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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
Amendment No. 1
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
-------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ___________________
Commission file number 0-16824
CNL INCOME FUND II, LTD.
(Exact name of registrant as specified in its charter)
Florida 59-2733859
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
400 East South Street
Orlando, Florida 32801
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (407) 650-1000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of exchange on which registered:
None Not Applicable
Securities registered pursuant to section 12(g) of the Act:
Units of limited partnership interest ($500 per Unit)
(Title of class)
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 such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes X No __________
---------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [x]
Aggregate market value of the voting stock held by nonaffiliates of the
registrant: The registrant registered an offering of 50,000 units of limited
partnership interest (the "Units") on Form S-11 under the Securities Act of
1933, as amended. Since no established market for such Units exists, there is
no market for such Units. Each Unit was originally sold at $500 per Unit.
DOCUMENTS INCORPORATED BY REFERENCE:
None
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The Form 10-K of CNL Income Fund X, Ltd. for the year ended December 31,
1998 is being amended to revise the disclosure under Item 1. Business, Item 2.
Properties, Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations and Item 8. Financial Statements and Supplementary
Data.
PART I
Item 1. Business
CNL Income Fund II, Ltd. (the "Registrant" or the "Partnership") is a
limited partnership which was organized pursuant to the laws of the State of
Florida on November 13, 1986. The general partners of the Partnership are
Robert A. Bourne, James M. Seneff, Jr. and CNL Realty Corporation, a Florida
corporation (the "General Partners"). Beginning on January 2, 1987, the
Partnership offered for sale up to $25,000,000 in limited partnership interests
(the "Units") (50,000 Units at $500 per Unit) pursuant to a registration
statement on Form S-11 under the Securities Act of 1933, as amended. The
offering terminated on August 21, 1987, as of which date the maximum offering
proceeds of $25,000,000 had been received from investors who were admitted to
the Partnership as limited partners (the "Limited Partners").
The Partnership was organized to acquire both newly constructed and
existing restaurant properties, as well as properties upon which restaurants
were to be constructed (the "Properties"), which are leased primarily to
operators of selected national and regional fast-food restaurant chains (the
"Restaurant Chains"). Net proceeds to the Partnership from its offering of
Units, after deduction of organizational and offering expenses, totalled
$22,300,178, and were used to acquire, either directly or indirectly through
joint venture arrangements, 39 Properties. During the year ended December 31,
1993, the Partnership sold its Property in Salisbury, North Carolina, and
reinvested the majority of the net sales proceeds in a Jack in the Box Property
in Lubbock, Texas. During the year ended December 31, 1994, the Partnership
sold two of its Properties in Graham, Texas, and Medina, Ohio, and reinvested
the net sales proceeds in two Checkers Properties, consisting of only land,
located in Fayetteville and Atlanta, Georgia, and a Kenny Rogers Roasters
Property in Arvada, Colorado, which is owned as tenants-in-common with an
affiliate of the General Partners. During the year ended December 31, 1997, the
Partnership sold its Properties in Eagan, Minnesota; Jacksonville, Florida;
Farmington Hills (10-mile Road), Michigan; Farmington Hills (12-mile Road),
Michigan; Plant City, Florida; Mathis, Texas and Avon Park, Florida and
reinvested a portion of these net sales proceeds in a Property in Mesa, Arizona,
a Property in Smithfield, North Carolina and a Property in Vancouver,
Washington, all of which are owned as tenants-in-common with affiliates of the
General Partners. In addition, during 1997, Show Low Joint Venture, in which
the Partnership owns a 64 percent interest, sold its Property in Show Low,
Arizona to the tenant and reinvested the net sales proceeds in a Property in
Greensboro, North Carolina. During 1998, the Partnership reinvested the net
sales proceeds from the 1997 sales of the Properties in Jacksonville, Florida
and Mathis, Texas in a Property in Overland Park, Kansas, and a Property in
Memphis, Tennessee, as tenants-in-common with affiliates of the General
Partners. As a result of the above transactions, as of December 31, 1998, the
Partnership owned 38 Properties. The 38 Properties included interests in three
Properties owned by joint ventures in which the Partnership is a co-venturer and
six Properties owned with affiliates as tenants-in-common. The lessee of the
two Properties consisting of only land owns the buildings currently on the land
and has the right, if not in default under the lease, to remove the buildings
from the land at the end of the lease terms. The Properties are leased on a
triple-net basis with the lessees responsible for all repairs and maintenance,
property taxes, insurance and utilities.
On March 11, 1999, the Partnership entered into an Agreement and Plan of
Merger with CNL American Properties Fund, Inc. ("APF"), pursuant to which the
Partnership would be merged with and into a subsidiary of APF (the "Merger").
APF is a real estate investment trust whose primary business is the ownership of
restaurant properties leased on a long-term, "triple-net" basis to operators of
national and regional restaurant chains. APF has agreed to issue shares of its
common stock, par value $0.01 per share (the "APF Shares"), as consideration for
the Merger. At a special meeting of the partners that is expected to be held in
the fourth quarter of 1999, Limited Partners holding in excess of 50% of the
Partnership's outstanding limited partnership interests must approve the Merger
prior to consummation of the transaction. If the Limited Partners at the
special meeting approve the Merger, APF will own the Properties and other assets
of the Partnership.
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In the event that the Limited Partners vote against the Merger, the
Partnership will hold its Properties until the General Partners determine that
the sale or other disposition of the Properties is advantageous in view of the
Partnership's investment objectives. In deciding whether to sell Properties,
the General Partners will consider factors such as potential capital
appreciation, net cash flow and federal income tax considerations. Certain
lessees have been granted options to purchase Properties, generally at the
Property's then fair market value after a specified portion of the lease term
has elapsed. The Partnership has no obligation to sell all or any portion of a
Property at any particular time, except as may be required under property or
joint venture purchase options granted to certain lessees.
Leases
Although there are variations in the specific terms of the leases, the
following is a summarized description of the general structure of the
Partnership's leases. The leases of the Properties owned by the Partnership
and joint ventures in which the Partnership is a co-venturer provide for initial
lease terms, ranging from four to 20 years (the average being 16 years), and
expire between 2000 and 2018. The leases are on a triple-net basis, with the
lessee generally responsible for all repairs and maintenance, property taxes,
insurance and utilities. The leases of the Properties provide for minimum base
annual rental payments (payable in monthly installments) ranging from
approximately $8,300 to $222,800. Generally, the leases provide for percentage
rent, based on sales in excess of a specified amount, to be paid annually. In
addition, certain leases provide for increases in the annual base rent during
the lease term.
Generally, the leases of the Properties provide for two to four five-year
renewal options subject to the same terms and conditions as the initial lease.
Certain lessees also have been granted options to purchase Properties at the
Property's then fair market value, or pursuant to a formula based on the
original cost of the Property, after a specified portion of the lease term has
elapsed. Fair market value will be determined through an appraisal by an
independent appraisal firm. Additionally, certain leases provide the lessee an
option to purchase up to a 49 percent joint venture interest in the Property,
after a specified portion of the lease term has elapsed, at an option purchase
price similar to those described above multiplied by the percentage interest in
the Property with respect to which the option is being exercised. A limited
number of leases provide for a purchase option price which is computed pursuant
to a formula based on various measures of value contained in an independent
appraisal of the Property.
The leases also generally provide that, in the event the Partnership wishes
to sell the Property subject to a particular lease, the Partnership must first
offer the lessee the right to purchase the Property on the same terms and
conditions, and for the same price, as any offer which the Partnership has
received for the sale of the Property.
During the year ended December 31, 1998, the Partnership reinvested the net
sales proceeds from the 1997 sales of the Properties in Jacksonville, Florida
and Mathis, Texas in a Property in Overland Park, Kansas, and a Property in
Memphis, Tennessee, as tenants-in-common with affiliates of the General
Partners. The lease terms for these Properties are substantially the same as
the Partnership's other leases as described above in the first three paragraphs
of this section.
In addition, during 1998, the tenant of the Property in Oxford, Alabama
exercised its option to extend the lease for an additional five years beginning
in May 1998 with an increase in rental payments of 20 percent per year. All
other lease terms remained unchanged and are substantially the same as the
Partnership's other leases as described above.
Major Tenants
During 1998, two lessees of the Partnership, Golden Corral Corporation and
Restaurant Management Services, Inc., each contributed more than ten percent of
the Partnership's total rental income (including the Partnership's share of the
rental income from three Properties owned by joint ventures and six Properties
owned with affiliates as tenants-in-common). As of December 31, 1998, Golden
Corral Corporation was the lessee under leases relating to six restaurants and
Restaurant Management Services, Inc. was the lessee under leases relating to
four restaurants. It is anticipated that, based on the minimum rental payments
required by the leases, each of these lessees will continue to contribute more
than ten percent of the Partnership's total rental income in 1999. In addition,
two Restaurant Chains, Golden Corral Family Steakhouse Restaurants ("Golden
Corral") and Popeyes Famous Fried Chicken Restaurants ("Popeyes"), each
accounted for more than ten percent of the Partnership's total rental and
mortgage interest income in
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1998 (including the Partnership's share of the rental income from three
Properties owned by joint ventures and six Properties owned with affiliates as
tenants-in-common). In 1999, it is anticipated that these two Restaurant Chains
each will continue to account for more than ten percent of the total rental
income to which the Partnership is entitled under the terms of its leases. Any
failure of these lessees or Restaurant Chains could materially affect the
Partnership's income if the Partnership is not able to re-lease the Properties
in a timely manner. As of December 31, 1998, no single tenant or group of
affiliated tenants leased Properties with an aggregate carrying value in excess
of 20 percent of the total assets of the Partnership.
Joint Venture and Tenancy in Common Arrangements
The Partnership has entered into a joint venture arrangement, Kirkman Road
Joint Venture, with an unaffiliated entity to purchase and hold one Property.
In addition, the Partnership has entered into two separate joint venture
arrangements: Holland Joint Venture with CNL Income Fund IV, Ltd., an affiliate
of the General Partners, to purchase and hold one Property; and Show Low Joint
Venture with CNL Income Fund VI, Ltd., an affiliate of the General Partners, to
purchase and hold one Property. The affiliates are limited partnerships
organized pursuant to the laws of the State of Florida. Each joint venture
arrangement provides for the Partnership and its joint venture partners to share
in all costs and benefits associated with the joint venture in proportion to
each partner's percentage interest in the joint venture. The Partnership has a
50 percent interest in Kirkman Road Joint Venture, a 49 percent interest in
Holland Joint Venture, and a 64 percent interest in Show Low Joint Venture. The
Partnership and its joint venture partners are also jointly and severally liable
for all debts, obligations and other liabilities of the joint venture.
Each joint venture has an initial term of approximately 20 years (generally
the same term as the initial term of the lease for the Property in which the
joint venture invested), and after the expiration of the initial term, continues
in existence from year to year unless terminated at the option of any joint
venture partner or by an event of dissolution. Events of dissolution include
the bankruptcy, insolvency or termination of any joint venturer, sale of the
Property owned by the joint venture and mutual agreement of the Partnership and
its joint venture partner or partners to dissolve the joint venture.
The Partnership shares management control equally with an unaffiliated
entity for Kirkman Road Joint Venture and shares management control equally with
affiliates of the General Partners for Holland Joint Venture and Show Low Joint
Venture. The joint venture agreements restrict each venturer's ability to sell,
transfer or assign its joint venture interest without first offering it for sale
to its joint venture partner or partners, either upon such terms and conditions
as to which the venturers may agree or, in the event the venturers cannot agree,
on the same terms and conditions as any offer from a third party to purchase
such joint venture interest.
