##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

|                |  |                                                                                  
|--------------- |  | ---------------------------------------------------------------------------------
|X IN BALLOT BOX |  | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

|                               |  |                   
|------------------------------ |  | ------------------
|For the quarterly period ended |  | September 30, 2001

OR

|                |  |                                                                                   
|--------------- |  | ----------------------------------------------------------------------------------
|OPEN BALLOT BOX |  | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

|                        |  |        
|----------------------- |  | -------
|Commission file number: |  | 0-29650

CAPTEC NET LEASE REALTY, INC.

Delaware

38-3368333

24 Frank Lloyd Wright Drive, Ann Arbor, Michigan 48106

(734) 994-5505

Not Applicable

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90
days. Yes X IN BALLOT BOX No OPEN BALLOT BOX

APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the registrants
classes of common equity, as of the latest practicable date.

9,508,108 shares of Common Stock, $.01 par value, outstanding as of November 14, 2001.

1



---

TABLE OF CONTENTS



|                              |                                                                                               |                                                           |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | --------------------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | Consolidated Balance Sheets                              
|                              |                                                                                               | Consolidated Statements of Operations                    
|                              |                                                                                               | Consolidated Statement of Changes in Stockholders Equity
|                              |                                                                                               | Consolidated Statements of Cash Flows                    
|                              |                                                                                               | Notes to Consolidated Financial Statements               
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Quantitative and Qualitative Disclosures about Market Risk                           
|PART II  OTHER INFORMATION  
|                              | Item 1. Legal Proceedings                                                                    
|                              | Item 2. Changes in Securities                                                                
|                              | 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 Report on Form 8-K                                                      



---



##### Table of Contents



CAPTEC NET LEASE REALTY, INC.
and SUBSIDIARIES

CONTENTS

|         |  |                                                                                       |  |        
|-------- |  | ------------------------------------------------------------------------------------- |  | -------
|Item No. |  |                                                                                       |  | Page   
|         |  |                                                                                       |  |        
|PART I   |  | FINANCIAL INFORMATION                                                                 |  |        
|        
|Item 1.  |  | Financial Statements:                                                                 |  |        
|        
|         |  | Consolidated Balance Sheets                                                           |  | 3      
|         |  | Consolidated Statements of Operations                                                 |  | 4      
|         |  | Consolidated Statement of Changes in Stockholders Equity                             |  | 5      
|         |  | Consolidated Statements of Cash Flows                                                 |  | 6      
|         |  | Notes to Consolidated Financial Statements                                            |  | 7  10 
|        
|Item 2.  |  | Managements Discussion and Analysis of
Financial Condition and Results of Operations |  | 11  14
|        
|Item 3.  |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 14     
|        
|PART II  |  | OTHER INFORMATION                                                                     |  |        
|        
|Item 1.  |  | Legal Proceedings                                                                     |  | 15     
|Item 2.  |  | Changes in Securities                                                                 |  | 15     
|Item 3.  |  | Defaults upon Senior Securities                                                       |  | 15     
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                   |  | 15     
|Item 5.  |  | Other Information                                                                     |  | 15     
|Item 6.  |  | Exhibits and Report on Form 8-K                                                       |  | 16     

2



---



##### Table of Contents












Part I. Financial InformationItem 1. Financial Statements

CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

|                                     |                                                                                                 |                                            |           |               |             |   |              |             |             | 
|------------------------------------ | ----------------------------------------------------------------------------------------------- | ------------------------------------------ | --------- | ------------- | ----------- | - | ------------ | ----------- | ----------- | 
|                                     |                                                                                                 |                                            |           | September 30, |             |   | December 31, |            
|                                     |                                                                                                 |                                            |           | 2001          |             |   | 2000         |            
|                                     |                                                                                                 |                                            |           |               |             |   |              |            
|ASSETS                               |                                                                                                 | (unaudited)                                |           |               |             |   |             
|                                    
|Cash and cash equivalents            |                                                                                                 | $                                          | 3,794,425 |               |             | $ | 665,408      |            
|                                    
|Investments:                         |                                                                                                 |                                            |           |               |             |   |              |            
|                                     | Properties subject to operating leases, net                                                     |                                            |           | 193,645,604   |             |   |              | 195,842,231 |            
|                                     | Properties subject to financing leases, net                                                     |                                            |           | 7,192,694     |             |   |              | 4,535,446   |            
|                                     | Loans to affiliates, collateralized by mortgage loans                                           |                                            |           | 11,246,212    |             |   |              | 11,280,234  |            
|                                     | Investment in joint venture                                                                     |                                            |           | 7,016,657     |             |   |              | 7,031,073   |            
|                                     | Investment in affiliated limited partnerships, net                                              |                                            |           | 4,114,960     |             |   |              | 4,163,069   |            
|                                     | Other loans                                                                                     |                                            |           | 257,145       |             |   |              | 283,323     |            
|                                     | Other loans, related party                                                                      |                                            |           | 360,214       |             |   |              | 373,799     |            
|                                     |                                                                                                 |                                            |           |               |             |  
|                                     |                                                                                                 | Total investments                          |           |               | 223,833,486 |   |              |             | 223,509,175 | 
|                                    
|Unbilled rent, net                   |                                                                                                 |                                            | 8,089,357 |               |             |   | 6,840,646    |            
|Accounts receivable                  |                                                                                                 |                                            | 803,250   |               |             |   | 693,101      |            
|Due from affiliates                  |                                                                                                 |                                            | 1,020,516 |               |             |   | 1,856,950    |            
|Other assets                         |                                                                                                 |                                            | 349,972   |               |             |   | 1,005,796    |            
|                                     |                                                                                                 |                                            |           |               |             |  
|                                    
|                                     |                                                                                                 | Total assets                               |           | $             | 237,891,006 |   |              | $           | 234,571,076 | 
|                                     |                                                                                                 |                                            |           |               |             |  
|                                    
|LIABILITIES AND STOCKHOLDERS EQUITY |                                                                                                 |                                            |           |               |             |   |              |            
|                                    
|Liabilities:                         |                                                                                                 |                                            |           |               |             |   |              |            
|                                     | Notes payable                                                                                   |                                            | $         | 103,443,632   |             |   | $            | 98,365,915  |            
|                                     | Accounts payable and accrued expenses                                                           |                                            |           | 2,068,632     |             |   |              | 952,252     |            
|                                     | Security deposits held on leases                                                                |                                            |           | 207,527       |             |   |              | 225,612     |            
|                                     |                                                                                                 |                                            |           |               |             |  
|                                    
|                                     |                                                                                                 | Total liabilities                          |           |               | 105,719,791 |   |              |             | 99,543,779  | 
|                                     |                                                                                                 |                                            |           |               |             |  
|Stockholders Equity:                |                                                                                                 |                                            |           |               |             |   |              |            
|                                     | Common stock, ($.01 par value) authorized: 40,000,000
shares; issued and outstanding: 9,508,108 |                                            |           | 95,081        |             |   |              | 95,081      |            
|                                     | Paid in capital                                                                                 |                                            |           | 134,711,056   |             |   |              | 134,711,056 |            
|                                     | Retained earnings (distributions in excess of earnings)                                         |                                            |           | (2,634,922    | )           |   |              | 221,160     |            
|                                     |                                                                                                 |                                            |           |               |             |  
|                                    
|                                     |                                                                                                 | Total stockholders equity                 |           |               | 132,171,215 |   |              |             | 135,027,297 | 
|                                     |                                                                                                 |                                            |           |               |             |  
|                                    
|                                     |                                                                                                 | Total liabilities and stockholders equity |           | $             | 237,891,006 |   |              | $           | 234,571,076 | 
|                                     |                                                                                                 |                                            |           |               |             |  

The accompanying notes are an integral part of the consolidated financial statements.

