##### Table of Contents



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

FORM 10-Q

| |  |                                                                                   
| |  | ----------------------------------------------------------------------------------
| |  | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 
|
|
|
|
| |  | For the quarterly period ended                June 30, 2001                       
|
|
|
|
| |  | OR                                                                                
|
|
|
|
| |  | 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.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)

38-3368333
(IRS Employer Identification Number)

24 Frank Lloyd Wright Drive, Ann Arbor, Michigan 48106
(Address of principal executive offices, including zip code)

(734) 994-5505
(Registrants telephone number)

Not Applicable
(Former name, former address and former fiscal year, if changed since last year)

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  No

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 August 14, 2001.

1



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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                    
|                             |                                                                                               | Consolidated Notes to 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                                                      



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##### 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       | 
|        
|        
|        
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|         |  | Consolidated Notes to Financial Statements                                            |  |      | 7  9   | 
|        
|        
|        
|        
|Item 2.  |  | Managements Discussion and Analysis of
Financial Condition and Results of Operations |  |      | 10  13 | 
|        
|        
|        
|        
|Item 3.  |  | Quantitative and Qualitative Disclosures about Market Risk                            |  |      | 13      | 
|        
|        
|        
|        
|PART II  |  | OTHER INFORMATION                                                                    
|        
|        
|        
|        
|Item 1.  |  | Legal Proceedings                                                                     |  |      | 14      | 
|        
|        
|        
|        
|Item 2.  |  | Changes in Securities                                                                 |  |      | 14      | 
|        
|        
|        
|        
|Item 3.  |  | Defaults upon Senior Securities                                                       |  |      | 14      | 
|        
|        
|        
|        
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                   |  |      | 14      | 
|        
|        
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|Item 5.  |  | Other Information                                                                     |  |      | 14      | 
|        
|        
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|Item 6.  |  | Exhibits and Report on Form 8-K                                                       |  |      | 14      | 

