**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 thequarterly period ended March 31, 2002**

 

**OR**

 

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

 

**For thetransition period from                  to                  **

 

**Commissionfile 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 May 3, 2002, U.S. Restaurant Properties, Inc. had 19,551,207shares 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 March 31, 2002 (Unaudited) and December 31,  2001                                       |   |
|     |     |                                                                                                                                 |   |
|     |     | Condensed  Consolidated Statements of Operations for the three months ended March 31,  2002 and 2001 (Unaudited)                     |
|     |     |                                                                                                                                 |   |
|     |     | Condensed  Consolidated Statements of Other Comprehensive Operations for the three  months ended March 31, 2002 and 2001 (Unaudited) |
|     |     |                                                                                                                                 |   |
|     |     | Condensed  Consolidated Statement of Stockholders’ Equity for the three months ended  March 31, 2002 (Unaudited)                |
|     |     |                                                                                                                                 |   |
|     |     | Condensed  Consolidated Statements of Cash Flows for the three months ended March 31,  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                                                                          |
|     |     |                                                                                                                                 |   |
| 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

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**PART I.       FINANCIALINFORMATION**

 

**Item1.    Financial Statements**

 

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

**Condensed Consolidated Balance Sheets**

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

 
|                                                                                                                                                                                                          |   | **March 31,  2002** |       | **December 31,  2001** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|------------------------|------------|
|                                                                                                                                                                                                          |   |                |       |
|                                                                                                                                                                                                          |   | **(Unaudited)**     |       |                   |       |
| **Assets**                                                                                                                                                                                                    |   |                |       |                   |       |
|                                                                                                                                                                                                          |   |                |       |                   |       |
| Property, net                                                                                                                                                                                                 |   |                |       |                   |       |
| Land                                                                                                                                                                                                          |   | $                   | 181,290    |                   | $          | 184,074 |   |
| Building and leasehold improvements                                                                                                                                                                           |   | 359,543             |       | 362,920                |       |
| Machinery and equipment                                                                                                                                                                                       |   | 11,005              |       | 11,018                 |       |
|                                                                                                                                                                                                          |   | 551,838             |       | 558,012                |       |
| Less:  accumulated depreciation                                                                                                                                                                          |   | (87,713             | )          | (83,233                | )          |
|                                                                                                                                                                                                          |   | 464,125             |       | 474,779                |       |
|                                                                                                                                                                                                          |   |                |       |                   |       |
| Assets held for sale                                                                                                                                                                                          |   | 22,094              |       | 22,071                 |       |
| Construction in progress                                                                                                                                                                                      |   | 431                 |       | 640                    |       |
| Cash and cash equivalents                                                                                                                                                                                     |   | 8,991               |       | 10,346                 |       |
| Restricted cash and marketable securities                                                                                                                                                                     |   | 4,052               |       | 6,622                  |       |
| Rent and other receivables, net (includes $4,289 and $4,747 allowance  for doubtful accounts at March 31, 2002 and December 31, 2001, respectively)                                                           |   | 16,901              |       | 16,760                 |       |
| Prepaid expenses and other assets                                                                                                                                                                             |   | 2,196               |       | 2,534                  |       |
| Inventories                                                                                                                                                                                                   |   | 2,222               |       | 633                    |       |
| Investments                                                                                                                                                                                                   |   | 3,085               |       | 5,108                  |       |
| Notes receivable, net (includes $488 due from related parties and  $3,727 and $4,040 allowance for doubtful accounts at March 31, 2002 and  December 31, 2001, respectively)                                  |   | 14,816              |       | 8,145                  |       |
| Mortgage loans receivable, net (includes $2,500 allowance for doubtful  accounts at March 31, 2002 and December 31, 2001)                                                                                     |   | 15,006              |       | 16,187                 |       |
| Net investment in direct financing leases                                                                                                                                                                     |   | 1,131               |       | 1,300                  |       |
| Deferred financing costs and intangibles, net                                                                                                                                                                 |   | 11,912              |       | 12,383                 |       |
| **Total assets**                                                                                                                                                                                              |   | $                   | 566,962    |                   | $          | 577,508 |   |
|                                                                                                                                                                                                          |   |                |       |                   |       |
| **Liabilities  and stockholders’ equity**                                                                                                                                                                |   |                | ** ** |                   | ** ** |
|                                                                                                                                                                                                          |   |                |       |                   |       |
| Accounts payable and accrued liabilities                                                                                                                                                                      |   | $                   | 14,792     |                   | $          | 18,255 |   |
| Accrued dividends and distributions                                                                                                                                                                           |   | 2,187               |       | 6,112                  |       |
| Unearned contingent rent                                                                                                                                                                                      |   | 1,000               |       | 1,124                  |       |
| Deferred gain on sale of property                                                                                                                                                                             |   | 213                 |       | 215                    |       |
| Interest rate swap agreements at fair value                                                                                                                                                                   |   | 2,100               |       | 3,746                  |       |
| Notes payable                                                                                                                                                                                                 |   | 333,042             |       | 336,140                |       |
| Mortgage note payable                                                                                                                                                                                         |   | 971                 |       | 979                    |       |
| **Total  liabilities**                                                                                                                                                                                        |   | 354,305             |       | 366,571                |       |
|                                                                                                                                                                                                          |   |                |       |                   |       |
| **Commitments  and contingencies**                                                                                                                                                                            |   |                | ** ** |                   | ** ** |
|                                                                                                                                                                                                          |   |                |       |                   |       |
| **Minority  interest in operating partnerships**                                                                                                                                                              |   | 54,272              |       | 54,337                 |       |
|                                                                                                                                                                                                          |   |                |       |                   |       |
| **Stockholders’  equity**                                                                                                                                                                                |   |                | ** ** |                   | ** ** |
|                                                                                                                                                                                                          |   |                |       |                   |       |
| Preferred stock, $.001 par value per share;   50,000 shares authorized, Series A — 3,680 shares issued and outstanding at  March 31, 2002 and December 31, 2001 (aggregate liquidation value of $92,000) |   | 4                   |       | 4                      |       |
| Common stock, $.001 par value per share;   100,000 shares authorized, 19,551 and 19,459 shares issued and outstanding at  March 31, 2002 and December 31, 2001, respectively                                  |   | 20                  |       | 19                     |       |
| Additional paid-in capital                                                                                                                                                                                    |   | 325,510             |       | 324,448                |       |
| Excess stock, $.001 par value per share  15,000 shares authorized, no shares issued                                                                                                                           |   | —              |       | —                 |       |
| Accumulated other comprehensive loss                                                                                                                                                                          |   | (3,975              | )          | (5,071                 | )          |
| Loans to stockholders for common stock                                                                                                                                                                        |   | (874                | )          | (850                   | )          |
| Distributions in excess of net income                                                                                                                                                                         |   | (162,300            | )          | (161,950               | )          |
| **Total  stockholders’ equity**                                                                                                                                                                          |   | 158,385             |       | 156,600                |       |
| **Total  liabilities and stockholders’ equity**                                                                                                                                                          |   | $                   | 566,962    |                   | $          | 577,508 |   |

 

*See Notes toCondensed Consolidated Financial Statements.*

 

3

----

 