3



---



##### Table of Contents






CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |            |      |           |            |            |      | 
|----------------------------------------------------------------------- | --------------------------------------------- | ----------------------------------------------------------------------------------------- | --------- | --------- | ------------------ | ---- | --------- | ----------------- | --------- | ---- | --------- | ---------- | ---------- | ---- | --------- | ---------- | ---------- | ---- | 
|                                                                        |                                               |                                                                                           |           |           | Three Months Ended |      |           | Nine Months Ended |          
|                                                                        |                                               |                                                                                           |           |           | September 30,      |      |           | September 30,     |          
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |          
|                                                                        |                                               |                                                                                           |           |           | 2001               |      |           | 2000              |           |      | 2001      |            |            | 2000 |          
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |            |      |          
|Revenue:                                                                |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |            |      |           |           
|                                                                        | Rental income from operating leases           |                                                                                           | $         | 5,465,998 |                    |      | $         | 5,940,528         |           |      | $         | 16,439,038 |            |      | $         | 18,145,776 |           
|                                                                        | Earned income from financing leases           |                                                                                           |           | 173,622   |                    |      |           | 152,467           |           |      |           | 514,880    |            |      |           | 463,974    |           
|                                                                        | Interest income on loans to affiliates        |                                                                                           |           | 313,279   |                    |      |           | 316,642           |           |      |           | 935,552    |            |      |           | 947,736    |           
|                                                                        | Other income, principally affiliated ventures |                                                                                           |           | 382,675   |                    |      |           | 522,362           |           |      |           | 1,113,185  |            |      |           | 2,049,566  |           
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |           
|                                                                       
|                                                                        |                                               | Total revenue                                                                             |           |           | 6,335,574          |      |           |                   | 6,931,999 |      |           |            | 19,002,655 |      |           |            | 21,607,052 |     
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |           
|                                                                       
|Expenses:                                                               |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |            |      |           |           
|                                                                        | Interest                                      |                                                                                           |           | 2,329,288 |                    |      |           | 2,427,414         |           |      |           | 6,917,728  |            |      |           | 7,540,858  |           
|                                                                        | Management fees, affiliates, net              |                                                                                           |           | 116,895   |                    |      |           |                  |           |      |           | 352,507    |            |      |           |           |           
|                                                                        | General and administrative                    |                                                                                           |           | 391,447   |                    |      |           | 344,607           |           |      |           | 1,183,470  |            |      |           | 1,075,471  |           
|                                                                        | Depreciation and amortization                 |                                                                                           |           | 895,109   |                    |      |           | 859,414           |           |      |           | 2,588,320  |            |      |           | 2,591,927  |           
|                                                                        | Non-recurring merger and other costs          |                                                                                           |           | 917,260   |                    |      |           |                  |           |      |           | 1,180,132  |            |      |           | 1,143,000  |           
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |           
|                                                                       
|                                                                        |                                               | Total expenses                                                                            |           |           | 4,649,999          |      |           |                   | 3,631,435 |      |           |            | 12,222,157 |      |           |            | 12,351,256 |     
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |           
|                                                                       
|                                                                        |                                               | Income before equity in joint venture,
gain on sale of properties and other
non-recurring |           |           | 1,685,575          |      |           |                   | 3,300,564 |      |           |            | 6,780,498  |      |           |            | 9,255,796  |     
|                                                                       
|Equity in net income of joint venture                                   |                                               |                                                                                           | 209,697   |           |                    |      | 131,524   |                   |           |      | 623,056   |            |            |      | 426,601   |           
|                                                                       
|Gain on sale of properties                                              |                                               |                                                                                           |          |           |                    |      | 1,253,172 |                   |           |      | 579,607   |            |            |      | 2,864,393 |           
|                                                                       
|Other non-recurring                                                     |                                               |                                                                                           |          |           |                    |      |          |                   |           |      |          |            |            |      | 706,421   |           
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |           
|                                                                       
|                                                                        |                                               | Net Income                                                                                |           | $         | 1,895,272          |      |           | $                 | 4,685,260 |      |           | $          | 7,983,161  |      |           | $          | 13,253,211 |     
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |           
|                                                                       
|                                                                        |                                               | Income per common share:                                                                  |           |           |                    |      |           |                   |           |      |           |            |            |      |           |            |            |     
|                                                                        |                                               |                                                                                           | Basic     |           | $                  | 0.20 |           |                   | $         | 0.49 |           |            | $          | 0.84 |           |            | $          | 1.39 | 
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |           
|                                                                        |                                               |                                                                                           | Diluted   |           | $                  | 0.20 |           |                   | $         | 0.49 |           |            | $          | 0.84 |           |            | $          | 1.39 | 
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |           
|Weighted average number of common shares
outstanding, basic and diluted |                                               |                                                                                           | 9,508,108 |           |                    |      | 9,508,108 |                   |           |      | 9,508,108 |            |            |      | 9,508,108 |           
|                                                                        |                                               |                                                                                           |           |           |                    |      |           |                   |           |      |           |            |           

The accompanying notes are an integral part of the consolidated financial statements.

4



---



##### Table of Contents






CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001
(unaudited)



|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |           |              |           |             |           |                   |  | 
|---------------------------------------- | --------------------------- | ----------------------- | -------------------- | - | ------------ | - | ------ | ------- | - | - | ------------- | - | - | ------------------------ | - | --------- | ------------ | --------- | ----------- | --------- | ----------------- |  | 
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |           |              |           |             |           | Retained Earnings | 
|                                         |                             |                         |                      |   | Common Stock |   |        | Paid-In |   |   | Comprehensive |   |   | (Distributions in excess |  
|                                         |                             |                         |                      |   |              |  
|                                         |                             |                         |                      |   | Shares       |   |        | Amount  |   |   | Capital       |   |   | Income                   |   |           | of earnings) |          
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |           |              |          
|BALANCE, JANUARY 1, 2001                 |                             |                         | 9,508,108            |   |              | $ | 95,081 |         |   | $ | 134,711,056   |   |   | $                        |  |           |              | $         | 221,160     |          
|                                         | Net Income                  |                         |                      |  |              |   |        |        |   |   |               |  |   |                          |   | 7,983,161 |              |           |             | 7,983,161 |                  
|                                         | Other comprehensive income: |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |           |              |           |             |           |                  
|                                         |                             | Net loss on derivatives |                      |   |             |   |        |         |  |   |               |   |  |                          |   |           | (206,399     | )         |             |           |                  | 
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |           |              |           |            
|                                         |                             |                         | Comprehensive income |   |              |   |        |         |   |   |               |   |   |                          |   |           |              | 7,776,762 |             |           |                   |  | 
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |           |              |           |            
|Common stock dividends ($1.14 per share) |                             |                         |                     |   |              |   |       |         |   |   |              |   |   |                          |   |           |              |           | (10,839,243 | )        
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |          
|BALANCE, SEPTEMBER 30, 2001              |                             |                         | 9,508,108            |   |              | $ | 95,081 |         |   | $ | 134,711,056   |   |   |                          |   |           |              | $         | (2,634,922  | )        
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |          

