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Section 1: 10-Q (10-Q)

SRC-2014.03.31-10Q
 
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 March 31, 2014
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)

(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 May 6, 2014, there were 372,306,689 shares of common stock, par value $0.01, of Spirit Realty Capital, Inc. outstanding.
 


Table of Contents

SPIRIT REALTY CAPITAL, INC.
INDEX
 
 
Condensed Consolidated Balance Sheets as of March 31, 2014 (Unaudited) and December 31, 2013
Condensed Consolidated Statements of Operations for the three months ended March 31, 2014 and 2013 (Unaudited)
Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2014 and 2013 (Unaudited)
Condensed Consolidated Statement of Stockholders' Equity for the three months ended March 31, 2014 (Unaudited)
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013 (Unaudited)
 

 

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)

 
March 31,
2014
 
December 31,
2013
 
(Unaudited)
 
 
Assets
 
 
 
Investments:
 
 
 
Real estate investments:
 
 
 
Land and improvements
$
2,378,716

 
$
2,330,510

Buildings and improvements
4,280,895

 
4,188,783

Total real estate investments
6,659,611

 
6,519,293

Less: accumulated depreciation
(636,748
)
 
(590,067
)
 
6,022,863

 
5,929,226

Loans receivable, net
115,846

 
117,721

Intangible lease assets, net
613,162

 
618,121

Real estate assets under direct financing leases, net
56,803

 
58,760

Real estate assets held for sale, net
25,087

 
19,611

Net investments
6,833,761

 
6,743,439

Cash and cash equivalents
29,984

 
66,588

Deferred costs and other assets, net
120,229

 
129,597

Goodwill
291,421

 
291,421

Total assets
$
7,275,395

 
$
7,231,045

Liabilities and stockholders’ equity
 
 
 
Liabilities:
 
 
 
Revolving credit facilities, net
$
135,606

 
$
35,120

Mortgages and notes payable, net
3,738,053

 
3,743,098

Intangible lease liabilities, net
219,877

 
220,114

Accounts payable, accrued expenses and other liabilities
108,902

 
114,679

Total liabilities
4,202,438

 
4,113,011

Commitments and contingencies (see Note 8)


 


Stockholders’ equity:
 
 
 
Common stock, $0.01 par value; 370,949,721 shares issued; 370,732,369 outstanding shares at March 31, 2014 and 370,570,565 shares issued; 370,363,803 outstanding shares at December 31, 2013
3,710

 
3,706

Capital in excess of par value
3,862,454

 
3,859,823

Accumulated deficit
(790,444
)
 
(742,915
)
Accumulated other comprehensive loss
(717
)
 
(638
)
Treasury stock, at cost
(2,046
)
 
(1,942
)
Total stockholders’ equity
3,072,957

 
3,118,034

Total liabilities and stockholders’ equity
$
7,275,395

 
$
7,231,045

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
March 31,
 
2014
 
2013
Revenues:
 
 
 
Rentals
$
137,479

 
$
69,776

Interest income on loans receivable
1,837

 
1,113

Earned income from direct financing leases
846

 

Tenant reimbursement income
3,319

 

Interest income and other
491

 
79

Total revenues
143,972

 
70,968

Expenses:
 
 
 
General and administrative
11,067

 
6,968

Merger costs

 
6,537

Property costs
5,282

 
940

Real estate acquisition costs
1,281

 
89

Interest
54,399

 
36,439

Depreciation and amortization
60,549

 
26,939

Impairments
1,707

 

Total expenses
134,285

 
77,912

Income (loss) from continuing operations before income tax expense
9,687

 
(6,944
)
Income tax expense
217

 
74

Income (loss) from continuing operations
9,470

 
(7,018
)
Discontinued operations:
 
 
 
Income (loss) from discontinued operations
3,054

 
(1,494
)
(Loss) gain on dispositions of assets
(7
)
 
180

Income (loss) from discontinued operations
3,047

 
(1,314
)
Income (loss) before gain on dispositions of assets
12,517

 
(8,332
)
Gain on dispositions of assets
1,722

 

Net income (loss)
$
14,239

 
$
(8,332
)
Net income (loss) per share of common stock—basic and diluted:
 
 
 
Continuing operations
$
0.03

 
$
(0.04
)
Discontinued operations
0.01

 
(0.01
)
Net income (loss) per share
$
0.04

 
$
(0.05
)
Weighted average common shares outstanding:
 
 
 
Basic
368,684,942

 
159,421,377

Diluted
369,387,638

 
159,421,377

 
 
 
 
Dividends declared per common share issued
$
0.16625

 
$
0.16406

See accompanying notes.

4


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

 
Three Months Ended 
 March 31,
 
2014
 
2013
Net income (loss)
$
14,239

 
$
(8,332
)
Other comprehensive (loss) income:
 
 
 
Change in net unrealized losses on cash flow hedges
(402
)
 
(31
)
Net cash flow hedge losses reclassified to operations
323

 
114

Total comprehensive income (loss)
$
14,160

 
$
(8,249
)
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, 2013
370,570,565

 
$
3,706

 
$
3,859,823

 
$
(742,915
)
 
$
(638
)
 
(206,762
)
 
$
(1,942
)
 
$
3,118,034

Net income

 

 

 
14,239

 

 

 

 
14,239

Other comprehensive loss

 

 

 

 
(79
)
 

 

 
(79
)
Dividends declared on common stock

 

 

 
(61,628
)
 

 

 

 
(61,628
)
Repurchase of common shares

 

 

 

 

 
(10,590
)
 
(104
)
 
(104
)
Exercise of stock options
20,000

 

 
183

 

 

 

 

 
183

Stock-based compensation, net
359,156

 
4

 
2,448

 
(140
)
 

 

 

 
2,312

Balances, March 31, 2014
370,949,721

 
$
3,710

 
$
3,862,454

 
$
(790,444
)
 
$
(717
)
 
(217,352
)
 
$
(2,046
)
 
$
3,072,957

See accompanying notes.

6


SPIRIT REALTY CAPITAL, INC.
Condensed Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
 
Three Months Ended 
 March 31,
 
2014
 
2013
Operating activities
 
Net income (loss)
$
14,239

 
$
(8,332
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
60,549

 
28,316

Impairments
1,707

 
2,103

Amortization of deferred financing costs
973

 
3,901

Amortization of interest rate hedge losses and derivative net settlements
(26
)
 
22

Amortization of debt (premiums) discounts
(929
)
 
2,961

Stock-based compensation expense
2,452

 
1,772

Gains on dispositions of real estate and other assets, net
(1,715
)
 
(202
)
Non-cash revenue
(3,962
)
 
(521
)
Other
121

 
(14
)
Changes in operating assets and liabilities:
 
 
 
Deferred costs and other assets
(1,510
)
 
(3,103
)
Accounts payable, accrued expenses and other liabilities
(6,055
)
 
1,329

Net cash provided by operating activities
65,844

 
28,232

Investing activities
 
 
 
Acquisitions/improvements of real estate
(137,188
)
 
(56,854
)
Collections of principal on loans receivable and real estate assets under direct financing leases
1,319

 
763

Proceeds from dispositions of real estate and other assets
6,243

 
2,829

Transfers of sale proceeds and loan principal collections (to) from restricted account
(6,345
)
 
14,081

Net cash used in investing activities
(135,971
)
 
(39,181
)
Financing activities
 
 
 
Borrowings under lines of credit
180,535

 
11,400

Repayments under lines of credit
(80,049
)
 

Borrowings under mortgages and notes payable
10,000

 
24,800

Repayments under mortgages and notes payable
(14,116
)
 
(10,839
)
Deferred financing costs
(503
)
 
(4,113
)
Proceeds from exercise of stock options
183

 

Stock issuance costs

 
(293
)
Purchase of treasury stock
(104
)
 

Consent fees paid to lenders

 
(222
)
Dividends paid/distributions to equity owners
(61,573
)
 
(28,247
)
Transfers (to) from escrow deposits with lenders
(850
)
 
250

Net cash provided by (used in) financing activities
33,523

 
(7,264
)
Net decrease in cash and cash equivalents
(36,604
)
 
(18,213
)
Cash and cash equivalents, beginning of period
66,588

 
73,568

Cash and cash equivalents, end of period
$
29,984

 
$
55,355

See accompanying notes.

