Toggle SGML Header (+)


Section 1: 10-Q (FORM 10-Q)

Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended March 31, 2013

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 001-32386

 

 

SPIRIT REALTY CAPITAL, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland   20-0175773

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

16767 North Perimeter Dr., Suite 210

Scottsdale, Arizona 85260

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (480) 606-0820

 

 

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 whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date. 84,833,181 shares of common stock, $0.01 par value, outstanding as of May 6, 2013.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page  

PART I - FINANCIAL INFORMATION

     3   

Item 1. Financial Statements:

     3   

Condensed Consolidated Balance Sheets as of March 31, 2013 (unaudited) and December 31, 2012

     3   

Condensed Consolidated Statements of Operations for the Three Months ended March  31, 2013 and 2012 (unaudited)

     4   

Condensed Consolidated Statements of Comprehensive Loss for the Three Months ended March  31, 2013 and 2012 (unaudited)

     5   

Condensed Consolidated Statement of Stockholders’ Equity for the Three Months ended March  31, 2013 (unaudited)

     6   

Condensed Consolidated Statements of Cash Flows for the Three Months ended March  31, 2013 and 2012 (unaudited)

     7   

Notes to Condensed Consolidated Financial Statements (unaudited)

     8   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     21   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     35   

Item 4. Controls and Procedures

     36   

PART II - OTHER INFORMATION

     37   

Item 1. Legal Proceedings

     37   

Item 1A. Risk Factors

     37   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     37   

Item 3. Defaults Upon Senior Securities

     37   

Item 4. Mine Safety Disclosures

     37   

Item 5. Other Information

     37   

Item 6. Exhibits

     37   

Signatures

     40   

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

SPIRIT REALTY CAPITAL, INC.

Condensed Consolidated Balance Sheets

(In Thousands, Except Share and Per Share Data)

 

     March 31, 2013     December 31, 2012  
    

(Unaudited)

       
              

Assets

    

Investments:

    

Real estate investments:

    

Land and improvements

   $ 1,344,924      $ 1,328,437   

Buildings and improvements

     2,063,137        2,036,987   
  

 

 

   

 

 

 

Total real estate investments

     3,408,061        3,365,424   

Less: accumulated depreciation

     (512,870     (490,938
  

 

 

   

 

 

 
     2,895,191        2,874,486   

Loans receivable, net

     50,960        51,862   

Intangible lease assets, net

     183,224        187,362   

Real estate assets held for sale, net

     11,637        5,898   
  

 

 

   

 

 

 

Net investments

     3,141,012        3,119,608   

Cash and cash equivalents

     55,355        73,568   

Deferred costs and other assets, net

     50,473        54,501   
  

 

 

   

 

 

 

Total assets

   $ 3,246,840      $ 3,247,677   
  

 

 

   

 

 

 

Liabilities and stockholders’ equity

    

Liabilities:

    

Revolving credit facilities, net

   $ 11,400      $ —    

Mortgages and notes payable, net

     1,910,952        1,894,878   

Intangible lease liabilities, net

     45,161        45,603   

Accounts payable, accrued expenses and other liabilities

     58,863        53,753   
  

 

 

   

 

 

 

Total liabilities

     2,026,376        1,994,234   

Commitments and contingencies (see Note 8)

    

Stockholders’ equity:

    

Common stock, $0.01 par value per share, 100 million shares authorized, 84,833,181 and 84,851,515 shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively

     849        849   

Capital in excess of par value

     1,830,171        1,828,399   

Accumulated deficit

     (609,868     (575,034

Accumulated other comprehensive loss

     (688     (771
  

 

 

   

 

 

 

Total stockholders’ equity

     1,220,464        1,253,443   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 3,246,840      $ 3,247,677   
  

 

 

   

 

 

 

See accompanying notes.

 

3


Table of Contents

SPIRIT REALTY CAPITAL, INC.

Condensed Consolidated Statements of Operations

(In Thousands, Except Share and Per Share Data)

(Unaudited)

 

     Three Months Ended March 31,  
     2013     2012  

Revenues:

    

Rentals

   $ 71,614      $ 67,628   

Interest income on loans receivable

     1,113        1,436   

Interest income and other

     78        438   
  

 

 

   

 

 

 

Total revenues

     72,805        69,502   

Expenses:

    

General and administrative

     13,577        6,248   

Property costs

     963        1,190   

Interest

     36,439        38,939   

Depreciation and amortization

     28,174        27,271   

Impairments

     —         8,135   
  

 

 

   

 

 

 

Total expenses

     79,153        81,783   
  

 

 

   

 

 

 

Loss from continuing operations before income tax expense

     (6,348     (12,281

Income tax expense

     74        64   
  

 

 

   

 

 

 

Loss from continuing operations

     (6,422     (12,345

Discontinued operations:

    

Loss from discontinued operations

     (2,090     (1,507

Net gain on dispositions of assets

     180        1,450   
  

 

 

   

 

 

 

Loss from discontinued operations

     (1,910     (57
  

 

 

   

 

 

 

Net loss attributable to common stockholders

   $ (8,332   $ (12,402
  

 

 

   

 

 

 

Net loss per share of common stock—basic and diluted:

    

Continuing operations

   $ (0.08   $ (0.48

Discontinued operations

     (0.02     (0.00
  

 

 

   

 

 

 

Net loss

   $ (0.10   $ (0.48
  

 

 

   

 

 

 

Weighted average common shares outstanding:

    

Basic and diluted

     83,694,549        25,863,976   
  

 

 

   

 

 

 

See accompanying notes.

 

4


Table of Contents

SPIRIT REALTY CAPITAL, INC.

Condensed Consolidated Statements of Comprehensive Loss

(In Thousands)

(Unaudited)

 

     Three Months Ended March 31,  
     2013     2012  

Net loss

   $ (8,332   $ (12,402

Other comprehensive loss:

    

Change in net unrealized losses on cash flow hedges

     (31     (72

Net cash flow hedge losses reclassified to operations

     114        1,186   
  

 

 

   

 

 

 

Total comprehensive loss

   $ (8,249   $ (11,288
  

 

 

   

 

 

 

See accompanying notes.

 

5


Table of Contents

SPIRIT REALTY CAPITAL, INC.

Condensed Consolidated Statement of Stockholders’ Equity

(In Thousands, Except Share Data)

(Unaudited)

 

     Common
Shares
    Common
Stock
Par Value
     Capital in
Excess of

Par
Value
     Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
    Total
Stockholders’
Equity
 

Balances, December 31, 2012

     84,851,515      $ 849       $ 1,828,399       $ (575,034   $ (771   $ 1,253,443   

Net loss

     —          —           —           (8,332     —          (8,332

Other comprehensive income

     —          —           —           —          83        83   

Dividends declared on common stock

     —          —           —           (26,502     —          (26,502

Restricted stock activity, net

     (18,334     —           1,772         —          —          1,772   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balances, March 31, 2013

     84,833,181      $ 849       $ 1,830,171       $ (609,868   $ (688   $ 1,220,464   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

6


Table of Contents

SPIRIT REALTY CAPITAL, INC.

Condensed Consolidated Statements of Cash Flows

(In Thousands)

(Unaudited)

 

     Three Months
Ended March 31,
 
     2013     2012  

Operating activities

  

Net loss

   $ (8,332   $ (12,402

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Depreciation and amortization

     28,316        27,898   

Impairments

     2,103        9,937   

Amortization of deferred financing costs

     3,901        852   

Amortization of interest rate hedge losses and other derivative losses

     22        1,809   

Amortization of debt discounts

     2,961        417   

Stock-based compensation expense

     1,772        —     

Gains on dispositions of real estate and other assets, net

     (202     (1,450

Noncash revenue

     (643     (553

Other

     108        35   

Changes in operating assets and liabilities:

    

Accounts receivable and other assets

     (3,103     44   

Accounts payable, accrued expenses and other liabilities

     1,329        (1,277
  

 

 

   

 

 

 

Net cash provided by operating activities

     28,232        25,310   

Investing activities

    

Acquisitions/improvements of real estate

     (56,854     (33,662

Collections of principal on loans receivable

     763        5,478   

Proceeds from dispositions of real estate and other assets

     2,829        10,800   

Transfers of sale proceeds and loan principal collections from restricted account

     14,081        7,610   
  

 

 

   

 

 

 

Net cash used in investing activities

     (39,181     (9,774

Financing activities

    

Borrowings under line of credit

     11,400        —     

Borrowings under mortgages and notes payable

     24,800        11,460  

Repayments under mortgages and notes payable

     (10,839     (10,036

Transfers to restricted cash accounts designated for mortgage note repayments

     —          (338

Deferred financing costs

     (4,113     (192

Offering costs

     (293     —     

Deferred offering costs

     —          (403

Consent fees paid to lenders

     (222     (1,840

Dividends paid

     (28,247     —     

Transfers from (to) escrow deposits with lenders

     250        (4
  

 

 

   

 

 

 

Net cash used in financing activities

     (7,264     (1,353
  

 

 

   

 

 

 

Net (decrease) / increase in cash and cash equivalents

     (18,213     14,183   

Cash and cash equivalents, beginning of period

     73,568        49,536   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 55,355      $ 63,719   
  

 

 

   

 

 

 

See accompanying notes.

 

7


Table of Contents

SPIRIT REALTY CAPITAL, INC.

Notes to Condensed Consolidated Financial Statements

March 31, 2013

(Unaudited)

Note 1. Organization

Company Organization and Operations

Spirit Realty Capital, Inc. is a Maryland corporation incorporated on August 14, 2003. References in this quarterly report to “Spirit Realty Capital,” the “Company,” “we,” “our,” and “us” are to Spirit Realty Capital, Inc. The Company became a public company in December 2004 and was subsequently taken private in August 2007 by a consortium of private investors. On September 10, 2012, the Company paid a stock dividend (that is treated akin to a stock split for accounting purposes) to existing stockholders of the 200 shares of common stock of the Company whereby the existing stockholders received a stock dividend of 129,318.88 shares of common stock for each share of common stock of the Company they owned. All references in the unaudited condensed consolidated financial statements to the number of shares of common stock and related per share amounts retroactively reflect the effect of the stock dividend for all periods presented.

On September 25, 2012, the Company completed its initial public offering (the “IPO”) of 29.0 million shares of common stock. On October 1, 2012, the underwriters exercised their option to purchase additional shares in full and the Company issued an additional 4.4 million shares of common stock.

Concurrently with the completion of the IPO, the Company issued shares of its common stock to extinguish $330.0 million of its term note (the “Term Note”) indebtedness (the “TLC debt conversion”) (see Note 5). In addition, equity awards in the form of restricted stock were granted to certain directors, executive officers and other employees of the Company (see Note 13).

The Company’s operations are carried out through its operating partnership, Spirit Realty, L.P. (the “Spirit Operating Partnership”), which is a Delaware limited partnership. Spirit General OP Holdings, LLC, one of the Company’s wholly owned subsidiaries, is the sole general partner and owns 1.0% of the Spirit Operating Partnership. The Company is the sole limited partner and owns the remaining 99.0% of the Spirit Operating Partnership. Although the Spirit Operating Partnership is wholly owned by the Company, in the future, the Company could agree to issue equity interests in the Spirit Operating Partnership to third parties in exchange for property owned by such third parties. In general, any equity interests of the Spirit Operating Partnership issued to third parties would be exchangeable for cash or, at the Company’s election, shares of its common stock at specified ratios set when equity interests in the Spirit Operating Partnership are issued. The Company is a self-administered and self-managed real estate investment trust (“REIT”) that primarily invests in single-tenant, operationally essential real estate throughout the United States that is leased on a long-term, triple-net basis primarily to tenants engaged in retail, service, and distribution industries. Single-tenant, operationally essential real estate consists of properties that are generally free-standing, commercial real estate facilities where the Company’s tenants conduct retail, distribution, or service activities that are essential to the generation of their sales and profits. Under a triple-net lease the tenant is typically responsible for all improvements and is contractually obligated to pay all property operating expenses, such as insurance, real estate taxes, and repair and maintenance costs. In support of its primary business of owning and leasing real estate, the Company has also strategically originated or acquired long-term, commercial mortgage and equipment loans to provide a range of financing solutions to its tenants.

On January 22, 2013, Spirit Realty Capital, the Spirit Operating Partnership, Cole Credit Property Trust II, Inc., a Maryland corporation (“CCPTII”), and Cole Operating Partnership II, LP, a Delaware limited partnership (the “Cole Operating Partnership”), entered into an Agreement and Plan of Merger (the “Merger Agreement”). The Merger Agreement provides for the merger of Spirit Realty Capital with and into CCPTII (the “Company Merger”) with CCPTII continuing as the surviving corporation and the merger of the Cole Operating Partnership with and into the Spirit Operating Partnership (the “Partnership Merger” and together with the Company Merger, the “Merger”) with the Spirit Operating Partnership continuing as the surviving limited partnership. The board of directors of Spirit Realty Capital has unanimously approved the Merger Agreement, the Merger and the other transactions contemplated by the Merger Agreement. The Merger is expected to close in the third quarter of 2013 contingent on the receipt of approval of the majority of shares outstanding of the Company and CCPTII and other customary regulatory approvals and the satisfaction of other contractual closing conditions.

In connection with the Merger Agreement, on January 22, 2013, the Company entered into a commitment letter (the Barclays Commitment Letter) with Barclays Bank PLC, pursuant to which Barclays Bank PLC has committed to provide, subject to the conditions set forth in the Barclays Commitment Letter, a $575.0 million secured term loan facility and a $50.0 million senior secured revolving credit facility. As a result of obtaining the Barclays Commitment Letter, the Company incurred approximately $9.5 million in commitment and structuring fees, which were capitalized as deferred financing costs and are being amortized over the term of the commitment. There can be no assurances, however, that this financing will be completed as it is subject to a number of conditions including, but not limited to, the execution of mutually agreeable documentation. The foregoing description of the Barclays Commitment Letter and the transactions contemplated thereby is qualified in its entirety by reference to the complete terms and conditions of the definitive documentation to be negotiated and executed in connection therewith.

 

8


Table of Contents

Note 2. Summary of Significant Accounting Policies

Basis of Accounting and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements of Spirit Realty Capital and its consolidated subsidiaries have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the unaudited condensed consolidated financial statements include the normal, recurring adjustments necessary for a fair statement of the information required to be set forth therein. The results for interim periods are not necessarily indicative of the results for the entire year. Certain information and note disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), have been condensed or omitted from these statements pursuant to SEC rules and regulations and, accordingly, these financial statements should be read in conjunction with the Company’s audited consolidated financial statements as filed with the SEC in its Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

The unaudited condensed consolidated financial statements include the accounts of Spirit Realty Capital and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Spirit Realty Capital has formed numerous special purpose entities to acquire and hold real estate subject to mortgage notes payable (see Note 5). As a result, the vast majority of the Company’s consolidated assets are held in these wholly owned special purpose entities and are subject to debt. Each special purpose entity is a separate legal entity and is the sole owner of its assets and responsible for its liabilities. The assets of these special purpose entities are not available to pay, or otherwise satisfy obligations to, the creditors of any owner or affiliate of the special purpose entity. At March 31, 2013 and December 31, 2012, assets totaling $2.9 billion and $3.0 billion, respectively, were held, and liabilities totaling $2.0 billion and $2.0 billion, respectively, were owed by these special purpose entities and are included in the accompanying condensed consolidated balance sheets.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although management believes its estimates are reasonable, actual results could differ from those estimates.

Reclassifications

Certain reclassifications have been made to prior period balances to conform to the current period presentation.

Segment Reporting

Accounting Standards Codification Topic 280, Segment Reporting (ASC 280), established standards for the manner in which public enterprises report information about operating segments. The Company views its operations as one segment, which consists of triple-net leasing operations. The Company has no other reportable segments.

Real Estate Investments

Purchase Accounting and Acquisition of Real Estate- When acquiring a property for investment purposes, the Company allocates the purchase price (including acquisition and closing costs) to land, building, improvements and equipment based on their relative fair values. For properties acquired with in-place leases, the Company allocates the purchase price of real estate to the tangible and intangible assets and liabilities acquired based on their estimated fair values. In making estimates of fair values for this purpose, the Company uses a number of sources, including independent appraisals and information obtained about each property as a result of its pre-acquisition due diligence and its marketing and leasing activities.

Lease Intangibles- Lease intangibles, if any, acquired in conjunction with the purchase of real estate represent the value of in-place leases and above- or below-market leases. For real estate acquired subject to existing lease agreements, in-place lease intangibles are valued based on the Company’s estimates of costs related to tenant acquisition and the carrying costs that would be incurred during the time it would take to locate a tenant if the property were vacant, considering current market conditions and costs to execute similar leases at the time of the acquisition, and are amortized on a straight-line basis over the remaining initial term of the related lease. Above- and below-market lease intangibles are recorded based on the present value of the difference between the contractual amounts to be paid pursuant to the leases at the time of acquisition of the real estate and the Company’s estimate of current market lease rates for the property, measured over a period equal to the remaining initial term of the lease. Capitalized above-market lease intangibles are amortized over the remaining initial terms of the respective leases as a decrease to rental revenue. Below-market lease intangibles are amortized as an

 

9


Table of Contents

increase in rental revenue over the remaining initial terms of the respective leases plus any fixed-rate renewal periods on those leases. Should a lease terminate early, the unamortized portion of any related lease intangible is immediately recognized in the Company’s consolidated statements of operations.

