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Section 1: 10-Q (10-Q)

SRC-2013.09.30-10Q
 
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 September 30, 2013
OR
o
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 001-36004
_______________________________________________
SPIRIT REALTY CAPITAL, INC.
(Exact name of registrant as specified in its charter)
_______________________________________________
Maryland
 
20-1676382
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
 
 
16767 North Perimeter Drive, Suite 210, Scottsdale, Arizona 85260
 
(480) 606-0820
(Address of principal executive offices; zip code)
 
(Registrant’s telephone number, including area code)
Cole Credit Property Trust II, Inc.
2325 East Camelback Road, Suite 1100, Phoenix, Arizona 85016
(Former name, former address and former fiscal year, if changed since last report)
______________________________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x    No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 o
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
 
Accelerated filer
o
Non-accelerated filer
x
(Do not check if smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes o    No x
As of November 7, 2013, there were 370,354,279 shares of common stock, par value $0.01, of Spirit Realty Capital, Inc. (f/k/a Cole Credit Property Trust II, Inc.) outstanding.
 


Table of Contents

SPIRIT REALTY CAPITAL, INC.
INDEX
 
 
29
 

 

2


PART I — FINANCIAL INFORMATION
Item 1. Financial Statements

SPIRIT REALTY CAPITAL, INC.
Condensed Consolidated Balance Sheets
(In Thousands, Except Share and Per Share Data)

 
September 30,
2013
 
December 31,
2012
 
(Unaudited)
 
 
Assets
 
 
 
Investments:
 
 
 
Real estate investments:
 
 
 
Land and improvements
$
2,264,359

 
$
1,328,437

Buildings and improvements
4,033,928

 
2,036,987

Real estate assets under direct financing leases, net
58,843

 

Total real estate investments
6,357,130

 
3,365,424

Less: accumulated depreciation
(547,065
)
 
(490,938
)
 
5,810,065

 
2,874,486

Loans receivable, net
119,009

 
51,862

Intangible lease assets, net
614,436

 
187,362

Real estate assets held for sale, net
86,691

 
5,898

Net investments
6,630,201

 
3,119,608

Cash and cash equivalents
42,375

 
73,568

Deferred costs and other assets, net
97,820

 
54,501

Goodwill
290,055

 

Total assets
$
7,060,451

 
$
3,247,677

Liabilities and stockholders’ equity
 
 
 
Liabilities:
 
 
 
Revolving credit facilities, net
$
151,508

 
$

Mortgages and notes payable, net
3,454,935

 
1,894,878

Intangible lease liabilities, net
213,918

 
45,603

Accounts payable, accrued expenses and other liabilities
105,505

 
53,753

Total liabilities
3,925,866

 
1,994,234

Commitments and contingencies (see Note 9)


 


Stockholders’ equity:
 
 
 
Common stock, $0.01 par value; 370,561,041 issued shares; 370,354,279 outstanding shares at September 30, 2013 and 161,625,144 shares issued and outstanding at December 31, 2012
3,706

 
1,616

Capital in excess of par value
3,857,955

 
1,827,632

Accumulated deficit
(724,843
)
 
(575,034
)
Accumulated other comprehensive loss
(291
)
 
(771
)
Treasury stock, at cost (206,762 shares)
(1,942
)
 

Total stockholders’ equity
3,134,585

 
1,253,443

Total liabilities and stockholders’ equity
$
7,060,451

 
$
3,247,677

See accompanying notes.


3


SPIRIT REALTY CAPITAL, INC.
Condensed Consolidated Statements of Operations
(In Thousands, Except Share and Per Share Data)
(Unaudited)


 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
Rentals
$
131,495

 
$
66,581

 
$
271,702

 
$
198,631

Interest income on loans receivable
1,797

 
1,483

 
4,037

 
4,495

Earned income from direct financing leases
708

 

 
708

 

Tenant reimbursement income
2,589

 

 
2,589

 

Interest income and other
500

 
161

 
1,816

 
701

Total revenues
137,089

 
68,225

 
280,852

 
203,827

Expenses:
 
 
 
 
 
 
 
General and administrative
9,946

 
17,362

 
26,068

 
30,083

Merger costs
45,071

 

 
56,629

 

Property costs
5,131

 
947

 
6,586

 
3,181

Real estate acquisition costs
470

 
33

 
688

 
1,293

Interest
50,386

 
41,975

 
126,376

 
122,938

Depreciation and amortization
48,338

 
26,237

 
105,197

 
78,554

Impairments

 

 
1,602

 
7,955

Total expenses
159,342

 
86,554

 
323,146

 
244,004

Loss from continuing operations before other expense and income tax expense
(22,253
)
 
(18,329
)
 
(42,294
)
 
(40,177
)
Other expense:
 
 
 
 
 
 
 
Loss on debt extinguishment

 
(32,522
)
 

 
(32,522
)
Total other expense

 
(32,522
)
 

 
(32,522
)
Loss from continuing operations before income tax expense
(22,253
)
 
(50,851
)
 
(42,294
)
 
(72,699
)
Income tax expense
803

 
74

 
946

 
394

Loss from continuing operations
(23,056
)
 
(50,925
)
 
(43,240
)
 
(73,093
)
Discontinued operations:
 
 
 
 
 
 
 
(Loss) income from discontinued operations
(89
)
 
45

 
105

 
(340
)
Gain on dispositions of assets
1,237

 
1,021

 
1,226

 
2,390

Income from discontinued operations
1,148

 
1,066

 
1,331

 
2,050

Net loss
(21,908
)
 
(49,859
)
 
(41,909
)
 
(71,043
)
Less: preferred dividends

 

 

 
(8
)
Net loss attributable to common stockholders
$
(21,908
)
 
$
(49,859
)
 
$
(41,909
)
 
$
(71,051
)
Net (loss) income per share of common stock—basic and diluted:
 
 
 
 
 
 
 
Continuing operations
$
(0.07
)
 
$
(0.91
)
 
$
(0.20
)
 
$
(1.42
)
Discontinued operations

 
0.02

 
0.01

 
0.04

Net loss per share attributable to common stockholders
$
(0.07
)
 
$
(0.89
)
 
$
(0.19
)
 
$
(1.38
)
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic and diluted common shares
329,527,874

 
55,909,384

 
216,749,378

 
51,496,427

Dividends declared per common share issued
$
0.1641

 
$

 
$
0.4922

 
$

See accompanying notes.

4


SPIRIT REALTY CAPITAL, INC.
Condensed Consolidated Statements of Comprehensive Loss
(In Thousands)
(Unaudited)

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2013
 
2012
 
2013
 
2012
Net loss
$
(21,908
)
 
$
(49,859
)
 
$
(41,909
)
 
$
(71,043
)
Other comprehensive (loss) income:
 
 
 
 
 
 
 
Change in net unrealized (losses) gains on cash flow hedges
(320
)
 
(433
)
 
149

 
(873
)
Net cash flow hedge losses reclassified to operations
120

 
5,190

 
331

 
7,591

Total comprehensive loss
$
(22,108
)
 
$
(45,102
)
 
$
(41,429
)
 
$
(64,325
)
See accompanying notes.


5


SPIRIT REALTY CAPITAL, INC.
Condensed Consolidated Statement of Stockholders’ Equity
(In Thousands, Except Share Data)
(Unaudited)

 
Common Stock
 
 
 
 
 
Treasury Stock
 
 
 
Shares
 
Par Value
 
Capital in
Excess of
Par Value
 
Accumulated
Deficit
 
Accumulated
Other
Comprehensive
Loss
 
 Shares
 
 Value
 
Total
Stockholders’
Equity
Balances, December 31, 2012
161,625,144

 
$
1,616

 
$
1,827,632

 
$
(575,034
)
 
$
(771
)
 

 
$

 
$
1,253,443

Common shares issued in connection with merger
208,570,007

 
2,086

 
2,023,426

 

 

 

 

 
2,025,512

Net loss

 

 

 
(41,909
)
 

 

 

 
(41,909
)
Other comprehensive income

 

 

 

 
480

 

 

 
480

Dividends declared on common stock

 

 

 
(107,827
)
 

 

 

 
(107,827
)
Repurchase of common shares

 

 

 

 

 
(206,762
)
 
(1,942
)
 
(1,942
)
Stock-based compensation, net
365,890

 
4

 
6,897

 
(73
)
 

 

 

 
6,828

Balances, September 30, 2013
370,561,041

 
$
3,706

 
$
3,857,955

 
$
(724,843
)
 
$
(291
)
 
(206,762
)
 
$
(1,942
)
 
$
3,134,585

See accompanying notes.