7


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements
March 31, 2014
(Unaudited)



Note 1. Organization
Company Organization and Operations
Spirit Realty Capital, Inc. (the "Company") is a Maryland corporation and operates as a self-administered and self-managed REIT that seeks to generate and deliver sustainable and attractive returns for stockholders by investing primarily in and managing a portfolio of single-tenant, operationally essential real estate throughout the United States that is generally leased on a long-term, triple-net basis primarily to tenants engaged in retail, service and distribution industries. Single tenant, operationally essential real estate generally refers to free-standing, commercial real estate facilities where tenants conduct activities that are essential to the generation of their sales and profits.
On July 17, 2013, the Company merged with and into Cole Credit Property Trust II, Inc. ("Cole II"), a Maryland Corporation, pursuant to the Merger Agreement ("Merger").
The Company’s operations are carried out through its operating partnership, Spirit Realty, L.P. (the “Operating 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 Operating Partnership. The Company is the sole limited partner and owns the remaining 99.0% of the Operating Partnership.

As of March 31, 2014, our undepreciated gross investment in real estate and loans totaled approximately $7.38 billion, representing investments in 2,287 properties, including properties securing our mortgage loans. Of this amount, 98.4% consisted of our gross investment in real estate, representing ownership of 2,142 properties, and the remaining 1.6% consisted of commercial mortgage loans receivable secured by the remaining 145 properties or other related assets.

Acquisitions and dispositions

During the three months ended March 31, 2014, the Company purchased 104 properties, representing an aggregate gross investment in real estate properties of $157.1 million. During the same period, the Company sold or disposed of three properties for $6.3 million in gross sales proceeds. See Note 3 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, Inc. 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, 2013.
The unaudited condensed consolidated financial statements include the accounts of Spirit Realty Capital, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
The Company has formed numerous special purpose entities to acquire and hold real estate subject to mortgage notes payable (see Note 5). As a result, the vast majority of the Company’s consolidated assets are held in these wholly owned special purpose entities, and are subject to debt. Each special purpose entity is a separate legal entity, and is the sole owner of its assets and responsible for its liabilities. The assets of these special purpose entities are not

8


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

available to pay, or otherwise satisfy obligations to, the creditors of any owner or affiliate of the special purpose entity. At both March 31, 2014 and December 31, 2013, assets totaling $6.1 billion were held, and liabilities totaling $3.8 billion were owed by these special purpose entities and are included in the accompanying condensed consolidated balance sheets.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although management believes its estimates are reasonable, actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to prior period balances to conform to the current period presentation.
Segment Reporting
Accounting Standards Codification Topic (“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 condensed consolidated statements of operations.

9


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(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 $5.1 million and $4.6 million at March 31, 2014 and December 31, 2013, respectively, against accounts receivable balances of $15.9 million and $14.3 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 $10.8 million and $9.6 million at March 31, 2014 and December 31, 2013, respectively, against accrued rental revenue receivables of $39.8 million and $35.3 million, respectively. The Company's periodic review includes management’s estimates of amounts that will not be realized and an assessment of the risks inherent in the portfolio, giving consideration to historical experience and industry default rates for long-term receivables.
Loans Receivable
Impairment and 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. There was no allowance for loan losses at March 31, 2014 or December 31, 2013.
A loan is placed on nonaccrual status when the loan has become 60 days past due, or earlier if management determines that full recovery of the contractually specified payments of principal and interest is doubtful. While on nonaccrual status, interest income is recognized only when received. As of March 31, 2014 and December 31, 2013, there were no mortgages or notes on nonaccrual status.
Restricted Cash and Escrow Deposits

Restricted cash and deposits in escrow, classified within in deferred costs and other assets, net in the accompanying condensed consolidated balance sheets consisted of the following at March 31, 2014 and December 31, 2013:
 
March 31,
2014
 
December 31,
2013
Collateral deposits (1)
$
21,865

 
$
21,816

Tenant improvements, repairs, and leasing commissions (2)
11,455

 
10,297

Master trust release / title company escrow (3)
7,456

 
21,893

Loan impounds (4)
2,410

 
2,018

Other (5)
1,917

 
2,667

 
$
45,103

 
$
58,691

(1) Funds held in reserve by lenders which, at their sole discretion, can be applied to the repayment of Debt.  Any funds remaining on deposit after the debt is paid in full are released to the borrower.
(2) Deposits held by lenders that are reserved to fund tenant improvements/repairs on collateral properties or when leasing commissions are incurred to secure a new tenant.
(3) Reflects net sales proceeds from property dispositions held as collateral that can be released upon qualified re-investment.
(4) Funds held in lender controlled accounts generally used to meet future debt service or certain property cost requirements.
(5) Funds held in lender controlled accounts released within the following month after debt service requirements are met.

10


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)


A significant amount of these reserves were established in connection with obtaining lender consents relating to our initial public offering during 2012 and Merger during 2013.
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 the Company 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 the Company's financial position or results of operations upon adoption.

In April 2014, the FASB issued Accounting Standards Update (ASU) 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360), Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which amends the requirements for reporting discontinued operations. Under ASU 2014-08, a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results when the component or group of components meets the criteria to be classified as held for sale or when the component or group of components is disposed of by sale or other than by sale. In addition, this ASU requires additional disclosures about both discontinued operations and the disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements. The Company has early adopted the provisions of ASU 2014-08 beginning with the period ended March 31, 2014, and has applied the provisions prospectively.

Note 3. Investments
Real Estate Investments
At March 31, 2014 and December 31, 2013, the Company’s gross investment in real estate properties and loans, including real estate assets held for sale, totaled approximately $7.38 billion and $7.24 billion, respectively. These investments are comprised of 2,287 and 2,186, respectively, owned or financed properties that are geographically dispersed throughout 48 states. Only one state, Texas, with a 13.1% investment, accounted for more than 10% of the total dollar amount of the Company’s investment portfolio. At March 31, 2014 and December 31, 2013, respectively, the Company’s gross investment portfolio was comprised of 2,142 and 2,041 owned properties. The Company also held 145 properties securing mortgage loans receivable with aggregate carrying amounts of $115.4 million and $117.3 million as of March 31, 2014 and December 31, 2013, respectively. Other loans receivable with aggregate carrying amounts of $0.4 million were also held as of March 31, 2014 and December 31, 2013.

11


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

During the three months ended March 31, 2014, 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, 2013
2,186

 
$
7,235,732

Acquisitions/improvements
104

 
157,972

Dispositions of real estate (b) (Note 11)
(3
)
 
(6,219
)
Principal payments and payoffs

 
(1,243
)
Impairments

 
(1,707
)
Loan premium amortization and other

 
(1,060
)
Balance, March 31, 2014
2,287

 
$
7,383,475

(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 $1.7 million for the three months ended March 31, 2014.
 
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 March 31, 2014, 24 of the Company’s properties were vacant, not subject to a lease and in the Company’s possession; five of these properties were held for sale. At December 31, 2013, 21 properties were vacant, not subject to a lease and in the Company’s possession; six of these properties were held for sale.
Scheduled minimum future contractual rent to be received under the remaining non-cancelable term of operating leases at March 31, 2014 (in thousands):
Scheduled Future Rental Payments
March 31,
2014
Remainder of 2014
$
407,977

2015
535,137

2016
520,326

2017
505,289

2018
489,417

Thereafter
3,377,651

Total future minimum rentals
$
5,835,797

Because lease renewal periods are exercisable at the option of the lessee, the preceding table presents future minimum lease payments due during the initial lease term only. In addition, the future minimum rentals do not include any contingent rentals based on a percentage of the lessees' gross sales or lease escalations based on future changes in the consumer price index ("CPI").
Certain of the Company’s leases contain tenant purchase options. Most of these options are at or above fair market value at the time the option is exercisable, and none of these purchase options represent bargain purchase options under GAAP.