Net cash flow from operations of Kirkman Road Joint Venture, Holland Joint
Venture and Show Low Joint Venture is distributed 50 percent, 49 percent and 64
percent, respectively, to the Partnership and the balance is distributed to each
other joint venture partner in accordance with its percentage interest in the
joint venture. Any liquidation proceeds, after paying joint venture debts and
liabilities and funding reserves for contingent liabilities, will be distributed
first to the joint venture partners with positive capital account balances in
proportion to such balances until such balances equal zero, and thereafter in
proportion to each joint venture partner's percentage interest in the joint
venture.
In addition to the above joint venture agreements, in September 1994, the
Partnership entered into an agreement to hold a Property as tenants-in-common,
with CNL Income Fund XIII, Ltd., a limited partnership organized pursuant to the
laws of the State of Florida, and an affiliate of the General Partners. The
agreement provides for the Partnership and the affiliate to share in the profits
and losses of the Property in proportion to each co-venturer's percentage
interest. The Partnership owns a 33.87% interest in this Property.
In addition, during the year ended December 31, 1997, the Partnership
entered into three separate agreements: one to hold a Property in Mesa, Arizona,
as tenants-in-common, with CNL Income Fund V, Ltd., an affiliate of the General
Partners; one to hold a Property in Smithfield, North Carolina, as tenants-in-
common, with CNL Income Fund VII, Ltd., an affiliate of the General Partners;
and one to hold a Property in Vancouver, Washington, as tenants-in-common, with
CNL Income Fund, Ltd., CNL Income V, Ltd. and CNL Income Fund VI, Ltd., each of
which is an affiliate of the General Partners. The agreements provide for the
Partnership and the affiliates to share in the profits and
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losses of the Properties in proportion to each co-tenant's percentage interest.
The Partnership owns an approximate 58 percent, 47 percent, and 37 percent
interest, in these Properties in Mesa, Arizona, Smithfield, North Carolina and
Vancouver, Washington, respectively.
In addition, in January 1998, the Partnership entered into two separate
agreements: to hold a Property in Overland Park, Kansas, as tenants-in-common,
with CNL Income Fund III, Ltd. and CNL Income Fund VI, Ltd., affiliates of the
General Partners; and to hold a Property in Memphis, Tennessee, as tenants-in-
common, with CNL Income Fund VI, Ltd. and CNL Income Fund XVI, Ltd., affiliates
of the General Partners. The agreements provide for the Partnership and the
affiliates to share in the profits and losses of the Property and net cash flow
from the Property, in proportion to each co-tenant's percentage interest. The
Partnership owns a 39.39% and a 13.38% interest in the Properties in Overland
Park, Kansas and Memphis, Tennessee, respectively.
Each of the affiliates is a limited partnership organized pursuant to the
laws of the State of Florida. The tenancy in common agreement restricts each
co-tenant's ability to sell, transfer, or assign its interest in the tenancy in
common's Property without first offering it for sale to the remaining co-tenant.
The use of joint venture and tenancy in common arrangements allows the
Partnership to fully invest its available funds at times at which it would not
have sufficient funds to purchase an additional property, or at times when a
suitable opportunity to purchase an additional property is not available. The
use of joint venture and tenancy in common arrangements also provides the
Partnership with increased diversification of its portfolio among a greater
number of properties. In addition, tenancy in common arrangements may allow the
Partnership to defer the gain for federal income tax purposes upon the sale of
the property if the proceeds are reinvested in an additional property.
Certain Management Services
CNL Fund Advisors, Inc., an affiliate of the General Partners, provides
certain services relating to management of the Partnership and its Properties
pursuant to a management agreement with the Partnership. Under this agreement,
CNL Fund Advisors, Inc. is responsible for collecting rental payments,
inspecting the Properties and the tenants' books and records, assisting the
Partnership in responding to tenant inquiries and notices and providing
information to the Partnership about the status of the leases and the
Properties. CNL Fund Advisors, Inc. also assists the General Partners in
negotiating the leases. For these services, the Partnership has agreed to pay
CNL Fund Advisors, Inc. an annual fee of one-half of one percent of Partnership
assets (valued at cost) under management, not to exceed the lesser of one
percent of gross rental revenues or competitive fees for comparable services.
Under the property management agreement, the property management fee is
subordinated to receipt by the Limited Partners of an aggregate, ten percent,
noncumulative, noncompounded annual return on their adjusted capital
contributions (the "10% Preferred Return"), calculated in accordance with the
Partnership's limited partnership agreement (the "Partnership Agreement"). In
any year in which the Limited Partners have not received the 10% Preferred
Return, no property management fee will be paid.
The management agreement continues until the Partnership no longer owns an
interest in any Properties unless terminated at an earlier date upon 60 days'
prior notice by either party.
Employees
The Partnership has no employees. The officers of CNL Realty Corporation
and the officers and employees of CNL Fund Advisors, Inc. perform certain
services for the Partnership. In addition, the General Partners have available
to them the resources and expertise of the officers and employees of CNL Group,
Inc., a diversified real estate company, and its affiliates, who may also
perform certain services for the Partnership.
5
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Item 2. Properties
As of December 31, 1998, the Partnership owned 38 Properties. Of the 38
Properties, 29 are owned by the Partnership in fee simple, three are owned
through joint venture arrangements and six are owned through tenancy in common
arrangements. See Item 1. Business - Joint Venture and Tenancy in Common
Arrangements. The Partnership is not permitted to encumber its Properties under
the terms of its partnership agreement. Reference is made to the Schedule of
Real Estate and Accumulated Depreciation for a listing of the Properties and
their respective costs, including acquisition fees and certain acquisition
expenses. This schedule was filed with the Partnership's Form 10-K for the year
ended December 31, 1998.
Description of Properties
Land. The Partnership's Property sites range from approximately 11,500 to
86,000 square feet depending upon building size and local demographic factors.
Sites purchased by the Partnership are in locations zoned for commercial use
which have been reviewed for traffic patterns and volume.
The following table lists the Properties owned by the Partnership as of
December 31, 1998 by state. More detailed information regarding the location of
the Properties is contained in the Schedule of Real Estate and Accumulated
Depreciation filed with the Partnership's Form 10-K for the year ended December
31, 1998.
<TABLE>
<CAPTION>
State Number of Properties
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<S> <C>
Alabama 2
Arizona 1
Colorado 3
Florida 6
Georgia 2
Illinois 1
Indiana 1
Kansas 1
Louisiana 1
Michigan 2
Minnesota 1
Missouri 1
North Carolina 2
New Mexico 2
Tennessee 1
Texas 8
Washington 1
Wyoming 2
------
TOTAL PROPERTIES: 38
=======
</TABLE>
Buildings. Each of the Properties owned by the Partnership includes a
building that is one of a Restaurant Chain's approved designs. However, the
buildings located on the two Checkers Properties are owned by the tenant while
the land parcels are owned by the Partnership. The buildings generally are
rectangular and are constructed from various combinations of stucco, steel,
wood, brick and tile. The sizes of the buildings owned by the Partnership range
from approximately 1,300 to 9,900 square feet. All buildings on Properties
acquired by the Partnership are freestanding and surrounded by paved parking
areas. Buildings are suitable for conversion to various uses, although
modifications may be required prior to use for other than restaurant operations.
As of December 31, 1998, the Partnership had no plans for renovation of the
Properties. Depreciation expense is computed for buildings and improvements
using the straight line method using depreciable lives of 31.5 and 39 years for
federal income tax purposes. As of December 31, 1998, the aggregate cost of the
Properties owned by the Partnership and joint ventures (including Properties
owned through tenancy in common arrangements) for federal income tax purposes
was $16,420,257 and $5,091,168, respectively.
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The following table lists the Properties owned by the Partnership as of
December 31, 1998 by Restaurant Chain.
<TABLE>
<CAPTION>
Restaurant Chain Number of Properties
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<S> <C>
Arby's 1
Boston Market 1
Burger King 1
Checkers 2
Chevy's Fresh Mex 1
Darryl's 1
Denny's 3
Golden Corral 6
IHOP 2
Jack in the Box 1
KFC 3
Pizza Hut 5
Ponderosa 1
Popeyes 4
Wendy's 2
Other 4
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TOTAL PROPERTIES: 38
=======
</TABLE>
The General Partners consider the Properties to be well-maintained and
sufficient for the Partnership's operations.
The General Partners believe that the Properties are adequately covered by
insurance. In addition, the General Partners have obtained contingent liability
and property coverage for the Partnership. This insurance is intended to reduce
the Partnership's exposure in the unlikely event a tenant's insurance policy
lapses or is insufficient to cover a claim relating to the Property.
Leases. The Partnership leases the Properties to operators of selected
national and regional fast-food restaurant chains. The leases are generally on
a long-term "triple net" basis, meaning that the tenant is responsible for
repairs, maintenance, property taxes, utilities and insurance. Generally, a
lessee is required, under the terms of its lease agreement, to make such capital
expenditures as may be reasonably necessary to refurbish buildings, premises,
signs and equipment so as to comply with the lessee's obligations, if
applicable, under the franchise agreement to reflect the current commercial
image of its Restaurant Chain. These capital expenditures are required to be
paid by the lessee during the term of the lease. The terms of the leases of the
Properties owned by the Partnership are described in Item 1. Business - Leases.
As of December 31, 1998, 1997, 1996, 1995 and 1994, the Properties were
100%, 100%, 100%, 100% and 95% occupied, respectively. The following is a
schedule of the average annual rent for each of the five years ended
December 31:
<TABLE>
<CAPTION>
For the Year Ended December 31:
1998 1997 1996 1995 1994
--------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Rental Income (1) $2,337,182 $2,277,558 $2,485,645 $2,472,523 $2,353,103
Properties 38 36 40 40 39
Average per Unit $ 61,505 $ 63,266 $ 62,141 $ 61,813 $ 60,336
</TABLE>
(1) Rental income includes the Partnership's share of rental income from the
Properties owned through joint venture arrangements and the Properties
owned through tenancy in common arrangements. Rental revenues have been
adjusted, as applicable, for any amounts for which the Partnership has
established an allowance for doubtful accounts.
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The following is a schedule of lease expirations for leases in place as of
December 31, 1998 for each of the ten years beginning with 1999 and thereafter.
<TABLE>
<CAPTION>
Percentage of
Number Annual Rental Gross Annual
Expiration Year of Leases Revenues Rental Income
---------------------- ------------------ ------------------ ---------------------
<S> <C> <C> <C>
1999 1 84,000 3.71%
2000 2 65,069 2.87%
2001 -- -- --
2002 5 397,845 17.56%
2003 1 40,452 1.79%
2004 -- -- --
2005 2 62,563 2.76%
2006 1 63,172 2.79%
2007 12 672,443 29.67%
2008 1 62,740 2.77%
Thereafter 13 817,897 36.08%
----- ------------ --------
Totals 38 2,266,181 100.00%
===== ============ ========
</TABLE>
Leases with Major Tenants. The terms of the leases with each of the
Partnership's major tenants as of December 31, 1998 (see Item 1. Business -
Major Tenants), are substantially the same as those described in Item 1.
Business - Leases.
Golden Corral Corporation leases six Golden Corral restaurants. The
initial term of each lease is 15 years (expiring between 2002 and 2012) and the
average minimum base annual rent is approximately $91,800 (ranging from
approximately $56,200 to $152,700).