6


SPIRIT REALTY CAPITAL, INC.
Condensed Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
 
Nine Months Ended 
 September 30,
 
2013
 
2012
Operating activities
 
 
 
Net loss
$
(41,909
)
 
$
(71,043
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
108,336

 
83,725

Impairments
5,668

 
11,147

Amortization of deferred financing costs
12,457

 
2,550

Amortization of interest rate hedge (gains) losses and other derivative losses
(101
)
 
11,477

Amortization of debt discounts
5,588

 
7,726

Stock-based compensation expense
6,901

 
4,121

(Gain) loss on debt extinguishment
(1,028
)
 
32,522

Gains on dispositions of real estate and other assets, net
(1,467
)
 
(2,390
)
Non-cash revenue
(15,191
)
 
(1,683
)
Other
(41
)
 
(39
)
Changes in operating assets and liabilities:
 
 
 
Deferred costs and other assets
(8,262
)
 
1,637

Accounts payable, accrued expenses and other liabilities
(1,826
)
 
(2,873
)
Net cash provided by operating activities
69,125

 
76,877

Investing activities
 
 
 
Acquisitions/improvements of real estate
(176,080
)
 
(86,878
)
Investments in loans receivable

 
(3,500
)
Collections of principal on loans receivable and real estate assets under direct financing leases
13,878

 
16,385

Proceeds from dispositions of real estate and other assets
135,270

 
19,736

Cash acquired in connection with merger
9,400

 

Transfers of sale proceeds and loan principal collections from (to) restricted account
7,018

 
(2,113
)
Net cash used in investing activities
(10,514
)
 
(56,370
)
See accompanying notes.










7



SPIRIT REALTY CAPITAL, INC.
Condensed Consolidated Statements of Cash Flows - (continued)
(In Thousands)
(Unaudited)
 
Nine Months Ended 
 September 30,
 
2013
 
2012
Financing activities
 
 
 
Borrowings under lines of credit
266,705

 

Repayments under lines of credit
(115,197
)
 

Repayment of line of credit previously belonging to Cole II
(324,111
)
 

Borrowings under mortgages and notes payable
238,140

 
41,210

Repayments under mortgages and notes payable
(33,339
)
 
(31,594
)
Repayments/repurchases of Term Note payable

 
(398,983
)
Deferred financing costs
(20,041
)
 
(2,926
)
Proceeds from issuance of common stock, net of offering costs

 
400,915

Stock issuance costs
(518
)
 

Purchase of treasury stock
(1,942
)
 

Consent fees paid to lenders
(5,449
)
 
(10,672
)
Dividends paid/distributions to equity owners
(85,897
)
 
(8
)
Transfers to escrow deposits with lenders
(8,155
)
 
(22,584
)
Net cash used in financing activities
(89,804
)
 
(24,642
)
Net decrease in cash and cash equivalents
(31,193
)
 
(4,135
)
Cash and cash equivalents, beginning of period
73,568

 
49,536

Cash and cash equivalents, end of period
$
42,375

 
$
45,401

See accompanying notes.

8


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements
September 30, 2013
(Unaudited)



Note 1. Organization
Company Organization and Operations
Spirit Realty Capital, Inc. (the "Company") is a Maryland corporation incorporated on August 14, 2003. 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 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.
On July 17, 2013, the Company merged with and into Cole Credit Property Trust II, Inc. ("Cole II"), a Maryland Corporation formed on September 29, 2004, pursuant to the Merger Agreement (as defined below).
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 ("OP Holdings"), 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.
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.
References in these notes to “Spirit Realty Capital,” the “Company,” “we,” “our,” and “us” are to Spirit Realty Capital, Inc. The financial results of pre-merger Spirit Realty Capital include all periods presented prior to July 17, 2013, and those of the combined Spirit Realty Capital and Cole II ("New Spirit") are from July 17, 2013 through September 30, 2013.
Recent developments
    Close of the Merger
On July 17, 2013, the Company, Cole II, the Spirit Operating Partnership and the Cole Operating Partnership II, LP (the “Cole Operating Partnership”) closed the transactions contemplated by the Agreement and Plan of Merger (the “Merger Agreement” or "Merger") and the Company merged with and into Cole II, resulting in the pre-merger legal entity of the Company ceasing to exist and Cole II, continuing as the surviving corporation (the "Surviving Corporation") and adopting the name Spirit Realty Capital, Inc. Additionally, the Cole Operating Partnership merged with and into the Spirit Operating Partnership with the Spirit Operating Partnership continuing as the surviving limited partnership (the “Surviving Partnership”).
In accordance with ASC 805, Business Combinations, the Company has accounted for the transaction as a reverse acquisition. Consequently, the Company is presented as the accounting acquirer, and the results of operations of Cole II are included in the Company's Condensed Consolidated Statements of Operations beginning on July 17, 2013, the date of the Merger. In the Merger, the Company acquired 747 properties and 69 secured mortgage loans

9


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

receivable, representing a $3.6 billion investment in real estate. The property portfolio is comprised of operationally essential commercial real estate and is generally consistent with the Company’s core investment strategy. The properties collateralize approximately $1.8 billion of indebtedness, which was assumed in the transaction. See Note 3 for additional discussion of the Company's Merger with Cole II.
Financing
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 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. On June 19, 2013, the Barclays Commitment Letter was replaced with commitments for a new $400.0 million credit facility (the “New Credit Facility”) and two new loan agreements of Commercial Mortgage Backed Securities (“New CMBS") that provide for extensions of credit aggregating $203.0 million.
At the close of the Merger on July 17, 2013, Spirit Realty, L.P. terminated its $100.0 million secured revolving Credit Facility (the “Credit Facility”), pursuant to that certain credit agreement, dated as of September 25, 2012. Concurrent with the Credit Facility termination, the Surviving Partnership, and various affiliates thereof, executed the New Credit Facility credit agreement (the “Credit Agreement”) with various lenders. The Surviving Partnership’s obligations under the Credit Agreement are guaranteed by the Company and certain affiliates of the Company. Pursuant to the terms of the Credit Agreement, the Surviving Partnership and its affiliates may obtain loans and/or extensions of credit (under a revolving credit facility) in an aggregate amount not to exceed $400.0 million. The initial term expires on July 17, 2016 and may be extended for an additional 12 months subject to the satisfaction of specified requirements.
On July 17, 2013, two special purpose entities of the Company entered into separate New CMBS loan agreements with German American Capital Corporation (“GACC”) and Barclays Bank PLC (“Barclays”) for loan amounts of $100.9 million and $102.1 million, respectively. As of September 30, 2013, the GACC and Barclays loans were collateralized by 24 and 26 properties, respectively. As of the date of the agreements, the Surviving Partnership entered into a guaranty of certain non-recourse carve out obligations for each special purpose entity under the loan agreements. See Note 6 for additional discussion of the Company's indebtedness.
Acquisitions and dispositions
Excluding the properties acquired in the Merger, during the nine months ended September 30, 2013, the Company purchased 80 properties, representing an aggregate gross investment in real estate properties of $175.8 million. During the same period, the Company sold or disposed of 17 properties, including the sale of two multi-tenant properties acquired in the Merger. The fair value of the multi-tenant properties sold totaled $263.5 million and were encumbered by $148.2 million of indebtedness assumed by the Company. See Note 4 for additional discussion of the Company's investments.
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.

10


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

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 6). 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.
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 (“ASC”) 280, Segment Reporting, 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 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 and acquisition costs are expensed as incurred. 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 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.

