**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, 2002**                                                                                                                                                                        |
|                                                                                                                                                                                                                          |                                                                                          |
| **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.**

(Exactname 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)       |
|                                                             |   |                                   |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes  ý               No  o

 

As of November 7, 2002, U.S. Restaurant Properties, Inc. had 19,811,689shares of common stock $.001 par value outstanding.

 

 

----

 

U.S. RESTAURANTPROPERTIES, INC.

 

 
| PART  I.  | FINANCIAL  INFORMATION                                                                                                                                 |
|-----------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |                                                                                                                                                   |
| Item 1.   | Financial Statements                                                                                                                                   |   |
|      |                                                                                                                                                   |   |
|      | Condensed  Consolidated Balance Sheets as of September 30, 2002 (Unaudited) and  December 31, 2001                                                |   |
|      |                                                                                                                                                   |   |
|      | Condensed  Consolidated Statements of Operations for the three and nine months ended  September 30, 2002 and 2001 (Unaudited)                          |   |
|      |                                                                                                                                                   |   |
|      | Condensed  Consolidated Statements of Comprehensive Operations for  the three and nine months ended  September 30, 2002 and 2001 (Unaudited) |   |
|      |                                                                                                                                                   |   |
|      | Condensed  Consolidated Statement of Stockholders’ Equity for the nine months ended  September 30, 2002 (Unaudited)                |   |
|      |                                                                                                                                                   |   |
|      | Condensed  Consolidated Statements of Cash Flows for the nine months ended  September 30, 2002 and 2001 (Unaudited)                     |   |
|      |                                                                                                                                                   |   |
|      | Notes  to Condensed Consolidated Financial Statements (Unaudited)                                                                                      |   |
|      |                                                                                                                                                   |   |
| 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 1.   | Legal Proceedings                                                                                                                                      |
|      |                                                                                                                                                   |
| Item 2.   | Changes in Securities and Use of Proceeds                                                                                                              |
|      |                                                                                                                                                   |
| Item 3.   | Defaults upon Senior Securities                                                                                                                        |
|      |                                                                                                                                                   |
| Item 4.   | Submission of Matters to a Vote of Security  Holders                                                                                                   |
|      |                                                                                                                                                   |
| Item 5.   | Other Information                                                                                                                                      |
|      |                                                                                                                                                   |
| Item 6.   | Exhibits and Reports on Form 8-K                                                                                                                       |

 

2

----

 

**PARTI.    FINANCIAL INFORMATION**

 

**Item 1.    Financial Statements**

 

**U.S. Restaurant Properties, Inc.**

**Condensed Consolidated Balance Sheets**

**(In thousands, except per share data)**

 
|                                                                                                                                                                                      |   | **September 30,  2002** |    | **December 31,  2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                                                                                                                                                      |   | **(Unaudited)**         |    |                   |   |
| **Assets**                                                                                                                                                                                |   |                    |    |                   |   |
|                                                                                                                                                                                      |   |                    |    |                   |   |
| Property, net                                                                                                                                                                             |   |                    |    |                   |   |
| Land                                                                                                                                                                                      |   | $                       | 198,290 |                   | $      | 184,074 |   |
| Buildings and leasehold improvements                                                                                                                                                      |   | 375,137                 |    | 362,920                |   |
| Machinery and equipment                                                                                                                                                                   |   | 11,811                  |    | 11,018                 |   |
|                                                                                                                                                                                      |   | 585,238                 |    | 558,012                |   |
| Less:  accumulated depreciation                                                                                                                                                      |   | (97,485                 | )       | (83,233                | )      |
|                                                                                                                                                                                      |   | 487,753                 |    | 474,779                |   |
|                                                                                                                                                                                      |   |                    |    |                   |   |
| Assets held for sale                                                                                                                                                                      |   | —                  |    | 22,071                 |   |
| Construction in progress                                                                                                                                                                  |   | 237                     |    | 640                    |   |
| Cash and cash equivalents                                                                                                                                                                 |   | 5,590                   |    | 10,346                 |   |
| Restricted cash and marketable securities                                                                                                                                                 |   | 1,227                   |    | 6,622                  |   |
| Rent and other receivables, net  (includes $2,905 and $3,460 allowance for doubtful accounts at September 30,  2002 and December 31, 2001, respectively)                                  |   | 6,235                   |    | 6,747                  |   |
| Straight-line rent, net  (includes $473 and $1,287 allowance for doubtful accounts at September 30,  2002 and December 31, 2001, respectively)                                            |   | 11,409                  |    | 10,013                 |   |
| Prepaid expenses and other assets                                                                                                                                                         |   | 4,027                   |    | 2,534                  |   |
| Inventories                                                                                                                                                                               |   | 1,379                   |    | 633                    |   |
| Investments                                                                                                                                                                               |   | 5,949                   |    | 5,108                  |   |
| Notes receivable, net  (includes $13 and $488 due from related parties and $3,635 and $4,040  allowance for doubtful accounts at September 30, 2002 and December 31, 2001,  respectively) |   | 9,236                   |    | 8,145                  |   |
| Mortgage loans receivable, net  (includes $1,922 and $2,500 allowance for doubtful accounts at September 30,  2002 and December 31, 2001, respectively)                                   |   | 27,720                  |    | 16,187                 |   |
| Net investment in direct financing leases                                                                                                                                                 |   | 723                     |    | 1,300                  |   |
| Deferred financing costs and intangibles, net                                                                                                                                             |   | 11,103                  |    | 12,383                 |   |
| **Total assets**                                                                                                                                                                          |   | $                       | 572,588 |                   | $      | 577,508 |   |

* *

*See Notes to Condensed ConsolidatedFinancial Statements.*

 

3

----

 

 
|                                                                                                                                                                                                         |   | **September 30,  2002** |    | **December 31,  2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                                                                                                                                                                         |   | **(Unaudited)**         |    |                   |   |
| **Liabilities and stockholders’ equity**                                                                                                                                                                |   |                    |    |                   |   |
|                                                                                                                                                                                                         |   |                    |    |                   |   |
| Accounts payable and accrued liabilities                                                                                                                                                                     |   | $                       | 16,513  |                   | $      | 18,255 |   |
| Accrued dividends and distributions                                                                                                                                                                          |   | 2,180                   |    | 6,112                  |   |
| Unearned contingent rent                                                                                                                                                                                     |   | 996                     |    | 1,124                  |   |
| Deferred gain on sale of property                                                                                                                                                                            |   | 229                     |    | 215                    |   |
| Line of credit                                                                                                                                                                                               |   | 15,200                  |    | —                 |   |
| Interest rate swap agreements at fair value                                                                                                                                                                  |   | 4,467                   |    | 3,746                  |   |
| Notes payable                                                                                                                                                                                                |   | 329,566                 |    | 336,140                |   |
| Mortgage note payable                                                                                                                                                                                        |   | 954                     |    | 979                    |   |
| **Total  liabilities**                                                                                                                                                                                       |   | 370,105                 |    | 366,571                |   |
|                                                                                                                                                                                                         |   |                    |    |                   |   |
| **Commitments  and contingencies**                                                                                                                                                                           |   |                    |    |                   |   |
|                                                                                                                                                                                                         |   |                    |    |                   |   |
| **Minority  interest in operating partnerships**                                                                                                                                                             |   | 52,845                  |    | 54,337                 |   |
|                                                                                                                                                                                                         |   |                    |    |                   |   |
| **Stockholders’  equity**                                                                                                                                                                               |   |                    |    |                   |   |
|                                                                                                                                                                                                         |   |                    |    |                   |   |
| Preferred stock, $.001 par value per share;  50,000 shares authorized, Series A - 3,680 shares issued and outstanding at  September 30, 2002 and December 31, 2001 (aggregate liquidation value of  $92,000) |   | 4                       |    | 4                      |   |
|                                                                                                                                                                                                         |   |                    |    |                   |   |
| Common stock, $.001 par value per share;  100,000 shares authorized, 19,822 and 19,459 shares issued and outstanding at  September 30, 2002 and December 31, 2001, respectively                              |   | 20                      |    | 19                     |   |
| Additional paid-in capital                                                                                                                                                                                   |   | 327,484                 |    | 324,448                |   |
| Excess stock, $.001 par value per share  15,000 shares authorized, no shares issued                                                                                                                          |   | —                  |    | —                 |   |
| Accumulated other comprehensive loss                                                                                                                                                                         |   | (4,221                  | )       | (5,071                 | )      |
| Loans to stockholders for common stock                                                                                                                                                                       |   | (849                    | )       | (850                   | )      |
| Distributions in excess of net income                                                                                                                                                                        |   | (172,800                | )       | (161,950               | )      |
| **Total  stockholders’ equity**                                                                                                                                                                         |   | 149,638                 |    | 156,600                |   |
| **Total  liabilities and stockholders’ equity**                                                                                                                                                         |   | $                       | 572,588 |                   | $      | 577,508 |   |

* *

*See Notes to Condensed ConsolidatedFinancial Statements.*

 

4

----

 

**U.S. Restaurant Properties, Inc.Condensed Consolidated Statementsof Operations(In thousands, except per share data)**

**(Unaudited)**

 
|                                                                                                |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|-----------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                                                |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
| **Real Estate**                                                                                     |   |                                  |   |                                 |   |   |   |   |   |
| Revenues:                                                                                           |   |                                  |   |                                 |   |   |   |   |   |
| Rental income                                                                                       |   | $                                     | 16,141 |                                 | $      | 16,349 |   | $ | 49,308 |   | $ | 50,662 |   |
| Interest income                                                                                     |   | 1,272                                 |   | 1,262                                |   | 3,093 |   | 3,940 |   |
| Amortization of unearned income on direct financing leases                                          |   | 75                                    |   | 70                                   |   | 209 |   | 246 |   |
| Total revenues                                                                                      |   | 17,488                                |   | 17,681                               |   | 52,610 |   | 54,848 |   |
| Expenses:                                                                                           |   |                                  |   |                                 |   |   |   |   |   |
| Property                                                                                            |   | 344                                   |   | 486                                  |   | 1,421 |   | 1,203 |   |
| Depreciation and amortization                                                                       |   | 5,409                                 |   | 5,348                                |   | 16,567 |   | 16,637 |   |
| General and administrative                                                                          |   | 1,632                                 |   | 1,798                                |   | 5,562 |   | 6,805 |   |
| Provisions for doubtful accounts                                                                    |   | (229                                  | )      | 1,964                                |   | (234 | ) | 2,914 |   |
| Interest expense                                                                                    |   | 4,450                                 |   | 5,885                                |   | 13,015 |   | 19,426 |   |
| Amortization of loan origination fees                                                               |   | 580                                   |   | 637                                  |   | 1,426 |   | 4,739 |   |
| Derivative settlement payments                                                                      |   | 710                                   |   | 518                                  |   | 2,652 |   | 1,053 |   |
| Impairment of long-lived assets                                                                     |   | 133                                   |   | 944                                  |   | 983 |   | 16,993 |   |
| Fair value adjustment for interest rate swaps                                                       |   | (146                                  | )      | 248                                  |   | (402 | ) | 2,607 |   |
| Total expenses                                                                                      |   | 12,883                                |   | 17,828                               |   | 40,990 |   | 72,377 |   |
| Income (loss) from real estate operations                                                           |   | 4,605                                 |   | (147                                 | )      | 11,620 |   | (17,529 | ) |
|                                                                                                |   |                                  |   |                                 |   |   |   |   |   |
| **Retail  Operations**                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Operating revenue                                                                                   |   | 10,839                                |   | 5,490                                |   | 28,056 |   | 7,476 |   |
| Operating general and administrative                                                                |   | (1,479                                | )      | (469                                 | )      | (4,105 | ) | (599 | ) |
| Depreciation and amortization                                                                       |   | (10                                   | )      | —                               |   | (27 | ) | — |   |
| Cost of sales                                                                                       |   | (9,030                                | )      | (4,870                               | )      | (23,424 | ) | (6,535 | ) |
| Income from retail operations                                                                       |   | 320                                   |   | 151                                  |   | 500 |   | 342 |   |
|                                                                                                |   |                                  |   |                                 |   |   |   |   |   |
| Gain on sale of property                                                                            |   | —                                |   | 285                                  |   | — |   | 1,893 |   |
| Minority interests                                                                                  |   | (1,163                                | )      | (1,150                               | )      | (3,512 | ) | (3,324 | ) |
| Net income (loss) from continuing operations before discontinued  operations and extraordinary item |   | 3,762                                 |   | (861                                 | )      | 8,608 |   | (18,618 | ) |
| Income from discontinued operations                                                                 |   | 995                                   |   | 49                                   |   | 1,367 |   | 14 |   |
| Loss on early extinguishment of debt                                                                |   | —                                |   | —                               |   | — |   | (340 | ) |
| Net income (loss)                                                                                   |   | 4,757                                 |   | (812                                 | )      | 9,975 |   | (18,944 | ) |
| Dividends on preferred stock                                                                        |   | (1,776                                | )      | (1,776                               | )      | (5,327 | ) | (5,327 | ) |
| Net income (loss) allocable to common stockholders                                                  |   | $                                     | 2,981  |                                 | $      | (2,588 | ) | $ | 4,648 |   | $ | (24,271 | ) |
|                                                                                                |   |                                  |   |                                 |   |   |   |   |   |
| Basic and diluted net income (loss) per share:                                                      |   |                                  |   |                                 |   |   |   |   |   |
| Income (loss) from continuing operations                                                            |   | $                                     | 0.10   |                                 | $      | (0.14 | ) | $ | 0.17 |   | $ | (1.34 | ) |
| Income from discontinued operations                                                                 |   | 0.05                                  |   | —                               |   | 0.07 |   | — |   |
| Extraordinary loss                                                                                  |   | —                                |   | —                               |   | — |   | (0.02 | ) |
| Net income (loss) per share                                                                         |   | $                                     | 0.15   |                                 | $      | (0.14 | ) | $ | 0.24 |   | $ | (1.36 | ) |
|                                                                                                |   |                                  |   |                                 |   |   |   |   |   |
| Weighted average shares outstanding                                                                 |   |                                  |   |                                 |   |   |   |   |   |
| Basic                                                                                               |   | 19,737                                |   | 17,964                               |   | 19,606 |   | 17,796 |   |
| Diluted                                                                                             |   | 19,824                                |   | 17,964                               |   | 19,741 |   | 17,796 |   |