Allowance for Doubtful Accounts

The Company reviews its rent receivables for collectability on a regular basis, taking into consideration changes in factors such as the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area where the property is located. In the event that the collectability of a receivable with respect to any tenant is in doubt, a provision for uncollectible amounts will be established or a direct write-off of the specific rent receivable will be made. The Company provided for reserves for uncollectible amounts totaling $3.7 million and $3.6 million at March 31, 2013 and December 31, 2012, respectively, against accounts receivable balances of $8.7 million and $7.6 million, respectively. For accrued rental revenues related to the straight-line method of reporting rental revenue, the Company established a provision for losses of $15.9 million and $15.3 million at March 31, 2013 and December 31, 2012, respectively, against accrued rental revenue receivables of $23.8 million and $22.7 million, respectively, based on management’s estimates of uncollectible receivables and management’s assessment of the risks inherent in the portfolio, giving consideration to historical experience and industry default rates for long-term receivables.

Loans Receivable

Impairment and Provision for Loan Losses-The Company periodically evaluates the collectability of its loans receivable, including accrued interest, by analyzing the underlying property-level economics and trends, collateral value and quality, and other relevant factors in determining the adequacy of its allowance for loan losses. A loan is determined to be impaired when, in management’s judgment based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Specific allowances for loan losses are provided for impaired loans on an individual loan basis in the amount by which the carrying value exceeds the estimated fair value of the underlying collateral less disposition costs. Delinquent loans receivable are written off against the allowance when all possible means of collection have been exhausted. The allowance for loan losses was $5.1 million at March 31, 2013 and December 31, 2012.

A loan is placed on nonaccrual status when the loan has become 60 days past due, or earlier if management determines that full recovery of the contractually specified payments of principal and interest is doubtful. While on nonaccrual status, interest income is recognized only when received. As of March 31, 2013 and December 31, 2012, two mortgages and one note were placed on nonaccrual status and have been fully reserved.

Restricted Cash and Escrow Deposits

The Company classified restricted cash and deposits in escrow totaling $20.4 million and $34.7 million at March 31, 2013 and December 31, 2012, respectively, in deferred costs and other assets in the accompanying condensed consolidated balance sheets. Included in the balance at each of March 31, 2013 and December 31, 2012 is approximately $9.7 million in restricted cash deposited to secure lenders consents to the IPO. These cash balances are restricted as to use under certain of the Company’s debt agreements. In addition, the Company deposited $8.0 million in a collateral account with one of its lenders which may be applied, at the lender’s discretion, towards a reduction of the outstanding principal balance of the related loan. The Company also has the right to replace this cash collateral with a letter of credit.

Income Taxes

The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended. As a REIT, the Company generally will not be subject to federal income tax provided it continues to satisfy certain tests concerning the Company’s sources of income, the nature of its assets, the amounts distributed to its stockholders and the ownership of Company stock. Management believes the Company has qualified and will continue to qualify as a REIT and therefore, no provision has been made for federal income taxes in the accompanying condensed consolidated financial statements. Even if the Company qualifies for taxation as a REIT, it may be subject to state and local income and franchise taxes and to federal income tax and excise tax on its undistributed income. Franchise taxes are included in general and administrative expenses on the accompanying condensed consolidated statements of operations. Taxable income from non-REIT activities managed through the Company’s taxable REIT subsidiary is subject to federal, state, and local taxes, which are not material.

New Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or the SEC that are adopted by us as of the specified effective date. Unless otherwise discussed, these new accounting pronouncements entail technical corrections to existing guidance or affect guidance related to specialized industries or entities and therefore will have minimal, if any, impact on our financial position or results of operations upon adoption.

 

10


Table of Contents

In January 2013, the FASB issued Accounting Standards Update (“ASU”) No. 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. The update clarifies that ASU 2011-11 applies to entities that are accounting for derivatives under Topic 815 including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are offset under Section 210-20-45 or Section 815-10-45 or an enforceable master netting arrangement or similar agreement. This update became effective for fiscal years beginning on or after January 1, 2013, and interim periods therein. The adoption of this ASU did not have a material impact on the Company’s financial statements.

In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income to improve reporting of reclassification of items out of accumulated other comprehensive income by requiring entities to report the effect of any significant reclassifications on the respective line items on the income statement when the amount is required to be reclassified in its entirety in the same reporting period. Additionally, for items that are not required to be reclassified completely to net income, the entity will be required to cross reference other disclosures that provide additional information about the amounts. The information provided about amounts that are reclassified out of accumulated other comprehensive income must be reported by component. The amendments of this update are effective beginning December 15, 2012. The adoption of this ASU did not have a material impact on the Company’s financial statements.

Note 3. Investments

Real Estate Investments

At March 31, 2013 and December 31, 2012, the Company’s gross investment in real estate properties and loans, including real estate assets held for sale, totaled approximately $3.70 billion and $3.65 billion, respectively. These investments are comprised of 1,232 and 1,207, respectively, owned or financed properties that are geographically dispersed throughout 47 states. Only one state, Wisconsin, with an 11% investment, accounted for more than 10% of the total dollar amount of the Company’s investment portfolio. At March 31, 2013 and December 31, 2012, respectively, the Company’s gross investment portfolio was comprised of 1,147 and 1,122 owned properties. The Company also held 85 properties securing mortgage loans receivable with aggregate carrying amounts of $40.5 million and $40.1 million as of March 31, 2013 and December 31, 2012, respectively. Other loans receivable with aggregate carrying amounts of $10.5 million and $11.8 million were also held as of March 31, 2013 and December 31, 2012, respectively.

During the three months ended March 31, 2013, the Company had the following gross real estate and loan activity:

 

     Number of
Properties
Owned or
Financed
    Dollar
Amount  of
Investments (a)
 
           (In Thousands)  

Balance, December 31, 2012

     1,207      $ 3,654,925   

Acquisitions/improvements and loan originations

     31        56,507   

Dispositions of real estate (b) (Note 11)

     (6     (4,346

Principal payments and payoffs

     —          (763

Impairments

     —          (2,103

Loan premium amortization and other

     —          (140
  

 

 

   

 

 

 

Balance, March 31, 2013

     1,232      $ 3,704,080   
  

 

 

   

 

 

 

 

(a) 

The dollar amount of investments includes the gross investment in land, buildings and lease intangibles, as adjusted for any impairment, related to properties owned and the carrying amount of loans receivable.

(b) 

The total accumulated depreciation and amortization associated with dispositions of real estate was $0.6 million for the three months ended March 31, 2013.

The properties that the Company owns are leased to tenants under long-term operating leases that typically include one or more renewal options. The leases are generally triple-net, which provides that the lessee is responsible for the payment

 

11


Table of Contents

of all property operating expenses, including property taxes, maintenance and repairs, and insurance costs; therefore, the Company is generally not responsible for repairs or other capital expenditures related to its properties, unless the property is not subject to a lease agreement. At March 31, 2013, 13 of the Company’s properties were vacant, not subject to a lease and in the Company’s possession; five of these properties were held for sale. At December 31, 2012, 14 properties were vacant, not subject to a lease and in the Company’s possession; five of these properties were held for sale. Scheduled minimum future rentals to be received under the remaining non-cancelable term of the operating leases at March 31, 2013 (including realized rent increases occurring after January 1, 2013) are as follows:

 

Scheduled Future Rental Payments

   March 31,
2013
 

Remainder of 2013

   $ 215,133   

2014

     286,631   

2015

     280,701   

2016

     277,335   

2017

     275,008   

Thereafter

     1,938,464   
  

 

 

 

Total future minimum rentals

   $ 3,273,272   
  

 

 

 

Since lease renewal periods are exercisable at the option of the lessee, the preceding table presents future minimum lease payments due during the initial lease term only. In addition, the future minimum rentals do not include any contingent rentals based on a percentage of the lessees’ gross sales or lease escalations based on future changes in the Consumer Price Index (“CPI”).

Certain of the Company’s leases contain tenant purchase options. Most of these options are at or above fair market value at the time the option is exercisable, and none of these purchase options represent bargain purchase options under GAAP.

Real Estate Assets Held for Sale

The following table shows the activity in real estate assets held for sale for the three months ended March 31, 2013:

 

     Number of
Properties
    Carrying
Value
 
           (In Thousands)  

Balance, December 31, 2012

     7      $ 5,898   

Transfers from real estate investments

     5        9,187   

Sales (Note 11)

     (5     (3,448
  

 

 

   

 

 

 

Balance, March 31, 2013

     7      $ 11,637   
  

 

 

   

 

 

 

Impairments

The following table summarizes total impairment losses recognized for the three months ended March 31, 2013 and 2012:

 

     Three Months Ended
March 31,
 
     2013      2012  
     (In Thousands)  

Real estate and intangible asset impairment

   $ 2,103       $ 7,128   

Write-off of lease intangibles due to lease terminations

     —          2,809   
  

 

 

    

 

 

 

Total impairment loss – continuing and discontinued operations

   $ 2,103       $ 9,937   
  

 

 

    

 

 

 

 

12


Table of Contents

Note 4. Lease Intangibles, Net

The following details lease intangible assets and liabilities, net of accumulated amortization, at March 31, 2013 and December 31, 2012:

 

     March 31, 2013     December 31, 2012  
     (In Thousands)  

In-place leases

   $ 271,814      $ 271,392   

Above-market leases

     21,139        21,139   

Less: accumulated amortization

     (109,729     (105,169
  

 

 

   

 

 

 

Intangible lease assets, net

   $ 183,224      $ 187,362   
  

 

 

   

 

 

 

Below-market leases

   $ 62,240      $ 61,938   

Less: accumulated amortization

     (17,079     (16,335
  

 

 

   

 

 

 

Intangible lease liabilities, net

   $ 45,161      $ 45,603   
  

 

 

   

 

 

 

The amounts amortized as a net increase to rental revenue for capitalized above- and below-market leases was $0.3 million for each of the three-month periods ended March 31, 2013 and 2012. The value of in-place leases amortized to expense was $4.4 million and $4.5 million for the three months ended March 31, 2013 and 2012, respectively.

Note 5. Debt

Secured Revolving Credit Facilities

$100 Million Credit Facility- In September 2012, the Spirit Operating Partnership entered into a secured revolving credit facility (the “Credit Facility”) allowing borrowings of up to $100.0 million and providing for a maximum additional loan commitment of $50.0 million, subject to the satisfaction of specified requirements and obtaining additional commitments from lenders. The amount available to borrow under the Credit Facility, and the Company’s ability to request issuances of letters of credit, will be subject to the Spirit Operating Partnership’s maintenance of a minimum ratio of the total value of the unencumbered properties to the outstanding Credit Facility obligations of 1.75:1.00. As of March 31, 2013, no borrowings were outstanding under the Credit Facility and $100.0 million was available.

The initial term of the Credit Facility expires on September 25, 2015 and may be extended for an additional 12 months subject to the satisfaction of specified requirements. The Credit Facility bears interest, at the Company’s option, of either (i) the “Alternate Base Rate” (as defined in the credit agreement) plus 2.50% to 3.50%; or (ii) LIBOR plus 3.50% to 4.50%, depending on our leverage ratio. The Company is also required to pay a quarterly fee on the unused portion of the Credit Facility at a rate of between 0.30% and 0.40% per annum, based on percentage thresholds for the average daily unused balance during a fiscal quarter. For the three months ended March 31, 2013, the Company paid non utilization fees of $0.1 million.

As a result of entering into the Credit Facility, the Company incurred costs of $2.3 million which have been deferred and are included in deferred costs and other assets, net on the accompanying condensed consolidated balance sheets. These costs are being amortized to interest expense over the remaining initial term of the Credit Facility.

The Company’s ability to borrow under the Credit Facility is subject to the Spirit Operating Partnership’s ongoing compliance with a number of customary financial covenants. As of March 31, 2013, the Spirit Operating Partnership was in compliance with all financial covenants on the Credit Facility.

Pursuant to the terms of the Credit Facility, the Company’s distributions may not exceed the greater of (1) 100% of its funds from operations, as defined in the credit agreement governing the Credit Facility, or (2) the amount required for the Company to qualify and maintain its status as a REIT. If a default or event of default occurs and is continuing, the Company may be precluded from making certain distributions (other than those required to allow it to qualify and maintain its status as a REIT). Spirit Realty Capital guarantees the Spirit Operating Partnership’s obligations under the Credit Facility and, to the extent not prohibited by applicable law, all of the Company’s assets and the Spirit Operating Partnership’s assets, other than interests in subsidiaries that are contractually prohibited from being pledged, are pledged as collateral for obligations under the Credit Facility.

Line of Credit- In March 2013, a special purpose entity owned by the Company entered into a $25.0 million secured revolving credit facility (“Line of Credit”). Advances under the Line of Credit are to be used to purchase or refinance commercial real estate properties. The initial term of the Line of Credit expires in March 2016, and each advance under the Line of Credit has a 24 month term. The interest rate is determined on the date of each advance, and is the greater of (i) the stated prime

 

13


Table of Contents

rate plus 0.5% or (ii) the floor rate equal to 4.0%. As of March 31, 2013, $11.4 million was outstanding under the Line of Credit at an interest rate of 4.0%. The special purpose entity was in compliance with all financial covenants associated with the Line of Credit as of March 31, 2013.

Mortgages and Notes Payable

The Company’s mortgages and notes payable are summarized below:

 

     2013
Effective
Interest
Rates (a)
    March 31,
2013
    December 31,
2012
 
           (In Thousands)  

Net-lease mortgage notes payable:

      

Series 2005-1, Class A-1 amortizing mortgage note, 5.05%, due 2020

     6.39   $ 108,838      $ 111,831   

Series 2005-1, Class A-2 interest-only mortgage note, 5.37%, due 2020

     6.66        258,300        258,300   

Series 2006-1, Class A amortizing mortgage note, 5.76%, balloon due 2021

     6.65        243,746        245,614   

Series 2007-1, Class A amortizing mortgage note, 5.74%, balloon due 2022

     6.56        320,167        321,650   

Secured fixed-rate amortizing mortgage notes payable:

      

5.90% notes, balloons due 2012 (b)

     9.82        7,882        7,755   

5.40% notes, balloons due 2014

     7.27        30,983        31,165   

5.26%–5.62% notes, balloons due 2015

     6.89-7.20        102,184        102,766   

5.04%–8.39% notes, balloons due 2016

     6.57-8.57        38,460        38,652   

6.59% notes, balloons due 2016

     6.94-7.11        562,196        564,669   

5.85% note, balloon due 2017

     7.09        53,199        53,414   

6.17% note, balloon due 2017

     7.01        143,113        143,647   

6.64% note, balloon due 2017

     7.35        21,510        21,595   

3.90% note, balloon due 2018

     3.90        24,800        —     

Secured variable-rate, 1-month LIBOR + 3.25% mortgage notes, balloon due 2016 (c)(d)

     4.61-5.14        16,768        16,851   

Secured variable-rate, 1-month LIBOR + 3.50% mortgage note, balloon due 2017 (c)(d)

     5.16        10,165        11,181   

Secured variable-rate, 3-month LIBOR + 4.25% mortgage note, balloon due 2017 (d)

     5.82        21,352        21,428   

Unsecured fixed-rate promissory note, 7.00%, due 2021

     10.06        1,539        1,571   
    

 

 

   

 

 

 
       1,965,202        1,952,089   

Unamortized debt discount

       (54,250     (57,211
    

 

 

   

 

 

 

Total mortgages and notes payable

     $ 1,910,952      $ 1,894,878   
    

 

 

   

 

 

 

 

(a) 

The effective rates include amortization of debt discount, amortization of deferred financing costs, and related debt insurer premiums, where applicable, calculated as of March 31, 2013.

(b) 

This note matured on December 1, 2012 and was borrowed by a special purpose entity owned by the Company. At the time of the maturity the special purpose entity informed the lender that it would be unable to refinance or sell the property and determined that an orderly transition of the property was required. The lender provided the special purpose entity a notice of default and subsequently foreclosed on the property in April 2013. The default interest rate on the note was 9.90% and was added to the balance of the note.

(c) 

Maturity dates assume exercise of the Company’s two one-year extension options under the note agreements.

(d) 

Variable-rate notes are hedged with interest rate swaps (see Note 6).

 

14


Table of Contents

As of March 31, 2013, scheduled debt maturities of the Company’s mortgages and notes payable, including balloon payments, during the next five years and thereafter are as follows:

 

     Scheduled
Principal
     Balloon
Payment
     Total (a)  
     (In Thousands)  

Remainder of 2013

   $ 32,666       $ —         $ 32,666   

2014

     46,169         29,761         75,930   

2015

     36,354         107,465         143,819   

2016

     40,770         580,673         621,443   

2017

     33,720         233,547         267,267   

Thereafter

     115,894         700,301         816,195   
  

 

 

    

 

 

    

 

 

 
   $ 305,573       $ 1,651,747       $ 1,957,320   
  

 

 

    

 

 

    

 

 

 

 

(a) 

The total excludes the note obligation of $7.9 million that was due in 2012 and referenced in footnote (b) above

Balloon payments subsequent to 2017 are as follows: $24.8 million due in 2018, $258.3 million due in 2020, $167.5 million due in 2021, and $249.7 million due in 2022.

Term Note Payable

Prior to the completion of the IPO on September 25, 2012, the Company had $729 million principal balance outstanding of a variable rate Term Note payable. The Company entered into various interest rate derivative products to hedge the risk of variability in cash flows which were accounted for as cash flow hedges (see Note 6). The Term Note interest rate was 3.43% at the beginning of 2012 and 3.78%, effective February 1, 2012, and was reset on August 1, 2012 to 3.44%, which remained in effect until the Term Note was extinguished on September 25, 2012.

The following table summarizes interest expense on the related borrowings:

 

     Three Months
Ended March 31,
 
     2013      2012  
     (In Thousands)  

Interest expense – Term Note payable (a)

   $ —         $ 6,747   

Interest expense – revolving credit facilities (b)

     105         —     

Interest expense – mortgages and notes payable

     29,472         29,783   

Interest expense – other

     —           2   

Amortization of deferred financing costs (c)

     3,901         852   

Amortization of net losses related to interest rate swap

     —           1,156   

Amortization of debt discount(d)

     2,961         399   
  

 

 

    

 

 

 

Total interest expense

   $ 36,439       $ 38,939   
  

 

 

    

 

 

 

 

(a) 

Includes related hedge expense.