11


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

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 $4.9 million and $3.6 million at September 30, 2013 and December 31, 2012, respectively, against accounts receivable balances of $15.3 million and $7.6 million, respectively; receivables are recorded within deferred cost and other assets, net in the accompanying condensed consolidated balance sheets. For accrued rental revenues related to the straight-line method of reporting rental revenue, the Company performs a periodic review of receivable balances and established a provision for losses of $8.8 million and $15.3 million at September 30, 2013 and December 31, 2012, respectively, against accrued rental revenue receivables of $31.1 million and $22.7 million, respectively. The Company's periodic review includes management’s estimates of uncollectible receivables and an assessment of the risks inherent in the portfolio, giving consideration to historical experience and industry default rates for long-term receivables. During the three months ended September 30, 2013, the Company decreased its allowance for straight-line rent by $10.9 million due primarily to the Company’s determination that the risk of loss associated with a tenant that had a significant concentration in the straight-line rent portfolio had decreased as a result of the tenant’s sustained improvement in financial performance.
Loans Receivable
Impairment and Allowance 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 $4.7 million and $5.1 million at September 30, 2013 and December 31, 2012, respectively.
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 September 30, 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 $39.6 million and $34.7 million at September 30, 2013 and December 31, 2012, respectively, in deferred costs and other assets, net in the accompanying condensed consolidated balance sheets. Included in the balance at each of September 30, 2013 and December 31, 2012 is approximately $9.7 million in restricted cash deposited during 2012 to secure lender consents to the IPO. At September 30, 2013, the Company held restricted cash related to $8.1 million of deposits to lender accounts as a condition of securing lender consents to the Merger. These cash balances are restricted as to use under certain of the Company’s debt agreements. In addition, during 2012, 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. Also included in the restricted cash balance as of September 30, 2013 is $7.5 million of proceeds related to property dispositions that occurred during the quarter that have yet to be released or used towards the acquisition of new properties. The remaining balance of restricted cash consists primarily of cash held in lender controlled accounts that is used to meet future debt service requirements.

12


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

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.
In January 2013, the FASB issued Accounting Standards Update (“ASU”) No. 2013-1, 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 ASC 815, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are offset under ASC 210-20-45 or ASC 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. 2013-2, 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 any impact on the Company’s financial statements.

Note 3. Merger with Cole II

On July 17, 2013, the Company and Cole II merged, with Cole II continuing as the Surviving Corporation and adopting the name Spirit Realty Capital, Inc. The Cole Operating Partnership also merged with and into the Spirit Operating Partnership, with the Spirit Operating Partnership continuing as the surviving partnership. After consideration of all applicable factors pursuant to the business combination accounting rules, the Merger resulted in a reverse merger in which (a) Cole II was deemed the "legal acquirer" because Cole II issued its common stock to the Spirit Realty Capital stockholders and (b) the Company was the "accounting acquirer." The Company’s prevailing influence over New Spirit, including a majority of its Board of Directors remaining and its surviving senior management, was a key factor in the Company obtaining control and being deemed the accounting acquirer. With the Merger, the Company added 747 properties and 69 secured mortgage loans to its portfolio.

At the effective time of the Merger, each share of common stock, par value $0.01 per share, of the Company (“Company Common Stock”), issued and outstanding immediately prior to the effective time of the Merger on July 17, 2013 was canceled and converted into the right to receive 1.9048 shares of common stock, par value $0.01 per

13


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

share, of New Spirit (“New Spirit Common Stock”). Upon receiving the converted shares of New Spirit Common Stock, the stockholders of the Company held an equity interest of approximately 44% of New Spirit.

The consideration transferred was computed on the basis of the Company’s closing stock price of $18.50 on July 17, 2013, multiplied by the inverse of the Merger Agreement exchange ratio (0.525) multiplied by the number of Cole II shares of common stock outstanding at the close of the Merger.

The preliminary allocation of the purchase price consideration of approximately $2.0 billion is calculated below as of the July 17, 2013 closing date (dollars in thousands, except per share amounts):
Cole II shares outstanding
208,570,007

Inverse of exchange ratio
0.525

 
109,499,254

Spirit Realty Capital share price
$
18.50

Consideration paid
$
2,025,737


The Company has accounted for the Cole II merger in accordance with ASC 805, Business Combinations, and is in the process of completing the allocation of the purchase price for the Merger, which the Company expects to finalize later this year. The following table summarizes the preliminary purchase price allocation, which represents the current best estimate of acquisition date fair values of the assets acquired and liabilities assumed (in thousands):
Assets
 
Investments:
 
Real estate investments:
 
Land and improvements
$
944,060

Buildings and improvements
2,204,704

Real estate investments under direct financing leases, net
58,765

Loans receivable, net
81,433

Intangible lease assets
482,321

Net investments
3,771,283

Cash and cash equivalents
9,400

Deferred costs and other assets, net
12,278

 
 
Total assets
$
3,792,961

 
 
Liabilities
 
Revolving credit facilities
$
324,111

Mortgages and notes payable, net
1,512,029

Intangible lease liabilities
190,330

Accounts payable, accrued expenses and other liabilities
30,809

 
 
Total liabilities
$
2,057,279

 
 
Estimated fair value of net assets acquired
$
1,735,682


The final allocation of the purchase price will be based on the Company's assessment of the fair value of the acquired assets and liabilities using both Level 2 and 3 inputs, as summarized below.  The final purchase price allocation may differ significantly from the estimates above.

14


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

 
Real estate investments
The fair value of real estate is generally calculated by applying an income approach methodology using both direct capitalization and discounted cash flow analysis. Key assumptions include capitalization and discount rates. Our valuations are based, in part, on valuations prepared by an independent valuation firm.
 
Lease Intangibles
The fair value of in-place leases are calculated based upon our estimate of the costs to obtain tenants in each of the applicable markets. An asset or liability is recognized for acquired leases with favorable or unfavorable rents based on our estimate of current market rents in each of the applicable markets. Our valuations of the intangible assets are based, in part, on valuations prepared by an independent valuation firm. Total lease intangibles acquired had a weighted-average remaining amortization period of 15.7 years. Included in lease intangibles are in-place leases, above market leases, and below market leases which, upon acquisition, had weighted-average remaining amortization periods of 14.1, 11.1, and 21.0 years, respectively.
 
Debt 
The fair value of debt is estimated based on contractual future cash flows discounted using borrowing spreads and market interest rates that would be available to us for the issuance of debt with similar terms and remaining maturities.
 
Merger Costs
In connection with the Merger, the Company incurred and expensed merger costs of approximately $45.1 million and $56.6 million during the three and nine months ended September 30, 2013, respectively, which included legal, accounting and financial advisory services, debt financing related costs, and other third-party expenses. Goodwill is allocated to the Company at an enterprise level, which is representative of the reporting unit.

Goodwill
Goodwill of $290.1 million was recognized as part of the preliminary purchase price allocation. The Merger and integration of the Cole II portfolio provides for several potential benefits and synergies that include, but are not limited to, the following; the Merger will double the size of the total portfolio, further diversify the portfolio geographically and by industry, reduce tenant concentrations, improve overall credit quality of the portfolio, and increase operating efficiency. The Merger is also expected to significantly improve the Company’s access to the capital markets and allow for more advantageous acquisition opportunities.

Pro Forma Information
The following unaudited pro forma information presents our operating results as though the Merger had been consummated as of January 1, 2012. The pro forma information does not necessarily reflect the actual results of operations had the Merger been consummated at the beginning of the period indicated nor is it necessarily indicative of future results. Additionally, the unaudited pro forma condensed consolidated financial statements do not include the impact of all the potential synergies that may be achieved from the Merger or any strategies that New Spirit's management may consider in order to continue to efficiently manage the on-going operations of New Spirit. The actual results for the three and nine months ended September 30, 2013 include total revenues and net income attributable to common stockholders from the acquired properties of $52.3 million and $8.3 million, respectively, from the close of the Merger (July 17, 2013) through September 30, 2013.
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Total revenues
 
$
148,100

 
$
133,924

 
$
420,712

 
$
402,058

Income from continuing operations
 
26,280

 
16,264

 
57,799

 
38,976



15


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

The Company incurred nonrecurring pro forma adjustments to operations directly attributable to the merger consisting primarily of legal, accounting and financial advisory services, debt financing related costs, and other third-party expenses, as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Nonrecurring pro forma adjustments
 
$
44,952

 
$
(4,338
)
 
$
71,369

 
$
(14,888
)

Note 4. Investments
Real Estate Investments
At September 30, 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 $7.10 billion and $3.65 billion, respectively. These investments are comprised of 2,083 and 1,207, respectively, owned or financed properties that are geographically dispersed throughout 48 states. Only one state, Texas, with a 12.9% investment, accounted for more than 10% of the total dollar amount of the Company’s investment portfolio. At September 30, 2013 and December 31, 2012, respectively, the Company’s gross investment portfolio was comprised of 1,932 and 1,122 owned properties. The Company also held 151 and 85 properties securing mortgage loans receivable with aggregate carrying amounts of $118.5 million and $40.1 million as of September 30, 2013 and December 31, 2012, respectively. Other loans receivable with aggregate carrying amounts of $0.5 million and $11.8 million were also held as of September 30, 2013 and December 31, 2012, respectively.
As of September 30, 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 - Non-merger
80

 
176,620

       Acquisitions/improvements and loan originations - Cole/Merger
816

 
3,581,131

Dispositions of real estate (b) (c) (Note 12)
(17
)
 