 

*See Notes toCondensed Consolidated Financial Statements.*

 

5

----

 

 

**U.S. Restaurant Properties, Inc.Condensed Consolidated Statementsof Comprehensive Operations(In thousands)(Unaudited)**

 
|                                                                |   | **Three months ended  September 30,** |       | **Nine months ended  September 30,** |       |
|---------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                                                |   | **2002**                              |       | **2001**                             |       | **2002** |   | **2001** |   |
|                                                                |   |                                  | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| Net income (loss)                                                   |   | $                                     | 4,757      |                                 | $          | (812 | ) | $ | 9,975 |   | $ | (18,944 | ) |
|                                                                |   |                                  |       |                                 |       |   |   |   |   |
| Cumulative effect of change in accounting for derivative instrument |   | —                                |       | —                               |       | — |   | (1,474 | ) |
| Reclassification adjustment - hedge settlement                      |   | —                                |       | —                               |       | — |   | 1,474 |   |
| Other comprehensive income (loss) -                                 |   |                                  |       |                                 |       |   |   |   |   |
| Change in unrealized loss on derivative  valuation                  |   | (1,794                                | )          | (3,205                               | )          | (1,672 | ) | (3,205 | ) |
| Change in unrealized gain (loss) on bond  investments               |   | 2,506                                 |       | (256                                 | )          | 2,522 |   | (211 | ) |
| Comprehensive income (loss)                                         |   | $                                     | 5,469      |                                 | $          | (4,273 | ) | $ | 10,825 |   | $ | (22,360 | ) |

 

*See Notes to Condensed ConsolidatedFinancial Statements.*

 

6

----

 

**U.S. Restaurant Properties, Inc.**

**Condensed Consolidated Statement ofStockholders’ Equity**

**For the Nine Months Ended September 30,2002**

**(In thousands)**

**(Unaudited)**

 
|                                                      |   |                |   |             |   |        |   |              |   |           |   | **Accumulated**   |    |             |   |              |   |      |   |
|-----------------------------------------------------------|--------|---------------------|--------|------------------|--------|-------------|--------|-------------------|--------|----------------|--------|-------------------|---------|------------------|--------|-------------------|--------|-----------|--------|
|                                                      |   |                |   |             |   |        |   |              |   | **Additional** |   | **Other**         |    | **Loans**        |   | **Distributions** |   |      |   |
|                                                      |   | **Preferred Stock** |   | **Common Stock** |   | **Paid-in** |   | **Comprehensive** |   | **To**         |   | **In Excess of**  |    |             |   |
|                                                      |   | **Shares**          |   | **Par Value**    |   | **Shares**  |   | **Par Value**     |   | **Capital**    |   | **Income (Loss)** |    | **Stockholders** |   | **Net Income**    |   | **Total** |   |
| Balance at January 1, 2002                                |   | 3,680               |   | $                | 4      |        | 19,459 |              | $      | 19             |   | $                 | 324,448 |             | $      | (5,071            | )      | $         | (850   | ) | $ | (161,950 | ) | $ | 156,600 |   |
| Net income                                                |   |                |   |             |   |        |   |              |   |           |   |              |    |             |   | 9,975             |   | 9,975     |   |
| Purchase of common stock by officers                      |   |                |   |             |   | 10          |   |              |   | 120            |   |              |    | (24              | )      |              |   | 96        |   |
| Repayment by Officers on loans for common stock           |   |                |   |             |   |        |   |              |   |           |   |              |    | 500              |   |              |   | 500       |   |
| Reclassification of Officer Notes                         |   |                |   |             |   |        |   |              |   |           |   |              |    | (475             | )      |              |   | (475      | )      |
| Proceeds from exercised stock options                     |   |                |   |             |   | 132         |   | 1                 |   | 1,419          |   |              |    |             |   |              |   | 1,420     |   |
| Stock-based compensation to employees                     |   |                |   |             |   |        |   |              |   | 86             |   |              |    |             |   |              |   | 86        |   |
| Common stock issued to redeem guaranteed price  OP  units |   |                |   |             |   | 221         |   |              |   | 1,411          |   |              |    |             |   |              |   | 1,411     |   |
| Other comprehensive income (loss) -                       |   |                |   |             |   |        |   |              |   |           |   |              |    |             |   |              |   |      |   |
| Change in unrealized loss on derivatives                  |   |                |   |             |   |        |   |              |   |           |   | (1,672            | )       |             |   |              |   | (1,672    | )      |
| Change in unrealized gain on investments                  |   |                |   |             |   |        |   |              |   |           |   | 2,522             |    |             |   |              |   | 2,522     |   |
| Distributions declared on common stock                    |   |                |   |             |   |        |   |              |   |           |   |              |    |             |   | (17,274           | )      | (17,274   | )      |
| Distributions declared on preferred stock                 |   |                |   |             |   |        |   |              |   |           |   |              |    |             |   | (3,551            | )      | (3,551    | )      |
| Balance at September 30, 2002                             |   | 3,680               |   | $                | 4      |        | 19,822 |              | $      | 20             |   | $                 | 327,484 |             | $      | (4,221            | )      | $         | (849   | ) | $ | (172,800 | ) | $ | 149,638 |   |
|                                                           |        |                     |        |                  |        |             |        |                   |        |                |        |                   |         |                  |        |                   |        |           |        |  |  |  |  |  |  |  |  |

 

 

*See Notes to Condensed ConsolidatedFinancial Statements.*

 

7

----

 

**U.S. Restaurant Properties, Inc.Condensed Consolidated Statementsof Cash Flows(In thousands)(Unaudited)**

 
|                                                                                     |   | **Nine Months Ended  September 30,** |       |
|------------------------------------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                                                     |   | **2002**                             |       | **2001** |   |
|                                                                                     |   |                                 | ** ** |   | ** ** |
| **Cash flows  from operating activities:**                                               |   |                                 |       |   |   |
|                                                                                     |   |                                 |       |   |   |
| Net income (loss)                                                                        |   | $                                    | 9,975      |   | $ | (18,944 | ) |
|                                                                                     |   |                                 |       |   |   |
| Adjustments to reconcile net income (loss) to net cash flows from  operating activities: |   |                                 |       |   |   |
| Depreciation and amortization                                                            |   | 16,796                               |       | 17,361 |   |
| Extraordinary loss on extinguishment of debt                                             |   | —                               |       | 340 |   |
| Amortization of deferred financing costs and discounts                                   |   | 1,452                                |       | 4,815 |   |
| Impairment of long-lived assets                                                          |   | 1,851                                |       | 17,091 |   |
| Provision for doubtful accounts                                                          |   | (213                                 | )          | 2,914 |   |
| Stock-based compensation                                                                 |   | 86                                   |       | — |   |
| Accretion of interest income                                                             |   | (444                                 | )          | (454 | ) |
| Fair value adjustment for interest rate swap agreements                                  |   | (402                                 | )          | 2,607 |   |
| Minority interests                                                                       |   | 3,512                                |       | 3,324 |   |
| Gain on sale of property                                                                 |   | (2,253                               | )          | (1,893 | ) |
| Gain on sale of investments                                                              |   | (176                                 | )          | — |   |
| Decrease (increase) in rent and other receivables, net                                   |   | (267                                 | )          | 886 |   |
| Increase in straight-line rent, net                                                      |   | (1,451                               | )          | (1,806 | ) |
| Decrease (increase) in prepaid expenses                                                  |   | (632                                 | )          | 1,894 |   |
| Increase in inventories                                                                  |   | (746                                 | )          | (529 | ) |
| Reduction in net investment in direct financing leases                                   |   | 406                                  |       | 600 |   |
| Decrease in accounts payable and accrued liabilities                                     |   | (2,360                               | )          | (1,323 | ) |
| Increase (decrease) in unearned contingent rent                                          |   | (128                                 | )          | 106 |   |
| Cash provided by operating activities                                                    |   | 25,006                               |       | 26,989 |   |
|                                                                                     |   |                                 |       |   |   |
| **Cash flows  from investing activities:**                                               |   |                                 |       |   |   |
|                                                                                     |   |                                 |       |   |   |
| Proceeds from sale of property and equipment                                             |   | 16,300                               |       | 17,121 |   |
| Purchase of property                                                                     |   | (10,774                              | )          | (2,547 | ) |
| Purchase of machinery and equipment                                                      |   | (259                                 | )          | (46 | ) |
| Purchase of investments                                                                  |   | (3,014                               | )          | (2,490 | ) |
| Proceeds from sale of investments                                                        |   | 4,838                                |       | — |   |
| Distributions received on investments                                                    |   | 565                                  |       | 45 |   |
| Decrease (increase) in restricted cash                                                   |   | 5,395                                |       | (3,347 | ) |
| Increase in mortgage notes receivable                                                    |   | (26,583                              | )          | (40 | ) |
| Reduction of mortgage loans receivable principal                                         |   | 4,120                                |       | 3,593 |   |
| Increase in notes receivable                                                             |   | (1,275                               | )          | (1,429 | ) |
| Reduction of notes receivable principal                                                  |   | 959                                  |       | 5,522 |   |
| Cash provided by (used in) investing activities                                          |   | (9,728                               | )          | 16,382 |   |
|                                                                                     |   |                                 |       |   |   |
| **Cash flows  from financing activities:**                                               |   |                                 |       |   |   |
|                                                                                     |   |                                 |       |   |   |
| Proceeds from line of credit                                                             |   | $                                    | 17,700     |   | $ | — |   |
| Payments on line of credit                                                               |   | (2,500                               | )          | (119,036 | ) |
| Distributions to minority interest                                                       |   | (3,593                               | )          | (3,639 | ) |
| Cash distributions to stockholders                                                       |   | (19,420                              | )          | (17,574 | ) |
| Payment of preferred stock dividends                                                     |   | (5,327                               | )          | (5,327 | ) |
| Proceeds from sale of stock                                                              |   | 1,516                                |       | 6,215 |   |
| Payments on notes/mortgage payable                                                       |   | (7,540                               | )          | (231,904 | ) |
| Proceeds on notes/mortgage payable                                                       |   | —                               |       | 360,700 |   |
| Financing costs and other intangibles                                                    |   | (870                                 | )          | (11,712 | ) |
| Purchase and retirement of common stock                                                  |   | —                               |       | (323 | ) |
| Cash flows used in financing activities                                                  |   | (20,034                              | )          | (22,600 | ) |
|                                                                                     |   |                                 |       |   |   |
| Increase (decrease) in cash and cash equivalents                                         |   | (4,756                               | )          | 20,771 |   |
| Cash and cash equivalents at beginning of period                                         |   | 10,346                               |       | 5,509 |   |
| Cash and cash equivalents at end of period                                               |   | $                                    | 5,590      |   | $ | 26,280 |   |
|                                                                                     |   |                                 |       |   |   |
| **Supplemental  disclosure:**                                                            |   |                                 |       |   |   |
| Interest paid during the period                                                          |   | $                                    | 12,097     |   | $ | 19,248 |   |
|                                                                                     |   |                                 |       |   |   |
| **Non-cash  investing and financing activities:**                                        |   |                                 |       |   |   |
| Interest receivable transferred to mortgage receivable                                   |   | $                                    | 38         |   | $ | — |   |
| Net transfer of property from direct financing leases to property and  equipment         |   | 171                                  |       | 657 |   |
| Unrealized gain (loss) on investments classified as available for sale                   |   | 2,522                                |       | (211 | ) |
| Notes received on sale of property                                                       |   | 294                                  |       | 1,033 |   |
| Notes written off on repossessed property                                                |   | —                               |       | 563 |   |
| Adjustment for interest rate swap recorded to other comprehensive  income                |   | 1,672                                |       | 3,205 |   |
| Net transfers from construction in progress to property                                  |   | 42                                   |       | 7,855 |   |
| Mortgage loans receivable used for property acquisitions                                 |   | 11,547                               |       | — |   |
| Security deposit and note receivable transferred                                         |   | —                               |       | 700 |   |
| Account receivable conversion to note                                                    |   | —                               |       | 124 |   |
| Operating Partnership units exchanged for common stock                                   |   | 1,411                                |       | — |   |
| Increase (decrease) in common and preferred stock dividends accrued                      |   | (3,932                               | )          | 72 |   |
| Common stock grant                                                                       |   | —                               |       | 98 |   |
| Loan to stockholder for common stock                                                     |   | 24                                   |       | 550 |   |
| Reclassification of notes receivable to loan to stockholder                              |   | 475                                  |       | — |   |

 

*See Notes to Condensed ConsolidatedFinancial Statements.*

 

8

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**U.S. Restaurant Properties, Inc.Notes to Condensed ConsolidatedFinancial Statements(Unaudited)**

 

**1.             Interim Unaudited FinancialInformation**

 

U.S. Restaurant Properties, Inc. (the “Company”) is a self-administeredand self-managed real estate investment trust (“REIT”), as defined under theInternal Revenue Code of 1986, as amended. As noted in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2001, the Company became the successor entity to U.S. RestaurantProperties Master L.P. (collectively with its subsidiaries, “USRP”) in October1997.  The business and operations ofthe Company are conducted primarily through U.S. Restaurant PropertiesOperating L.P. (“OP”).  At September 30,2002, the Company, directly or indirectly, owned 100% of and controlled theOP.  As of September 30, 2002, theCompany owned 812 properties in 48 states.