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

**Condensed Consolidated Statements ofOperations**

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

**(Unaudited)**

 
|                                                                                                |   | **Three Months Ended  March 31,** |   |
|-----------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                |   |                              |
|                                                                                                |   | **2002**                          |   | **2001** |   |
| **Real Estate**                                                                                     |   |                              |   |   |   |
| Revenues:                                                                                           |   |                              |   |   |   |
| Rental income                                                                                       |   | $                                 | 16,590 |   | $ | 17,258 |   |
| Interest income                                                                                     |   | 1,041                             |   | 1,346 |   |
| Amortization of unearned income on direct financing leases                                          |   | 62                                |   | 95 |   |
| Total  revenues                                                                                     |   | 17,693                            |   | 18,699 |   |
| Expenses:                                                                                           |   |                              |   |   |   |
| Property                                                                                            |   | 628                               |   | 335 |   |
| Depreciation and amortization                                                                       |   | 5,318                             |   | 5,980 |   |
| General and administrative                                                                          |   | 1,925                             |   | 3,173 |   |
| Provision for doubtful accounts                                                                     |   | 86                                |   | 1,148 |   |
| Interest expense                                                                                    |   | 4,286                             |   | 6,973 |   |
| Amortization of loan origination fees                                                               |   | 423                               |   | 2,003 |   |
| Derivative settlement payments                                                                      |   | 984                               |   | 128 |   |
| Impairment of long-lived assets                                                                     |   | 809                               |   | 15,929 |   |
| Fair value adjustment for interest rate swap                                                        |   | (172                              | )      | 1,690 |   |
| Total  expenses                                                                                     |   | 14,287                            |   | 37,359 |   |
| Income (loss) from real estate operations                                                           |   | 3,406                             |   | (18,660 | ) |
|                                                                                                |   |                              |   |   |   |
| **Retail  Operations**                                                                              |   |                              |   |   |   |
| Operating revenue                                                                                   |   | 7,216                             |   | — |   |
| Operating general and administrative                                                                |   | (1,109                            | )      | — |   |
| Cost of sales                                                                                       |   | (5,940                            | )      | — |   |
| Income from retail operations                                                                       |   | 167                               |   | — |   |
|                                                                                                |   |                              |   |   |   |
| Gain on sale of property                                                                            |   | —                            |   | 66 |   |
| Income (loss) from continuing operations                                                            |   | 3,573                             |   | (18,594 | ) |
| Minority interests                                                                                  |   | (1,133                            | )      | (1,004 | ) |
| Net income (loss) from continuing operations before discontinued  operations and extraordinary item |   | 2,440                             |   | (19,598 | ) |
| Income from discontinued operations (includes gain on disposal of  $1,480 for 2002)                 |   | 1,510                             |   | 19 |   |
| Loss on early extinguishment of debt                                                                |   | —                            |   | (340 | ) |
| Net income (loss)                                                                                   |   | 3,950                             |   | (19,919 | ) |
| Dividends on preferred stock                                                                        |   | (1,776                            | )      | (1,776 | ) |
| Net income (loss) allocable to common stockholders                                                  |   | $                                 | 2,174  |   | $ | (21,695 | ) |
|                                                                                                |   |                              |   |   |   |
| Basic and diluted net income (loss) per share:                                                      |   |                              |   |   |   |
| Income (loss) from continuing operations                                                            |   | $                                 | 0.03   |   | $ | (1.22 | ) |
| Income from discontinued operations                                                                 |   | 0.08                              |   | — |   |
| Extraordinary loss                                                                                  |   | —                            |   | (0.02 | ) |
| Net income (loss) per share                                                                         |   | $                                 | 0.11   |   | $ | (1.24 | ) |
|                                                                                                |   |                              |   |   |   |
| Weighted average shares outstanding                                                                 |   |                              |   |   |   |
| Basic                                                                                               |   | 19,518                            |   | 17,532 |   |
| Diluted                                                                                             |   | 19,784                            |   | 17,532 |   |

 

*See Notes to Condensed Consolidated Financial Statements.*

 

4

----

 

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

**Condensed Consolidated Statements ofOther Comprehensive Operations**

**(In thousands)**

**(Unaudited)**

 
|                                                                |   | **Three months ended March 31,** |       |
|---------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                |   | **2002**                         |       | **2001** |   |
|                                                                |   |                             | ** ** |   | ** ** |
| Net income (loss)                                                   |   | $                                | 3,950      |   | $ | (19,919 | ) |
| Cumulative effect of change in accounting for derivative instrument |   | —                           |       | (1,474 | ) |
| Reclassification adjustment — hedge settlement                 |   | —                           |       | 737 |   |
| Other comprehensive income (loss) —                            |   |                             |       |   |   |
| unrealized gain on derivative valuation                             |   | 1,147                            |       | — |   |
| unrealized loss on bond investments                                 |   | (51                              | )          | (113 | ) |
| Comprehensive income (loss)                                         |   | $                                | 5,046      |   | $ | (20,769 | ) |

 

*See Notes to Condensed Consolidated Financial Statements.*

 

5

----

 

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

**Condensed Consolidated Statement ofStockholders’ Equity**

**For the Three Months Ended March 31,2002**

**(In thousands)**

**(Unaudited)**

 
|                                   |   |                |   |             |   |           |   |      |   |              |   |             |    |             |   | **Accumulated**   |   |      |     |
|----------------------------------------|--------|---------------------|--------|------------------|--------|----------------|--------|-----------|--------|-------------------|--------|------------------|---------|------------------|--------|-------------------|--------|-----------|----------|
|                                   |   | **Preferred Stock** |   | **Common Stock** |   | **Additional** |   | **Loans** |   | **Distributions** |   | **Other**        |    |             |   |
|                                   |   |                |   | **Par**          |   |           |   | **Par**   |   | **Paid-in**       |   | **To**           |    | **In Excess of** |   | **Comprehensive** |   |      |     |
|                                   |   | **Shares**          |   | **Value**        |   | **Shares**     |   | **Value** |   | **Capital**       |   | **Shareholders** |    | **Net Income**   |   | **Gain (Loss)**   |   | **Total** |     |
|                                   |   |                |   |             |   |           |   |      |   |              |   |             |    |             |   |              |   |      |     |
| Balance at January 1,  2002            |   | 3,680               |   | $                | 4      |           | 19,459 |      | $      | 19                |   | $                | 324,448 |             | $      | (850              | )      | $         | (161,950 | ) | $ | (5,071 | ) | $156,600 |   |
| Net income                             |   |                |   |             |   |           |   |      |   |              |   |             |    | 3,950            |   |              |   | 3,950     |     |
| Purchase of common stock by officers   |   |                |   |             |   | 10             |   |      |   | 120               |   | (24              | )       |             |   |              |   | 96        |     |
| Proceeds from exercised stock options  |   |                |   |             |   | 82             |   | 1         |   | 880               |   |             |    |             |   |              |   | 881       |     |
| Stock-based compensation to employees  |   |                |   |             |   |           |   |      |   | 62                |   |             |    |             |   |              |   | 62        |     |
| Other comprehensive gain (loss) — |   |                |   |             |   |           |   |      |   |              |   |             |    |             |   |              |   |      |     |
| unrealized gain on derivatives         |   |                |   |             |   |           |   |      |   |              |   |             |    |             |   | 1,147             |   | 1,147     |     |
| unrealized loss on investments         |   |                |   |             |   |           |   |      |   |              |   |             |    |             |   | (51               | )      | (51       | )        |
| Distributions declared on common stock |   |                |   |             |   |           |   |      |   |              |   |             |    | (4,300           | )      |              |   | (4,300    | )        |
| Balance at March 31, 2002              |   | 3,680               |   | $                | 4      |           | 19,551 |      | $      | 20                |   | $                | 325,510 |             | $      | (874              | )      | $         | (162,300 | ) | $ | (3,975 | ) | $158,385 |   |

 

*See Notes to Condensed Consolidated Financial Statements.*

 

