFAS No. 150.

 

FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” requires disclosures to be made by a guarantor about its obligations under certain guarantees that it has issued.  FIN No. 45 is generally effective prospectively for guarantees issued or modified after December 31, 2002.  FIN No. 45 also requires liability recognition for certain types of debt.  The Interpretation requires a guarantor to recognize a liability at the inception of a guarantee whether or not payment is probable, creating the concept of a “stand ready” obligation.  See Note 10, “Commitments and Contingencies,” for disclosure of the Company’s guarantees at September 30, 2003.

 

11



 

Income Per Share

 

Basic income per share is computed based upon the weighted average number of shares of common stock outstanding.  Diluted income per share typically reflects the dilutive effect of stock options, units of beneficial interest in the Operating Partnership (“OP Units”), convertible preferred stock and convertible stock warrants.  A reconciliation of the basic and diluted weighted average shares is as follows:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

(In thousands, except per share amounts)

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Net income from continuing operations before discontinued operations and cumulative effect of change in accounting principle

 

$

1,014

 

$

3,149

 

$

5,916

 

$

6,930

 

Dividends on preferred stock

 

(2,185

)

(1,776

)

(5,736

)

(5,327

)

 

 

(1,171

)

1,373

 

180

 

1,603

 

Income from discontinued operations

 

4,306

 

1,608

 

10,377

 

3,045

 

Cumulative effect of change in accounting principle

 

 

 

(270

)

 

Net income allocable to common stockholders

 

$

3,135

 

$

2,981

 

$

10,287

 

$

4,648

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations allocable to common stockholders

 

$

(0.06

)

$

0.07

 

$

0.01

 

$

0.08

 

Income from discontinued operations

 

0.22

 

0.08

 

0.52

 

0.16

 

Cumulative effect of change in accounting principle

 

 

 

(0.01

)

 

Net income per share, basic and diluted

 

$

0.16

 

$

0.15

 

$

0.52

 

$

0.24

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

19,909

 

19,737

 

19,871

 

19,606

 

Dilutive effect of OP units

 

80

 

47

 

54

 

103

 

Dilutive effect of stock options

 

20

 

40

 

15

 

32

 

Dilutive effect of preferred stock

 

15

 

 

15

 

 

Diluted

 

20,024

 

19,824

 

19,955

 

19,741

 

 

 

 

 

 

 

 

 

 

 

Antidilutive securities:

 

 

 

 

 

 

 

 

 

Stock options

 

14

 

46

 

41

 

46

 

Convertible preferred stock

 

4,438

 

3,453

 

4,438

 

3,453

 

Convertible stock warrants

 

206

 

 

206

 

 

 

12



 

Investments

 

Investments in equity securities with readily determinable fair values and debt securities are classified as either available-for-sale or trading, based on the Company’s intent with respect to those securities.  These investments are classified as trading if held principally for the purpose of selling in the near term.  All others are classified as available-for-sale.  These investments are recorded at fair value on the balance sheet.  Changes in fair value during the period are recorded in earnings for trading securities and in other comprehensive operations for available-for-sale securities.  Investments in equity securities that do not have readily determinable fair values are recorded using the cost method since the Company does not have the ability to exercise significant influence over the investees.  The Company disposed of all of its trading and available-for-sale securities in 2002.

 

Derivatives

 

Derivative financial instruments are recognized as either assets or liabilities on the balance sheet at fair value.  If the derivative is designated as a fair-value hedge, the changes in the fair value of the derivative and the hedged item are recognized currently in earnings.  If the derivative is designated as a cash flow hedge, the effective portion of the changes in fair value of the derivative is included in other comprehensive income and is reclassified to earnings when the hedged item affects earnings.  For a derivative that does not qualify or is not designated as a hedge, changes in fair value are recognized currently in earnings.

 

Revenue Recognition

 

The Company’s revenues primarily include rental income on real estate properties and operating revenue from retail operations.

 

Rental revenues are derived primarily from the leasing of the Company’s properties to operators (primarily restaurants) on a “triple net” basis.  Triple net leases typically require the tenants to be responsible for property operating costs, including property taxes, insurance, maintenance and, in most cases, the ground rents where applicable.  The triple net structure is designed to provide a predictable stream of income while minimizing ongoing property operating costs.  Accordingly, the accompanying condensed consolidated financial statements do not reflect property taxes and insurance costs or reimbursements when the tenant has legally assumed responsibility for these liabilities.  As the Company remains legally responsible for ground rents under its ground leases and receives payment from its tenants for these costs, amounts reimbursed from tenants for ground rents are recorded as rental revenue.  Rental revenues and ground rent expense are recognized on a straight-line basis unless significant collection problems occur with the lessee, at which time rents are recognized on a cash basis.  The Company occasionally provides remodeling grants, which are included in the straight-lining of revenue, to tenants in consideration for early renewal and restructure of existing leases.  Contingent rent is recognized as revenue after the related lease sales targets are achieved.  The Company recognized contingent rent revenues of $0.8 million and $2.3 million for the three and nine months ended September 30, 2003, respectively, as compared to $1.0 million and $2.9 million for the three and nine months ended September 30, 2002, respectively.

 

Retail revenues are derived from gasoline sales, car washes, convenience store merchandise and food sales at properties operated by the Company.  Revenue is recognized upon the sale of gasoline, merchandise or the delivery of services.

 

 

2.                                      Property

 

Discontinued Operations

 

SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires that the results of operations of assets sold or held for sale, and any gains or losses recognized on assets sold or held for sale, be

 

13



 

classified separately in the Company’s Condensed Consolidated Statements of Operations.  In accordance with SFAS No. 144, the results of operations of the assets sold or held for sale have been presented as “Income from discontinued operations” in the accompanying Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2002.

 

During the three and nine months ended September 30, 2003, the Company completed the sale of 25 and 62 properties, respectively, for net cash proceeds of $14.1 million and $35.1 million, respectively, net of closing costs of $1.2 million and $2.2 million, respectively.

 

The following table presents the revenues, depreciation and amortization, impairment of long-lived assets, other expenses, net gain on sales of property, and income from discontinued operations for the three and nine months ended September 30, 2003 and 2002 for the 62 properties sold during the nine months ended September 30, 2003 and 46 properties sold during the twelve months ended December 31, 2002 (in thousands):

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

806

 

$

2,049

 

$

3,852

 

$

5,892

 

Depreciation and amortization

 

(50

)

(409

)

(529

)

(1,416

)

Impairment of long-lived assets

 

 

(133

)

(1,530

)

(1,328

)

Other expenses

 

(21

)

(878

)

(1,691

)

(2,356

)

 

 

735

 

629

 

102

 

792

 

Gain on sales of property, net

 

3,571

 

979

 

10,275

 

2,253

 

Income from discontinued operations

 

$

4,306

 

$

1,608

 

$

10,377

 

$

3,045

 

 

Other Impairments

 

During the three and nine months ended September 30, 2003, impairment charges of $1.5 million and $2.3 million were recognized from the revaluing of 19 and 33 assets, respectively, to their estimated fair values.  Impairment charges result when the Company determines from its regular analysis of real property assets that circumstances indicate the book value of an asset may not be fully recoverable.  As part of this regular analysis, any time a property is marketed for sale at a price less than net book value, an impairment charge is immediately recognized.  Of the Company’s $1.5 million third quarter impairment charges, approximately $0.8 million resulted from this analysis.  The remaining $0.7 million resulted in part from a $0.3 million charge related to a workout agreement with a multi-unit tenant during 2002. Under the terms of this agreement, the Company may be able to fully recover the outstanding balances due, which would then require the Company to recognize gains or impairments on each specific property as the settlement agreement is executed.  The remaining $0.4 million resulted from an analysis of short-lived ground leases on which the tenant had vacated.  Since ownership of the building and any fixtures typically reverts to the landowner at the expiration of a ground lease, it was unlikely that the Company would find a tenant for the property due to the brevity of the remaining ground lease term.  Accordingly, management recognized an impairment for the remaining asset value for the fixtures on the ground leases.