12


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

Loans Receivable
The following table details loans receivable, net of premium, as of March 31, 2014 and December 31, 2013 (in thousands):
 
March 31,
2014
 
December 31,
2013
Mortgage - principal
$
101,083

 
$
102,315

Mortgage - premium
14,345

 
14,976

    Mortgages, net
115,428

 
117,291

Other notes - principal
418

 
430

Total Loans receivable, net
$
115,846

 
$
117,721

Real Estate Assets Under Direct Financing Leases
The components of investment assets held under direct financing leases as of March 31, 2014 and December 31, 2013 were as follows (in thousands):
 
March 31,
2014
 
December 31,
2013
Minimum lease payments receivable
$
18,633

 
$
19,555

Estimated residual value of leased assets
55,858

 
57,739

Unearned income
(17,688
)
 
(18,534
)
Total
$
56,803

 
$
58,760

Real Estate Assets Held for Sale
The following table shows the activity in real estate assets held for sale for the three months ended March 31, 2014:
 
Number of
Properties
 
Carrying
Value
 
 
 
(In Thousands)
Balance, December 31, 2013
11

 
$
19,611

Transfers from real estate investments
1

 
8,611

Sales (Note 11)
(2
)
 
(3,135
)
Balance, March 31, 2014 (a)
10

 
$
25,087

(a) Includes a single property with a net carrying amount of $8.6 million in which its operating results are reported in continuing operations.
The following table is a reconciliation of the major classes of assets and liabilities from discontinued operations included in real estate assets held for sale on the condensed consolidated balance sheet as of March 31, 2014 and December 31, 2013 (in thousands):

13


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

 
March 31,
2014
 
December 31,
2013
Assets
 
 
 
Land and improvements
$
8,878

 
$
10,003

Buildings and improvements
11,135

 
14,178

Total real estate investments
20,013

 
24,181

Less: Accumulated depreciation
(3,656
)
 
(4,819
)
Intangible lease assets, net
567

 
697

Total assets
$
16,924

 
$
20,059

 
 
 
 
Liabilities
 
 
 
Intangible lease liabilities, net
$
448

 
$
448

Total liabilities
$
448

 
$
448

Impairments
The following table summarizes total impairment losses recognized for the three months ended March 31, 2014 and 2013 (in thousands): 
 
Three Months Ended 
 March 31,
 
2014
 
2013
Real estate and intangible asset impairment
$
1,637

 
$
2,103

Write-off of lease intangibles due to lease terminations
70

 

Total impairment loss continuing and discontinued operations
$
1,707

 
$
2,103


Note 4. Lease Intangibles, net
The following table details lease intangible assets and liabilities, net of accumulated amortization, as of March 31, 2014 and December 31, 2013 (in thousands):
 
March 31,
2014
 
December 31,
2013
In-place leases
$
670,789

 
$
663,027

Above-market leases
97,571

 
95,118

Less: accumulated amortization
(155,198
)
 
(140,024
)
Intangible lease assets, net
$
613,162

 
$
618,121

 
 
 
 
Below-market leases
$
246,452

 
$
243,237

Less: accumulated amortization
(26,575
)
 
(23,123
)
Intangible lease liabilities, net
$
219,877

 
$
220,114

The amounts amortized as a net increase to rental revenue for capitalized above- and below-market leases was $1.3 million and $0.3 million for the three months ended March 31, 2014 and 2013, respectively. Above- and below-market lease amortization from properties acquired in connection with the Merger contributed $0.9 million of the increase during 2014. The value of in-place leases amortized and included in depreciation and amortization expense was $13.4

14


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

million and $4.4 million for the three months ended March 31, 2014 and 2013, respectively. Lease-in-place amortization from properties acquired in connection with the Merger contributed $8.0 million of the increase in 2014.

Note 5. Debt
The Company's debt is summarized below:
 
2014
Weighted Average Effective
Interest Rates (a)
 
March 31,
2014
 
December 31,
2013
 
 
 
(In Thousands)
Revolving credit facilities (b)
7.89
%
 
$
135,606

 
$
35,120

Master trust notes
6.27
%
 
1,233,724

 
1,241,437

CMBS - fixed-rate
5.60
%
 
2,391,246

 
2,387,532

CMBS - variable-rate (c)
3.30
%
 
110,935

 
111,018

Unsecured fixed rate promissory note
9.74
%
 
1,408

 
1,442

 
 
 
3,872,919

 
3,776,549

Unamortized net debt premium
 
 
740

 
1,669

Total debt, net
 
 
$
3,873,659

 
$
3,778,218


(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 March 31, 2014.
(b) 
The effective interest rate on the revolving credit facilities, excluding the impact of non-cash amortization of deferred financing costs and non-utilization fee, was 2.97% as of March 31, 2014.
(c) 
Variable-rate notes are predominately hedged with interest rate swaps (see Note 6).
Revolving Credit Facilities
$400 million Credit Facility - On July 17, 2013, the Operating Partnership and various affiliates thereof, entered into a three-year credit agreement ("Credit Facility") with various lenders and terminated the $100.0 million secured revolving credit facility. The Operating Partnership may obtain loans and/or extensions of credit 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 Credit Facility bears interest, at the 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 Operating Partnership’s leverage ratio. The Operating Partnership is also required to pay a fee on the unused portion of the 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 $0.3 million for the three months ended March 31, 2014.
As a result of entering into the Credit Facility, the Company incurred origination costs of $4.5 million. These costs are being amortized to interest expense, on a straight-line basis, over the remaining initial term of the Credit Facility. At March 31, 2014, $3.5 million of the $4.5 million is included in deferred costs and other assets, net on the accompanying condensed consolidated balance sheet. The effective interest rate on outstanding borrowings under the Credit Facility, which includes cash interest, non-cash amortization of deferred financing costs, and non-utilization fees, was 8.09% for the three months ended March 31, 2014. The interest rate, excluding the impact of non-cash amortization of deferred financing costs and non-utilization fee, was 2.68% as of March 31, 2014. As of March 31, 2014, $120.0 million was outstanding on the Credit Facility under three separate advances, secured by 231 properties.
The Company guarantees the Operating Partnership's obligations under the Credit Facility and, to the extent not prohibited by law, all of its assets and the Operating Partnership's assets, other than interests in subsidiaries that are contractually prohibited from being pledged, are pledged as collateral for obligations under the Credit Facility.