6

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

**Condensed Consolidated Statements ofCash Flows**

**(In thousands)**

**(Unaudited)**
| ** **                                 | ** **                                                                               | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------|------------------------------------------------------------------------------------------|-----------------------------------|------------|
|                                       |
| **2002**                                   |                                                                                     | **2001**                          |       |
|                                       |                                                                                     |                              |       |   | ** ** |
| **Cash flows  from operating activities:** |                                                                                     |                              |       |   |   |
|                                       |                                                                                     |                              |       |   |   |
|                                       | Net income (loss)                                                                        |                              | $          | 3,950 |   | $ | (19,919 | ) |
|                                       | Adjustments to reconcile net income (loss) to net cash flows from  operating activities: |                              |       |   |   |   |
|                                       | Depreciation and amortization                                                            |                              | 5,346      |   | 6,030 |   |
|                                       | Extraordinary loss on extinguishment of debt                                             |                              | —     |   | 340 |   |
|                                       | Amortization of deferred financing costs and discounts                                   |                              | 436        |   | 2,032 |   |
|                                       | Impairment of long-lived assets                                                          |                              | 809        |   | 15,929 |   |
|                                       | Provision for doubtful accounts                                                          |                              | 86         |   | 1,148 |   |
|                                       | Stock-based compensation                                                                 |                              | 62         |   | — |   |
|                                       | Accretion of interest income                                                             |                              | (168       | ) | (168 | ) |
|                                       | Fair value adjustment for interest rate swap agreements                                  |                              | (172       | ) | 1,690 |   |
|                                       | Minority interests                                                                       |                              | 1,133      |   | 1,004 |   |
|                                       | Gain on sale of property                                                                 |                              | (1,480     | ) | (66 | ) |
|                                       | Gain on sale of investments                                                              |                              | (255       | ) | — |   |
|                                       | Decrease (increase) in rent and other receivables, net                                   |                              | (983       | ) | 1,065 |   |
|                                       | Decrease (increase) in prepaid expenses                                                  |                              | 338        |   | (48 | ) |
|                                       | Increase in inventories                                                                  |                              | (1,589     | ) | — |   |
|                                       | Reduction in net investment in direct financing leases                                   |                              | 169        |   | 224 |   |
|                                       | Decrease in accounts payable and accrued liabilities                                     |                              | (3,595     | ) | (1,824 | ) |
|                                       | Decrease in unearned contingent rent                                                     |                              | (124       | ) | (33 | ) |
|                                       | Cash provided by operating activities                                                    |                              | 3,963      |   | 7,404 |   |
|                                       |                                                                                     |                              |       |   |   |   |
|                                       | **Cash flows  from investing activities:**                                               |                              |       |   |   |   |
|                                       |                                                                                     |                              |       |   |   |   |
|                                       | Proceeds from sale of property and equipment                                             |                              | 6,246      |   | 1,754 |   |
|                                       | Purchase of property                                                                     |                              | —     |   | (479 | ) |
|                                       | Purchase of machinery and equipment                                                      |                              | (29        | ) | — |   |
|                                       | Purchase of investments                                                                  |                              | (1,073     | ) | — |   |
|                                       | Proceeds from sale of investments                                                        |                              | 3,408      |   | — |   |
|                                       | Distributions received on investments                                                    |                              | 24         |   | 22 |   |
|                                       | Decrease in restricted cash                                                              |                              | 2,570      |   | 668 |   |
|                                       | Increase in mortgage loans receivable                                                    |                              | (84        | ) | — |   |
|                                       | Reduction of mortgage loans receivable principal                                         |                              | 1,303      |   | 1,553 |   |
|                                       | Increase in notes receivable                                                             |                              | (6,500     | ) | (494 | ) |
|                                       | Reduction of notes receivable principal                                                  |                              | 184        |   | 2,004 |   |
|                                       | Cash provided by investing activities                                                    |                              | 6,049      |   | 5,028 |   |
|                                       |                                                                                     |                              |       |   |   |   |
|                                       | **Cash flows  from financing activities:**                                               |                              |       |   |   |   |
|                                       |                                                                                     |                              |       |   |   |   |
|                                       | Payments on line of credit                                                               |                              | $          | — |   | $ | (119,035 | ) |
|                                       | Distributions to minority interest                                                       |                              | (1,198     | ) | (1,214 | ) |
|                                       | Cash distributions to stockholders                                                       |                              | (6,449     | ) | (5,840 | ) |
|                                       | Payment of preferred stock dividends                                                     |                              | (1,776     | ) | (1,776 | ) |
|                                       | Proceeds from sale of stock                                                              |                              | 976        |   | 4,838 |   |
|                                       | Payments on notes/mortgage payable                                                       |                              | (2,914     | ) | (56,667 | ) |
|                                       | Proceeds from notes/mortgage payable                                                     |                              | —     |   | 180,700 |   |
|                                       | Financing costs and other intangibles                                                    |                              | (6         | ) | (4,422 | ) |
|                                       | Cash flows used in financing activities                                                  |                              | (11,367    | ) | (3,416 | ) |
|                                       |                                                                                     |                              |       |   |   |   |
|                                       | Increase (decrease) in cash and cash equivalents                                         |                              | (1,355     | ) | 9,016 |   |
|                                       | Cash and cash equivalents at beginning of period                                         |                              | 10,346     |   | 5,509 |   |
|                                       | Cash and cash equivalents at end of period                                               |                              | $          | 8,991 |   | $ | 14,525 |   |
|                                       |                                                                                     |                              |       |   |   |   |
|                                       | **Supplemental  disclosure:**                                                            |                              |       |   |   |   |
|                                       | Interest paid during the period                                                          |                              | $          | 3,421 |   | $ | 6,772 |   |
|                                       |                                                                                     |                              |       |   |   |   |
|                                       | **Non-cash  investing and financing activities:**                                        |                              |       |   |   |   |
|                                       | Interest receivable transferred to mortgage receivable                                   |                              | $          | 38 |   | $ | — |   |
|                                       | Transfer of property from capitalized lease to property and equipment                    |                              | —     |   | 303 |   |
|                                       | Unrealized loss on investments classified as available for sale                          |                              | 51         |   | 113 |   |
|                                       | Notes received on sale of property                                                       |                              | —     |   | 878 |   |
|                                       | Fair value adjustment for interest rate swap                                             |                              | (1,147     | ) | — |   |
|                                       | Net transfers from construction in progress to property                                  |                              | —     |   | 3,171 |   |
|                                       | Security deposit and note receivable transferred                                         |                              | —     |   | 700 |   |
|                                       | Account receivable conversion to note                                                    |                              | —     |   | 124 |   |
|                                       | Increase (decrease) in common and preferred stock dividends accrued                      |                              | (3,925     | ) | 17 |   |
|                                       | Loan to stockholder for common stock                                                     |                              | 24         |   | — |   |
|                                            |                                                                                          |                                   |            |  |  |  |  |  |  |  |  |  |  |

 

*See Notes to Condensed ConsolidatedFinancial Statements.*

 

7

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

**Notes to Condensed Consolidated Financial 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”).  The business and operations of the Companyare conducted primarily through U.S. Restaurant Properties Operating L.P.(“OP”).  At March 31, 2002, the Company,directly or indirectly, owned 99.34% of and controlled the OP.  As of March 31, 2002, the Company owned 804properties 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 months ended March 31, 2002 are not necessarily indicative of theresults to be expected for the year ending December 31, 2002.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States of America, havebeen condensed or omitted in this report on Form 10-Q pursuant to the Rules andRegulations of the SEC.  In the opinionof management, the disclosures contained in this report are adequate to makethe 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 March 31, 2002, and the consolidated results of its operations,comprehensive operations, stockholders’ equity and cash flows for the threemonths ended March 31, 2002 and 2001.

 

The Company derives itsrevenues primarily from the leasing of its properties to operators (primarilyrestaurants) on a “triple net” basis. Triple net leases typically require the tenants to be responsible forproperty operating costs, including property taxes, insurance, maintenance and,in most cases, the ground rents where applicable.  Accordingly, the accompanying condensed consolidated financialstatements do not include costs for property taxes and insurance which are theresponsibility of the tenants. Additionally, those amounts associated with ground rent expense wherethe tenant is responsible for the ground rents have been recorded as areduction to rent revenues with no impact on net income.  For the three months ended March 31, 2002and 2001, the Company has recorded rent expense of $925,000 and $1,023,000,respectively, as reductions to rent revenues.

 

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.

 

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 othercomprehensive operations for available-for-sale securities.

 

Investments in equity securities that do not have readily determinablefair values are recorded using the cost method since the Company does not havethe ability to exercise significant influence over the investees.