 

14



 

3.         Line of Credit, Notes Payable and Mortgage Note Payable

 

The Company’s total debt is summarized as follows (in thousands):

 

 

 

Maturity
Date

 

Interest
Rate

 

September 30,
2003

 

December 31,
2002

 

Revolving credit facility (1)

 

May 2004

 

LIBOR + 3.0

%

$

26,000

 

$

25,000

 

Notes Payable

 

 

 

 

 

 

 

 

 

Senior unsecured notes, interest-only paid semiannually

 

May 2005

 

7.15

%

$

111,000

 

$

111,000

 

Variable rate Certificates, principal and interest payable monthly

 

August 2006

 

LIBOR + 0.48

%

158,720

 

168,220

 

Senior unsecured notes, interest-only paid semiannually

 

August 2003

 

8.22

%

 

47,500

 

Debt premium, net

 

 

 

 

 

498

 

708

 

 

 

Total Notes Payable

 

 

 

$

270,218

 

$

327,428

 

 

 

 

 

 

 

 

 

 

 

Mortgage Note Payable

 

June 2007

 

8.00

%

$

919

 

$

946

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Debt

 

 

 

 

 

$

297,137

 

$

353,374

 

 


(1) On November 4, 2003, the line of credit was replaced with a new line.  See Note 11, “Subsequent Events,” for additional information.

 

In May 2002, the Company entered into a Credit Agreement with Bank of America (“BOA”) (the “Credit Agreement”), through its subsidiary USRP Funding 2002-A, L.P., for a secured line of credit of $35.0 million which is subject to a Derivative Exposure Reserve and a Borrowing Base, as defined.  Borrowings under this facility are used primarily to acquire certain Shoney’s and Captain D’s properties in purchase/leaseback transactions. This credit facility is secured by the capital stock of USRP Funding 2002-A, L.P and USRP (S&C), LLC, wholly-owned subsidiaries of the Company.  The Credit Agreement, as originally structured, had a term of up to two years and allowed for Base Rate Loans, Eurodollar Loans or a combination of the two.  Base Rate Loans bear interest at 3.0% plus the higher of the Federal Funds Rate plus 0.5% or the Prime Rate.  Eurodollar Loans bear interest at 3.0% plus LIBOR.  The Credit Agreement also provided that up to $10.0 million of the facility could be used for letters of credit.  There was a 3.0% fee per annum on outstanding letters of credit as well as a 3.0% Derivative Exposure Usage Fee under this facility.  As of September 30, 2003, the Company had  $2.1 million letters of credit outstanding and drawn under this facility. During 2003, the Company executed various extensions and modifications to this Credit Agreement as it negotiated a new credit facility.  One modification extended the Company’s $30.0 million borrowing capacity through November 17, 2003. As of September 30, 2003, funds available under the Credit Agreement were approximately $139,000.  On November 4, 2003, the Company replaced its line of credit, and as of November 7, 2003, funds available under the new line of credit were $3.5 million.  See Note 11, “Subsequent Events,” for additional information.

 

In 1998, the Company issued $47.5 million in senior notes in a private placement which were originally scheduled to mature on August 1, 2003.  On July 1, 2003, the Company prepaid $23.8 million of the notes.  In connection with this prepayment, the Company paid $0.8 million in accrued interest and incurred a make-whole interest payment of $137,000.  The Company repaid the remaining balance on July 29, 2003.

 

The Company is in compliance with all covenants associated with its debt and credit facilities as of September 30, 2003.

 

15



 

4.                                      Derivative Instruments

 

The Company’s derivative instruments as of September 30, 2003 are summarized as follows (in thousands):

 

 

 

 

 

Liability

 

Type

 

Settlement
Period

 

Maturity

 

Notional
Amount

 

Fixed
Swap
Rate
Paid

 

Floor
Rate

 

Cap
Rate

 

Sept. 30,
2003

 

Dec. 31,
2002

 

Interest rate swap

 

Quarterly

 

May 2003

 

$

15,000

 

7.05

%

 

 

 

 

$

 

$

325

 

Interest rate collar

 

Monthly

 

Aug. 2005

 

63,321

 

 

4.42

%

6.00

%

2,983

 

3,678

 

Interest rate swap

 

Monthly

 

June 2004

 

25,000

 

2.42

%

 

 

 

 

240

 

315

 

Interest rate swap (1)

 

Monthly

 

Aug. 2003

 

50,000

 

2.00

%

 

 

 

 

 

218

 

Interest rate swap (2)

 

Monthly

 

Sept. 2005

 

30,000

 

2.12

%

 

 

 

 

97

 

 

Interest rate swap (2)

 

Monthly

 

Sept. 2005

 

25,000

 

2.33

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

3,320

 

$

4,536

 

 


(1)  Expired upon maturity without renewal.

(2)  Effective April 2004.

 

Derivative financial instruments are utilized by the Company to manage its exposure to market risks from changes in interest rates.  The Company’s derivative financial instruments include interest rate swaps and interest rate collars, in which the Company receives variable payments based on an appropriate LIBOR index. The Company expects to make approximately $2.8 million in derivative settlement payments over the next 12 months.

 

The Company terminated a fixed to floating interest rate swap with Bank of America in September 2002.  Proceeds of $1.1 million from the termination were collected in October 2002.  A gain of approximately $0.9 million resulted from the termination, which increased the basis of the underlying note payable in the Company’s Condensed Consolidated Balance Sheets and is being amortized over the remaining term of the previously hedged item (May 2005).  As of September 30, 2003, the remaining unamortized basis adjustment was $0.5 million.

 

 

5.                                      Related Party Transactions

 

During 2002, the Company acquired a 7.5% equity interest in Shoney’s, Inc.  An affiliate of the Lone Star Funds (see Note 6 below) owns the remainder of Shoney’s, Inc.  As of September 30, 2003, the Company’s investments in Shoney’s consisted of an investment in common stock of $2.4 million, mortgage loans receivable of $2.1 million and a net book value of real estate purchased and leased back to Shoney’s of approximately $54.4 million.  See Note 11, “Subsequent Events,” for information regarding the sale of the Company’s equity interest in Shoney’s.

 

 

6.                                      Stockholders’ Equity and Minority Interests

 

The Company had 19,923,689 and 19,831,689 shares of common stock outstanding as of September 30, 2003 and December 31, 2002, respectively.

 

Lone Star Funds

 

Two stockholders of the Company (LSF3 Investments I, LLC, a Delaware limited liability company, and LSF3 Investments II, LLC, a Delaware limited liability company (the “Lone Star Funds”)) owned approximately 19.0% of the Company’s outstanding common stock as of September 30, 2003.  See Note 11, “Subsequent Events,” for additional information regarding the Company’s common stock offering on October 17, 2003, after which the equity interest of Lone Star Funds, as selling stockholders, was reduced to approximately 9.9%.

 

16



 

Series B Preferred

 

On June 19, 2003, the Company raised proceeds of $15.2 million, net of placement fees but excluding certain transaction costs, from the sale of 16,000 shares of Series B Convertible Preferred Stock (the “Series B Preferred”) in a private placement with certain institutional investors.

 

The Series B Preferred carries an 8.0% dividend and is convertible into shares of common stock at a fixed conversion price of $16.00 per share, which represented a premium to the market price for the Company’s common stock on the date of issuance.  The Series B preferred stock is not subject to mandatory redemption but is redeemable after three years at stated value plus accrued and unpaid dividends in cash, or, if specific conditions are met, in shares of common stock based on a weighted average conversion calculation.  The Company also issued warrants to the investors to purchase 206,452 shares of common stock at an exercise price of $16.50 per share.  The warrants have a seven-year term.  The estimated fair value of the warrants, utilizing Black-Scholes option valuation methodology, was $1.23 per share at the date of issuance.

 

The offering also included a twelve-month option for the institutional investors to invest an additional $4.0 million in stated value Series B Preferred under the same terms as the initial investment, with certain conversion price adjustments for the then current market price for the Company’s common stock.

 

See Note 11, “Subsequent Events,” for information regarding the October 2003 issuance of $4.0 million of additional Series B preferred shares in connection with the Company’s recent stock offering.

 

Distributions to Common and Preferred Stockholders

 

During the nine months ended September 30, 2003, the Company declared distributions of $19.7 million to its common stockholders (or $0.99 per share of Common Stock) and $5.6 million to its Series A preferred stockholders (or $1.45 per share of Series A Preferred Stock).  The Company also declared a pro-rated distribution from the date of issuance to September 30, 2003, of $0.3 million to its Series B preferred stockholders. During the nine months ended September 30, 2002, the Company distributed $19.4 million to its common stockholders (or $0.99 per share of Common Stock) and $5.3 million to its Series A preferred stockholders (or $1.45 per share of Series A Preferred Stock).