2



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##### Table of Contents









Part I. Financial Information
Item 1. Financial Statements




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

|                                     |                                                                                                 |                                            |           |             |             |   |              |             |             | 
|------------------------------------ | ----------------------------------------------------------------------------------------------- | ------------------------------------------ | --------- | ----------- | ----------- | - | ------------ | ----------- | ----------- | 
|                                     |                                                                                                 |                                            |           | June 30,    |             |   | December 31, |            
|                                     |                                                                                                 |                                            |           | 2001        |             |   | 2000         |            
|                                     |                                                                                                 |                                            |           |             |             |   |              |            
|ASSETS                               |                                                                                                 | (unaudited)                                |          
|                                    
|                                    
|                                    
|                                    
|Cash and cash equivalents            |                                                                                                 | $                                          | 2,729,592 |             |             | $ | 665,408      |            
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|Investments:                        
|                                    
|                                    
|                                    
|                                    
|                                     | Properties subject to operating leases, net                                                     |                                            |           | 194,457,988 |             |   |              | 195,842,231 |            
|                                    
|                                    
|                                    
|                                    
|                                     | Properties subject to financing leases, net                                                     |                                            |           | 7,254,298   |             |   |              | 4,535,446   |            
|                                    
|                                    
|                                    
|                                    
|                                     | Loans to affiliates, collateralized by mortgage loans                                           |                                            |           | 11,246,212  |             |   |              | 11,280,234  |            
|                                    
|                                    
|                                    
|                                    
|                                     | Investment in joint venture                                                                     |                                            |           | 7,356,851   |             |   |              | 7,031,073   |            
|                                    
|                                    
|                                    
|                                    
|                                     | Investment in affiliated limited partnerships, net                                              |                                            |           | 4,130,003   |             |   |              | 4,163,069   |            
|                                    
|                                    
|                                    
|                                    
|                                     | Other loans                                                                                     |                                            |           | 272,451     |             |   |              | 283,323     |            
|                                    
|                                    
|                                    
|                                    
|                                     | Other loans, related party                                                                      |                                            |           | 364,847     |             |   |              | 373,799     |            
|                                     |                                                                                                 |                                            |           |             |             |  
|                                     |                                                                                                 | Total investments                          |           |             | 225,082,650 |   |              |             | 223,509,175 | 
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|Unbilled rent, net                   |                                                                                                 |                                            | 7,476,307 |             |             |   | 6,840,646    |            
|                                    
|                                    
|                                    
|                                    
|Accounts receivable                  |                                                                                                 |                                            | 673,245   |             |             |   | 693,101      |            
|                                    
|                                    
|                                    
|                                    
|Due from affiliates                  |                                                                                                 |                                            | 937,445   |             |             |   | 1,856,950    |            
|                                    
|                                    
|                                    
|                                    
|Other assets                         |                                                                                                 |                                            | 771,293   |             |             |   | 1,005,796    |            
|                                     |                                                                                                 |                                            |           |             |             |  
|                                     |                                                                                                 | Total assets                               |           | $           | 237,670,532 |   |              | $           | 234,571,076 | 
|                                     |                                                                                                 |                                            |           |             |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|Liabilities:                        
|                                    
|                                    
|                                    
|                                    
|                                     | Notes payable                                                                                   |                                            | $         | 102,495,158 |             |   | $            | 98,365,915  |            
|                                    
|                                    
|                                    
|                                    
|                                     | Accounts payable and accrued expenses                                                           |                                            |           | 1,078,823   |             |   |              | 952,252     |            
|                                    
|                                    
|                                    
|                                    
|                                     | Security deposits held on leases                                                                |                                            |           | 207,527     |             |   |              | 225,612     |            
|                                     |                                                                                                 |                                            |           |             |             |  
|                                     |                                                                                                 | Total liabilities                          |           |             | 103,781,508 |   |              |             | 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)                                         |                                            |           | (917,113    | )           |   |              | 221,160     |            
|                                     |                                                                                                 |                                            |           |             |             |  
|                                     |                                                                                                 | Total stockholders equity                 |           |             | 133,889,024 |   |              |             | 135,027,297 | 
|                                     |                                                                                                 |                                            |           |             |             |  
|                                     |                                                                                                 | Total liabilities and stockholders equity |           | $           | 237,670,532 |   |              | $           | 234,571,076 | 
|                                     |                                                                                                 |                                            |           |             |             |  