(296,601
)
Principal payments and payoffs
(3
)
 
(13,956
)
Impairments

 
(5,951
)
Loan premium amortization and other

 
(619
)
Balance, September 30, 2013
2,083

 
$
7,095,549

(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 and real estate assets held under direct financing leases.
(b)
The total accumulated depreciation and amortization associated with dispositions of real estate was $8.2 million for the nine months ended September 30, 2013.
(c)
The balance includes a real estate property surrendered to a lender resulting in a gain on debt extinguishment of approximately $1.0 million.
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 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 September 30, 2013, 18 of the Company’s

16


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

properties were vacant, not subject to a lease and in the Company’s possession; two 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.
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 Under Direct Financing Leases
The Company had no direct financing leases at December 31, 2012. The components of investment assets held under direct financing leases, which were acquired in the Merger, as of September 30, 2013 were as follows (in thousands):
 
September 30,
2013
Minimum lease payments receivable
$
20,502

Estimated residual value of leased assets
57,739

Unearned income
(19,398
)
Total
$
58,843

Real Estate Assets Held for Sale
The following table shows the activity in real estate assets held for sale for the nine months ended September 30, 2013:
 
Number of
Properties
 
Carrying
Value
 
 
 
(In Thousands)
Balance, December 31, 2012
7

 
$
5,898

Transfers from real estate investments
9

 
86,604

Sales (Note 12)
(8
)
 
(5,811
)
Balance, September 30, 2013
8

 
$
86,691

Impairments
The following table summarizes total impairment losses recognized for the three and nine months ended September 30, 2013 and 2012 (in thousands): 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2013
 
2012
 
2013
 
2012
Real estate and intangible asset impairment
$
1,963

 
$
1,070

 
$
5,547

 
$
8,518

Write-off of lease intangibles due to lease terminations

 

 
488

 
2,809

Loans receivable recovery

 

 
(367
)
 
(180
)
Total impairment loss continuing and discontinued operations
$
1,963

 
$
1,070

 
$
5,668

 
$
11,147



17


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

Note 5. Lease Intangibles, net
The following table details lease intangible assets and liabilities, net of accumulated amortization, as of September 30, 2013 and December 31, 2012 (in thousands):
 
September 30,
2013
 
December 31,
2012
In-place leases
$
650,126

 
$
271,392

Above-market leases
88,493

 
21,139

Less: accumulated amortization
(124,183
)
 
(105,169
)
Intangible lease assets, net
$
614,436

 
$
187,362

 
 
 
 
Below-market leases
$
233,800

 
$
61,938

Less: accumulated amortization
(19,882
)
 
(16,335
)
Intangible lease liabilities, net
$
213,918

 
$
45,603

The amounts amortized as a net increase to rental revenue for capitalized above- and below-market leases was $1.5 million and $1.0 million for the nine months ended September 30, 2013 and 2012, respectively. $0.5 million of the increase in 2013 was attributable to the acquisition of properties in connection with the Merger. The value of in-place leases amortized and included in depreciation and amortization expense was $19.8 million and $13.4 million for the nine months ended September 30, 2013 and 2012, respectively. $6.5 million of the increase in 2013 was also a result of the properties acquired in the Merger.

Note 6. Debt
The Company's debt is summarized below:
 
2013
Weighted Average Effective
Interest Rates (a)
 
September 30,
2013
 
December 31, 2012
 
 
 
(In Thousands)
Revolving credit facilities
4.92
%
 
$
151,508

 
$

Master trust notes
6.54
%
 
918,073

 
937,395

CMBS - fixed-rate
5.26
%
 
2,403,340

 
963,663

CMBS - variable-rate (b)
4.71
%
 
129,638

 
49,460

Unsecured fixed rate promissory note
9.90
%
 
1,475

 
1,571

 
 
 
3,604,034

 
1,952,089

Unamortized net debt premium (discount)
 
 
2,409

 
(57,211
)
Total debt, net
 
 
$
3,606,443

 
$
1,894,878

(a) The effective interest rates include amortization of debt discount, amortization of deferred financing costs, and related debt insurer premiums, where applicable, calculated as of September 30, 2013.
(b) Variable-rate notes are predominately hedged with interest rate swaps (see Note 7).
Revolving Credit Facilities
$400 million Credit Facility - On July 17, 2013, the Spirit Operating Partnership and various affiliates thereof, entered into the New Credit Facility with various lenders. The Spirit Operating Partnership’s obligations under the New Credit Facility are guaranteed by Spirit Realty Capital, Inc., OP Holdings, Spirit Master Funding IV, LLC, a Delaware limited liability company, and Spirit Master Funding V, LLC, a Delaware limited liability company. Pursuant to the New Credit Facility, consistent with the terms, conditions and provisions of a three-year revolving credit

18


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

facility, the Spirit Operating Partnership and its affiliates may obtain loans and/or extensions of credit (under a revolving credit facility) in an aggregate amount not exceeding $400.0 million. The initial term expires on July 17, 2016 and may be extended for an additional 12 months subject to the satisfaction of specified requirements. The New Credit Facility bears interest, at the Spirit Operating Partnership’s option, of either (i) the “Base Rate” (as defined in the Credit Agreement) plus 1.00% to 2.00%; or (ii) LIBOR plus 2.00% to 3.00%, depending on the Spirit Operating Partnership’s leverage ratio. The Spirit Operating Partnership is also required to pay a fee on the unused portion of the New Credit Facility at a rate of either 0.25% or 0.35% per annum, based on percentage thresholds for the average daily unused balance during a fiscal quarter, which amounted to $0.2 million for the quarter ended September 30, 2013. As of September 30, 2013, unamortized deferred financing costs incurred in connection with the New Credit Facility totaled $4.2 million. As of September 30, 2013, $120.0 million was outstanding on the New Credit Facility under two separate advances, secured by 280 properties, at a weighted average effective interest rate during the quarter of 4.73%.

In connection with the Merger, the Company terminated its existing secured revolving credit facility that allowed for borrowings of up to $100.0 million and provided for a maximum additional loan commitment of $50.0 million. At the time of termination, $40.0 million of outstanding indebtedness was repaid along with approximately $0.1 million of interest and fees. At the time of the termination, $1.7 million of unamortized deferred financing fees were charged to interest expense. During the nine months ended September 30, 2013, $0.2 million of fees on the unused portion of the credit facility, were included in interest expense prior to termination.
Line of Credit - In March 2013, a special purpose entity owned by the Company entered into a $25.0 million secured revolving credit facility, which was subsequently amended to increase the size of the facility to $40.0 million (“Line of Credit”). 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 rate plus 0.5% or (ii) the floor rate equal to 4.0%. The interest rate with respect to each advance resets on the annual anniversary date of each advance, and is subject to the same terms as above. As of September 30, 2013, $31.5 million was outstanding on the Line of Credit under four separate advances, secured by 34 properties, at a weighted average effective interest rate of 5.62%.
Master Trust Notes
Spirit Master Funding, LLC, Spirit Master Funding II, LLC and Spirit Master Funding III, LLC, all of which are indirect wholly-owned subsidiaries, have issued three series of net-lease mortgage notes payable (the "Notes") that are secured by all assets owned by these entities. The Series 2005-1 Notes are comprised of two separate tranches; tranche A-1 is an amortizing note with a stated rate of 5.05% and tranche A-2 consists of an interest-only note with a stated rate of 5.37%; both are due in 2020, with outstanding balances as of September 30, 2013 of $102.7 million and $258.3 million, respectively. The Series 2006-1 Notes are amortizing with a stated rate of 5.76%, due in 2021, with a outstanding balance of $239.9 million as of September 30, 2013. The Series 2007-1 Notes are amortizing with a stated rate of 5.74%, due in 2020, with an outstanding balance of $317.2 million as of September 30, 2013. The Notes also require debt insurer premiums of 0.30% to 0.32% of the outstanding principal amount, which are reflected in interest expense. As of September 30, 2013, the Notes are secured by 626 properties in total.
CMBS
The Company has 198 fixed and 8 variable rate CMBS loans that are secured by mortgages on certain of the leased properties and related assets. The weighted average effective interest rates for the nine months ended September 30, 2013 for the fixed rate notes ranged from 3.90% to 8.39% and the variable notes ranged from 2.68% to 4.75%. As of September 30, 2013, the fixed and variable rate loans have balances outstanding of $2.4 billion and $129.6 million, respectively, and are secured by 893 and 77 properties, respectively.
Debt Covenants
The Company's debt agreements contain various financial and non-financial covenants, including maintenance of specified financial ratios. The Company was in compliance with all covenants as of September 30, 2013.