 

Minority Interests

 

During 1999, the Company issued $55.0 million of 8.5% preferred equity interest in the HJV to a third party for net proceeds of $52.8 million.  Under the terms of this transaction, the preferred interest holder receives annual distributions equal to $4.7 million, payable monthly from the cash flows of HJV.  Income is allocated to the preferred interest holder equal to the holder’s distribution. From time to time, the Company may be required to exchange properties that do not meet specified criteria as defined in the partnership agreement.

 

Based on an evaluation of the minority interests under SFAS No. 150, Management believes the current classification of its minority interests in the Company’s Condensed Consolidated Balance Sheets as of September 30, 2003 is appropriate.   See Note 11, “Subsequent Events,” for additional information regarding the redemption of the HJV minority interest on November 4, 2003.

 

During the nine months ended September 30, 2003, the Company acquired a property, including land and building, in exchange for 79,845 OP Units and the forgiveness of a $1.1 million note receivable owed to the Company.  The fair value of the land and building received at the time of the exchange was $2.3 million.

 

Minority interest activity for the nine months ended September 30, 2003 is as follows (in thousands):

 

Balance at January 1, 2003

 

$

52,845

 

Distributions paid and accrued

 

(3,576

)

Income allocated to minority interests

 

3,542

 

79,845 OP Units issued

 

1,146

 

Balance at September 30, 2003

 

$

53,957

 

 

17



 

7.                                      Segment Information

 

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.  The Company has two operating segments, real estate and retail.

 

Real Estate.  Real estate activities principally include acquiring, owning, leasing and managing restaurant and gas station properties. The Company derives its real estate revenues from rental income on its portfolio of 785 branded chain restaurants and service station properties located throughout 48 states.

 

Retail. Revenues from this segment are generated from the sales of gasoline and convenience store merchandise, and food sales at restaurants operated by the Company.  At September 30, 2003, FSI operated nine service stations in Texas, eight in Hawaii, one in California and one in Illinois, along with three restaurants, two in Texas and one in Kansas.  In January 2002, FSI began utilizing a fuel terminal in Hawaii to store fuel distributed to its Hawaii service stations.  At September 30, 2003, in addition to the service stations currently operated, FSI sold fuel to seven service stations in Hawaii, two in Texas and two in Illinois.

 

Intersegment Charges.  Intersegment charges are eliminated in consolidation and primarily include the costs of rent and interest.  The Retail segment pays rent to the Real Estate segment to lease the properties that it operates.  Interest is also paid by the Retail segment to the Real Estate segment.  Interest is charged at an annual rate of 9.5% on intercompany balances as well as on a note established on January 1, 2002 for the sale of the Hawaii fuel terminal to FSI.  Intercompany balances represent primarily the cash advances made by the Real Estate segment to the Retail segment to fund its operations.

 

18



The following tables present the Company’s reportable amounts by segment for the three months ended September 30, 2003 and 2002 (in thousands):

 

2003

 

Real Estate

 

Retail

 

Intercompany

 

Consolidated

 

Real estate rental

 

$

15,421

 

$

 

$

(322

)

$

15,099

 

Retail operations

 

 

15,682

 

 

15,682

 

Interest on mortgage loans and tenant
expense reimbursements

 

1,756

 

 

(326

)

1,430

 

Lease termination fees

 

29

 

 

 

29

 

Total revenues

 

17,206

 

15,682

 

(648

)

32,240

 

Interest expense

 

(4,612

)

(329

)

326

 

(4,615

)

Depreciation and amortization

 

(5,679

)

(112

)

 

(5,791

)

General and administrative

 

(1,286

)

(1,498

)

 

(2,784

)

Retail cost of sales

 

 

(13,393

)

 

(13,393

)

Other expenses, net

 

(4,683

)

(282

)

322

 

(4,643

)

Income from continuing operations
before discontinued operations

 

946

 

68

 

 

1,014

 

Income (loss) from discontinued operations

 

4,311

 

(5

)

 

4,306

 

Net income

 

$

5,257

 

$

63

 

$

 

$

5,320

 

 

2002

 

Real Estate

 

Retail

 

Intercompany

 

Consolidated

 

Real estate rental

 

$

15,529

 

$

 

$

(603

)

$

14,926

 

Retail operations

 

 

10,216

 

 

10,216

 

Interest on mortgage loans and tenant
expense reimbursements

 

2,043

 

 

(197

)

1,846

 

Total revenues

 

17,572

 

10,216

 

(800

)

26,988

 

Interest expense

 

(5,594

)

(197

)

197

 

(5,594

)

Depreciation and amortization

 

(4,952

)

(10

)

 

(4,962

)

General and administrative

 

(1,147

)

(1,384

)

 

(2,531

)

Retail cost of sales

 

 

(8,517

)

 

(8,517

)

Other expenses, net

 

(2,314

)

(524

)

603

 

(2,235

)

Income (loss) from continuing operations
before discontinued operations

 

3,565

 

(416

)

 

3,149

 

Income (loss) from discontinued operations

 

1,627

 

(19

)

 

1,608

 

Net income (loss)

 

$

5,192

 

$

(435

)

$

 

$

4,757

 

 

19



 

The following tables present the Company’s reportable amounts by segment as of and for the nine months ended September 30, 2003 and 2002 (in thousands):

 

2003

 

Real Estate

 

Retail

 

Intercompany

 

Consolidated

 

Real estate rental

 

$

46,256

 

$

 

$

(944

)

$

45,312

 

Retail operations

 

 

43,490

 

 

43,490

 

Interest on mortgage loans and tenant
expense reimbursements

 

5,931

 

 

(1,044

)

4,887

 

Lease termination fees

 

1,660

 

 

 

1,660

 

Total revenues

 

53,847

 

43,490

 

(1,988

)

95,349

 

Interest expense

 

(15,695

)

(1,056

)

1,044

 

(15,707

)

Depreciation and amortization

 

(16,151

)

(291

)

 

(16,442

)

General and administrative

 

(4,221

)

(5,251

)

 

(9,472

)

Retail cost of sales

 

 

(37,189

)

 

(37,189

)

Other expenses, net

 

(10,833

)

(734

)

944

 

(10,623

)

Income (loss) from continuing operations before discontinued operations and change in accounting principle

 

6,947

 

(1,031

)

 

5,916

 

Income (loss) from discontinued operations

 

10,558

 

(181

)

 

10,377

 

Change in accounting principle

 

(241

)

(29

)

 

(270

)

Net income (loss)

 

$

17,264

 

$

(1,241

)

$

 

$

16,023

 

 

 

 

 

 

 

 

 

 

 

Identifiable assets

 

$

528,322

 

$

13,078

 

$

(14,169

)

$

527,231

 

Cash allocable to segments

 

3,349

 

1,299

 

 

4,648

 

Total assets

 

$

531,671

 

$

14,377

 

$

(14,169

)

$

531,879

 

 

2002

 

Real Estate

 

Retail

 

Intercompany

 

Consolidated

 

Real estate rental

 

$

46,608

 

$

 

$

(1,210

)

$

45,398

 

Retail operations

 

 

26,607

 

 

26,607

 

Interest on mortgage loans and tenant
expense reimbursements

 

5,370

 

 

(579

)

4,791

 

Lease termination fees

 

92

 

 

 

92

 

Total revenues

 

52,070

 

26,607

 

(1,789

)

76,888

 

Interest expense

 

(16,691

)

(579

)

579

 

(16,691

)

Depreciation and amortization

 

(15,151

)

(28

)

 

(15,179

)

General and administrative

 

(4,021

)

(3,616

)

 

(7,637

)

Retail cost of sales

 

 

(22,499

)

 

(22,499

)

Other expenses, net

 

(8,009

)

(1,153

)

1,210

 

(7,952

)

Income (loss) from continuing operations
before discontinued operations

 

8,198

 

(1,268

)

 

6,930

 

Income (loss) from discontinued operations

 

3,095

 

(50

)

 

3,045

 

Net income (loss)

 

$

11,293

 

$

(1,318

)

$

 

$

9,975

 

 

 

 

 

 

 

 

 

 

 

Identifiable assets

 

$

567,292

 

$

7,776

 

$

(8,070

)

$

566,998

 

Cash allocable to segments

 

4,658

 

932

 

 

5,590

 

Total assets

 

$

571,950

 

$

8,708

 

$

(8,070

)

$

572,588

 

 

20



 

8.                                      Change in Accounting Principle

 

On January 1, 2003, the Company adopted SFAS No. 143, “Accounting for Asset Retirement Obligations.”  This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.  As a result of adopting SFAS No. 143, the Company capitalized net asset retirement costs of $0.3 million, recorded asset retirement obligations of $0.6 million and recognized a cumulative effect of change in accounting principle of $0.3 million on January 1, 2003.   The retirement obligations relate to the estimated future costs for the removal of tanks, fuel lines and other required modifications to the Company’s gas stations.  The Company recognized $32,000 in accretion expense related to the properties with asset retirement obligations during the nine months ended September 30, 2003.