 

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Statement of Financial Accounting Standards (“SFAS”) No. 133,“Accounting for Derivative Instruments and Hedging Activities,” as amended, waseffective for the Company January 1, 2001. This standard requires that all derivative financial instruments berecognized as either assets or liabilities on the balance sheet at their fairvalues and that accounting for the changes in the fair values is dependent uponthe intended use of the derivatives and their resulting designations.  If the derivative is designated as afair-value hedge, the changes in the fair value of the derivative and thehedged item will be recognized in earnings. If the derivative is designated as a cash flow hedge, changes in fairvalue of the derivative will be recorded in other comprehensive income and willbe recorded in the statement of operations when the hedged item affectsearnings.  SFAS No. 133 defines newrequirements for designation and documentation of hedging relationships as wellas ongoing effectiveness assessments in order to use hedge accounting.  For a derivative that does not qualify as ahedge, changes in fair value will be recognized in earnings.

 

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. 141, “Business Combinations” was effective July 1, 2001 andprohibits pooling-of-interests accounting for acquisitions.  SFAS No. 142, “Goodwill and Other IntangibleAssets” was effective January 1, 2002 and specifies that goodwill and someintangible assets will no longer be amortized but instead will be subject toperiodic impairment testing.  The effectof adopting SFAS No. 142 did not have a material impact on the Company’sfinancial statements.

 

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 andInfrequently Occurring Events and Transactions”, for the disposal of a *segment of abusiness* (as previously defined in that Opinion).  This Statement retains the requirements ofSFAS No. 121 to (a) recognize an impairment loss only if the carrying amount ofa long-lived asset is not recoverable from its undiscounted cash flows and (b)measure an impairment loss as the difference between the carrying amount andfair value of the asset.  This Statementrequires that a long-lived asset to be abandoned, exchanged for a similarproductive asset, or distributed to owners in a spinoff be considered held andused until it is disposed of.  Theaccounting model for long-lived assets to be disposed of by sale is used forall long-lived assets, whether previously held and used or newly acquired.  That accounting model retains therequirement of SFAS No. 121 to measure a long-lived asset classified as heldfor sale at the lower of its carrying amount or fair value less cost to selland to cease depreciation.  Thisstatement requires that the current and historical results of operations ofdisposed properties and assets classified as held for sale, are classified asdiscontinued operations.  This resultsin the reclassification of historical operations for property dispositions orassets classified as held for 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 FASB Statement No. 145, any gain or loss onextinguishment of debt will be included in income from continuing operations,rather than as an extraordinary item. In addition, gains and losses from extinguishment of debt that occurredin prior periods will be reclassified from extraordinary items into continuingoperations.

 

The Company had 19,551,207 and 19,459,207 shares of common stockoutstanding as of March 31, 2002 and December 31, 2001, respectively.

 

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

 
|                                                                                                |   | **Three months ended March 31,** |   |
|-----------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|
| **(In thousands, except per share amounts)**                                                        |   | **2002**                         |   | **2001** |   |
|                                                                                                |   |                             |   |   |   |
| Net income (loss) from continuing operations before discontinued  operations and extraordinary item |   | $                                | 2,440  |   | $ | (19,598 | ) |
| Dividends on preferred stock                                                                        |   | (1,776                           | )      | (1,776 | ) |
| Net income (loss) from continuing operations allocable to common  stockholders                      |   | 664                              |   | (21,374 | ) |
| Income from discontinued operations                                                                 |   | 1,510                            |   | 19 |   |
| Loss on early extinguishment of debt                                                                |   | —                           |   | (340 | ) |
|                                                                                                |   |                             |   |   |   |
| Net income (loss) allocable to common stockholders                                                  |   | $                                | 2,174  |   | $ | (21,695 | ) |
|                                                                                                |   |                             |   |   |   |
| Basic and diluted net income (loss) per share:                                                      |   |                             |   |   |   |
| Income (loss) from continuing operations                                                            |   | $                                | 0.03   |   | $ | (1.22 | ) |
| Income from discontinued operations                                                                 |   | 0.08                             |   | — |   |
| Extraordinary loss                                                                                  |   | —                           |   | (0.02 | ) |
| Net income (loss) per share                                                                         |   | $                                | 0.11   |   | $ | (1.24 | ) |

 

Basic income (loss) per share is computed based upon the weightedaverage number of shares of common stock outstanding.  Diluted income (loss) per share typically reflects the dilutiveeffect of stock options, OP units, OP units and shares on which the price isguaranteed (“Guaranteed Stock”) and convertible preferred stock.  The 41,004 stock options, 131,915 OP units,93,540 shares of Guaranteed Stock were dilutive, and 3,679,938 shares ofconvertible preferred stock were anti-dilutive in the three months ended March31, 2002.  The 6,274 stock options,134,344 OP units, 153,436 shares of Guaranteed Stock, and 3,679,938 shares ofconvertible preferred stock were anti-dilutive in the three months ended March31, 2001.

 

**3.****                                      Property**

 

During the three months ended March 31, 2002, the Company completed thesale and disposal of seven properties for net cash proceeds of $6,246,000, netof closing costs.  During the threemonths ended March 31, 2002, the Company purchased $29,000 of equipment used atthe Company’s corporate offices.

 

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 appraisal or other estimate of fair marketvalue of the property affected.  Duringthe first quarter of 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 $809,000 were recordedfrom the revaluing of seven assets to their estimated fair value.

 

**4.             Investments**

 

The aggregate cost basis and net unrealized loss for investmentsclassified as available for sale at March 31, 2002 were $4,997,000 and$2,574,000, respectively.  The netunrealized loss is recorded as accumulated other comprehensive loss of which aloss of $51,000 was recorded during the three months ended March 31, 2002.  In addition to these investments, theCompany has other investments carried at a cost basis of approximately$662,000.  During the three months endedMarch 31, 2002, the Company liquidated its trading securities.

 

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

 

In August 2001, theCompany completed a $180,000,000 offering of Triple Net Lease MortgageCertificates (the “Certificates”) through its subsidiary U.S. RestaurantProperties, Inc. 2001-A, L.P.  Proceedsfrom the offering were primarily used to repay approximately $156,997,000outstanding under the Company’s secured bridge facility with Bank of Americaand the balance of the net proceeds were used for general corporate purposesincluding the prepayment of the $27,500,000 Senior B Secured Guaranteed Notes(described below) in October 2001.  TheCertificates amortize over 15 years, bear interest at the 30 — day LIBOR plus48 basis points and other associated fees of approximately 52.6 basis points,and have an assumed final distribution or maturity date of August 28,2006.  At March 31, 2002, there was$174,905,000 outstanding on the Certificates. The Certificates are secured by 273 properties with a net book value of$201,304,000 at March 31, 2002.

 

In January 2001, the Company entered into an indenture agreement withBank of America for a secured bridge facility of $175,000,000.  Proceeds from this bridge facility were usedto pay-off the outstanding balance of the OP’s $175,000,000 revolving creditline and a $50,000,000 unsecured term loan from Credit Lyonnais.  The initial term of the bridge loan maturedin July 2001, and the Company entered into options to extend the facilitythrough August 31, 2001.  In August2001, the Company paid the outstanding balance of this bridge facility with theproceeds from the offering 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.  The Credit Agreement has aterm of up to two years and bears interest in traunches of 30, 60, 90 or 180 -day LIBOR contracts plus 225 basis points. The Credit Agreement also provides that up to $3,500,000 of the facilitymay be used for letters of credit. During 2001, Bank of America issued a letter of credit in the amount of$1,775,000 on behalf of the Company for the benefit of the preferredstockholders and letters of credit in the amount of $812,000 for the benefit ofa supplier of fuel.  There is a 2.25%fee per annum on the outstanding letters of credit.  Amounts available under this facility are further reduced by themarket value of the Bank of America Derivatives (described in Note 6 below) inexcess of a $2,000,000 threshold.  AtMarch 31, 2002, the availability under this facility was $1,354,000.