19


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

As of September 30, 2013, scheduled debt maturities of the Company’s revolving credit facilities, mortgages and notes payable, including balloon payments, are as follows (in thousands):
 
Scheduled
Principal
 
Balloon
Payment
 
Total
Remainder of 2013
$
13,292

 
$
5,000

 
$
18,292

2014
54,907

 
72,261

 
127,168

2015
55,578

 
271,147

 
326,725

2016
49,087

 
889,805

 
938,892

2017
42,428

 
944,994

 
987,422

Thereafter
146,225

 
1,059,310

 
1,205,535

 
$
361,517

 
$
3,242,517

 
$
3,604,034

Balloon payments subsequent to 2017 are as follows: $95.8 million due in 2018, $39.5 million due in 2019, $294.5 million due in 2020, $167.5 million due in 2021, $292.2 million due in 2022, and $169.8 million due in 2023.
The following table summarizes interest expense on the related borrowings (in thousands):
 
Three Months 
 Ended September 30,
 
Nine Months 
 Ended September 30,
 
2013
 
2012
 
2013
 
2012
Interest expense – Term Note payable
$

 
$
6,210

 
$

 
$
19,925

Interest expense – revolving credit facilities
1,196

 

 
1,572

 

Interest expense – mortgages and notes payable
47,196

 
29,879

 
106,284

 
89,313

Interest expense – other
8

 
1

 
475

 
9

Amortization of deferred financing costs (a)
2,327

 
837

 
12,457

 
2,550

Amortization of net losses related to interest rate swaps

 
1,081

 

 
3,415

Amortization of debt (premium)/discount(b)
(341
)
 
3,967

 
5,588

 
7,726

Total interest expense
$
50,386

 
$
41,975

 
$
126,376

 
$
122,938

(a)
Includes $9.5 million arising from financing commitments related to the Merger for the nine months ended September 30, 2013.
(b)
Income recognized for the three months ended September 30, 2013 is attributable to the amortization of debt premiums recorded on debt assumed in the Merger and recorded at fair value under purchase accounting.
Debt premium/discount net 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 $12.5 million and $3.8 million at September 30, 2013 and December 31, 2012, respectively, and are included in deferred costs and other assets, net on the accompanying condensed consolidated balance sheets.


20


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

Note 7. 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 included in the accompanying condensed consolidated balance sheets. Assessments of hedge effectiveness are performed quarterly using regression analysis and the measurement of hedge ineffectiveness is based on the hypothetical derivative method. 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.
In connection with the Merger, the Company acquired three interest rate swap derivative contracts. The Company formally documented and re-designated these interest rate swaps as cash flow hedges. Although the derivatives were recorded at fair value at the time of the merger, the resulting off-market cash flow hedges were deemed highly effective upon re-designation.
The following table summarizes the notional amount and fair value of the Company’s derivative instruments (in thousands):
 
 
Balance Sheet Location
 
 
 
 
 
 
 
 
 
Fair Value of Liability
 
Fair Value of Asset
Derivatives Designated as Hedging Instruments
 
September 30,
2013
 
Notional
Amount
 
Interest
Rate
 
Effective
Date
 
Maturity
Date
 
September 30,
2013
 
December 31,
2012
 
September 30,
2013
 
December 31,
2012
Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
6,788

 
4.67
%
 
10/06/11
 
10/06/16
 
$
(147
)
 
$
(218
)
 
$

 
$

Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
7,594

 
4.34
%
 
02/06/12
 
10/06/16
 
(94
)
 
(157
)
 

 

Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
11,055

 
4.62
%
 
06/28/12
 
07/06/17
 
(69
)
 
(219
)
 

 

Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
6,860

 
5.80
%
 
07/17/13
 
03/01/16
 
(361
)
 

 

 

Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
32,400

 
3.15
%
 
07/17/13
 
09/05/15
 
(204
)
 

 

 

Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
38,250

 
3.52
%
 
07/17/13
 
09/26/14
 
(195
)
 

 

 

Interest Rate Swap
 
Deferred costs and other assets, net
 
$
17,742

 
5.24
%
 
08/30/12
 
08/30/17
 

 
(177
)
 
61

 

 
 
 
 
 
 
 
 
 
 
 
 
$
(1,070
)
 
$
(771
)
 
$
61

 
$


21


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

The following tables provide information about the amounts recorded in AOCL, as well as the gain or (loss) recorded in operations, when reclassified out of AOCL or recognized in earnings immediately, for the three and nine months ended September 30, 2013 and 2012, respectively (in thousands):
 
 
Amount of Gain or (Loss) Recognized
in AOCL on Derivative
(Effective Portion)
 
 
Three Months 
 Ended September 30,
 
Nine Months 
 Ended September 30,
Derivatives in Cash Flow Hedging Relationships
 
2013
 
2012
 
2013
 
2012
Interest rate swaps
 
$
(320
)
 
$
(433
)
 
$
149

 
$
(873
)
 
 
Amount of Loss Reclassified from
AOCL into Operations
(Effective Portion)
 
 
Three Months 
 Ended September 30,
 
Nine Months 
 Ended September 30,
Location of Loss Reclassified from AOCL into Operations
 
2013
 
2012
 
2013
 
2012
Interest expense
 
$
(120
)
 
$
(1,153
)
 
$
(309
)
 
$
(3,554
)
General and administrative expense
 
$

 
$
(4,037
)
 
$
(22
)
 
$
(4,037
)
 
 
Amount of Gain or (Loss) Recognized in
Operations on Derivative
(Ineffective Portion)
 
 
Three Months 
 Ended September 30,
 
Nine Months 
 Ended September 30,
Location of (Loss) or Gain Recognized in Operations on Derivatives
 
2013
 
2012
 
2013
 
2012
General and administrative expense
 
$
(22
)
 
$
(13
)
 
$
32

 
$
(13
)
The balance of ineffectiveness recorded in earnings for the three and nine months ended September 30, 2013, includes a $0.1 million loss resulting from the cash net settlement of the off-market financing element associated with the derivatives assumed in the Merger. Approximately $0.4 million of the remaining balance in AOCL is estimated to be reclassified as an increase to interest expense during the next 12 months. The Company does not enter into derivative contracts for speculative or trading purposes.
The Company is exposed to credit risk in the event of non-performance by its derivative counterparties. The Company believes it mitigates its credit risk by entering into agreements with counterparties it considers credit-worthy. As of September 30, 2013 and December 31, 2012, there were no termination events or events of default related to the interest rate swaps.

Note 8. Stockholders’ Equity
The equity structure in the condensed consolidated financial statements following the reverse merger reflects the equity structure of the Surviving Corporation. As a result, the Company's common shares outstanding have been adjusted retroactively for all prior periods presented computed on the basis of the number of shares outstanding multiplied by the exchange ratio of 1.9048 established in the Merger Agreement. As updated by an amendment and restatement of the charter of Cole II at the effective time of the Merger, and as of September 30, 2013, the total number of shares of all classes of capital stock which the Surviving Corporation will have the authority to issue is 490 million, consisting of 470 million shares of common stock, par value $0.01 per share and 20 million shares of preferred stock, par value of $0.01 per share. As of December 31, 2012 and prior to the effective time of the Merger, the total number of shares of all classes of capital stock which the Company had the authority to issue was 120 million, consisting of 100 million shares of common stock, par value $0.01 per share and 20 million shares of preferred stock, par value of $0.01 per share.

During the six months ended June 30, 2013, the Company declared cash dividends equivalent to $0.625 per share (or $0.3281 adjusted for the 1.9048 merger exchange ratio) on its common stock. During the three months ended

22


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

September 30, 2013, the Company declared pre- and post-merger pro-rata daily cash dividends equivalent to $0.0034 (or $0.001783 adjusted for the 1.9048 merger exchange ratio) per share and $0.001783 per share, respectively.
On September 25, 2013, portions of awards of restricted common stock granted to certain of the Company’s officers and other employees vested. The vesting of these shares, granted in connection with the Company’s initial public offering one year ago and pursuant to the Company’s 2012 Incentive Award Plan (the "Plan"), resulted in federal and state income tax liabilities for the recipients. As permitted by the terms of the Plan and the award grants, certain executive officers elected to surrender 0.2 million shares valued at $1.9 million solely to pay some or all of the associated minimum statutory tax withholdings. The surrendered shares are held as treasury stock and included in stockholders' equity.