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

3



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##### Table of Contents






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

|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |           |           |      |           |            |            |  |           |            |            | 
|----------------------------------------------------------------------- | --------------------------------------------- | ----------------------------------------------------------------------------------------- | --------- | ------------------ | --------- |  | ---------------- | --------- | --------- | ---- | --------- | ---------- | ---------- |  | --------- | ---------- | ---------- | 
|                                                                        |                                               |                                                                                           |           | Three Months Ended |           |  | Six Months Ended |          
|                                                                        |                                               |                                                                                           |           | June 30,           |           |  | June 30,         |          
|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |          
|                                                                        |                                               |                                                                                           |           | 2001               |           |  | 2000             |           |           | 2001 |           |            | 2000       | 
|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |           |           |      |           |            |            | 
|Revenue:                                                               
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | Rental income from operating leases           |                                                                                           | $         | 5,491,129          |           |  | $                | 6,066,499 |           |      | $         | 10,973,040 |            |  | $         | 12,205,248 |           
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | Earned income from financing leases           |                                                                                           |           | 175,854            |           |  |                  | 154,658   |           |      |           | 341,258    |            |  |           | 311,507    |           
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | Interest income on loans to affiliates        |                                                                                           |           | 310,721            |           |  |                  | 315,033   |           |      |           | 622,273    |            |  |           | 631,094    |           
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | Other income, principally affiliated ventures |                                                                                           |           | 360,199            |           |  |                  | 507,499   |           |      |           | 730,510    |            |  |           | 1,527,204  |           
|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |           |           |      |           |           
|                                                                        |                                               | Total revenue                                                                             |           |                    | 6,337,903 |  |                  |           | 7,043,689 |      |           |            | 12,667,081 |  |           |            | 14,675,053 | 
|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |           |           |      |           |           
|Expenses:                                                              
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | Interest                                      |                                                                                           |           | 2,398,393          |           |  |                  | 2,567,252 |           |      |           | 4,588,440  |            |  |           | 5,113,444  |           
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | Management fees, affiliates, net              |                                                                                           |           | 116,459            |           |  |                  |          |           |      |           | 235,612    |            |  |           |           |           
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | General and administrative                    |                                                                                           |           | 408,304            |           |  |                  | 388,268   |           |      |           | 792,023    |            |  |           | 730,864    |           
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | Depreciation and amortization                 |                                                                                           |           | 851,277            |           |  |                  | 867,545   |           |      |           | 1,693,211  |            |  |           | 1,732,513  |           
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        | Non-recurring merger and other costs          |                                                                                           |           | 225,650            |           |  |                  |          |           |      |           | 262,872    |            |  |           | 1,143,000  |           
|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |           |           |      |           |           
|                                                                        |                                               | Total expenses                                                                            |           |                    | 4,000,083 |  |                  |           | 3,823,065 |      |           |            | 7,572,158  |  |           |            | 8,719,821  | 
|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |           |           |      |           |           
|                                                                        |                                               | Income before equity in
joint venture,
gain on sale of
properties and other
non-recurring |           |                    | 2,337,820 |  |                  |           | 3,220,624 |      |           |            | 5,094,923  |  |           |            | 5,955,232  | 
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Equity in net income of joint venture                                   |                                               |                                                                                           | 235,597   |                    |           |  | 144,535          |           |           |      | 413,359   |            |            |  | 295,077   |           
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Gain on sale of properties                                              |                                               |                                                                                           | 198,608   |                    |           |  | 985,574          |           |           |      | 579,607   |            |            |  | 1,611,221 |           
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|Other non-recurring                                                     |                                               |                                                                                           |          |                    |           |  | 706,421          |           |           |      |          |            |            |  | 706,421   |           
|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |           |           |      |           |           
|                                                                        |                                               | Net Income                                                                                |           | $                  | 2,772,025 |  |                  | $         | 5,057,154 |      |           | $          | 6,087,889  |  |           | $          | 8,567,951  | 
|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |           |           |      |           |           
|                                                                        |                                               | Income per common share:                                                                 
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|                                                                        |                                               | Basic                                                                                     |           | $                  | 0.29      |  |                  | $         | 0.53      |      |           | $          | 0.64       |  |           | $          | 0.90       | 
|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |           |           |      |           |           
|                                                                        |                                               | Diluted                                                                                   |           | $                  | 0.29      |  |                  | $         | 0.53      |      |           | $          | 0.64       |  |           | $          | 0.90       | 
|                                                                        |                                               |                                                                                           |           |                    |           |  |                  |           |           |      |           |           
|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