15


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

The ability to borrow under the Credit Facility is subject to the Operating Partnerships' ongoing compliance with a number of customary financial covenants. As of March 31, 2014, the Operating Partnership was in compliance with these financial covenants.
Line of Credit - As of March 31, 2014, a special purpose entity owned by the Company had access to a $40.0 million secured revolving credit facility (“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 March 31, 2014, $15.6 million was outstanding on the Line of Credit under three separate advances, secured by 3 properties, at a weighted average effective interest rate of 4.26%. Each advance under the Line of Credit is secured only by its specified asset. The ability to borrow under the Line of Credit is subject to the Company's and special purposes entity's ongoing compliance with a number of customary financial covenants. As of March 31, 2014, the Company and special purpose entity were in compliance with these financial covenants.
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 (collectively referred to as the "Notes") that are secured by substantially all of the 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 March 31, 2014 of $96.4 million and $258.3 million, respectively. The Series 2006-1 notes are amortizing with a stated rate of 5.76%, due in 2021, with an outstanding balance of $236.0 million as of March 31, 2014. The Series 2007-1 notes are amortizing with a stated rate of 5.74%, due in 2022, with an outstanding balance of $314.0 million as of March 31, 2014. 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 March 31, 2014, these notes are secured by 722 properties in total, including 76 properties securing mortgage loans. The obligations under the four series net-lease mortgage notes are cross collateralized.
In December 2013, Spirit Master Funding VII ("SMF VII") issued new investment grade rated $330 million net-lease mortgage notes under a new securitization platform. The issue was comprised of $125.0 million of 3.89% Series 2013-1 Class A interest only, net-lease mortgage notes expected to be repaid in December 2018 and $205.0 million of 5.27% Series 2013-2 Class A amortizing net-lease mortgage notes expected to be repaid in December 2023. The notes are secured by the assets of SMF VII and are non-recourse. The Company used the proceeds of the issue to replace shorter-term debt, fund acquisitions and for general corporate purposes. As of March 31, 2014, the Series 2013-1 and Series 2013-2 notes have outstanding balances of $125.0 million and $204.0 million, respectively, and are secured by 318 properties, including 79 properties securing mortgage loans.
CMBS
The Company has 232 fixed and 26 variable rate CMBS loans that are secured by mortgages on certain of the leased properties and related assets. The stated interest rates as of March 31, 2014 for the fixed rate notes ranged from 3.90% to 8.39% with a weighted average stated rate of 5.87%. The variable rate notes ranged from 2.67% to 3.67% with a weighted average stated rate of 3.28%. As of March 31, 2014, the fixed and variable rate loans have balances outstanding of $2.4 billion and $110.9 million, respectively, and are secured by 854 and 123 properties, respectively.

16


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

Debt Maturities
As of March 31, 2014, 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 2014
$
42,720

 
$
29,761

 
$
72,481

2015
58,123

 
245,794

 
303,917

2016
51,888

 
889,330

 
941,218

2017
45,745

 
925,164

 
970,909

2018
45,445

 
248,851

 
294,296

Thereafter
134,285

 
1,155,813

 
1,290,098

 
$
378,206

 
$
3,494,713

 
$
3,872,919

Balloon payments subsequent to 2018 are as follows: $49.5 million due in 2019, $294.5 million due in 2020, $167.5 million due in 2021, $292.2 million due in 2022, $352.1 million due in 2023. As of March 31, 2014, the remaining weighted average maturity of the Company's outstanding indebtedness was 4.7 years.

The following table summarizes interest expense on the related borrowings (in thousands):
 
Three Months 
 Ended March 31,
 
2014
 
2013
Interest expense – revolving credit facilities
$
720

 
$
105

Interest expense – mortgages and notes payable
53,596

 
29,472

Interest expense – other
39

 

Amortization of deferred financing costs (a)
973

 
3,901

Amortization of debt (premium)/discount
(929
)
 
2,961

Total interest expense
$
54,399

 
$
36,439

(a) 
Includes $3.6 million arising from financing commitments related to the Merger for the three months ended March 31, 2013.
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 $23.4 million and $23.8 million at March 31, 2014 and December 31, 2013, respectively, and are included in deferred costs and other assets, net on the accompanying condensed consolidated balance sheets.


17


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

Note 6. Derivative and Hedging Activities
The Company uses interest rate derivative contracts to manage its exposure to changes in interest rates on its variable rate debt. These derivatives are considered cash flow hedges and are recorded on a gross basis at fair value and 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.
The following table summarizes the notional amount and fair value of the Company’s derivative instruments (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
Fair Value of Liability
Derivatives Designated as Hedging Instruments
 
Balance Sheet Location
 
Notional
Amount
 
Interest
Rate
 
Effective
Date
 
Maturity
Date
 
March 31,
2014
 
December 31,
2013
Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
10,968

 
4.62
%
 
06/28/12
 
07/06/17
 
$
(43
)
 
$
(42
)
Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
6,783

 
5.75
%
 
07/17/13
 
03/01/16
 
(292
)
 
(326
)
Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
32,400

 
3.15
%
 
07/17/13
 
09/05/15
 
(175
)
 
(178
)
Interest Rate Swaps(a)
 
Accounts payable, accrued expenses and other liabilities
 
$
61,758

 
5.14
%
 
01/02/14
 
12/13/18
 
(335
)
 
(246
)
 
 
 
 
 
 
 
 
 
 
 
 
$
(845
)
 
$
(792
)
(a)Represents a tranche of eight individual interest rate swap agreements with notional amounts ranging from $7.6 million to $7.9 million. The swap agreements contain the same payment terms, stated interest rate, effective date, and maturity date.

The following tables provide information about the amounts recorded in AOCL, as well as the loss recorded in operations, when reclassified out of AOCL or recognized in earnings immediately, for the three months ended ended March 31, 2014 and 2013, respectively (in thousands):
 
 
Amount of Loss Recognized
in AOCL on Derivative
(Effective Portion)
 
 
Three Months 
 Ended March 31,
Derivatives in Cash Flow Hedging Relationships
 
2014
 
2013
Interest rate swaps
 
$
(402
)
 
$
(31
)
 
 
 
 
 
 
 
Amount of Loss Reclassified from
AOCL into Operations
(Effective Portion)
 
 
Three Months 
 Ended March 31,
Location of Loss Reclassified from AOCL into Operations
 
2014
 
2013
Interest expense
 
$
(323
)
 
$
(92
)
General and administrative expense
 

 
(22
)
Approximately $1.2 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 March 31, 2014 and December 31, 2013, there were no termination events or events of default related to the interest rate swaps.


18


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

Note 7. Stockholders’ Equity

During the three months ended March 31, 2014, the Company declared cash dividends equivalent to $0.16625 per share on its common stock, payable on April 15, 2014, to stockholders of record as of March 31, 2014. On January 1, 2014, portions of awards of restricted common stock granted to certain of the Company’s officers and other employees vested. As permitted by the terms of the Plan and the award grants, certain executive officers elected to surrender shares to the Company 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 8. Commitments and Contingencies
The Company is periodically subject to claims or litigation in the ordinary course of business, including claims generated from business conducted by tenants on real estate owned by the Company. In these instances, the Company is typically indemnified by the tenant against any losses that might be suffered, and the Company and/or the tenant are insured against such claims.
As of March 31, 2014, 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.
As of March 31, 2014, the Company had commitments totaling $16.9 million, of which $14.1 million relates to future acquisitions and the remainder to fund improvements on properties the Company currently owns. All of these commitments are expected to be funded by December 31, 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.

Note 9. Fair Value Measurements
The Company’s assets and liabilities that are required to be measured at fair value in the accompanying condensed consolidated financial statements are summarized below.
The following table sets forth the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of March 31, 2014 and December 31, 2013 (in thousands):
 
 
 
Fair Value Hierarchy Level
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
March 31, 2014:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Interest rate swaps financial liabilities
$
(845
)
 
$

 
$
(845
)
 
$

December 31, 2013:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Interest rate swaps financial liabilities
$
(792
)
 
$

 
$
(792
)
 
$


19


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

The interest rate swaps are measured using a market approach, using prices obtained from a nationally recognized pricing service and pricing models with market observable inputs such as interest rates and equity index levels. These measurements are classified as Level 2 of the fair value hierarchy.
The following table sets forth the Company’s assets that were accounted for at fair value on a nonrecurring basis as of March 31, 2014 and December 31, 2013 (in thousands):
 
 
 
 
 
Fair Value Hierarchy Level
 
Impairment
Charges (1)
Description
Fair Value
 
Dispositions
 
Level 1
 
Level 2
 
Level 3
 
March 31, 2014:
 
 
 
 
 
 
 
 
 
 
 
Long-lived assets held and used
$
7,488

 
$

 
$

 
$

 
$
7,488

 
$
(795
)
Lease intangible assets

 

 

 

 

 
(70
)
Long-lived assets held for sale
8,611

 

 

 

 
8,611

 
(842
)
 
 
 
 
 
 
 
 
 
 
 
$
(1,707
)
December 31, 2013:
 
 
 
 
 
 
 
 
 
 
 
Lease intangible assets
$

 
$

 
$

 
$

 
$

 
$
(182
)
Long-lived assets held for sale
11,198

 
(26,832
)
 

 

 
38,030

 
(7,134
)
 
 
 
 
 
 
 
 
 
 
 
$
(7,316
)
(1) Impairment charges are presented for the three months ended March 31, 2014 and for the year ended December 31, 2013.
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 perceived risks at March 31, 2014 and December 31, 2013. 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.