 

9.                                      Significant Tenant Negotiations

 

Fina

 

In February 2002, the leasehold lender of 51 Fina stations in the Dallas/Ft. Worth area assumed the defaulting tenant’s interest in the lease and took over operations from the bankrupt tenant. As of December 31, 2002, there was $2.6 million owed to the Company under the leases, representing pre-assumption property taxes, for which the Company had reserved $0.8 million. Effective in February 2003, the Company entered into a lease termination agreement and received a lease termination fee of $3.4 million, a portion of which was applied to outstanding receivable balances, with the remaining $1.7 million recorded as lease termination fee revenue.  The Company also, through its subsidiary FSI, purchased equipment for approximately $2.2 million, gas and convenience store inventory from the tenant at an agreed-upon cost of $2.9 million, and took over the operation of 25 of these Fina stations.  The remaining 26 properties were temporarily closed.  As of September 30, 2003, 21 stations had been re-leased, 14 stations had been sold and two leasehold properties were returned to the property owners.  Of the remaining 14 properties, nine are fee-owned and five are leaseholds.  Of the nine fee properties, FSI is operating four and five are vacant. Of the remaining leaseholds, FSI is operating three and two are vacant.  During the nine months ended September 30, 2003, impairment charges of $1.0 million were recognized from revaluing 14 Fina stations to their estimated fair value.

 

Lyon’s of California

 

At September 30, 2003, the Company had $2.9 million of mortgage loans receivable from Lyon’s of California, Inc. (“Lyons”).  The loans were secured by certain Lyons restaurant properties and partially guaranteed by ICH Corporation (“ICH”), the former owner of Lyons.  The Company also held a $0.1 million note receivable from ICH which was written off during the 2003 third quarter. Sybra, Inc. (“Sybra”), a former wholly-owned subsidiary of ICH, is the lessee of 58 of the Company’s Arby’s restaurants, making it the Company’s largest tenant.

 

Due to the 2001 Lyons and ICH bankruptcy filings, the Company recorded an allowance for doubtful accounts of $2.5 million and $0.3 million on balances due from Lyons and ICH, respectively, during the year ended December 31, 2001.  Interest income associated with these notes has not been recognized since September 2001.  All of these notes are valued based on the estimated fair value of the collateral, as collateral disposal is the only means through which the Company will collect proceeds.  Since the inceptions of the notes, through September 30, 2003, the Company has received $6.9 million in proceeds from the liquidation of this collateral, including $3.6 million in April 2003, which is primarily associated with the ICH guarantee.  As a result of these events, the fair value of the collateral supporting these notes has become more certain.  The allowance on the Lyons notes was reduced from $2.5 million to $0.6 million during the year ended December 31, 2002.  The Company further reduced the allowance on the Lyons and ICH notes by $0.5 million during the first nine months of 2003.

 

Embers

 

During 2002, a significant tenant/mortgagee, Embers, experienced financial difficulty, and the Company executed a workout agreement whereby Embers would sell all of its real estate, including fee properties owned by the Company that were leased to the tenant, and would remit all net proceeds to the Company until 100% of all mortgage loans, accrued interest, real estate taxes, rent receivables, late fees and other costs had been recovered. Interest income associated with these loans has not been recognized since December 2002.  During 2002, the Company received approximately $1.5 million of cash from these sale transactions to partially repay its mortgage notes.  During 2003,

 

21



 

the Company received $2.8 million in cash from the sale of four of the fee-owned properties, and recognized a gain on sale of $1.3 million.  Each quarter, the Company individually evaluates all of its mortgage loans and real estate associated with this tenant to determine if any asset has been impaired.   As a result of this evaluation, a $0.5 million impairment was recognized on the Embers-related assets during the first nine months of 2003, of which $0.3 million was recognized in the third quarter. At September 30, 2003, the Company held mortgage loans receivable of $2.6 million, net book value of real estate and equipment of $0.7 million and rent receivables and other assets of $1.8 million related to Embers.

 

10.                               Commitment and Contingencies

 

Litigation

 

Alon USA, L.P.

 

During the first quarter of 2003, the Company filed a lawsuit against Alon USA, L.P. (“Alon”), the owner of the Fina brand.  The Company terminated the tenant’s leasehold interest during February 2003 for 51 Fina service locations, and immediately closed 26 of them.  Alon counter-claimed against the Company, alleging that pursuant to a Branding Assurance Agreement entered into with the Company, these gas stations must be continuously operated selling Fina branded gasoline.  The Company’s suit maintained that the Branding Assurance Agreement only required open and operating stations to remain under the Fina brand during the Company’s ownership period, and that the Company had a right to sell the properties for other than Fina branded gasoline stations.  The Company disputed Alon’s position and did not reopen several of the stations and sold two stations for other than Fina branded gasoline stations.

 

Effective August 22, 2003, a Settlement Agreement and Mutual Release (the “Settlement Agreement”) was executed between the parties. The Agreement expires on December 31, 2008, after which time the Company is no longer under an obligation to maintain continuously operating stores under the Fina brand.

 

Summarized below are significant terms of the Settlement Agreement.

 

                  For each property covered under the Settlement Agreement, a partial “release price,” as defined, is due Alon for stores which do not remain open and operating under the Fina brand since the inception of the branding assurance agreement.

                  USRP paid approximately $0.3 million at closing which included approximately $0.2 million for the release of five stores and approximately $39,000 for days that stores were closed through the effective date of the Settlement Agreement, August 22, 2003.

                  USRP has an obligation for future payments, or release prices as defined in the Settlement Agreement, in the event stores do not remain open and operating under the Fina brand.

                  In the event of a sale of a store, USRP may contractually require the purchaser to assume responsibility for the branding assurance agreement and the release price.

                  If the new owner defaults on the agreement with USRP to maintain a continuously operating store under the Fina brand, USRP would be directly responsible for the release price payment to Alon.  However, if this occurs, the Company would seek recourse against the defaulting owner.

 

During the third quarter, two additional releases totaling $0.1 million were made by the Company under the terms of the Settlement Agreement. The Company recovered the release price for one of the properties from its tenant.  Accordingly, the net release prices paid during the quarter, including the amounts paid at closing, totaled approximately $0.3 million.

 

FIN No. 45, as further discussed in “Guarantees” below, requires disclosures to be made by a guarantor about its obligations under certain guarantees and also requires liability recognition for certain types of debt whether or not payment is probable.  Guarantees under the Alon agreement are included in the guarantees table below.

 

22



 

Motel Enterprises, Inc.

 

Prior to 2001, the Company lost a case at the trial court level. After a judgment of specific performance was entered against the Company for a total of $0.6 million plus interest and attorneys’ fees, USRP posted an $0.8 million bond and appealed the damage award of the trial court, arguing that the court provided erroneous instructions as to the measure of damages and improperly excluded the Company’s expert witness.  During 2001, USRP wrote off $0.4 million for this case, believing that the underlying note had sufficient value to cover the remainder of the judgment.  USRP prevailed on appeal and the judgment was reversed and remanded for a new trial.  A verdict was again issued against the Company.  The case was then appealed to the Supreme Court of Texas.  Late in the third quarter of 2003, the State Supreme Court declined to hear the case, whereupon the Company immediately filed a petition for re-hearing.  Based on this most recent declination by the courts, and even though no ruling has been made on the most recent petition, the Company further evaluated the note and has determined that collectibility is unlikely.  Management therefore charged off the remaining amount under the judgement.