Restaurant Management Services, Inc. leases four Popeyes restaurants. The
initial term of each lease is from 12 to 20 years (expiring between 2000 and
2008) and the average minimum base annual rent is approximately $57,100 (ranging
from approximately $50,400 to $64,400).
Competition
The fast-food and family-style restaurant business is characterized by
intense competition. The restaurants on the Partnership's Properties compete
with independently owned restaurants, restaurants which are part of local or
regional chains, and restaurants in other well-known national chains, including
those offering different types of food and service.
PART II
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The Partnership was organized on November 13, 1986, to acquire for cash,
either directly or through joint venture arrangements, both newly constructed
and existing restaurant Properties, as well as land upon which restaurant
Properties were to be constructed, which are leased primarily to operators of
selected national and regional fast-food Restaurant Chains. The leases are
triple-net leases, with the lessees responsible for all repairs and maintenance,
property taxes, insurance and utilities. As of December 31, 1998, the
Partnership owned 38 Properties, either directly or indirectly through joint
venture or tenancy in common arrangements.
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Capital Resources
During the years ended December 31, 1998, 1997, and 1996, the Partnership
generated cash from operations (which includes cash received from tenants,
distributions from joint ventures and interest received, less cash paid for
expenses) of $2,135,691, $2,157,912, and $2,347,731, respectively. The decrease
in cash from operations during 1998, as compared to 1997, is primarily a result
of changes in income and expenses as described in "Results of Operations" below,
and a result of changes in the Partnership's working capital. The decrease in
cash from operations during 1997, as compared to 1996, is primarily a result of
changes in the Partnership's working capital. Cash from operations was also
affected by the following transactions during the years ended December 31, 1998,
1997, and 1996.
Other sources and uses of capital included the following during the years
ended December 31, 1998, 1997, and 1996.
In 1993, the Partnership accepted a promissory note from the tenant of two
Properties in Farmington Hills, Michigan, whereby $61,987, which had been
included in receivables for past due rents, was converted to a loan receivable.
The loan, which was non-interest bearing, was collected in 48 monthly
installments with collections commencing January 1993. The receivable was
collected in full during 1996.
In March 1996, the Partnership accepted a promissory note from the former
tenant of the Property in Gainesville, Texas, in the amount of $96,502,
representing past due rental and other amounts that had been included in
receivables and for which the Partnership had established an allowance for
doubtful accounts, and real estate taxes previously recorded as an expense by
the Partnership. Payments are due in 60 monthly installments of $2,156,
including interest at a rate of 11 percent per annum, commencing on June 1,
1996. Due to the uncertainty of the collectibility of this note, the
Partnership established an allowance for doubtful accounts and is recognizing
income as collected. During 1998, the Partnership collected and recognized as
income approximately $18,700 relating to this promissory note. As of December
31, 1998 and 1997, the balance in the allowance for doubtful accounts relating
to this promissory note was $55,330 and $74,590, respectively, including accrued
interest of $2,654 in 1998 and 1997.
In November 1995, the Partnership entered into a new lease for the Property
in Lombard, Illinois. In connection therewith, the Partnership incurred
approximately $40,600 in renovation costs which were paid during the years ended
December 31, 1996 and 1997. Additional renovation costs of $25,000 were funded
by the tenant, in accordance with the terms of the lease. The renovations were
completed in November 1996 and rental payments commenced in July 1997, in
accordance with the terms of the lease.
In January 1996, the Partnership entered into a promissory note with the
corporate General Partner for a loan in the amount of $26,300 in connection with
the operations of the Partnership. The loan, which was uncollateralized and
bore interest at a rate of prime plus 0.25% per annum was due on demand. As of
December 31, 1996, the interest rate was 8.50%. The Partnership repaid the loan
in full, along with approximately $200 in interest, to the corporate General
Partner. In addition, in 1997 and 1996, the Partnership entered into various
promissory notes with the corporate General Partner for loans totalling $721,000
and $177,600, respectively, in connection with the operations of the
Partnership. The loans were uncollateralized, non-interest bearing and due on
demand. As of December 31, 1997, the Partnership had repaid the loans in full
to the corporate General Partner.
In January 1997, Show Low Joint Venture, in which the Partnership owns a 64
percent interest, sold its Property to the tenant for $970,000, resulting in a
gain to the joint venture of approximately $360,000 for financial reporting
purposes. The Property was originally contributed to Show Low Joint Venture in
July 1990 and had a total cost of approximately $663,500, excluding acquisition
fees and miscellaneous acquisition expenses; therefore, the joint venture sold
the Property for approximately $306,500 in excess of its original purchase
price. In June 1997, Show Low Joint Venture reinvested $782,413 of the net
sales proceeds in a Darryl's Property in Greensboro, North Carolina. As of
December 31, 1997, the Partnership had received approximately $124,400,
representing a return of capital, for its pro-rata share of the uninvested net
sales proceeds. The Partnership used these amounts to pay liabilities of the
Partnership, including quarterly distributions to the Limited Partners.
9
<PAGE>
During 1997, the Partnership sold its Property in Eagan, Minnesota, to the
tenant, for $668,033 and received net sales proceeds of $665,882, of which
$42,000 were in the form of a promissory note, resulting in a gain of $158,251
for financial reporting purposes. This Property was originally acquired by the
Partnership in August 1987 and had a cost of approximately $601,100, excluding
acquisition fees and miscellaneous acquisition expenses; therefore, the
Partnership sold the Property for approximately $64,800 in excess of its
original purchase price. In October 1997, the Partnership reinvested the net
cash sales proceeds of approximately $623,900 in a Property in Mesa, Arizona, as
tenants-in-common with an affiliate of the General Partners. In connection
therewith, the Partnership and the affiliate entered into an agreement whereby
each co-venturer will share in the profits and losses of the Property in
proportion to each co-venturer's interest. The Partnership owns an approximate
58 percent interest in the Property. The Partnership distributed amounts
sufficient to enable the Limited Partners to pay federal and state income taxes,
(at a level reasonably assumed by the General Partners), resulting from the
sale.
In connection with the sale during 1997 of its Property in Eagan,
Minnesota, the Partnership accepted a promissory note in the principal sum of
$42,000. The promissory note bears interest at a rate of 10.50% per annum and
is collateralized by personal property. Initially, the note was to be collected
in 18 monthly installments of interest only and thereafter, the entire principal
balance became due. During 1998, the note was amended to require six monthly
installments of $7,368, including interest, commencing on July 1, 1998. As of
December 31, 1998 and 1997, the mortgage note receivable balance was $6,872 and
$42,734, respectively, including accrued interest of $56 and $734, respectively.
In January 1999, the balance, including accrued interest, was collected.
In addition, during 1997, the Partnership sold its Properties in
Jacksonville, Plant City and Avon Park, Florida; its Property in Mathis, Texas
and its two Properties in Farmington Hills, Michigan to third parties for
aggregate sales prices of $4,162,006 and received aggregate net sales proceeds
of $4,035,196, resulting in aggregate gains of $1,317,873 for financial
reporting purposes. These six Properties were originally acquired by the
Partnership during 1987 and had aggregate costs of approximately $3,338,800,
excluding acquisition fees and miscellaneous acquisition expenses; therefore,
the Partnership sold these six Properties for approximately $714,400, in the
aggregate, in excess of their original aggregate purchase prices. During 1997,
the Partnership reinvested approximately $1,512,400 of these net sales proceeds
in a Property in Vancouver, Washington, and a Property in Smithfield, North
Carolina, as tenants-in-common with affiliates of the General Partners. As of
December 31, 1997, remaining net sales proceeds from five of the six Properties
of $2,470,175, including accrued interest of $12,505, were being held in
interest bearing escrow accounts. In January 1998, the Partnership reinvested a
portion of the net sales proceeds in a Property in Overland Park, Kansas, and a
Property in Memphis, Tennessee, as tenants-in-common with affiliates of the
General Partners. The Partnership distributed amounts sufficient to enable the
Limited Partners to pay federal and state income taxes, (at a level reasonably
assumed by the General Partners), resulting from these sales. During 1998, the
Partnership distributed the remaining net sales proceeds to the Limited Partners
in a special distribution, as described below. In connection with the sale of
both of the Farmington Hills, Michigan Properties, the Partnership also received
$214,000 as a lease termination fee from the former tenant in consideration of
the Partnership's releasing the tenant from its obligation under the terms of
the leases.
None of the Properties owned by the Partnership, or the joint ventures or
tenancy in common arrangements in which the Partnership owns an interest, is or
may be encumbered. Subject to certain restrictions on borrowing from the
General Partners, however, the Partnership may borrow, in the discretion of the
General Partners, for the purpose of maintaining the operations and paying
liabilities of the Partnership including quarterly distributions. The
Partnership will not borrow for the purpose of returning capital to the Limited
Partners. The Partnership will not encumber any of the Properties in connection
with any borrowing or advances. The Partnership also will not borrow under
circumstances which would make the Limited Partners liable to creditors of the
Partnership. Affiliates of the General Partners from time to time incur certain
operating expenses on behalf of the Partnership for which the Partnership
reimburses the affiliates without interest.
Currently, rental income from the Partnership's Properties and net sales
proceeds from the sale of Properties, pending reinvestment in additional
Properties, distributions to Limited Partners or use for the payment of
Partnership liabilities, are invested in money market accounts or other short-
term, highly liquid investments such as demand deposit accounts at commercial
banks, CDs and money market accounts with less than a 30-day maturity date,
pending the Partnership's use of such funds to pay Partnership expenses or to
make distributions to the partners. At December 31, 1998, the Partnership had
$889,891 invested in such short-term investments, as compared to $470,194 at
December 31,
10
<PAGE>
1997. The increase in cash and cash equivalents during 1998, as compared to
1997, is primarily attributable to the release of funds held in escrow at
December 31, 1997 relating to the sales of certain Properties during 1997. As of
December 31, 1998, the average interest rate earned on the rental income
deposited in demand deposit accounts at commercial banks was approximately three
percent annually. The funds remaining at December 31, 1998, after payment of
distributions and other liabilities, will be used to meet the Partnership's
working capital and other needs.
Short-Term Liquidity
The Partnership's short-term liquidity requirements consist primarily of
the operating expenses of the Partnership.
The Partnership's investment strategy of acquiring Properties for cash and
leasing them under triple-net leases to operators who generally meet specified
financial standards minimizes the Partnership's operating expenses. The General
Partners believe that the leases will continue to generate cash flow in excess
of operating expenses.
Due to low operating expenses and ongoing cash flow, the General Partners
do not believe that working capital reserves are necessary at this time. In
addition, because the leases for the Partnership's Properties are on a triple-
net basis, it is not anticipated that a permanent reserve for maintenance and
repairs will be established at this time. To the extent, however, that the
Partnership has insufficient funds for such purposes, the General Partners will
contribute to the Partnership an aggregate amount of up to one percent of the
offering proceeds for maintenance and repairs.
The General Partners have the right, but not the obligation, to make
additional capital contributions if they deem it appropriate in connection with
the operations of the Partnership.
The Partnership generally distributes cash from operations remaining after
the payment of the operating expenses of the Partnership, to the extent that the
General Partners determine that such funds are available for distribution.