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                         |                             |                         |                      |   |                   |   |             |               |          |   | 
|---------------------------------------- | --------------------------- | ----------------------- | -------------------- | - | ----------------- | - | ----------- | ------------- | -------- | - | 
|                                         |                             |                         |                      |   | Accumulated Other |   |             | Total         |         
|                                         |                             |                         |                      |   | Comprehensive     |   |             | Stockholders' |         
|                                         |                             |                         |                      |   | Income (Loss)     |   |             | Equity        |         
|                                         |                             |                         |                      |   |                   |   |             |               |         
|BALANCE, JANUARY 1, 2001                 |                             | $                       | 206,399              |   |                   | $ | 135,233,696 |              
|                                         | Net Income                  |                         |                      |  |                   |   |             | 7,983,161     |         
|                                         | Other comprehensive income: |                         |                      |   |                   |   |             |               |         
|                                         |                             | Net loss on derivatives |                      |   | (206,399          | ) |             |               | (206,399 | )
|                                         |                             |                         |                      |   |                   |   |             |              
|                                         |                             |                         | Comprehensive income |   |                   |   |             |               |          |   | 
|                                         |                             |                         |                      |   |                   |   |             |              
|Common stock dividends ($1.14 per share) |                             |                         |                     |   |                   |   | (10,839,243 | )            
|                                         |                             |                         |                      |   |                   |  
|BALANCE, SEPTEMBER 30, 2001              |                             | $                       |                     |   |                   | $ | 132,171,215 |              
|                                         |                             |                         |                      |   |                   |  

The accompanying notes are an integral part of the consolidated financial statements.

5



---



##### Table of Contents






CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

|                                                                     |                                                              |   |                   |            |   |      |             |             |  
|-------------------------------------------------------------------- | ------------------------------------------------------------ | - | ----------------- | ---------- | - | ---- | ----------- | ----------- | -
|                                                                     |                                                              |   | Nine Months Ended |           
|                                                                     |                                                              |   | September 30,     |           
|                                                                     |                                                              |   |                   |           
|                                                                     |                                                              |   | 2001              |            |   | 2000 |            
|                                                                     |                                                              |   |                   |            |   |      |            
|                                                                    
|CASH FLOWS FROM OPERATING ACTIVITIES:                                |                                                              |   |                   |            |   |      |             |            
|Net income                                                           |                                                              | $ | 7,983,161         |            |   | $    | 13,253,211  |            
|Adjustments to net income:                                           |                                                              |   |                   |            |   |      |             |            
|                                                                     | Depreciation and amortization                                |   |                   | 2,588,320  |   |      |             | 2,591,927   |  
|                                                                     | Amortization of debt issuance costs                          |   |                   | 1,443,506  |   |      |             | 819,396     |  
|                                                                     | Equity in net income of joint venture                        |   |                   | (623,056   | ) |      |             | (426,601    | )
|                                                                     | Gain on sale of property, net                                |   |                   | (579,607   | ) |      |             | (2,864,393  | )
|                                                                     | Increase in unbilled rent                                    |   |                   | (1,248,711 | ) |      |             | (1,117,863  | )
|                                                                     | Increase in accounts receivable and other assets             |   |                   | (168,421   | ) |      |             | (2,189,788  | )
|                                                                     | Increase (decrease) in accounts payable and accrued expenses |   |                   | 1,116,380  |   |      |             | (1,723,490  | )
|                                                                     |                                                              |   |                   |            |   |     
|                                                                    
|                                                                     | Net cash provided by operating activities                    |   |                   | 10,511,572 |   |      |             | 8,342,399   |  
|                                                                     |                                                              |   |                   |            |   |     
|                                                                    
|CASH FLOWS FROM INVESTING ACTIVITIES:                                |                                                              |   |                   |            |   |      |             |            
|Acquisition of properties subject to operating leases                |                                                              |   | (8,499,472        | )          |   |      | (12,468,080 | )          
|Acquisition of properties subject to financing leases                |                                                              |   | (2,686,203        | )          |   |      |            |            
|Advances on short-term loans to affiliates, net                      |                                                              |   |                  |            |   |      | (1,571,224  | )          
|Proceeds from the disposition of properties                          |                                                              |   | 8,842,519         |            |   |      | 27,962,782  |            
|Collections on loans to affiliates, collateralized by
mortgage loans |                                                              |   | 34,022            |            |   |      | 1,643,858   |            
|Collection of principal on other loans                               |                                                              |   | 39,763            |            |   |      | 12,396      |            
|Proceeds from joint venture distribution                             |                                                              |   | 637,472           |            |   |      | 700,211     |            
|Collection of principal on financing leases, net                     |                                                              |   | 28,955            |            |   |      | (99,475     | )          
|Lease security deposits                                              |                                                              |   | (18,085           | )          |   |      | (28,082     | )          
|                                                                     |                                                              |   |                   |            |   |     
|                                                                    
|                                                                     | Net cash (used in) provided by investing activities          |   |                   | (1,621,029 | ) |      |             | 16,152,386  |  
|                                                                     |                                                              |   |                   |            |   |     
|                                                                    
|CASH FLOWS FROM FINANCING ACTIVITIES:                                |                                                              |   |                   |            |   |      |             |            
|Dividends paid on common stock                                       |                                                              |   | (10,839,243       | )          |   |      | (10,839,243 | )          
|Borrowings of notes payable                                          |                                                              |   | 15,500,000        |            |   |      | 11,945,000  |            
|Repayments of notes payable                                          |                                                              |   | (10,422,283       | )          |   |      | (24,488,143 | )          
|                                                                     |                                                              |   |                   |            |   |     
|                                                                    
|                                                                     | Net cash used in financing activities                        |   |                   | (5,761,526 | ) |      |             | (23,382,386 | )
|                                                                     |                                                              |   |                   |            |   |     
|                                                                    
|NET CASH FLOWS                                                       |                                                              |   | 3,129,017         |            |   |      | 1,112,399   |            
|                                                                    
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                       |                                                              |   | 665,408           |            |   |      | 1,035,607   |            
|                                                                     |                                                              |   |                   |            |   |     
|                                                                    
|CASH AND CASH EQUIVALENTS, END OF PERIOD                             |                                                              | $ | 3,794,425         |            |   | $    | 2,148,006   |            
|                                                                     |                                                              |   |                   |            |   |     

The accompanying notes are an integral part of the consolidated financial statements.