 

Other Legal

 

The Company is subject to various legal proceedings in the ordinary course of business.  The resolution of these matters cannot be predicted with any certainty, but management believes the final outcome of such matters will not have a material effect on the financial position, results of operations or cash flows of the Company.

 

Guarantees

 

FIN No. 45 requires disclosures to be made by a guarantor about its obligations under certain guarantees it has issued and also requires liability recognition for guarantees.  A guarantor is required to recognize a liability at the inception of a guarantee whether or not payment is probable, creating the concept of a “stand ready” obligation.

 

The Company’s guarantees in place as of September 30, 2003 are listed in the table below.  For the guarantees on indebtedness, no triggering events or conditions have occurred that would require payment under the guarantees, and management believes the assets associated with the loans that are guaranteed are sufficient to cover the maximum potential amount of future payments and therefore would not require the Company to provide additional collateral to support the guarantees.

 

(in thousands)

 

 

 

 

 

Debtor

 

September 30, 2003

 

Maximum
Guaranteed Amount

 

Alon (1)

 

$

36

 

$

2,978

 

Letters of Credit (2)

 

$

 

$

3,092

 

Total Guarantees

 

$

36

 

$

6,070

 

 


(1)A Settlement Agreement between Alon and the Company obligated USRP to potential future payments of property release prices, as defined, on Alon properties that do not remain open and operating under the Fina brand during the term of the Agreement, through December 2008.  Contracts for sales of any of these properties by USRP to third parties may contractually obligate the purchaser to maintain the Fina brand on the gasoline service stations, or pay the release price should a branding change be desired by the purchaser.  In the event a new owner defaults on the agreement with USRP to maintain a continuously operating store under the Fina brand, the Company would remain directly responsible for payment of the release price to Alon.

 

(2)The Company obtains irrevocable standby letters of credit to guarantee payment of a specific financial obligations.  As of September 30, 2003, the Company had one letter of credit funded by its line of credit, and three other letters of credit which were collateralized with cash for its wholly-owned subsidiary FSI. Two of the FSI letters of credit secure payment to a gasoline provider and expire April 2004, and one secures payment of excise taxes to the Internal Revenue Service and expires December 2003.  If the Company defaults on its financial obligations under the stipulations of the letters of credit, it would be required to pay up to the maximum guaranteed amount.

 

 

11.                               Subsequent Events

 

Common Stock Offering

 

On October 14, 2003, the Company completed a common stock offering of 4,075,000 shares of its common stock, including 1,500,000 shares offered by the Lone Star Funds.  The Company did not receive any of the proceeds from the sale of the common stock by the Lone Star Funds. The Company and the selling stockholders granted the

 

23



 

underwriters an option to purchase an additional 611,250 shares to cover over-allotments, if any. Proceeds of $38.5 million from the offering, net of transaction expenses, were received on October 17, 2003.

 

Series B Restriction Waiver

 

In connection with the private placement of the Series B preferred stock, the Company agreed with the Series B preferred stock investors that the Company would not, without their prior written consent, prior to December 30, 2003 (90 days following the October 1, 2003 effective date of the resale registration statement), issue any additional shares of common stock or securities convertible into common stock.  The Series B preferred stock investors agreed to waive the foregoing restriction in order to permit the Company to sell the shares of common stock being offered in the common stock offering in exchange for the Company’s agreement to:

 

                  Sell to the Series B preferred stock investors an additional $4.0 million of Series B preferred stock at stated value, with a fixed conversion price of $16.00 per share and issue additional warrants; and

                  Increase the amount of Series B preferred stock that the Series B preferred stock investors have the right to purchase under the 12-month option by an additional $1.0 million for a total option of $5.0 million.

 

On October 17, 2003, the Company issued the $4.0 million of additional Series B preferred stock to the existing holders.

 

Shoney’s and Captain D’s Transactions

 

On October 6, 2003, the Company completed the sale of its 7.5% equity interest in Shoney’s, Inc. to Shoney’s largest shareholder.  Net proceeds were $4.5 million.  The Company anticipates recognizing a gain of approximately $2.1 million.

 

On October 17 and 22, 2003, the Company completed two purchase transactions totaling approximately $26.7 million in which 33 Captain D’s properties were acquired with proceeds from the common stock offering.

 

On October 22, 2003, the Company purchased $15.0 million of Captain D’s mortgage loans with proceeds from the common stock offering and other available funds.

 

New Revolving Credit Facility

 

On November 4, 2003, the Company executed the first part of its new $50.0 million credit facility, in a transaction that provided $30.0 million of the facility from Bank of America, N.A.  The Company anticipates that the remaining $20.0 million will be provided by participating lenders. Commitments are expected during the fourth quarter. The term of the facility is three years expiring November 2006, and subject to various conditions.  The annual interest rate on the borrowings under the facility is LIBOR plus 300 basis points. The facility provides that up to $5.0 million may be used for letters of credit.  The amount borrowed under the facility is based on the earnings before interest, taxes, depreciation and amortization generated by the properties that collateralize the facility.  Borrowings under the facility are secured by a negative pledge on the properties and a pledge of the Company’s equity interests in the subsidiaries which own the borrowing base properties.  Borrowings under the new facility will be used to repay the debt on the original facility, fund property acquisitions and for general corporate purposes.

 

Redemption of Highland Joint Venture Preferred Partnership Interests

 

On November 4, 2003, the Company redeemed the $52.8 million partnership interest in one of its operating partnerships, USRP/HCI Partnership 1, L.P., that was owned by an affiliate of Bank of America. In conjunction with the new revolving credit facility, the commitment from Bank of America also provided for a term loan facility in the amount of $35.0 million to partially fund the redemption of the partnership interest. The remaining $17.8 million required to redeem the interest was paid with cash, including cash generated from the issuance of additional shares of the Company’s series A preferred stock to an affiliate of Bank of America.

 

24



 

Hawaii Term Loan

 

The Company has received a non-binding indication of interest from, and is in the process of negotiating definitive documents with First Hawaiian Bank to provide a $12.0 million secured term loan facility.  Borrowings under this facility would bear interest at either LIBOR plus 250 basis points, or 50 basis points over the lender’s prime rate, at the Company’s option.  Principal amounts outstanding would be amortized over a 15-year period but would mature on the eighth anniversary of the date of funding.  This facility would be secured by certain of the Company’s properties in Hawaii. Borrowings under the term loan facility will be used to fund new property acquisitions, pay down other debt and for general corporate purposes.

 

25



 

Item 2.           Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management’s discussion and analysis of financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these consolidated financial statements requires management of the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities.  On a regular basis, the Company evaluates these estimates, including asset impairments and provision for doubtful accounts.  Management’s estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances.  Actual results may differ from these estimates.

 

Results of Operations

 

Real estate rental revenues are derived primarily from leasing the Company’s properties (primarily branded chain restaurants) to operators on a “triple net” basis.  Triple net leases typically require the tenants to be responsible for property operating costs, including property taxes, insurance, maintenance, and in most cases, the ground rents where applicable.  Approximately 47.1% of the Company’s leases provide for a base rent plus a percentage of the sales in excess of a threshold amount.  As a result, portions of the Company’s revenues are a function of the number of properties in operation and their level of sales.  Sales at individual properties are influenced by local market conditions, the efforts of specific operators, marketing, new product programs, support of the franchisor and the general state of the economy.