Based primarily on current and anticipated future cash from operations, and for
the year ended December 31, 1997, the return of capital from Show Low Joint
Venture and a portion of the proceeds received from the sale of Properties, as
described above, the Partnership declared distributions to the Limited Partners
of $3,294,507 for the year ended December 31, 1998, and $2,376,000 for each of
the years ended December 31, 1997 and 1996. This represents distributions of
$65.89 per Unit for the year ended December 31, 1998, and $47.52 per Unit for
each of the years ended December 31, 1997 and 1996. The distributions to the
Limited Partners for 1997 and 1996 were also based on loans received from the
General Partners of $721,000 and $177,600, respectively, all of which were
subsequently repaid, as described above in "Capital Resources." Distributions
for the year ended December 31, 1998 included $1,232,003 as a result of the
distribution of the majority of the net sales proceeds from the 1997 sales of
the Properties in Avon Park, Florida and Farmington Hills, Michigan. This
special distribution was effectively a return of a portion of the Limited
Partners' investment; although, in accordance with the Partnership agreement, it
was applied to the Limited Partners' unpaid preferred return. As a result of
the sales of the Properties, the Partnership's total revenue was reduced during
1998 and is expected to remain at reduced amounts in subsequent years, while the
majority of the Partnership's operating expenses remained fixed. Therefore,
distributions of net cash flow were adjusted during 1998. No amounts
distributed or to be distributed to the Limited Partners for the years ended
December 31, 1998, 1997, and 1996, are required to be treated by the Partnership
as a return of capital for purposes of calculating the Limited Partners' return
on their adjusted capital contributions. The Partnership intends to continue to
make distributions of cash available for distribution to the Limited Partners on
a quarterly basis.
During 1998, 1997, and 1996, affiliates of the General Partners incurred on
behalf of the Partnership $116,317, $68,555, and $103,909, respectively, for
certain operating expenses. As of December 31, 1998 and 1997, the Partnership
owed $138,153 and $126,284, respectively, to affiliates for such amounts and
accounting and administrative services. In addition, during the year ended
December 31, 1998, the Partnership incurred $45,150 in real estate disposition
fees due to an affiliate as a result of its services in connection with the 1997
sales of the Properties in Avon Park, Florida and Farmington Hills, Michigan.
The payment of such fees is deferred until the Limited Partners have received
their cumulative 10% Preferred Return and their adjusted capital contributions.
Other liabilities, including distributions payable, decreased to $568,727 at
December 31, 1998, from $631,126 at December 31, 1997, primarily as a result of
a decrease in distributions payable to Limited Partners at December 31, 1998.
The General Partners believe that the Partnership has sufficient cash on hand to
meet its current working capital needs.
11
<PAGE>
Long-Term Liquidity
The Partnership has no long-term debt or other long-term liquidity
requirements.
Results of Operations
During 1996 and 1997, the Partnership owned and leased 36 wholly owned
Properties (including seven Properties sold during 1997). During 1998, the
Partnership owned and leased 29 wholly owned Properties. In addition, during
1998, 1997, and 1996, the Partnership was a co-venturer in three separate joint
ventures that each owned and leased one Property. During 1996, the Partnership
and an affiliate owned and leased one Property as tenants-in-common, during
1997, the Partnership owned and leased four Properties with affiliates as
tenants-in-common, and during 1998, the Partnership owned and leased six
Properties with affiliates, as tenants-in-common. As of December 31, 1998, the
Partnership owned, either directly, as tenants-in-common with affiliates, or
through joint venture arrangements, 38 Properties, which are, in general,
subject to long-term triple-net leases. The leases of the Properties provide
for minimum base annual rental amounts (payable in monthly installments) ranging
from approximately $8,300 to $222,800. Generally, the leases provide for
percentage rent based on sales in excess of a specified amount to be paid
annually. In addition, certain leases provide for increases in the annual base
rent during the lease term. For further description of the Partnership's leases
and Properties, see Item 1. Business - Leases and Item 2. Properties,
respectively.
During the years ended December 31, 1998, 1997, and 1996, the Partnership
earned $1,773,925, $2,024,119, and $2,224,500, respectively, in rental income
from the Partnership's wholly owned Properties described above. The decrease in
rental income during 1998, as compared to 1997, is primarily attributable to a
decrease in rental income as a result of the sales of seven Properties during
1997. The Partnership reinvested the majority of the net sales proceeds from
the 1997 sales of several Properties in Properties held as tenants-in-common
with affiliates of the General Partners resulting in an increase in equity in
earnings of joint ventures, as described below. Rental income earned from
wholly owned Properties is expected to remain at reduced amounts as a result of
the Partnership reinvesting the net sales proceeds in Properties held as
tenants-in-common with affiliates of the General Partners, and distributing net
sales proceeds to the Limited Partners, as described above in "Capital
Resources."
Rental income for 1997, as compared to 1996, decreased primarily as the
result of the sales of seven Properties during 1997. The decrease in rental
income was partially offset by an increase during 1997 due to the fact that
rental payments began in July 1997 under the new lease for the Property in
Lombard, Illinois, as described above in "Capital Resources."
During the years ended December 31, 1998, 1997, and 1996, the Partnership
also earned $51,029, $68,920, and $79,313, respectively, in contingent rental
income. The decrease in contingent rental income for 1998 and 1997, each as
compared to the previous year, is primarily due to the 1997 sales of several
Properties, the leases of which required the payment of contingent rental
income.
For the years ended December 31, 1998, 1997, and 1996 , the Partnership
also earned $431,974, $389,915, and $130,996, respectively, attributable to net
income earned by joint ventures in which the Partnership is a co-venturer. The
increase in net income earned by joint ventures during 1998 and 1997, each as
compared to the previous year, is primarily attributable to the fact that during
1998 and 1997, the Partnership reinvested a portion of the net sales proceeds
from the 1997 sales of Properties, in two and five Properties, respectively,
with affiliates of the General Partners as tenants-in-common. The increase in
net income earned by joint ventures during 1998 is partially offset by, and the
increase during 1997, as compared to 1996, is primarily attributable to, the
fact that in January 1997, Show Low Joint Venture, in which the Partnership owns
a 64 percent interest, recognized a gain of approximately $360,000 for financial
reporting purposes from the sale of its Property, as described above in "Capital
Resources," above. Show Low Joint Venture reinvested the majority of the net
sales proceeds in an additional Property in June 1997.
During the year ended December 31, 1998, two of the Partnership's lessees,
Golden Corral Corporation and Restaurant Management Services, Inc., each
contributed more than ten percent of the Partnership's total rental income
(including the Partnership's share of rental income from three Properties owned
by joint ventures and six Properties owned with affiliates as tenants-in-
common). As of December 31, 1998, Golden Corral Corporation was the lessee
under leases relating to six restaurants and Restaurant Management Services,
Inc. was the lessee under leases relating to
12
<PAGE>
four restaurants. It is anticipated that, based on the minimum annual rental
payments required by the leases, these two lessees will continue to contribute
more than ten percent of the Partnership's total rental income during 1999. In
addition, during the year ended December 31, 1998, two Restaurant Chains, Golden
Corral, and Popeyes, each accounted for more than ten percent of the
Partnership's total rental and mortgage interest income (including the
Partnership's share of the rental income from three Properties owned by joint
ventures and six Properties owned with affiliates as tenants-in-common). In
1999, it is anticipated that these two Restaurant Chains each will continue to
account for more than ten percent of the total rental income to which the
Partnership is entitled under the terms of its leases. Any failure of these
lessees or Restaurant Chains could materially affect the Partnership's income if
the Partnership is not able to re-lease the Properties in a timely manner.
Operating expenses, including depreciation and amortization expense, were
$558,525, $598,098, and $588,923 for the years ended December 31, 1998, 1997,
and 1996, respectively. The decrease in operating expenses during 1998, as
compared to 1997, is primarily due to a decrease in depreciation expense as a
result of the sales of several Properties during 1997. The decrease is
partially offset by an increase in general operating and administrative expenses
as a result of the Partnership incurring certain repairs relating to the
Property in Lombard, Illinois. The Partnership has entered into a new lease for
this Property and does not anticipate incurring such expenses in the future
periods.
The decrease in operating expenses during 1998, as compared to 1997, is
also partially offset by an increase as a result of the Partnership incurring
$16,208 in transaction costs relating to the General Partners retaining
financial and legal advisors to assist them in evaluating and negotiating the
proposed Merger with APF, as described below. If the Limited Partners reject
the Merger, the Partnership will bear the portion of the transaction costs based
upon the percentage of "For" votes and the General Partners will bear the
portion of such transaction costs based upon the percentage of "Against" votes
and abstentions.
The decrease in operating expenses during 1998, as compared to 1997, and
the increase during 1997, as compared to 1996, is partially due to the fact that
during 1997, the Partnership recorded bad debt expense for past due rental
amounts relating to the Property in Eagan, Minnesota, due to financial
difficulties of the tenant. This Property was sold in June 1997, as described
above in "Capital Resources." The increase in operating expenses during 1997,
as compared to 1996, was also attributable to an increase in accounting and
administrative expenses associated with operating the Partnership and its
Properties. The increase in operating expenses during 1997, as compared to
1996, was partially offset by a decrease in depreciation expense which resulted
from the sale of the seven Properties during 1997, as described above in
"Capital Resources."
During the year ended December 31, 1998, the Partnership recorded deferred,
subordinated real estate disposition fees of $45,150 payable to CNL Fund
Advisors, Inc. relating to the 1997 sales of the Properties in Avon Park,
Florida and Farmington Hills, Michigan. Initially, the Partnership considered
reinvesting the sales proceeds in additional Properties and therefore did not
include these amounts in the determination of the gain on sale for financial
reporting purposes during 1997. However, during the year ended December 31,
1998, the Partnership declared a special distribution of net sales proceeds from
these Properties payable to the Limited Partners. Accordingly, the Partnership
recorded these subordinated real estate disposition fees during the year ended
December 31, 1998. The payment of these fees is subordinated to the Limited
Partners receiving their cumulative 10% Preferred Return and their adjusted
capital contribution.
As a result of the sales of several Properties, the Partnership recognized
gains totalling $1,476,124 during the year ended December 31, 1997, for
financial reporting purposes. In addition, in connection with the sale of the
Properties in Farmington Hills, Michigan, the Partnership also received $214,000
as a lease termination fee from the former tenant in consideration of the
Partnership's releasing the tenant from its obligation under the terms of the
leases. No such transactions occurred during the years ended December 31, 1998
and 1996.
The Partnership's leases as of December 31, 1998, are, in general, triple-
net leases and contain provisions that the General Partners believe mitigate the
adverse effect of inflation. Such provisions include clauses requiring the
payment of percentage rent based on certain restaurant sales above a specified
level and/or automatic increases in base rent at specified times during the term
of the lease. Management expects that increases in restaurant sales volumes due
to inflation and real sales growth should result in an increase in rental income
(for certain Properties) over time. Continued inflation also may cause capital
appreciation of the Partnership's Properties. Inflation and changing prices,
13
<PAGE>
however, also may have an adverse impact on the sales of the restaurants and on
potential capital appreciation of the Properties.
Proposed Merger
On March 11, 1999, the Partnership entered into an Agreement and Plan of
Merger with APF, pursuant to which the Partnership would be merged with and into
a subsidiary of APF. As consideration for the Merger, APF has agreed to issue
2,393,267 APF Shares. In order to assist the General Partners in evaluating the
proposed merger consideration, the General Partners retained Valuation
Associates, a nationally recognized real estate appraisal firm, to appraise the
Partnership's restaurant property portfolio. Based on Valuation Associates'
appraisal, the fair value of the Partnership's property portfolio and other
assets was $23,548,652 as of December 31, 1998. The APF Shares are expected to
be listed for trading on the New York Stock Exchange concurrently with the
consummation of the Merger, and, therefore, would be freely tradable at the
option of the former Limited Partners. At a special meeting of the Limited
Partners that is expected to be held in the fourth quarter of 1999, Limited
Partners holding in excess of 50% of the Partnership's outstanding limited
partnership interests must approve the Merger prior to consummation of the
transaction. If the Limited Partners at the special meeting approve the Merger,
APF will own the Properties and other assets of the Partnership. The General
Partners intend to recommend that the Limited Partners of the Partnership
approve the Merger. In connection with their recommendation, the General
Partners will solicit the consent of the Limited Partners at the special
meeting.