 

The accompanying condensed consolidated financial statements should beread in conjunction with the consolidated financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2001, which was filed with the Securities and Exchange Commission(“SEC”).  The results of operations forthe three and nine months ended September 30, 2002 are not necessarilyindicative of the results to be expected for the year ending December 31,2002.  Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of America,have been condensed or omitted in this report on Form 10-Q pursuant to theRules and Regulations of the SEC.  Inthe opinion of management, the disclosures contained in this report areadequate to make the information presented not misleading.

 

Accounting measurements at interim dates inherently involve greaterreliance on estimates than at year end, and the results of operations for theinterim periods shown in this report are not necessarily indicative of resultsto be expected for the fiscal year.  Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements include all adjustments (of a normal recurring nature)necessary to present fairly the consolidated financial position of the Companyas of September 30, 2002, and the consolidated results of its operations,comprehensive operations, stockholders’ equity and cash flows for the three andnine months ended September 30, 2002 and 2001.

 

The Company derives itsreal estate revenues primarily from the leasing of its properties to operators(primarily restaurants) on a “triple net” basis.  Triple net leases typically require the tenants to be responsiblefor property operating costs, including property taxes, insurance, maintenanceand, in most cases, the ground rents where applicable.  Accordingly, the accompanying condensedconsolidated financial statements do not include costs for property taxes andinsurance which are the responsibility of the tenants.  Additionally, those amounts associated withground rent expense where the tenant is responsible for the ground rents havebeen recorded as a reduction to rent revenues with no impact on net income.  For the three and nine months endedSeptember 30, 2002 and 2001, the Company has recorded rent expense of $936,000and $2,796,000 in 2002, respectively, and $873,000 and $2,872,000 in 2001,respectively, as reductions to rent revenues.

 

The Company derives its retail revenues from the sale of gasoline andconvenience store merchandise, and food sales at restaurants operated by theCompany.  Revenue is recognized as it isreceived.

 

The preparation of consolidated financial statements, in conformitywith accounting principles generally accepted in the United States of America,requires management to make estimates and assumptions that affect reportedamounts of certain assets, liabilities, revenues and expenses as of and for thereporting periods.  Actual results maydiffer from such estimates.

 

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

 

Rent revenues and expenses under operating leases are recognized on astraight-line basis, unless significant collection problems occur with thelessee, at which time rents are recorded on a cash basis.  Contingent rent is recognized as revenueafter the related lease sales targets are achieved.

 

Investments in equity securities with readily determinable fair valuesand debt securities are classified as either available-for-sale or trading,based on the Company’s intent with respect to those securities.  Such investments are classified as tradingsecurities if those securities are held principally for the purpose of sellingthem in the near term.  All other suchinvestments are classified as available-for-sale.  These investments are recorded at fair value on the balancesheet.  Changes in fair value during theperiod are recorded in earnings for trading securities and in other

 

9

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comprehensive operations for available-for-sale securities.  Investments in equity securities that do nothave readily determinable fair values are recorded using the cost method sincethe Company does not have the ability to exercise significant influence overthe investees.

 

Statement of FinancialAccounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instrumentsand Hedging Activities,” as amended, was effective for the Company January 1,2001.  This standard requires that allderivative financial instruments be recognized as either assets or liabilitieson the balance sheet at their fair values and that accounting for the changesin the fair values is dependent upon the intended use of the derivatives andtheir resulting designations.  If thederivative is designated as a fair-value hedge, the changes in the fair valueof the derivative and the hedged item will be recognized in earnings.  If the derivative is designated as a cashflow hedge, changes in fair value of the derivative will be recorded in othercomprehensive income and will be recorded in the statement of operations whenthe hedged item affects earnings.  SFASNo. 133 defines new requirements for designation and documentation of hedgingrelationships as well as ongoing effectiveness assessments in order to usehedge accounting.  For a derivative thatdoes not qualify as a hedge, changes in fair value will be recognized inearnings. The adoption of SFAS No. 133 as of January 1, 2001, resulted in therecognition of a liability of $1,474,000, which was amortized into operationsduring the first six months of 2001.

 

SFAS No. 143, “Accountingfor Asset Retirement Obligations” was issued in June 2001, and will be adoptedby the Company on January 1, 2003.  ThisStatement addresses financial accounting and reporting for obligationsassociated with the retirement of tangible long-lived assets and the associatedasset retirement costs.  The Company hasnot yet determined the effect adopting SFAS No. 143 will have on its financialstatements.

 

SFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets” was issued in August 2001, and was adopted by the Company on January 1,2002.  This Statement supersedes SFASNo. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-LivedAssets to Be Disposed Of”, and the accounting and reporting provisions of APBOpinion No. 30, “Reporting the Results of Operations—Reporting the Effects ofDisposal of a Segment of a Business, and Extraordinary, Unusual and InfrequentlyOccurring Events and Transactions”, for the disposal of a *segment of a business* (aspreviously defined in that Opinion). SFAS No. 144 retains the requirements of SFAS No. 121 to (a) recognizean impairment loss only if the carrying amount of a long-lived asset is notrecoverable from its undiscounted cash flows and (b) measure an impairment lossas the difference between the carrying amount and fair value of the asset.  This Statement requires that a long-livedasset to be abandoned, exchanged for a similar productive asset, or distributedto owners in a spinoff be considered held and used until it is disposedof.  The accounting model for long-livedassets to be disposed of by sale is used for all long-lived assets, whetherpreviously held and used or newly acquired. That accounting model retains the requirement of SFAS No. 121 to measurea long-lived asset classified as held for sale at the lower of its carryingamount or fair value less cost to sell and to cease depreciation.  This Statement requires that the current andhistorical results of operations of disposed properties and assets classifiedas held for sale be classified as discontinued operations.  This results in the reclassification ofhistorical operations for property dispositions or assets classified as heldfor sale that occur subsequent to January 1, 2002.

 

SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections” was issued inApril 2002 and is effective for fiscal years beginning after May 15, 2002.  Portions of the Statement that areapplicable to the Company include the rescission of FASB Statement No. 4,“Reporting Gains and Losses from Extinguishment of Debt”, and an amendment toFASB Statement No. 13, “Accounting for Leases”, to eliminate an inconsistencybetween the required accounting for sale-leaseback transactions and therequired accounting for certain lease modifications that have economic effectsthat are similar to sale-leaseback transactions. When the Company adopts FASBStatement No. 145, any gain or loss on extinguishment of debt will be includedin income from continuing operations, rather than as an extraordinaryitem.  In addition, gains and lossesfrom extinguishment of debt that occurred in prior periods will be reclassifiedfrom extraordinary items into continuing operations.

 

SFAS No. 146, “Accounting for Costs Associated with Exit or DisposalActivities” was issued in June 2002 and will be effective for exit or disposalactivities subsequent to December 31, 2002. The Company has not yet determined the effect SFAS No. 146 will have onits financial statements.

 

The Company had 19,821,689 and 19,459,207 shares of common stockoutstanding as of September 30, 2002 and December 31, 2001, respectively.

 

10

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**2.             NetIncome (Loss) per Share of Common Stock**

 
|                                                                                                |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|-----------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
| **(In thousands, except per share amounts)**                                                        |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
|                                                                                                |   |                                  |   |                                 |   |   |   |   |   |
| Net income (loss) from continuing operations before discontinued  operations and extraordinary item |   | $                                     | 3,762  |                                 | $      | (861 | ) | $ | 8,608 |   | $ | (18,618 | ) |
| Dividends on preferred stock                                                                        |   | (1,776                                | )      | (1,776                               | )      | (5,327 | ) | (5,327 | ) |
| Net income (loss) from continuing operations allocable to common  stockholders                      |   | 1,986                                 |   | (2,637                               | )      | 3,281 |   | (23,945 | ) |
| Income from discontinued operations                                                                 |   | 995                                   |   | 49                                   |   | 1,367 |   | 14 |   |
| Loss on early extinguishment of debt                                                                |   | —                                |   | —                               |   | — |   | (340 | ) |
|                                                                                                |   |                                  |   |                                 |   |   |   |   |   |
| Net income (loss) allocable to common stockholders                                                  |   | $                                     | 2,981  |                                 | $      | (2,588 | ) | $ | 4,648 |   | $ | (24,271 | ) |
|                                                                                                |   |                                  |   |                                 |   |   |   |   |   |
| Basic and diluted net income (loss) per share:                                                      |   |                                  |   |                                 |   |   |   |   |   |
| Income (loss) from continuing operations                                                            |   | $                                     | 0.10   |                                 | $      | (0.14 | ) | $ | 0.17 |   | $ | (1.34 | ) |
| Income from discontinued operations                                                                 |   | 0.05                                  |   | —                               |   | 0.07 |   | — |   |
| Extraordinary loss                                                                                  |   | —                                |   | —                               |   | — |   | (0.02 | ) |
| Net income (loss) per share                                                                         |   | $                                     | 0.15   |                                 | $      | (0.14 | ) | $ | 0.24 |   | $ | (1.36 | ) |
|                                                                                                |   |                                  |   |                                 |   |   |   |   |   |
| Weighted average shares outstanding(a):                                                             |   |                                  |   |                                 |   |   |   |   |   |
| Basic                                                                                               |   | 19,737                                |   | 17,964                               |   | 19,606 |   | 17,796 |   |
| Dilutive effect of stock options                                                                    |   | 40                                    |   | —                               |   | 32 |   | — |   |
| Dilutive effect of guaranteed stock                                                                 |   | 47                                    |   | —                               |   | 103 |   | — |   |
| Diluted                                                                                             |   | 19,824                                |   | 17,964                               |   | 19,741 |   | 17,796 |   |
|                                                                                                |   |                                  |   |                                 |   |   |   |   |   |
| Antidilutive securities:                                                                            |   |                                  |   |                                 |   |   |   |   |   |
| Stock options                                                                                       |   | 46                                    |   | 46                                   |   | 46 |   | 70 |   |
| OP units                                                                                            |   | —                                |   | 134                                  |   | — |   | 134 |   |
| Guaranteed stock                                                                                    |   | —                                |   | 153                                  |   | — |   | 120 |   |
| Convertible preferred stock                                                                         |   | 3,680                                 |   | 3,680                                |   | 3,680 |   | 3,680 |   |

 

----

 

(a)                                  Basicincome (loss) per share is computed based upon the weighted average number ofshares of common stock outstanding. Diluted income (loss) per share typically reflects the dilutive effectof stock options, OP units, OP units and shares on which the price isguaranteed (“Guaranteed Stock”) and convertible preferred stock.

 

**3.****                                      Property**

 

On January 1, 2002, the Company adopted SFAS No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets”.  This statement requires current and historical results ofoperations for disposed properties and assets classified as held for sale thatoccur subsequent to January 1, 2002 to be reclassified separately asdiscontinued operations.   Results ofdiscontinued operations for the three and nine months ended September 30, 2002and 2001 relate to the sale of 10 and 27 properties, respectively.  The operating results of these properties aswell as the gain on their disposal are included under the Statement ofOperations caption of “Income from discontinued operations” as follows:

 

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|                                                                |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|---------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
| Operating Income before Depreciation, Amortization & Impairment |   | $                                     | 38     |                                 | $      | 297 |   | $ | 184 |   | $ | 836 |   |
| Depreciation and amortization                                       |   | (22                                   | )      | (150                                 | )      | (202 | ) | (724 | ) |
| Impairment of long-lived assets                                     |   | —                                |   | (98                                  | )      | (868 | ) | (98 | ) |
|                                                                |   | 16                                    |   | 49                                   |   | (886 | ) | 14 |   |
| Gain on sale of property                                            |   | 979                                   |   | —                               |   | 2,253 |   | — |   |
| Income from discontinued operations                                 |   | $                                     | 995    |                                 | $      | 49 |   | $ | 1,367 |   | $ | 14 |   |

 

During the nine months ended September 30, 2002, the Company completedthe sale and disposal of properties for net cash proceeds of $16,300,000, netof closing costs, and $294,000 of notes. During the nine months ended September 30, 2002, the Company purchased$11,033,000 of land, buildings and equipment, which was comprised of $259,000of equipment, $10,327,000 of land and buildings, and $447,000 of remodelingcosts.  The Company reclassified a netamount of $171,000 between property and net investment in direct financingleases during the nine months ended September 30, 2002.