Note 9. 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 September 30, 2013, there were no outstanding claims against the Company that are expected to have a material adverse effect on the Company’s financial position, results of operations or cash flows.
At September 30, 2013, the Company had commitments totaling $54.5 million, of which $48.7 million relates to future acquisitions with the remainder to fund improvements on properties the Company currently owns. $50.6 million of these commitments are expected to be funded by December 31, 2013 with the remainder being funded during 2014. 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 as of each September 30, 2013 and December 31, 2012.
As of September 30, 2013, there were no outstanding claims against the Company that are expected to have a material adverse effect on the Company's financial position, results of operations or cash flows.


23


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

Note 10. 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 and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2013 and December 31, 2012 (in thousands):
 
 
 
Fair Value Hierarchy Level
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
September 30, 2013:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Interest rate swaps financial liabilities
$
(1,070
)
 
$

 
$
(1,070
)
 
$

Interest rate swap financial asset
61

 

 
61

 

December 31, 2012:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Interest rate swaps financial liabilities
$
(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 September 30, 2013 and December 31, 2012 (in thousands):
 
 
 
 
 
Fair Value Hierarchy Level
 
Impairment
Charges
Description
Fair Value
 
Dispositions
 
Level 1
 
Level 2
 
Level 3
 
September 30, 2013:
 
 
 
 
 
 
 
 
 
 
 
Long-lived assets held and used
$
8,134

 
$

 
$

 
$

 
$
8,134

 
$
(1,481
)
Lease intangible assets

 

 

 

 

 
(487
)
Long-lived assets held for sale
33,404

 
(1,157
)
 

 

 
34,561

 
(4,066
)
 
 
 
 
 
 
 
 
 
 
 
$
(6,034
)
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 agreements or letters 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 values. The fair values of financial instruments are estimates based upon market conditions and

24


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

perceived risks at September 30, 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, revolving credit facilities and the fixed-rate mortgages and notes payable have been derived based on market quotes for comparable instruments or discounted cash flow analyses using estimates of the amount and timing of future cash flows, market rates and credit spreads. The mortgage and other loans receivable, revolving credit facilities and the 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 (in thousands): 
 
September 30, 2013
 
December 31, 2012
 
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Loans receivable, net
$
119,009

 
$
126,262

 
$
51,862

 
$
69,926

Revolving credit facilities
151,508

 
148,910

 

 

Mortgages and notes payable
3,454,935

 
3,648,134

 
1,894,878

 
2,112,670


Note 11. Significant Credit and Revenue Concentration
As of September 30, 2013 and December 31, 2012, the Company’s real estate investments are operated by 354 and 165 tenants, respectively, 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. Total revenues from the combined Shopko/Pamida (“Shopko/Pamida”) entity for the nine months ended September 30, 2013 and 2012, contributed 21.0% and 26.0% of the Company's total revenues from continuing and discontinued operations, respectively. For the month ended September 30, 2013, revenues for Shopko/Pamida represented 14.5% of the Company's total revenues. No other tenant contributed 10% or more of the Company’s total revenues during any of the periods presented. As of September 30, 2013 and December 31, 2012, the combined properties that are operated by Shopko/Pamida represent approximately 14.6% and 28.4%, respectively, of the Company’s total investment portfolio.


25


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

Note 12. 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 (dollars in thousands): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Revenues
$
3,016

 
$
3,171

 
$
6,967

 
$
8,974

Expenses:
 
 
 
 
 
 
 
General and administrative
(13
)
 
16

 
(1
)
 
194

Property costs
362

 
142

 
513

 
349

Interest
47

 
140

 
241

 
408

Depreciation and amortization
769

 
1,758

 
3,139

 
5,171

Impairments
1,963

 
1,070

 
4,066

 
3,192

Total expenses
3,128

 
3,126

 
7,958

 
9,314

(Loss) gain from discontinued operations before other income
(112
)
 
45

 
(991
)
 
(340
)
Other income:
 
 
 
 
 
 
 
Gain on debt extinguishment

 

 
1,028

 

Other
23

 

 
68

 

Total other income
23

 

 
1,096

 

(Loss) income from discontinued operations
(89
)
 
45

 
105

 
(340
)
Gain on dispositions of real estate
1,237

 
1,021

 
1,226

 
2,390

Total discontinued operations
$
1,148

 
$
1,066

 
$
1,331

 
$
2,050

 Number of properties disposed of during period
7

 
7

 
17

 
25



26


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

Note 13. Supplemental Cash Flow Information
In connection with its Merger with Cole II, the Company acquired net assets totaling $1.74 billion in exchange for $2.03 billion of common stock of the Company. During the nine months ended September 30, 2013, the Company reduced its indebtedness by $149.2 million in conjunction with the sale of certain real estate properties including $148.2 million assumed in the Merger. During the same period, the Company surrendered a real estate property totaling $6.9 million, which was encumbered by a mortgage note payable of $7.9 million following a notice of foreclosure. As of September 30, 2013, the Company declared a common stock dividend of $50.2 million, which was paid in October 2013 and approximately $1.1 million of deferred financing costs recorded in deferred costs and other assets were unpaid. During the nine months ended September 30, 2012, in connection with the IPO, the Company reduced its Term Note indebtedness by $330.0 million through the conversion of a portion of its outstanding Term Note into shares of its common stock. The Company also repaid $2.6 million of mortgages and notes payable in conjunction with sales of certain real estate properties and paid $0.7 million of real estate acquisition costs accrued for at December 31, 2011. In addition, as of September 30, 2012, $5.2 million of deferred offering costs recorded in deferred costs and other assets on the condensed consolidated balance sheet were unpaid.

Note 14. Incentive Award Plan and Stock Option Plan
Under the Company’s Incentive Award Plan (the “Plan”), we may grant equity incentive awards to eligible employees, directors and other service providers. 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. A total of 5.9 million shares, adjusted for the merger exchange ratio, were initially registered under the Plan. Pursuant to the Merger Agreement, the Plan was assumed by the Surviving Corporation at the effective time of the Merger and the Surviving Corporation registered 3.1 million of the remaining available shares under the Plan in addition to 45,000 shares of common stock options, which were fully vested and remained unexercised under the Surviving Corporation's former non-qualified stock option plan. In connection with the Merger, New Spirit terminated the non-qualified stock option plan, although the outstanding options under this plan continue to be subject to its terms and conditions.
On August 1, 2013, the Compensation Committee of the Board of Directors approved a 2013 bonus program to the Company's named executive officers including performance share awards under the Plan. Pursuant to the performance share awards, each participant is eligible to vest in and receive a percentage range of a target number of shares of the Company's common stock based on the attainment of total shareholder return during the performance period running from September 20, 2012 (the day of the Company's IPO) through December 31, 2015. The percentage range of performance shares that vests is based on the comparative performance of the Company to a specified peer group of companies. In addition, each performance share award entitles its holder to a cash payment equal to the aggregate dividends that would have been paid on the total number of performance shares that ultimately vest, as if such shares had been outstanding on each dividend record date over the period from August 1, 2013 through the issuance date of the shares. In the event of a non-qualifying termination of a participant prior to the performance period end date, all of the rights to performance shares will be automatically forfeited along with the participants' rights to the cash payment of any dividend equivalent.
During the three months ended September 30, 2013, the Company granted 0.4 million shares under the Plan to certain members of the Board, named executive officers and employees. The Company recorded $3.2 million in deferred compensation associated with all grants under the Plan. As of September 30, 2013, 2.9 million shares remain available for grant under the Plan. As of September 30, 2013, approximately 1.8 million non-vested restricted shares of common stock were outstanding.
For the three and nine months ended September 30, 2013, the Company recognized $2.8 million and $6.9 million, respectively, in stock-based compensation expense, which is included in general and administrative expenses in the condensed consolidated statements of operations. The Company recognized $4.1 million in stock-based

27


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
September 30, 2013
(Unaudited)

compensation expense for the three and nine months ended September 30, 2012. During the three months ended September 30, 2013, the Company did not record any stock-based compensation charges related to the fair value measurement of the stock options assumed in Merger.
As of September 30, 2013 and December 31, 2012, the remaining unamortized stock-based compensation expense, including amounts relating to the performance awards, totaled $19.7 million and $15.7 million, respectively, 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.