(b) 

Comprised primarily of non-utilization fees on the $100.0 million Credit Facility.

(c) 

Includes $3.6 million arising from financing committments related to the proposed Merger.

(d)

Interest expense for the first quarter of 2012 was adjusted by a $2.9 million decrease related to the amortization period utilized in 2011 for the debt discount. In the opinion of management, the impact of this adjustment is immaterial to the Company’s 2012 results of operations.

Debt discount is amortized to interest expense using the effective interest method over the terms of the related notes. The financing costs related to the establishment of debt are deferred and amortized to interest expense using the effective interest method over the term of the related debt instrument. Unamortized financing costs totaled $10.4 million and $3.8 million at March 31, 2013 and December 31, 2012, respectively, and are included in deferred costs and other assets, net on the accompanying condensed consolidated balance sheets. The balance as of March 31, 2013 includes $5.9 million in Merger-related financing committments.

 

15


Table of Contents

Note 6. Derivative and Hedging Activities

The Company uses interest rate derivative contracts to manage its exposure to changes in interest rates on its variable rate debt. These derivatives are considered cash flow hedges and are recorded on a gross basis at fair value and are included in accounts payable, accrued expenses and other liabilities on the accompanying condensed consolidated balance sheets. The effective portion of changes in fair value are recorded in accumulated other comprehensive loss (“AOCL”) and subsequently reclassified to earnings when the hedged transactions affect earnings. The ineffective portion is recorded immediately in earnings in general and administrative expenses.

The Company discontinues hedge accounting if it determines that a derivative no longer meets the criteria for hedge accounting or management determines that designation of the derivative as a hedging instrument is no longer appropriate. When hedge accounting is discontinued, the Company continues to carry the derivative at its fair value on the balance sheet and records changes in fair value directly to earnings.

As of March 31, 2013 and December 31, 2012, the Company recognized derivative liabilities of $0.7 million and $0.8 million, respectively, related to various interest rate derivative contracts. The Company recognized no derivative assets at March 31, 2013 and December 31, 2012, and is not required to post collateral to its counterparties for any liability positions.

The net unamortized loss deferred in AOCL related to all derivative instruments during the three months ended March 31, 2013 and 2012 totaled $31,000 and $72,000, respectively. Amounts reported in AOCL related to the cash flow hedges are reclassified to interest expense when the originally forecasted hedged transactions affect earnings. During the three months ended March 31, 2013 and 2012, such reclassifications totaled $0.1 million and $1.2 million, respectively.

The net unamortized loss included in AOCL related to all derivative instruments at March 31, 2013 totaled $0.7 million. Approximately $0.3 million is estimated to be reclassified as an increase to interest expense during the next 12 months.

During the three months ended March 31, 2013, the Company recognized a net loss of $21,654 related to a portion of forecasted hedged transactions that were no longer probable of occurring. These amounts were included in general and administrative expenses. There were no such losses during the comparable period ended March 31, 2012.

The Company does not enter into derivative contracts for speculative or trading purposes.

Note 7. Stockholders’ Equity

In March 2013, the Company declared a cash dividend of $0.3125 per share on its common stock, payable on April 16, 2013, to stockholders of record as of April 1, 2013.

Note 8. Commitments and Contingencies

The Company is periodically subject to claims or litigation in the ordinary course of business, including claims generated from business conducted by tenants on real estate owned by the Company. In these instances, the Company is typically indemnified by the tenant against any losses that might be suffered, and the Company and/or the tenant are insured against such claims. At March 31, 2013, there were no outstanding claims against the Company that are expected to have a material adverse effect on the Company’s financial position or results of operations.

At March 31, 2013, the Company had commitments totaling $10.2 million to make property acquisitions and to fund improvements on properties the Company currently owns. These commitments are expected to be funded by December 31, 2013. In addition, the Company is contingently liable for $5.7 million of debt owed by one of its tenants and is indemnified by that tenant for any payments the Company may be required to make on such debt.

The Company estimates future costs for known environmental remediation requirements when it is probable that the Company has incurred a liability and the related costs can be reasonably estimated. The Company considers various factors when estimating its environmental liabilities, and adjustments are made when additional information becomes available that affects the estimated costs to study or remediate any environmental issues. When only a wide range of estimated amounts can be reasonably established and no other amount within the range is better than another, the low end of the range is recorded in the financial statements. Based on an ongoing environmental study on one of its properties, the Company’s estimated remediation liability was $0.1 million at March 31, 2013 and December 31, 2012.

 

16


Table of Contents

Note 9. Fair Value Measurements

The Company’s assets and liabilities that are required to be measured at fair value in the accompanying condensed consolidated financial statements are summarized below.

The following table sets forth the Company’s financial assets that were accounted for at fair value on a recurring basis as of March 31, 2013 and December 31, 2012:

 

           Fair Value Hierarchy Level  
     Fair Value     Level 1      Level 2     Level 3  
     (In Thousands)  

March 31, 2013:

         

Derivatives:

         

Interest rate swaps

   $ (709   $ —         $ (709   $ —     

December 31, 2012:

         

Derivatives:

         

Interest rate swaps

   $ (771   $ —         $ (771   $ —     

The interest rate swaps are measured using a market approach, using prices obtained from a nationally recognized pricing service and pricing models with market observable inputs such as interest rates and equity index levels. These measurements are classified as Level 2 of the fair value hierarchy.

The following table sets forth the Company’s assets that were accounted for at fair value on a nonrecurring basis as of March 31, 2013 and December 31, 2012:

 

                  Fair Value Hierarchy Level      Impairment
Charges
 

Description

   Fair Value      Dispositions     Level 1      Level 2      Level 3     
     (In Thousands)  

March 31, 2013:

                

Long-lived assets held for sale

   $ 6,677       $ —        $ —         $ —         $ 6,677       $ (2,103

December 31, 2012:

                

Long-lived assets held and used

   $ 27,449       $ (425   $ —         $ —         $ 27,874       $ (7,404

Lease intangible assets

     —           —          —           —           —           (2,680

Long-lived assets held for sale

     4,184         (7,983     —           —           12,167         (3,648
                

 

 

 
                 $ (13,732
                

 

 

 

The fair values of impaired real estate and intangible assets were determined by using the following information, depending on availability, in order of preference: signed purchase and sale agreement or letter of intent; recently quoted bid or ask prices, or market prices for comparable properties; estimates of cash flow, which consider, among other things, contractual and forecasted rental revenues, leasing assumptions, and expenses based upon market conditions; and expectations for the use of the real estate. Based on these inputs, the Company determined that its valuation of the impaired real estate and intangible assets falls within Level 3 of the fair value hierarchy.

In addition to the disclosures for assets and liabilities required to be measured at fair value at the balance sheet date, companies are required to disclose the estimated fair values of all financial instruments, even if they are not carried at their fair value. The fair values of financial instruments are estimates based upon market conditions and perceived risks at March 31, 2013 and December 31, 2012. These estimates require management’s judgment and may not be indicative of the future fair values of the assets and liabilities.

Financial assets and liabilities for which the carrying values approximate their fair values include cash and cash equivalents, restricted cash and escrow deposits and accounts receivable and payable. Generally, these assets and liabilities are short-term in duration and are recorded at fair value on the accompanying condensed consolidated balance sheets.

The estimated fair values of the fixed-rate mortgage and other loans receivable and the fixed-rate mortgages and notes payable have been derived based on market quotes for comparable instruments or discounted cash flow analysis using

 

17


Table of Contents

estimates of the amount and timing of future cash flows, market rates and credit spreads. The mortgage and other loans receivable and mortgages and notes payable were measured using a market approach from nationally recognized financial institutions with market observable inputs such as interest rates and credit analytics. These measurements are classified as Level 2 of the fair value hierarchy. The following table discloses fair value information for these financial instruments:

 

     March 31, 2013      December 31, 2012  
     Carrying
Value
     Estimated
Fair Value
     Carrying
Value
     Estimated
Fair Value
 
     (In Thousands)  

Mortgage and other loans receivable

   $ 50,960       $ 68,943       $ 51,862       $ 69,926   

Mortgages and notes payable

     1,910,952         2,137,320         1,894,878         2,112,670   

Revolving credit facilities

     11,400         11,585         —          —    

Note 10. Significant Credit and Revenue Concentration

As of March 31, 2013, the Company’s real estate investments are operated by approximately 165 tenants that engage in retail, service and distribution activities across various industries throughout the United States. Shopko Stores Operating Co., LLC (“Shopko”) and Pamida Stores Operating Co., LLC (“Pamida”), which merged in 2012, operate in the general and discount retailer industry and represent the Company’s largest tenant. As of March 31, 2013 and 2012, rental revenues from the combined Shopko/Pamida entity (“Shopko/Pamida”) contributed 29.0% and 30.0% of our total rent (from continuing and discontinued operations), respectively. No other tenant contributed 10% or more of the Company’s total annual rent during any of the periods presented. As of March 31, 2013 and December 31, 2012, the combined properties that are operated by Shopko/Pamida represent approximately 28.1% and 28.4%, respectively, of the Company’s total investment portfolio.

Note 11. Discontinued Operations

Periodically, the Company may sell real estate properties it owns. Gains and losses from any such dispositions of properties and all operations from these properties are required to be reclassified as “discontinued operations” in the condensed consolidated statements of operations, as long as there is no significant continuing involvement in the future cash flows from these properties. As a result of this reporting requirement, each time a property is sold or classified as real estate assets held for sale, the operations of such property previously reported as part of “loss from continuing operations” are reclassified into “discontinued operations.” This presentation has no impact on net loss or cash flow. The net gains or losses from the real estate dispositions as well as the current and prior operations have been reclassified to discontinued operations as summarized below:

 

     Three Months Ended
March 31,
 
     2013     2012  
     (In Thousands)  

Revenues

   $ 403      $ 1,336   

Expenses:

    

General and administrative

     3        97   

Property costs

     51        183   

Interest

     194        134   

Depreciation and amortization

     142        627   

Impairments

     2,103        1,802   
  

 

 

   

 

 

 

Total expenses

     2,493        2,843   
  

 

 

   

 

 

 

Loss from discontinued operations

     (2,090     (1,507

Net gains on dispositions of real estate (a)

     180        1,450   
  

 

 

   

 

 

 

Total discontinued operations

   $ (1,910   $ (57
  

 

 

   

 

 

 

 

(a)       Number of properties disposed of during period

     6        11   

 

18


Table of Contents

Note 12. Supplemental Cash Flow Information

In March 2013, the Company declared a common stock dividend of $26.5 million, which was paid in April 2013. During the three months ended March 31, 2013, the Company repaid approximately $1.0 million of mortgages and notes payable in conjunction with sales of certain real estate properties. In addition, at March 31, 2013, $6.4 million of deferred financing fees were unpaid. During the three months ended March 31, 2012, the Company repaid $0.4 million of mortgages and notes payable concurrently with the sales of certain real estate properties and paid $0.7 million of real estate acquisition costs accrued for at December 31, 2011. Furthermore, as of March 31, 2012, $3.5 million of deferred offering costs were unpaid.

Note 13. Incentive Award Plan

Under the Company’s Incentive Award Plan (the “Plan”), we may grant equity incentive awards to eligible employees, directors and other service providers. An aggregate of approximately 3.1 million shares of common stock is available for issuance under the Plan. As of March 31, 2013, 1.7 million shares remain available for grant. Awards under the Plan may be in the form of stock options, restricted stock, dividend equivalents, restricted stock units, stock appreciation rights, performance awards, stock payment awards, performance share awards, LTIP units and other incentive awards. If an award under the Plan is forfeited, expires or is settled for cash, any shares subject to such award may, to the extent of such forfeiture, expiration or cash settlement, be used again for new grants under the Plan.

The following table summarizes our restricted common stock grant activity under the Plan:

 

     Three Months Ended
March 31, 2013
 
     Number of
Shares
    Weighted
average
price (1)
 

Outstanding non-vested shares, December 31, 2012

     1,156,966      $ 15.61   

Shares granted

     —          —     

Shares vested

     —          —     

Shares forfeited

     (18,334     15.25   
  

 

 

   

 

 

 

Outstanding non-vested shares, end of period

     1,138,632      $ 15.61   
  

 

 

   

 

 

 

 

(1)       Grant date fair value

    

Historical staff turnover rates are used by the Company to estimate the forfeiture rate for its non-vested shares. Accordingly, changes in actual forfeiture rates will affect stock-based compensation expense during the applicable period.

Under the terms of the restricted common stock grants issued, holders of the non-vested shares are eligible to receive non-refundable dividends. The Company charges to compensation expense the amount of dividend accrued and/or paid to the extent they relate to non-vested shares that are not expected to vest.

The amount of stock-based compensation expense recognized in general and administrative expenses was $1.8 million for the three months ended March 31, 2013.

As of March 31, 2013 the remaining unamortized stock-based compensation expense totaled $13.9 million, which is recognized as the greater of the amount amortized on a straight-line basis over the service period of each applicable award or the amount vested over the vesting periods.

 

19


Table of Contents

Note 14. Earnings (Loss) Per Share

Basic and diluted loss per share is computed by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. The table below is a reconciliation of the numerator used in the computation of basic and diluted loss per share:

 

     Three Months Ended March 31,  
     2013     2012  
     (In Thousands)  

Loss from continuing operations attributable to common stockholders

   $ (6,422   $ (12,345

Loss from discontinued operations

     (1,910     (57
  

 

 

   

 

 

 

Net loss attributable to common stockholders

   $ (8,332   $ (12,402
  

 

 

   

 

 

 

Weighted average shares of common stock outstanding:

    

Basic and diluted

     83,694,549        25,863,976   
  

 

 

   

 

 

 

For all periods presented, no potentially dilutive securities were included in computing loss per share of common stock as their effect would be anti-dilutive. Potentially dilutive securities excluded were the non-vested restricted stock during the three months ended March 31, 2013 and the potential shares of common stock for the TLC debt conversion during the three months ended March 31, 2012. The weighted average number of shares of potentially dilutive securities were as follows:

 

     Three Months Ended
March 31,
 
     2013      2012  
     (In Thousands)  

TLC convertible debt

     —           24,245,278   

Non-vested shares of restricted stock

     380,748         —     
  

 

 

    

 

 

 

Potentially dilutive shares

     380,748         24,245,278  
  

 

 

    

 

 

 

Note 15. Subsequent Events

On April 2, 2013, the SEC declared effective the joint proxy statement/prospectus filed by the Company and CCPTII with the SEC on March 8, 2013, as amended on March 29, 2013 related to the proposed Merger of the Company and CCPTII. The Merger is expected to close in the third quarter of 2013 contingent on the receipt of approval of the majority of shares outstanding of the Company and CCPTII and other customary regulatory approvals and the satisfaction of other contractual closing conditions.

 

20


Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Special Note Regarding Forward-looking Statements

This quarterly report contains forward-looking statements within the meaning of the federal securities laws. In particular, statements pertaining to our business and growth strategies, investment and leasing activities and trends in our business, including trends in the market for long-term, triple-net leases of freestanding, single-tenant properties, contain forward-looking statements. When used in this quarterly report, the words “estimate,” “anticipate,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “seek,” “approximately” or “plan,” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters are intended to identify forward-looking statements. You can also identify forward-looking statements by discussions of strategy, plans or intentions of management.

Forward-looking statements involve numerous risks and uncertainties and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:

 

   

general business and economic conditions;

 

   

continued volatility and uncertainty in the credit markets and broader financial markets, including potential fluctuations in the CPI;

 

   

other risks inherent in the real estate business, including tenant defaults, potential liability relating to environmental matters, illiquidity of real estate investments, and potential damages from natural disasters;

 

   

availability of suitable properties to acquire and our ability to acquire and lease those properties on favorable terms;

 

   

ability to renew leases, lease vacant space or re-lease space as existing leases expire;

 

   

the degree and nature of our competition;

 

   

our failure to generate sufficient cash flows to service our outstanding indebtedness;

 

   

access to debt and equity capital markets;

 

   

fluctuating interest rates;

 

   

availability of qualified personnel and our ability to retain our key management personnel;

 

   

the outcome of any legal proceedings to which we are a party;

 

   

risks related to the proposed Merger;

 

   

changes in, or the failure or inability to comply with, government regulation, including Maryland laws;

 

   

failure to maintain our status as a REIT;

 

   

changes in the U.S. tax law and other U.S. laws, whether or not specific to REITs; and

 

   

additional factors discussed in this section and in our other filings with the SEC.

You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this quarterly report. While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, of new information, data or methods, future events or other changes, except as required by law. For a further discussion of these and other factors, see the section entitled “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012. In light of these risks and uncertainties, the forward-looking events discussed in this quarterly report might not occur.

Overview

Spirit Realty Capital was incorporated on August 14, 2003 as a Maryland corporation. The Company is a self-administered and self-managed REIT that primarily invests in single-tenant, operationally essential real estate throughout the United States that is leased on a long-term, triple-net basis primarily to tenants engaged in retail, service, and distribution industries. Single-tenant, operationally essential real estate consists of properties that are generally free-standing, commercial real estate facilities where the Company’s tenants conduct retail, distribution, or service activities that are essential to the generation of their sales and profits. Under a triple-net lease the tenant is typically responsible for all improvements and is contractually obligated to pay all property operating expenses, such as insurance, real estate taxes,

 

21


Table of Contents

and repair and maintenance costs. In support of its primary business of owning and leasing real estate, the Company has also strategically originated or acquired long-term, commercial mortgage and equipment loans to provide a range of financing solutions to its tenants.