 

The Company’s management routinely reviews its investments for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Indicators of possible impairment include default of lease terms,non-payment or late payment of rents, decreases in tenant’s sales levels andgeneral declines in the success of the operating brand names of itstenants.  When these indicators arepresent, the Company reviews the circumstances of the indicator and, if animpairment is likely, secures an estimate of fair market value of the propertyaffected.  During the nine months endedSeptember 30, 2002, as a result of the Company’s regular analysis of itsinvestments to determine if circumstances indicate that the carrying amount ofan asset may not be recoverable, impairment charges of $1,851,000 were recordedfrom the revaluing of seventeen assets to their estimated fair value.  Included in the total amount of impairmentcharges is $868,000 which is reflected in income from discontinued operations.

 

The assets classified as held for sale as of December 31, 2001 of$22,071,000 were reclassified to held and used during the second quarter of2002 because the assets no longer met the criteria to continue to be classifiedas held for sale at that date.  Thechange in circumstances resulted from the termination of a sales agreement forthe assets by the potential purchaser during the second quarter of 2002,followed by the Company’s decision to operate the assets for the foreseeablefuture.  As required by FASB StatementNo. 144, at the time the assets were reclassified, the Company estimated thefair value of each asset individually, and recorded each asset at the lower ofits (a) carrying amount before the asset was classified as held for sale,adjusted for any depreciation expense that would have been recognized had theasset been continuously classified as held and used, or (b) fairvalue.  In the second quarter of 2002,the Company recorded  $610,000 ofimpairment charges related to these assets as well as depreciation expense of$690,000 for the period April 1, 2001 through June 30, 2002, the period of timethat these assets were classified as held for sale.

 

On October 30, 2002, the Company completed the purchase of anothertranche of its planned acquisitions of Shoney’s and Captain D’s properties insale/leaseback transactions.  Thistranche consisted of the purchase of fifteen Captain D’s properties for a totalpurchase price of $9,208,000.

 

**4.             Investments**

 

The fair market value of investments classified as available for saleat September 30, 2002 was $3,887,000. As a result of the recent availability of verification of the marketvalue of these investments, approximately $2,522,000 of unrealized gains inAccumulated other comprehensive loss were realized in the third quarter of2002, increasing the value of these investments.  In addition to these investments, the Company has otherinvestments carried at a cost basis of approximately $2,062,000.  During the nine months ended September 30,2002, the Company liquidated its trading securities.

 

**5.             Lines of Credit, Bridge Loan andNotes Payable**

 

In May 2002, the Company entered into a Credit Agreement with Bank ofAmerica, through its subsidiary USRP Funding 2002-A, L.P., for a securedrevolving credit facility of $35,000,000, which is subject to a DerivativeExposure Reserve and a Borrowing Base, as defined.  Borrowings under this facility are being used primarily to

 

12

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acquire certain Shoney’s and Captain D’s properties in sale/leaseback transactions.  This facility is secured by the 175properties owned by USRP Funding 2002-A, L.P. with a borrowing base value inexcess of the $35,000,000 limit and a net book value of $96,329,000 as of  September 30, 2002.  The Credit Agreement has a term of up to twoyears and allows for Base Rate Loans, Eurodollar Loans or a combination of thetwo.  Base Rate Loans bear interest at3.0% plus the higher of the Federal Funds Rate plus 0.5% or the Prime Rate.  Eurodollar Loans bear interest at 3.0% plusLIBOR.  The Credit Agreement alsoprovides that up to $10,000,000 of the facility may be used for letters ofcredit.  There is a 3% fee per annum onoutstanding letters of credit as well as a 3% Derivative Exposure Usage Feeunder this facility.  As of September30, 2002, there were $15,200,000 of borrowings under this facility, and theCompany had letters of credit outstanding and drawn on Bank of America in theamount of $3,323,000.

 

On July 1, 2002, a limited and temporary waiver and amendment wasexecuted under this $35,000,000 Credit Agreement with Bank of America whichallowed the Company to borrow funds under this facility to partially financethe purchase of mortgage notes issued by Captain D’s with a face value of$20,000,000 on July 10, 2002.  The amountof this investment, without the waiver, would have violated the limitations oninvestments under this facility.  Theinitial waiver period was extended through October 30, 2002.  The Captain D’s mortgage notes bear interestat 12% per annum. As of September 30, 2002, the Company held a balance ofapproximately $8,500,000 of the original $20,000,000 of mortgage notespurchased on July 10, 2002.  As ofOctober 30, 2002, the Company had fully utilized these notes as considerationto substantially finance the acquisition of certain Captain D’s properties.

 

The First Amendment to the Credit Agreement with Bank of America wasentered into in September 2002.  Thisamendment, which clarified the parties original intent, revised the tangiblenet worth financial covenant.  Thetangible net worth requirement was reduced from a minimum of $270,000,000 to$230,000,000, plus 85% of the net cash proceeds of any equity issuance receivedby the Company after December 31, 2001, calculated on a cumulative basis.

 

In August 2001, theCompany completed a $180,000,000 offering of Triple Net Lease MortgageCertificates (the “Certificates”) through its subsidiary USRP Funding 2001-A,L.P.  Proceeds from the offering wereprimarily used to repay approximately $156,997,000 outstanding under theCompany’s secured bridge facility with Bank of America in August 2001(described below) and the balance of the net proceeds was used for generalcorporate purposes including the prepayment of the $27,500,000 Senior B SecuredGuaranteed Notes (described below) in October 2001.  The Certificates amortize over 15 years, bear interest at the 30— day LIBOR plus 48 basis points and other associated fees of approximately52.6 basis points, and have an assumed final distribution or maturity date ofAugust 28, 2006.  As of September 30,2002, there was $170,295,000 outstanding on the Certificates.  The Certificates are secured by 273properties with a net book value of $197,746,000 at September 30, 2002.

 

In January 2001, theCompany entered into an indenture with Bank of America for a secured bridgefacility of $175,000,000.  Proceeds fromthis bridge facility were used to pay-off the outstanding balance of the OP’s$175,000,000 revolving credit line (described below) and a $50,000,000unsecured term loan from Credit Lyonnais. The initial term of the bridge loan matured in July 2001, and theCompany entered into options to extend the facility through August 31,2001.  In August 2001, the Company paidthe outstanding balance of this bridge facility with the proceeds from theoffering of the Certificates.

 

In January 2001, the Company entered into a Credit Agreement with Bankof America for an unsecured revolving credit facility in the amount of$7,000,000.  This facility was replacedin the second quarter of 2002 by the $35,000,000 Credit Agreement with Bank ofAmerica (described above).

 

In January 1998, the OP entered into a credit agreement with asyndicate of banks for an unsecured revolving credit line of $175,000,000.  On January 9, 2001, the Company paid theoutstanding balance under this facility as scheduled with proceeds from abridge loan advanced by Bank of America (described above).

 

On February 26, 1997, the Company issued $40,000,000 in privately placeddebt which consisted of $12,500,000 Series A Senior Secured Guaranteed Noteswith a 8.06% interest rate, due January 31, 2000, and $27,500,000 Series BSenior Secured Guaranteed Notes with a 8.30% interest rate, due January 31,2002. In January 2000, the Company paid the $12,500,000 Series A Senior SecuredGuaranteed Notes in full as scheduled. Effective January 9, 2001, the Company secured the Series B Senior Noteswith properties having an aggregate net book value of approximately$38,575,000.  Under the terms of theWaiver and Second Amendment to the Note Purchase Agreement, the Company wasrequired to secure the noteholders on the same basis and with similarcollateral as that provided to Bank of America.  In October

 

13

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2001, the Company prepaid the $27,500,000 Series B Senior SecuredGuaranteed Notes in full.  In connectionwith this prepayment, the Company paid $388,000 of make-whole fees and expensed$216,000 worth of unamortized loan origination fees associated with thisfacility.

 

On May 12, 1998, the Company issued $111,000,000 of seven year fixedrate senior unsecured notes payable in a private placement.  The notes bear interest at the rate of 7.15%per annum and are due May 1, 2005.  Thenet proceeds of the notes were used to repay a portion of a revolving creditagreement and for general corporate purposes. In conjunction with the notes payable agreement, the underwriters andthe Company entered into a rate lock agreement for the purpose of setting theinterest rate on these notes payable. The fee paid to lock in the rate on these notes payable wasapproximately $424,000 and is being amortized over the term of the notes as anadjustment to interest expense.  As aresult of certain guarantees required by the existing Bank of America CreditAgreement, the subsidiaries of the Company executed a Subsidiary Guaranty inthe first quarter of 2001 and May 2002 for the benefit of these noteholders.

 

On November 13, 1998, the Company issued $47,500,000 in senior notespayable in a private placement.  Thenotes bear interest at the rate of 8.22% per annum and are due August 1,2003.  The net proceeds were used torepay a portion of a revolving credit agreement and for general corporatepurposes.  In conjunction with the notespayable agreement, the underwriters and the Company entered into a rate lockagreement for the purpose of setting the interest rate of these notespayable.  The fee paid to lock in therate on these notes payable was approximately $406,000 and is being amortizedover the term of the notes as an adjustment to interest expense.  As a result of certain guarantees requiredby the existing Bank of America Credit Agreement, the subsidiaries of theCompany executed a Subsidiary Guaranty in the first quarter of 2001 and May2002 for the benefit of these noteholders.

 

On August 10, 1998, the Company assumed a mortgage note payable as partof an office building acquisition.  Thenote bears interest at a rate of 8.00% per annum with payments of principal andinterest due monthly through June 2007. As of September 30, 2002, the balance was $954,000.

 

In April 1999, the OPentered into a credit agreement with Credit Lyonnais for an unsecured term loanof $50,000,000.  This credit facilitywas scheduled to mature in April 2002. On January 9, 2001, the Company paid the outstanding balance under thisfacility with proceeds from a bridge loan issued by Bank of America.  In connection with this pay-off, the Companyexpensed $340,000 worth of unamortized loan origination fees associated withthis facility in January 2001.

 

The Company is in compliance with all covenantsassociated with its debt and credit facilities as of September 30, 2002.

 

**6.             Derivative Instruments**

 

Derivative financialinstruments are utilized by the Company to manage market risks associated withchanges in interest rates.  Derivativefinancial instruments include interest rate swaps and interest ratecollars.  During the three and ninemonths ended September 30, 2002, the Company recognized $146,000 and $402,000,respectively, in income related to the ineffective portion of an interest rateswap with Credit Lyonnais, and recognized ($1,794,000) and ($1,672,000),respectively, in Accumulated other comprehensive loss representing theeffective portion of the cash flow hedges.

 

Effective February 2002,the Company entered into a fixed to floating interest rate swap with Bank ofAmerica.  This fixed to floatinginterest rate swap was on a $25,000,000 notional value on which the Companyreceived a fixed rate of 7.15% and paid a floating rate based on the threemonth LIBOR plus a spread of 2.92%.  TheCompany designated this swap as a fair value hedge on the $111,000,000 sevenyear fixed rate senior unsecured notes payable.  Accordingly, all changes in value of the derivative and hedgeditem are recorded in earnings.  Thisinterest rate swap, originally scheduled to terminate in May 2005, wasterminated by the Company in September 2002. Proceeds from the termination of $1,105,000 were collected in October2002.  The gain resulting from thetermination of approximately $860,000, recorded as debt discount in  notes payable on the balance sheet, is beingamortized over the original term of the fixed to floating interest rate swap.

 

In conjunction with theoffering of the Certificates, the Company has entered into various interestrate protection agreements, including: an interest rate swap at a fixed rate of2.42% expiring June 2004 on a notional amount of $25,000,000, an interest rateswap at a fixed rate of 1.9975% expiring February 2003 on a notional amount of$50,000,000, and an interest rate collar with a floor of 4.42% and a ceiling of6.00% expiring August 2006 on an original notional amount

 

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of $80,000,000 which hasbeen amortized down to $71,774,000 as of September 30, 2002.  These derivatives effectively lock in$25,000,000 at 3.426% (2.42% plus 1.006%) through June 2004, lock in$50,000,000 at 3.004% (1.9975% plus 1.006%) through February 2003, and lock in$71,774,000 as of September 30, 2002 at between 5.4260% (4.42% plus 1.006%) and7.006% (6.0% plus 1.006%) though August 2006.

 

Effective July 3, 2000, the Company entered into an interest rate swapwith Credit Lyonnais for a notional amount of $50,000,000 on which the Companypays a fixed rate of 7.05% and receives a variable rate based upon LIBOR.  The interest rate swap agreement terminatesin May 2003 but may be terminated earlier subject to certain restrictions.  The agreement calls for the net expense orincome to be paid or received quarterly. This swap is secured by two properties with an aggregate net book valueof $686,000.  The adoption of SFAS No.133 as of January 1, 2001 resulted in the recognition of a liability of$1,474,000 with a cumulative effect adjustment to other comprehensive income of$1,474,000.  The interest rate swap wasdesignated as a cash flow hedge of the variable rate interest payments relatedto the Company’s term loan with Credit Lyonnais.  As previously discussed, during January 2001, the Company repaidthe Credit Lyonnais term loan in full with proceeds from a bridge loan.Accordingly, the cash flow hedge relationship was terminated, and the$1,474,000 in accumulated other comprehensive operations was reclassified toearnings over a six-month period, which was the anticipated term of the bridgeloan.  From January 2001 until August2001, this interest rate swap was not designated as a hedge, and accordinglyall changes in value were recorded directly to earnings.  In connection with the completion of theCertificate offering, the Company designated this interest rate swap as a cashflow hedge of the variable interest rate payments on $50,000,000 of theCertificates.  The Company reduced thenotional amount of this interest rate swap by $20,000,000 during 2001 for acost of approximately $1,405,000. During the first quarter of 2002, the Company paid $549,000 to reducethe notional amount of this interest rate swap to $15,000,000 effective May 13,2002.