 

In January 1998, the OP entered into a credit agreement with asyndicate of banks for an unsecured revolving credit line of $175,000,000.  The OP received advances under this creditagreement to finance the acquisition of properties, to repair and updateproperties and for working capital. This credit agreement, which expired on January 9, 2001, and providedthat borrowings thereunder bear interest in traunches of 30, 60 or 90 — dayLIBOR contracts at the then current LIBOR plus a margin spread of either 1.05%,1.20% or 1.35%, dependent on a leverage ratio formula.  The line of credit required the Company tomaintain a Minimum Combined Equity Value of $200,000,000, total adjustedoutstanding indebtedness not to exceed 60% of capitalization value, securedindebtedness not to exceed 15% of capitalization value, debt yield of not lessthan 16%, distributions not to exceed Consolidated Net Earnings and other financialcovenants as defined in the line of credit agreement.  On February 23, 1999, the OP entered into an Assignment andAcceptance agreement that became effective on April 12, 1999.  Under the terms of the Assignment andAcceptance, the OP accepted the assignment of $10,000,000 of the availablecredit line.  This agreement effectivelyreduced the maximum availability under the revolving credit agreement by$10,000,000.  On January 9, 2001, theCompany paid the outstanding balance under this facility as scheduled withproceeds from a bridge loan advanced by Bank of America.

 

On February 26, 1997, the Company issued $40,000,000 in privatelyplaced debt which consisted of $12,500,000 Series A Senior Secured GuaranteedNotes with a 8.06% interest rate, which were due January 31, 2000, and$27,500,000 Series B Senior Secured Guaranteed Notes with a 8.30% interestrate, due January 31, 2002.  In January1998, the note holders agreed to release the collateral for these notes.  In January 2000, the Company paid the $12,500,000Series A Senior Secured Guaranteed Notes in full as scheduled.  Effective January 9, 2001, the Companysecured the Series B Senior Notes with properties having an aggregate net bookvalue of approximately $38,575,000. Under the terms of the Waiver and Second Amendment to Note PurchaseAgreement, the Company was required to secure the noteholders on the same basisand with similar collateral as that provided to Bank of America.  In October 2001, the Company prepaid the$27,500,000 Series B Senior Secured Guaranteed Notes in full.  In connection with this prepayment, theCompany paid $388,000 of make-whole fees and wrote-off $216,000 worth ofunamortized loan origination fees associated with this facility.

 

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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 the Bank of America Credit Agreement and certain guarantees requiredby it, the subsidiaries of the Company executed a Subsidiary Guaranty for thebenefit 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 the Bank of America CreditAgreement and certain guarantees required by it, the subsidiaries of theCompany executed a Subsidiary Guaranty for the benefit of these noteholders.

 

On August 10, 1998, the Company assumed a mortgage note payable as partof an office building acquisition.  Themortgage bears interest at a rate of 8.00% per annum with payments of principaland interest due monthly through June 2007. As of March 31, 2002, the balance was $971,000.

 

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 Companywrote-off $340,000 worth of unamortized loan origination fees associated withthis facility in January 2001.

 

TheCompany is in compliance with all covenants associated with its debt and creditfacilities as of March 31, 2002.

 

**6.****              DerivativeInstruments**

 

Derivative financial instruments are utilized by the Company to managemarket risks associated with changes in interest rates.  Derivative financial instruments includeinterest rate swaps and interest rate collars. During the three months ended March 31, 2002, the Company recognized$172,000 in income related to the ineffective portion of the interest rate swapwith Credit Lyonnais, and recognized $1,147,000 in other comprehensive gainrepresenting the effective portion of the cash flow hedges.

 

Effective February 2002, the Company entered into a fixed to floatinginterest rate swap with Bank of America. This fixed to floating interest rate swap is on a $25,000,000 notionalvalue on which the Company receives a fixed rate of 7.15% and pays a floatingrate based on the three month LIBOR plus a spread of 2.92%.  This interest rate swap terminates in May2005.  The Company has designated thisswap as a cash flow hedge.  Accordingly,all changes in value of the derivative and hedged item are recorded inearnings.

 

In conjunction with the completion of the offering of the Certificates,the Company entered into various interest rate protection agreements (the “Bankof America Derivatives”), including: an interest rate swap at a fixed rate of3.825% for one year on a notional amount of $50,000,000 and an interest ratecollar with a floor of 4.42% and a ceiling of 6.00% for four years on anotional amount of $80,000,000. Subsequently, the Company entered into an interest rate swap at a fixedrate of 2.20% for six months on a notional amount of $20,000,000.  These derivatives effectively lock in$50,000,000 at 4.8310% (3.825% plus 1.006%) for one year, lock in $80,000,000at between 5.4260% (4.42% plus 1.006%) and 7.006% (6.0% plus 1.006%) for fouryears, and lock in $20,000,000 at 3.206% (2.200% plus 1.006%) for six months.

 

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.  Theadoption of SFAS No. 133 as

 

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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 re-classified 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.

 

In conjunction with the Merger between the Company and QSV on December29, 2000, the Company assumed a note receivable from Mr. Stetson in the amountof $959,000 due on January 22, 2001 with an interest rate of 10.00% as well asa note payable to Mr. Darrel L. Rolph, who was then a Director of the Companyfor $959,000 due on January 22, 2001 with an interest rate of 10.00%.  Both the note receivable and note payable werepaid in full on the scheduled due date.

 

**7.             Related Party Transactions**

 

In order to satisfy franchisor requirements, the Managing GeneralPartner of Arkansas Restaurants #10 L.P. (“ARK #10”) is owned by the ChiefExecutive Officer of the Company and a member of the Board of Directors of theCompany.  The Chief Executive Officerreceives no compensation for this role. ARK #10 was established to hold and operate five Burger King and oneSchlotzsky’s franchises in Arkansas and Kansas, respectively.  The Burger King operations were either soldto third parties or closed in 1999.  AtDecember 31, 1999, a note receivable of $1,187,000 was due from ARK #10 forwhich the Company had reserved $1,141,000 as an allowance foruncollectability.  The note receivablewas due on July 1, 2016 and had an interest rate of 9.0% per annum.  During 2000, the Company determined that thereduced operations of ARK #10 made collection of this note improbable and wrotedown the note against the established reserve. The Schlotzsky’s franchise was transferred to the Company effectiveOctober 1, 2001 as partial payment for the note receivable.  At March 31, 2002, there were no othermonies owed to the Company by ARK #10.

 

In connection with Mr. Robert Stetson’s resignation as Chief ExecutiveOfficer and President of the Company, the Company entered into a SettlementAgreement and Consulting Agreement with Mr. Stetson as of October 6, 1999.  Pursuant to the terms of the SettlementAgreement, the Company agreed to provide Mr. Stetson one or more loans, up tothe aggregate of $800,000, for the sole purpose of acquiring shares of theCompany’s common stock from time to time in the open market.  In March 2000, the Company advanced $400,000to Mr. Stetson for the purchase of the common stock of the Company.  The promissory note provides for an interestrate of 7.0% per annum and quarterly payments of interest only through December2005, with a final payment of principal and interest due in March, 2006.  Pursuant to the note agreement, Mr. Stetsonhas pledged the common stock purchased with the note proceeds as collateral forthe loans.  This note is classified as anote receivable on the balance sheet.

 

Effective September 22, 2000, the Company and Mr. Stetson entered intoan Amendment to the Settlement Agreement that provided for two changes to theoriginal Settlement Agreement that were completed in October 2000.  First, Mr. Stetson executed a secondpromissory note in the amount of $300,000 in exchange for which he received35,037 restricted shares of the Company’s Common Stock (calculated based on avalue of $8.5625 per share).  Second,the Company advanced Mr. Stetson $75,000 under a third promissory note to beused for the sole purpose of acquiring shares of the Company’s Common Stock in theopen market.  Both notes bear interestat 7.0% per annum and provide for quarterly payments of interest only throughJuly 2006, with a final payment of principal and interest due in October 2006.  In addition, both notes are secured by therestricted Common Stock and stock purchased with the proceeds of thenotes.  The $300,000 note is classifiedas a loan to shareholders for Common Stock on the balance sheet and the notefor $75,000 is classified as a note receivable on the balance sheet.