6



---



##### Table of Contents






CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



|1. |  | ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Organization: Captec Net Lease Realty, Inc. (the Company), which has operated as a REIT since
November 1997, acquires, develops and owns freestanding properties which are leased on a
long-term triple-net basis to operators of national and regional chain restaurants and national
retailers. Triple-net leases generally impose on the lessee responsibility for all operating
costs and expense of the property, including the costs of repairs, maintenance, real property
taxes, assessments, utilities and insurance. The Companys leases typically provide for minimum
rent plus specified fixed periodic rent increases.                                                                                                                                                                                                                                                                             
|  
|   |  | On July 2, 2001, the Company announced it had entered into a merger agreement with Commercial
Net Lease Realty, Inc. (CNL). CNL will acquire all of the outstanding shares of common stock
of the Company for a combination of cash and stock. The merger is subject to approval by the
Companys stockholders and other conditions set forth in the merger agreement, and is expected
to close in the fourth quarter of 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|  
|   |  | Unaudited Interim Financial Information: The consolidated balance sheet as of September 30,
2001 and the consolidated statements of operations, stockholders equity and cash flows for the
three and nine months ended September 30, 2001 and 2000 have not been audited. In the opinion
of management, all adjustments (including normal recurring adjustments) considered necessary
for a fair presentation have been reflected therein. Results of operations for the interim
periods are not necessarily indicative of results for the full year. These unaudited financial
statements should be read in conjunction with the financial statements and notes thereto
included in the Companys Annual Report on Form 10-K for the year ended December 31, 2000 filed
with the United States Securities and Exchange Commission on March 30, 2001.                                                             
|  
|   |  | Derivatives: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities (FAS 133). In June 2000, FASB issued SFAS No. 138, Accounting for Certain
Derivative Instruments and Certain Hedging Activities, (FAS 138) which amends FAS 133. The
statement requires that all derivative instruments be recorded at fair value on the balance
sheet with changes in fair value recorded each period in current earnings and/or other
comprehensive income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. Any change in fair value resulting
from ineffectiveness, as defined by FAS 133 is recognized immediately in current earnings. The
Company adopted FAS 133, as amended, on January 1, 2001.
|  
|2. |  | PROPERTIES SUBJECT TO OPERATING LEASES:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  
|   |  | Properties subject to operating leases represent various properties leased to tenants under
long-term net operating leases. The lease agreements generally provide for monthly rents based
upon a percentage of the propertys cost. The initial term of the leases typically ranges from
15 to 20 years, although the Company in certain cases will enter into leases with terms that
are shorter or longer. Most leases also provide for one or more five year renewal options. In
addition, certain leases provide the tenant one or more options to purchase the properties at a
predetermined price, generally only during stated periods during the fifth to seventh lease
years.                                                                                                                                                                                                                            

7



---



##### Table of Contents



CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



| |                                                                                                                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Companys investment in properties subject to operating leases includes capitalized
acquisition and interest costs which have been allocated between land and buildings and
improvements on a pro rata basis. The net investment in properties subject to operating leases
is comprised of the following as of:

|                                 |  |               |             |   |              |   |             |  
|-------------------------------- |  | ------------- | ----------- | - | ------------ | - | ----------- | -
|                                 |  | September 30, |             |   | December 31, |  
|                                 |  | 2001          |             |   | 2000         |  
|                                 |  |               |             |   |              |  
|Land                             |  | $             | 78,848,674  |   |              | $ | 79,432,815  |  
|Buildings and improvements       |  |               | 126,325,232 |   |              |   | 124,194,854 |  
|Construction draws on properties |  |               |            |   |              |   | 1,698,032   |  
|                                 |  |               |             |   |              |  
|                                 |  |               | 205,173,906 |   |              |   | 205,325,701 |  
|Less accumulated depreciation    |  |               | (11,528,302 | ) |              |   | (9,483,470  | )
|                                 |  |               |             |   |              |  
|Total                            |  | $             | 193,645,604 |   |              | $ | 195,842,231 |  
|                                 |  |               |             |   |              |  



| |                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Company sold 8 properties during the nine months ended September 30, 2001, collecting total
net proceeds of $8.8 million and reflected a net gain totaling approximately $580,000 on the
sale of these properties.



|3. |  | FINANCING LEASES:                                                                                                                                                                                                                                                                                    
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Properties subject to financing leases is comprised of six properties with respect to which the
Company owns only the building and the land is subject to a ground lease between the tenant and
an unrelated third party. The net investment in financing leases is comprised of the following
as of:

|                                      |                                      |   |               |            |  |              |            |           | 
|------------------------------------- | ------------------------------------ | - | ------------- | ---------- |  | ------------ | ---------- | --------- | 
|                                      |                                      |   | September 30, |            |  | December 31, |           
|                                      |                                      |   | 2001          |            |  | 2000         |           
|                                      |                                      |   |               |            |  |              |           
|Minimum lease payments to be received |                                      | $ | 15,414,443    |            |  | $            | 9,703,037  |          
|Estimated residual value              |                                      |   |              |            |  |              |           |          
|                                      |                                      |   |               |            |  |             
|                                      | Gross investment in financing leases |   |               | 15,414,443 |  |              |            | 9,703,037 | 
|Unearned income                       |                                      |   | (8,221,749    | )          |  |              | (5,167,591 | )        
|                                      |                                      |   |               |            |  |             
|                                      | Net investment in financing leases   |   | $             | 7,192,694  |  |              | $          | 4,535,446 | 
|                                      |                                      |   |               |            |  |             



|4. |  | INVESTMENT IN JOINT VENTURE:                                                                                                                                                                                                                                                                            
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The Company has a 22.6% membership interest in FC Venture I, LLC (FC Venture). The
investment is accounted for under the equity method. Summarized financial information of the
Companys joint venture investment as of and for the nine months ended September 30, 2001 and
2000 is set forth below:

|                                                |  |      |            |  |      |   |            | 
|----------------------------------------------- |  | ---- | ---------- |  | ---- | - | ---------- | 
|                                                |  | 2001 |            |  | 2000 |  
|                                                |  |      |            |  |      |  
|Investment in properties subject to leases, net |  | $    | 47,516,418 |  |      | $ | 48,389,457 | 
|Total assets                                    |  |      | 50,862,090 |  |      |   | 51,238,984 | 
|Notes payable                                   |  |      | 20,549,227 |  |      |   | 20,233,425 | 
|Total liabilities                               |  |      | 20,763,619 |  |      |   | 21,071,372 | 
|Members equity                                 |  |      | 30,098,471 |  |      |   | 30,167,612 | 
|Revenues                                        |  |      | 4,329,587  |  |      |   | 3,537,521  | 
|Net income                                      |  |      | 2,756,884  |  |      |   | 1,887,614  | 

8



---



##### Table of Contents



CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



|5. |  | NOTES PAYABLE:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The Companys credit facility, as amended February 26, 2001, provides up to $105.0 million for
the acquisition and development of properties and working capital. The Company extended the
termination date of the credit facility to November 30, 2001, pursuant to the credit facility
agreement. The credit facility is subject to certain borrowing base restrictions. The Company
had approximately $101.6 million of aggregate outstanding borrowings under the credit facility
at September 30, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  
|   |  | During 2000, the Company entered into three promissory notes for an aggregate amount of
$1,945,000 with a lending institution. The notes are collateralized by certain properties in
the Companys property portfolio. The notes have terms ranging from 15 years to 20 years and
bear interest at 9.0% per annum. As of September 30, 2001, the outstanding balance of the
promissory notes is $1,828,231.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|  
|6. |  | DERIVATIVE INSTRUMENTS:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|  
|   |  | In accordance with the provisions of FAS 133, on January 1, 2001 the Company recorded a
cumulative-effect-type transition adjustment of $206,399 in accumulated other comprehensive
income to recognize at fair value two derivatives that were designated as cash-flow hedging
instruments. These derivative instruments expired on July 2, 2001 and as a result, during the
nine months ended September 30, 2001 the Company recorded a decrease in fair value of the
interest rate instruments of $206,399, which has been recognized in accumulated other
comprehensive loss. The cash flow hedges had no ineffectiveness for the period and accordingly,
no amounts were recorded in the statement of operations. At September 30, 2001, the Company had
one derivative instrument, an interest rate cap agreement. This instrument has been entered
into to meet the Companys risk management objective, which is to manage the interest rate
exposure associated with borrowings under its floating rate credit facility. The Company has
designated this instrument as a cash flow hedge as it is used to hedge fluctuations in interest
payments. At September 30, 2001 this instrument had a fair value of $0.
|  
|7. |  | EARNINGS PER SHARE:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  
|   |  | Stock options currently outstanding were excluded from the computation of diluted earnings per
share because their exercise price was in excess of the average market price of the Companys
common stock during the nine months ended September 30, 2001 and 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  
|8. |  | NON-RECURRING ITEMS:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|  
|   |  | On May 1, 2000, the Company terminated a merger agreement that resulted in the Company
recognizing expense of $1.1 million in non-recurring merger costs during the nine months ended
September 30, 2000. During the nine months ended September 30, 2001, the Company incurred $1.2
million in costs associated with the sale of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|  
|9. |  | RELATED PARTY TRANSACTIONS:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|  
|   |  | The Company is party to an advisory agreement, as amended, with Captec Net Lease Realty
Advisors, Inc. (Captec Advisors), an affiliate, whereby the Company pays to Captec Advisors a
management fee. During the nine months ended September 30, 2001, the Company incurred
approximately $950,000 in management fees to Captec Advisors, of which $600,000 was paid by
Family Realty II, Inc., an affiliate of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|  
|   |  | During the nine months ended September 30, 2001, the Company purchased three properties from
Family Realty II, Inc., an affiliate, for an aggregated purchase price of $6,285,400. In
addition, during the nine months ended September 30, 2001, the Company purchased one property
from FC Venture, an affiliate, for $1,156,203.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