 

**7.             Related Party Transactions**

 

In March 2000, the Company advanced $400,000 to Mr. Stetson, theCompany’s Chief Executive Officer, for the purchase of the common stock of theCompany.  The promissory note providesfor an interest rate of 7.0% per annum and quarterly payments of interest onlythrough December 2005, with a final payment of principal and interest due inMarch, 2006.  Pursuant to the noteagreement, Mr. Stetson has pledged the common stock purchased with the noteproceeds as collateral for the loan. This note is classified as Loans to stockholders for common stock on thebalance sheet.  During the three monthsended September 30, 2002, this promissory note was paid down by $125,000.  At September 30, 2002, there was a balanceof $275,000 due on this note.  EffectiveSeptember 22, 2000, Mr. Stetson executed a second promissory note in the amountof $300,000 in exchange for which he received 35,037 restricted shares of theCompany’s Common Stock (calculated based on a value of $8.5625 per share).  Second, the Company advanced Mr. Stetson$75,000 under a third promissory note to be used for the sole purpose ofacquiring shares of the Company’s common stock in the open market.  Both notes bore interest at 7.0% per annumand provided for quarterly payments of interest only through July 2006, with afinal payment of principal and interest due in October 2006.  In addition, both notes were secured by therestricted Common Stock and stock purchased with the proceeds of the notes.Both of these notes were classified as Loans to stockholders for common stockon the balance sheet.  During the threemonths ended September 30, 2002, these promissory notes were paid in fullpursuant to an agreement between Mr. Stetson and the Board of Directors inDecember 2001.  As a result of paymentson these three notes, the pledges of stock were released.

 

On December 20, 2000,USRP/HCI Partnership 1, L.P., a subsidiary of the Company (“HJV”), made anadvance to the preferred interest holder in the amount of $700,000.  Under the terms of the advance agreementdated December 1, 2000, the $700,000 advance bore interest at an annualinterest rate of 9.0%.   This advancewas paid in full as scheduled in April 2001.

 

In conjunction with the merger between the Company and QSV Properties,Inc., the former managing partner of USRP, the Company’s predecessor, theCompany assumed a note receivable from Mr. Stetson in the amount of $959,000due on January 22, 2001 with an interest rate of 10.00% as well as a notepayable to Mr. Darrel L. Rolph, who was then a director of the Company, for$959,000 due on January 22, 2001 with an interest rate of 10.00%.  Both the note receivable and note payablewere paid in full on the scheduled due date.

 

In connection with their resignations from the Company’s board ofdirectors in March 2001, Messrs. Margolin, Rolph and Rolph entered intoNoncompetition and Release Agreements with the Company pursuant to which eachof them agreed not to (a) submit or cause the submission of any proposals ornominations of candidates for election as directors of the Company or (b)solicit proxies from any of the Company’s stockholders, in each case prior to

 

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December 31, 2003. Additionally, Mr. Margolin agreed not to directly or indirectly ownmanage, control, participate in, invest in or provide consulting services toany entity or business organization that engages in or owns, invests in,manages or controls any venture engaged in the ownership, management,acquisition or development of restaurant, gasoline and convenience storeproperties similar to those of the Company and its affiliates for the one-yearperiod ended March 9, 2002.  Asconsideration under such agreement and in connection with the termination ofMr. Margolin’s employment agreement with the Company, the Company paid Mr.Margolin $800,000 in severance compensation which was expensed during thequarter ended March 31, 2001. Similarly, each of the Rolphs agreed not to directly or indirectlycompete with the Company, other than through the restaurant operations of theRolphs in existence as of March 2001.

 

On August 27, 2001, as part of the employment arrangement with theCompany’s former Chief Financial Officer and Chief Operating Officer, H.G.Carrington, Jr., the Company advanced Mr. Carrington $550,000 for the purposeof acquiring shares of the Company’s common stock.  The promissory note provided for an interest rate of 5.0% perannum and quarterly payments of interest only through May 2006, with a finalpayment of principal and interest due in August 2006.  This $550,000 note, classified as a Loan to stockholders forcommon stock on the balance sheet as of September 30, 2002, was paid in full inOctober 2002.

 

Pursuant to an agreementbetween Harry O. Davis, the Company's Chief Operating Officer, and the Board ofDirectors, in January 2002, the Company advanced Mr. Davis $24,000 for thepurpose of acquiring shares of the Company’s Common Stock.  The promissory note provides for an interestrate of 6.0% per annum and quarterly payments of interest only beginning inApril 2002 through December 2006, with a final payment of principal and allunpaid interest in January 2007.  Thisnote is classified as a Loan to stockholders for common stock on the balancesheet.

 

On January 24, 2002, Lone Star U.S. Acquisitions LLC (an affiliate ofthe Lone Star Holders described in Note 8 below), the OP, LSF 4 Acquisition,LLC and Shoney’s Inc. entered into an Agreement and Plan of Merger pursuant towhich LSF 4 Acquisition, LLC would merge into Shoney’s, with Shoney’s being thesurviving entity.  Pursuant to the termsof the merger, which was consummated on April 10, 2002, all of the outstandingshares of common stock of Shoney’s were cancelled and converted into the rightto receive $0.36 in cash and each outstanding membership interest in LSF 4Acquisition, LLC (owned 90.1% by Lone Star U.S. Acquisitions and 9.9% by theOP) would be converted into and exchanged for 100 shares of common stock ofShoney’s, as the surviving entity in the merger.  Under  the terms of the limitedliability company agreement, Lone Star Acquisitions contributed 90.1% of theinitial capital and the OP contributed 9.9% of the initial capital to LSF 4Acquisition, LLC.  Pursuant to the termsof financing arrangements entered into in conjunction with the merger, the OPnow owns 7.5% of the equity of the sole shareholder of Shoney’s.  In addition, the OP has no obligation tofund any additional capital requirements of the entity, other than its initialcapital contribution.  The Company hadcompleted the purchase of 28 properties from Shoney’s as of September 30, 2002and intends to acquire additional properties in the near future.

 

In order to satisfyfranchisor requirements, the Managing General Partner of Arkansas Restaurants#10 L.P. (“ARK #10”) is owned by Robert J. Stetson, chief executive officer andmember of the board of directors of the Company.  Mr. Stetson receives no compensation for this role.  ARK #10 was established to hold and operatesix locations.  The Burger Kingoperations were either sold to third parties or closed in 1999.  At December 31, 1999, a note receivable of$1,187,000 was due from ARK #10 for which the Company had reserved $1,141,000as an allowance for uncollectability. The note receivable was due on July 1, 2016 and had an interest rate of9.0% per annum.  During 2000, theCompany determined that the reduced operations of ARK #10 made collection ofthis note improbable and wrote down the note against the established reserve.  The Schlotzsky’s franchise was transferred tothe Company effective October 1, 2001 as partial payment for the notereceivable.  At September 30, 2002,there were no other monies owed to the Company by ARK #10.

 

**8.             Stockholders’ Equity and MinorityInterests**

 

Two stockholders of the Company (LSF3 Investments I, LLC, a Delawarelimited liability company, and LSF3 Investments II, LLC, a Delaware limitedliability company (the “Lone Star Holders”)) own approximately 19%  of the outstanding Common Stock as of September30, 2002.

 

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**Distributionsto Common and Preferred Stockholders**

 

During the three months ended March 31, 2002, the Company changed itsdeclaration date for its dividends from the last working day of the previousperiod to the first working day of the current period.  During the nine months ended September 30,2002, the Company paid nine common stock dividends and declared eight, and paidthree preferred stock dividends and declared two.

 

**MinorityInterests**

 

As described in the Company’s Annual Report on Form 10-K for the yearended December 31, 2001, each OP unit not owned by the Company represented aminority interest in the OP.  Each OPunit participated in any income (loss) of the OP based on the percent ownershipin the OP and received a cash dividend in an amount equivalent to a share ofCommon Stock.  Each OP unit could beexchanged at any time by the holder thereof for one share of common stock ofthe Company.  With each exchange ofoutstanding OP units for common stock, the Company’s percentage ownershipinterest in the OP, directly or indirectly, would increase.  These OP units expired July 29, 2002 andwere exchanged for 221,482 shares of common stock August 2, 2002.

 

During 1999, the Company issued $55,000,000 of 8.5% preferred interestin HJV to a third party for net proceeds of $52,793,000.  Under the terms of this transaction, thepreferred interest holder receives annual distributions equal to $4,675,000payable monthly from the cash flows of HJV. Income is allocated to the preferred interest holder equal to theirdistribution.  The Company may berequired from time to time to exchange properties that do not meet specifiedcriteria as defined in the partnership agreement.  These preferred partnership interests represent the minorityinterests of the Company at September 30, 2002.

 

Minority interest in the OP and the preferred partnership consists ofthe following at September 30, 2002 (in thousands):

 

| Balance at January 1, 2002                   |   | $      | 54,337 |   |
|----------------------------------------------|--------|--------|--------|--------|
| Distributions paid and accrued in the period |   | (3,593 | )      |
| Income allocated to minority interest        |   | 3,512  |   |
| OP units exchanged for common stock          |   | (1,411 | )      |
| Balance at September 30, 2002                |   | $      | 52,845 |   |

 

**9.****                                      Segment Information**

 

Effective April2001, with the formation of Fuel Supply Inc., a wholly-owned subsidiary of theCompany (“FSI”), and the commencement of retail operations, the Company now hastwo operating segments, real estate and retail.  Operating segments are defined as components of an enterprise forwhich separate financial information is available that is evaluated by thechief operating decision maker(s) in deciding how to allocate resources and inassessing performance.

 

*RealEstate.*  Real estateactivities are comprised of property management, acquisition and developmentoperations and related business objectives. The Company derives its revenues primarily from rental income receivedon its 812 restaurant and service station properties located throughout 48states.

 

*Retail*.  Commencing in April 2001, the Company formedFSI, which began retail operations. Revenues from this segment are generatedfrom the sale of gasoline and convenience store merchandise, and food sales atrestaurants operated by the Company.  AtSeptember 30, 2002, FSI operated three service stations in Texas, seven inHawaii and two in Illinois.  In January2002, FSI commenced operating a fuel terminal in Hawaii to store fuel sold atits Hawaii service stations.  AtSeptember 30, 2002, in addition to the service stations currently operated, FSIsold fuel to seven service stations in Hawaii, six in Texas and two inIllinois.  FSI also operates fournon-service station properties: one car wash in California and threerestaurants, two located in Texas and one located in Kansas.

 

*IntersegmentCharges. *Intersegmentcharges are eliminated in consolidation and include the costs of rent andinterest.  The Retail segment pays rentto the Real Estate segment for leased properties that it operates.  Effective January 1, 2002, interest is alsopaid by the Retail segment to the Real Estate segment.  Interest is charged at an

 

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annual rate of 9.5% on intercompany balances as well as on a noteestablished on January 1, 2002 for the sale of the Hawaii fuel terminal toFSI.  Intercompany balances representprimarily the cash advances made by the Real Estate segment to the Retailsegment to fund its operations. Intersegment rent and interest eliminated in consolidation for the ninemonths ended September 30, 2002 were $1,210,000 and $579,000, respectively.

 

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**Item2.    Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**Results ofOperations**

 

TheCompany derives its revenue primarily from the leasing of its properties(primarily restaurants) to operators on a “triple net” basis.  Triple net leases typically require thetenants to be responsible for property operating costs, including propertytaxes, insurance, maintenance and, in most cases, the ground rents whereapplicable.  Approximately 48% of theCompany’s leases provide for a base rent plus a percentage of the sales inexcess of a threshold amount.  As aresult, portions of the Company’s revenues are a function of the number ofproperties in operation and their level of sales.  Sales at individual properties are influenced by local marketconditions, the efforts of specific operators, marketing, new product programs,support of the franchisor and the general state of the economy.

 

Thefollowing discussion considers the specific impact of such factors on theresults of operations of the Company for the following periods.

 

**CriticalAccounting Policies and Estimates**

 

Management’s discussion and analysis of financial condition and resultsof operations are based upon the Company’s consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these financial statements requires management of theCompany to make estimates and assumptions that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities.  On aregular basis, the Company evaluates these estimates, including asset impairmentand provision for doubtful accounts. These estimates are based on historical experience and on various otherassumptions that are believed to be reasonable under the circumstances.  Actual results may differ from theseestimates.

 

*Rent Recognition*

 

Rent revenues and expenses under operating leases are recognized on astraight-line basis, unless significant collection problems occur with thelessee, at which time rents are recorded on a cash basis.  Contingent rent is recognized as revenueafter the related lease sales targets are achieved.

 

In May 1998, the Financial Accounting Standards Board’s Emerging IssuesTask Force issued EITF 98-9, “Accounting for Contingent Rent in InterimFinancial Periods,” (“EITF 98-9”), which provided guidance on recognition ofrental income during interim periods for leases which provide for contingentrents (commonly referred to as “percentage rent”).  In accordance with the initial consensus reached in EITF 98-9,the Company revised its method of accounting for contingent rent on aprospective basis effective May 21, 1998. As the Company has already complied with the requirements of accountingfor contingent rents, the Company believes it is in compliance with StaffAccounting Bulletin (“SAB”) No. 101, “Revenue Recognition in FinancialStatements” which was effective October 1, 2000.