 

Comparison of the three months ended September 30, 2003 to the three months ended September 30, 2002

 

Revenues

 

Revenues from real estate properties consist of rental revenues, tenant expense reimbursements, lease termination fees and interest on mortgage loans.  Revenue from retail operations is derived primarily from service properties operated by the Company, including gasoline service stations and car washes, as well as from convenience store sales.  For the three months ended September 30, 2003, revenues increased $5.3 million, or 19.5%, to $32.2 million.  The change was primarily attributable to the following:

 

                  an increase of $5.5 million, or 53.5%, to $15.7 million in retail operations which related primarily to revenue growth in fuel sales, including an increase of  $4.6 million in the Company’s Hawaii service station operations.  The nature of the Company’s retail operations causes a relatively high number of ownership changes, as well as numerous acquisitions and dispositions, making it difficult to utilize a same store measure that presents meaningful information. One measure of store performance utilized by the Company relates to the number of months that the stores are open for business in each period.  During the 2003 third quarter, there were eight additional store months in Hawaii compared to the prior year quarter.  There was also a greater number of service stations operated by the Company compared to the prior year period, including the remaining unsold Fina stores, which the Company began operating after a lease termination in February 2003;

                  an increase of $0.2 million, or 1.2%, to $15.1 million in rental income due primarily to:

                  an increase of $0.4 million in base rents attributable to an increase in the number of new leases entered into over the prior 12 months which related to the period ended September 30, 2003; and

                  a decrease of $0.2 million in percentage rents, primarily attributable to lower sales at Burger King units.

 

These increases are partially offset by a decrease of $0.6 million, or 49.6%, in interest on mortgage loans, due primarily to a $23.1 million decline in the Company’s mortgage loans receivable portfolio, which included $12.0 million of Captain D’s mortgage loans which were tendered for the purchase of 15 Captain D’s properties in the second quarter.

 

 

26



 

Expenses

 

Expenses increased $8.1 million, or 46.9%, to $25.4 million for the three months ended September 30, 2003.  The increase was primarily attributable to the following:

 

                  an increase of $4.9 million, or 57.3%, to $13.4 million in retail cost of sales due to increased number of store months and sales volumes during the period, particularly in Hawaii, and to the inclusion of operations of the remaining unsold Fina stores, which the Company began operating after a lease termination in February 2003;

                  an increase of $1.5 million in impairments of long-lived assets due to the revaluation of 19 properties to their

estimated fair values.  Impairment charges result when the Company determines from its regular analysis of real property assets that circumstances indicate the book value of an asset may not be fully recoverable.  As part of this regular analysis, any time a property is marketed for sale at a price less than net book value, an impairment charge is immediately recognized.  Of the Company’s third quarter impairment charges, approximately $0.8 million resulted from this analysis. The remaining $0.7 million resulted in part from a $0.3 million charge related to a workout agreement with a multi-unit tenant during 2002. Under the terms of this agreement, the Company may be able to fully recover the outstanding balances due, which would then require the Company to recognize gains or impairments on each specific property as the settlement agreement is executed. The remaining $0.4 million resulted from an analysis of short-lived ground leases on which the tenant had vacated.  Since ownership of the building and any fixtures typically reverts to the landowner at the expiration of a ground lease, it was unlikely that the Company would find a tenant for the property due to the brevity of the remaining ground lease term.  Accordingly, management recognized an impairment for the remaining asset value for the fixtures on the ground leases. No impairment expense was recorded in continuing operations for the prior year period;

                  an increase of $0.8 million, or 16.7%, to $5.8 million in depreciation and amortization due primarily to a full quarter’s depreciation on the 51 Shoney’s and Captain D’s acquired in the prior year and the 22 Shoney’s and Captain D’s acquired through September of 2003;

                  an increase of $0.5 million, or 96.2%, to $0.9 million in legal expenses due to higher costs, particularly costs related to a branding assurance suit and to another pending case; and

                  a net increase of $0.4 million, or 13.0%, to $3.8 million in various accounts mostly attributable to an increase in the provision for doubtful accounts and higher ground rent and property expenses.

 

Gains on sales of property for the three months ended September 30, 2003 were $3.6 million resulting from the sale of 25 properties, compared to gains of $1.0 million for the prior year quarter from the sale of 10 properties. These gains are reflected in the Company’s Unaudited Condensed Consolidated Statements of Operations as “Income from discontinued operations” in accordance with the requirements of SFAS No. 144.

 

Non-operating income decreased $0.2 million due primarily to the 2002 liquidation of the Company’s trading securities and to gains on the sale of securities in 2002.

 

Interest expense decreased $1.0 million, or 17.5%, to $4.6 million due to a lower overall notes payable balance outstanding, as well as lower interest rates in 2003 compared to 2002.

 

Income from discontinued operations was $4.3 million for the three months ended September 30, 2003. In accordance with SFAS No. 144, discontinued operations represent the operations of properties sold, as well as any gain or loss recognized on their disposition.  The operating results relate to the sale of 62 properties during the nine months ended September 30, 2003 and 46 properties during the twelve months ended December 31, 2002 and is reflected in the Company’s Unaudited Condensed Consolidated Statements of Operations as “Income from discontinued operations.”

 

Comparison of the nine months ended September 30, 2003 to the nine months ended September 30, 2002

 

Revenues

 

Revenues from real estate properties consist of rental revenues, tenant expense reimbursements, lease termination fees and interest on mortgage loans.  Revenue from retail operations is derived primarily from service properties operated by the Company, including gasoline service stations and car washes, as well as from convenience store

 

27



 

sales.  For the nine months ended September 30, 2003, revenues increased $18.5 million, or 24.0%, to $95.3 million compared to the corresponding prior year period. The increase is primarily attributable to the following:

 

                  an increase of $16.9 million, or 63.5%, to $43.5 million in retail operations which related primarily to revenue growth in fuel sales, including an increase of $14.5 million in the Company’s Hawaii service station operations.  During the nine months ended September 30, 2003, there were 35 additional store months in Hawaii compared to the same prior year period.  Store months for non-Hawaii operations also increased. There were 326  store months based on an average of 36 stores open during the period, compared to 279 based on an average of 31 stores open during the same prior year period.  There was also a greater number of service stations operated by the Company compared to the prior year period, including the remaining unsold Fina stores, which the Company began operating after a lease termination in February 2003;

                  an increase of $1.6 million in lease termination fee income, due almost entirely to the February 2003  termination of Fina station leases in the Dallas/Fort Worth, Texas area; and

                  an increase of $0.2 million in tenant expense reimbursements, due to a higher average per store value for ground leases for which reimbursements were received in 2003.  The average per store reimbursement in the first nine months of 2003 was $32,300 for 79 stores compared to $29,239 for 81 stores for the corresponding prior year period.

 

Expenses

 

Expenses increased $19.6 million, or 38.8%, to $70.2 million compared to the prior year period.  The increase was primarily attributable to the following:

 

                  an increase of $14.7 million, or 65.3%, to $37.2 million in cost of sales due to increased sales volumes and store months, particularly in Hawaii, and to the inclusion of operations of the remaining unsold Fina stores, which the Company began operating after a lease termination in February 2003.  The increased volumes resulted from an increase to 36 stores operated from 31 in the same prior year period and from an increase to 326 months from 279 in the same prior year period;

                  an increase of $1.8 million in impairments of long-lived assets due to the revaluing of 33 assets to their estimated fair value. Of the Company’s impairment charges of $2.3 million in the nine months ended September 30, 2003, approximately $1.5 million related to the third quarter as discussed on the prior page.

                  an increase of $1.8 million, or 14.8%, to $14.2 million in various accounts mostly attributable to an increase in the provision for doubtful accounts and higher ground rent, partially offset by lower property taxes; and

                  an increase of $1.3 million, or 8.3%, to $16.4 million in depreciation and amortization due primarily to nine months’ depreciation on the 51 Shoney’s and Captain D’s acquired in the prior year and the 22 Shoney’s and Captain D’s acquired through September of 2003;

 

Retail operations are administered by Fuel Supply, Inc. (“FSI”), a wholly-owned subsidiary of USRP Holding Corp. (“Holding”).   Holding is a taxable REIT subsidiary of U.S. Restaurant Properties, Inc..  FSI has incurred net operating losses (“NOLs”) since inception.  The Company recognized a deferred tax benefit in 2002 of approximately $0.1 million associated with these NOLs, which management believes may be used to offset any USRP (S&C), LLC and USRP (Hawaii), LLC taxable income.

 

28



 

Income from discontinued operations was $10.4 million for the nine months ended September 30, 2003. These results relate to the sale of 62 properties during the nine months ended September 30, 2003 and 46 properties during the twelve months ended December 31,2002, and are reflected in the Company’s Unaudited Condensed Consolidated Statements of Operations as  “Income from discontinued operations.”

 

Minority interests in earnings were $3.5 million for the nine months ended September 30, 2003 and 2002, respectively, and are related to the Highland Joint Venture preferred partnership interests and the OP Units outstanding at September 30, 2003.