 

On December 20, 2000, USRP/HCI Partnership 1, L.P., a subsidiary of theCompany, (“HJV”) made an advance to the preferred interest holder in the amountof $700,000.  Under the terms of theAdvance Agreement dated December 1, 2000, the $700,000 advance bears interest atan annual interest rate of 9.0%.  Thisadvance was paid in full as scheduled in April 2001.

 

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In conjunction with the Merger between the Company and QSV, the Companyassumed a note receivable from Mr. Stetson in the amount of $959,000 due onJanuary 22, 2001 with an interest rate of 10.00% as well as a note payable toMr. Darrel L. Rolph, who was then a Director of the Company, for $959,000 dueon January 22, 2001 with an interest rate of 10.00%.  Both the note receivable and note payable were paid in full onthe scheduled due date.

 

In connection with their resignations, Messrs. Margolin, Rolph andRolph entered into Noncompetition and Release Agreements with the Companypursuant to which each of them agreed not to (a) submit or cause thesubmission of any proposals or nominations of candidates for election asdirectors of the Company or (b) solicit proxies from any of the Company’sstockholders, in each case prior to December 31, 2003.  Additionally, Mr. Margolin agreed not todirectly or indirectly own manage, control, participate in, invest in orprovide consulting services to any entity or business organization that engagesin or owns, invests in, manages or controls any venture engaged in the ownership,management, acquisition or development of restaurant, gasoline and conveniencestore properties similar to those of the Company and its affiliates for aone-year period ending March 9, 2002. As consideration under such agreement and in connection with thetermination of Mr. Margolin’s Employment Agreement with the Company, theCompany paid Mr. Margolin $800,000 in severance compensation which was expensedduring the quarter 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 new 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 provides 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 is classified as a loan to shareholders forCommon Stock on the balance sheet.

 

In January 2002, theCompany advanced Harry O. Davis, the Company’s Senior Vice-President of AssetManagement, $24,000 for the purpose of acquiring shares of the Company’s CommonStock.  The promissory note provides foran interest rate of 6.0% per annum and quarterly payments of interest onlybeginning in April 2002 through December 2006, with a final payment ofprincipal and all unpaid interest in January 2007.  This note is classified as a loan to stockholders for CommonStock on the balance sheet.

 

On January 24, 2002, Lone Star U.S. Acquisitions LLC, the OP, LSF 4Acquisition, LLC and Shoney’s Inc. entered into an Agreement and Plan of Mergerpursuant to which LSF 4 Acquisition, LLC would merge into Shoney’s, withShoney’s being the surviving entity. Pursuant to the terms of the merger, which was consummated on April 10,2002, all of the outstanding shares of common stock of Shoney’s would becancelled and converted into the right to receive $.36 in cash and eachoutstanding membership interest in LSF 4 Acquisition, LLC (owned 90.1% by LoneStar U.S. Acquisitions and 9.9% by the OP) would be converted into andexchanged for 100 shares of common stock of Shoney’s, as the surviving entityin the merger.  Pursuant to the terms ofthe limited liability company agreement, Lone Star Acquisitions contributed90.1% of the initial capital and the OP contributed 9.9% of the initial capitalto LSF 4 Acquisition, LLC.  Pursuant tothe terms of financing arrangements entered into in conjunction with themerger, the OP now owns 7.5% of the equity of the sole shareholder ofShoney's.  In addition, the OP has noobligation to fund any additional capital requirements of the entity, otherthan its initial capital contribution. While no formal agreements are currently in place, it is anticipatedthat the OP will acquire from the surviving corporation in the merger a numberof their real estate properties owned by that corporation through a series ofsale/leaseback transactions.

 

**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”)) owned as of March 31, 2002approximately 19.19% of the outstanding Common Stock.

 

**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 of every period. During the first quarter of 2002, the Company

 

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paid three common stock dividends and declared two, and paid onepreferred stock dividend and declared none. Both the May common stock and June preferred stock dividends weredeclared on April 1, 2002.

 

**Minority Interests**

 

As reported in the Company’s Annual Report on Form 10-K for the yearended December 31, 2001, each OP unit not owned by the Company represents aminority interest in the OP.  Each OPunit participates in any income (loss) of the OP based on the percent ownershipin the OP and receives a cash dividend in an amount equivalent to a share ofCommon Stock.  Each OP unit may 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, will increase.  As of March 31, 2002 there were 131,915 OPunits outstanding.

 

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.

 

The OP units outstanding at March 31, 2002 and December 31, 2001 of131,915 and the preferred partnership interests represent the minorityinterests of the Company.

 

Minority interest in the OP and the preferred partnership consists ofthe following at March 31, 2002 (in thousands):

 

| Balance at January 1, 2002                   |   | $      | 54,337 |   |
|----------------------------------------------|--------|--------|--------|--------|
| Distributions paid and accrued in the period |   | (1,198 | )      |
| Income allocated to minority interest        |   | 1,133  |   |
| Balance at March 31, 2002                    |   | $      | 54,272 |   |

 

**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, theCompany now has two operating segments, real estate and retail.  Operating segments are defined as componentsof an enterprise for which separate financial information is available that isevaluated by the chief operating decision maker(s) in deciding how to allocateresources and in assessing 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 804 restaurant and service station properties located throughout 48states.

 

*Retail*.  Commencing in April 2001, the Company formedFSI, which began retail sales. Revenues from this segment are generated fromthe sale of gasoline and convenience store merchandise, and food sales atrestaurants.  At March 31, 2002, FSIoperated five service stations in Texas and one service station in Illinois.  In January 2002, FSI commenced operating afuel terminal in Hawaii to store fuel sold at its Hawaii service stations.  At March 31, 2002, in addition to theservice stations currently operated, FSI sold fuel to eight service stations inHawaii, seven in Texas and five in Illinois. FSI also operates four non-service station properties: one car wash inCalifornia and three restaurants, two located in Texas and one located inKansas.  Intersegment rental revenues,paid to the Real Estate segment from the Retail segment, were $211,000, whichhave been eliminated in consolidation.

 

**10.****                               Discontinued Operations**

 

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.  During thethree months ended March 31, 2002, the Company recognized income fromdiscontinued operations of $1,510,000, which includes a gain on disposal of$1,480,000 related to the sale of seven properties.  During the three months ended March 31, 2001, the Companyrecognized income from discontinued operations of $19,000.

 

15

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

 

**Results ofOperations**

 

The Company derives its revenue primarily from the leasing of itsproperties (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 50% 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.

 

***Comparison of the three months endedMarch 31, 2002 to the three months ended March 31, 2001***

 

Revenues from real estate operations, including income earned on directfinancing leases, in the three months ended March 31, 2002 totaled $17,693,000,down 5.4% from the $18,699,000 recorded for the three months ended March 31,2001.  The decrease in revenues isprimarily due to sales of properties during 2001, as well as lower interest incomedue to a liquidation of the Company’s trading securities during 2002.  For the three months ended March 31, 2002,approximately 5.5% of the Company’s rental revenues resulted from percentagerents (rents determined as a percentage of tenant sales), compared with 6.7%for the three months ended March 31, 2001. Also included in revenues is interest income relating to notes andmortgage receivables from tenants and related parties.  Interest income was $1,041,000 for the threemonths ended March 31, 2002, compared with $1,346,000 for the three monthsended March 31, 2001.

 

Retail operations commenced in April 2001.  Retail income, which is comprised of revenue from operatingactivities, was $7,216,000 for the three months ended March 31, 2002.  Cost of sales associated with this revenuetotaled $5,940,000 and general and administrative costs associated with thisrevenue totaled $1,109,000 for the three months ended March 31, 2002.