 

*Asset Impairment*

 

The Company’s management routinely reviews its investments forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable.  Indicators of possible impairment include default of lease terms,non-payment or late payment of rents, decreases in tenant’s sales levels andgeneral declines in the success of the operating brand names of itstenants.  When these indicators arepresent, the Company reviews the circumstances of the indicator and, if animpairment is likely, secures an estimate of fair market value of the propertyaffected.

 

*Provision for DoubtfulAccounts*

 

On a regular basis, management of the Company analyzes thecollectability of amounts owed to the Company. Included in this analysis are all tenants which have significantbalances due to the Company which are past due or collection of the amounts arequestionable.  If management determinesthat the ultimate collection of these amounts is impaired, a provision fordoubtful accounts is recorded to bring the net receivable to its realizablevalue.

 

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***Comparison of the three months endedSeptember 30, 2002 to the three months ended September 30, 2001***

 

Revenues from real estate operations, including interest income andincome earned on direct financing leases, in the three months ended September30, 2002 totaled $17,488,000, down 1.1% from the $17,681,000 recorded for thethree months ended September 30, 2001. The decrease in revenues is primarily due to sales of properties,partially offset by properties acquired during the third quarter 2002. For thethree months ended September 30, 2002, approximately 6.3% of the Company’srental revenues resulted from percentage rents (rents determined as apercentage of tenant sales), compared with 6.1% for the three months endedSeptember 30, 2001.  Also included inrevenues is interest income relating to notes and mortgage receivables fromtenants and related parties.  Interestincome was $1,272,000 for the three months ended September 30, 2002, comparedwith $1,262,000 for the three months ended September 30, 2001.   Interest income in the three months endedSeptember 30, 2002 was positively affected by the purchase of $20,000,000 ofCaptain D’s mortgage notes in July 2002. These notes are being used as consideration for the acquisition ofCaptain D’s properties.  This increaseis almost entirely offset by the Company’s decision in the third quarter of2001 to cease accruing interest on certain mortgages involved in bankruptcy.

 

Property expenses for thethree months ended September 30, 2002 totaled $344,000, a decrease of $142,000when compared to the three months ended September 30, 2001.  Depreciation and amortization expenses inthe three months ended September 30, 2002 increased 1.1% to $5,409,000,compared to the three months ended September 30, 2001 due to the acquisitionsin the third quarter 2002, partially offset by sales of properties.

 

General and administrative expenses for the three months endedSeptember 30, 2002 totaled $1,632,000, a decrease of 9.2% when compared to thethree months ended September 30, 2001. This decrease is primarily due to reduced costs, consisting primarily oflegal fees, associated with tenant work-outs incurred during the three monthsended September 30, 2002 as compared to the three months ended September 30,2001**.**

 

Provisions for doubtfulaccounts for the three months ended September 30, 2002 totaled ($229,000)compared to $1,964,000 for the three months ended September 30, 2001.  During 2002, the Company collectedsignificant portions of past due amounts on which provisions had been made inprevious periods.

 

Interest expense, amortization of loan origination fees and derivativesettlement payments for the three months ended September 30, 2002 totaled$5,740,000, a decrease of 18.5% when compared to the three months endedSeptember 30, 2001.  This decrease isprimarily due to the Company’s decrease in its outstanding debt at September30, 2002 compared to September 30, 2001 by approximately $22,000,000, thehigher amortization of costs in 2001 associated with the $175,000,000 bridgeloan provided by Bank of America, as well as a reduction in interest rates.

 

During the three months ended September 30, 2002, as a result of theCompany’s regular analysis of its investments to determine if circumstancesindicate that the carrying amount of an asset may not be recoverable, an assetimpairment charge of $133,000 was recorded from the revaluing of five assets totheir estimated fair value.  During thethree months ended September 30, 2001, the Company recorded an asset impairmentcharge of $944,000 from the revaluing of 5 assets to their estimated fairvalue.

 

Derivative financial instruments are utilized by the Company to manageits exposure to market risks from changes in interest rates.  Derivative financial instruments includeinterest rate swaps and interest rate collars. During the three months ended September 30, 2002, the Company recognized$146,000 in income related to the ineffective portion of an interest rateswap.  Loss on the interest rate swapagreement for the three months ended September 30, 2001 totaled $248,000.

 

Retail income, which is comprised of revenue from operating activities,was $10,839,000 for the three months ended September 30, 2002, compared to$5,490,000 for the three months ended September 30, 2001.  Cost of sales associated with this revenuetotaled $9,030,000 and general and administrative costs associated with thisrevenue totaled $1,479,000 for the three months ended September 30, 2002,compared to $4,870,000 and $469,000, respectively, during the three monthsended September 30, 2001.   The numberof properties being operated by the Company has remained virtually the same asof September 30, 2002 and 2001 at 31 and 32 properties, respectively.  However, retail operating results have morethan doubled in the three months ended September 30, 2002 compared to the threemonths ended September 30, 2001 due to the mix of operated properties improvingto properties with higher volumes.

 

 

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Gain on sale of propertyfor the three months ended September 30, 2002 of $979,000 is reflected inincome from discontinued operations in accordance with SFAS No. 144 (asdescribed below).  Gain on sale ofproperty was $285,000 for the three months ended September 30, 2001 and relatesto the sale of four properties for cash proceeds of $2,628,000 and notes of$155,000.

 

Minority interests were $1,163,000 for the three months ended September30, 2002 compared to $1,150,000 for the three months ended September 30, 2001and relates primarily to the Company’s minority interest in USRP/HCI Partnership1, L.P., a subsidiary of the Company ("HJV"), which was formed inOctober 1999.

 

Income from discontinued operations was $995,000 for the three monthsended September 30, 2002 compared to $49,000 for the three months endedSeptember 30, 2001.  In accordance withSFAS No. 144, discontinued operations represent the operations of propertiesdisposed of or classified as held for sale subsequent to January 1, 2002 aswell as any gain or loss recognized in their disposition.  Seventeen properties were disposed of in thethird quarter of 2002 resulting in a gain of $979,000 with cash proceeds of$6,311,000, net of closing costs.  Theoperating results of these 17 properties sold in the third quarter of 2002 arereflected as income from discontinued operations for the three months endedSeptember 30, 2002 and 2001.

 

*Comparison of the ninemonths ended September 30, 2002 to the nine months ended September 30, 2001*

 

Revenues from real estate operations, including interest income andincome earned on direct financing leases, in the nine months ended September30, 2002 totaled $52,610,000, down 4.1% from the $54,848,000 recorded for thenine months ended September 30, 2001. Rental revenues decreased 2.7% from $50,662,000 in the nine months endedSeptember 30, 2001 to $49,308,000 in 2002, primarily due to decreases in thenumber of properties owned during 2002 as compared to the same period in 2001,partially offset by the acquisition of properties in the third quarter2002.  For the nine months endedSeptember 30, 2002, approximately 6.3% of the Company’s rental revenuesresulted from percentage rents (rents determined as a percentage of tenantsales), compared with 6.9% for the nine months ended September 30, 2001.  The decrease of 21.5% in interest incomefrom $3,940,000 in the nine months ended September 30, 2001 to $3,093,000 in2002 is primarily due to the sales of the Company’s trading and available forsale securities during 2002, the short-term investment of excess cash during2001 and the Company’s decision in the third quarter of 2001 to cease accruinginterest on certain mortgages involved in bankruptcy.  These decreases were partially offset by the acquisition of$20,000,000 of Captain D’s mortgage notes in the third quarter 2002.

 

Property expenses for thenine months ended September 30, 2002 totaled $1,421,000, an increase of 18.1%when compared to the nine months ended September 30, 2001.  This increase is primarily due to higherproperty taxes and higher rent expense during the first quarter of 2002 versus2001.  Depreciation and amortizationexpenses in the nine months ended September 30, 2002 totaled $16,567,000, adecrease of less than 1% when compared to the nine months ended September 30,2001.  This decrease is primarily due tolower depreciation expense on fewer properties owned during 2002 as compared tothe same period in 2001, partially offset by $690,000 expense recorded in June2002 for fifteen months of depreciation of assets reclassified from Assets heldfor sale to Property, and depreciation associated with properties acquired inthe third quarter of 2002.

 

General and administrative expenses for the nine months ended September30, 2002 totaled $5,562,000, a decrease of 18.3% when compared to the ninemonths ended September 30, 2001.  Duringthe nine months ended September 30, 2001, the Company incurred costs of$813,000 for severance related to the Company’s former chief executive officer,a provision of $350,000 for severance related to the Company’s former chieffinancial officer and $230,000

 

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for costs associated with hiring the Company’s new chief operatingofficer/chief financial officer.  Thesecosts were partially offset by higher costs associated with tenant work-outs inthe first quarter of 2002.

 

Provisions for doubtful accounts for the nine months ended September30, 2002 totaled ($234,000) compared to $2,914,000 for the nine months endedSeptember 30, 2001.  During 2002, theCompany has collected significant portions of past due amounts on whichprovisions had been made in previous periods.

 

Interest expense, amortization of loan origination fees and derivativesettlement payments for the nine months ended September 30, 2002 totaled$17,093,000, a decrease of 32.2%, when compared to the nine months endedSeptember 30, 2001. This decrease is primarily due to the decrease inoutstanding debt at September 30, 2002 compared to September 30, 2001 byapproximately $22,000,000, lower interest rates and lower amortization of loanfees.  Amortization of loan originationfees decreased 69.9% from $4,739,000 in 2001 to $1,426,000 in 2002.  This decrease is due to the fees associatedwith the Bank of America bridge facility which were expensed over the first sixmonths of 2001.

 

During the nine months ended September 30, 2002, as a result of theCompany’s regular analysis of its investments to determine if circumstancesindicate that the carrying amount of an asset may not be recoverable, an assetimpairment charge of $983,000 was recorded from the revaluing of 12 assets totheir estimated fair value.  During thenine months ended September 30, 2001, the Company recorded an asset impairmentcharge of $16,993,000. During the nine months ended September 30, 2001, BC OilVentures LLC, the tenant leasing the service stations and fuel terminal inHawaii, defaulted on its monthly rent payments.  After careful assessment of various factors relevant to theseproperties, management determined it was appropriate to sell theseproperties.  Accordingly, the Companyclassified these properties as Assets held for sale at that time and animpairment charge of $7,743,000 was recorded to write these assets down totheir estimated proceeds from the anticipated disposal of these properties netof estimated costs to sell.  Inaddition, management analyzed service stations in Missouri, Illinois and Texas,which were late paying rent and defaulting on certain lease terms, for possibleimpairment.  It was determined that 16of these properties had carrying values in excess of fair value.  The Company recorded an impairment charge of$7,567,000 in the nine months ended September 30, 2001 to revalue these assetsto estimated fair value.  The estimatedfair value of these assets was determined by discounting the estimated cashflows of each asset.  As a result of theCompany’s regular analysis of its investments to determine if circumstancesindicate that the carrying amount of an asset may not be recoverable,additional impairment charges of $1,683,000 were recorded for the nine monthsended September 30, 2001 from the revaluing of 15 other assets to theirestimated fair value.

 

Derivative financial instruments are utilized by the Company to manageits exposure to market risks from changes in interest rates.  Derivative financial instruments includeinterest rate swaps and interest rate collars. During the nine months ended September 30, 2002, the Company recognized$402,000 in income related to the ineffective portion of an interest rateswap.  Loss on this interest rate swapagreement for the nine months ended September 30, 2001 totaled $2,607,000. Ofthe $2,607,000 recorded, $1,474,000 represents reclassification of the January1, 2001 adjustment from other comprehensive income, and $1,133,000 representsthe change in the fair value of the interest rate swap.

 

Retail operations commenced in April 2001.  Retail income, which is comprised of revenue from operatingactivities, was $28,056,000 for the nine months ended September 30, 2002,compared to $7,476,000 for the nine months ended September 30, 2001.  Cost of sales associated with this revenuetotaled $23,424,000 and general and administrative costs associated with thisrevenue totaled $4,105,000 for the nine months ended September 30, 2002,compared to $6,535,000 and $599,000, respectively, during the nine months endedSeptember 30, 2001.  The number ofproperties being operated by the Company has remained virtually the same as ofSeptember 30, 2002 and 2001 at 31 and 32 properties, respectively.  However, retail operating results havesignificantly improved in the nine months ended September 30, 2002 compared tothe nine months ended September 30, 2001 due to the mix of operated propertiesimproving to properties with higher volumes and a full period of operations forthe nine months ended September 30, 2002.

 

Gain on sale of property for the ninemonths ended September 30, 2002 of $2,253,000 is reflected in income fromdiscontinued operations in accordance with SFAS No. 144 (as describedbelow).  Gain on sale of property was$1,893,000 for the nine months ended September 30, 2001 and relates to the saleof 26 properties for cash proceeds of $17,121,000, net of closing costs, andnotes of $1,033,000.

 

Minority interests were $3,512,000 for the nine months ended September30, 2002 compared to $3,324,000 for the nine months ended September 30, 2001and relates primarily to the Company’s minority interest in HJV, which wasformed in October 1999.

 

Income from discontinued operations was $1,367,000 for the nine monthsended September 30, 2002 compared to $14,000 for the nine months endedSeptember 30, 2001.  In accordance withSFAS No. 144, discontinued operations represent the operations of propertiesdisposed of subsequent to January 1, 2002, as well as any gain or loss recognizedin their disposition.  Twenty sevenproperties were disposed of or classified as held for sale in the nine monthsended September 30, 2002, resulting in a gain of $2,253,000 with cash proceedsof $16,300,000, net of closing costs and $294,000 of notes.  The operating results of these 27 propertiesdisposed of in the first nine months of 2002 are reflected as income fromdiscontinued operations for the nine months ended September 30, 2002 and 2001.