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##### Table of Contents






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

|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |                   |               |           |                   |               |   |       |         |   |          |   |             |           |          |   | 
|---------------------------------------- | --------------------------- | ----------------------- | -------------------- | - | ------------ | - | ------ | ------- | - | - | ------------- | - | - | ------------------------ | - | ----------------- | ------------- | --------- | ----------------- | ------------- | - | ----- | ------- | - | -------- | - | ----------- | --------- | -------- | - | 
|                                         |                             |                         |                      |   | Common Stock |   |        |         |   |   |               |   |   |                          |   | Retained Earnings |               |           | Accumulated Other |               |   | Total |        
|                                         |                             |                         |                      |   |              |   |        | Paid-In |   |   | Comprehensive |   |   | (Distributions in excess |   |                   | Comprehensive |           |                   | Stockholders' |  
|                                         |                             |                         |                      |   | Shares       |   |        | Amount  |   |   | Capital       |   |   | Income                   |   |                   | of earnings)  |           |                   | Income (Loss) |   |       | Equity  |  
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |                   |               |           |                   |               |   |       |         |  
|BALANCE, JANUARY 1, 2001                 |                             |                         | 9,508,108            |   |              | $ | 95,081 |         |   | $ | 134,711,056   |   |   | $                        |  |                   |               | $         | 221,160           |               |   | $     | 206,399 |   |          | $ | 135,233,696 |          
|                                        
|                                        
|                                        
|                                        
|                                         | Net Income                  |                         |                      |  |              |   |        |        |   |   |               |  |   |                          |   | 6,087,889         |               |           |                   | 6,087,889     |   |       |         |  |          |   |             | 6,087,889 |         
|                                        
|                                        
|                                        
|                                        
|                                         | Other comprehensive
income:
|                                        
|                                        
|                                        
|                                        
|                                         |                             | Net loss on derivatives |                      |   |             |   |        |         |  |   |               |   |  |                          |   |                   | (206,399      | )         |                   |               |  |       |         |   | (206,399 | ) |             |           | (206,399 | )
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |  
|                                         |                             |                         | Comprehensive
income |   |              |   |        |         |   |   |               |   |   |                          |   |                   |               | 5,881,490 |                  
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |  
|Common stock dividends
($0.76 per share) |                             |                         |                     |   |              |   |       |         |   |   |              |   |   |                          |   |                   |               |           | (7,226,162        | )             |   |       |        |   |          |   | (7,226,162  | )        
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |                   |               |           |                   |               |   |      
|BALANCE, JUNE 30, 2001                   |                             |                         | 9,508,108            |   |              | $ | 95,081 |         |   | $ | 134,711,056   |   |   |                          |   |                   |               | $         | (917,113          | )             |   | $     |        |   |          | $ | 133,889,024 |          
|                                         |                             |                         |                      |   |              |   |        |         |   |   |               |   |   |                          |   |                   |               |           |                   |               |   |      

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

5



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##### Table of Contents






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

|                                                                     |                                                              |   |                  |            |   |      |             |             |  
|-------------------------------------------------------------------- | ------------------------------------------------------------ | - | ---------------- | ---------- | - | ---- | ----------- | ----------- | -
|                                                                     |                                                              |   | Six Months Ended |           
|                                                                     |                                                              |   | June 30,         |           
|                                                                     |                                                              |   |                  |           
|                                                                     |                                                              |   | 2001             |            |   | 2000 |            
|                                                                     |                                                              |   |                  |            |   |      |            
|CASH FLOWS FROM OPERATING ACTIVITIES:                               
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Net income                                                           |                                                              | $ | 6,087,889        |            |   | $    | 8,567,951   |            
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Adjustments to net income:                                          
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Depreciation and amortization                                |   |                  | 1,693,211  |   |      |             | 1,732,513   |  
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Amortization of debt issuance costs                          |   |                  | 729,220    |   |      |             | 509,193     |  
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Equity in net income of joint venture                        |   |                  | (413,359   | ) |      |             | (295,077    | )
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Gain on sale of property, net                                |   |                  | (579,607   | ) |      |             | (1,640,470  | )
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Increase in unbilled rent                                    |   |                  | (635,661   | ) |      |             | (1,157,745  | )
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Decrease (increase) in accounts receivable and other assets  |   |                  | 404,457    |   |      |             | (681,201    | )
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|                                                                     | Increase (decrease) in accounts payable and accrued expenses |   |                  | 126,571    |   |      |             | (39,195     | )
|                                                                     |                                                              |   |                  |            |   |     
|                                                                     | Net cash provided by operating activities                    |   |                  | 7,412,721  |   |      |             | 6,995,969   |  
|                                                                     |                                                              |   |                  |            |   |     
|CASH FLOWS FROM INVESTING ACTIVITIES:                               
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Acquisition of properties subject to operating leases                |                                                              |   | (8,498,627       | )          |   |      | (6,187,101  | )          
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Acquisition of properties subject to financing leases                |                                                              |   | (2,686,203       | )          |   |      |            |            
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Advances on short-term loans to affiliates, net                      |                                                              |   |                 |            |   |      | (3,266,163  | )          
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Proceeds from the disposition of properties                          |                                                              |   | 8,842,519        |            |   |      | 16,454,522  |            
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Collections on loans to affiliates, collateralized by
mortgage loans |                                                              |   | 34,022           |            |   |      | 3,313,999   |            
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Collection of principal on other loans                               |                                                              |   | 19,824           |            |   |      | 8,169       |            
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Proceeds from joint venture distribution                             |                                                              |   | 87,581           |            |   |      | 361,600     |            
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Collection of principal on financing leases                          |                                                              |   | (32,649          | )          |   |      | (68,508     | )          
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Lease security deposits                                              |                                                              |   | (18,085          | )          |   |      | (10,082     | )          
|                                                                     |                                                              |   |                  |            |   |     
|                                                                     | Net cash (used in) provided by investing activities          |   |                  | (2,251,618 | ) |      |             | 10,606,436  |  
|                                                                     |                                                              |   |                  |            |   |     
|CASH FLOWS FROM FINANCING ACTIVITIES:                               
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Dividends paid on common stock                                       |                                                              |   | (7,226,162       | )          |   |      | (7,226,162  | )          
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Borrowings of notes payable                                          |                                                              |   | 14,000,000       |            |   |      | 4,500,000   |            
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Repayments of notes payable                                          |                                                              |   | (9,870,757       | )          |   |      | (14,941,528 | )          
|                                                                     |                                                              |   |                  |            |   |     
|                                                                     | Net cash used in financing activities                        |   |                  | (3,096,919 | ) |      |             | (17,667,690 | )
|                                                                     |                                                              |   |                  |            |   |     
|NET CASH FLOWS                                                       |                                                              |   | 2,064,184        |            |   |      | (65,285     | )          
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                       |                                                              |   | 665,408          |            |   |      | 1,035,607   |            
|                                                                     |                                                              |   |                  |            |   |     
|CASH AND CASH EQUIVALENTS, END OF PERIOD                             |                                                              | $ | 2,729,592        |            |   | $    | 970,322     |            
|                                                                     |                                                              |   |                  |            |   |     