 

Property expenses for thethree months ended March 31, 2002 totaled $628,000, an increase of 87.5% whencompared to the three months ended March 31, 2001.  This increase is primarily due to approximately $235,000 higherproperty taxes and $55,000 higher ground rent during 2002.  Depreciation and amortization expenses inthe three months ended March 31, 2002 totaled $5,318,000, a decrease of 11.1%when compared to the three months ended March 31, 2001.  This decrease relates directly to thedecrease in the number of properties owned during 2002 as compared to the sameperiod in 2001.

 

General and administrative expenses for the three months ended March31, 2002 totaled $1,925,000, a decrease of 39.3% when compared to the threemonths ended March 31, 2001.  Thisdecrease is primarily due to an $813,000 severance package to the Company’sformer Chief Executive Officer, $211,000 of costs associated with theconversion of the Company’s property management/accounting software system,$247,000 of costs associated with alternative financing for the Company andlegal costs associated with tenant litigation matters, all of which wereincurred in the quarter ended March 31, 2001.

 

Provisions for doubtful accounts for the three months ended March 31,2002 totaled $86,000 compared to $1,148,000 for the three months ended March31, 2001.  Provisions during the threemonths ended March 31, 2002 and 2001 resulted from the Company’s regularanalysis of its receivables to determine if circumstances indicate that thecarrying value of the receivable may not be recovered.

 

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Interest expense, amortization of loan origination fees and derivativesettlement payments for the three months ended March 31, 2002 totaled$5,693,000, a decrease of 37.5% when compared to the three months ended March31, 2001.  This decrease is primarilydue to the amortization of costs associated with the $175,000,000 bridge loanprovided by Bank of America during 2001, as well as a reduction in interestrates and lower debt levels in 2002.

 

During the three months ended March 31, 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 $809,000 was recorded from the revaluing of seven assetsto their estimated fair value.  Duringthe three months ended March 31, 2001, the Company recorded an asset impairmentcharge of $15,929,000.

 

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 March 31, 2002, the Company recognized$172,000 in income related to the ineffective portion of the interest rate swapwith Credit Lyonnais.  Loss on thisinterest rate swap agreement for the three months ended March 31, 2001 totaled$1,690,000.

 

The gain on sale of properties of $1,480,000, included in income fromdiscontinued operations, relates to the sale of seven properties for cash of$6,246,000, net of closing costs, for the three months ended March 31,2002.  The gain on sale of properties of$66,000 for the three months ended March 31, 2001 relates to the sale of sevenproperties for cash of $1,754,000, net of closing costs and notes of $878,000.

 

Minority interest in net income was $1,133,000 for the three monthsended March 31, 2002 compared to $1,004,000 for the three months ended March31, 2001.  For both the three monthsended March 31, 2002 and 2001, the amounts relate primarily to the Company’sminority interest in HJV which was formed in October 1999.

 

Loss on earlyextinguishment of debt was $340,000 for the three months ended March 31,2001.  On January 9, 2001, the Companypaid the outstanding balance under the Credit Lyonnais facility with proceedsfrom a bridge loan issued by Bank of America. In connection with this pay-off, the Company wrote-off $340,000 worth ofunamortized loan origination fees associated with this facility.

 

**Liquidity and Capital Resources**

 

The Company’s principalsource of cash to meet its short-term cash requirements is rental revenuesgenerated by the Company’s properties. As of March 31, 2002, the Company had one letter of intent for theacquisition of a restaurant property for approximately $700,000.  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 $600,000 during the remainder of the year endingDecember 31, 2002 to renovate and remodel currently owned properties.

 

During the first quarter of 2002 a party with a contract to purchasefrom the Company, 23 properties located in Hawaii defaulted on thecontract.  In April 2002 a settlementagreement was reached and cash of $660,000 and a note receivable of $125,000was received by the Company.  Of this$785,000, approximately $125,000 will be used to pay receivables due to theCompany and $660,000 will be recognized as revenue in the quarter ending June30, 2002.

 

In March 2002, the Company changed its declaration date for itsdividends from the last working day of the previous period to the first ofevery period.  During the first quarterof 2002, the Company paid three common stock dividends and declared two andpaid one preferred stock dividend and declared none.  Both the May common stock and June preferred stock dividends weredeclared on April 1, 2002.

 

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,filed on May 21, 2001.  Annual rent fromthese properties is approximately $1,504,000. At March 31, 2002, there was approximately $16,000 of receivables duefrom this tenant and the Company had no reserve for these amounts.

 

During October 2001, the Company was informed that one of itsborrowers, Lyon’s of California, Inc., had filed for protection under Chapter11 of the Bankruptcy Code.  At March 31,2002 there was approximately $10,000,000 due on notes from Lyon’s for which$2,500,000 had been reserved.  Interestincome associated with these notes has not been recognized since September2001.

 

17

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During February 2002, the Company was informed that ICH Corporation andits wholly owned subsidiary, Sybra, Inc., filed for protection under Chapter 11of the Bankruptcy Code.  At March 31,2002 there was approximately $562,000 due from ICH for which $275,000 had beenreserved.  ICH Corporation also servesas a guarantor for the Lyon’s notes previously described.  Sybra, Inc. currently leases 59 Arby’s®restaurant sites from the Company. Annual rent from these properties is approximately $4,622,000.  All post-bankruptcy rent has been receivedfrom this tenant, and the Company does not anticipate any adverse impairment ofvalues associated with these properties.

 

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 were 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.  AtMarch 31, 2002 there was $174,905,000 outstanding on the Certificates.

 

In conjunction with the completion of the offering of the Certificates,the Company entered into various interest rate protection agreements,including: an interest rate swap at a fixed rate of 3.825% for one year on anotional amount of $50,000,000, an interest rate collar with a floor of 4.42%and a ceiling of 6.00% for four years on a notional amount of $80,000,000.  Subsequently, the Company entered into aninterest rate swap at a fixed rate of 2.20% for six months on a notional amountof $20,000,000.  These derivativeseffectively lock in $50,000,000 at 4.8310% (3.825% plus 1.006%) for one year,lock in $80,000,000 at between 5.4260% (4.42% plus 1.006%) and 7.006% (6.0%plus 1.006%) for four years, and lock in $20,000,000 at 3.206% (2.200% plus1.006%) for six months.

 

Effective February 2002,the Company entered into a fixed to floating interest rate swap with Bank ofAmerica.  This fixed to floating interestrate swap is on a $25,000,000 notional value on which the Company receives afixed rate of 7.15% and pays a floating rate based on the three month LIBORplus a spread of 2.92%.  This interestrate swap terminates in May 2005.

 

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.  Theadoption of SFAS No. 133 as of January 1, 2001 resulted in the recognition of aliability of $1,474,000 with a cumulative effect adjustment to othercomprehensive income of $1,474,000.  Theinterest rate swap was designated as a cash flow hedge of the variable rateinterest payments related to the Company’s term loan with Credit Lyonnais.  As previously discussed, during January2001, the Company repaid the Credit Lyonnais term loan in full with proceedsfrom a bridge loan. Accordingly, the cash flow hedge relationship wasterminated, and the $1,474,000 in accumulated other comprehensive operationswas re-classified to earnings over a six-month period, which was theanticipated term of the bridge loan. From January 2001 until August 2001, this interest rate swap was notdesignated as a hedge, and accordingly all changes in value were recordeddirectly to earnings.  In connectionwith the completion of the Certificate offering, the Company designated thisinterest rate swap as a cash flow hedge of the variable interest rate paymentson $50,000,000 of the Certificates.  TheCompany reduced the notional amount of this interest rate swap by $20,000,000during 2001 for a cost of approximately $1,405,000.  During the first quarter of 2002, the Company paid $549,000 toreduce the notional amount of this interest rate swap to $15,000,000 effectiveMay 13, 2002.

 

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.  The Credit Agreement has aterm of up to two years and bears interest in traunches of 30, 60, 90 or 180 -day LIBOR contracts plus 225 basis points. The Credit Agreement also provides that up to $3,500,000 of the facilitymay be used for letters of credit. During 2001, Bank of America issued a letter of credit in the amount of$1,775,000 on behalf of the Company for the benefit of the preferredstockholders and letters of credit in the amount of $812,000 for the benefit ofa supplier of fuel.  There is a 2.25%fee per annum on the outstanding letters of credit.  Amounts available under this facility are further reduced by themarket value of the Bank of America Derivatives in excess of a $2,000,000threshold.  At March 31, 2002, theavailability under this facility was $1,354,000.