9



---



##### Table of Contents



CAPTEC NET LEASE REALTY, INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



|10. |  | SUBSEQUENT EVENTS:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | In October 2001, the Company declared dividends to its shareholders of $3,613,081, or $0.38 per
share of common stock, which was paid on October 18, 2001.                                                                                                                                                                                                                                                                                                                                                                                                   
|   
|    |  | On October 11, 2001, the Company announced it had commenced the mailing of its definitive proxy
materials to the stockholders for approval of its proposed merger with Commercial Net Lease
Realty, Inc. In addition, the Company filed a Definitive Proxy Statement with the United States
Securities and Exchange Commission. A Special Meeting of stockholders has been scheduled for
November 19, 2001 to vote on the merger. Pending approval by the stockholders on November 19,
2001, the Company expects to close on the merger by November 30, 2001.

10



---



##### Table of Contents






ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

The Company, which operates as a REIT, acquires, develops and owns freestanding properties
which are leased on a long-term triple-net basis to operators of national and regional chain
restaurants and retailers. The Companys triple-net leases generally impose on the lessee
responsibility for all operating costs and expenses of the property, including the costs of
repairs, maintenance, real property taxes, assessments, utilities and insurance. The Companys
leases typically provide for minimum rent plus specified fixed periodic rent. The Companys
long-term leases with creditworthy lessees mitigate short-term fluctuations in the general
economy, thereby reducing the impact these fluctuations have on its operations. Other revenues
are derived primarily from fee income earned from affiliates and interest income on loans to
affiliates.

As of September 30, 2001, the Company owned 136 properties, located in 26 states, subject to
long-term net leases with 54 different lessees under major restaurant and retail concepts
including Bennigans, Applebees, Dennys, Blockbuster Video, and Jared Jewelers.

On July 2, 2001, the Company announced it has entered into a merger agreement with Commercial
Net Lease Realty, Inc. (CNL). CNL will acquire all of the outstanding shares of common stock
of the Company for a combination of cash and stock. The merger is subject to stockholder
approval by the Companys stockholders and other conditions set forth in the merger agreement.
A Special Meeting of stockholders has been scheduled for November 19, 2001 to vote on the
merger. Pending approval by the stockholders on November 19, 2001, the Company expects to
close on the merger by November 30, 2001

RESULTS OF OPERATIONS

Three Months Ended September 30, 2001.During the three months ended September 30, 2001 total
revenue decreased 8.6% to $6.3 million as compared to $6.9 million for the three months ended
September 30, 2000. Rental revenue from operating leases for the three months ended September
30, 2001 decreased 8.0% to $5.5 million as compared to $5.9 million for the three months ended
September 30, 2000, due to the reduction of the Companys property portfolio as a result of
property sales. Earned income from financing leases for the three months ended September 30,
2001 increased 13.9% to approximately $174,000 as compared to approximately $152,000 for the
three months ended September 30, 2000. The increase is the result of the addition of two
properties subject to financing leases in the first quarter of 2001. Other income decreased
26.7% to approximately $383,000 for the three months ended September 30, 2001 as compared to
$522,000 for the three months ended September 30, 2000. The decrease is due to reduced
one-time acquisition related fees from affiliated ventures. The amount of fees earned for the
acquisition, development and management of properties on behalf of
affiliated ventures is subject to variations, principally by the amount of new properties identified and acquired by
the affiliated ventures.

Total expenses increased 28.1% to $4.7 million for the three months ended September 30, 2001 as
compared to $3.6 million for the three months ended September 30, 2000. Interest expense
decreased 4.0% to $2.3 million for the three months ended September 30, 2001 as compared to
$2.4 million for the three months ended September 30, 2000. The decrease was due to a 185
basis point decrease in the weighted average interest rate and a $5.3 million decrease in the
average outstanding borrowings under the Companys credit facility used to fund the acquisition
and development of properties, partially offset by an increase of approximately $400,000 in
amortization of deferred financing costs. Management fees were approximately $117,000 during
the three months ended September 30, 2001. The increase is the result of reduced acquisition
levels for the affiliated ventures, which provide for a reduction in the management fee paid by
the Company to Captec Advisors, an affiliate. During the three months ended September 30,
2000, the acquisition levels for the affiliated ventures fully supported the management fee paid
by the Company. The management fee paid and reductions received are subject to variations,
principally changes in the Companys property portfolio balance caused by property acquisitions
and dispositions, and the amount of new properties identified and acquired by the affiliated
ventures. General and administrative expenses increased 13.6%

11



---



##### Table of Contents



to approximately $391,000 for
the three months ended September 30, 2001 as compared to approximately $345,000 for the three
months ended September 30, 2000 as a result of increases in payroll related costs and property
taxes paid on vacant properties. Non-recurring items for the three months ended September 30,
2001 were approximately $917,000. The costs incurred during the three months ended September
30, 2001 represent costs related to the proposed merger of the Company.

The Company holds a 22.6% membership interest in FC Venture I, LLC. During the three months
ended September 30, 2001, the Company recorded approximately $210,000 as its portion of FC
Ventures equity earnings as compared to approximately $132,000 for the three months ended
September 30, 2000. The increase is primarily due to the growth of FC Ventures property
portfolio.

As a result of the foregoing, the Companys net income decreased 59.6% to $1.9 million for the
three months ended September 30, 2001 as compared to $4.7 million for the three months ended
September 30, 2000.

Nine Months Ended September 30, 2001.During the nine months ended September 30, 2001 total
revenue decreased 12.1% to $19.0 million as compared to $21.6 million for the nine months ended
September 30, 2000. Rental revenue from operating leases for the nine months ended September
30, 2001 decreased 9.4% to $16.4 million as compared to $18.1 million for the nine months ended
September 30, 2000. The decrease is due to the reduction in the Companys property portfolio
as a result of property sales. Earned income from financing leases for the nine months ended
September 30, 2001 increased 11.0% to approximately $515,000 as compared to approximately
$464,000 for the nine months ended September 30, 2000. The increase is the result of the
addition of two properties subject to financing leases in the first quarter of 2001. Other
income decreased 45.7% to $1.1 million for the nine months ended September 30, 2001 as compared
to $2.0 million for the nine months ended September 30, 2000. The decrease is due to reduced
one-time acquisition related fees from affiliated ventures. The amount of fees earned for the
acquisition, development and management of properties on behalf of affiliated ventures are
subject to variations, principally by the amount of new properties identified and acquired by
the affiliated ventures.