We generate our revenue primarily by leasing our properties to our tenants. As of March 31, 2013, our undepreciated gross investment in real estate and loans totaled approximately $3.70 billion, representing investment in 1,232 properties, including properties securing our mortgage loans. Of this amount, 98.6% consisted of our gross investment in real estate, representing ownership of 1,147 properties, and the remaining 1.4% consisted of commercial mortgage and equipment loans receivable secured by 85 properties or related assets. As of March 31, 2013, our owned properties were approximately 98.9% occupied (based on number of properties), and our leases had a weighted average non-cancelable remaining lease term (based on annual rent) of approximately 10.9 years. Our leases are generally long-term, typically with non-cancelable initial terms of 15 to 20 years and tenant renewal options for additional terms. As of March 31, 2013, approximately 96% of our leases (based on annual rent) provided for increases in future annual base rent.

Our operations are carried out through the Spirit Operating Partnership, which is a Delaware limited partnership. Spirit General OP Holdings, LLC, one of our wholly owned subsidiaries, is the sole general partner and owns 1.0% of the Spirit Operating Partnership. Spirit Realty Capital is the sole limited partner and owns the remaining 99.0% of the Spirit Operating Partnership. Although the Spirit Operating Partnership is wholly owned by us, in the future, we could agree to issue equity interests in the Spirit Operating Partnership to third parties in exchange for property owned by such third parties. In general, any equity interests of the Spirit Operating Partnership issued to third parties would be exchangeable for cash or, at our election, shares of our common stock at specified ratios set when equity interests in the Spirit Operating Partnership are issued.

We have elected to be taxed as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2003. We believe that we have been organized and have operated in a manner that has allowed us to qualify as a REIT for federal income tax purposes commencing with such taxable year, and we intend to continue operating in such a manner.

Factors that May Influence Our Operating Results

Rental Revenue

Our revenues are generated predominantly from receipt of rental revenue. Our ability to grow rental revenue will depend on our ability to acquire additional properties, increase rental rates and/or occupancy. Approximately 96% of our leases contain rent escalators, or provisions that periodically increase the base rent payable by the tenant under the lease. Generally, our rent escalators increase rent at specified dates by: (1) a fixed amount; or (2) the lesser of (a) 1 to 1.25 times any increase in the CPI over a specified period, or (b) a fixed percentage, typically 1% to 2% per year. As of March 31, 2013, 98.9% of our owned properties (based on number of properties) were occupied.

In February 2012, Shopko and Pamida, two of our general merchandising tenants, completed a merger. As a result, Shopko/Pamida contributed 29.0% of our annual rent as of March 31, 2013. 84 Properties, LLC (“84 Lumber”), our next largest tenant, contributed 6.5% of our annual rent as of March 31, 2013. Because a significant portion of our revenues are derived from rental revenues received from Shopko/Pamida and 84 Lumber, defaults, breaches or delay in payment of rent by these tenants may materially and adversely affect us.

The audited consolidated financial statements of Specialty Retail Shops Holding Corp., the parent company of Shopko/Pamida, for the fiscal years ended February 2, 2013, January 28, 2012 and January 29, 2011 are included in Exhibit 99.1 to this quarterly report and are incorporated by reference herein.

Without giving effect to the exercise of tenant renewal options, the weighted average remaining term of our leases as of March 31, 2013 was 10.9 years (based on annual rent). Approximately 6.0% of our leases (based on annual rent) as of March 31, 2013 will expire prior to January 1, 2017. The stability of our rental revenue generated by our properties depends principally on our tenants’ ability to pay rent and our ability to collect rents, renew expiring leases or re-lease space upon the expiration or other termination of leases, lease currently vacant properties and maintain or increase rental rates at our leased properties. Adverse economic conditions, particularly those that affect the markets in which our properties are located, or downturns in our tenants’ industries could impair our tenants’ ability to meet their lease obligations to us and our ability to renew expiring leases or re-lease space. In particular, the bankruptcy of one or more of our tenants could adversely affect our ability to collect rents from such tenant and maintain our portfolio’s occupancy.

 

22


Table of Contents

Our ability to grow revenue will depend, to a significant degree, on our ability to acquire additional properties. We primarily focus on opportunities to provide capital to small and middle market companies that we conclude have stable and proven operating histories and attractive credit characteristics, but lack the access to capital that large companies often have. We believe our experience, in-depth market knowledge and extensive network of long-standing relationships in the real estate industry will provide us access to an ongoing pipeline of attractive investment opportunities.

Our Triple-Net Leases

We generally lease our properties to tenants pursuant to long-term, triple-net leases that require the tenant to pay all property operating expenses, such as real estate taxes, insurance premiums and repair and maintenance costs. As of March 31, 2013, approximately 95% of our properties (based on annual rent) are subject to triple-net leases. Occasionally, we have entered into a lease pursuant to which we retain responsibility for the costs of structural repairs and maintenance. Although these instances are infrequent and have not historically resulted in significant costs to us, an increase in costs related to these responsibilities could negatively influence our operating results. Similarly, an increase in the vacancy rate of our portfolio would increase our costs, as we would be responsible for costs that our tenants are currently required to pay. Additionally, contingent rents based on a percentage of the tenant’s gross sales have been historically negligible, contributing less than 1% of our rental revenue. Approximately 64.8% of our annual rent is attributable to master leases, where multiple properties are leased to a single tenant on an “all or none” basis and which contain cross-default provisions. Where appropriate, we seek to use master leases to prevent a tenant from unilaterally giving up underperforming properties while maintaining well performing properties.

Interest Expense

As of March 31, 2013, we had approximately $1.97 billion principal balance outstanding of predominately secured, fixed-rate mortgage notes payable. During the three months ended March 31, 2013, the weighted average interest rate on our fixed and variable-rate debt, excluding the amortization of deferred financing costs and debt discounts, was approximately 6.03%. Our fixed-rate debt structure will provide us with a stable and predictable cash requirement related to our debt service. The variable rate debt consists of four mortgage notes. We entered into interest rate swaps that effectively fixed the interest rates at approximately 4.85% on a significant portion of this variable rate debt. We amortize on a non-cash basis the deferred financing costs and debt discounts associated with our fixed-rate debt to interest expense using the effective interest rate method over the terms of the related notes. For the three months ended March 31, 2013, non-cash interest expense recognized on our credit facilities, mortgages and notes payable totaled approximately $6.9 million. Any changes to our debt structure, including borrowings under the $100.0 million Credit Facility or debt financing associated with property acquisitions, could materially influence our operating results depending on the terms of any such indebtedness. Most of our debt provides for scheduled principal payments. As principal is repaid, our interest expense decreases.

General and Administrative Expenses

General and administrative expenses include employee compensation costs, professional fees, consulting, portfolio servicing costs and other general and administrative expenses. As a public company, we estimate our annual general and administrative expenses will increase due to increased legal, insurance, accounting and other expenses related to corporate governance, SEC reporting and other compliance matters.

Transaction Costs

As we acquire properties, we may incur transaction costs that we are required to expense.

Impact of Inflation

Our leases typically contain provisions designed to mitigate the adverse impact of inflation on our results of operations. Since tenants are typically required to pay all property operating expenses, increases in property-level expenses at our leased properties generally do not adversely affect us. However, increased operating expenses at vacant properties and the limited number of properties that are not subject to full triple-net leases could cause us to incur additional operating expense. Additionally, our leases generally provide for rent escalators (see “—Rental Revenue” above) designed to mitigate the effects of inflation over a lease’s term. However, since some of our leases do not contain rent escalators and many that do limit the amount by which rent may increase, any increase in our rental revenue may not keep up with the rate of inflation.

Proposed Merger with Cole

On January 22, 2013, Spirit Realty Capital, the Spirit Operating Partnership, CCPTII, and the Cole Operating Partnership entered into the Merger Agreement which provides for the merger of Spirit Realty Capital with and into CCPTII with CCPTII continuing as the surviving corporation and the merger of the Cole Operating Partnership with and into the Spirit Operating Partnership with the Spirit Operating Partnership continuing as the surviving limited partnership. The board of directors of Spirit Realty Capital has unanimously

 

23


Table of Contents

approved the Merger Agreement, the Merger and the other transactions contemplated by the Merger Agreement. While the Merger is pending, we will be subject to various uncertainties and contractual restrictions that could adversely affect our financial results. The Merger is expected to close in the third quarter of 2013 contingent on the receipt of approval of the majority of shares outstanding of the Company and CCPTII and other customary regulatory approvals and the satisfaction of other contractual closing conditions

In connection with the Merger Agreement, on January 22, 2013, the Company entered into the Barclays Commitment Letter, pursuant to which Barclays Bank PLC has committed to provide, subject to the conditions set forth in the Barclays Commitment Letter, a $575.0 million secured term loan facility and a $50.0 million senior secured revolving credit facility. As a result of obtaining the Barclays Commitment Letter, the Company incurred approximately $9.5 million in commitment and structuring fees, which were capitalized as deferred financing costs and are being amortized over the term of the commitment.

On April 26, 2013, the Spirit Operating Partnership entered into a commitment letter (the “DB Commitment Letter”) with Deutsche Bank Securities Inc. (“DBSI”), on behalf of Deutsche Bank AG New York Branch. Subject to certain conditions set forth in the DB Commitment Letter, DBSI has agreed to provide $300.0 million of a $325.0 million senior secured revolving credit facility. The remaining $25.0 million, as well as an accordion feature allowing the Spirit Operating Partnership to increase such facility by up to an additional $75.0 million, are each subject to acceptance of commitments from existing or new lenders. The DB Commitment Letter contemplates that the credit facility will be guaranteed by the Company and all subsidiaries of the Spirit Operating Partnership that own certain unencumbered properties. The proceeds of this loan facility would be available for general corporate purposes of the Spirit Operating Partnership and its subsidiaries, including but not limited to working capital, capital expenditures and acquisitions. The revolving credit facility contemplated under the DB Commitment Letter would be an alternative source of funding to a portion of the facilities contemplated under the Barclays Commitment Letter but, until the actual funding thereof, the commitments under the DB Commitment Letter are not intended to replace any or all of the commitments contemplated under the Barclays Commitment Letter. In connection with the DB Commitment Letter, the Company incurred approximately $3.0 million in commitment fees subsequent to March 31, 2013.

There can be no assurances, however, that the financings discussed above will be completed as they are subject to a number of conditions including, but not limited to, the execution of mutually agreeable documentation. The foregoing descriptions of the Barclays Commitment Letter and the DB Commitment Letter and the transactions contemplated by each are qualified in their entirety by reference to the complete terms and conditions of the definitive documentation to be negotiated and executed in connection therewith.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with GAAP requires our management to use judgment in the application of accounting policies, including making estimates and assumptions. We base estimates on the best information available to us at the time, our experience and on various other assumptions believed to be reasonable under the circumstances. These estimates affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions or other matters had been different, it is possible that different accounting would have been applied, resulting in a different presentation of our condensed consolidated financial statements. From time to time, we re-evaluate our estimates and assumptions. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current estimates and assumptions about matters that are inherently uncertain. A summary of our critical accounting policies is included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We have not made any material changes to these policies during the periods covered by this quarterly report.

 

24


Table of Contents

Results of Operations

Comparison of the Three Months Ended March 31, 2013 to Three Months Ended March 31, 2012

The following discussion includes the results of our continuing operations as summarized in the table below:

 

     Three Months
Ended March 31,
 
     2013     2012     Change     %  
     (In Thousands)  

Revenues:

        

Rentals

   $ 71,614      $ 67,628      $ 3,986        5.9

Interest income on loans receivable

     1,113        1,436        (323     (22.5 )% 

Interest income and other

     78        438        (360     (82.2 )% 
  

 

 

   

 

 

   

 

 

   

Total revenues

     72,805        69,502        3,303        4.8
  

 

 

   

 

 

   

 

 

   

Expenses:

        

General and administrative

     13,577        6,248        7,329        117.3

Property costs

     963        1,190        (227     (19.1 )% 

Interest

     36,439        38,939        (2,500     (6.4 )% 

Depreciation and amortization

     28,174        27,271        903        3.3

Impairments

     —          8,135        (8,135     (100.0 )% 
  

 

 

   

 

 

   

 

 

   

Total expenses

     79,153        81,783        (2,630     (3.2 )% 
  

 

 

   

 

 

   

 

 

   

Loss from continuing operations before income tax expense

     (6,348     (12,281     5,933        48.3

Income tax expense

     74        64       10        15.6
  

 

 

   

 

 

   

 

 

   

Loss from continuing operations(1)

   $ (6,422   $ (12,345   $ 5,923        48.0
  

 

 

   

 

 

   

 

 

   

 

(1) For the three months ended March 31, 2013 and 2012, losses of $1.9 million and $0.06 million, respectively, resulted from discontinued operations.

Revenues

For the three months ended March 31, 2013, approximately 98.5% of our lease and loan revenues were attributable to long-term leases. Total revenue increased by $3.3 million to $72.8 million for the three months ended March 31, 2013 as compared to $69.5 million for same period in 2012. The increase in revenue was due primarily to an increase in base rental revenue resulting from real estate acquisitions of approximately $182.8 million subsequent to March 31, 2012 and contractual rent escalations on our owned real estate properties.

Rentals

Rental revenue increased by $4.0 million to $71.6 million for the three months ended March 31, 2013 as compared to $67.6 million for the same period in 2012. The increase was attributable to an increase in the number of active leases due to real estate acquisitions, contractual rent escalations and fewer vacant properties compared to the period ended March 31, 2012. Rental revenue attributable to non-cash straight-line rent and amortization of above and below-market lease intangibles for the three months ended March 31, 2013 and 2012 was $0.8 million and $0.7 million, respectively, representing approximately 1.0% of total rental revenue from continuing operations for each of the three-month periods ended March 31, 2013 and 2012.

As of March 31, 2013, 98.9% (based on number of properties) of our owned properties were occupied. The majority of our nonperforming leases were in the restaurant and automotive industries. We regularly review and analyze the operational and financial condition of our tenants and the industries in which they operate in order to identify underperforming properties that we may seek to dispose of in an effort to mitigate risks in the portfolio. As of March 31, 2013, 13 of our properties, representing approximately 1.1% of our owned properties, were vacant and not generating rent, compared to 22 vacant properties, representing 2.0% of our owned properties, as of March 31, 2012.

 

25


Table of Contents

Interest income on loans receivable and other income

Interest income on loans receivable decreased by $0.3 million to $1.1 million for the three months ended March 31, 2013 as compared to $1.4 million for the same period in 2012. The decrease in interest income on loans was primarily due to the prepayment of two notes totaling $9.0 million and scheduled maturities and amortization subsequent to March 31, 2012. Interest income and other decreased by $0.4 million to $0.4 million for the three months ended March 31, 2013 as compared to $0.8 million for the same period in 2012. Interest income and other was lower during 2013 as a result of $0.3 million in lease termination revenue recognized in 2012 from one of our tenants.

Expenses

General and administrative

General and administrative expenses increased $7.3 million for the three months ended March 31, 2013 due primarily to $6.1 million in transaction costs associated with the proposed Merger and $1.8 million in stock-based compensation and incentive awards. During the same period in 2012, the Company recognized $1.0 million in costs related to our IPO. Due to the proposed Merger, we anticipate that we will continue to incur similar Merger-related expenses through the remainder of the year.

Property costs

Our leases are generally triple-net and provide that the tenant is responsible for the payment of all property operating expenses, such as real estate taxes, insurance premiums and repair and maintenance costs. Therefore, we are generally not responsible for operating costs related to the properties, unless a property is not subject to a triple-net lease or is vacant. Total property costs decreased by $0.2 million to $1.0 million for the three months ended March 31, 2013, as compared to $1.2 million for the same period in 2012. The decrease in property costs was due to a decrease in the average number of property vacancies, from an average of 20 vacant properties during the three months ended March 31, 2012 to an average of 15 vacant properties during the comparable period in 2013. The Company also reduced property costs by approximately $0.2 million as actual repair costs accrued on a non-triple net lease were lower than expected.

Interest

Interest expense decreased by $2.5 million to $36.4 million for the three months ended March 31, 2013 as compared to $38.9 million for the same period in 2012.The decrease in interest expense was due primarily to the extinguishment of the Term Note indebtedness as a result of the IPO on September 25, 2012. This decrease was partially offset by an increase in the amortization of deferred financing fees and $69.0 million of new borrowings subsequent to March 31, 2012 related to recent acquisitions. The increase in deferred financing fees is due to capitalized debt issue costs incurred to provide bridge financing in connection with the Merger. These costs are being amortized over the estimated interim period preceding the placement of permanent financing expected sometime in the third quarter.

The following table summarizes our interest expense and related borrowings from continuing operations:

 

     Three Months Ended March 31,  
     2013     2012  
     (In Thousands)  

Interest expense—Term Note payable

   $ —        $ 6,747   

Interest expense—revolving credit facilities

     105        —     

Interest expense—mortgages and notes payable

     29,472        29,783   

Interest expense—other

     —          2   

Amortization of deferred financing costs

     3,901        852   

Amortization of net losses related to interest rate swap

     —          1,156   

Amortization of debt discount

     2,961        399   
  

 

 

   

 

 

 

Total interest expense

   $ 36,439      $ 38,939   
  

 

 

   

 

 

 

Weighted average debt outstanding before Term Note and debt discount(1)

   $ 1,961,731      $ 1,952,302   

Weighted average Term Note

     —          729,000   

Weighted average debt discount(1)

     (56,832     (61,976
  

 

 

   

 

 

 

Weighted average debt outstanding

   $ 1,904,899      $ 2,619,326   
  

 

 

   

 

 

 

Adjusted interest(2)/weighted average mortgages and notes payable

     6.03     6.10

Term Note interest(3)/weighted average Term Note payable

     —          3.70

 

(1) Excludes debt associated with discontinued operations.
(2) Excludes interest expense associated with the Term Note indebtedness, amortization of deferred financing costs and debt discounts.
(3) Excludes interest expense associated with amortization of deferred financing costs and net losses related to a hedging contract.