 

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

 

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transaction, the preferred interest holder receives annualdistributions equal to $4,675,000 payable monthly from the cash flows ofHJV.  Income is allocated to thepreferred 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.

 

During the quarter ending June 30, 2002, the Company anticipatesclosing on a $35,000,000 revolving credit facility with Bank of America.  Proceeds from this facility will be used toacquire properties in a series of sale/leaseback transactions.

 

Management believes that cash flow from operations, along with theCompany’s ability to raise additional equity or debt and anticipated sales ofproperties will provide the Company with sufficient liquidity to meet itsshort-term and long-term capital needs. However, there can be no assurances that the terms at which new debt isobtained will be as favorable 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 and April5, 2002, which may differ from the methodology for calculating FFO utilized byother equity REITs, and, accordingly, may not be comparable to such otherREITs.  The Company’s FFO is computed asnet income (loss) available to common stockholders (computed in accordance withaccounting principles generally accepted in the United States of America), plusreal estate related depreciation and amortization, gains (or losses) from salesof property, impairment of long-lived assets, extraordinary items andincome/loss allocable to minority interest holders.  The Company believes FFO is helpful to investors as a measure ofthe performance of an equity REIT because, along with the Company’s statementsof financial condition, results of operations and cash flows, it providesinvestors with an understanding of the ability of the Company to incur andservice debt and make capital expenditures. In evaluating FFO and the trends it depicts, investors should considerthe major factors affecting FFO.  Growthin FFO will result from increases in revenue or decreases in related operatingexpenses.  Conversely, FFO will declineif revenues decline or related operating expenses increase.  FFO does not represent amounts available formanagement’s discretionary use because of needed capital replacement orexpansion, debt service obligation, or other commitments anduncertainties.  FFO should not beconsidered as an alternative to net income (determined in accordance withaccounting principles generally accepted in the United States of America), asan indication of the Company’s financial performance, to cash flows fromoperating activities (determined in accordance with accounting principlesgenerally accepted in the United State of America) or as a measure of theCompany’s liquidity, nor is it indicative of funds available to fund theCompany’s cash needs, including its ability to make distributions.

 

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The following table sets forth, for the threemonths ended March 31, 2002 and 2001, the calculation of funds from operations.

 
|                                               |   | **Three Months Ended  March 31,** |   |
|----------------------------------------------------|--------|-----------------------------------|--------|
|                                               |   |                              |
| **(in thousands)**                                 |   | **2002**                          |   | **2001** |   |
|                                               |   |                              |   |   |   |
| Net income (loss) allocable to common stockholders |   | $                                 | 2,174  |   | $ | (21,695 | ) |
|                                               |   |                              |   |   |   |
| Depreciation and amortization                      |   | 5,321                             |   | 5,999 |   |
| Gain on sale of property                           |   | (1,480                            | )      | (66 | ) |
| Impairment of long-lived assets                    |   | 809                               |   | 15,929 |   |
| Income allocable to minority interests             |   | (31                               | )      | (165 | ) |
| Extraordinary item                                 |   | —                            |   | 340 |   |
|                                               |   |                              |   |   |   |
| Funds from operations — basic                 |   | 6,793                             |   | 342 |   |
| Adjustments to minority interest                   |   | (36                               | )      | (165 | ) |
| Income allocable to minority interest              |   | 31                                |   | 165 |   |
|                                               |   |                              |   |   |   |
| Funds from operations — diluted               |   | $                                 | 6,788  |   | $ | 342 |   |

 

**Inflation**

 

Some of the Company’s leases are subject toadjustments for increases in the Consumer Price Index, which reduces the riskto the Company of the adverse effects of inflation.  Additionally, to the extent inflation increases sales volume,percentage rents may tend to offset the effects of inflation on theCompany.  Because triple net leases alsorequire the property operator to pay for some or all operating expenses,property taxes, property repair and maintenance costs and insurance, some orall of the inflationary impact of these expenses will be borne by the property operatorand not by the Company.

 

**Seasonality**

 

Fast food restaurant operations historically havebeen seasonal in nature, reflecting higher unit sales during the second andthird quarters due to warmer weather and increased leisure travel.  This seasonality can be expected to causefluctuations in the Company’s quarterly revenue to the extent it earnspercentage rent.

 

**Risks Associated with Forward-LookingStatements 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 anychange in 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**

 

The Company has limited exposure to financialmarket risks, including changes in interest rates and other relevant marketprices, except as noted below.  The Companydoes not have any foreign operations and thus is not exposed to foreigncurrency 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 $3,085,000 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 decrease in interest rates would affect interest costsrelating to the Company’s variable rate Certificates.  At March 31, 2002 there was $174,905,000 of variable rate debtoutstanding on these Certificates.  TheCertificates bear interest at the 30 - day LIBOR plus 100.6 basis points.  The Company has entered into an interestrate swap effective July 3, 2000 with a notional amount of $50,000,000 whichwas subsequently reduced to $30,000,000 during the fourth quarter of 2001 andfurther reduced to $15,000,000 effective May 13, 2002.  The Company will pay a fixed rate of 7.05%and receive a variable rate based upon LIBOR under this swap agreement. Inconjunction with the completion of the offering of the Certificates, theCompany entered into the Bank of America Derivatives, including: an interestrate swap at a fixed rate of 3.825% for one year on a notional amount of$50,000,000, an interest rate collar with a floor of 4.42% and a ceiling of6.00% for four years on a notional amount of $80,000,000.  Subsequently, the Company entered into aninterest rate swap at a fixed rate of 2.20% for six months on a notional amountof $20,000,000.  These derivativeseffectively lock in $50,000,000 at 4.8310% (3.825% plus 1.006%) for one year,lock in $80,000,000 at between 5.4260% (4.42% plus 1.006%) and 7.006% (6.0%plus 1.006%) for four years, and lock in $20,000,000 at 3.206% (2.200% plus1.006%) for six months.  Based on theCompany’s variable rate debt and the derivatives designated as cash flow hedgesagainst this debt, a 10.0% increase or decrease in interest rates would resultin an annual increase or decrease in interest charges of approximately$155,000. Changes in interest rates do not have a direct impact on interestexpense relating to the remaining fixed rate debt facilities.

 

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.  At March 31, 2002 there were 131,915 OPUnits outstanding with a guaranteed market price of $23.50 per unit whichexpire July 29, 2002.

 

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**PARTII.                OTHER INFORMATION**

** **

**Item 1.****           Legal Proceedings**

 

None

 

**Item 2.****           Changes in Securitiesand Use of Proceeds**

 

None

 

**Item3.****           Defaults upon SeniorSecurities**

 

None

 

**Item 4.****           Submission of Mattersto a Vote of Security Holders**

 

None

 

**Item 5.****           Other Information**

 

None

 

**Item 6.****           Exhibits and Reports onForm 8-K**

 

a)                                      Exhibits

 

1)                                      Exhibit11.1 — Earnings per Share Computation

 

b)                                     Reportsof Form 8-K

 

No reports on Form 8-K were filed during the quarterended March 31, 2002.

 

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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:  May  14, 2002 | By:    | /s/ H.G.  Carrington, Jr.           |
|                       |   |  H.G. Carrington, Jr.          |
|                       |   |  Chief Financial Officer       |
|                       |   |  Chief Operating Officer       |
|                       |   |  (Principal Financial Officer) |

 

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**INDEX TO EXHIBITS**

 
| **EXHIBIT  NUMBER** |            |                           |   |
|---------------------|-----------------|--------------------------------|--------|
|                | **DESCRIPTION** |                           |
|                |            |                           |   |
| 11.1                |            | Earnings per Share Computation |   |

 

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