Interest expense for the nine months ended September 30, 2001 decreased 8.3% to $6.9 million as
compared to $7.5 million for the nine months ended September 30, 2000. The decrease was due to
a 79 basis point decrease in the weighted average interest rate as well a $14.1 million
decrease in the average outstanding borrowings under the Companys credit facility used to fund
the acquisition and development of properties, partially offset by an increase of approximately
$620,000 in amortization of deferred financing costs. Management fees were approximately
$353,000 during the nine months ended September 30, 2001. The increase is the result of
reduced acquisition levels for the affiliated ventures, which provide for a reduction in the
management fee paid by the Company to Captec Advisors, an affiliate. During the nine months
ended September 30, 2000, the acquisition levels of the affiliated ventures fully supported the
management fee paid by the Company. The management fee paid and reductions received are
subject to variations, principally changes in the Companys property portfolio balance caused
by property acquisitions and dispositions, and the amount of new properties identified and
acquired by the affiliated ventures. General and administrative expenses increased 10.0% to
$1.2 million for the nine months ended September 30, 2001 as compared to $1.1 million for the
nine months ended September 30, 2000 as a result of increases in payroll related costs and
property taxes paid on vacant properties. Non-recurring items increased 3.3% to $1.2 for the
nine months ended September 30, 2001 as compared to $1.1 million for the nine months ended
September 30, 2000. The costs incurred during the nine months ended September 30, 2001
represent costs related to the proposed merger of the Company. The $1.1 million expensed
during the nine months ended September 30, 2000 relates to the termination of a previous merger
agreement that was announced on May 1, 2000.

The Company sold 8 properties during the nine months ended September 30, 2001, collecting total
net proceeds of $8.8 million and reflecting a net gain of approximately $580,000 on the sale of
these properties.

During the nine months ended September 30, 2001, the Company recorded approximately $623,000 as
its portion of FC Ventures equity earnings. The increase is primarily due to the growth of FC
Ventures property portfolio.

During the nine months ended September 30, 2000 an IRS audit of periods prior to the Companys
initial public

12



---



##### Table of Contents



offering was completed resulting in no additional tax payment. As a result of
the completed audit the Company recorded other non-recurring income of approximately $706,000
representing a reversal of a previously provided allowance for estimated taxes .

As a result of the foregoing, the Companys net income decreased 39.8% to $8.0 million for the
nine months ended September 30, 2001 as compared to $13.3 million for the nine months ended
September 30, 2000.

LIQUIDITY AND CAPITAL RESOURCES

The Companys principal use of funds is for property development and acquisition, payment of
interest on its outstanding indebtedness, and payment of operating expenses and dividends.
Historically, interest expense, operating expenses and dividends have been paid out of cash
flows from operations. Property acquisition and development have been typically funded out of
proceeds from borrowings. The Company expects to meet its liquidity requirements, which are
principally property acquisition and development and scheduled debt maturities, through a
variety of future sources of capital, including long-term collateralized and uncollateralized
indebtedness, the issuance of additional equity or debt securities and off-balance sheet
financing through the formation of joint ventures.

The Companys leases generally provide for specified periodic rent increases. In addition,
most of the Companys leases require the lessee to pay all operating costs and expenses
including repairs, maintenance, real property taxes, assessments, utilities and insurance,
thereby substantially reducing the Companys exposure to increases in costs and operating
expenses. Based upon these factors, the Company does not anticipate significant capital
demands related to the management of its properties.

At September 30, 2001, the Company had cash and cash equivalents of $3.8 million. For the nine
months ended September 30, 2001, the Company generated cash from operations of $10.5 million as
compared to $8.3 million for the nine months ended September 30, 2000. Cash generated from
operations provides funds for dividends. Any excess cash from operations may also be used for
investment in properties. For the nine months ended September 30, 2001 the Company utilized
$1.6 million in investing activities as compared to generating $16.1 million from investing
activities during the nine months ended September 30, 2000. The Company used $5.8 million for
financing activities during the nine months ended September 30, 2001 as compared to using $23.4
million during the nine months ended September 30, 2000.

CREDIT FACILITY. In February 2001, the Company amended and extended the maturity of its credit
facility with First Union National Bank. The effect of the amendment was to extend the maturity
to August 31, 2001. The amendment also resulted in an increased interest rate spread over LIBOR
to a range of 2.25% to 2.50%, dependent upon the ratio of debt to asset value, and reduced the
facility borrowing capacity to $105.0 million. Prior to August 31, 2001, the Company extended
the maturity of the credit facility an additional three months to November 30, 2001, pursuant to the agreement. The
extension of the credit facility has been designed to be short-term in nature to enable the
Company to continue to operate with a flexible capital structure. With the extension of the
credit facility termination date, the borrowing spread over LIBOR increased to a range of 2.75%
to 3.00%, dependent upon the ratio of debt to asset value. Upon expiration of the credit
facility, the Company intends to refinance its indebtedness under the credit facility through a
new facility or loan with an institutional lender and/or through the issuance of debt
securities. The terms of the Companys obligations with respect to any indebtedness incurred in
refinancing the credit facility will be based on market conditions applicable to such form of
indebtedness at the time, which may cause the terms of any such indebtedness to vary materially
from the terms of the credit facility. No assurances can be made that the Company will be able
to refinance such debt. At September 30, 2001, the Company had $101.6 million outstanding
under the credit facility. Notwithstanding the above, pursuant to the merger agreement with
CNL, the Companys entire outstanding principal balance under the credit facility will be
repaid by CNL upon completion of the merger which remains subject to stockholder approval and
other conditions set forth in the merger agreement.

PROPERTY SALES. The Company periodically has explored the marketability of certain properties
in its portfolio that would contribute to greater diversification levels in tenants, geography,
property type and property size thereby

13



---



##### Table of Contents



increasing the strength of its current portfolio. At
September 30, 2001, no properties in the Companys portfolio are being actively marketed.

DIVIDENDS. During the nine months ended September 30, 2001 the Company paid dividends of
$10,839,243. In October 2001, the Company declared a third quarter dividend on its common
stock in the amount of $0.38 per share or $3,613,081. The dividend was payable to stockholders
of record on October 11, 2001 and was paid on October 18, 2001. The Company expects to pay
future dividends from cash available for distribution. The Company believes that cash from
operations will be sufficient to allow the Company to make distributions necessary to enable
the Company to continue to qualify as a REIT.

Recently Issued Accounting Standards

In June 2001, the FASB issued Statement of Financial Accounting Standard ( SFAS ) No. 141 -
Business Combinations which addresses financial accounting and reporting for business
combinations. This standard also addresses financial accounting and reporting for goodwill and
other intangible assets acquired in a business combination at acquisition. The provisions of
this SFAS apply to all business combinations initiated after June 30, 2001. The Company does
not expect this pronouncement to have a material impact on the Company s financial position or
cash flows.

In June 2001, the FASB issued SFAS No. 142  Goodwill and Other Intangibles which addresses
financial accounting and reporting for intangible assets acquired individually or with a group
of other assets (but not those acquired in a business combination) at acquisition. This
standard also addresses financial accounting and reporting for goodwill and other intangible
assets subsequent to their acquisition. The new standard becomes effective for the Company for
the year ending December 31, 2002. The Company does not expect this pronouncement to have a
material impact on the Company s financial position or cash flows.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. This Statement supersedes SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting
provisions of APB Opinion No. 30, Reporting the Results of Operations  Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions, for the disposal of a segment of a business (as previously defined in
that Opinion). The provisions of this SFAS 144 are effective for financial statements issued
for fiscal years beginning after December 15, 2001, and interim periods within those fiscal
years, with early application encouraged. The provisions of this standard generally are to be
applied prospectively. The Company is currently evaluating the impact this standard will have
on its financial statements.