 

Non-operating income was $29,000 and $0.8 million for the nine months ended September 30, 2003 and 2002, respectively.  The decrease was primarily due to the 2002 liquidation of the Company’s trading securities and to the gains on sale of securities in 2002.

 

Interest expense decreased $1.0 million, or 5.9%, to $15.7 million during the period due to:

                  $1.3 million decrease in interest expense due to a lower notes payable balance outstanding, as well as lower interest rates in 2003 compared to 2002;

                  $0.4 million decrease in derivative settlement payments; offset by

                  $0.4 million increase for the fair value of interest rate derivatives; and

                  $0.3 million increase in amortization of loan origination fees.

 

On January 1, 2003, the Company adopted SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.  As a result of adopting SFAS No. 143, the Company recognized a $0.3 million charge in the Company’s Unaudited Condensed Consolidated Statements of Operations as “Cumulative effect of change in accounting principle” on January 1, 2003.  This retirement obligation relates to the estimated future costs for the removal of tanks, fuel lines and other required modifications to the Company’s gas stations.

 

 

Liquidity and Capital Resources

 

 

CASH FLOWS

(in thousands)

 

For the nine
months ended
September 30, 2003

 

 

 

 

 

Cash flows provided by operating activities

 

$

32,448

 

Cash flows provided by investing activities

 

37,269

 

Cash flows used in financing activities

 

(69,461

)

 

 

 

 

Increase in cash and cash equivalents

 

$

256

 

Cash and cash equivalents, beginning of period

 

4,392

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

4,648

 

 

OPERATING ACTIVITIES

 

The Company’s principal sources of cash to meet its working capital and dividend requirements are rental revenues generated by the Company’s properties and operating revenues from the Company’s retail segment.

 

Cash flows provided by operating activities of $32.4 million was attributable to the real estate and retail operations.

 

INVESTING ACTIVITIES

 

Cash generated in excess of operating requirements and dividend payments is generally used to acquire additional properties or to reduce amounts outstanding under the Company’s credit agreement.

 

29



 

The Company’s cash flows provided by investing activities of $37.3 million was primarily attributable to:

 

                  $35.1 million of net proceeds from property sales;

                  $11.7 million of proceeds from paydowns on mortgage loans receivable; and

                  $2.2 million of proceeds from paydowns on notes receivable.

 

The cash flows used in investing activities was partially offset by:

 

                  $11.0 million for the acquisition of rental properties and equipment; and

                  $0.8 million increase in restricted cash and marketable securities, of which $0.6 million related to restricted cash collateralizing two letters of credit and $0.2 million related to additional marketable securities.

 

FINANCING ACTIVITIES

 

The Company’s cash flows used in financing activities of $69.5 million was attributable to:

 

                  $57.0 million in payments resulting in a decrease in notes payable, primarily related to the payoff of the Company’s $47.5 million senior unsecured notes, and a $9.5 million payment on the variable rate certificates;

                  $34.0 million of repayments under the Company’s line of credit;

                  $19.7 million in Common Stock dividend distributions;

                  $5.6 million in Preferred Stock dividend distributions; and

                  $3.6 million in distributions to minority interest stockholders.

 

 

The Company’s cash flows from financing activities was partially offset by:

 

                  $35.0 million of proceeds from borrowings under the Company’s line of credit;

                  $14.7 million, net of placement fees of approximately $1.3 million, of proceeds from the Series B convertible preferred stock offering and the Series B warrants; and

                  $1.0 million of proceeds from the sale of stock and exercised stock options.

 

LIQUIDITY REQUIREMENTS

 

The Company expects to spend approximately $18,000 during the remainder of 2003 to renovate and remodel currently owned properties.  Management expects to meet its short-term liquidity requirements consisting of normal recurring operating expenses, debt service requirements, property improvements and distributions to stockholders primarily through cash flows provided from real estate and retail operations.  To the extent the Company’s cash flow from real estate and retail operating activities is not sufficient to finance such short-term liquidity requirements, the Company may utilize its credit facility.  As of September 30, 2003, the funds available to the Company under the credit facility were $139,000.  The Company’s long-term liquidity requirements as of September 30, 2003 consist primarily of debt maturing after September 30, 2003, totaling approximately $269.7 million, which includes maturities through August 2006. The Company expects to meet these long-term liquidity requirements primarily through long-term secured and unsecured borrowings, other debt and equity financing alternatives, as well as cash proceeds received from the sale of properties.

 

During the third quarter of 2003, the Company paid in full the $47.5 million senior unsecured note balance.

 

 

Status of Financially Troubled Tenants and Legal Proceedings

 

 

Fina

 

In February 2002, the leasehold lender of 51 Fina stations in the Dallas/Ft. Worth area assumed the defaulting tenant’s interest in the lease and took over operations from the bankrupt tenant. As of December 31, 2002, there was $2.6 million owed to the Company under the leases, representing pre-assumption property taxes, for which the

 

30



 

Company had reserved $0.8 million. Effective in February 2003, the Company entered into a lease termination agreement and received a lease termination fee of $3.4 million, a portion of which was applied to outstanding receivable balances, with the remaining $1.7 million recorded as lease termination fee revenue.  The Company also, through its subsidiary FSI, purchased equipment for approximately $2.2 million, gas and convenience store inventory from the tenant at an agreed-upon cost of $2.9 million, and took over the operation of 25 of these Fina stations.  The remaining 26 properties were temporarily closed.  As of September 30, 2003, 21 stations had been re-leased, 14 stations had been sold and two leasehold properties were returned to the property owners.  Of the remaining 14 properties, nine are fee-owned and five are leaseholds.  Of the nine fee properties, FSI is operating four and five are vacant. Of the remaining leaseholds, FSI is operating three and two are vacant.  During the nine months ended September 30, 2003, impairment charges of $1.0 million were recognized from revaluing 14 Fina stations to their estimated fair value.

 

Lyon’s of California

 

At September 30, 2003, the Company had $2.9 million of mortgage loans receivable from Lyon’s of California, Inc. (“Lyons”).  The loans were secured by certain Lyons restaurant properties and partially guaranteed by ICH Corporation (“ICH”), the former owner of Lyons.  The Company also held a $0.1 million note receivable from ICH which was written off during the 2003 third quarter. Sybra, Inc. (“Sybra”), a former wholly-owned subsidiary of ICH, is the lessee of 58 of the Company’s Arby’s restaurants, making it the Company’s largest tenant.

 

Due to the 2001 Lyons and ICH bankruptcy filings, the Company recorded an allowance for doubtful accounts of $2.5 million and $0.3 million on balances due from Lyons and ICH, respectively, during the year ended December 31, 2001.  Interest income associated with these notes has not been recognized since September 2001.  All of these notes are valued based on the estimated fair value of the collateral, as collateral disposal is the only means through which the Company will collect proceeds.  Since the inceptions of the notes, through September 30, 2003, the Company has received $6.9 million in proceeds from the liquidation of this collateral, including $3.6 million in April 2003, which is primarily associated with the ICH guarantee.  As a result of these events, the fair value of the collateral supporting these notes has become more certain.  The allowance on the Lyons notes was reduced from $2.5 million to $0.6 million during the year ended December 31, 2002.  The Company further reduced the allowance on the Lyons and ICH notes by $0.5 million during the first nine months of 2003.

 

Embers

 

During 2002, a significant tenant/mortgagee, Embers, experienced financial difficulty, and the Company executed a workout agreement whereby Embers would sell all of its real estate, including fee properties owned by the Company that were leased to the tenant, and would remit all net proceeds to the Company until 100% of all mortgage loans, accrued interest, real estate taxes, rent receivables, late fees and other costs had been recovered. Interest income associated with these loans has not been recognized since December 2002.  During 2002, the Company received approximately $1.5 million of cash from these sale transactions to partially repay its mortgage notes.  During 2003, the Company received $2.8 million in cash from the sale of four of the fee-owned properties, and recognized a gain on sale of $1.3 million.  Each quarter, the Company individually evaluates all of its mortgage loans and real estate associated with this tenant to determine if any asset has been impaired.   As a result of this evaluation, a $0.5 million impairment was recognized on the Embers-related assets during the first nine months of 2003, of which $0.3 million was recognized in the third quarter. At September 30, 2003, the Company held mortgage loans receivable of $2.6 million, net book value of real estate and equipment of $0.7 million and rent receivables and other assets of $1.8 million related to Embers.