Year 2000 Readiness Disclosure
Overview of Year 2000 Problem
The year 2000 problem concerns the inability of information and non-
information technology systems to properly recognize and process date sensitive
information beyond January 1, 2000. The failure to accurately recognize the
year 2000 could result in a variety of problems from data miscalculations to the
failure of entire systems.
Information and Non-Information Technology Systems
The Partnership does not have any information or non-information technology
systems. The General Partners and their affiliates provide all services
requiring the use of information and non-information technology systems pursuant
to a management agreement with the Partnership. The information technology
system of the General Partners' affiliates consists of a network of personal
computers and servers built using hardware and software from mainstream
suppliers. The non-information technology systems of the affiliates are
primarily facility related and include building security systems, elevators,
fire suppressions, HVAC, electrical systems and other utilities. The affiliates
have no internally generated programmed software coding to correct, because
substantially all of the software utilized by the affiliates is purchased or
licensed from external providers. The maintenance of non-information technology
systems at the Partnership's restaurant properties is the responsibility of the
tenants of such properties in accordance with the terms of the Partnership's
leases.
The Y2K Team
In early 1998, the General Partners and their affiliates formed a Year 2000
committee (the "Y2K Team") for the purpose of identifying, understanding and
addressing the various issues associated with the year 2000 problem. The Y2K
Team consists of the General Partners and members from their affiliates,
including representatives from senior management, information systems,
telecommunications, legal, office management, accounting and property
management.
Assessing Year 2000 Readiness
The Y2K Team's initial step in assessing year 2000 readiness consists of
identifying any systems that are date-sensitive and, accordingly, could have
potential year 2000 problems. The Y2K Team has conducted inspections,
interviews and tests to identify which of the systems used by the Partnership
could have a potential year 2000 problem.
14
<PAGE>
The information system of the General Partners' affiliates is comprised of
hardware and software applications from mainstream suppliers. Accordingly, the
Y2K Team has contacted and is evaluating documentation from the respective
vendors and manufacturers to verify the year 2000 compliance of their products.
The Y2K Team has also requested and is evaluating documentation from the non-
information technology systems providers of the affiliates.
In addition, the Y2K Team has requested and is evaluating documentation
from other companies with which the Partnership has material third party
relationships. Such third parties, in addition to the providers of information
and non-information technology systems, consist of the Partnership's transfer
agent and financial institutions. The Partnership depends on its transfer agent
to maintain and track investor information and its financial institutions for
availability of cash.
As of September 15, 1999, the Y2K Team had received responses from
approximately 60% of the third parties. All of the responses were in writing.
Of the third parties responding, all indicated that they are currently year 2000
compliant or will be year 2000 compliant prior to the year 2000. Although the
Y2K Team continues to receive positive responses from the companies with which
the Partnership has third party relationships regarding their year 2000
compliance, the General Partners cannot be assured that the third parties have
adequately considered the impact of the year 2000.
In addition, the Y2K Team has requested documentation from the
Partnership's tenants. The Y2K Team is in the process of evaluating the
responses and expects to complete this process by October 31, 1999. The
Partnership has also instituted a policy of requiring any new tenants to
indicate that their systems are year 2000 compliant or are expected to be year
2000 compliant prior to the year 2000.
Achieving Year 2000 Compliance
The Y2K Team has identified and completed upgrades of the hardware
equipment that was not year 2000 compliant. In addition, the Y2K Team has
identified and completed upgrades of the software applications that were not
year 2000 compliant, although the General Partners cannot be assured that the
upgrade solutions provided by the vendors have addressed all possible year 2000
issues.
The cost for these upgrades and other remedial measures is the
responsibility of the General Partners and their affiliates. The General
Partners do not expect that the Partnership will incur any costs in connection
with year 2000 remedial measures.
Assessing the Risks to the Partnership of Non-Compliance and Developing
Contingency Plans
Risk of Failure of Information and Non-Information Technology Systems Used by
the Partnership
The General Partners believe that the reasonably likely worst case scenario
with regard to the information and non-information technology systems used by
the Partnership is the failure of one or more of these systems as a result of
year 2000 problems. Because the Partnership's major source of income is rental
payments under long-term triple-net leases, any failure of information or non-
information technology systems used by the Partnership is not expected to have a
material impact on the results of operations of the Partnership. Even if such
systems failed, the payment of rent under the Partnership's leases would not be
affected. In addition, the Y2K Team is expected to correct any Y2K problems
within the control of the General Partners and their affiliates before the year
2000.
The Y2K Team has determined that a contingency plan to address this risk is
not necessary at this time. However, if the Y2K Team identifies additional
risks associated with the year 2000 compliance of the information or non-
information technology systems used by the Partnership, the Y2K Team will
develop a contingency plan if deemed necessary at that time.
15
<PAGE>
Risk of Inability of Transfer Agent to Accurately Maintain Partnership Records
The General Partners believe that the reasonably likely worst case scenario
with regard to the Partnership's transfer agent is that the transfer agent will
fail to achieve year 2000 compliance of its systems and will not be able to
accurately maintain the records of the Partnership. This could result in the
inability of the Partnership to accurately identify its Limited Partners for
purposes of distributions, delivery of disclosure materials and transfer of
units. The Y2K Team has received certification from the Partnership's transfer
agent of its year 2000 compliance. Despite the positive response from the
transfer agent, the General Partners cannot be assured that the transfer agent
has addressed all possible year 2000 issues.
The Y2K Team has developed a contingency plan pursuant to which the General
Partners and their affiliates would maintain the records of the Partnership
manually, in the event that the systems of the transfer agent are not year 2000
compliant. The General Partners and their affiliates would have to allocate
resources to internally perform the functions of the transfer agent. The
General Partners do not anticipate that the additional cost of these resources
would have a material impact on the results of operations of the Partnership.
Risk of Loss of Short-Term Liquidity from Failure of Financial Institutions to
Achieve Year 2000 Compliance
The General Partners believe that the reasonably likely worst case scenario
with regard to the Partnership's financial institutions is that some or all of
its funds on deposit with such financial institutions may be temporarily
unavailable. The Y2K Team has received responses from 93% of the Partnership's
financial institutions indicating that their systems are currently year 2000
compliant or are expected to be year 2000 compliant prior to the year 2000.
Despite the positive responses from the financial institutions, the General
Partners cannot be assured that the financial institutions have addressed all
possible year 2000 issues. The loss of short-term liquidity could affect the
Partnership's ability to pay its expenses on a current basis. The General
Partners do not anticipate that a loss of short-term liquidity would have a
material impact on the results of operations of the Partnership.
Based upon the responses received from the Partnership's financial
institutions and the inability of the Y2K Team to identify a suitable
alternative for the deposit of funds that is not subject to potential year 2000
problems, the Y2K Team has determined not to develop a contingency plan to
address this risk.
Risks of Late Payment or Non-Payment of Rent by Tenants
The General Partners believe that the reasonably likely worst case scenario
with regard to the Partnership's tenants is that some of the tenants may make
rental payments late as the result of the failure of the tenants to achieve year
2000 compliance of their systems used in the payment of rent, the failure of the
tenant's financial institutions to achieve year 2000 compliance, or the
temporary disruption of the tenants' businesses. The Y2K Team is in the process
of requesting responses from the Partnership's tenants indicating the extent to
which their systems are currently year 2000 compliant or are expected to be year
2000 compliant prior to the year 2000. The General Partners cannot be assured
that the tenants have addressed all possible year 2000 issues. The late payment
of rent by one or more tenants would affect the results of operations of the
Partnership in the short-term.
The General Partners are also aware of predictions that the year 2000
problem, if uncorrected, may result in a global economic crisis. The General
Partners are not able to determine if such predictions are true. A widespread
disruption of the economy could affect the ability of the Partnership's tenants
to pay rent and, accordingly, could have a material impact on the results of
operations of the Partnership.
Because payment of rent is under the control of the Partnership's tenants,
the Y2K Team is not able to develop a contingency plan to address these risks.
In the event of late payment or non-payment of rent, the General Partners will
assess the remedies available to the Partnership under its lease agreements.
Item 8. Financial Statements and Supplementary Data
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CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
CONTENTS
--------
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants 18
Financial Statements:
Balance Sheets 19
Statements of Income 20
Statements of Partners' Capital 21
Statements of Cash Flows 22
Notes to Financial Statements 24
</TABLE>
17
<PAGE>
Report of Independent Accountants
---------------------------------
To the Partners
CNL Income Fund II, Ltd.
In our opinion, the financial statements listed in the index appearing under
item 14(a)(1) present fairly, in all material respects, the financial position
of CNL Income Fund II, Ltd. (a Florida limited partnership) at December 31, 1998
and 1997, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles. In addition, in our opinion, the financial
statement schedules listed in the index appearing under item 14(a)(2) present
fairly, in all material respects, the information set forth therein when read in
conjunction with the related financial statements. These financial statements
and financial statement schedules are the responsibility of the Partnership's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedules based on our audits. We conducted
our audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Orlando, Florida
January 13, 1999, except for Note 12 for which the date is March 11, 1999
18
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
BALANCE SHEETS
--------------
<TABLE>
<CAPTION>
December 31,
1998 1997
--------------- ---------------
ASSETS
------
<S> <C> <C>
Land and buildings on operating leases, less
accumulated depreciation $12,835,304 $13,164,568
Investment in joint ventures 4,353,427 3,568,155
Mortgage note receivable 6,872 42,734
Cash and cash equivalents 889,891 470,194
Restricted cash -- 2,470,175
Receivables, less allowance for doubtful
accounts of $55,435 and $83,254 122,560 80,577
Prepaid expenses 4,801 5,510
Lease costs, less accumulated amortization
of $14,889 and $11,520 5,674 9,043
Accrued rental income 174,382 148,103
----------------- ----------------
$18,392,911 $19,959,059
================= ================
LIABILITIES AND PARTNERS' CAPITAL
---------------------------------
Accounts payable $ 4,621 $ 7,170
Accrued and escrowed real estate taxes
payable 8,065 4,656
Distributions payable 515,629 594,000
Due to related parties 183,303 126,284
Rents paid in advance and deposits 40,412 25,300
----------------- ----------------
Total liabilities 752,030 757,410
Partners' capital 17,640,881 19,201,649
----------------- ----------------
$18,392,911 $19,959,059
================= ================
</TABLE>
See accompanying notes to financial statements.