Note 15. 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 equity structure in the condensed consolidated financial statements following the reverse merger reflect the equity structure of the Surviving Corporation including the equity interests issued by the Surviving Corporation to effect the Merger and the retroactive adjustment of the Company's prior period common shares outstanding. The denominator of basic loss per share for each comparative period before the Merger is computed using the Company's historical weighted average number of common shares outstanding multiplied by the exchange ratio of 1.9048 established in the Merger Agreement. The denominator of basic loss per share from the acquisition date to the end of that period shall be the actual number of common shares of the Surviving Corporation outstanding during that period.
The table below is a reconciliation of the numerator used in the computation of basic and diluted loss per share (dollars in thousands):
 
Three Months 
 Ended September 30,
 
Nine Months 
 Ended September 30,
 
2013
 
2012
 
2013
 
2012
Loss from continuing operations
$
(23,056
)
 
$
(50,925
)
 
$
(43,240
)
 
$
(73,093
)
Less: preferred dividends

 

 

 
(8
)
Loss from continuing operations attributable to common stockholders
(23,056
)
 
(50,925
)
 
(43,240
)
 
(73,101
)
Income from discontinued operations
1,148

 
1,066

 
1,331

 
2,050

Net loss attributable to common stockholders
$
(21,908
)
 
$
(49,859
)
 
$
(41,909
)
 
$
(71,051
)
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic and diluted
329,527,874

 
55,909,384

 
216,749,378

 
51,496,427

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 non-vested restricted stock and non-vested performance shares during the three and nine months ended September 30, 2013 and primarily the potential shares of common stock for the Term Note debt conversion during the three and nine months ended September 30, 2012. The weighted average number of shares of potentially dilutive securities were as follows:
 
Three Months 
 Ended September 30,
 
Nine Months 
 Ended September 30,
 
2013
 
2012
 
2013
 
2012
Convertible Term Note debt

 
43,170,510

 

 
45,171,111

Non-vested shares of restricted stock
607,505

 
2,586

 
761,617

 
869

Non-vested performance shares
94,711

 

 
31,917

 

Potentially dilutive shares
702,216

 
43,173,096

 
793,534

 
45,171,980



28


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements
September 30, 2013
(Unaudited)


Note 16. Subsequent Events
On November 8, 2013, the Company filed an automatic shelf registration statement, as defined in Rule 405 under the Securities Act of 1933, on Form S-3 with the SEC, which become automatically effective. The shelf registration provides for the registration of common and preferred stock, depositary shares, warrants, rights and units by us or selling security holders on a delayed or continuous basis. Proceeds from any future securities sales by the Company under this shelf registration statement may be used by the Company for general corporate purposes, including repayment of borrowings, working capital, capital expenditures and acquisitions, or for such other purposes as may be specified in the applicable prospectus supplement.
 

29

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 Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Exchange Act. 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 that are predictions of or indicate future events or trends and that 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 consumer price index;
our success in implementing our business strategy and our ability to identify, underwrite, finance, consummate, integrate and manage diversifying acquisitions or investments;
the nature and extent of future competition;
increases in our costs of borrowing as a result of changes in interest rates and other factors;
our ability to access debt and equity capital markets;
our ability to pay down, refinance, restructure and/or extend our indebtedness as it becomes due;
our ability and willingness to renew our leases upon expiration of the leases and our ability to reposition our properties on the same or better terms in the event such leases expire and are not renewed by the tenants or in the event we exercise our rights to replace an existing tenant upon default;
the impact of any financial, accounting, legal or regulatory issues or litigation that may affect us or our major tenants;
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;
the risk that the anticipated benefits from the merger may not be realized or may take longer to realize than expected;
our ability and willingness to maintain our qualification as a REIT due to economic, market, legal, tax or other considerations;
We have incurred substantial expenses related to the Merger and expect to continue to incur substantial expenses related to the integration; and
Our future results may suffer if we do not effectively manage our expanded operations.

The factors included in this quarterly report, including the documents incorporated by reference, and documents we subsequently file with the Securities and Exchange Commission ("SEC") and incorporate by reference, are not exhaustive and additional factors could adversely affect our business and financial performance. For a discussion of additional risk factors, see the factors included under the caption “Risk Factors” in our most recent Annual Report on Form 10-K, and subsequent Quarterly Reports on Form 10-Q and shelf registration statement on Form S-3. All forward-looking statements are based on information that was available, and speak only, as of the date on which they were made. We assume no obligation to update any forward-looking statement that becomes untrue because of subsequent events, new information or otherwise, except to the extent we are required to do so in connection with our ongoing requirements under Federal securities laws.

30

Table of Contents

Overview

Spirit Realty Capital, Inc. is a Maryland corporation incorporated on August 14, 2003 that was merged with and into Cole II effective as of July 17, 2013, pursuant to the Merger Agreement. In connection with the Merger, Cole II issued less than a majority of its common stock to the Spirit Realty Capital stockholders, while Spirit Realty Capital maintained a prevailing influence over New Spirit. As a result, Cole II was the "legal acquirer" and Spirit Realty Capital was deemed the "accounting acquirer". The Spirit Realty Capital stockholders received 1.9048 shares of Cole II stock for each outstanding share of Spirit Realty Capital common stock held prior to the Merger. Upon receiving the converted shares of New Spirit Common Stock, the stockholders of the Company held an equity interest of approximately 44% of the combined company.The Company’s prevailing influence over New Spirit, through its majority representation on the Board of Directors of New Spirit and the continuation of its senior management, was a key factor in the Company obtaining control and being designated as the accounting acquirer.

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.
We generate our revenue primarily by leasing our properties to our tenants. As of September 30, 2013, our undepreciated gross investment in real estate and loans totaled approximately $7.1 billion, representing investment in 2,083 properties, including properties securing our mortgage loans. Of this amount, 98.3% consisted of our gross investment in real estate, representing ownership of 1,932 properties, and the remaining 1.7% consisted of commercial mortgage and equipment loans receivable secured by 151 properties or related assets. As of September 30, 2013, our owned properties were approximately 99.1% occupied (based on number of properties), and our leases had a weighted average non-cancelable remaining lease term (based on annual contractual rent) of approximately 10.3 years. Our leases are generally originated with long lease terms, typically non-cancelable initial terms of 15 to 20 years and tenant renewal options for additional terms. As of September 30, 2013, approximately 89% of our leases (based on annual contractual rent) provided for increases in future annual base contractual 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.

2013 Highlights

For the third quarter ended September 30, 2013:
Completed the Merger with Cole II on July 17, 2013.
Generated revenues of $137.1 million, more than doubling the revenues reported in the third quarter of 2012.
Produced Funds from Operations (FFO) of $0.08 per share, Adjusted Funds from Operations (AFFO) of $0.19 per share, and a net loss of $(0.07) per share.

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Completed on July 19, 2013, the sale of two non-core multi-tenant properties acquired in the Merger in a transaction with an acquisition value of $263.5 million.
Invested $81.7 million, adding 40 properties with tenants in place and a weighted average initial yield of 7.82%.

For the nine months ended September 30, 2013:
Generated revenues of $280.9 million, a 37.8% increase over the first nine months of 2012.
Invested $175.8 million, adding 80 properties, with a weighted average initial yield of 8.06%.
Produced FFO of $0.33 per share, AFFO of $0.64 per share and a net loss of $(0.19) per share.
Maintained essentially full occupancy above 99%.
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 89% 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 September 30, 2013, 99.1% 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. For the nine months ended September 30, 2013, Shopko/Pamida contributed 21.0% of our total revenue. During the month of September 2013, revenue from Shopko/Pamida represented only 14.5% of our owned real estate properties. We believe this Shopko/Pamida percentage is a better indicator of our current exposure and tenant diversification as a result of the Merger. Walgreen Company (“Walgreens”), our next largest tenant, contributed 4.3% of our total revenue as of September 30, 2013. Because a significant portion of our revenues are derived from rental revenues received from Shopko/Pamida and Walgreens, defaults, breaches or delay in payment of rent by these tenants may materially and adversely affect us.
Without giving effect to the exercise of tenant renewal options, the weighted average remaining term of our leases as of September 30, 2013 was 10.3 years (based on annual contractual rent). Approximately 9.5% of our leases (based on annual contractual rent) as of September 30, 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.
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. Of the leases acquired in our Merger, the percentage of leases which are triple-net, is marginally less than the percentage of triple-net leases in our legacy portfolio. As of September 30, 2013, approximately 85% 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

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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 43% 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 September 30, 2013, we had an approximately $3.6 billion principal balance outstanding of predominately secured, fixed-rate mortgage notes payable and borrowings under our revolving credit facilities. During the nine months ended September 30, 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 5.84%. 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 seven mortgage notes. We entered into interest rate swaps that effectively fixed the interest rates at approximately 4.0% on a significant portion of this variable rate debt. We amortize on a non-cash basis the deferred financing costs and debt discounts/premiums associated with our fixed-rate debt to interest expense using the effective interest rate method over the terms of the related notes. For the nine months ended September 30, 2013, non-cash interest expense recognized on our revolving credit facilities, mortgages and notes payable totaled approximately $18.0 million. Any changes to our debt structure, including borrowings under the $400.0 million New 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. In connection with our Merger, we have incurred and expect to incur additional transaction, integration and transitional costs. Although we anticipate some of these costs to be short-term, a marginal increase in general and administrative expenses is expected due to the increased portfolio management demands as result of more than doubling our net investments since December 2012.
Transaction Costs
As we acquire properties, we may incur transaction costs that we may be 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.
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

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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.
Results of Operations
Comparison of the Three Months Ended September 30, 2013 to Three Months Ended September 30, 2012
The following discussion includes the results of our continuing operations as summarized in the table below:
 
 
Three Months Ended September 30,
 
 
2013
 
2012
 
 Change
 
 %
 
 
 (In Thousands)
 
 
Revenues:
 
 
 
 
 
 
 
 
Rentals
 
$
131,495

 
$
66,581

 
$
64,914

 
97.5
 %
Interest income on loans receivable
 
1,797

 
1,483

 
314

 
21.2
 %
Earned income from direct financing leases
 
708

 

 
708

 
NM

Tenant reimbursement income
 
2,589

 

 
2,589

 
NM

Interest income and other
 
500

 
161

 
339

 
210.6
 %
Total revenues
 
137,089

 
68,225

 
68,864

 
100.9
 %
Expenses:
 
 
 
 
 
 
 
 
General and administrative
 
9,946

 
17,362

 
(7,416
)
 
(42.7
)%
Merger costs
 
45,071

 

 
45,071

 
NM

Property costs
 
5,131

 
947

 
4,184

 
441.8
 %
Real estate acquisition costs
 
470

 
33

 
437

 
1,324.2
 %
Interest
 
50,386

 
41,975

 
8,411

 
20.0
 %
Depreciation and amortization
 
48,338

 
26,237

 
22,101

 
84.2
 %
Total expenses
 
159,342

 
86,554

 
72,788

 
84.1
 %
Loss from continuing operations before other expense and income tax expense
 
(22,253
)
 
(18,329
)
 
(3,924
)
 
21.4
 %
Other expense:
 
 
 
 
 
 
 
 
Loss on debt extinguishment
 

 
(32,522
)
 
32,522

 
(100.0
)%
Loss from continuing operations before income tax expense
 
(22,253
)
 
(50,851
)
 
28,598

 
(56.2
)%
Income tax expense
 
803

 
74

 
729

 
985.1
 %
Loss from continuing operations
 
$
(23,056
)
 
$
(50,925
)
 
$
27,869

 
(54.7
)%
Revenues
For the three months ended September 30, 2013, approximately 95.9% of our lease and loan revenues were attributable to long-term leases. Total revenue increased by $68.9 million to $137.1 million for the three months ended September 30, 2013 as compared to $68.2 million for same period in 2012. The increase in revenue was due primarily to $52.3 million of additional revenue provided by the properties acquired in the Merger and $10.9 million of previously unrecognized straight-line rent. The remaining increase is attributable to an increase in base rental revenue resulting from $248.2 million of non-merger real estate acquisitions subsequent to September 30, 2012 and contractual rent escalations on our owned real estate properties.





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Rentals

Rental revenue increased by $64.9 million to $131.5 million for the three months ended September 30, 2013 as compared to $66.6 million for the same period in 2012. The increase was primarily attributable to $50.7 million of rental income generated from properties acquired in the the Merger. Since the Merger was closed on July 17, 2013, the contribution of the acquired properties does not reflect a full quarter of revenue. Rental revenue attributable to non-cash straight-line rent and amortization of above and below-market lease intangibles for the three months ended September 30, 2013 and 2012 was $14.8 million and $0.7 million, respectively, representing approximately 11.2% and 1.0% of total rental revenue from continuing operations for each of the three months ended September 30, 2013 and 2012, respectively. During the three months ended September 30, 2013, the Company recognized $10.9 million of previously unrecognized straight-line rent due primarily to our determination that the risk of loss associated with a specific tenant had decreased due to the tenant’s sustained improvement in financial performance. Additionally, subsequent to September 30, 2012, we acquired 113 properties with a gross investment value of $248.2 million, which factored into the rental increase. Furthermore, contractual rent escalations and a decreased vacancy rate compared to the period ended September 30, 2012 contributed to the increase.

As of September 30, 2013, 99.1% of our owned properties were occupied (based on number of properties). The majority of our nonperforming leases were in the restaurant and specialty retail 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 selectively dispose of in an effort to mitigate risks in the portfolio. At each of September 30, 2013 and 2012, 18 of our properties, representing approximately 0.9% and 1.6%, respectively, of our owned properties, were vacant and not generating rent.
Interest income on loans receivable and other income
Interest income on loans receivable increased by $0.3 million to $1.8 million for the three months ended September 30, 2013 as compared to $1.5 million for the same period in 2012. The increase was attributable to $0.9 million of additional income from loans receivable acquired in the Merger, which was partially offset by a decrease of approximately $0.5 million related to the prepayment of three notes as well as scheduled maturities and amortization totaling $14.0 million subsequent to December 31, 2012.
In connection with the Merger, the Company acquired 13 properties accounted for as direct financing leases which generated earned income of $0.7 million for the three month period ended September 30, 2013. Prior to the Merger, the Company did not own any properties that were accounted for as direct financing leases.
As part of the Merger, the company acquired a number of non-triple-net leases that require the tenants to reimburse the Company for certain property costs the Company incurs. The revenues recorded for the three months ended September 30, 2013 of $2.6 million are offset by expenses recorded under property costs in the accompanying condensed consolidated statements of operations.
Interest income and other contributed $0.5 million and $0.2 million for the three month periods ended September 30, 2013 and 2012, respectively.
Expenses
General and administrative
General and administrative expenses decreased $7.4 million to $9.9 million for the three months ended September 30, 2013, as compared to $17.4 million for the same period in 2012. This decrease was primarily attributable to increases during 2013 for costs associated with professional services and license and franchise taxes of $1.8 million, in the aggregate, offset by lower compensation expense of $1.2 million during the three months ended September 30, 2013 and $8.3 million of higher charges in 2012 associated with the completion of our IPO and extinguishing the Term Note indebtedness. Compensation and benefits, excluding stock compensation, during the three months ended September 30, 2013, increased approximately $0.5 million, which was attributable to the hiring of additional personnel in connection with the Merger.
       

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Merger Related Costs

In connection with the Merger, the Company incurred merger related costs costs of approximately $45.1 million for the three months ended September 30, 2013, which include legal, accounting and financial advisory services, debt financing related costs, and other third-party expenses. No such costs were incurred during the same period in 2012.
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 historically, we were generally not responsible for operating costs related to the properties, unless a property is not subject to a triple-net lease or is vacant. The Merger with Cole II resulted in the acquisition of several single and double-net leases that require the Company to initially incur certain expenses which are billed and subsequently received from the tenants, subject to certain caps and other limitations as provided in the leases. Property costs increased $4.2 million to $5.1 million for the three months ended September 30, 2013, as compared to $0.9 million for the same period in 2012. Of this increase, approximately $3.0 million is attributable to reimbursable costs associated with acquired non-triple-net leases. The remaining increase is due to a $0.9 million increase in non-reimbursable costs related to operating properties, of which $0.6 million relates to properties acquired in the Merger.
Interest
Interest expense increased by $8.4 million to $50.4 million for the three months ended September 30, 2013, as compared to $42.0 million for the same period in 2012. The increase in interest expense was primarily due to the the increase in total indebtedness of approximately $1.7 billion at September 30, 2013 compared to the same period in 2012. The vast majority of our increased indebtedness was the assumption of debt in connection with our Merger. During the three months ended September 30, 2013, the Company incurred $17.3 million and $1.2 million in higher interest charges on its fixed and variable rate mortgages and notes payable and lines of credit, respectively. These increases were partially offset by $7.3 million in higher interest charges associated with the Term Note and $2.8 million in non-cash debt discount/premium and deferred financing amortization during the same period in 2012.

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The following table summarizes our interest expense and related borrowings from continuing operations:
 
 Three Months Ended
 
September 30,
 
2013
 
2012
 
 (In Thousands)
Interest expense – Term Note payable
$