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

6



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##### 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.                                                                                                                                                                                                                                                                             
|  
|   |  | Unaudited Interim Financial Information:The consolidated balance
sheet as of June 30, 2001 and the consolidated statements of
operations, stockholders equity and cash flows for the three and
six months ended June 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.                                                                                                                                                                                                                           
|  
|   |  | 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:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

|                                 |  |          |             |   |              |   |             |  
|-------------------------------- |  | -------- | ----------- | - | ------------ | - | ----------- | -
|                                 |  | June 30, |             |   | December 31, |  
|                                 |  | 2001     |             |   | 2000         |  
|                                 |  |          |             |   |              |  
|Land                             |  | $        | 78,848,674  |   |              | $ | 79,432,815  |  
|                                
|                                
|                                
|                                
|Buildings and improvements       |  |          | 126,326,687 |   |              |   | 124,194,854 |  
|                                
|                                
|                                
|                                
|Construction draws on properties |  |          |            |   |              |   | 1,698,032   |  
|                                 |  |          |             |   |              |  
|                                 |  |          | 205,175,361 |   |              |   | 205,325,701 |  
|                                
|                                
|                                
|                                
|Less accumulated depreciation    |  |          | (10,717,373 | ) |              |   | (9,483,470  | )
|                                 |  |          |             |   |              |  
|Total                            |  | $        | 194,457,988 |   |              | $ | 195,842,231 |  
|                                 |  |          |             |   |              |  

7



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##### Table of Contents



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



|   |  | The Company sold 8 properties during the six months ended June 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:

|                                      |                                      |   |            |            |  |              |            |           | 
|------------------------------------- | ------------------------------------ | - | ---------- | ---------- |  | ------------ | ---------- | --------- | 
|                                      |                                      |   | June 30,   |            |  | December 31, |           
|                                      |                                      |   | 2001       |            |  | 2000         |           
|                                      |                                      |   |            |            |  |              |           
|Minimum lease payments to be received |                                      | $ | 15,643,319 |            |  | $            | 9,703,037  |          
|                                     
|                                     
|                                     
|                                     
|Estimated residual value              |                                      |   |           |            |  |              |           |          
|                                      |                                      |   |            |            |  |             
|                                      | Gross investment in financing leases |   |            | 15,643,319 |  |              |            | 9,703,037 | 
|                                     
|                                     
|                                     
|                                     
|Unearned income                       |                                      |   | (8,389,021 | )          |  |              | (5,167,591 | )        
|                                      |                                      |   |            |            |  |             
|                                      | Net investment in financing leases   |   | $          | 7,254,298  |  |              | $          | 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 six months ended June 30, 2001
and 2000 is set forth below:

|                                                |  |      |            |  |      |   |            | 
|----------------------------------------------- |  | ---- | ---------- |  | ---- | - | ---------- | 
|                                                |  | 2001 |            |  | 2000 |  
|                                                |  |      |            |  |      |  
|Investment in properties subject to leases, net |  | $    | 49,870,025 |  |      | $ | 45,714,093 | 
|                                               
|                                               
|                                               
|                                               
|Total assets                                    |  |      | 52,873,943 |  |      |   | 48,340,447 | 
|                                               
|                                               
|                                               
|                                               
|Notes payable                                   |  |      | 21,032,082 |  |      |   | 16,517,252 | 
|                                               
|                                               
|                                               
|                                               
|Total liabilities                               |  |      | 31,603,756 |  |      |   | 17,256,521 | 
|                                               
|                                               
|                                               
|                                               
|Members equity                                 |  |      | 30,561,293 |  |      |   | 31,083,926 | 
|                                               
|                                               
|                                               
|                                               
|Revenues                                        |  |      | 2,904,492  |  |      |   | 2,255,126  | 
|                                               
|                                               
|                                               
|                                               
|Net income                                      |  |      | 1,829,022  |  |      |   | 1,305,649  | 



|5. |  | NOTES PAYABLE:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The Companys credit facility, as amended February 26, 2001,
provides up to $105 million for the acquisition and development of
properties and working capital. The credit facility expires on
August 31, 2001 and is subject to certain borrowing base
restrictions. The Company had approximately $100.6 million of
aggregate outstanding borrowings under the credit facility at June
30, 2001. The Company also has an option to extend the maturity of
the credit facility an additional three months.
|  
|   |  | 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 June 30, 2001,
the outstanding balance of the promissory notes is $1,861,035.                                                                                                     

8



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##### Table of Contents



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



|6.  |  | DERIVATIVE INSTRUMENTS:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | At June 30, 2001, the Company had two derivative instruments, an
interest rate cap agreement and an interest rate swap agreement.
These instruments have 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 these instruments as cash flow hedges as
they are used to hedge fluctuations in interest payments. 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 the two derivatives that are designated as cash-flow
hedging instruments. At June 30, 2001, the fair value of these
instruments was $0. During the six months ended June 30, 2001, the
Company recorded a loss on the interest rate instruments of $206,399,
which has been recognized in accumulated other comprehensive loss.
The termination date of the two derivative instruments is July 2,
2001. The cash flow hedges had no ineffectiveness for the period and
accordingly, no amounts were recorded in the statement of operations.
|   
|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 six months ended June 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 six months ended June 30,
2000. During the six months ended June 30, 2001, the Company
incurred approximately $263,000 in costs associated with the planned
sale of the Company (see Note 10).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|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 six months ended June 30, 2001, the Company
incurred approximately $636,000 in management fees to Captec
Advisors, of which $400,000 was paid by Family Realty II, Inc., an
affiliate of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   
|    |  | During the six months ended June 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
six months ended June 30, 2001, the Company purchased one property
from FC Venture, an affiliate, for $1,156,203.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|10. |  | SUBSEQUENT EVENTS:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   
|    |  | In July 2001, the Company declared dividends to its shareholders of
$3,613,081, or $0.38 per share of common stock, which was paid on
July 18, 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|    |  | 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 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

9



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##### 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 June 30, 2001, the Company owned 136 properties, located in 26
states, subject to long-term net leases with 56 different lessees
under major restaurant and retail concepts including Bennigans,
Applebees, Dennys, Best Buy, 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 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.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2001.During the three months ended
June 30, 2001 total revenue decreased 10.0% to $6.3 million as
compared to $7.0 million for the three months ended June 30, 2000.
Rental revenue from operating leases for the three months ended June
30, 2001 decreased 9.4% to $5.5 million as compared to $6.1 million
for the three months ended June 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 June
30, 2001 increased 13.7% to approximately $176,000 as compared to
approximately $155,000 for the three months ended June 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 29.0% to approximately $360,000 for the three months ended
June 30, 2001 as compared to $507,000 for the three months ended
June 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.

Total expenses increased 4.6% to $4.0 million for the three months
ended June 30, 2001 as compared to $3.8 million for the three months
ended June 30, 2000. Interest expense decreased 6.6% to $2.4
million for the three months ended June 30, 2001 as compared to $2.6
million for the three months ended June 30, 2000. The decrease was
due to a 14 basis point decrease in the weighted average interest
rate and a $14.8 million decrease in the average outstanding
borrowings under the Companys credit facility used to fund the
acquisition and development of properties, slightly offset by an
increase of approximately $100,000 in amortization of deferred
financing costs. Management fees were approximately $116,000 during
the three months ended June 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 June
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 5.2% to approximately
$408,000 for the three months ended June 30, 2001 as compared to
approximately $388,000 for the three months ended June 30, 2000 as a
result of increases in payroll related costs and property taxes paid
on vacant properties. Depreciation and amortization decreased 1.9%
to approximately $851,000 for the three months ended June 30, 2001
as compared to approximately $868,000 for the three months ended
June 30, 2000. The decrease is due to the reduction of the
Companys property portfolio as a result of property sales.
Non-recurring items for the three months ended June 30, 2001 were
approximately $226,000. The costs incurred during the three months
ended June 30, 2001 represent costs related to the proposed merger
of the Company.

10



---



##### Table of Contents



The Company holds a 22.6% membership interest in FC Venture I, LLC.
During the three months ended June 30, 2001, the Company recorded
approximately $236,000 as its portion of FC Ventures equity
earnings as compared to approximately $146,000 for the three months
ended June 30, 2000. The increase is primarily due to the growth of
FC Ventures property portfolio.

The Company sold 3 properties during the three months ended June 30,
2001, collecting total net proceeds of $3.5 million and reflected a
net gain totaling approximately $199,000 on the sale of these
properties.

During the three months ended June 30, 2000 an IRS audit of periods
prior to the Companys initial public 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 an estimated tax obligation.

As a result of the foregoing, the Companys net income decreased
45.2% to $2.8 million for the three months ended June 30, 2001 as
compared to $5.1 million for the three months ended June 30, 2000.

Six Months Ended June 30, 2001.   During the six months ended June
30, 2001 total revenue decreased 13.7% to $12.7 million as compared
to $14.7 million for the six months ended June 30, 2000. Rental
revenue from operating leases for the six months ended June 30, 2001
decreased 10.1% to $10.9 million as compared to $12.2 million for
the six months ended June 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 six
months ended June 30, 2001 increased 9.6% to approximately $341,000
as compared to approximately $312,000 for the six months ended June
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 52.2% to approximately $731,000 for the six
months ended June 30, 2001 as compared to $1.5 million for the six
months ended June 30, 2000. The decrease is the 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 six months ended June 30, 2001 decreased
10.3% to $4.6 million as compared to $5.1 million for the six months
ended June 30, 2000. The decrease was due to a 22 basis point
decrease in the weighted average interest rate as well a $17.0
million decrease in the average outstanding borrowings under the
Companys credit facility used to fund the acquisition and
development of properties, slightly offset by an increase of
approximately $220,000 in amortization of deferred financing costs.
Management fees were approximately $236,000 during the six months
ended June 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 six months ended June 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 8.4% to approximately $792,000 for
the six months ended June 30, 2001 as compared to approximately
$731,000 for the six months ended June 30, 2000 as a result of
increases in payroll related costs and property taxes paid on vacant
properties. Depreciation and amortization decreased 2.3% for the
six months ended June 30, 2001 as compared to the six months ended
June 30, 2000. The decrease is due to the reduction of the
Companys property portfolio as a result of property sales.
Non-recurring items decreased 77.0% to approximately $263,000 for
the six months ended June 30, 2001 as compared to $1.1 million for
the six months ended June 30, 2000. The costs incurred during the
six months ended June 30, 2001 represent costs related to the
proposed merger of the Company. The $1.1 million expensed during
the six months ended June 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 six months ended June 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.
11Table of ContentsDuring the six months ended June 30, 2001 the Company recorded
approximately $413,000 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 six months ended June 30, 2000 an IRS audit of periods
prior to the Companys initial public 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 an estimated tax obligation.As a result of the foregoing, the Companys net income decreased
29.0% to $6.1 million for the six months ended June 30, 2001 as
compared to $8.6 million for the six months ended June 30, 2000.LIQUIDITY AND CAPITAL RESOURCESThe 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 June 30, 2001, the Company had cash and cash equivalents of $2.7
million. For the six months ended June 30, 2001, the Company
generated cash from operations of $7.4 million as compared to $7.0
million for the six months ended June 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
six months ended June 30, 2001 the Company utilized $2.3 million in
investing activities as compared to generating $10.6 million during
the six months ended June 30, 2000. The Company used $3.1 million
in financing activities during the six months ended June 30, 2001 as
compared to using $17.7 million during the six months ended June 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. The Company also intends to extend
the maturity of the credit facility an additional three months
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. 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 June 30, 2001, the Company
had $100.6 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 increasing the strength of
its current portfolio. At June 30, 2001, no properties in the
Companys portfolio are being12Table of Contentsactively marketed.DIVIDENDS.   During the six months ended June 30, 2001 the Company
paid dividends of $7,226,162. In July
2001, the Company declared a second 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 July 11, 2001 and was paid
on July 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKMarket 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 June 30,
2001, approximately 98% of the Companys debt bore interest at
variable rates of LIBOR plus 2.25% to 2.50%.The following table presents certain information on the Companys
assets and liabilities which are sensitive to interest rate changes
at June 30, 2001:

|             |                           |  |          |             |   |       |   |             | 
|------------ | ------------------------- |  | -------- | ----------- | - | ----- | - | ----------- | 
|             |                           |  | Maturity |            
|             |                           |  |          |            
|             |                           |  | 0 to 6   |            
|             |                           |  | Months   |             |   | Total |  
|             |                           |  |          |             |   |       |  
|Assets:     
|            
|            
|            
|            
|             | Cash and cash equivalents |  | $        | 2,729,592   |   |       | $ | 2,729,592   | 
|             |                           |  |          |             |   |      
|Liabilities:
|            
|            
|            
|            
|             | Notes payable             |  | $        | 100,634,123 |   |       | $ | 100,634,123 | 
|             |                           |  |          |             |   |      
|             | Reprice difference        |  | $        | (97,904,531 | )
|            
|            
|            
|            
|             | Cumulative gap            |  | $        | (97,904,531 | )

A 1.0% increase in the variable interest rate for the six months ended
June 30, 2001 would have resulted in additional interest expense of
approximately $249,000.

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 June 30, 2001, the Company had an interest rate swap
contract outstanding with a total notional amount of $50 million, and
an interest rate cap contract outstanding with a total notional amount
of $25 million. The notional amounts serve 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 swap contract, the Company agrees to pay a fixed rate of
5.8% and the counterparty agrees to make payments based on 3-month
LIBOR. Under the interest rate cap agreement the counterparty agrees
to make payments to the Company if LIBOR exceeds 7.5%. Both the
interest rate swap contract and interest rate cap contract terminated
on July 2, 2001 and were replaced with an interest rate cap contract
with a total notional amount of $68.3 million. Under the new interest
rate cap contract the counterparty agrees to make payments to the
Company if LIBOR exceeds 5.0%.

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PART II  OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS.None.




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.




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

| |     |  |                                                                          
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| | (a) |  | Reports on Form 8-K                                                      
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| |     |  | No reports on Form 8-K were filed during the quarter ended June 30, 2001.

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.

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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.

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

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