 

26


Table of Contents

Depreciation and amortization

Depreciation and amortization expense relates primarily to depreciation on the commercial buildings and improvements we own and to amortization of the related lease intangibles. Depreciation and amortization expense increased by $0.9 million to $28.2 million for the three months ended March 31, 2013 as compared to $27.3 million for the same period in 2012. The slight increase was due to higher depreciation expense following acquisitions of approximately $182.8 million in properties between March 31, 2012 and March 31, 2013, partially offset by dispositions of properties subsequent to March 31, 2012. The following table summarizes our depreciation and amortization expense from continuing operations:

 

     Three Months Ended March 31,  
     2013      2012  
     (In Thousands)  

Depreciation of real estate assets

   $ 23,727       $ 22,785   

Other depreciation

     27         11   

Amortization of lease intangibles

     4,420         4,475   
  

 

 

    

 

 

 

Total depreciation and amortization

   $ 28,174       $ 27,271   
  

 

 

    

 

 

 

Impairments

Impairment charges on properties and other assets that are classified as part of continuing operations were zero and $8.1 million for the three months ended March 31, 2013 and 2012, respectively. The reduction in the average number of vacancies over the past 12 months has resulted in lower impairment charges during the three months ended March 31, 2013 as compared to the same period in 2012. We strategically seek to identify non-performing properties that we may re-lease or dispose of in an effort to improve our returns. The disposition or re-leasing of non-performing or under-performing properties may trigger impairment charges when the expected future cash flows from the properties for sale or re-lease are less than their net book value. Key assumptions used in estimating future cash flows and fair values include, but are not limited to, revenue growth rates, interest rates, discount rates, capitalization rates, lease renewal probabilities, tenant vacancy rates and other factors.

 

    
Three Months ended March 31,
 
     2013      2012  
     (In Thousands)  

Real estate and intangible asset impairment

   $     —         $ 6,304   

Write-off of lease intangibles due to lease terminations

     —          1,831   
  

 

 

    

 

 

 

Total impairment loss

   $ —         $ 8,135   
  

 

 

    

 

 

 

Discontinued Operations

Gains and losses from property dispositions during a period or expected losses from properties classified as held for sale at the end of the period, as well as all operations from those properties, are reclassified to and reported as part of “discontinued operations.”

For the three months ended March 31, 2013 and 2012, we had losses from discontinued operations of $1.9 million and $0.06 million, respectively. Included in these amounts were losses from properties held for sale of $2.1 million and $1.6 for the three months ended March 31, 2013 and 2012, respectively. Non-cash impairment charges included in the loss from discontinued operations for the three months ended March 31, 2013 and 2012 were $2.1 million and $1.8 million, respectively.

Property Portfolio Information

Our diverse real estate portfolio at March 31, 2013 consisted of 1,147 owned properties:

 

   

leased to approximately 165 tenants;

 

   

located in 47 states, with only 4 states contributing more than 5% of our annual rent;

 

27


Table of Contents
   

operating in 18 different industries;

 

   

with an occupancy rate of 98.9%; and

 

   

with a weighted average remaining lease term of 10.9 years.

The following tables present the diversity of our portfolio and are calculated based on percentage of total annual rent.

Diversification by Tenant

The following table lists the top 10 tenants of our owned real estate properties (based on annual rent) as of March 31, 2013:

 

   

Tenant

   Number
of
Properties
     Annual Rent
(in thousands)(1)
     Percent of Total
Annual Rent
 

  1.

  Shopko/Pamida      181       $ 83,459         29.0

  2.

  84 Properties, LLC      109         18,647         6.5   

  3.

  Carmike Cinemas, Inc.      12         8,028         2.8   

  4.

  Universal Pool Co., Inc.      14         6,679         2.3   

  5.

  CBH20, LP (Camelback Ski Resort)      1         5,779         2.0   

  6.

  United Supermarkets, LLC      15         5,155         1.8   

  7.

  Destination XL Group, Inc.      1         4,814         1.7   

  8.

  Carmax, Inc.      5         4,726         1.6   

  9.

  Main Event Entertainment, LP      6         4,477         1.6   

10.

  NE Opco, Inc.      6         4,458         1.5   
  Other      797         141,842         49.2   
    

 

 

    

 

 

    

 

 

 
  Total      1,147       $  288,064         100
    

 

 

    

 

 

    

 

 

 

 

(1) We define annual rent as rental revenue for the three months ended March 31, 2013 multiplied by four.

Diversification by Industry

The following table sets forth information regarding the diversification of our owned real estate properties among different industries (based on annual rent) as of March 31, 2013:

 

Industry

   Number
of
Properties
     Percent of Total
Annual Rent(1)
 

General and discount retail properties

     181         29.0

Restaurants—quick service

     395         11.0   

Specialty retail properties

     48         9.1   

Restaurants—casual dining

     129         7.8   

Movie theatres

     23         7.6   

Building material suppliers

     110         6.6   

Industrial properties

     26         5.0   

Educational properties

     22         4.6   

Automotive dealers, parts and service properties

     78         4.2   

Recreational properties

     8         3.6   

Convenience stores / car washes

     40         2.9   

Medical/other office properties

     12         2.3   

Supermarkets

     21         2.1   

Distribution properties

     36         1.4   

Health clubs/gyms

     5         1.1   

Interstate travel plazas

     3         1.0   

Drugstores

     9         *   

Call centers

     1         *   
  

 

 

    

 

 

 

Total

     1,147         100
  

 

 

    

 

 

 

 

* Less than 1%
(1) We define annual rent as rental revenue for the three months ended March 31, 2013 multiplied by four.

 

28


Table of Contents

Diversification by Geography

The following table sets forth information regarding the geographic diversification of our owned real estate properties (based on annual rent) as of March 31, 2013:

 

Location

   Number of
Properties
     Percent of Total
Annual  Rent(1)
 

Wisconsin

     57         11.0

Texas

     84         8.7   

Illinois

     91         6.8   

Pennsylvania

     50         5.2   

Florida

     69         4.5   

Minnesota

     36         4.4   

Arizona

     26         4.4   

Georgia

     67         3.4   

Indiana

     40         3.2   

Michigan

     34         3.1   

Nebraska

     17         3.1   

Ohio

     50         3.0   

Massachusetts

     6         2.8   

California

     9         2.5   

North Carolina

     29         2.2   

Utah

     13         2.2   

Tennessee

     60         2.2   

Iowa

     34         2.1   

Idaho

     9         2.0   

Kentucky

     37         1.9   

Alabama

     51         1.7   

Washington

     9         1.6   

Missouri

     29         1.5   

Montana

     7         1.4   

South Dakota

     9         1.4   

New York

     28         1.3   

West Virginia

     26         1.3   

Virginia

     29         1.3   

Oregon

     6         1.2   

Oklahoma

     11         1.2   

Colorado

     8         1.0   

Kansas

     6         1.0   

South Carolina

     18         *   

Maryland

     18         *   

Louisiana

     13         *   

Arkansas

     7         *   

Maine

     18         *   

New Jersey

     3         *   

Wyoming

     8         *   

New Mexico

     4         *   

Nevada

     1         *   

Delaware

     2         *   

Vermont

     2         *   

Mississippi

     7         *   

North Dakota

     2         *   

New Hampshire

     6         *   

Rhode Island

     1         *   
  

 

 

    

 

 

 

Total owned properties

     1,147         100
  

 

 

    

 

 

 

 

* Less than 1%
(1) We define annual rent as rental revenue for the three months ended March 31, 2013 multiplied by four.

 

29


Table of Contents

Lease Expirations

The following table sets forth a summary schedule of lease expirations for leases in place as of March 31, 2013. As of March 31, 2013, the weighted average remaining non-cancelable term of our leases (based on annual rent) was 10.9 years. The information set forth in the table assumes that tenants exercise no renewal options and all early termination rights:

 

Leases expiring in

   Number
of
Properties
     Expiring
Annual Rent(1)
     Percent  of
Total

Annual
Rent
 
     (In Thousands)  

Remainder of 2013

     11       $ 2,246         0.8

2014

     53         7,643         2.7   

2015

     19         4,734         1.6   

2016

     21         2,578         0.9   

2017

     35         7,216         2.5   

2018

     38         12,372         4.3   

2019

     61         12,630         4.4   

2020

     84         27,959         9.7   

2021

     123         21,725         7.5   

2022

     63         6,065         2.1   

2023 and thereafter

     626         182,669         63.5   

Vacant

     13                 
  

 

 

    

 

 

    

 

 

 

Total owned properties

     1,147       $ 287,837         100
  

 

 

    

 

 

    

 

 

 

 

(1) We define annual rent as rental revenue for the three months ended March 31, 2013 multiplied by four.

Liquidity and Capital Resources

Our short-term liquidity requirements consist primarily of funds necessary to pay for our operating expenses, including costs relating to servicing our outstanding debt and cash distributions. We expect to meet our short-term liquidity requirements primarily from cash and cash equivalents, net cash from operating activities and borrowings under our $100 million secured revolving Credit Facility. We believe that our long-term, triple-net leases provide stable rental revenue during various market environments.

Our long-term liquidity requirements consist primarily of funds necessary to acquire additional properties, selectively fund notes receivable and repay indebtedness. We expect to meet our long-term liquidity requirements through various sources of capital, including borrowings under the Credit Facility, net cash from operating activities, future financings, working capital, proceeds from select sales of our properties and other secured and unsecured borrowings. However, there are a number of factors that may have a material and adverse effect on our ability to access these capital sources, including the current state of the overall equity and credit markets, our degree of leverage, our unencumbered asset base, borrowing restrictions imposed by our lenders, general market conditions for REITs, our operating performance, liquidity and market perceptions about us. The success of our business strategy will depend, in part, on our ability to access these various capital sources.

 

30


Table of Contents

As of March 31, 2013, we had $55.4 million of cash and cash equivalents as compared to $63.7 million as of March 31, 2012. This decrease resulted primarily from the use of cash and cash equivalents to reduce our indebtedness, fund acquisitions and pay dividends, partially offset by $114.7 million of cash generated from operations during the twelve months ended March 31, 2013. Proceeds from the IPO were utilized to repay a portion of our Term Note and partially fund acquisitions.

 

31


Table of Contents

Description of Certain Debt

Mortgages and Notes Payable

We primarily use long-term, fixed-rate debt to finance our properties on a “match-funded” basis. In general, the obligor of our property-level debt is a special purpose entity that holds the real estate and other collateral securing the indebtedness. We seek to use property-level financing that bears interest at an annual rate less than the annual rent on the related lease(s) and that matures prior to the expiration of such lease(s). As of March 31, 2013, we had approximately $1.97 billion principal balance of outstanding indebtedness with a weighted average annual interest rate of 6.03% and a weighted average maturity of 5.5 years. Most of this debt is partially amortizing and requires a balloon payment at maturity. Scheduled debt payments as of March 31, 2013 are as follows:

 

Year

   Scheduled
Principal
     Balloon
Payments  (1)
     Total(2)  
     (In Thousands)  

Remainder of 2013

   $ 32,666       $ —         $ 32,666   

2014

     46,169         29,761         75,930   

2015

     36,354         107,465         143,819   

2016

     40,770         580,673         621,443   

2017

     33,720         233,547         267,267   

Thereafter

     115,894         700,301         816,195   
  

 

 

    

 

 

    

 

 

 

Total

   $ 305,573       $ 1,651,747       $ 1,957,320   
  

 

 

    

 

 

    

 

 

 

 

(1) Balloon payments subsequent to 2017 are as follows: $24.8 million due in 2018, $258.3 million due in 2020, $167.5 million due in 2021, and $249.7 million due in 2022.
(2) The total excludes the note obligation of $7.9 million that was due in 2012 (see Note 5 in “Item 1. Financial Statements”)

Secured Revolving Credit Facilities

In September 2012, the Operating Partnership entered into a secured revolving credit facility (“the Credit Facility”) allowing borrowings of up to $100.0 million and providing for a maximum additional loan commitment of $50.0 million, subject to the satisfaction of specified requirements and obtaining additional commitments from lenders. The amount available for us to borrow under the Credit Facility, and our ability to request issuances of letters of credit, will be subject to the Operating Partnership’s maintenance of a minimum ratio of the total value of the unencumbered properties to the outstanding Credit Facility obligations of 1.75:1.00. As of March 31, 2013, no borrowings were outstanding under the Credit Facility and $100.0 million was available.

In March 2013, a special purpose entity owned by the Company entered into a $25.0 million Line of Credit. Advances under the Line of Credit are to be used to purchase or refinance commercial real estate properties. The initial term of the Line of Credit expires in March 2016, and each advance under the Line of Credit has a 24 month term. As of March 31, 2013, $11.4 million was outstanding under the Line of Credit at an interest rate of 4.0%.

Contractual Obligations

During the first three months of 2013, there were no material changes outside the ordinary course of business in the information regarding specified contractual obligations as disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 and filed with the SEC.

Distribution Policy

Distributions from our current or accumulated earnings and profits are generally classified as ordinary income, whereas distributions in excess of our current and accumulated earnings and profits, to the extent of a stockholder’s federal income tax basis in our common stock, are generally classified as a return of capital. Distributions in excess of a stockholder’s federal income tax basis in our common stock are generally characterized as capital gain.

We are required to distribute 90% of our taxable income (subject to certain adjustments and excluding net capital gain) on an annual basis to maintain qualification as a REIT for federal income tax purposes and are required to pay federal income tax at regular corporate rates to the extent we distribute less than 100% of our taxable income (including capital gains).

We intend to make distributions that will enable us to meet the distribution requirements applicable to REITs and to eliminate or minimize our obligation to pay corporate-level federal income and excise taxes.

 

32


Table of Contents

Any distributions will be at the sole discretion of our board of directors, and their form, timing and amount, if any, will depend upon a number of factors, including our actual and projected results of operations, funds from operations (“FFO”), liquidity, cash flows and financial condition, the revenue we actually receive from our properties, our operating expenses, our debt service requirements, our capital expenditures, prohibitions and other limitations under our financing arrangements, our REIT taxable income, the annual REIT distribution requirements, applicable law and such other factors as our board of directors deems relevant.

Cash Flows

Comparison of Three Months Ended March 31, 2013 to Three Months Ended March 31, 2012

Our cash flows from operating activities are primarily dependent upon the occupancy level of our portfolio, the rental rates specified in our leases, the collectability of rent and the level of our operating expenses and other general and administrative costs. Net cash provided by operating activities increased $2.9 million to $28.2 million for the three months ended March 31, 2013 as compared to $25.3 million for the same period in 2012. The increase was primarily attributable to an increase in rental revenues as a result of property acquisitions and scheduled rent escalations, as well as a reduction in cash paid for interest following the extinguishment of the Term Note. These favorable variances were offset by higher general and administrative expenses as a result of transaction costs incurred in connection with the proposed Merger.

Our net cash used in investing activities is generally used to fund property acquisitions, for investments in loans receivable and, to a limited extent, for capital expenditures. Cash provided by investing activities generally relates to the disposition of real estate and other assets. Net cash used in investing activities was $39.2 million for the three months ended March 31, 2013 as compared to $9.8 million for the same period in 2012. The increase in cash used in investing activities during 2013 included $56.9 million to fund the acquisition of 31 properties, partially offset by cash proceeds of $2.8 million from the disposition of 6 properties and transfers of sales proceeds from restricted cash accounts of $14.1 million. During the three months ended March 31, 2012, our investing activity included $33.7 million in acquisitions and capital improvements partially offset by cash proceeds of $10.8 million from the sale of properties, $5.5 million from collection of principal on loans receivable and $7.6 million of sales proceeds transferred from restricted cash accounts.

Our net cash used in financing activities is generally impacted by our borrowings. Net cash used in financing activities increased by $5.9 million to $7.3 million for the three months ended March 31, 2013 as compared to $1.4 million for the same period in 2012. During the first quarter of 2013, we paid cash dividends of $28.2 million, repaid $10.8 million of our mortgage and notes payable and paid $4.1 million of financing costs, offset by borrowings of $36.2 million to finance portions of certain acquisitions.

 

33


Table of Contents

FFO and Adjusted Funds from Operations (AFFO) Attributable to Common Stockholders

The following is a reconciliation of net income attributable to common stockholders (which we believe is the most comparable GAAP measure) to FFO and adjusted FFO (“AFFO”). Also presented is information regarding distributions paid to common stockholders and the weighted average common shares outstanding used for the basic and diluted computation per share:

 

     Three Months Ended March 31,  
     2013     2012  
    

(In Thousands, Except Share and Per Share Data)

(Unaudited)

 

Net loss attributable to common stockholders

   $ (8,332   $ (12,402

Add/(less):

    

Portfolio depreciation and amortization

    

Continuing operations

     28,147        27,260   

Discontinued operations

     142        627   

Portfolio impairments

    

Continuing operations

     —          8,135   

Discontinued operations

     2,103        1,802   

Realized (gains) on sales of real estate

     (180     (1,450
  

 

 

   

 

 

 

Total adjustments

     30,212        36,374   
  

 

 

   

 

 

 

Funds from operations (FFO) attributable to common stockholders

   $ 21,880      $ 23,972   

Add/(less):

    

Loss on derivative instruments related to Term Note extinguishment

     —          653   

Expenses incurred to secure lenders’ consents (a)

     397        1,026   

CCPTII Merger related transaction costs

     6,140        —     

CCPTII Merger related financing costs

     3,614        —     

Non-cash interest expense

     3,248        2,425   

Non-cash revenues

     (521     (505

Non-cash compensation expense

     1,772        —     
  

 

 

   

 

 

 

Total adjustments to FFO

     14,650        3,599   
  

 

 

   

 

 

 

Adjusted funds from operations (AFFO) attributable to common stockholders

   $ 36,530      $ 27,571   
  

 

 

   

 

 

 

Net loss per share of common stock

    

Basic and Diluted (b)

   $ (0.10   $ (0.48

FFO per share of common stock

    

Diluted (b)

   $ 0.26      $ 0.52   

AFFO per share of common stock

    

Diluted (b)

   $ 0.43      $ 0.61   

Weighted average shares of common stock outstanding:

    

Basic

     83,694,549        25,863,976   

Diluted (b)

     84,075,297        50,109,254   

 

(a) These third-party expenses were incurred to secure lenders’ consents to the IPO and the CCPTII proposed Merger in 2012 and 2013, respectively.
(b) Assumes the issuance of potentially issuable shares unless the result would be anti-dilutive.