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents a risk of loss arising from adverse changes in market prices and interest
rates. The Companys market risk arises from interest rate risk inherent in its financial
instruments. The Company is not subject to foreign currency exchange rate risk or commodity
price risk.

The Company monitors and manages interest rate exposure as an integral part of its overall risk
management program, which recognizes the unpredictability of financial markets and seeks to
reduce the potentially adverse effect on its results. At September 30, 2001, approximately 98%
of the Companys debt bore interest at variable rates of LIBOR plus 2.75% to 3.00%.

14



---



##### Table of Contents



The following table presents certain information on the Companys assets and liabilities which
are sensitive to interest rate changes at September 30, 2001:

|             |                           |  |          |             |   |       |   |             | 
|------------ | ------------------------- |  | -------- | ----------- | - | ----- | - | ----------- | 
|             |                           |  | Maturity |            
|             |                           |  | 0 to 6   |             |   |       |   |            
|             |                           |  | Months   |             |   | Total |  
|             |                           |  |          |             |   |       |  
|Assets:      |                           |  |          |             |   |       |   |            
|             | Cash and cash equivalents |  | $        | 3,794,425   |   |       | $ | 3,794,425   | 
|             |                           |  |          |             |   |       |  
|Liabilities: |                           |  |          |             |   |       |   |            
|             | Notes payable             |  | $        | 101,615,401 |   |       | $ | 101,615,401 | 
|             |                           |  |          |             |   |       |  
|             | Reprice difference        |  | $        | (97,820,976 | ) |       |   |             | 
|             | Cumulative gap            |  | $        | (97,820,976 | ) |       |   |             | 

A 1.0% increase in the variable interest rate for the nine months ended September 30, 2001 would
have resulted in additional interest expense of approximately $506,000.

The Company uses derivative financial instruments in the normal course of business to manage its
exposure to fluctuations in interest rates. Those instruments involve, to varying degrees, market
risk, as the instruments are subject to rate and price fluctuations, and elements of credit risk
in the event the counterparty should default. The Company does not enter into derivative
transactions for trading purposes. At September 30, 2001, the Company had an interest rate cap
contract outstanding with a total notional amount of $68.3 million. The notional amount serves
solely as a basis for the calculation of payments to be exchanged and are not a measure of the
exposure of the Company through the use of derivatives. Under the interest rate cap agreement the
counterparty agrees to make payments to the Company if LIBOR exceeds 5.0%.




PART II  OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS.



|a. |  | Sagel v. Captec Net Lease Realty, Inc., C.A. 19030 NC (Court of Chancery
of the State of Delaware in and for New Castle County)
|-- |  | -------------------------------------------------------------------------------------------------------------------------------

On July 31, 2001 a complaint was filed by Audrey Sagel, a purported
stockholder of the Company, individually and on behalf of an alleged class
consisting of the public stockholders of the Company, other than the defendants
and any person related to or affiliated with the defendants, against the
Company and each of the Companys directors individually in the Court of
Chancery of the State of Delaware in and for New Castle County (the Delaware
Chancery Court). The allegations of the complaint arise from a July 1, 2001
Agreement and Plan of Merger (the Merger Agreement) between the Company and
Commercial Net Lease Realty, Inc. (CNLR), which provides for the merger of
the Company with and into CNLR with CNLR as the surviving corporation (the
Merger). The complaint alleges, among other things, that the Merger
consideration afforded the Companys stockholders is inadequate and that the
defendants breached fiduciary duties owed to plaintiffs and the alleged class
by entering into the Merger. The complaint alleges that as part of the Merger,
Patrick L. Beach, the Companys Chairman, President and Chief Executive
Officer, will enter into an asset purchase agreement, pursuant to which Mr.
Beach will acquire certain non-real estate assets of the Company (the Excluded
Assets) at substantially less than their actual value for the purpose of
personal gain. The complaint also alleges that the purchase of the Excluded
Assets by Mr. Beach (the Asset Purchase), will lower the overall value of the
Company, thereby preventing the plaintiff and the alleged class from obtaining
fair and full merger consideration for their shares of the Companys common
stock. The complaint also alleges that by agreeing to pay a breakup fee up to
$5 million, minus $1 million in expenses to CNLR in the event that the Merger
is terminated, the Companys board of directors has precluded consideration of
a potentially more favorable acquisition proposal from a third party. The
complaint further alleges that the alleged class will be irreparably damaged if
the Merger is consummated.

The complaint seeks a declaration that the suit is properly maintainable
as a class action; a preliminary and permanent injunction against the Merger
Agreement and the Asset Purchase and the consummation of the Merger; rescission
of the Merger and/or the Asset Purchase if consummated; and compensatory
damages in the amount determined at trial and attorneys fees and expenses
incurred by the alleged class; and such other relief as the court deems just
and proper. The Company believes the claims made by Ms. Sagel are without
merit and intends to defend vigorously against them.



|b. |  | Larriva v. Beach, et al., C.A. 19026 NC (Court of Chancery of the State
of Delaware in and for New Castle County)
|-- |  | -----------------------------------------------------------------------------------------------------------------

On July 27, 2001 a complaint was filed by Alfonso Larriva, a stockholder
of the Company, individually and on behalf of an alleged class consisting of
the public stockholders of the Company, other than the defendants and any
person related to or affiliated with the defendants, against the Company and
each of the Companys directors individually in the Delaware Chancery Court.
The complaint alleges, among other things, that the Merger is unfair to the
Companys stockholders and that the defendants breached fiduciary duties owed
to plaintiffs and the alleged class by entering into the Merger. The
complaint alleges that as part of the Merger, Mr. Beach will acquire the
Excluded Assets at far less than their actual value due to alleged also alleges
that the alleged class will be irreparably damaged if the Merger is
consummated. The complaint further alleges that the merger consideration to be
paid to the Companys stockholders is unfair since it did not result from an
appropriate consideration of the value of the Company.

The complaint seeks a declaration that the suit is properly maintainable
as a class action, that the Merger Agreement was entered into in breach of
fiduciary duties by the defendants and is unlawful and unenforceable; a
preliminary and permanent injunction against the Merger Agreement and Asset
Purchase and the consummation of the Merger, and compensatory damages and
reasonable attorneys fees and expenses incurred by the alleged class; and such
other relief as the court deems just and proper.

On or about July 10, 2001, Mr. Larriva filed a class action complaint
arising out of the Merger against the same defendants in the United States
District Court for the Eastern District of Michigan. On or about August 3,
2001, Mr. Larriva voluntarily dismissed this action without prejudice. The
Company believes the claims made by Mr. Larriva are without merit and intends
to defend vigorously against them.



|c. |  | Bailey, et al. v. Beach, et al., C.A. 19008 NC (Court of Chancery of the
State of Delaware in and for New Castle County)
|-- |  | ------------------------------------------------------------------------------------------------------------------------

A complaint was filed by John Bailey and William Steiner, both of whom are
allegedly stockholders of the Company, individually and on behalf of an alleged
class consisting of the Companys public stockholders, other than the
defendants and any person related to or affiliated with the defendants, against
the Company and each of the Companys directors individually in the Delaware
Chancery Court. Neither the Company nor the individual defendants named in the
complaint had been served with a summons for this action as of July 24, 2001.
The complaint alleges, among other things, that the Merger is unfair to the
Companys stockholders and that the defendants breached fiduciary duties owed
to plaintiffs and the alleged class by entering into the Merger. The complaint
alleges that as part of the Merger, Mr. Beach will purchase the Excluded Assets
at far less than their actual value. The complaint also alleges that the merger
consideration to be paid to the Companys stockholders is unfair and inadequate
because the exchange rate of the Companys common stock shares for CNLR common
and preferred stock shares places no limit on the movement of CNLR stock, thus
subjecting the Companys stockholders to potentially declining per share
values. The complaint further alleges that the alleged class will be
irreparably damaged if the Merger is consummated.