19
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
STATEMENTS OF INCOME
--------------------
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
--------------- --------------- ----------------
<S> <C> <C> <C>
Revenues:
Rental income from operating leases $1,773,925 $2,024,119 $2,224,500
Contingent rental income 51,029 68,920 79,313
Interest and other income 80,486 64,900 21,075
--------------- --------------- ----------------
1,905,440 2,157,939 2,324,888
--------------- --------------- ----------------
Expenses:
General operating and administrative 160,220 137,924 131,628
Professional services 34,731 21,576 26,634
Bad debt expense -- 27,965 --
Real estate taxes -- 410 4,647
State and other taxes 14,733 10,403 4,255
Depreciation and amortization 332,633 399,820 421,759
Transaction costs 16,208 -- --
--------------- --------------- ----------------
558,525 598,098 588,923
--------------- --------------- ----------------
Income Before Equity in Earnings of
Joint Ventures, Gain on Sale of Land
and Buildings, Real Estate Disposition
Fees, and Lease Termination Income 1,346,915 1,559,841 1,735,965
Equity in Earnings of Joint Ventures 431,974 389,915 130,996
Gain on Sale of Land and Buildings -- 1,476,124 --
Real Estate Disposition Fees (45,150) -- --
Lease Termination Income -- 214,000 --
--------------- --------------- ----------------
Net Income $1,733,739 $3,639,880 $1,866,961
=============== =============== ================
Allocation of Net Income:
General partners $ 17,789 $ 30,736 $ 18,670
Limited partners 1,715,950 3,609,144 1,848,291
--------------- --------------- ----------------
$1,733,739 $3,639,880 $1,866,961
=============== =============== ================
Net Income Per Limited Partner Unit $34.32 $72.18 $36.97
=============== =============== ================
Weighted Average Number of
Limited Partner Units Outstanding 50,000 50,000 50,000
=============== =============== ================
</TABLE>
See accompanying notes to financial statements.
20
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
STATEMENTS OF PARTNERS' CAPITAL
-------------------------------
Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
General Partners Limited Partners
---------------------------- --------------------------------------------------------
Accumulated Accumulated Syndication
Contributions Earnings Contributions Distributions Earnings Costs Total
-------------- ------------- --------------- ------------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 $162,000 $161,705 $25,000,000 $(20,317,377) $16,130,302 $(2,689,822) $18,446,808
Distributions to limited
partners ($47.52 per
limited partner unit) -- -- -- (2,376,000) -- -- (2,376,000)
Net income -- 18,670 -- -- 1,848,291 -- 1,866,961
-------------- ------------- --------------- ------------- ------------ ----------- -----------
Balance, December 31, 1996 162,000 180,375 25,000,000 (22,693,377) 17,978,593 (2,689,822) 17,937,769
Distributions to limited
partners ($47.52 per
limited partner unit) -- -- -- (2,376,000) -- -- (2,376,000)
Net income -- 30,736 -- -- 3,609,144 -- 3,639,880
-------------- ------------- --------------- ------------- ------------ ----------- -----------
Balance, December 31, 1997 162,000 211,111 25,000,000 (25,069,377) 21,587,737 (2,689,822) 19,201,649
Distributions to limited
partners ($65.89 per
limited partner unit) -- -- -- (3,294,507) -- -- (3,294,507)
Net income -- 17,789 -- -- 1,715,950 -- 1,733,739
-------------- ------------- --------------- ------------- ------------ ----------- -----------
Balance, December 31, 1998 $162,000 $228,900 $25,000,000 $(28,363,884) $23,303,687 $(2,689,822) $17,640,881
============== ============= =============== ============= ============ =========== ===========
</TABLE>
See accompanying notes to financial statements.
21
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
STATEMENTS OF CASH FLOWS
------------------------
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
---------------- --------------- ---------------
<S> <C> <C> <C>
Increase (Decrease) in Cash and Cash
Equivalents:
Cash Flows from Operating Activities:
Cash received from tenants $ 1,796,989 $ 2,054,519 $ 2,295,531
Distributions from joint ventures 482,671 147,995 164,718
Cash paid for expenses (227,335) (80,744) (130,042)
Interest received 83,366 36,142 17,524
---------------- --------------- ---------------
Net cash provided by operating
activities 2,135,691 2,157,912 2,347,731
---------------- --------------- ---------------
Cash Flows from Investing Activities:
Proceeds from sale of land and buildings -- 4,659,078 --
Proceeds received from tenant in connection
with termination of leases -- 214,000 --
Additions to land and buildings on operating
leases -- (29,526) (11,107)
Investment in joint ventures (835,969) (2,136,289) --
Return of capital from joint venture -- 124,440 --
Collections on mortgage note receivable 35,183 -- --
Decrease (increase) in restricted cash 2,457,670 (2,457,670) 25,000
Payment of lease costs -- (4,507) (1,930)
Other -- -- (25,000)
---------------- --------------- ---------------
Net cash provided by (used in)
investing activities 1,656,884 369,526 (13,037)
---------------- --------------- ---------------
Cash Flows from Financing Activities:
Proceeds from loans from corporate
general partner -- 721,000 203,900
Repayment of loans from corporate
general partner -- (721,000) (203,900)
Distributions to limited partners (3,372,878) (2,376,000) (2,376,000)
---------------- --------------- ---------------
Net cash used in financing activities (3,372,878) (2,376,000) (2,376,000)
---------------- --------------- ---------------
Net Increase (Decrease) in Cash and Cash
Equivalents 419,697 151,438 (41,306)
Cash and Cash Equivalents at Beginning of Year 470,194 318,756 360,062
---------------- --------------- ---------------
Cash and Cash Equivalents at End of Year $ 889,891 $ 470,194 $ 318,756
================ =============== ===============
</TABLE>
See accompanying notes to financial statements.
22
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
STATEMENTS OF CASH FLOWS - CONTINUED
------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
------------------- ------------------ -------------------
<S> <C> <C> <C>
Reconciliation of Net Income to Net Cash
Provided by Operating Activities:
Net income $1,733,739 $ 3,639,880 $1,866,961
------------------- ------------------ -------------------
Adjustments to reconcile net income to
net cash provided by operating
activities:
Bad debt expense -- 27,965 --
Depreciation 329,264 395,837 417,776
Amortization 3,369 3,983 3,983
Gain on sale of land and buildings -- (1,476,124) --
Lease termination income -- (214,000) --
Equity in earnings of joint ventures,
net of distributions 50,697 (241,920) 33,722
Increase in receivables (28,799) (4,166) (8,803)
Decrease (increase) in prepaid expenses 709 (691) (1,570)
Increase in accrued rental income (26,279) (30,746) (33,234)
Decrease in other assets -- -- 1,750
Increase (decrease) in accounts
payable and accrued expenses 860 (2,304) 4,014
Increase in due to related parties 57,019 81,206 35,824
Increase (decrease) in rents paid in
advance and deposits 15,112 (21,008) 27,308
------------------- ------------------ -------------------
Total adjustments 401,952 (1,481,968) 480,770
------------------- ------------------ -------------------
Net Cash Provided by Operating Activities $2,135,691 $ 2,157,912 $2,347,731
=================== ================== ===================
Supplemental Schedule of Non-Cash Investing and
Financing Activities
Mortgage note accepted as consideration in
sale of land and building $ -- $ 42,000 $ --
=================== ================== ===================
Deferred real estate disposition fees incurre
and unpaid at end of period $ 45,150 $ -- $ --
=================== ================== ===================
Distributions declared and unpaid at
December 31 $ 515,629 $ 594,000 $ 594,000
=================== ================== ===================
</TABLE>
See accompanying notes to financial statements.
23
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS
-----------------------------
Years Ended December 31, 1998, 1997, and 1996
1. Significant Accounting Policies:
-------------------------------
Organization and Nature of Business - CNL Income Fund II, Ltd. (the
-----------------------------------
"Partnership") is a Florida limited partnership that was organized for the
purpose of acquiring both newly constructed and existing restaurant
properties, as well as properties upon which restaurants were to be
constructed, which are leased primarily to operators of national and
regional fast-food restaurant chains.
The general partners of the Partnership are CNL Realty Corporation (the
"Corporate General Partner"), James M. Seneff, Jr. and Robert A. Bourne.
Mr. Seneff and Mr. Bourne are also 50 percent shareholders of the Corporate
General Partner. The general partners have responsibility for managing the
day-to-day operations of the Partnership.
Real Estate and Lease Accounting - The Partnership records the acquisition
--------------------------------
of land and buildings at cost, including acquisition and closing costs.
Land and buildings are leased to unrelated third parties on a triple-net
basis, whereby the tenant is generally responsible for all operating
expenses relating to the property, including property taxes, insurance,
maintenance and repairs. The leases are accounted for using the operating
method. Under the operating method, land and building leases are recorded
at cost, revenue is recognized as rentals are earned and depreciation is
charged to operations as incurred. Buildings are depreciated on the
straight-line method over their estimated useful lives of 30 years. When
scheduled rentals vary during the lease term, income is recognized on a
straight-line basis so as to produce a constant periodic rent over the
lease term commencing on the date the property is placed in service.
Accrued rental income represents the aggregate amount of income recognized
on a straight-line basis in excess of scheduled rental payments to date.
Whenever a tenant defaults under the terms of its lease, or events or
changes in circumstance indicate that the tenant will not lease the
property through the end of the lease term, the Partnership either reserves
or writes-off the cumulative accrued rental income balance.
When the properties are sold, the related cost and accumulated depreciation
plus any accrued rental income, are removed from the accounts and gains or
losses from sales are reflected in income. The general partners of the
Partnership review the properties for impairment whenever events or changes
in circumstances indicate that the carrying amount of the assets may not be
recoverable through operations. The general partners determine whether an
impairment in value has occurred by comparing the estimated future
undiscounted cash flows, including the residual value of the property, with
the carrying cost of the individual property. If an impairment is
indicated, a loss will be recorded for the amount by which the carrying
value of the asset exceeds its fair market value. Although the
24
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
1. Significant Accounting Policies - Continued:
-------------------------------------------
general partners have made their best estimate of these factors based on
current conditions, it is reasonably possible that changes could occur in
the near term which could adversely affect the general partners' estimate
of net cash flows expected to be generated from its properties and the need
for asset impairment write-downs.
When the collection of amounts recorded as rental or other income is
considered to be doubtful, an adjustment is made to increase the allowance
for doubtful accounts, which is netted against receivables, and to decrease
rental or other income or increase bad debt expense for the current period,
although the Partnership continues to pursue collection of such amounts. If
amounts are subsequently determined to be uncollectible, the corresponding
receivable and allowance for uncollectible accounts are decreased
accordingly.
Investment in Joint Ventures - The Partnership's investments in Kirkman
----------------------------
Road Joint Venture, Holland Joint Venture and Show Low Joint Venture, and
the properties in Arvada, Colorado; Mesa, Arizona; Smithfield, North
Carolina; Vancouver, Washington; Overland Park, Kansas; and Memphis,
Tennessee, each of which is held as tenants-in-common with affiliates, are
accounted for using the equity method since the Partnership shares control
with affiliates which have the same general partners.
Cash and Cash Equivalents - The Partnership considers all highly liquid
-------------------------
investments with a maturity of three months or less when purchased to be
cash equivalents. Cash and cash equivalents consist of demand deposits at
commercial banks and money market funds (some of which are backed by
government securities). Cash equivalents are stated at cost plus accrued
interest, which approximates market value.
Cash accounts maintained on behalf of the Partnership in demand deposits at
commercial banks and money market funds may exceed federally insured
levels; however, the Partnership has not experienced any losses in such
accounts. The Partnership limits investment of temporary cash investments
to financial institutions with high credit standing; therefore, the
Partnership believes it is not exposed to any significant credit risk on
cash and cash equivalents.
Lease Costs - Lease incentive costs and brokerage and legal fees associated
-----------
with negotiating new leases are amortized over the terms of the new leases
using the straight-line method. When a property is sold or a lease is
terminated, the related lease cost, if any, net of accumulated amortization
is removed from the accounts and charged against income.