 

22

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Loss on early extinguishment of debt was $340,000 for the nine monthsended September 30, 2001.  On January 9,2001, the Company paid the outstanding balance under the Credit Lyonnaisfacility with proceeds from a bridge loan issued by Bank of America.  In connection with this pay-off, the Companywrote-off $340,000 in unamortized loan origination fees associated with thisfacility.

 

**Liquidityand Capital Resources**

 

The Company’s principalsource of cash to meet its short-term cash requirements is from rental revenuesgenerated by the Company’s properties. As of September 30, 2002, the Company had non-binding letters of intentfor the acquisition of 36 restaurant properties for approximately $23,419,000.  The terms of the Company’s leases (“triplenet leases”) generally require that the tenant is responsible for maintenanceand improvements to the pertinent property. Thus, the Company is generally not required to expend funds for remodelsand renovations.  However, the Companyexpects to spend approximately $570,000 during the remainder of the year endingDecember 31, 2002 to renovate and remodel currently owned properties.

 

During the three months ended March 31, 2002, the Company changed itsdeclaration date for its dividends from the last working day of the previousperiod to the first of every period. During the nine months ended September 30, 2002, the Company paid ninecommon stock dividends and declared eight, and paid three preferred stockdividends and declared two.

 

During June 2001, the Company was informed that one of its tenants hadfiled for protection under Chapter 11 of the Bankruptcy Code of the UnitedStates (the “Bankruptcy Code”).  GantAcquisition LLC (“Gant”), which leases 27****service stations in North Carolina under aMaster Lease with the Company, filed on May 21, 2001.  Annual rent from these properties is approximately$1,288,000.  At September 30, 2002,there was approximately $27,000 of receivables due from this tenant and theCompany had no reserve for these amounts.****The Bankruptcy Court has severed theMaster Lease between Gant and the Company, permitting Gant to reject 12 of theleases subject to the Master Lease while continuing to pay rent on theremaining 15 properties.  The Companyappealed this ruling in May 2002. Depending on the outcome of this appeal, which is anticipated to beruled upon in the fourth quarter of 2002, the remaining 12 properties willeither be sold, with all proceeds payable to the Company, or Gant will beresponsible for all back rent due. Gant continues to pay rent on 15 of the 27properties.

 

During October 2001, the Company was informed that one of itsborrowers, Lyon’s of California, Inc. (“Lyons”), had filed for protection underChapter 11 of the Bankruptcy Code.  AtSeptember 30, 2002 there was approximately $7,790,000 due on notes from Lyon’sfor which $1,922,000 had been reserved. Interest income associated with these notes has not been recognizedsince September 2001.

 

During February 2002, the Company was informed that ICH Corporation(“ICH”) and its wholly owned subsidiary, Sybra, Inc. (“Sybra”), filed forprotection under Chapter 11 of the Bankruptcy Code.  At September 30, 2002 there was approximately $567,000 due fromICH for which $275,000 had been reserved. ICH Corporation also serves as a guarantor for the Lyon’s notespreviously described.  Sybra, Inc.currently leases 59 Arby’s® restaurant sites from the Company.  Annual rent from these properties isapproximately $4,591,000.  Allpost-bankruptcy rent has been received from this tenant, and the Company doesnot anticipate any impairment of values associated with these properties.

 

During the first quarter of 2002, the lease on 56 Fina stations in theDallas/Ft. Worth area was assumed by the creditor of the original lessee.  All post-assumption rent has been collectedby the Company.  There is currently$1,739,000 owed to the Company under the lease, representing pre-assumptionproperty taxes, for which the Company has reserved $792,000.  The Company does not anticipate the need forany additional reserves at this time.

 

The Company has recently become aware of a tenant, which leases 12Burger King properties, experiencing financial difficulties.  As of September 30, 2002, the tenant owedthe Company approximately $23,000 for which there has been no reserveestablished.  The 12 properties have anet book value of approximately $6,053,000 and the annual rent on theseproperties is $1,010,000.

 

In August 2001, the Company completed a $180,000,000 offering of theCertificates through its subsidiary USRP Funding 2001-A, L.P.  Proceeds from the offering were primarilyused to repay approximately $156,997,000 outstanding under the Company’ssecured bridge facility with Bank of America, and the balance of the netproceeds was used for general corporate purposes including the prepayment ofthe $27,500,000 Senior B Secured Guaranteed Notes in October 2001.  The Certificates amortize over 15 years,bear interest at the 30 – day LIBOR plus 48 basis points and other associatedfees of approximately 52.6 basis points, and have an assumed final distributionor maturity date of August 28, 2006.  AtSeptember 30, 2002 there was $170,295,000 outstanding on the Certificates.

 

23

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In conjunction with the offering of the Certificates, the Companyentered into various interest rate protection agreements, including: aninterest rate swap at a fixed rate of 2.42% expiring June 2004 on a notionalamount of $25,000,000, an interest rate swap at a fixed rate of 1.9975% expiringFebruary 2003 on a notional amount of $50,000,000, and an interest rate collarwith a floor of 4.42% and a ceiling of 6.00% expiring August 2006 on anoriginal notional amount of $80,000,000 which has been amortized down to$71,774,000 as September 30, 2002. These derivatives effectively lock in$25,000,000 at 3.426% (2.42% plus 1.006%) through June 2004, lock in$50,000,000 at 3.004% (1.9975% plus 1.006%) through February 2003, and lock in$71,774,000 as of September 30, 2002 at between 5.4260% (4.42% plus 1.006%) and7.006% (6.0% plus 1.006%) through August 2006.

 

Effective February 2002,the Company entered into a fixed to floating interest rate swap with Bank ofAmerica.  This fixed to floatinginterest rate swap was on a $25,000,000 notional value on which the Companyreceived a fixed rate of 7.15% and paid a floating rate based on the threemonth LIBOR plus a spread of 2.92%. This interest rate swap, originally scheduled to terminate in May 2005,was terminated by the Company in September 2002.  Proceeds from the termination of $1,105,000 were collected inOctober 2002.  The gain resulting fromthe termination of approximately $860,000 is being amortized over the term ofthe fixed to floating interest rate swap.

 

Effective July 3, 2000, the Company entered into an interest rate swapwith Credit Lyonnais for a notional amount of $50,000,000 on which the Companypays a fixed rate of 7.05% and receives a variable rate based upon LIBOR.  The interest rate swap agreement terminatesin May 2003 but may be terminated earlier subject to certain restrictions.  The agreement calls for the net expense orincome to be paid or received quarterly. This swap was secured by six properties with an aggregate net book valueof $3,198,000 on February 23, 2001. The Company reduced the notional amount ofthis interest rate swap by $20,000,000 during 2001 for a cost of approximately$1,405,000.  During the first quarter of2002, the Company paid $549,000 to reduce the notional amount of this interestrate swap to $15,000,000 effective May 13, 2002.

 

In May 2002, the Company entered into a Credit Agreement with Bank ofAmerica, through its subsidiary USRP Funding 2002-A, L.P., for a securedrevolving credit facility of $35,000,000, which is subject to a DerivativeExposure Reserve and a Borrowing Base, as defined.  Borrowings under this facility will be used primarily to acquirecertain Shoney’s and Captain D’s properties in sale/leasebacktransactions.  This facility is securedby the 175 properties owned by USRP Funding 2002-A, L.P. with a borrowing basevalue in excess of the $35,000,000 limit and a net book value of $96,329,000 asof  September 30, 2002.  The Credit Agreement has a term of up to twoyears and allows for Base Rate Loans, Eurodollar Loans or a combination of thetwo.  Base Rate Loans bear interest at3.0% plus the higher of the Federal Funds Rate plus 0.5% or the PrimeRate.  Eurodollar Loans bear interest at3.0% plus LIBOR.  The Credit Agreementalso provides that up to $10,000,000 of the facility may be used for letters ofcredit.  There is a 3% fee per annum onoutstanding letters of credit as well as a 3% Derivative Exposure Usage Feeunder this facility.  As of September30, 2002, there were $15,200,000 of borrowings under this facility, and theCompany had letters of credit outstanding and drawn on Bank of America in theamount of $3,323,000.

 

On July 1, 2002, a limited and temporary waiver and amendment wasexecuted under this $35,000,000 Credit Agreement with Bank of America whichallowed the Company to borrow funds under this facility to partially financethe purchase of mortgage notes issued by Captain D’s with a face value of$20,000,000 on July 10, 2002.  Theamount of this investment, without the waiver, would have violated thelimitations on investments under this facility.  The initial waiver period expired on September 29, 2002 withextensions possible through December 28, 2002, subject to specified extensionfees which were reduced in September 2002 by a revision to the originalwaiver.  The Captain D’s mortgage notesbear interest at 12% per annum. As of September  30, 2002, the Company held a balance of approximately $8,500,000of the original $20,000,000 of mortgage notes purchased on July 10, 2002.  As of October 30, 2002, the Company hadfully utilized these notes as consideration to partially finance theacquisition of certain Captain D’s properties.

 

The First Amendment to the Credit Agreement with Bank of America wasissued in September 2002.  Thisamendment revised the Tangible Net Worth financial covenant. The tangible networth requirement was reduced from a minimum of $270,000,000 to $230,000,000,plus 85% of the net cash proceeds of any equity issuance received by theCompany after December 31, 2001, calculated on a cumulative basis.   As of September 30, 2002, the Company wasin compliance with all of its debt covenants.

 

During 1999, the Company issued $55,000,000 of 8.5% preferred interestin USRP/HCI Partnership 1, L.P. (“HJV”), a subsidiary of the Company, to athird party for net proceeds of $52,793,000. Under the terms of this transaction, the preferred interest holderreceives annual distributions equal to $4,675,000 payable monthly from the

 

24

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cash flows of HJV.  Income isallocated to the preferred interest holder equal to their distribution.  The Company may be required from time totime to exchange properties that do not meet specified criteria as defined inthe partnership agreement.

 

In October 2002, the Company received notice of a tender offer fromShoney's Inc. to purchase the Shoney's Liquid Yield Option Notes Due 2004(Zero-Coupon Subordinated).  This tenderoffer expires on November 15, 2002.  Thepurchase price is $840 per $1,000 principal amount at maturity of the notes.  The Company has tendered its notes in theamount of $4,716,000.  Proceeds of$3,961,000 are expected to be collected by the Company in relation to thistender offer in November 2002 on the notes valued at $3,887,000 by the Companyas of September 30, 2002.

 

Management believes that cash flow from operations and borrowingsavailable under its $35 million credit agreement, along with the Company’sability to raise additional equity or debt and anticipated sales of propertieswill provide the Company with sufficient liquidity to meet its short-term andlong-term capital needs.  However, therecan be no assurances that the terms at which new debt is obtained will be asfavorable to the Company as under the existing facilities.

 

**Funds From Operations (FFO)**

 

TheCompany believes that it computes FFO in accordance with the standardsestablished by the National Association of Real Estate Investment Trusts(“NAREIT”) in their National Policy Bulletins dated November 8, 1999, April 26,2001 and April 5, 2002, which may differ from the methodology for calculatingFFO utilized by other equity REITs, and, accordingly, may not be comparable tosuch other REITs.  The Company’s FFO iscomputed as net income (loss) available to common stockholders (computed inaccordance with accounting principles generally accepted in the United Statesof America), plus real estate related depreciation and amortization, gains (orlosses) from sales of property, impairment of long-lived assets, extraordinaryitems and income/loss allocable to minority interest holders.  The Company believes FFO is helpful toinvestors as a measure of the performance of an equity REIT because, along withthe Company’s statements of financial condition, results of operations and cashflows, it provides investors with an understanding of the ability of theCompany to incur and service debt and make capital expenditures.  In evaluating FFO and the trends it depicts,investors should consider the major factors affecting FFO.  Growth in FFO will result from increases inrevenue or decreases in related operating expenses.  Conversely, FFO will decline if revenues decline or relatedoperating expenses increase.  FFO doesnot represent amounts available for management’s discretionary use because ofneeded capital replacement or expansion, debt service obligation, or othercommitments and uncertainties.  FFOshould not be considered as an alternative to net income (determined inaccordance with accounting principles generally accepted in the United Statesof America), as an indication of the Company’s financial performance, to cashflows from operating activities (determined in accordance with accountingprinciples generally accepted in the United State of America) or as a measureof the Company’s liquidity, nor is it indicative of funds available to fund theCompany’s cash needs, including its ability to make distributions.

 

The following table sets forth, for the three andnine months ended September 30, 2002 and 2001, the calculation of funds fromoperations.