 

31



 

Alon USA, L.P.

 

During the first quarter of 2003, the Company filed a lawsuit against Alon USA, L.P. (“Alon”), the owner of the Fina brand.  The Company terminated the tenant’s leasehold interest during February 2003 for 51 Fina service locations, and immediately closed 26 of them.  Alon counter-claimed against the Company, alleging that pursuant to a Branding Assurance Agreement entered into with the Company, these gas stations must be continuously operated selling Fina branded gasoline.  The Company’s suit maintained that the Branding Assurance Agreement only required open and operating stations to remain under the Fina brand during the Company’s ownership period, and that the Company had a right to sell the properties for other than Fina branded gasoline stations.  The Company disputed Alon’s position and did not reopen several of the stations and sold two stations for other than Fina branded gasoline stations.

 

Effective August 22, 2003, a Settlement Agreement and Mutual Release (the “Settlement Agreement”) was executed between the parties. The Agreement expires on December 31, 2008, after which time the Company is no longer under an obligation to maintain continuously operating stores under the Fina brand.

 

Summarized below are significant terms of the Settlement Agreement.

 

                  For each property covered under the Settlement Agreement, a partial “release price,” as defined, is due Alon for stores which do not remain open and operating under the Fina brand since the inception of the branding assurance agreement.

                  USRP paid approximately $0.3 million at closing which included approximately $0.2 million for the release of five stores and approximately $39,000 for days that stores were closed through the effective date of the Settlement Agreement, August 22, 2003.

                  USRP has an obligation for future payments, or release prices as defined in the Settlement Agreement, in the event stores do not remain open and operating under the Fina brand.

                  In the event of a sale of a store, USRP may contractually require the purchaser to assume responsibility for the branding assurance agreement and the release price.

                  If the new owner defaults on the agreement with USRP to maintain a continuously operating store under the Fina brand, USRP would be directly responsible for the release price payment to Alon.  However, if this occurs, the Company would seek recourse against the defaulting owner.  As a result, the Company does not expect to have a significant obligation under the Settlement Agreement for the remainder of its term.

 

In addition, for those stores retained by the Company and those leased to tenants, the Company intends to utilize the Fina brand until the term of the branding agreement expires.

 

Motel Enterprises, Inc.

 

Prior to 2001, the Company lost a case at the trial court level. After a judgment of specific performance was entered against the Company for a total of $0.6 million plus interest and attorneys’ fees, USRP posted an $0.8 million bond and appealed the damage award of the trial court, arguing that the court provided erroneous instructions as to the measure of damages and improperly excluded the Company’s expert witness.  During 2001, USRP wrote off $0.4 million for this case, believing that the underlying note had sufficient value to cover the remainder of the judgment.  USRP prevailed on appeal and the judgment was reversed and remanded for a new trial.  A verdict was again issued against the Company.  The case was then appealed to the Supreme Court of Texas.  Late in the third quarter of 2003, the State Supreme Court declined to hear the case, whereupon the Company immediately filed a petition for re-hearing.  Based on this most recent declination by the courts, and even though no ruling has been made on the most recent petition, the Company further evaluated the note and has determined that collectibility is unlikely.  Management therefore charged off the remaining amount under the judgement.

 

32



 

Company Debt and Derivatives

 

In May 2002, the Company entered into a Credit Agreement with Bank of America (“BOA”) (the “Credit Agreement”), through its subsidiary USRP Funding 2002-A, L.P., for a secured line of credit of $35.0 million which is subject to a Derivative Exposure Reserve and a Borrowing Base, as defined.  Borrowings under this facility are used primarily to acquire certain Shoney’s and Captain D’s properties in purchase/leaseback transactions. This credit facility is secured by the capital stock of USRP Funding 2002-A, L.P and USRP (S&C), LLC, wholly-owned subsidiaries of the Company.  The Credit Agreement, as originally structured, had a term of up to two years and allowed for Base Rate Loans, Eurodollar Loans or a combination of the two.  Base Rate Loans bear interest at 3.0% plus the higher of the Federal Funds Rate plus 0.5% or the Prime Rate.  Eurodollar Loans bear interest at 3.0% plus LIBOR.  The Credit Agreement also provided that up to $10.0 million of the facility could be used for letters of credit.  There was a 3.0% fee per annum on outstanding letters of credit as well as a 3.0% Derivative Exposure Usage Fee under this facility.  As of September 30, 2003, the Company had  $2.1 million letters of credit outstanding and drawn under this facility.   During 2003, the Company executed various extensions and modifications to this Credit Agreement as it negotiated a new credit facility.  One modification extended the Company’s $30.0 million borrowing capacity through November 17, 2003. As of September 30, 2003, funds available under the Credit Agreement were approximately $139,000.  On November 4, 2003, the Company replaced its line of credit, and on November 7, 2003, funds available under the new line of credit were $3.5 million.  See Note 11, “Subsequent Events,” for additional information.

 

In 1998, the Company issued $47.5 million in senior notes in a private placement which were originally scheduled to mature on August 1, 2003.  On July 1, 2003, the Company prepaid $23.8 million of the notes.  In connection with this prepayment, the Company paid $0.8 million in accrued interest and incurred a make-whole interest payment of $137,000.  The Company repaid the remaining balance on July 29, 2003.

 

The Company is in compliance with all covenants associated with its debt and credit facilities as of September 30, 2003.

 

Derivative financial instruments are utilized by the Company to manage its exposure to market risks from changes in interest rates.  The Company’s derivative financial instruments include interest rate swaps and interest rate collars, in which the Company receives variable payments based on an appropriate LIBOR index. The Company expects to make approximately $2.8 million in derivative settlement payments over the next 12 months.

 

Management believes that cash flow from operations, along with the Company’s ability to raise additional equity, anticipated sales of properties, funds available under the Credit Agreement and the Company’s anticipated ability to obtain financing will provide the Company with sufficient liquidity to meet its foreseeable capital needs.  However, there can be no assurance that such additional financing will be available at the time the Company needs it or the terms of anticipated financing will be as favorable to the Company as under the existing facilities.

 

Funds From Operations (FFO)

 

The Company believes the supplemental non-GAAP measure FFO is a useful indicator of operating performance and that it is most directly comparable to GAAP net income.   Management uses FFO as a supplemental measure to conduct and evaluate the business because there are certain limitations of utilizing GAAP net income by itself as the primary measure of our operating performance.  Historical cost accounting for real estate assets in accordance with GAAP requires that the value of real estate assets be depreciated.  Since real estate values instead have historically risen or fallen with market conditions, the presentation of operating results for real estate companies that use historical cost accounting is insufficient by itself.  As a result, the National Association of Real Estate Investment Trusts (“NAREIT”) created FFO as a supplemental performance measure that excludes historical cost real estate depreciation, among other items, from GAAP net income.  The Company’s FFO is computed as net income (loss) available to common stockholders (computed in accordance with accounting principles generally accepted in the United States of America), plus real estate related depreciation and amortization, excluding gains (or losses) from sales of property, cumulative effects of changes in accounting principles, and income/loss allocable to minority interest holders.  The Company believes that the use of FFO, combined with the required primary GAAP presentations, has improved management’s and the investing public’s understanding of REIT operating results.  Further, the use of FFO has made comparisons of those results more meaningful and has enabled the evaluation of the Company’s operating performance compared to other REITs that use the NAREIT definition in order to make more informed business

 

33



 

decisions based on industry trends or conditions. Therefore, the Company considers FFO a useful measure for reviewing its comparative operating and financial performance because, by excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO assists in the comparison of the operating performance of real estate between periods or as compared to other REITs.  Other REITS may use a difference definition of FFO.

 

The following table sets forth, for the three and nine months ended September 30, 2003 and 2002, the reconciliation of funds from operations to net income.

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(in thousands)

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Funds from operations allocable to common
stockholders - diluted

 

$

5,413

 

$

7,345

 

$

17,202

 

$

18,925

 

Loss (income) allocable to minority interest

 

(36

)

6

 

(36

)

(6

)

Gain on sales of property

 

3,571

 

979

 

10,275

 

2,253

 

Depreciation and amortization