25
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
1. Significant Accounting Policies - Continued:
-------------------------------------------
Income Taxes - Under Section 701 of the Internal Revenue Code, all income,
------------
expenses and tax credit items flow through to the partners for tax
purposes. Therefore, no provision for federal income taxes is provided in
the accompanying financial statements. The Partnership is subject to
certain state taxes on its income and property.
Additionally, for tax purposes, syndication costs are included in
Partnership equity and in the basis of each partner's investment. For
financial reporting purposes, syndication costs are netted against
partners' capital and represent a reduction of Partnership equity and a
reduction in the basis of each partner's investment.
Use of Estimates - The general partners of the Partnership have made a
----------------
number of estimates and assumptions relating to the reporting of assets and
liabilities and the disclosure of contingent assets and liabilities to
prepare these financial statements in conformity with generally accepted
accounting principles. The more significant areas requiring the use of
management estimates relate to the allowance for doubtful accounts and
future cash flows associated with long-lived assets. Actual results could
differ from those estimates.
Reclassification - Certain items in the prior years' financial statements
----------------
have been reclassified to conform to 1998 presentation. These
reclassifications had no effect on partners' capital or net income.
2. Leases:
------
The Partnership leases its land or land and buildings primarily to
operators of national and regional fast-food restaurants. The leases are
accounted for under the provisions of Statement of Financial Accounting
Standards No. 13, "Accounting for Leases." The leases have been classified
as operating leases. Substantially all leases are for 15 to 20 years and
provide for minimum and contingent rentals. In addition, the tenant
generally pays all property taxes and assessments, fully maintains the
interior and exterior of the building and carries insurance coverage for
public liability, property damage, fire and extended coverage. The lease
options generally allow tenants to renew the leases for two to four
successive five-year periods subject to the same terms and conditions as
the initial lease. Most leases also allow the tenant to purchase the
property at fair market value after a specified portion of the lease has
elapsed.
26
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
3. Land and Buildings on Operating Leases:
--------------------------------------
Land and buildings on operating leases consisted of the following at
December 31:
<TABLE>
<CAPTION>
1998 1997
---------------- ----------------
<S> <C> <C>
Land $ 6,608,400 $ 6,608,400
Buildings 9,858,263 9,858,263
---------------- ----------------
16,466,663 16,466,663
Less accumulated depreciation (3,631,359) (3,302,095)
---------------- ----------------
$12,835,304 $13,164,568
================ ================
</TABLE>
In June 1997, the Partnership sold its property in Eagan, Minnesota, to the
tenant, for $668,033 and received net sales proceeds of $665,882, of which
$42,000 were in the form of a promissory note, resulting in a gain of
$158,251 for financial reporting purposes. This property was originally
acquired by the Partnership in August 1987 and had a cost of approximately
$601,100, excluding acquisition fees and miscellaneous acquisition
expenses; therefore, the Partnership sold the property for approximately
$64,800 in excess of its original purchase price. In October 1997, the
Partnership used the net sales proceeds to acquire a property in Mesa,
Arizona, as tenants-in-common (see Note 4).
In addition, during 1997, the Partnership sold its properties in
Jacksonville, Plant City and Avon Park, Florida; its property in Mathis,
Texas and two properties in Farmington Hills, Michigan to third parties for
aggregate sales prices of $4,162,006 and received aggregate net sales
proceeds (net of $18,430, which represents amounts due to the former tenant
for prorated rent) of $4,035,196, resulting in aggregate gains of
$1,317,873 for financial reporting purposes. These six properties were
originally acquired by the Partnership during 1987 and had aggregate costs
of approximately $3,338,800, excluding acquisition fees and miscellaneous
acquisition expenses; therefore, the Partnership sold these six properties
for approximately $714,400, in the aggregate, in excess of their original
aggregate purchase prices. During 1997, the Partnership reinvested
approximately $1,512,400 of these net sales proceeds in a property in
Vancouver, Washington, and a property in Smithfield, North Carolina, as
tenants-in-common with affiliates of the General Partners (see Note 4). In
January 1998, the Partnership reinvested a portion of these net sales
proceeds in a property in Overland Park, Kansas, and a property in Memphis,
Tennessee, as tenants-in-common with affiliates of the General Partners
(see Note 4). In connection with the sale of both of
27
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
3. Land and Buildings on Operating Leases - Continued:
--------------------------------------------------
the Farmington Hills, Michigan properties, the Partnership also received
$214,000 as a lease termination fee from the former tenant in consideration
of the Partnership's releasing the tenant from its obligation under the
terms of the leases.
Some of the leases provide for escalating guaranteed minimum rents
throughout the lease terms. Income from these scheduled rent increases is
recognized on a straight-line basis over the terms of the leases. For the
years ended December 31, 1998, 1997, and 1996, the Partnership recognized
$26,279, $30,746, and $33,234, respectively, of such income.
The following is a schedule of the future minimum lease payments to be
received on noncancellable operating leases at December 31, 1998:
<TABLE>
<S> <C>
1999 $ 1,617,078
2000 1,545,876
2001 1,561,629
2002 1,394,850
2003 1,146,347
Thereafter 5,112,565
----------------
$12,378,345
================
</TABLE>
Since lease renewal periods are exercisable at the option of the tenant,
the above table only presents future minimum lease payments due during the
initial lease terms. In addition, this table does not include any amounts
for future contingent rentals which may be received on the leases based on
a percentage of the tenant's gross sales.
4. Investment in Joint Ventures:
----------------------------
The Partnership has a 50 percent interest, a 49 percent interest and a 64
percent interest in the profits and losses of Kirkman Road Joint Venture,
Holland Joint Venture and Show Low Joint Venture, respectively. The
remaining interests in Holland Joint Venture and Show Low Joint Venture are
held by affiliates of the general partners. The Partnership also has a
33.87% interest in a property in Arvada, Colorado, with an affiliate of the
general partners, as tenants-in-common. The Partnership accounts for its
investment in this property using the equity method since the Partnership
shares control with an affiliate. Amounts relating to its investment are
included in investment in joint ventures.
28
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
4. Investment in Joint Ventures - Continued:
----------------------------------------
In January 1997, Show Low Joint Venture, in which the Partnership owns a 64
percent interest, sold its property to the tenant for $970,000, resulting
in a gain to the joint venture of approximately $360,000 for financial
reporting purposes. The property was originally contributed to Show Low
Joint Venture in July 1990 and had a total cost of approximately $663,500,
excluding acquisition fees and miscellaneous acquisition expenses;
therefore, the joint venture sold the property for approximately $306,500
in excess of its original purchase price. In June 1997, Show Low Joint
Venture reinvested $782,413 of the net sales proceeds in a Darryl's
property in Greensboro, North Carolina. As of December 31, 1997, the
Partnership had received approximately $124,400 representing a return of
capital for its pro-rata share of the uninvested net sales proceeds. As of
December 31, 1998, the Partnership owned a 64 percent interest in the
profits and losses of the joint venture.
In October 1997, the Partnership used the net sales proceeds from the sale
of the property in Eagan, Minnesota (see Note 3) to acquire a property in
Mesa, Arizona, as tenants-in-common with an affiliate of the general
partners. The Partnership accounts for its investment in this property
using the equity method since the Partnership shares control with an
affiliate, and amounts relating to its investment are included in
investment in joint ventures. As of December 31, 1998, the Partnership
owned an approximate 58 percent interest in this property.
In December 1997, the Partnership used the net sales proceeds from the sale
of one of the properties in Farmington Hills, Michigan, to acquire a
property in Smithfield, North Carolina, as tenants-in-common with an
affiliate of the general partners. The Partnership accounts for its
investment in this property using the equity method since the Partnership
shares control with an affiliate, and amounts relating to its investment
are included in investment in joint ventures. As of December 31, 1998, the
Partnership owned a 47 percent interest in this property.
In addition, in December 1997, the Partnership used the net sales proceeds
from the sale of the property in Plant City, Florida, to acquire a property
in Vancouver, Washington, as tenants-in-common with affiliates of the
general partners. The Partnership accounts for its investment in this
property using the equity method since the Partnership shares control with
affiliates, and amounts relating to its investment are included in
investment in joint ventures. As of December 31, 1998, the Partnership
owned an approximate 37 percent interest in this property.
29
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
4. Investment in Joint Ventures - Continued:
----------------------------------------
In addition, in January 1998, the Partnership used the net sales proceeds
from the sales of the properties in Jacksonville, Florida and Mathis,
Texas, to acquire a 39.39% and a 13.38% interest in a property in Overland
Park, Kansas, and a property in Memphis, Tennessee, respectively, as
tenants-in-common with affiliates of the general partners. The Partnership
accounts for its investments in these properties using the equity method
since the Partnership shares control with affiliates, and amounts relating
to its investments are included in investment in joint ventures.
Kirkman Road Joint Venture, Holland Joint Venture, Show Low Joint Venture
and the Partnership and affiliates, as tenants-in-common in six separate
tenancy-in-common arrangements, each own and lease one property to an
operator of national fast-food or family-style restaurants. The following
presents the combined, condensed financial information for the joint
ventures and the six properties held as tenants-in-common with affiliates
at December 31:
<TABLE>
<CAPTION>
1998 1997
---------------- ---------------
<S> <C> <C>
Land and buildings on operating
leases, less accumulated
depreciation $ 8,410,940 $7,091,781
Net investment in direct financing
leases 2,121,822 518,399
Cash 37,128 56,815
Receivables 1,570 4,685
Accrued rental income 207,239 102,913
Other assets 1,069 418
Liabilities 32,229 31,673
Partners' capital 10,747,539 7,743,338
Revenues 1,254,276 399,579
Gain on sale of land and building -- 360,002
Net income 1,051,988 687,021
</TABLE>
The Partnership recognized income totalling $431,974, $389,915, and
$130,996 for the years ended December 31, 1998, 1997, and 1996,
respectively, from these joint ventures and the properties held as tenants-
in-common with affiliates.
30
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
5. Mortgage Note Receivable:
------------------------
In connection with the sale in June 1997 of its property in Eagan,
Minnesota, the Partnership accepted a promissory note in the amount of
$42,000. The promissory note bears interest at a rate of 10.50% per annum
and is collateralized by personal property. Initially, the note was to be
collected in 18 monthly installments of interest only and thereafter, the
entire principal balance shall become due. During 1998, the note was
amended to require six monthly installments of $7,368, including interest,
commencing on July 1, 1998. As of December 31, 1998 and 1997, the mortgage
note receivable balance was $6,872 and $42,734, including accrued interest
of $56 and $734, respectively.
6. Restricted Cash:
---------------
As of December 31, 1997, remaining net sales proceeds of $2,470,175 from
the sales of several properties (see Note 3) including accrued interest of
$12,505, were being held in interest-bearing escrow accounts pending the
release of funds by the escrow agent to acquire additional properties on
behalf of the Partnership and to distribute net sales proceeds to the
limited partners. In 1998, the funds were released from escrow to the
Partnership and were used to acquire two additional properties with
affiliates of the general partners and to make a special distribution to
the limited partners (see note 4 and note 8).