 

|                                               |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|----------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
| **(In thousands)**                                 |   | **2002**                              |   | **2001**                             |   | **2002** |   | **2001** |   |
|                                               |   |                                  |   |                                 |   |   |   |   |   |
| Net income (loss) allocable to common stockholders |   | $                                     | 2,981  |                                 | $      | (2,588 | ) | $ | 4,648 |   | $ | (24,271 | ) |
|                                               |   |                                  |   |                                 |   |   |   |   |   |
| Depreciation and amortization                      |   | 5,417                                 |   | 5,474                                |   | 16,724 |   | 17,274 |   |
| Gain on sale of property                           |   | (979                                  | )      | (285                                 | )      | (2,253 | ) | (1,893 | ) |
| Impairment of long-lived assets                    |   | 133                                   |   | 1,042                                |   | 1,851 |   | 17,091 |   |
| Adjustments allocable to minority interest         |   | (32                                   | )      | (44                                  | )      | (108 | ) | (240 | ) |
| Extraordinary loss                                 |   | —                                |   | —                               |   | — |   | 340 |   |
|                                               |   |                                  |   |                                 |   |   |   |   |   |
| Funds from operations – basic                 |   | 7,520                                 |   | 3,599                                |   | 20,862 |   | 8,301 |   |
| Income (loss) allocable to minority interest       |   | (6                                    | )      | (19                                  | )      | 6 |   | (182 | ) |
| Adjustments allocable to minority interest         |   | 32                                    |   | 44                                   |   | 108 |   | 240 |   |
|                                               |   |                                  |   |                                 |   |   |   |   |   |
| Fund from operations – diluted                |   | $                                     | 7,546  |                                 | $      | 3,624 |   | $ | 20,976 |   | $ | 8,359 |   |

 

**Inflation**

 

Some of the Company’sleases are subject to adjustments for increases in the Consumer Price Index,which reduces the risk to the Company of the adverse effects of inflation.  Additionally, to the extent inflationincreases sales

 

25

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volume, percentage rentsmay tend to offset the effects of inflation on the Company.  Because triple net leases also require theproperty operator to pay for some or all operating expenses, property taxes,property repair and maintenance costs and insurance, some or all of theinflationary impact of these expenses will be borne by the property operatorand not by the Company.

 

**Seasonality**

 

Fastfood restaurant operations historically have been seasonal in nature,reflecting higher unit sales during the second and third quarters due to warmerweather and increased leisure travel. This seasonality can be expected to cause fluctuations in the Company’squarterly revenue to the extent it earns percentage rent.

 

**Risks Associatedwith Forward-Looking Statements included in this Form 10-Q**

 

Certain statements contained in this Form 10-Q, including withoutlimitation statements regarding the objectives of management for futureoperations and statements containing the words “believe,” “may,” “will,”“estimate,” “continue,” “anticipate,” “intend,” “expect” and similarexpressions, are forward-looking statements within the meaning of the federalsecurities laws.  Such forward-lookingstatements are subject to known and unknown risks, uncertainties andassumptions which may cause the Company’s actual results, performance orachievements to differ materially from those anticipated or implied by theforward-looking statements.  The Companydisclaims any obligation to update any such statements or publicly announce anyupdates or revisions to any of the forward-looking statements contained hereinto reflect any change in the Company’s expectation with regard thereto or any changein events, conditions, circumstances or assumptions underlying suchstatements.  Reference is hereby made tothe disclosures contained in the Company’s filings with the Securities andExchange Commission, including, but not limited to, the disclosures under theheading “Risk Factors” in “Item 1. Business” of the Company’s Annual Report onForm 10-K filed with the Securities and Exchange Commission on April 1, 2002.

 

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**Item3.    Quantitative and QualitativeDisclosures About Market Risk**

 

TheCompany has limited exposure to financial market risks, including changes ininterest rates and other relevant market prices, except as noted below.  The Company does not have any foreignoperations and thus is not exposed to foreign currency fluctuations.

 

The fair value of the Company’s investments would be affected by anincrease or decrease in interest rates as the majority of the investments areinterest denominated instruments. However, the Company’s investment portfolio of $5,949,000 is relativelysmall, and changes in value relating to market risks would not significantlyimpact the Company’s operations.  TheCompany also has investments in fixed rate notes and mortgage loansreceivable.  Changes in interest ratesdo not have a direct impact on interest income related to these notes andloans.

 

An increase or decreasein interest rates and fees would affect interest costs relating to theCompany’s variable rate debt.  Variablerate debt consists of Triple Net Lease Mortgage Certificates (the Certificates)and borrowings under the Credit Agreement with Bank of America.

 

At September 30, 2002,there was $170,295,000 of variable rate debt outstanding on theCertificates.  The Certificates bearinterest at the 30 - day LIBOR plus 100.6 basis points.  The Company entered into an interest rateswap effective July 3, 2000 with a notional amount of $50,000,000 which wassubsequently reduced to $30,000,000 during the fourth quarter of 2001 andfurther reduced to $15,000,000 during the second quarter of 2002.  The Company pays a fixed rate of 7.05% andreceives a variable rate based upon LIBOR under this swap agreement. 

 

In conjunction with theoffering of the Certificates, the Company has entered into various interestrate protection agreements, including: an interest rate swap at a fixed rate of2.42% expiring June 2004 on a notional amount of $25,000,000, an interest rateswap at a fixed rate of 1.9975% expiring February 2003 on a notional amount of$50,000,000, and an interest rate collar with a floor of 4.42% and a ceiling of6.00% expiring August 2006 on an original notional amount of $80,000,000, whichhas been amortized down to $71,774,000 as of September 30, 2002. Thesederivatives effectively lock in $25,000,000 at 3.426% (2.42% plus 1.006%)through June 2004, lock in $50,000,000 at 3.004% (1.9975% plus 1.006%) throughFebruary 2003, and lock in $71,774,000 as of September 30, 2002 at between5.4260% (4.42% plus 1.006%) and 7.006% (6.0% plus 1.006%) through August 2006.

 

The Company may borrowfunds under its $35,000,000 Credit Agreement with Bank of America at Prime plus3.00%, at LIBOR plus 3.00% or a combination of the two.  As of September 30, 2002, borrowingsoutstanding under this agreement were $15,200,000.  Of the $15,200,000 of borrowings, $10,000,000 is a six monthborrowing at 4.92% (1.92% plus 3.00%) and $5,200,000 is a 30 day borrowing at4.80% (1.8% plus 3.00%).

 

Based on the Company’svariable rate debt and the derivatives designated as cash flow hedges againstthis debt, a 10.0% increase or decrease in interest rates would result in anannual increase or decrease in interest charges of approximately $44,000.

 

Effective February 2002,the Company entered into a fixed to floating interest rate swap with Bank ofAmerica.  This fixed to floatinginterest rate swap was on a $25,000,000 notional value on which the Companyreceived a fixed rate of 7.15% and paid a floating rate based on the threemonth LIBOR plus a spread of 2.92%. The Company designated this swap as a fairvalue hedge.  Accordingly, all changesin value of the derivative and hedged item are recorded in earnings.  This interest rate swap, originallyscheduled to terminate in May 2005, was terminated by the Company in September2002.  Proceeds from the termination of$1,105,000 were collected in October 2002. The gain resulting from the termination of approximately $860,000 isbeing amortized over the term of the $111,000,000 seven year fixed rate seniorunsecured notes payable that were being hedged, through May 1, 2005.

 

The Company has on occasion issued shares of common stock or OP Unitsin exchange for property, and has guaranteed a minimum value for thoseshares/units.  Should the market valueof the common stock not reach the guaranteed value by a specified date (usuallytwo or three years after issue), then the Company may be obligated to issueadditional shares/units under the guarantee agreements. In August 2002, 131,915OP Units with a guaranteed market price of $25.00 per unit were exchanged for 221,482 shares of common stock.At September 30, 2002 there were no OP Units outstanding.

 

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**Item 4.    Controls and Procedures**

 

****TheChief Executive Officer and Interim Chief Financial Officer of the Company (itsprincipal executive officer and principal financial officer) has concluded,based on his evaluation as of a date within 90 days prior to the date of thefiling of this Report, that the Company’s disclosure controls and proceduresare effective to ensure that information required to be disclosed by theCompany in the reports filed or submitted by it under the Securities ExchangeAct of 1934, as amended, is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms, and include controlsand procedures designed to ensure that information required to be disclosed bythe Company in such reports is accumulated and communicated to the Company’smanagement, including the Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosure.****

 

****There were no significant changesin the Company’s internal controls or in other factors that could significantlyaffect these controls subsequent to the date of such evaluation.****

 

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**PART II.    OTHER INFORMATION**

 

 
| **Item  1.** | **Legal  Proceedings**                                   |
|--------------|----------------------------------------------------------|
|         |                                                     |
|         | None                                                     |
|         |                                                     |
| **Item  2.** | **Changes  in Securities and Use of Proceeds**           |
|         |                                                     |
|         | None                                                     |
|         |                                                     |
| **Item  3.** | **Defaults  upon Senior Securities**                     |
|         |                                                     |
|         | None                                                     |
|         |                                                     |
| **Item  4.** | **Submission  of Matters to a Vote of Security Holders** |
|         |                                                     |
|         | None                                                     |
|         |                                                     |
| **Item  5.** | **Other  Information**                                   |
|         |                                                     |
|         | None                                                     |
|         |                                                     |
| **Item  6.** | **Exhibits  and Reports on Form 8-K**                    |

 
|   | a)     | Exhibits |
|--------|--------|----------|
|   |   |     |   |
|   |   | 1)       | Exhibit 10.1 – First Amendment (dated September  2002) to Credit Agreement dated May 31, 2002 |
|   |   | 2)       | Exhibit 10.2 – September 2002 Revision to Temporary  Waiver and Amendment (dated July 1, 2002) on Credit Agreement dated  May 31, 2002 |
|   |   | 3)       | Exhibit 11.1 – Earnings per Share Computation |
|   |   | 4)       | Exhibit 99.1 – Certification by Robert J. Stetson  Pursuant to the Sarbanes-Oxley Act of 2002 |
|   |   | 5)       | Exhibit 99.2 – Certification by Robert J. Stetson  Pursuant to the Sarbanes-Oxley Act of 2002 |

 

 
|   | b)     | Reports on Form 8-K                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |
|   |   | A report on Form 8-K dated September 10, 2002 was  filed with the Securities and Exchange Commission on September 17, 2002  reporting the issuance of updated consents by Deloitte & Touche LLP to  Registration Statements No. 333-66371 and 333-68302.                                                                                                                                                                                                                                                                                                                                               |   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |
|   |   | A report on Form 8-K dated July 29, 2002 was filed  with the Securities and Exchange Commission on August 7, 2002 reporting the  issuance of two press releases related to the release of earnings for the 2nd  Quarter 2002.  A press release on July  29, 2002 announced that the 2nd quarter press release issued on  July 25, 2002 included an inaccuracy in cost of goods sold for retail  operations due to an underaccrual for state fuel taxes that resulted from a  change in fuel suppliers.  On July 30,  2002, the Company issued a press release with revised 2nd Quarter  results. |   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |
|   |   | A report on Form 8-K dated October 30, 2002 was  filed with the Securities and Exchange Commission on November 5, 2002  reporting the issuance of a press release on October 30, 2002 announcing  third quarter earnings.                                                                                                                                                                                                                                                                                                                                                                                  |   |
|        |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  |  |

 

29

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**SIGNATURE**

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                            | U.S. Restaurant Properties, Inc. |
|---------------------------------|----------------------------------|
|                            |                             |
|                            |                             |
| Dated:   November 14, 2002 | By:                              | /s/ Robert J. Stetson |   |
|                            |                             | Robert J. Stetson |
|                            |                             | Chief Executive Officer |
|                            |                             | (Interim Principal Financial Officer) |

 

30

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CERTIFICATION OF CHIEFEXECUTIVE OFFICERPURSUANT TOSECURITIES EXCHANGE ACT RULES 13A-14 AND 15D-14

 

I, Robert J. Stetson, Chief Executive Officer of the registrant,certify that:

 

1.             I have reviewedthis quarterly report on Form 10-Q of U.S. Restaurant Properties, Inc.

 

2.             Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.             Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.             The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

a)             Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)            Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)             Presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate.

 

5.             The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons fulfilling the equivalentfunction):

 

a)             Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarize,and report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)            Anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls.

 

6.             The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

 
| /s/ Robert J.  Stetson   |   |   |
|--------------------------|--------|--------|
| Robert J. Stetson        |   |
| Chief Executive Officer  |   |
|                     |   |
|                     |   |
| Dated: November 14, 2002 |   |

 

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CERTIFICATION OF INTERIMCHIEF FINANCIAL OFFICERPURSUANT TOSECURITIES EXCHANGE ACT RULES 13A-14 AND 15D-14

 

I, Robert J. Stetson, Interim Chief Financial Officer of theregistrant, certify that:

 

1.             I have reviewedthis quarterly report on Form 10-Q of U.S. Restaurant Properties, Inc.

 

2.             Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.             Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.             The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

a)             Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)            Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)             Presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate.

 

5.             The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons fulfilling the equivalentfunction):

 

a)             Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarize,and report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)            Anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls.

 

6.             The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

 
| /s/ Robert J.  Stetson          |   |   |
|---------------------------------|--------|--------|
| Robert J. Stetson               |   |
| Interim Chief Financial Officer |   |
|                            |   |
|                            |   |
| Dated: November 14, 2002        |   |

 

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**Index to Exhibits**

 
| **Exhibit  Number** |   | **Description**                                                                                                         |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                    |
| 10.1                |   | First Amendment (dated  September 2002) to Credit Agreement dated May 31, 2002                                          |
| 10.2                |   | September 2002 Revision to  Temporary Waiver and Amendment (dated July 1, 2002) on Credit Agreement dated  May 31, 2002 |
| 11.1                |   | Earnings per Share Computation                                                                                          |
| 99.1                |   | Certification by Robert J.  Stetson Pursuant to the Sarbanes-Oxley Act of 2002                                          |
| 99.2                |   | Certification by Robert J.  Stetson Pursuant to the Sarbanes-Oxley Act of 2002                                          |

 

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