 

34


Table of Contents

We calculate FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts (“NAREIT”). FFO represents net income (loss) attributable to common stockholders (computed in accordance with GAAP), excluding real estate-related depreciation and amortization, impairment charges and net losses (gains) on the disposition of assets. FFO is a supplemental non-GAAP financial measure. We use FFO as a supplemental performance measure because we believe that FFO is beneficial to investors as a starting point in measuring our operational performance. Specifically, in excluding real estate-related depreciation and amortization, gains and losses from property dispositions and impairment charges, which do not relate to or are not indicative of operating performance, FFO provides a performance measure that, when compared year over year, captures trends in occupancy rates, rental rates and operating costs. We also believe that, as a widely recognized measure of the performance of equity REITs, FFO will be used by investors as a basis to compare our operating performance with that of other equity REITs. However, because FFO excludes depreciation and amortization and does not capture the changes in the value of our properties that result from use or market conditions, all of which have real economic effects and could materially impact our results from operations, the utility of FFO as a measure of our performance is limited. In addition, other equity REITs may not calculate FFO as we do, and, accordingly, our FFO may not be comparable to such other equity REITs’ FFO. Accordingly, FFO should be considered only as a supplement to net income (loss) as a measure of our performance. FFO should not be used as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions or service indebtedness. FFO also should not be used as a supplement to or substitute for cash flow from operating activities computed in accordance with GAAP.

AFFO is a non-GAAP financial measure of operating performance used by many companies in the REIT industry. It adjusts FFO to eliminate the impact of non-recurring items that are not reflective of ongoing operations and certain non-cash items that reduce or increase net income in accordance with GAAP. Our computation of AFFO may differ from the methodology for calculating AFFO used by other equity REITs, and, therefore, may not be comparable to such other REITs.

Off-Balance Sheet Arrangements

As of March 31, 2013, we did not have any material off-balance sheet arrangements.

New Accounting Pronouncements

See Note 2 to the March 31, 2013 unaudited condensed consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to financial market risks, especially interest rate risk. Interest rates and other factors, such as occupancy, rental rate and the financial condition of our tenants, influence our performance more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. As described above, we generally offer leases that provide for payments of base rent with scheduled increases, based on a fixed amount or the lesser of a multiple of the increase in the CPI over a specified period term or fixed percentage and, to a lesser extent, contingent rent based on a percentage of the tenant’s gross sales to help mitigate the effect of inflation. Because the properties in our portfolio are generally leased to tenants under triple-net leases, where the tenant is responsible for property operating costs and expenses, this tends to reduce our exposure to rising property operating costs due to inflation.

Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and global economic and political conditions, and other factors which are beyond our control. Our operating results will depend heavily on the difference between the revenue from our assets and the interest expense incurred on our borrowings. We may incur additional variable rate debt in the future, including amounts that we may borrow under our credit facilities. In addition, decreases in interest rates may lead to additional competition for the acquisition of real estate due to a reduction in desirable alternative income-producing investments. Increased competition for the acquisition of real estate may lead to a decrease in the yields on real estate we have targeted for acquisition. In such circumstances, if we are not able to offset the decrease in yields by obtaining lower interest costs on our borrowings, our results of operations will be adversely affected. Significant increases in interest rates may also have an adverse impact on our earnings if we are unable to acquire real estate with rental rates high enough to offset the increase in interest rates on our borrowings.

In the event interest rates rise significantly or there is an economic downturn, defaults may increase and result in credit losses, which may adversely affect our liquidity and operating results. In a decreasing interest rate environment, borrowers are generally more likely to prepay their loans in order to obtain financing at lower interest rates. However, our investments in mortgage and equipment loans receivable have significant prepayment protection in the form of yield maintenance provisions which provide us with substantial yield protection in a decreasing interest rate environment with respect to this portion of our investment portfolio.

 

35


Table of Contents

The objective of our interest rate risk management policy is to match fund fixed-rate assets with fixed-rate liabilities and variable-rate assets with variable-rate liabilities. As of March 31, 2013, our assets were primarily long-term, fixed-rate leases (though most have scheduled rental increases during the terms of the leases). Essentially all of our approximately $1.97 billion principal balance of outstanding mortgages and notes payable as of March 31, 2013 were long-term, fixed-rate obligations. For the three months ended March 31, 2013, the weighted average interest rate on our debt, excluding amortization of deferred financing and debt discounts, was approximately 6.03%.

We intend to continue our practice of employing interest rate derivative contracts, such as interest rate swaps and futures, to reduce our exposure, on specific transactions or on a portfolio basis, to changes in cash flows as a result of interest rate changes. We do not intend to enter into derivative contracts for speculative or trading purposes. We generally intend to utilize derivative instruments to hedge interest rate risk on our liabilities and not use derivatives for other purposes, such as hedging asset-related risks. Hedging transactions, however, may generate income which is not qualified income for purposes of maintaining our REIT status. We intend to structure any hedging transactions in a manner that does not jeopardize our status as a REIT.

Even with hedging strategies in place, there can be no assurance that our results of operations will remain unaffected as a result of changes in interest rates. In addition, hedging transactions using derivative instruments involve additional risks such as counterparty credit risk and basis risk. Basis risk in a hedging contract occurs when the index upon which the contract is based is more or less variable than the index upon which the hedged asset or liability is based, thereby making the hedge less effective. We address basis risk by matching, to a reasonable extent, the contract index to the index upon which the hedged asset or liability is based. Our interest rate risk management policy addresses counterparty credit risk (the risk of nonperformance by the counterparties) by requiring that we deal only with major financial institutions that have high credit ratings.

The estimated fair values of our fixed and variable-rate mortgages and notes payable and revolving credit facilities have been derived based on market quotes for comparable instruments or discounted cash flow analysis using estimates of the amount and timing of future cash flows, market rates and credit spreads. The following table discloses the fair value information for these financial instruments as of March 31, 2013:

 

     Carrying
Value
     Estimated
Fair Value
 
     (In Thousands)
 

Mortgages and notes payable

   $ 1,910,952       $ 2,137,320   

Revolving credit facilities

     11,400         11,585   

Item 4. Controls and Procedures

Disclosure Controls and Procedures

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness as of March 31, 2013 of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded, as of March 31, 2013, that the design and operation of these disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

36


Table of Contents

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

From time-to-time, we may be subject to various legal proceedings and claims that arise in the normal course of our business activities. We are not currently a party, as plaintiff or defendant, to any legal proceedings that we believe to be material or that, individually or in the aggregate, would be expected to have a material effect on our business, financial condition or results of operations.

In connection with the Company Merger, on March 5, 2013, a putative class action and derivative lawsuit was filed in the Circuit Court for Baltimore City, Maryland against and purportedly on behalf of Spirit Realty Capital captioned Kendrick, et al. v. Spirit Realty Capital, Inc., et al. The complaint was amended on April 26, 2013, and names as defendants Spirit Realty Capital, the members of the board of directors of Spirit Realty Capital, the Spirit Operating Partnership, CCPTII and the Cole Operating Partnership, and alleges that the directors of Spirit Realty Capital breached their fiduciary duties by engaging in an unfair process leading to the Merger Agreement, failing to disclose sufficient material information for Spirit Realty Capital stockholders to make an informed decision regarding whether or not to approve the Merger, agreeing to a Merger Agreement at an opportunistic and unfair price, allowing draconian and preclusive deal protection devices in the Merger Agreement, and engaging in self-interested and otherwise conflicted actions. The complaint alleges that Spirit Realty Capital, the Spirit Operating Partnership, CCPTII and the Cole Operating Partnership aided and abetted those breaches of fiduciary duty. The complaint seeks a declaration that defendants have breached their fiduciary duties or aided and abetted such breaches and that the Merger Agreement is unenforceable, an order enjoining a vote on the transactions contemplated by the Merger Agreement, rescission of the transactions in the event they are consummated, imposition of a constructive trust, an award of fees and costs, including attorneys’ and experts’ fees and costs, and other relief.

 

Item 1A. Risk Factors.

There have been no material changes to the risk factors as disclosed in the section entitled “Risk Factors” beginning on page 11 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 and filed with the SEC. Please review the Risk Factors set forth in the Form 10-K.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Not applicable.

 

Item 3. Defaults Upon Senior Securities.

Not applicable.

 

Item 4. Mine Safety Disclosures.

Not applicable.

 

Item 5. Other Information.

Not applicable.

 

Item 6. Exhibits

 

Exhibit No.

 

Description

    2.1(4)   Agreement and Plan of Merger, among Spirit Realty Capital, Inc., Spirit Realty, L.P., Cole Credit Property Trust II, Inc., and Cole Operating Partnership II, LP, dated as of January 22, 2013.
    3.(i)1(1)   Sixth Articles of Amendment and Restatement of Spirit Realty Capital, Inc.
    3.(ii)1(1)   Fourth Amended and Restated Bylaws of Spirit Realty Capital, Inc.
    4.1(5)   Form of Common Stock Certificate of Spirit Realty Capital, Inc.
    4.2(6)   Amended and Restated Master Indenture dated as of March 17, 2006, between Spirit Master Funding, LLC, Spirit Master Funding II, LLC and Spirit Master Funding III, LLC, each a Delaware limited liability company, collectively as issuers, and Citibank, N.A., as indenture trustee.

 

37


Table of Contents
    4.3(6)   Series 2005-1 Indenture Supplement dated as of July 26, 2005, between Spirit Master Funding, LLC and Citibank, N.A., as indenture trustee.
    4.4(6)   Series 2006-1 Indenture Supplement dated as of March 17, 2006, between Spirit Master Funding, LLC, Spirit Master Funding II, LLC and Citibank, N.A., as indenture trustee.
    4.5(6)   Series 2007-1 Indenture Supplement dated as of March 17, 2006, between Spirit Master Funding, LLC, Spirit Master Funding II, LLC, Spirit Master Funding III, LLC and Citibank, N.A., as indenture trustee.
  10.1(1)   Agreement of Limited Partnership of Spirit Realty, L.P., dated September 25, 2012.
  10.2(1)   Registration Rights Agreement among Spirit Realty Capital, Inc. and the persons named therein, dated September 25, 2012.
  10.3(2)   Spirit Realty Capital, Inc. Director Compensation Program.
  10.4(2)   Spirit Realty Capital, Inc. and Spirit Realty, L.P. 2012 Incentive Award Plan.
  10.5(1)   Credit Agreement between Spirit Realty, L.P., Deutsche Bank AG New York Branch, as administrative agent, and the various financial institutions as are or may become parties thereto dated September 25, 2012.
  10.6(1)   Guaranty by Spirit Realty Capital, Inc. and Spirit General OP Holdings, LLC to and for the benefit of the Credit Parties, as defined therein, dated as of September 25, 2012.
  10.7(1)   Consent to Transaction by and among Spirit SPE Portfolio 2006-1, LLC and Spirit SPE Portfolio 2006-2, LLC, Spirit Realty Capital, Inc., Spirit Realty, L.P. and U.S. Bank National Association, as trustee, successor–in-interest to Bank of America, N.A., as trustee, successor by merger to LaSalle Bank National Association, as trustee, under that certain Pooling and Servicing Agreement dated as of June 1, 2006, for the Registered Holders of Citigroup Commercial Mortgage Trust 2006-C4 Commercial Mortgage Pass-Through Certificates, Series 2006-C4, U.S. Bank National Association, as trustee successor-in-interest to Bank of America, N.A., as trustee, successor by merger to LaSalle Bank National Association, as trustee under that certain Pooling and Servicing Agreement dated as of October 1, 2006, for the Registered Holders of CD 2006-CD3 Commercial Mortgage Pass-Through Certificates, and U.S. Bank National Association, in its capacity as trustee, successor-in interest to Bank of America, N.A. in its capacity as trustee, successor-in-interest to Wells Fargo Bank, N.A., in its capacity as trustee, under that certain Pooling and Servicing Agreement dated as of December 1, 2006, for the Registered Holders of COBALT CMBS Commercial Mortgage Trust 2006-C1 Commercial Mortgage Pass-Through Certificates, Series 2006-C1, dated September 25, 2012.
  10.8(1)   Omnibus Modification Agreement by and among Spirit Master Funding, LLC, Spirit Master Funding II, LLC and Spirit Master Funding III, LLC, as issuers, Spirit Realty Capital, Inc., Spirit Realty, L.P., Midland Loan Services, Inc., Ambac Assurance Corporation, Citibank, N.A., Spirit Property Holdings, LLC and Spirit Pocono Corporation, dated September 25, 2012.
  10.9(1)   Consent and Acknowledgement and Eighth Amendment to Loan Agreement by and among U.S. Bank National Association, as trustee for the registered holders of Wachovia Bank Commercial Mortgage Trust, Commercial Mortgage Pass-Through Certificates, Series 2007-C33, Spirit SPE Portfolio 2007-2, LLC, Spirit Realty Capital, Inc. and Spirit Realty, L.P., dated September 25, 2012.
  10.10(7)   Amendment No. 1 to Employment Agreement among Spirit Realty Capital, Inc., Redford Holdco, LLC and Michael A. Bender, dated October 1, 2011.
  10.11(7)   Amendment No. 2 to Employment Agreement among Spirit Realty Capital, Inc., Redford Holdco, LLC and Michael A. Bender, dated November 9, 2011.
  10.12(7)   Amendment No. 1 to Employment Agreement among Spirit Realty Capital, Inc., Redford Holdco, LLC and Peter M. Mavoides, dated October 1, 2011.
  10.13(7)   Amendment No. 2 to Employment Agreement among Spirit Realty Capital, Inc., Redford Holdco, LLC and Peter M. Mavoides, dated November 9, 2011.
  10.14(7)   Amendment No. 1 to Employment Agreement among Spirit Realty Capital, Inc., Redford Holdco, LLC and Thomas H. Nolan, Jr., dated August 29, 2011.

 

38


Table of Contents
  10.15(7)   Amendment No. 2 to Employment Agreement among Spirit Realty Capital, Inc., Redford Holdco, LLC and Thomas H. Nolan, Jr., dated October 1, 2011.
  10.16(7)   Amendment No. 3 to Employment Agreement among Spirit Realty Capital, Inc., Redford Holdco, LLC and Thomas H. Nolan, Jr., dated November 9, 2011.
  10.17(4)   First Amendment to the Change of Control Severance Plan for Certain Covered Participants of Spirit Finance Corporation.
  10.18(4)   Agreement among Spirit Realty Capital, Inc. and Thomas H. Nolan, Jr., dated January 22, 2013.
  10.19(4)   Agreement among Spirit Realty Capital, Inc. and Peter M. Mavoides, dated January 22, 2013.
  10.20(4)   Agreement among Spirit Realty Capital, Inc. and Michael A. Bender, dated January 22, 2013.
  10.21(4)   Agreement among Spirit Realty Capital, Inc. and Mark Manheimer, dated January 22, 2013.
  10.22(4)   Agreement among Spirit Realty Capital, Inc. and Gregg A. Seibert, dated January 22, 2013.
  23.1*   Consent of KPMG LLP
  31.1*   Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2*   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1*   Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  99.1*  

Consolidated Financial Statements of Specialty Retail Shops Holding Corp. and Subsidiaries as of February 2, 2013 and January 28, 2012 and for the Fiscal Years Ended February 2, 2013, January 28, 2012, and January 29, 2011 (audited)

  101(3)*   The following financial information from Spirit Realty Capital, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Comprehensive Loss (iv) Consolidated Statement of Stockholders’ Equity, (v) Condensed Consolidated Statements of Cash Flows and (vi) the Notes to Consolidated Financial Statements.

 

* Filed herewith.
(1) Previously filed by Spirit Realty Capital, Inc. as an exhibit to its Current Report on Form 8-K as filed with the Securities and Exchange Commission on September 28, 2012.
(2) Previously filed by Spirit Realty Capital, Inc. as an exhibit to its Registration Statement on Form S-11, as amended (File No. 333-177904), as filed with the Securities and Exchange Commission on August 31, 2012.
(3) Pursuant to applicable securities laws and regulations, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act, are deemed not filed for purposes of section 18 of the Exchange Act and otherwise are not subject to liability under these sections.
(4) Previously filed by Spirit Realty Capital, Inc. as an exhibit to its Current Report on Form 8-K as filed with the Securities and Exchange Commission on January 23, 2013.
(5) Previously filed by Spirit Realty Capital, Inc. as an exhibit to its Registration Statement on Form S-11, as amended (File No. 333-177904), as filed with the Securities and Exchange Commission on June 8, 2012.
(6) Previously filed by Spirit Realty Capital, Inc. as an exhibit to its Registration Statement on Form S-11, as amended (File No. 333-177904), as filed with the Securities and Exchange Commission on November 10, 2011.
(7) Previously filed by Spirit Realty Capital, Inc. as an exhibit to its Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on November 8, 2012.

 

39


Table of Contents

SIGNATURES

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

 

    SPIRIT REALTY CAPITAL, INC.

Date: May 9, 2013

    /s/ MICHAEL A. BENDER
    Michael A. Bender
   

Chief Financial Officer (principal financial

and accounting officer)

(Back To Top)

Section 2: EX-23.1 (EX-23.1)

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

We consent to the incorporation by reference in the registration statement on Form S-8 (No. 333-184057) of Spirit Realty Capital, Inc. of our report dated April 18, 2013, with respect to the consolidated balance sheets of Specialty Retail Shops Holding Corp. (the Company) as of February 2, 2013 and January 28, 2012 and the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three-year period ended February 2, 2013, which report is incorporated by reference in the quarterly report on Form 10-Q for the three-months ended March 31, 2013 filed by Spirit Realty Capital, Inc.