The complaint seeks a declaration that the suit is properly maintainable
as a class action and that the defendants breached their fiduciary duties to
plaintiffs and other members of the alleged class. The complaint further seeks
a preliminary and permanent injunction against the defendants and their
counsel, agents, employees and all persons acting under, in concert with, or
for them, from proceeding with or implementing the Merger. In the event that
the Merger is consummated, the complaint seeks an order rescinding the Merger
or, alternatively, awarding rescissory damages. The complaint also seeks an
accounting by the defendants to the alleged class for all the damages the plaintiffs and the alleged class have
suffered as a result of defendants actions, with interest; awarding plaintiffs
and the alleged class the costs and disbursements of the action as well as
reasonable allowances for plaintiffs counsel and experts fees and such other
relief as the court deems just and proper. The Company believes the request for
class certification and the claims are without merit and intends to defend
vigorously against the action.



|d. |  | In re Captec Net Lease Realty, Inc. Shareholders Litigation, Consolidated
C.A. No. 19008-NC
|-- |  | -------------------------------------------------------------------------------------------

By order of the Delaware Chancery Court dated October 11, 2001, the three
complaints described above were consolidated under the caption In re Captec Net
Lease Realty, Inc. Shareholders Litigation. On October 19, 2001, plaintiffs in
the consolidated Delaware litigation filed an Amended Consolidated Class Action
Complaint seeking injunctive relief, declaratory relief and damages. The
Amended Consolidated Class Action Complaint alleges, among other things, that
the Companys directors breached their fiduciary duties by agreeing to the
termination fee provision contained in the merger agreement with CNLR, by
agreeing to the purchase of the Excluded Assets by Mr. Beach from the Company,
and by omitting allegedly material facts from the Companys proxy statement for
its special meeting of stockholders regarding the Merger and purchase of the
Excluded Assets.

The defendants in the Delaware litigation deny any liability with respect
to the claims alleged in the Amended Complaint and believe that those claims
are without merit. However, to minimize the expense, inconvenience and
distraction of litigation and to avoid the delays in judicial resolution of the
Delaware litigation that could affect the Companys ability to complete the
proposed merger if stockholder approval and other closing conditions are
satisfied, defendants authorized the execution of a memorandum of understanding
with counsel for the plaintiffs on November 1, 2001. In the memorandum of
understanding, and as the basis for settling the Delaware litigation, the
Company and the other defendants agreed that the Company would mail to its
stockholders certain supplemental disclosures regarding the purchase of the
Excluded Assets.

The memorandum of understanding generally provides that the final
settlement will include a dismissal of the Delaware litigation with prejudice.
The final settlement also will include a release of the Company, the Companys
directors, CNLR and other persons from any and all claims, causes of action,
liabilities, damages, judgments and suits that have been or could have been
asserted in the Delaware litigation, or in any court, tribunal or proceeding,
by or on behalf of the plaintiff class (described below) or any of its members
against any of the released persons, including any claims arising under federal
or state law relating to breach of any duty, in connection with the Merger, the purchase of the Excluded Assets by Mr. Beach and related matters.

The final settlement of the Delaware litigation is subject to a number of
conditions, including execution of a definitive settlement agreement containing
the terms and conditions set forth in the memorandum of understanding, and
approval of the settlement by the Delaware Chancery Court. The settlement
agreement will provide for certification of a class of stockholder plaintiffs
for settlement purposes, which will consist of all record and beneficial
stockholders of the Company who held the Companys common stock at any time
during the period from July 2, 2001 to the date of the closing of the Merger,
and their successors and assigns, other than the Companys directors and their
immediate families.

As part of the proposed settlement, the Company and the other defendants
have agreed that they will not oppose an application to the Delaware Chancery
Court by counsel to the plaintiffs in the Delaware litigation for an award of
attorneys fees and expenses in an aggregate amount not to exceed $350,000, and
that the Company will pay such amount within such limit as may be awarded by
the Delaware Chancery Court.




ITEM 2. CHANGES IN SECURITIES.None.




ITEM 3. DEFAULTS UPON SENIOR SECURITIES.None.




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None.




ITEM 5. OTHER INFORMATION.None.

15



---



##### Table of Contents






ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.



| | (a) |  | Reports on Form 8-K                                                                                                                                                                                                                                 
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     |  | The Registrant filed the following Current Reports on Form 8-K during the three months ended September 30,
2001:                                                                                                                                    
|
| |     |  | Current Report on Form 8-K dated July 1, 2001 as filed with the United States Securities and Exchange
Commission on July 6, 2001 included information regarding the merger agreement the Company entered into
with Commercial Net Lease Realty, Inc.
|
| |     |  | Current Report on Form 8-K dated July 9, 2001 as filed with the Securities and Exchange Commission on July
17, 2001 included information regarding a lawsuit filed against the Company.                                                             
|
| |     |  | Current Report on Form 8-K dated July 19, 2001 as filed with the Securities and Exchange Commission on July
25, 2001 included information regarding a lawsuit filed against the Company.                                                            
|
| |     |  | Current Report on Form 8-K dated July 27, 2001 as filed with the Securities and Exchange Commission on
August 8, 2001 included information regarding a lawsuit filed against the Company.                                                           
|
| |     |  | Current Report on Form 8-K dated July 31, 2001 as filed with the Securities and Exchange Commission on
September 7, 2001 included information regarding a lawsuit filed against the Company.                                                        
|
| |     |  |                                                                                                                                                                                                                                                     

FORWARD-LOOKING STATEMENTS

This Form 10-Q contains certain forward-looking statements which represent the Companys expectations
or beliefs, including, but not limited to, statements concerning industry performance and the Companys
operations, performance, financial condition, plans, growth and strategies. Any statements contained in
this Form 10-Q which are not statements of historical fact may be deemed to be forward-looking
statements. Without limiting the generality of the foregoing, words such as may, will, expect,
anticipate, intend, could, estimate or continue or the negative or other variations thereof or
comparable terminology are intended to identify forward-looking statements. These statements by their
nature involve substantial risks and uncertainties, certain of which are beyond the Companys control,
and actual results may differ materially depending on a variety of important factors many of which are
beyond the control of the Company.

16



---



##### Table of Contents



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.

|                  |  |                               |  |                                      
|----------------- |  | ----------------------------- |  | -------------------------------------
|                  |  | CAPTEC NET LEASE REALTY, INC.
|                 
|November 14, 2001 |  | By:                           |  | /s/ Patrick L. Beach                 
|                  |  |                               |  |                                      
|                  |  |                               |  | Patrick L. Beach                     
|                  |  |                               |  | Chief Executive Officer and President
|                 
|November 14, 2001 |  | By:                           |  | /s/ W. Ross Martin                   
|                  |  |                               |  |                                      
|                  |  |                               |  | W. Ross Martin                       
|                  |  |                               |  | Chief Financial Officer and          
|                  |  |                               |  | Executive Vice President             

17