20


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

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): 
 
March 31, 2014
 
December 31, 2013
 
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Loans receivable, net
$
115,846

 
$
125,493

 
$
117,721

 
$
131,587

Revolving credit facilities, net
135,606

 
136,441

 
35,120

 
34,911

Mortgages and notes payable, net
3,738,053

 
3,929,117

 
3,743,098

 
3,892,621


Note 10. Significant Credit and Revenue Concentration
As of March 31, 2014 and December 31, 2013, the Company’s real estate investments are operated by 387 and 377 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”), 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 three months ended March 31, 2014 and 2013, contributed 14.0% and 29.0% of the Company's total revenues from continuing and discontinued operations, respectively. No other tenant contributed 10% or more of the Company’s total revenues during any of the periods presented. As of March 31, 2014 and December 31, 2013, the combined properties that are operated by Shopko/Pamida represent approximately 14.1% and 14.4%, respectively, of the Company’s total investment portfolio.

Note 11. Discontinued Operations

In April 2014, the FASB issued ASU 2014-08, which amends the requirements for reporting discontinued operations (see Note 2). Under ASU 2014-08, a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results. The Company has early adopted the provisions of ASU 2014-08 beginning with the period ended March 31, 2014, and will apply the provisions prospectively. Properties that were reported as held for sale as of December 31, 2013, will continue to be reported under the prior standards and will be presented in discontinued operations until they are disposed of.

21


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

As a result, net gains or losses from the disposition of these properties, as well as the current and prior period operations, of these properties will continue to be reclassified to discontinued operations. The results of discontinued operations for the three months ended March 31, 2014 and 2013, are summarized below (dollars in thousands): 
 
Three Months Ended
March 31,
 
2014
 
2013
Revenues:
 
 
 
Rent
$
308

 
$
2,222

Non-cash rent
(29
)
 
18

    Other
2,917

 

Total revenues
3,196

 
2,240

Expenses:
 
 
 
General and administrative
3

 
9

Property costs
139

 
74

Interest

 
194

Depreciation and amortization

 
1,377

Impairments

 
2,103

Total expenses
142

 
3,757

Gain (loss) from discontinued operations before other income
3,054

 
(1,517
)
Other income:
 
 
 
Other

 
23

Total other income

 
23

Income (loss) from discontinued operations
3,054

 
(1,494
)
(Loss) gain on dispositions of assets
(7
)
 
180

Total discontinued operations
$
3,047

 
$
(1,314
)
 Number of properties disposed of during period (a)
2

 
6

(a) During the three months ended March 31, 2014 three properties were disposed of, but only two of them were held for sale at December 31, 2013 and qualified for discontinued operations under ASU 2014-08.

Note 12. Supplemental Cash Flow Information
 
Three Months Ended
March 31,
 
2014
 
2013
Supplemental Disclosures of Non-Cash Investing and Financing Activities:
(in thousands)
Distributions declared and unpaid
$
61,628

 
$
26,501

Reduction of debt through sale of certain real estate properties

 
(974
)
Real estate properties acquired under 1031 exchange
20,784

 

Accrued deferred financing costs

 
6,356



22


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

Note 13. Incentive Award Plan and Stock Option Plan
Under the Company’s Incentive Award Plan (the “Plan”), the Company 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. As of March 31, 2014, 2.6 million shares remained available for award under the Plan.
Restricted Shares of Common Stock
During the three months ended March 31, 2014, the Company granted 0.4 million shares under the Plan to certain named executive officers and employees. The Company recorded $3.8 million in deferred compensation associated with all restricted share grants under the Plan. As of March 31, 2014, approximately 2.0 million non-vested restricted shares of common stock were outstanding.
Performance Share Awards
During the three months ended March 31, 2014, in connection with the 2014 bonus program, the Compensation Committee of the Board of Directors approved an initial target grant of 242,883 performance shares to the named executive officers of the Company. The performance period of this grant runs from January 1, 2014 through December 31, 2016. Pursuant to the performance share award agreement, each participant is eligible to vest in and receive shares of the Company's common stock based on the initial target number of shares granted multiplied by a percentage range between 0% and 250%. The percentage range is based on the attainment of total shareholder return of the Company compared to a specified peer group of companies during the performance period. In addition, each performance share award entitles its holder to a cash payment equal to the aggregate dividends that would have been outstanding on each dividend record date over the performance period. Based on the grant date fair value, the Company expects to recognize $3.3 million in compensation expense on a straight-line basis over the requisite service period associated with this grant.
As of March 31, 2014, under each separate annual performance award, the Company's total shareholder return compared to the specified peer group during the performance periods would have resulted in the release of 1.5 million shares, in the aggregate. In addition, approximately $0.3 million in dividend rights have been accrued. The projected shares to be released are not considered issued under the Plan until the performance period has ended and the actual number of shares to be released is determined. The performance shares and dividend rights are subject to forfeiture in the event of a non-qualifying termination of a participant prior to the performance period end date.
Stock compensation
For the three months ended March 31, 2014 and 2013, the Company recognized $2.5 million and $1.8 million, respectively, in stock-based compensation expense, which is included in general and administrative expenses in the accompanying condensed consolidated statements of operations.
As of March 31, 2014 and December 31, 2013, the remaining unamortized stock-based compensation expense, including amounts relating to the performance awards, totaled $20.2 million and $15.6 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.


23


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

Note 14. Earnings (Loss) Per Share
Earnings per share have been computed using the two-class method. Earnings per common share under the two-class method are computed by dividing the sum of distributed earnings to common stockholders and undistributed earnings allocated to common stockholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities based on the weighted average shares outstanding during the period. Classification of the Company's unvested restricted stock, which contain rights to receive nonforfeitable dividends, are deemed participating securities under the two-class method. Under the two class method, earnings attributable to unvested restricted shares are deducted from income (loss) from continuing operations and net income (loss) attributable to common stockholders in the computation of income (loss) per share for each.

The table below is a reconciliation of the numerator and denominator used in the computation of basic and diluted earnings (loss) per share (dollars in thousands):
 
Three Months 
 Ended March 31,
 
2014
 
2013
Basic and diluted earnings (loss):
 
 
 
Income (loss) from continuing operations
$
9,470

 
$
(7,018
)
Gain on dispositions of assets
1,722

 

Less: income attributable to unvested restricted stock
(333
)
 
(346
)
Income (loss) used in basic and diluted income (loss) per share from continuing operations
10,859

 
(7,364
)
Income (loss) from discontinued operations
3,047

 
(1,314
)
Net income (loss) attributable to common stockholders used in basic an diluted income (loss) per share
$
13,906

 
$
(8,678
)
 
 
 
 
Basic weighted average shares of common stock outstanding:
 
 
 
Weighted average shares of common stock outstanding
370,535,587

 
161,599,979

Less: Unvested weighted average shares of restricted stock
(1,850,645
)
 
(2,178,602
)
Weighted average number of shares outstanding used in basic income (loss) per share
368,684,942

 
159,421,377

 
 
 
 
Dilutive weighted average shares of common stock (a)
 
 
 
Unvested performance shares
697,638

 

Stock options
5,058

 

Weighted average number of shares of common stock used in dilutive income (loss) per share
369,387,638

 
159,421,377

 
 
 
 
Potentially dilutive shares of common stock
 
 
 
Unvested shares of restricted stock
688,348

 
725,249

 
 
 
 
(a)  Assumes the most dilutive issuance of potentially issuable shares between the two-class and treasury method unless the result would be anti-dilutive.
 