Our report refers to the retroactive restatement of the consolidated financial statements for all periods presented to give effect to the common control merger between the Company and Pamida in 2012.

/s/ KPMG LLP

Chicago, IL

May 8, 2013

(Back To Top)

Section 3: EX-31.1 (EX-31.1)

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Thomas H. Nolan, Jr., certify that:

 

  1) I have reviewed this quarterly report on Form 10-Q of Spirit Realty Capital, Inc.;

 

  2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3) Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

  4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’ s internal control over financial reporting; and

 

  5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: May 9, 2013  

/s/ THOMAS H. NOLAN, JR.

  Thomas H. Nolan, Jr.
  Chief Executive Officer
(Back To Top)

Section 4: EX-31.2 (EX-31.2)

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Michael A. Bender, certify that:

 

  1) I have reviewed this quarterly report on Form 10-Q of Spirit Realty Capital, Inc.;

 

  2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3) Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

  4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’ s internal control over financial reporting; and

 

  5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: May 9, 2013  

/s/ MICHAEL A. BENDER

  Michael A. Bender
  Chief Financial Officer
(Back To Top)

Section 5: EX-32.1 (EX-32.1)

EX-32.1

Exhibit 32.1

WRITTEN STATEMENT

PURSUANT TO

18 U.S.C. SECTION 1350

The undersigned, Thomas H. Nolan, Jr., Chief Executive Officer, and Michael A. Bender, Chief Financial Officer of Spirit Realty Capital, Inc. (the “Company”), hereby certify as of the date hereof, solely for the purposes of 18 U.S.C. §1350, that:

(i) the Quarterly Report on Form 10-Q for the period ended March 31, 2013, of the Company (the “Report”) fully complies with the requirements of Section 13(a) and 15(d), as applicable, of the Securities Exchange Act of 1934; and

(ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company at the dates and for the periods indicated.

 

Date: May 9, 2013  

/s/ THOMAS H. NOLAN, JR.

  Thomas H. Nolan, Jr.
  Chief Executive Officer
Date: May 9, 2013  

/s/ MICHAEL A. BENDER

  Michael A. Bender
  Chief Financial Officer

The foregoing certification is being furnished solely pursuant to 18 U.S.C. Section 1350 and is not being filed as part of the Report or as a separate disclosure document.

(Back To Top)

Section 6: EX-99.1 (EX-99.1)

EX-99.1

Exhibit 99.1

SPECIALTY RETAIL SHOPS HOLDING CORP. AND SUBSIDIARIES

TABLE OF CONTENTS

 

 

     Page  

INDEPENDENT AUDITORS’ REPORT

     2   

CONSOLIDATED FINANCIAL STATEMENTS:

  

Statements of Operations and Comprehensive Income (Loss) for the Fiscal Years Ended February 2, 2013, January 28, 2012, and January 29, 2011

     3   

Balance Sheets as of February 2, 2013 and January 28, 2012

     4   

Statements of Cash Flows for the Fiscal Years Ended February 2, 2013, January 28, 2012, and January 29, 2011

     5   

Statements of Shareholders’ Equity for the Fiscal Years Ended February 2, 2013, January 28, 2012, and January 29, 2011

     6   

Notes to Consolidated Financial Statements

     7-26   


Independent Auditors’ Report

The Board of Directors

Specialty Retail Shops Holding Corp.:

We have audited the accompanying consolidated financial statements of Specialty Retail Shops Holding Corp. and subsidiaries (the Company), which comprise the consolidated balance sheets as of February 2, 2013 and January 28, 2012, and the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three year period ended February 2, 2013, and the related notes to the consolidated financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the consolidated financial statements referred to above present fairly in all material respects, the financial position of Specialty Retail Shops Holding Corp. and subsidiaries as of February 2, 2013 and January 28, 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended February 2, 2013 in accordance with U.S. generally accepted accounting principles.

Emphasis of Matter

As discussed in note 1 to the consolidated financial statements, the Company merged with Pamida Holding Company, Inc. (Pamida) in 2012. The Company and Pamida have common ownership and control. Accordingly, the accompanying financial statements as of all dates and for all periods presented have been retroactively restated to give effect to the merger as if it had occurred prior to all periods presented.

/s/ KPMG LLP

Chicago, Illinois

April 18, 2013

 

2


SPECIALTY RETAIL SHOPS HOLDING CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

FOR THE FISCAL YEARS ENDED FEBRUARY 2, 2013, JANUARY 28, 2012, AND JANUARY 29, 2011

(In thousands)

 

 

     February 2,
2013
    January 28,
2012
    January 29,
2011
 

REVENUES:

      

Net sales

   $ 2,749,260      $ 2,729,464      $ 2,740,160   

Licensed department rentals and other income

     15,943        15,337        15,284   
  

 

 

   

 

 

   

 

 

 

Total revenues

     2,765,203        2,744,801        2,755,444   
  

 

 

   

 

 

   

 

 

 

COSTS AND EXPENSES:

      

Cost of sales (before depreciation and amortization)

     1,957,436        1,933,007        1,932,134   

Selling, general and administrative expenses

     802,004        735,688        732,982   

Depreciation and amortization expenses

     44,763        34,194        29,793   
  

 

 

   

 

 

   

 

 

 

Total costs and expenses

     2,804,203        2,702,889        2,694,909   
  

 

 

   

 

 

   

 

 

 

EARNINGS (LOSS) FROM OPERATIONS

     (39,000     41,912        60,535   

INTEREST EXPENSE, NET

     31,123        35,867        36,979   
  

 

 

   

 

 

   

 

 

 

INCOME (LOSS) BEFORE INCOME TAXES

     (70,123     6,045        23,556   

INCOME TAX BENEFIT

     (27,603     (963     (15,162
  

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS)

   $ (42,520   $ 7,008      $ 38,718   

Other comprehensive loss-pension and postretirement benefit adjustment, net of tax benefit of $240, $468, and $561, respectively

     (364     (711     (852
  

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ (42,884   $ 6,297      $ 37,866   
  

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

3


SPECIALTY RETAIL SHOPS HOLDING CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF FEBRUARY 2, 2013 AND JANUARY 28, 2012

(In thousands)

 

 

     February 2,
2013
    January 28,
2012
 

ASSETS

    

CURRENT ASSETS:

    

Cash and cash equivalents

   $ 18,570      $ 20,806   

Receivables (net of allowance for losses of $782 and $965, respectively)

     64,496        63,868   

Merchandise inventories

     541,715        517,248   

Other current assets

     18,277        8,875   
  

 

 

   

 

 

 

Total current assets

     643,058        610,797   

PROPERTY AND EQUIPMENT, Net

     171,211        142,574   

INTANGIBLE ASSETS, Net

     26,096        26,061   

GOODWILL

     926        926   

DEFERRED INCOME TAXES

     98,513        77,994   

DEBT ISSUANCE COSTS

     12,528        9,256   

OTHER ASSETS

     10,826        10,109   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 963,158      $ 877,717   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

CURRENT LIABILITIES:

    

Current portion of long-term debt and capital lease obligations

   $ 9,362      $ 8,293   

Accounts payable

     244,634        236,038   

Accrued compensation and related taxes

     27,237        15,767   

Deferred income taxes

     44,632        43,724   

Other accrued liabilities

     59,063        50,818   

Accrued income and other taxes

     17,687        23,552   
  

 

 

   

 

 

 

Total current liabilities

     402,615        378,192   

LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS—Less current portion

     488,869        366,480   

OTHER LONG-TERM OBLIGATIONS

     55,091        49,060   

LONG-TERM RELATED PARTY OBLIGATIONS

     2,958        26,301   

SHAREHOLDERS’ EQUITY:

    

Common stock (par value $0.001: 11,500,000 shares authorized, 10,001,000 shares issued and outstanding at February 2, 2013; 10,000,000 shares authorized, issued and outstanding at January 28, 2012)

     10        10   

Additional paid-in capital

     56,242        57,417   

Retained earnings (deficit)

     (42,022     498   

Accumulated other comprehensive loss

     (605     (241
  

 

 

   

 

 

 

Shareholders’ equity

     13,625        57,684   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 963,158      $ 877,717   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

4


SPECIALTY RETAIL SHOPS HOLDING CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE FISCAL YEARS ENDED FEBRUARY 2, 2013, JANUARY 28, 2012, AND JANUARY 29, 2011

(In thousands)

 

 

     February 2,
2013
    January 28,
2012
    January 29,
2011
 

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net income (loss)

   $ (42,520   $ 7,008      $ 38,718   

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

      

Depreciation and amortization

     44,763        34,194        29,793   

Amortization of deferred financing costs

     6,191        6,580        4,776   

Gain on the sale of property and equipment

     (382     (2,754     (993

Gain on the sale of intangible assets

     (918     (1,066     (2,808

Impairment charges

     2,071        791        672   

Deferred income tax provision (benefit)

     (19,371     5,731        8,978   

Stock compensation expense (income)

     (1,175     495        551   

Change in assets and liabilities:

      

Receivables

     (1,128     (1,218     (3,806

Merchandise inventories

     (24,567     (18,348     (25,435

Other current assets

     (10,115     473        683   

Other long-term assets

     (453     509        (389

Accounts payable and accrued liabilities

     13,988        (20,034     29,208   

Long-term related party payable

     —          125        —     

Unrecognized tax benefits (Note 3)

     —          (2,809     (23,849

Other long-term obligations

     8,604        (1,594     (1,858
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     (25,012     8,083        54,241   
  

 

 

   

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Capital expenditures

     (59,352     (39,886     (25,981

Proceeds from the sale of property and equipment

     481        2,725        1,116   

Payments for pharmacy customer lists

     (6,089     (4,548     (1,979

Proceeds from the sale of pharmacy customer lists

     1,952        1,066        2,510   

Payments for commercial pharmacy acquisition

     —          —          (5,500
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (63,008     (40,643     (29,834
  

 

 

   

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

      

Dividends paid (Note 5)

     —          —          (30,000

Change in book cash overdraft

     2,300        149        (1,688

Borrowings under revolving credit facilities

     683,773        659,863        827,866   

Repayments under revolving credit facilities

     (573,117     (615,691     (800,787

Proceeds from issuance of debt

     —          —          2,107   

Repayment of other debt and capital lease obligations

     (8,673     (10,502     (8,690

Pamida stock repurchase

     —          (60     —     

Payment of financing costs (Note 9)

     (9,478     (875     (14,592

Borrowings under note payable

     3,000        —          —     

Repayment of related party note payable

     (23,217     —          —     

Borrowings under financing agreement

     11,196        —          —     
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     85,784        32,884        (25,784
  

 

 

   

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS—Beginning of period

     20,806        20,482        21,859   

Net increase (decrease) in cash and cash equivalents

     (2,236     324        (1,377
  

 

 

   

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS—End of period

   $ 18,570      $ 20,806      $ 20,482   
  

 

 

   

 

 

   

 

 

 

SUPPLEMENTAL CASH FLOW INFORMATION:

      

Cash paid (received) during the period for:

      

Interest

   $ 26,320      $ 26,469      $ 29,966   

Income taxes (net of refunds)

   $ (5,339   $ 6,107      $ 6,056   

Noncash investing activities—assets acquired under capital lease

   $ 7,797      $ 4,529      $ 8,353   

See accompanying notes to consolidated financial statements.

 

5


SPECIALTY RETAIL SHOPS HOLDING CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

FOR THE FISCAL YEARS ENDED FEBRUARY 2, 2013, JANUARY 28, 2012, AND JANUARY 29, 2011

(In thousands)

 

 

     Common Stock      Additional
Paid-in
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income
       
     Shares      Amount      Capital     (Deficit)     (Loss)     Total  

BALANCE—January 30, 2010

     10,000       $ 10       $ 56,431      $ (15,228   $ 1,322      $ 42,535   

Stock compensation expense

           551            551   

Net income

             38,718          38,718   

Dividends paid (Note 5)

             (30,000       (30,000

Other comprehensive loss

               (852     (852
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE—January 29, 2011

     10,000       $ 10       $ 56,982      $ (6,510   $ 470      $ 50,952   

Stock compensation expense

           495            495   

Net income

             7,008          7,008   

Pamida stock repurchase

           (60         (60

Other comprehensive loss

               (711     (711
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE—January 28, 2012

     10,000       $ 10       $ 57,417      $ 498      $ (241   $ 57,684   

Issuance of non-voting stock

     1         —                 —     

Stock compensation income

           (1,175         (1,175

Net loss

             (42,520       (42,520

Other comprehensive loss

               (364     (364
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE—February 2, 2013

     10,001       $ 10       $ 56,242      $ (42,022   $ (605   $ 13,625   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

6


SPECIALTY RETAIL SHOPS HOLDING CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF FEBRUARY 2, 2013 AND JANUARY 28, 2012,

AND FOR THE FISCAL YEARS ENDED FEBRUARY 2, 2013, JANUARY 28, 2012,

AND JANUARY 29, 2011

 

 

1. ORGANIZATION, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization—Specialty Retail Shops Holding Corp. (the “Company”) was incorporated by an investment fund affiliated with Sun Capital Partners, Inc. (“Sun Capital”) in December 2005 for the purpose of acquiring all of the outstanding shares of common stock of Shopko Stores, Inc. On December 28, 2005 (“the Acquisition Date”), the Company acquired all the issued and outstanding shares of Shopko Stores, Inc. (“the Acquisition”). The Company is a wholly-owned subsidiary of SKO Group Holding, LLC (the “Parent”) which is owned by an affiliate of Sun Capital and other co-investors.

On February 7, 2012, a merger became effective between the Company and Pamida Holding Company, Inc. (“Pamida”) (the “Merger”). See Note 2 for additional merger-related information. The combined entity has approximately 330 locations in 22 states. Prior to the Merger, the Company and Pamida were both owned by the Parent. Thus, the Merger has been accounted for as a related party asset transfer between entities under common control in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification ™ (“ASC”) Topic 805, Business Combinations. The Company’s financial statements have been retroactively restated to reflect the Merger.

Following the Merger, the Company has a wholly-owned operating subsidiary, ShopKo Holding Company, LLC (“Shopko”), surviving entity to ShopKo Holding Company, Inc. (“Shopko Inc.”). Shopko has a wholly-owned real estate subsidiary that owns certain real properties which are primarily leased to a Shopko wholly-owned subsidiary, ShopKo Stores Operating Co., LLC (“Shopko Operating”). Shopko Operating is a retailer engaged in selling general merchandise and providing retail health services with stores operated in Midwest, North Central, Western and Pacific Northwest states. Shopko Operating also has a wholly-owned commercial pharmacy subsidiary that operates two closed shop pharmacies serving institutions and homes with more than 4,500 beds.

Basis of Presentation—The Company operates on a 52/53-week fiscal year basis. The 2012 fiscal year was a 53 week period and ended on February 2, 2013 (“Fiscal 2012”). The 2011 fiscal year was a 52 week period and ended on January 28, 2012 (“Fiscal 2011”). The 2010 fiscal year was a 52 week period and ended on January 29, 2011 (“Fiscal 2010”).

Shareholders’ Equity and Stock Split—On February 7, 2012, the Company amended its certificate of incorporation to authorize 11,000,000 shares of $0.001 par value per share common stock, of which 10,000,000 shares are voting shares and 1,000,000 shares are non-voting. The Company subsequently executed a 1-for-10,000 common stock split. The stock split resulted in each outstanding share of common stock being reclassified and changed into 10,000 shares of common stock. All share data has been adjusted to give effect to the stock split.

The stock option plan previously maintained by Shopko Inc. has been assigned to and assumed by the Company. All other terms of the stock option plan and all stock options issued thereunder remain unchanged. The 1,000 shares of non-voting common stock, par value $0.01 of Shopko Inc., issued and outstanding pursuant to the Shopko Inc. stock option plan were exchanged for 1,000 shares of non-voting common stock of the Company.

 

7


On May 8, 2012, the Company amended its certificate of incorporation to authorize an additional 500,000 shares of $0.001 par value per share common stock. The newly authorized shares will be non-voting and as of the date of issuance of these consolidated financial statements, none have been issued.

At February 2, 2013, the Company had 10,000,000 shares of voting common stock and 1,000 shares of non-voting common stock issued and outstanding, respectively. At January 28, 2012, all 10,000,000 issued and outstanding shares of common stock were voting.

Principles of Consolidation—The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated.

Use of Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Corrections—The Company’s prior year financial results for the 52 weeks ended January 28, 2012 and January 29, 2011, as presented herein have been adjusted to reflect certain corrections that the Company has concluded are not material to the prior period financial statements taken as a whole.

The Consolidated Statements of Operations was revised to correct the presentation of optical service revenue that had been presented on a net basis and to correct the timing of revenue recognition for prescriptions filled but not yet delivered to customers. The effect of these corrections on the Company’s previously issued Consolidated Statements of Operations for the 52 weeks ended January 28, 2012 and January 29, 2011 is as follows:

 

     January 28, 2012  
     Reported      Corrections     Revised  

Net sales

   $ 2,714,099       $ 15,365      $ 2,729,464   

Cost of sales (before depreciation and amortization)

     1,933,031         (24     1,933,007   

Selling, general and administrative expenses

     720,318         15,370        735,688   

Net income

     6,989         19        7,008   
     January 29, 2011  
     Reported      Corrections     Revised  

Net sales

   $ 2,725,231       $ 14,929      $ 2,740,160   

Cost of sales (before depreciation and amortization)

     1,932,135         (1     1,932,134   

Selling, general and administrative expenses

     718,069         14,913        732,982   

Net income

     38,701         17        38,718   

 

8


The Consolidated Balance Sheet as of January 28, 2012 was revised to adjust for the impact of correcting the timing of revenue recognition for prescriptions filled but not yet delivered to customers, and to revise the presentation of accrued loss contingencies to reflect related receivables for recoveries from insurance providers on a gross basis. The effect on the Company’s previously issued Consolidated Balance Sheet as of January 28, 2012 is as follows:

 

     January 28, 2012  
     Reported      Revenue
Recognition
Correction
    Loss
Contingency
Correction
     Revised  

Receivables

   $ 65,501       $ (1,633   $ —          $ 63,868   

Merchandise inventories

     515,950         1,298        —           517,248   

Other Assets

     2,949         —          7,160         10,109   

Other long-term obligations

     41,900         —          7,160         49,060   

Retained earnings

     833         (335     —           498   

The retained deficit as of January 30, 2010 was increased by $0.3 million to reflect the historical impact of these corrections on the Consolidated Statements of Shareholders’ Equity.