7. Receivables:
-----------
In March 1996, the Partnership accepted a promissory note from the former
tenant of the property in Gainesville, Texas, in the amount of $96,502,
representing past due rental and other amounts, which had been included in
receivables and for which the Partnership had established an allowance for
doubtful accounts, and real estate taxes previously recorded as an expense
by the Partnership. Payments are due in 60 monthly installments of
$2,156, including interest at a rate of 11 percent per annum, commencing
on June 1, 1996. Due to the uncertainty of the collectibility of this
note, the Partnership established an allowance for doubtful accounts and is
recognizing income as collected. As of December 31, 1998 and 1997, the
balances in the allowance for doubtful accounts of $55,330 and $74,590,
respectively, including accrued interest of $2,654 in 1998 and 1997,
represent the uncollected amounts under this promissory note.
31
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
8. Allocations and Distributions:
-----------------------------
Generally, all net income and net losses of the Partnership, excluding
gains and losses from the sale of properties, are allocated 99 percent to
the limited partners and one percent to the general partners.
Distributions of net cash flow are made 99 percent to the limited partners
and one percent to the general partners; provided, however, that the one
percent of net cash flow to be distributed to the general partners is
subordinated to receipt by the limited partners of an aggregate, ten
percent, noncumulative, noncompounded annual return on their adjusted
capital contributions (the "10% Preferred Return").
Generally, net sales proceeds from the sale of properties not in
liquidation of the Partnership, to the extent distributed, will be
distributed first to the limited partners in an amount sufficient to
provide them with their cumulative 10% Preferred Return, plus the return of
their adjusted capital contributions. The general partners will then
receive, to the extent previously subordinated and unpaid, a one percent
interest in all prior distributions of net cash flow and a return of their
capital contributions. Any remaining sales proceeds will be distributed 95
percent to the limited partners and five percent to the general partners.
Any gain from the sale of a property not in liquidation of the Partnership
is, in general, allocated in the same manner as net sales proceeds are
distributable. Any loss from the sale of a property is, in general,
allocated first on a pro rata basis to partners with positive balances in
their capital accounts; and thereafter, 95 percent to the limited partners
and five percent to the general partners.
Generally, net sales proceeds from a liquidating sale of properties, will
be used in the following order: i) first to pay and discharge all of the
Partnership's liabilities to creditors, ii) second, to establish reserves
that may be deemed necessary for any anticipated or unforeseen liabilities
or obligations of the Partnership, iii) third, to pay all of the
Partnership's liabilities, if any, to the general and limited partners, iv)
fourth, after allocations of net income, gains and/or losses, to distribute
to the partners with positive capital accounts balances, in proportion to
such balances, up to amounts sufficient to reduce such positive balances to
zero, and v) thereafter, any funds remaining shall then be distributed 95
percent to the limited partners and five percent to the general partners.
During the years ended December 31, 1998, 1997, and 1996, the Partnership
declared distributions to the limited partners of $3,294,507, $2,376,000,
and $2,376,000. Distributions for the year ended December 31, 1998,
included $1,232,003 as a result of the distribution of net sales proceeds
from the 1997 sales of properties in Avon Park, Florida and Farmington
Hills, Michigan. This amount was applied toward the limited partners'
cumulative 10% Preferred Return. No distributions have been made to the
general partners to date.
32
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
9. Income Taxes:
------------
The following is a reconciliation of net income for financial reporting
purposes to net income for federal income tax purposes for the years ended
December 31:
<TABLE>
<CAPTION>
1998 1997 1996
----------------- ----------------- ----------------
<S> <C> <C> <C>
Net income for financial
reporting purposes $1,733,739 $3,639,880 $1,866,961
Depreciation for financial
reporting purposes in excess
of depreciation for tax
reporting purposes 17,510 19,440 20,922
Gain on sale of land and
buildings for financial
reporting purposes (in excess
of) less than gain for tax
reporting purposes 335,644 (638,739) --
Equity in earnings of joint
ventures for tax reporting
purposes less than equity in
earnings of joint ventures for
financial reporting purposes (32,934) (146,161) (1,240)
Capitalization of transaction costs
for tax reporting purposes 16,208 -- --
Allowance for doubtful
accounts (27,819) (42,782) 25,225
Accrued rental income (26,279) (30,746) (33,234)
Rents paid in advance 18,112 (21,008) 22,508
----------------- ----------------- ----------------
Net income for federal income
tax purposes $2,034,181 $2,779,884 $1,901,142
================= ================= ================
</TABLE>
33
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
10. Related Party Transactions:
--------------------------
One of the individual general partners, James M. Seneff, Jr., is one of the
principal shareholders of CNL Group, Inc., the majority stockholder of CNL
Fund Advisors, Inc. The other individual general partner, Robert A.
Bourne, serves as treasurer, director and vice chairman of the board of CNL
Fund Advisors. During the years ended December 31, 1998, 1997, and 1996,
CNL Fund Advisors, Inc. (hereinafter referred to as the "Affiliate")
performed certain services for the Partnership, as described below.
During the years ended December 31, 1998, 1997, and 1996, the Affiliate
acted as manager of the Partnership's Properties pursuant to a property
management agreement with the Partnership. In connection therewith, the
Partnership agreed to pay the Affiliate an annual, noncumulative,
subordinated property management fee of one-half of one percent of the
Partnership assets under management (valued at cost) annually. The
property management fee is limited to one percent of the sum of gross
operating revenues from properties wholly owned by the Partnership and the
Partnership's allocable share of gross operating revenues from joint
ventures and the properties held as tenants-in-common with affiliates or
competitive fees for comparable services. In addition, these fees will be
incurred and will be payable only after the limited partners receive their
aggregate, noncumulative 10% Preferred Return. Due to the fact that these
fees are noncumulative, if the limited partners do not receive their 10%
Preferred Return in any particular year, no property management fees will
be due or payable for such year. As a result of such threshold no property
management fees were incurred during the years ended December 31, 1998,
1997, and 1996.
The Affiliate is also entitled to receive a deferred, subordinated real
estate disposition fee, payable upon the sale of one or more properties
based on the lesser of one-half of a competitive real estate commission or
three percent of the sales price if the Affiliate provides a substantial
amount of services in connection with the sale. Payment of the real estate
disposition fee is subordinated to receipt by the limited partners of their
aggregate, cumulative 10% Preferred Return, plus their adjusted capital
contributions. For the year ended December 31, 1998, the Partnership
incurred $45,150 in deferred, subordinated, real estate disposition fees as
a result of the 1997 sales of properties in Avon Park, Florida and
Farmington Hills, Michigan. No deferred, subordinated, real estate
disposition fees were incurred for the years ended December 31, 1997 and
1996.
During the years ended December 31, 1998, 1997, and 1996, the Affiliate
provided accounting and administrative services to the Partnership on a
day-to-day basis. The Partnership incurred $86,009, $78,139 and $79,624
for the years ended December 31, 1998, 1997, and 1996, respectively, for
such services.
34
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
10. Related Party Transactions - Continued:
--------------------------------------
During 1997, the Partnership acquired a property in Mesa, Arizona, as
tenants-in-common with an affiliate of the general partners, for a purchase
price of $630,554 from CNL BB Corp., also an affiliate of the general
partners. CNL BB Corp. had purchased and temporarily held title to this
property in order to facilitate the acquisition of the property by the
Partnership. The purchase price paid by the Partnership represented the
Partnership's percentage of interest in the costs incurred by CNL BB Corp.
to acquire and carry the property, including closing costs.
The due to related parties consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Due to Affiliates:
Expenditures incurred on
behalf of the Partnership $ 76,326 $ 59,608
Accounting and administrative
services 61,827 66,676
Deferred, subordinated real
estate disposition fee 45,150 --
-------------- --------------
$183,303 $126,284
============== ==============
</TABLE>
11. Concentration of Credit Risk:
----------------------------
The following schedule presents total rental income from individual
lessees, each representing more than ten percent of the Partnerships' total
rental income (including the Partnership's share of rental income from
joint ventures and the properties held as tenants-in-common with
affiliates) for each of the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Golden Corral Corporation $485,839 $408,333 $403,875
Restaurant Management
Services, Inc. 252,292 251,480 N/A
</TABLE>
35
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
11. Concentration of Credit Risk - Continued:
----------------------------------------
In addition, the following schedule presents total rental and mortgage
interest income from individual restaurant chains, each representing more
than ten percent of the Partnership's total rental and mortgage interest
income (including the Partnership's share of rental income from joint
ventures and properties held as tenants-in-common with affiliates) for each
of the years ended December 31:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Golden Corral Family
Steakhouse Restaurants $485,839 $408,333 $403,875
Popeyes Famous Fried
Chicken Restaurants 252,292 251,480 N/A
Wendy's Old Fashioned
Hamburger Restaurants N/A 381,567 421,165
Denny's N/A N/A 388,050
KFC N/A 278,348 358,463
</TABLE>
The information denoted by N/A indicates that for each period presented,
the tenant and the chains did not represent more than ten percent of the
Partnership's total rental, mortgage interest, and earned income.
Although the Partnership's properties are geographically diverse throughout
the United States and the Partnership's lessees operate a variety of
restaurant concepts, default by any one of these lessees or restaurant
chains could significantly impact the results of operations of the
Partnership if the Partnership is not able to re-lease the properties in a
timely manner.
12. Subsequent Event:
----------------
On March 11, 1999, the Partnership entered into an Agreement and Plan of
Merger with CNL American Properties Fund, Inc. ("APF"), pursuant to which
the Partnership would be merged with and into a subsidiary of APF (the
"Merger"). As consideration for the Merger, APF has agreed to issue
2,393,267 shares of its common stock, par value $0.01 per shares (the "APF
Shares"). In order to assist the general partners in evaluating the
proposed merger consideration, the general partners retained Valuation
Associates, a nationally recognized real estate appraisal firm, to appraise
the Partnership's restaurant
36
<PAGE>
CNL INCOME FUND II, LTD.
(A Florida Limited Partnership)
NOTES TO FINANCIAL STATEMENTS - CONTINUED
-----------------------------------------
Years Ended December 31, 1998, 1997, and 1996
12. Subsequent Event - Continued:
----------------------------
property portfolio. Based on Valuation Associates' appraisal, the fair
value of the Partnership's property portfolio and other assets was
$23,548,652 as of December 31, 1998. The APF Shares are expected to be
listed for trading on the New York Stock Exchange concurrently with the
consummation of the Merger, and, therefore, would be freely tradable at the
option of the former limited partners. At a special meeting of the
partners, limited partners holding in excess of 50% of the Partnership's
outstanding limited partnership interests must approve the Merger prior to
consummation of the transaction. The general partners intend to recommend
that the limited partners of the Partnership approve the Merger. In
connection with their recommendation, the general partners will solicit the
consent of the limited partners at the special meeting. If the limited
partners reject the Merger, the Partnership will bear the portion of the
transaction costs based upon the percentage of "For" votes and the general
partners will bear the portion of such transaction costs based upon the
percentage of "Against" votes and abstentions.
37
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on the 28th day of
October, 1999.
CNL INCOME FUND II, LTD.
By: CNL REALTY CORPORATION
General Partner
/s/ Robert A. Bourne
-------------------------
ROBERT A. BOURNE, President
By: ROBERT A. BOURNE
General Partner
/s/ Robert A. Bourne
-------------------------
ROBERT A. BOURNE
By: JAMES M. SENEFF, JR.
General Partner
/s/ James M. Seneff, Jr.
-------------------------
JAMES M. SENEFF, JR.
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Robert A. Bourne President, Treasurer and Director October 28, 1999
- ------------------------------------ (Principal Financial and Accounting
Robert A. Bourne Officer)
/s/ James M. Seneff, Jr. Chief Executive Officer and Director October 28, 1999
- ------------------------------------ (Principal Executive Officer)
James M. Seneff, Jr.
</TABLE>