 


24


SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
March 31, 2014
(Unaudited)

Note 15. Subsequent Events

Spirit Master Funding Notes Exchange Offer

On April 9, 2014, the Company commenced an exchange offer for up to approximately $912.4 million in anticipated principal balance of certain net-lease mortgage notes issued by indirect wholly-owned subsidiaries Spirit Master Funding, LLC, Spirit Master Funding II, LLC and Spirit Master Funding III, LLC under the Company's Spirit Master Funding program.  The offer is to exchange any and all of the existing notes for no more than an equal aggregate principal amount of new net-lease mortgage notes from the same issuers.  The exchange offer is subject to the satisfaction or waiver of certain conditions set forth in the offering documents, including that at least 98% of the aggregate outstanding principal amount of existing notes be tendered for exchange (the "Minimum Tender Amount").  As of April 28, 2014, this Minimum Tender Amount had been tendered for exchange. 

In the event that the exchange offer is completed, among other differences, the new notes will be scheduled to amortize at a slower rate than the notes for which they are exchanged and each series of new notes will have a legal final payment date that is later than the legal final payment for the series of notes for which it is exchanged (the legal final payment dates for the three series of existing notes will occur in July 2023, March 2024 and March 2025, and the legal final payment dates for the three series of new notes will occur in July 2040, March 2041 and March 2042).

The exchange offer and the issuance of the new notes have not been and will not be registered with the SEC under the Securities Act of 1933, as amended (the “Securities Act”), or any other securities laws. The exchange offer will only be made, and the new notes are only being offered and will only be issued, to holders of existing notes (i) in the United States, that are “qualified institutional buyers” as defined in Rule 144A under the Securities Act (each, a “QIB”) and (ii) outside the United States, that are persons other than “U.S. persons” in compliance with Regulation S under the Securities Act.
At the Market Common Stock Offering Program
On April 15, 2014, in connection with the commencement of a “continuous equity offering,” the Company filed with the SEC a prospectus supplement (the “Prospectus Supplement”) under which the Company may sell up to an aggregate of $350.0 million of its common stock (the “Shares”) from time to time in “at the market” offerings (the “Offering”). The Company may sell the Shares in amounts and at times to be determined by the Company from time to time, but has no obligation to sell any of the Shares in the Offering. The Shares sold will be issued pursuant to the Prospectus Supplement and the Company’s shelf registration statement on Form S-3 (file No. 333-192237), which was filed with the SEC, and became effective on, November 8, 2013.
The Offering will operate pursuant to an equity distribution agreement (the “Agreement”) entered into by the Company and the Operating Partnership with a number of sales agents for the offer and sale of the Shares. The Agreement provides that a sales agent will be entitled to compensation that will not exceed, but may be lower than, 2.0% of the gross sales price of any of the Shares sold through it as sales agent. 
The Company sold 1,574,320 Shares under the program prior to April 24, 2014 for gross proceeds of $16.8 million at the weighted average Share price of $10.70, with aggregate net proceeds to the Company of $16.6 million after sales agent compensation. The proceeds from the sales were contributed to the Operating Partnership and used for general corporate purposes.


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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;
the risk that significant information technology systems conversions that we are undertaking or may undertake in the future may take longer to implement than expected or that anticipated benefits may not be realized;
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 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. 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.


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Overview
Spirit Realty Capital, Inc. (the "Company") is a Maryland corporation and operates as a self-administered and self-managed REIT that seeks to generate and deliver sustainable and attractive returns for stockholders by investing primarily in and managing a portfolio of single-tenant, operationally essential real estate throughout the United States that is generally leased on a long-term, triple-net basis primarily to tenants engaged in retail, service and distribution industries. Single tenant, operationally essential real estate generally refers to free-standing, commercial real estate facilities where tenants conduct activities that are essential to the generation of their sales and profits.
On July 17, 2013, the Company merged with and into Cole Credit Property Trust II, Inc. ("Cole II"), a Maryland Corporation, pursuant to the Merger Agreement ("Merger").
The Company’s operations are carried out through its operating partnership, Spirit Realty, L.P. (the “Spirit Operating 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.
We have elected to be taxed as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2005. 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.
We generate our revenue primarily by leasing our properties to our tenants. As of March 31, 2014, our undepreciated gross investment in real estate and loans totaled approximately $7.38 billion, representing investment in 2,287 properties, including properties securing our mortgage loans. Of this amount, 98.4% consisted of our gross investment in real estate, representing ownership of 2,142 properties, and the remaining 1.6% consisted of commercial mortgage and equipment loans receivable secured by 145 properties or related assets. As of March 31, 2014, our owned properties were approximately 98.9% occupied (based on number of properties), and our leases had a weighted average non-cancelable remaining lease term (based on annual contractual rent) of approximately 10.2 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 March 31, 2014, approximately 87% of our single-tenant properties (based on annual rent) provided for increases in future annual base contractual rent.

2014 Highlights

For the first quarter ended March 31, 2014:
Generated revenues of $144.0 million, more than doubling the revenues reported in the first quarter of 2013.
Produced Funds from Operations (FFO) of $0.20 per share, Adjusted Funds from Operations (AFFO) of $0.20 per share, and net income of $0.04 per share.
Acquired 104 properties for a gross investment of $157.1 million in 12 real estate transactions with an initial cash yield of 7.81% and an average remaining lease term of 12.2 years.

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 87% of our single-tenant properties contain rent escalators, or provisions that periodically increase the base rent payable by the tenant under the lease. Generally, our rent escalators increase rent at specified dates by: (1) a fixed amount; or (2) the lesser of (a) 1 to 1.25 times any increase in the CPI over a specified period, or (b) a fixed percentage, typically 1% to 2% per year. As of March 31, 2014, 98.9% of our owned properties (based on number of properties) were occupied.
For the three months ended ended March 31, 2014, Shopko/Pamida contributed 14.0% of our total revenue. Walgreen Company (“Walgreens”), our next largest tenant, contributed 4.1% of our total revenue for the three months ended March 31, 2014. 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.

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Table of Contents

Without giving effect to the exercise of tenant renewal options, the weighted average remaining term of our leases as of March 31, 2014 was 10.2 years (based on annual rent). Approximately 16.4% of our leases (based on annual rent) as of March 31, 2014 will expire prior to January 1, 2019. 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. As of March 31, 2014, approximately 80% of our properties (based on annual rent) are subject to triple-net leases. Occasionally, we have entered into a lease pursuant to which we retain responsibility for the costs of structural repairs and maintenance. Although these instances are infrequent and have not historically resulted in significant costs to us, an increase in costs related to these responsibilities could negatively influence our operating results. Similarly, an increase in the vacancy rate of our portfolio would increase our costs, as we would be responsible for costs that our tenants are currently required to pay. Additionally, contingent rents based on a percentage of the tenant’s gross sales have been historically negligible, contributing less than 1% of our rental revenue. Approximately 42.8% of our annual rent is attributable to master leases, where multiple properties are leased to a single tenant on an “all or none” basis and which contain cross-default provisions. Where appropriate, we seek to use master leases to prevent a tenant from unilaterally giving up underperforming properties while maintaining well performing properties.
Interest Expense
As of March 31, 2014, we had an approximately $3.9 billion principal balance outstanding of predominately secured, fixed-rate mortgage notes payable and borrowings under our revolving credit facilities. During the three months ended March 31, 2014, the weighted average interest rate on our fixed and variable-rate debt, excluding the amortization of deferred financing costs and debt discounts, was approximately 5.80%. 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 26 mortgage notes. We entered into interest rate swaps that effectively fixed the interest rates at approximately 4.55% on a significant portion of this variable rate debt. We amortize 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 three months ended March 31, 2014, non-cash interest expense recognized on our revolving credit facilities, mortgages and notes payable totaled approximately $0.1 million. Any changes to our debt structure, including borrowings under the $400.0 million Credit Facility or debt financing associated with property acquisitions, could materially influence our operating results depending on the terms of any such indebtedness. Most of our debt provides for scheduled principal payments. As principal is repaid, our interest expense decreases.
General and Administrative Expenses
General and administrative expenses include employee compensation costs, professional fees, consulting, portfolio servicing costs and other general and administrative expenses. As a public company, our annual general and administrative expenses have increased due to added legal, insurance, accounting and other expenses related to corporate governance, SEC reporting and other compliance matters. In connection with our Merger, we expect to incur additional 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 as a result of more than doubling our investment portfolio since December 2012.
Transaction Costs
As we acquire properties, we may incur transaction costs that we may be required to expense.

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Table of Contents

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 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, 2013 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.


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Table of Contents

Results of Operations
Comparison of the Three Months Ended March 31, 2014 to Three Months Ended March 31, 2013
The following discussion includes the results of our continuing operations as summarized in the table below:
 
Three Months Ended March 31,
 
2014
 
2013
 
 Change
 
 %
 
 (In Thousands)
 
 
Revenues:
 
 
 
 
 
 
 
Rentals
$
137,479

 
$
69,776

 
$
67,703

 
97.0
%
Interest income on loans receivable
1,837

 
1,113

 
724

 
65.0
%
Earned income from direct financing leases
846

 

 
846

 
NM

Tenant reimbursement income
3,319

 

 
3,319

 
NM

Interest income and other
491

 
79

 
412

 
521.5
%
Total revenues
143,972

 
70,968

 
73,004

 
102.9
%
Expenses:
 
 
 
 
 
 
 
General and administrative
11,067

 
6,968

 
4,099

 
58.8
%
Merger costs

 
6,537

 
(6,537
)
 
100.0
%
Property costs
5,282

 
940

 
4,342

 
461.9
%
Real estate acquisition costs
1,281

 
89

 
1,192

 
1,339.3
%
Interest
54,399

 
36,439

 
17,960

 
49.3
%
Depreciation and amortization
60,549

 
26,939

 
33,610

 
124.8
%
Impairments
1,707

 

 
1,707

 
NM

Total expenses
134,285

 
77,912

 
56,373

 
72.4
%
Income (loss) from continuing operations before income tax expense
9,687

 
(6,944
)
 
16,631

 
239.5
%
Income tax expense
217

 
74

 
143

 
193.2
%
Income (loss) from continuing operations
$
9,470

 
$
(7,018
)
 
$
16,488

 
234.9
%
 
 
 
 
 
 
 
 
Gains on dispositions of assets
$
1,722

 
$

 
$
1,722

 
NM

Revenues
For the three months ended March 31, 2014, approximately 95.5% of our total revenues were attributable to long-term leases. Total revenue increased by $73.0 million to $144.0 million for the three months ended March 31, 2014 as compared to $71.0 million for same period in 2013. The increase in revenue was due primarily to $63.3 million of additional revenue provided by the properties acquired in the Merger. The remaining increase is attributable to an increase in base rental revenue resulting from $509.6 million of non-merger real estate acquisitions subsequent to March 31, 2013 and contractual rent escalations on our owned real estate properties.

Rentals
Rental revenue increased by $67.7 million to $137.5 million for the three months ended March 31, 2014 as compared to $69.8 million for the same period in 2013. The increase was primarily attributable to $59.0 million of rental income generated from properties acquired in the the Merger. Rental revenue attributable to non-cash straight-line rent and amortization of above and below-market lease intangibles for the three months ended March 31, 2014 and 2013 was $4.7 million and $0.8 million, respectively, representing approximately 3.4% and 1.1% of total rental revenue from continuing operations for each of the three months ended March 31, 2014 and 2013, respectively. Additionally, subsequent to March 31, 2013, we acquired 267 properties with a gross investment value of $509.6 million, which contributed to the rental increase. Furthermore, contractual rent escalations subsequent to March 31, 2013 also contributed to the increase.


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Table of Contents

As of March 31, 2014, 98.9% 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. As of March 31, 2014, 24 of our properties representing approximately 1.1% of our owned properties were vacant and not generating rent compared to 13 vacant properties, representing 1.1% of our owned properties, as of March 31, 2013.
Interest income on loans receivable and other income
Interest income on loans receivable increased by $0.7 million to $1.8 million for the three months ended March 31, 2014 as compared to $1.1 million for the same period in 2013. The increase was attributable to $1.0 million of additional income from loans receivable acquired in the Merger, which was offset by the decrease in income related to the prepayment of three notes as well as scheduled maturities and amortization totaling $15.7 million subsequent to March 31, 2013.
In connection with the Merger, the Company acquired 13 properties accounted for as direct financing leases which generated earned income of $0.8 million for the three month period ended March 31, 2014. 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 March 31, 2014 of $3.3 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 $0.1 million for the three month periods ended March 31, 2014 and 2013, respectively. Of the $0.5 million recorded during the current period, $0.4 million related to lease settlement fees.
Expenses
General and administrative
General and administrative expenses increased $4.1 million to $11.1 million for the three months ended March 31, 2014, as compared to $7.0 million for the same period in 2013. During the three months ended March 31, 2014, the Company incurred higher compensation and related benefits of $1.8 million due primarily to the hiring of additional personnel in connection with the Merger along with $0.7 million of higher non-cash stock based compensation. Professional fees, technology costs and outside consulting services increased $2.2 million during 2014 primarily due to higher costs incurred for compliance and consulting fees incurred in connection with the integration of the net assets acquired in the Merger.

Merger Related Costs
In connection with the Merger, the Company incurred merger related costs of approximately $6.5 million for the three months ended March 31, 2013, which include legal, accounting and financial advisory services, and other third-party expenses. No such costs were incurred during the same period in 2014.
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 a limited number of 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 $4.3 million to $5.3 million for the three months ended March 31, 2014, as compared to $0.9 million for the same period in 2013. Of this increase, approximately $4.0 million is attributable to reimbursable costs associated with acquired non-triple-net leases.
Interest
Interest expense increased by $18.0 million to $54.4 million for the three months ended March 31, 2014, as compared to $36.4 million for the same period in 2013. The increase in interest expense was primarily due to the the increase

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Table of Contents

in total indebtedness of approximately $2.0 billion at March 31, 2014 compared to the same period in 2013. The vast majority of our increased indebtedness was the assumption of debt in connection with our Merger.
The following table summarizes our interest expense and related borrowings from continuing operations:
 
 Three Months Ended
 
March 31,
 
2014
 
2013
 
 (In Thousands)
Interest expense – revolving credit facilities
$
720

 
$
105

Interest expense – mortgages and notes payable
53,596

 
29,472

Interest expense – other
39

 

Amortization of deferred financing costs
973

 
3,901

Amortization of debt (premium) discount
(929
)
 
2,961

Total interest expense
$
54,399

 
$
36,439

 
 
 
 
Weighted average mortgages and notes outstanding excluding debt premium or discount (1)
$
3,742,026

 
$
1,961,731

Weighted average revolving credit facilities
60,502

 

Weighted average debt outstanding
$
3,802,528

 
$
1,961,731

Adjusted mortgages and notes interest (2) / weighted average mortgages and notes payable
5.73
%
 
6.01
%
Revolving credit facilities interest (3) / weighted average revolving credit facilities balance
4.76
%
 
%
(1)  Excludes debt associated with discontinued operations
 
 
 
(2)  Excludes interest expense associated with amortization of deferred financing costs and debt discounts.
(3)  Excludes interest expense associated with amortization of deferred financing costs and debt discounts, and includes approximately $0.3 million of non-utilization fees.
Depreciation and amortization
Depreciation and amortization expense relates primarily to depreciation on the commercial buildings and improvements we own and to amortization of the related lease intangibles. Depreciation and amortization expense increased by $33.6 million to $60.5 million for the three months ended March 31, 2014 as compared to $26.9 million for the same period in 2013. Of the total increase, a significant portion relates to depreciation and amortization on assets acquired in the Merger, with the remainder related to non-merger acquisitions. The following table summarizes our depreciation and amortization expense from continuing operations:
 
 Three Months Ended
 
March 31,
 
2014
 
2013
 
 (In Thousands)
Depreciation of real estate assets
$
47,016

 
$
22,492

Other depreciation
94

 
27

Amortization of lease intangibles
13,439

 
4,420

Total depreciation and amortization
$
60,549

 
$
26,939


Income tax expense
Income tax expense increased $0.1 million to $0.2 million for the three months ended March 31, 2014, as compared to $0.1 million for the same period in 2013. The increase was primarily due to an increase in income from operations contributed by properties acquired in the Merger.     
     

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Discontinued operations
Gains and losses from property dispositions during a period or expected losses from properties classified as held for sale at the end of the period, as well as all operations from those properties, are reclassified to and reported as part of “discontinued operations” so long as they meet certain criteria set forth in ASU 2014-08 (see Note 2). Properties that were reported as held for sale as of December 31, 2013, will continue to be reported under the prior standards and will be presented in discontinued operations until they are disposed of.
We recognized income from discontinued operations of $3.0 million for three months ended March 31, 2014 as compared to a loss of $1.3 million for the same period in 2013. For the three months ended March 31, 2014, $2.9 million of income was attributable to the receipt of a lease termination fee related to a property that was sold. For the same period in 2013, $1.5 million of loss was attributable to the properties held for sale. Non-cash impairment charges included in income from discontinued operations for the three months ended March 31, 2013 were $2.1 million. No such charges were incurred during the same period in 2014.
Gain on dispositions of assets
During the three months ended March 31, 2014, we recorded gains totaling $1.7 million from continuing operations on the disposition of certain real estate assets. These gains relate to disposed properties that did not qualify for discontinued operations under the guidance set forth in ASU 2014-08. Previous to the adoption of ASU 2014-08, which has been applied on a prospective basis during the three months ended March 31, 2014, these gains would have been recorded as part of discontinued operations.
Property Portfolio Information
Our diverse real estate portfolio at March 31, 2014 consisted of 2,142 owned properties:
leased to approximately 387 tenants;
located in 48 states as well as in the U.S. Virgin Islands, with only 4 states contributing 5% or more of our annual rent;
operating in 19 different industries;
with an occupancy rate of 98.9%; and
with a weighted average remaining lease term of 10.2 years.
The following tables present the diversity of our portfolio and are calculated based on percentage of contractual annual rent.

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Diversification By Tenant
The following table lists the top 10 tenants of our owned real estate properties as of March 31, 2014:
Tenant (2)
 
Number of Properties
 
Percent of Total Revenue (1)
 
Shopko Stores/Pamida Operating Co., LLC
 
181

 
14.0
%
Walgreen Company
 
69

 
4.1
 
84 Properties, LLC
 
109

 
3.3
 
Cajun Global LLC (Church's Chicken)
 
201

 
2.5
 
Academy Sports + Outdoors
 
9

 
2.2
 
Alimentation Couche-Tard, Inc. (Circle K)
 
83

 
2.1
 
CVS Caremark
 
37

 
1.7
 
CarMax, Inc.
 
9

 
1.4
 
Carmike Cinemas, Inc.
 
12

 
1.4
 
Rite Aid Corp
 
30

 
1.3
 
Other
 
1,402

 
66.0
 
Total
 
2,142

 
100.0
%
 
 
 
 
 
 
(1)  Total revenue for the quarter ended March 31, 2014.
 
 
 
(2)  Tenants represent legal entities with whom we have lease agreements. Other tenants may operate certain of the same business concepts set forth above, but represent separate legal entities.
 

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Diversification By Industry
The following table sets forth information regarding the diversification of the tenants leasing our owned real estate properties among different industries as of March 31, 2014:
Industry
 
Number of Properties
 
Percent of Total Rent (1)
 
Specialty Retail
 
194

 
18.5

%
General and discount retail
 
237

 
18.2

 
Restaurants - Quick Service
 
657

 
9.7

 
Drug Stores
 
134

 
7.5

 
Restaurants - Casual Dining
 
207

 
7.4

 
Automotive dealers, parts and service
 
143

 
5.3

 
Convenience Stores/car washes
 
158

 
4.5

 
Movie Theaters
 
25

 
4.2

 
Building material suppliers
 
110

 
3.6

 
Medical/other office
 
83

 
3.4

 
Industrial
 
29

 
3.1

 
Educational
 
33

 
2.9

 
Health clubs/gyms
 
18

 
2.3

 
Home Improvement
 
11

 
2.2

 
Supermarkets
 
39

 
2.1

 
Distribution
 
44

 
2.0

 
Recreational Facilities
 
8

 
1.4

 
Air Delivery & Freight Services
 
9

 
1.2

 
Interstate travel plazas
 
3

 
0.5

 
Total
 
2,142

 
100.0

%
 
 
 
 
 
 
(1)  Total rental revenue for the quarter ended March 31, 2014.
 
 
 


Diversification By Asset Type
The following table sets forth information regarding the diversification of our owned real estate properties among different asset types as of March 31, 2014:

Asset Type
 
Number of Properties
 
Percent of Total Revenue (1)
 
Retail
 
1,973

 
85.6
%
Industrial
 
80

 
9.0
 
Office
 
89

 
5.4
 
Total
 
2,142

 
100.0
%
 
 
 
 
 
 
(1)  Total rental revenue for the quarter ended March 31, 2014.
 
 
 


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Diversification By Geography
The following table sets forth information regarding the geographic diversification of our owned real estate properties as of March 31, 2014:
State
 
Number of Properties
 
Percent of Total Rent (1)
 
Texas
 
266

 
12.5
%
Illinois
 
125

 
6.5
 
Wisconsin
 
63

 
5.9
 
Georgia
 
154

 
5.0
 
Florida
 
116

 
4.5
 
Ohio
 
122

 
4.4
 
Arizona
 
49

 
2.9
 
Minnesota
 
48

 
2.9
 
Tennessee
 
111

 
2.9
 
Michigan
 
48

 
2.8
 
Indiana
 
72

 
2.8
 
North Carolina
 
64

 
2.7
 
Missouri
 
66

 
2.7
 
Alabama
 
100

 
2.7
 
Nebraska
 
21

 
2.6
 
South Carolina
 
45

 
2.6
 
California
 
15

 
2.4
 
Pennsylvania
 
64

 
2.4
 
Virginia
 
46

 
2.2
 
Kansas
 
28

 
1.9
 
Colorado
 
26

 
1.6
 
Utah
 
15

 
1.6
 
Idaho
 
15

 
1.6
 
New York
 
44

 
1.5
 
Oklahoma
 
47

 
1.5
 
Massachusetts
 
8

 
1.5
 
Nevada
 
4

 
1.4
 
Kentucky
 
44

 
1.3
 
Iowa
 
37

 
1.3
 
New Hampshire
 
17

 
1.0
 
Washington
 
13

 
1.0
 
Louisiana
 
30

 
1.0
 
New Mexico
 
24

 
*
 
Oregon
 
8

 
*
 
South Dakota
 
11

 
*
 
New Jersey
 
13

 
*
 
Mississippi
 
29

 
*
 
Maryland
 
22

 
*
 
Montana
 
7

 
*
 
West Virginia
 
26

 
*
 
Arkansas
 
28

 
*
 

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Table of Contents

State
 
Number of Properties
 
Percent of Total Rent (1)
 
North Dakota
 
5

 
*
 
Maine
 
26

 
*
 
Rhode Island
 
4

 
*