Reclassifications—Certain reclassifications were made to prior year financial results and balances to conform to the current year presentation. These reclassifications did not impact net income (loss) in any year.

Cash and Cash Equivalents—Cash and cash equivalents consist of cash on hand and in banks as well as all highly liquid investments with an original maturity at date of purchase of three months or less. Included in cash and cash equivalents are credit card and debit card receivables from banks, which generally settle between one to four business days, of $8.8 million at February 2, 2013 and $7.7 million at January 28, 2012. The Company’s cash management policy provides for controlled disbursement. As a result, the Company had outstanding checks in excess of funds on deposit at certain banks. These amounts, which were $16.0 million as of February 2, 2013 and $13.7 million as of January 28, 2012, are included in accounts payable in the accompanying Consolidated Balance Sheets.

Receivables—Receivables consist primarily of amounts collectible from third party insurance carriers, retail store customers for optical and pharmacy purchases, commercial pharmacy customers, governmental agencies such as Medicare and Medicaid, and merchandise vendors for promotional and advertising allowances (“Vendor Allowances”). Substantially all amounts are expected to be collected within one year. The Company assesses past due accounts based on contractual terms. The Company provides an allowance for losses based on historical experience and on a specific identification basis.

Vendor Allowances—The Company accounts for vendor consideration in accordance with FASB ASC Topic 605, Revenue Recognition. The Company records vendor allowances and discounts in the Consolidated Statements of Operations when the purpose for which those monies were designated is fulfilled. Rebates and allowances received as a result of attaining defined purchase levels are billed or accrued over the incentive period based on the terms of the vendor arrangement and estimates of qualifying purchases during the rebate program period. These estimates are reviewed on a regular basis and adjusted to reflect changes in anticipated product sales and expected purchase levels. Allowances provided by vendors generally relate to inventory recently purchased and, accordingly, are reflected as reductions of cost of sales as merchandise is sold. Vendor allowances received for advertising or fixturing programs reduce the Company’s expense or cost for the related advertising or fixturing program. The Company establishes a receivable for vendor allowances that are earned but not yet received. The majority of all year-end receivables associated with these activities are collected within the following fiscal quarter. The Company also maintains a valuation reserve in other accrued liabilities based on historical levels of vendor allowances that are paid back or not collected.

Merchandise Inventories—Merchandise inventories are stated at the lower of cost or market. Cost, which includes certain distribution and transportation costs, is determined through use of the last-in, first-out (“LIFO”) method for substantially all inventories. At February 2, 2013 and January 28, 2012, inventories would have been greater by $15.4 million and $11.8 million, respectively, if they had been

 

9


valued on a lower of first-in, first-out (“FIFO”) cost or market basis. LIFO inventory charges were $3.6 million for the 53 weeks ended February 2, 2013, and $4.2 million and $1.9 million for the 52 weeks ended January 28, 2012 and January 29, 2011, respectively. The Company reduces inventory for estimated losses related to shrink and markdowns. The shrink estimate is based on historical losses determined by ongoing physical inventory counts.

Property and Equipment—Property and equipment are stated at cost. Depreciation is computed using the straight-line method based upon the estimated useful lives of the assets, which are 15 to 40 years for buildings, 20 years for land improvements, and 5 to 10 years for fixtures and equipment. Leasehold improvements are amortized over the term of the lease or the estimated useful life of the asset, whichever is shorter. Property under capital leases is amortized over the related lease term.

Goodwill and Intangible Assets—Goodwill represents the excess of cost over fair value of net assets acquired. Intangible assets include customer relationships in the pharmacy business which were either acquired from third parties or were recognized in connection with a business combination. These customer relationships are recorded at fair value and amortized on a straight-line basis over an estimated useful life of 10 years. Goodwill is not amortized and is reviewed for impairment at least annually during the fourth quarter or more frequently when events occur that require additional review in accordance with FASB ASC Topic 350, Intangibles—Goodwill and Other. During Fiscal 2012, the Company elected to perform a qualitative assessment to determine whether it was more likely than not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was not more likely than not that the carrying value of the reporting unit exceeded its fair value. Therefore, the Company did not prepare a quantitative impairment test. As of February 2, 2013 and January 28, 2012 there was $0.9 million of goodwill recorded on the Consolidated Balance Sheet.

Impairment of Long-Lived Assets—In accordance with FASB ASC Topic 360, Property, Plant and Equipment, the Company evaluates whether events and circumstances have occurred that indicate the remaining estimated useful lives of long-lived assets may warrant revision or that the remaining carrying value of an asset may not be recoverable. The determination of possible impairment is based on assessment of the Company’s ability to recover the carrying value of assets from expected future operating cash flows on an undiscounted basis. Impairment losses, if any, would be measured by comparing the carrying amount of the asset to its fair value. During Fiscal 2012, the Company determined that there were indicators of impairment at certain stores. The Company completed tests for impairment at the identified stores and recorded impairment of certain store assets. See Note 14 for further discussion regarding impairment of assets.

Closed Location Reserves—Pursuant to the provisions of FASB ASC Topic 420, Exit or Disposal Cost Obligations, the Company expenses when incurred all amounts related to the discontinuance of operations of locations identified for closure. For closed locations that are under lease, the Company records a liability for the net present value of required lease payments and related costs from the date of closure through the end of the lease term, net of expected sublease rental income. During Fiscal 2012, the Company recognized liabilities for closed locations under long-term leases and recorded adjustments of estimates associated with previously closed locations. See Note 14 for further discussion.

Debt Issuance Costs—Costs related to the issuance of debt are capitalized and amortized to interest expense using the straight line method over the lives of the related debt, which approximates the effective interest method. Upon amendment of lines of credit, unamortized deferred financing fees are evaluated in accordance with FASB ASC Topic 470, Debt. The Company adjusts the amount of unamortized debt issuance costs as necessary based on the results of this evaluation.

 

10


Revenue Recognition—Revenue from the sale of products is recognized at the time both title and the risk of ownership are transferred to the customer, which generally occurs upon delivery to the customer for internet sales and at the point of sale for retail transactions. Revenue is recognized net of expected returns, which are estimated based on historical experience. The Company classifies the reserve for expected returns in other current liabilities. Revenues from services are recognized when the services are rendered. Revenues from licensed departments are recorded at the net amounts to be received from licensees at the time customers take possession of the merchandise. For third party prescription sales, revenue is recognized at the time the customer picks up the prescription. Revenues from optical services are recorded at the time of service. Revenues from optical products are recorded at the time customers take possession of the products. For commercial pharmacy sales, revenue is recognized at the time the prescription is delivered to the customer. Revenue from gift card sales is recognized when the gift card is redeemed.

Fees for shipping and handling charged to customers in connection with internet sale transactions are included in net sales. Costs related to shipping and handling are included in cost of sales. Taxes collected from customers are accounted for on a net basis and are excluded from sales.

Customer Loyalty Programs—The Company maintains two customer loyalty benefit programs that allow customers to earn discounts on future purchases in the form of discount coupons based on qualifying purchase activity. The first program provides customers with a $10 coupon for every tenth prescription filled at one of the Company’s pharmacies. The second program provides customers with a $10 coupon for every $300 in qualifying purchases. Reward coupons can be used on future purchases and expire 30 days after being issued. On a quarterly basis, an estimate of the obligation related to the benefits earned under the programs is recorded as deferred revenue and as a decrease to net sales. The estimate is based on assumptions related to customer purchase levels and redemption rates based on historical experience. At the time the $10 coupon is redeemed, deferred revenue is reduced and a corresponding amount is recognized in net sales.

Vendor Concentration—The Company purchases merchandise inventories from several hundred vendors worldwide. The Company had a major vendor that accounted for approximately 34%, 35%, and 35% of cost of sales in Fiscal 2012, Fiscal 2011, and Fiscal 2010, respectively. At February 2, 2013, the amount payable to this vendor was approximately $69 million.

Advertising—The Company expenses advertising costs, net of vendor allowances, in the period incurred. Advertising expense was $35.3 million for the 53 weeks ended February 2, 2013, and $36.2 million and $38.8 million for the 52 weeks ended January 28, 2012, and January 29, 2011, respectively.

Insurance / Self-Insurance—The Company retains a portion of the risk related to certain general liability, workers’ compensation, property loss and employee medical and dental claims. Recorded liabilities associated with these self-insured programs include estimates of losses for both claims filed and claims incurred but not yet reported. The Company estimates an ultimate cost based on an analysis of historical data. Workers’ compensation and general liabilities are recorded at an estimate of their net present value; other liabilities are not discounted. The Company maintains stop-loss coverage to limit the exposure related to certain risks and records receivables for related recoveries from insurance providers in other assets.

Pre-opening Costs—The Company expenses pre-opening costs of retail stores as incurred.

Income Taxes—The Company accounts for income taxes in accordance with FASB ASC Topic 740, Income Taxes, which requires that deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes, using enacted tax rates. FASB ASC Topic 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.

 

11


The determination of the Company’s provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The benefits of uncertain tax positions are recorded in the Company’s financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge, if any, from taxing authorities, based solely on the technical merits of the position. When facts and circumstances change, the Company reassesses its uncertain tax positions and records any necessary adjustments in the consolidated financial statements as appropriate.

The Company recognizes interest and penalty expense related to uncertain tax positions in the provision for income taxes. Accruals for income tax exposures, including penalties and interest, expected to be settled within the next year are included in accrued income and other taxes with the remainder included in other long-term obligations in the Consolidated Balance Sheets.

Stock-based Employee Compensation Plans—The Company follows the guidance contained in FASB ASC Topic 718, Compensation—Stock Compensation, which requires that the cost resulting from all share-based payment transactions be recognized as compensation cost over the vesting period based on the fair value of the instrument on the date of grant.

Fair Value of Financial Instruments—The carrying amounts of cash and cash equivalents, receivables, accounts payable, accrued liabilities and short-term debt approximate their fair value as they are generally short-term in nature. The fair value of the Company’s long-term debt is estimated using quoted market values or discounted cash flow analysis based on interest rates that are currently available to the Company for issuance of debt with similar terms and remaining maturities. As of February 2, 2013 and January 28, 2012, the carrying amount of the Company’s long-term debt approximated fair value as the interest rate is variable and similar to market rates.

Recent Accounting Pronouncements—Effective January 29, 2012, the Company adopted Accounting Standards Update (“ASU”) No. 2011-04, Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS, which amended ASC Topic 820, Fair Value Measurement. ASU No. 2011-04 is intended to result in convergence between accounting principles generally accepted in the Unites States (“GAAP”) and International Financial Reporting Standards (“IFRS”) requirements for measurement of and disclosures about fair value. This amendment clarifies the application of existing fair value measurements and disclosures, and changes certain principles or requirements for fair value measurements and disclosures. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2012, the FASB issued ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350)-Testing Indefinite-Lived Intangible Assets for Impairment. ASU No. 2012-02 simplifies how an entity is required to test indefinite-lived intangible assets for impairment. This guidance provides an entity the option to perform a qualitative, rather than quantitative, assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, which the Company did effective July 28, 2012. The Company’s adoption of this guidance during Fiscal 2012 did not have a material impact on its consolidated financial statements.

 

12


There are no other recently issued accounting pronouncements that apply to the Company that are expected to have a material impact on its consolidated financial statements.

 

2. MERGER

On February 7, 2012, the Merger became effective between the Company and Pamida. The combined entity has approximately 330 locations in 22 states. Subsequent to the Merger, the Company initiated a process to convert Pamida stores to a Shopko format. This included a change to the main store inventories to reflect a Shopko inventory assortment. The Company incurred capital costs of $45.4 million and assumed assets under capital lease of $4.8 million in conjunction with the conversions. During Fiscal 2012, the Company also closed several existing Pamida stores and the Pamida headquarters facility in Omaha, NE as discussed in Note 14.

The following table summarizes the merger related costs included in selling, general and administrative expenses incurred during the 53 weeks ended February 2, 2013, amounts paid for merger related costs during the 53 weeks ended February 2, 2013, and merger related costs included in other accrued liabilities and other long-term obligations as of February 2, 2013:

 

(In thousands)    Merger
expenses
     Amounts
paid
     Amounts
accrued
 

Store conversion expenses

   $ 24,959       $ 24,774       $ 185   

Inventory liquidation expenses

     8,289         8,289         —     

Establish closed location reserves

     8,065         61         8,004   

Severance and relocation expenses

     5,697         4,250         1,447   

Professional fees

     2,623         2,098         525   

Contract breakage costs

     2,450         122         2,328   

Asset impairment

     1,403         —           1,403   

Transaction fee

     1,000         1,000         —     

Other merger costs

     7,813         4,172         1,776   
  

 

 

    

 

 

    

 

 

 

Total merger costs

   $ 62,299       $ 44,766       $ 15,668   
  

 

 

    

 

 

    

 

 

 

In addition, $1.9 million of non-cash merger related costs included in selling, general and administrative expenses were incurred during the 53 weeks ended February 2, 2013.

 

3. INCOME TAXES

Prior to the Merger, the Company and Pamida filed separate company income tax returns in their respective jurisdictions. Separate filings preclude offsetting complementary tax positions of the merged entities in certain jurisdictions during the pre-merger periods, resulting in disproportionate tax effects when presented on a combined basis.

 

13


The benefit for income taxes includes the following for the years ended:

 

     February 2,
2013
    January 28,
2012
    January 29,
2011
 
(In thousands)                   

Current:

      

Federal

   $ (7,591   $ (2,820   $ (20,535

State

     (614     (3,874     (3,455

Deferred

     (19,398     5,731        8,828   
  

 

 

   

 

 

   

 

 

 

Total benefit

   $ (27,603   $ (963   $ (15,162
  

 

 

   

 

 

   

 

 

 

The effective income tax rate for the years presented below varies from the statutory U.S. federal income tax rate for the following reasons:

 

     February 2,
2013
    January 28,
2012
    January 29,
2011
 
(In thousands)                   

Statutory income tax rate

     35.0     35.0     35.0

State income taxes—net of federal tax benefits

     5.7     (37.9 )%      (4.3 )% 

Adjustment to uncertain tax positions

     0.0     0.0     (92.9 )% 

Tax credits

     0.0     (11.8 )%      (0.5 )% 

Other

     (1.3 )%      (1.3 )%      (1.7 )% 
  

 

 

   

 

 

   

 

 

 

Effective income tax rate

     39.4     (16.0 )%      (64.4 )% 
  

 

 

   

 

 

   

 

 

 

Components of the Company’s net deferred tax asset (liability) are as follows:

 

     February 2,
2013
    January 28,
2012
 
(In thousands)             

Deferred tax assets:

    

Reserves and allowances

   $ 10,685      $ 15,854   

Restructuring and impairment reserves

     11,598        7,426   

Capital leases

     20,147        22,255   

Compensation and benefits

     7,015        3,920   

Intangibles and other

     5,843        3,374   

Federal loss and credit carryforwards

     65,245        41,183   

State loss and credit carryforwards

     12,696        8,588   

Valuation allowance

     (892     (838
  

 

 

   

 

 

 

Total deferred tax assets

     132,337        101,762   
  

 

 

   

 

 

 

Deferred tax liabilities:

    

Inventory valuation

     (52,672     (53,428

Property and equipment

     (24,963     (12,165

Other

     (821     (1,899
  

 

 

   

 

 

 

Total deferred tax liabilities

     (78,456     (67,492
  

 

 

   

 

 

 

Net deferred tax asset

   $ 53,881      $ 34,270   
  

 

 

   

 

 

 

Long-term deferred tax asset

   $ 98,513      $ 77,994   
  

 

 

   

 

 

 

 

14


At February 2, 2013, the Company and its subsidiaries have federal net operating loss and tax credit carryforwards of $180.6 million and $2.0 million, respectively. These loss and credit carryforwards will expire in varying amounts through 2032 if not utilized. At February 2, 2013, the Company and its subsidiaries have state net operating loss and tax credit carryforwards of $189.9 million and $3.0 million, respectively. The state loss and credit carryforwards will expire in varying amounts through 2032 if not utilized.

Under FASB ASC Topic 740, Income Taxes, management is obligated to evaluate the likelihood of realizing deferred tax assets. A valuation allowance is required if, based upon available evidence, it is more likely than not that all or some portion of the assets will not be realized. Based upon its analysis, a $0.9 million valuation allowance, excluding federal benefit, was recorded for deferred tax assets related to certain state tax credit carryforwards as of February 2, 2013. Management believes the remaining recorded amount of deferred tax assets as of February 2, 2013 will more likely than not be realized, and that a valuation allowance is not required based upon its evaluation of available evidence that includes a history of operating profitability, reversing taxable temporary differences and expectations of future earnings.

The Company has no unrecognized tax benefits as of February 2, 2013 and January 28, 2012. The Company does not expect a significant change in unrecognized tax benefits within the next 12 months.

The following table presents a summary of activity in the Company’s unrecognized tax benefits: