SRC-2014.06.30-10Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 August 1, 2014, there were 398,809,443 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 June 30, 2014 (Unaudited) and December 31, 2013
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2014 and 2013 (Unaudited)
Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2014 and 2013 (Unaudited)
Condensed Consolidated Statement of Stockholders' Equity for the six months ended June 30, 2014 (Unaudited)
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 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)

 
June 30,
2014
 
December 31,
2013
 
(Unaudited)
 
 
Assets
 
 
 
Investments:
 
 
 
Real estate investments:
 
 
 
Land and improvements
$
2,453,528

 
$
2,330,510

Buildings and improvements
4,356,795

 
4,188,783

Total real estate investments
6,810,323

 
6,519,293

Less: accumulated depreciation
(679,453
)
 
(590,067
)
 
6,130,870

 
5,929,226

Loans receivable, net
113,321

 
117,721

Intangible lease assets, net
599,107

 
618,121

Real estate assets under direct financing leases, net
56,729

 
58,760

Real estate assets held for sale, net
40,955

 
19,611

Net investments
6,940,982

 
6,743,439

Cash and cash equivalents
120,976

 
66,588

Deferred costs and other assets, net
147,528

 
129,597

Goodwill
291,421

 
291,421

Total assets
$
7,500,907

 
$
7,231,045

Liabilities and stockholders’ equity
 
 
 
Liabilities:
 
 
 
Revolving credit facilities, net
$
15,528

 
$
35,120

Mortgages and notes payable, net
3,202,853

 
3,743,098

Convertible senior notes, net
691,711

 
—

Intangible lease liabilities, net
216,714

 
220,114

Accounts payable, accrued expenses and other liabilities
111,753

 
114,679

Total liabilities
4,238,559

 
4,113,011

Commitments and contingencies (see Note 8)


 


Stockholders’ equity:
 
 
 
Common stock, $0.01 par value; 399,030,681 shares issued; 398,812,745 outstanding shares at June 30, 2014 and 370,570,565 shares issued; 370,363,803 outstanding shares at December 31, 2013
3,990

 
3,706

Capital in excess of par value
4,208,376

 
3,859,823

Accumulated deficit
(946,705
)
 
(742,915
)
Accumulated other comprehensive loss
(1,261
)
 
(638
)
Treasury stock, at cost
(2,052
)
 
(1,942
)
Total stockholders’ equity
3,262,348

 
3,118,034

Total liabilities and stockholders’ equity
$
7,500,907

 
$
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
June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
Rentals
$
143,142

 
$
70,050

 
$
280,621

 
$
139,826

Interest income on loans receivable
1,821

 
1,128

 
3,658

 
2,241

Earned income from direct financing leases
838

 
—

 
1,684

 
—

Tenant reimbursement income
2,921

 
—

 
6,240

 
—

Interest income and other
3,067

 
1,236

 
3,558

 
1,315

Total revenues
151,789

 
72,414

 
295,761

 
143,382

Expenses:
 
 
 
 
 
 
 
General and administrative
10,451

 
9,151

 
21,501

 
16,119

Finance restructuring costs
13,016

 
—

 
13,033

 
—

Merger costs
—

 
5,020

 
—

 
11,557

Property costs
6,576

 
327

 
11,858

 
1,267

Real estate acquisition costs
226

 
129

 
1,507

 
218

Interest
55,992

 
39,552

 
110,391

 
75,991

Depreciation and amortization
61,968

 
29,700

 
122,517

 
56,639

Impairments (recoveries)
27,627

 
(185
)
 
29,334

 
(185
)
Total expenses
175,856

 
83,694

 
310,141

 
161,606

Loss from continuing operations before other expense and income tax expense
(24,067
)
 
(11,280
)
 
(14,380
)
 
(18,224
)
Other expense:
 
 
 
 
 
 
 
Loss on debt extinguishment
(64,708
)
 
—

 
(64,708
)
 
—

Total other expense
(64,708
)
 
—

 
(64,708
)
 
—

Loss from continuing operations before income tax expense
(88,775
)
 
(11,280
)
 
(79,088
)
 
(18,224
)
Income tax expense
127

 
68

 
344

 
142

Loss from continuing operations
(88,902
)
 
(11,348
)
 
(79,432
)
 
(18,366
)
Discontinued operations:
 
 
 
 

 

Income (loss) from discontinued operations
279

 
(130
)
 
3,333

 
(1,624
)
Gain (loss) on dispositions of assets
92

 
(191
)
 
85

 
(11
)
Income (loss) from discontinued operations
371

 
(321
)
 
3,418

 
(1,635
)
Loss before dispositions of assets
(88,531
)
 
(11,669
)
 
(76,014
)
 
(20,001
)
(Loss) gain on dispositions of assets
(1,290
)
 
—

 
432

 
—

Net loss
$
(89,821
)
 
$
(11,669
)
 
$
(75,582
)
 
$
(20,001
)
Net (loss) income per share of common stock—basic and diluted:
 
 
 
 
 
 
 
Continuing operations
$
(0.24
)
 
$
(0.08
)
 
$
(0.21
)
 
$
(0.12
)
Discontinued operations
—

 
—

 
0.01

 
(0.01
)
Net loss per share
$
(0.24
)
 
$
(0.08
)
 
$
(0.20
)
 
$
(0.13
)
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic and diluted
381,775,203

 
159,430,126

 
375,266,233

 
159,425,775

Dividends declared per common share issued
$
0.16625

 
$
0.16410

 
$
0.33250

 
$
0.32820

See accompanying notes.

4

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

 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Net loss
$
(89,821
)
 
$
(11,669
)
 
$
(75,582
)
 
$
(20,001
)
Other comprehensive (loss) income:
 
 
 
 
 
 
 
Change in net unrealized (losses) or gains on cash flow hedges
(875
)
 
502

 
(1,277
)
 
470

Net cash flow hedge losses reclassified to operations
331

 
95

 
654

 
210

Total comprehensive loss
$
(90,365
)
 
$
(11,072
)
 
$
(76,205
)
 
$
(19,321
)
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 loss
—

 
—

 
—

 
(75,582
)
 
—

 
—

 
—

 
(75,582
)
Other comprehensive loss
—

 
—

 
—

 
—

 
(623
)
 
—

 
—

 
(623
)
Dividends declared on common stock
—

 
—

 
—

 
(127,928
)
 
—

 
—

 
—

 
(127,928
)
Repurchase of common shares
—

 
—

 
—

 
—

 
—

 
(11,174
)
 
(110
)
 
(110
)
Issuance of common shares
28,024,320

 
280

 
287,174

 
—

 
—

 
—

 
—

 
287,454

Embedded conversion premium of convertible notes
—

 
—

 
55,131

 
—

 
—

 
—

 
—

 
55,131

Exercise of stock options
20,000

 
—

 
183

 
—

 
—

 
—

 
—

 
183

Stock-based compensation, net
415,796

 
4

 
6,065

 
(280
)
 
—

 
—

 
—

 
5,789

Balances, June 30, 2014
399,030,681

 
$
3,990

 
$
4,208,376

 
$
(946,705
)
 
$
(1,261
)
 
(217,936
)
 
$
(2,052
)
 
$
3,262,348

See accompanying notes.

6

SPIRIT REALTY CAPITAL, INC.
Condensed Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
 
Six Months Ended 
 June 30,
 
2014
 
2013
Operating activities
 
 
 
Net loss
$
(75,582
)
 
$
(20,001
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
122,517

 
59,229

Impairments
29,334

 
3,704

Amortization of deferred financing costs
2,297

 
10,130

Amortization of interest rate hedge losses and derivative net settlements
(50
)
 
(32
)
Amortization of debt (premiums) discounts
(1,043
)
 
5,929

Stock-based compensation expense
5,484

 
4,102

Loss (gain) on debt extinguishment
64,708

 
(1,028
)
Debt extinguishment costs
(59,069
)
 
—

Gains on dispositions of real estate and other assets, net
(517
)
 
(207
)
Non-cash revenue
(8,344
)
 
(1,278
)
Other
242

 
192

Changes in operating assets and liabilities:
 
 
 
Deferred costs and other assets
(2,352
)
 
(2,284
)
Accounts payable, accrued expenses and other liabilities
(9,062
)
 
1,944

Net cash provided by operating activities
68,563

 
60,400

Investing activities
 
 
 
Acquisitions/investments in real estate
(345,109
)
 
(95,150
)
Collections of principal on loans receivable and real estate assets under direct financing leases
3,286

 
8,030

Proceeds from dispositions of real estate and other assets
14,218

 
4,947

Transfers of sale proceeds and loan principal collections (to) from restricted account
(13,054
)
 
10,589

Net cash used in investing activities
(340,659
)
 
(71,584
)
Financing activities
 
 
 
Borrowings under lines of credit
405,535

 
26,555

Repayments under lines of credit
(425,127
)
 
(63
)
Borrowings under mortgages and notes payable
757,500

 
35,140

Repayments under mortgages and notes payable
(553,882
)
 
(21,511
)
Deferred financing costs
(20,000
)
 
(8,123
)
Proceeds from issuance of common stock, net of offering costs
287,704

 
(293
)
Proceeds from exercise of stock options
183

 
—

Offering costs paid on equity component of convertible debt
(1,609
)
 
—

Purchase of treasury stock
(110
)
 
—

Consent fees paid to lenders
—

 
(1,586
)
Dividends paid to stockholders
(123,207
)
 
(54,757
)
Transfers (to) from escrow deposits with lenders
(503
)
 
285

Net cash provided by (used in) financing activities
326,484

 
(24,353
)
Net increase (decrease) in cash and cash equivalents
54,388

 
(35,537
)
Cash and cash equivalents, beginning of period
66,588

 
73,568

Cash and cash equivalents, end of period
$
120,976

 
$
38,031

See accompanying notes.

7

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements
June 30, 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 and a wholly-owned subsidiary are the sole limited partner and own the remaining 99.0% of the Operating Partnership.

As of June 30, 2014, our undepreciated gross investment in real estate and loans totaled approximately $7.55 billion, representing investments in 2,369 properties, including properties securing our mortgage loans. Of this amount, 98.5% consisted of our gross investment in real estate, representing ownership of 2,224 properties, and the remaining 1.5% consisted of commercial mortgage loans receivable secured by the remaining 145 properties or other related assets.
Recent Developments

Common Stock and Convertible Notes Offerings

On May 20, 2014, the Company completed a secondary public offering of 26,450,000 shares of the Company’s common stock (the "Shares"), par value $0.01 per share, pursuant to an underwriting agreement dated May 14, 2014 (the "Common Stock Offering"). The Shares sold in the offering include 3,450,000 shares of common stock sold to the underwriters pursuant to their 30-day option to purchase additional Shares of common stock to cover over-allotments, which was exercised in full on May 16, 2014.

Concurrent with the Common Stock Offering, on May 20, 2014, the Company completed public offerings of $402.5 million aggregate principal amount of 2.875% Convertible Senior Notes due 2019 (the “2019 Notes”) and $345.0 million aggregate principal amount 3.75% Convertible Senior Notes due 2021 (the “2021 Notes” and, together with the 2019 Notes, the “Convertible Notes”), pursuant to an underwriting agreement dated May 14, 2014 ( the "Convertible Notes Offering"). The Convertible Notes sold in the offering include $52.5 million of the 2019 Notes and $45.0 million of the 2021 Notes sold to the underwriters pursuant to their 30-day option to purchase additional notes to cover over-allotments, which was exercised in full on May 16, 2014.

The resulting net proceeds to the Company from the Common Stock Offering and Convertible Notes Offering were approximately $271.2 million and $726.2 million, respectively, after deducting the underwriting discount and other transaction costs. Net proceeds raised from the concurrent public offerings were partially used to extinguish senior mortgage notes payable with an aggregate principal balance of $509.8 million, redeem $18.0 million of net-lease mortgage notes which were not tendered in connection with the Exchange Offer, repay all amounts drawn against the Credit Facility and to fund future acquisitions and for general corporate purposes.






8

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

Spirit Master Funding Notes Exchange Offer

On May 20, 2014 (the “Settlement Date”), the Company completed its offer to exchange (the "Exchange Offer") any and all of certain net-lease mortgage notes, (the “Old Notes”) issued by one or more indirectly-owned special purpose, bankruptcy remote subsidiaries of the Company, for new notes under an amended trust indenture and property management agreement (the “New Notes”). The Exchange Offer was subject to a minimum tender condition of at least 98% of the outstanding principal of Old Notes. Of the $912.4 million of Old Notes outstanding on the Settlement Date, $894.4 million or 98% elected to exchange their Old Notes for New Notes and $18.0 million of the Old Notes not tendered were redeemed.

The New Notes will maintain generally similiar structural terms as the Old notes. The New Notes bear interest at the same rate, amortize at a slower rate and have a 17 year extension of the legal final payment date (although the anticipated repayment date remains the same). The New Notes are not insured by third party financial guaranty insurance and the associated insurance premium was eliminated. The New Notes are secured by substantially all of the assets owned by these entities.

Debt Defeasance
On June 5, 2014, two indirectly owned subsidiaries of the Company defeased the loans outstanding under a master loan agreement. The original amount under the loan agreement was $545.7 million bearing interest at a fixed rate of 6.59% with a maturity date of June 5, 2016. On the defeasance date, the principal balance outstanding under the loan agreement was approximately $488.7 million. Prior to the defeasance date, the obligations under the loan agreement had been secured by 112 properties and rents therefrom leased to a significant tenant, which had an aggregate gross book value of approximately $917.7 million as of June 30, 2014. The Company funded the defeasance using a portion of the proceeds from the Convertible Notes Offering.
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 Securities and Exchange Commission ("SEC") a prospectus supplement under which the Company may sell up to an aggregate of $350.0 million of shares from time to time in “at the market” offerings (the “ATM Program”). 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 ATM Program. The ATM Program will operate pursuant to an equity distribution agreement entered into by the Company and the Operating Partnership with a number of sales agents for the offer and sale of the shares. During the quarter ended June 30, 2014, the company sold 1,574,320 shares under the program, raising proceeds of approximately $16.6 million, net of $0.3 million in sales agent compensation.

Acquisitions and dispositions

During the six months ended June 30, 2014, the Company purchased 190 properties, representing an aggregate gross investment in real estate properties of $365.5 million, which includes $1.8 million in revenue producing follow on investments in existing properties. During the same period, the Company sold seven properties for $15.3 million in gross sales proceeds. See Note 3 for additional discussion of the Company's investments.

9

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

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 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 available to pay, or otherwise satisfy obligations to, the creditors of any owner or affiliate of the special purpose entity. At June 30, 2014 and December 31, 2013, assets totaling $6.3 billion and $6.1 billion, respectively, were held, and liabilities totaling $3.3 billion and $3.8 billion, respectively, were owed by these special purpose entities and are included in the accompanying condensed consolidated balance sheets.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although management believes its estimates are reasonable, actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to prior period balances to conform to the current period presentation.
Segment Reporting
Accounting Standards Codification Topic (“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

10

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

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.
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 $5.4 million and $4.6 million at June 30, 2014 and December 31, 2013, respectively, against accounts receivable balances of $18.8 million and $14.3 million, respectively; receivables are recorded within deferred costs and other assets, net in the accompanying condensed consolidated balance sheets. For deferred 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 June 30, 2014 and December 31, 2013, respectively, against deferred rental revenue receivables of $42.0 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 June 30, 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 June 30, 2014 and December 31, 2013, there were no mortgages or notes on nonaccrual status.

11

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

Restricted Cash and Escrow Deposits

Restricted cash and deposits in escrow, classified within deferred costs and other assets, net in the accompanying condensed consolidated balance sheets consisted of the following at June 30, 2014 and December 31, 2013:
 
June 30,
2014
 
December 31,
2013
Collateral deposits (1)
$
21,945

 
$
21,816

Tenant improvements, repairs, and leasing commissions (2)
12,035

 
10,297

Master trust release / title company escrow (3)
14,165

 
21,893

Loan impounds (4)
2,239

 
2,018

Other (5)
1,082

 
2,667

 
$
51,466

 
$
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) Includes 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.

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,

12

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

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.

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers: Topic 606. This new guidance establishes a principles-based approach for accounting for revenue from contracts with customers. Lease contracts covered by Topic 840, Leases, are excluded from the scope of this new guidance. This new standard is effective for annual reporting periods beginning after December 15, 2016 and early adoption is not permitted. The Company is currently evaluating the impact of this new standard on its financial statements.
Note 3. Investments
Real Estate Investments
At June 30, 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 $7.55 billion and $7.24 billion, respectively. These investments are comprised of 2,369 and 2,186, respectively, owned or financed properties that are geographically dispersed throughout 49 states. Only one state, Texas, with a 13.0% investment, accounted for more than 10% of the total dollar amount of the Company’s investment portfolio. At June 30, 2014 and December 31, 2013, respectively, the Company’s gross investment portfolio was comprised of 2,224 and 2,041 owned properties. The Company also held 145 properties securing mortgage loans receivable with aggregate carrying amounts of $112.9 million and $117.3 million as of June 30, 2014 and December 31, 2013, respectively. Other unsecured loans receivable with aggregate carrying amounts of $0.4 million were also held as of June 30, 2014 and December 31, 2013.
During the six months ended June 30, 2014, the Company had the following gross real estate and loan activity:
 
Number of
Properties
Owned or
Financed
 
Dollar
Amount of
Investments (1)
 
 
 
(In Thousands)
Balance, December 31, 2013
2,186

 
$
7,235,732

Acquisitions/improvements
190

 
365,893

Dispositions of real estate(2) (Note 11)
(7
)
 
(16,498
)
Principal payments and payoffs
—

 
(3,136
)
Impairments
—

 
(28,847
)
Loan premium amortization and other
—

 
(4,045
)
Balance, June 30, 2014
2,369

 
$
7,549,099

(1) 
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.
(2) The total accumulated depreciation and amortization associated with dispositions of real estate was $2.8 million for the six months ended June 30, 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 June 30, 2014, 29 of the Company’s properties were vacant, not subject to a lease and in the Company’s possession; three of these properties were held for sale. At December 31,

13

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

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 June 30, 2014 (in thousands):
Scheduled Future Rental Payments
June 30,
2014
Remainder of 2014
$
282,376

2015
557,731

2016
540,709

2017
525,579

2018
510,083

Thereafter
3,669,882

Total future minimum rentals
$
6,086,360

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.
Loans Receivable
The following table details loans receivable, net of premium, as of June 30, 2014 and December 31, 2013 (in thousands):
 
June 30,
2014
 
December 31,
2013
Mortgage - principal
$
99,203

 
$
102,315

Mortgage - premium
13,713

 
14,976

    Mortgages, net
112,916

 
117,291

Other notes - principal
405

 
430

Total loans receivable, net
$
113,321

 
$
117,721

Real Estate Assets Under Direct Financing Leases
The components of investment assets held under direct financing leases as of June 30, 2014 and December 31, 2013 were as follows (in thousands):
 
June 30,
2014
 
December 31,
2013
Minimum lease payments receivable
$
17,721

 
$
19,555

Estimated residual value of leased assets
55,858

 
57,739

Unearned income
(16,850
)
 
(18,534
)
Total
$
56,729

 
$
58,760


14

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

Real Estate Assets Held for Sale
The following table shows the activity in real estate assets held for sale for the six months ended June 30, 2014:
 
Number of
Properties
 
Carrying
Value
 
 
 
(In Thousands)
Balance, December 31, 2013
11

 
$
19,611

Transfers from real estate investments
6

 
29,290

Sales (Note 11)
(5
)
 
(7,946
)
Balance, June 30, 2014 (a)
12

 
$
40,955

(a) Includes six properties with a net carrying amount of $29.1 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 sheets as of June 30, 2014 and December 31, 2013 (in thousands):
 
June 30,
2014
 
December 31,
2013
Assets
 
 
 
Land and improvements
$
6,699

 
$
10,003

Buildings and improvements
7,460

 
14,178

Total real estate investments
14,159

 
24,181

Less: Accumulated depreciation
(2,613
)
 
(4,819
)
Intangible lease assets, net
567

 
697

  Other
228

 
—

Total assets
$
12,341

 
$
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 and six months ended June 30, 2014 and 2013 (in thousands): 
 
Three Months 
 Ended June 30,
 
Six Months 
 Ended June 30,
 
2014
 
2013
 
2014
 
2013
Real estate and intangible asset impairment
$
24,610

 
$
1,481

 
$
26,247

 
$
3,584

Write-off of lease intangibles due to lease terminations
2,529

 
487

 
2,599

 
487

Loans receivable recovery
—

 
(367
)
 
—

 
(367
)
Other impairment
488

 
—

 
488

 
—

Total impairment loss continuing and discontinued operations
$
27,627

 
$
1,601

 
$
29,334

 
$
3,704



15

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

Note 4. Lease Intangibles, net
The following table details lease intangible assets and liabilities, net of accumulated amortization, as of June 30, 2014 and December 31, 2013 (in thousands):
 
June 30,
2014
 
December 31,
2013
In-place leases
$
667,434

 
$
663,027

Above-market leases
98,631

 
95,118

Less: accumulated amortization
(166,958
)
 
(140,024
)
Intangible lease assets, net
$
599,107

 
$
618,121

 
 
 
 
Below-market leases
$
247,262

 
$
243,237

Less: accumulated amortization
(30,548
)
 
(23,123
)
Intangible lease liabilities, net
$
216,714

 
$
220,114

The amounts amortized as a net increase to rental revenue for capitalized above- and below-market leases was $3.0 million and $0.7 million for the six months ended June 30, 2014 and 2013, respectively. Above- and below-market lease amortization from properties acquired in connection with the Merger contributed $1.5 million of the increase during 2014. The value of in-place leases amortized and included in depreciation and amortization expense was $26.9 million and $8.8 million for the six months ended June 30, 2014 and 2013, respectively. Lease-in-place amortization from properties acquired in connection with the Merger contributed $16.7 million of the increase in 2014.
Note 5. Debt
The Company's debt is summarized below:
 

Weighted Average Effective
Interest Rates (1)
 
Weighted Average Stated Interest Rate (2)
 
June 30,
2014
 
December 31,
2013
 
 
 
 
 
(In Thousands)
Revolving credit facilities (3)
5.31
%
 
4.00%
 
$
15,528

 
$
35,120

Master trust notes
6.13
%
 
5.35%
 
1,209,131

 
1,241,437

CMBS - fixed-rate
5.55
%
 
5.68%
 
1,876,187

 
2,387,532

CMBS - variable-rate (4)
3.34
%
 
3.28%
 
110,854

 
111,018

Unsecured fixed rate promissory note
10.00
%
 
7.00%
 
1,375

 
1,442

Convertible senior notes (5)
5.10
%
 
3.30%
 
747,500

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
3,960,575

 
3,776,549

Unamortized net debt (discount) or premium
 
 
 
 
(50,483
)
 
1,669

Total debt, net
 
 
 
 
$
3,910,092

 
$
3,778,218


(1) The effective interest rates include amortization of debt discount/premium, amortization of deferred financing costs and related debt insurer premiums, where applicable, calculated for the three months ended June 30, 2014.
(2) Represents the weighted average stated interest rate based on the outstanding principal balance as of June 30, 2014.
(3) Excluding the impact of non-cash amortization of deferred financing costs and non-utilization fee, the effective interest rate on the revolving credit facilities (Credit Facility and Line of Credit), was 2.96% as of June 30, 2014.
(4) Variable-rate notes are predominately hedged with interest rate swaps (see Note 6).
(5) The value of the embedded conversion premium of ($55.8) million is included in net debt (discount).



16

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

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 and $0.6 million for the three and six months ended June 30, 2014, respectively.
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 June 30, 2014, $3.1 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 5.49% for the three months ended June 30, 2014. The interest rate, excluding the impact of non-cash amortization of deferred financing costs and non-utilization fee of the Credit Facility, was 2.78% for the three months ended June 30, 2014. As of June 30, 2014, there were no amounts outstanding on the Credit Facility.
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.
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 June 30, 2014, the Operating Partnership was in compliance with these financial covenants.
Line of Credit - As of June 30, 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 June 30, 2014, $15.5 million was outstanding on the Line of Credit under three separate advances, secured by 3 properties, at a weighted average stated rate of 4.0% and an effective interest rate for the three months ended June 30, 2014 of 4.22%. 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 June 30, 2014, the Company and special purpose entity were in compliance with these financial covenants.

Master Trust Notes

On May 20, 2014, the Company completed its Exchange Offer for the outstanding 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. Of the $912.4 million of Old Notes outstanding as of the Settlement Date, $894.4 million elected to exchange their Old Notes for New Notes. Approximately $18.0 million of outstanding principal balance immediately prior to the Settlement Date were redeemed by the Company due to non-tender. The terms of the New Notes remain generally similar to the Old Notes including the interest rate and anticipated final repayment dates, however, the New Notes generally amortize more slowly than the Old Notes and have a legal final payment date that is 17 years later than the Old Notes. The New Notes are not insured by third party financial guaranty insurance and the associated insurance premium was eliminated. The revisions to the Spirit Master Funding Program in connection with the issuance of the New Notes, also generally provide the Company more administrative flexibility as property manager and special servicer.


17

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)



The following table summarizes certain key terms under the Old Notes and the New Notes (post exchange):
Old Notes
 
New Notes
Issuer
 
Principal Amount
 
Interest Rate
 
Anticipated payment date
 
Legal Maturity Date
 
Issuer
 
Principal Amount
 
Interest Rate
 
Anticipated payment date
 
Legal Maturity Date
SMF, 2005-1, Class A-1
 
$
94,264

 
5.05
%
 
July 2020
 
July 2023
 
SMF, 2014-1, Class A-1
 
$
81,309

 
5.05
%
 
July 2020
 
July 2040
SMF, 2005-1, Class A-2
 
258,300

 
5.37
%
 
July 2020
 
July 2023
 
SMF, 2014-1, Class A-2
 
253,300

 
5.37
%
 
July 2020
 
July 2040
SMF II, 2006-1, Class A (1)
 
246,915

 
5.76
%
 
March 2021
 
March 2024
 
SMF II, 2014-2, Class A
 
246,915

 
5.76
%
 
March 2021
 
March 2041
SMF III, 2007-1, Class A
 
312,944

 
5.74
%
 
March 2022
 
March 2025
 
SMF III, 2014-3, Class A
 
312,944

 
5.74
%
 
March 2022
 
March 2042
 
 
$
912,423

 
 
 
 
 
 
 
 
 
$
894,468

 
 
 
 
 
 
(1) Principal amounts include $12.3 million of SMF II, Class A notes repurchased by the Company in 2010, which is shown net on the condensed consolidated balance sheets.
As of June 30, 2014, the Series 2014-1, Class A-1, Series 2014-1, Class A-2, Series 2014-2 and Series 2014-3 have outstanding balances of $80.5 million, $253.3 million, $234.4 million and $312.9 million, respectively, and are secured by 719 properties, including 82 properties securing mortgage loans.
In December 2013, Spirit Master Funding VII, LLC ("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 June 30, 2014, the Series 2013-1 and Series 2013-2 notes have outstanding balances of $125.0 million and $203.0 million, respectively, and are secured by 318 properties, including 79 properties securing mortgage loans.
CMBS
The Company has 229 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 June 30, 2014 for the fixed rate notes ranged from 3.90% to 8.39% with a weighted average stated rate of 5.68%. The variable rate notes ranged from 2.65% to 3.56% with a weighted average stated rate of 3.28%. As of June 30, 2014, the fixed and variable rate loans have balances outstanding of $1.9 billion and $110.9 million, respectively, and are secured by 736 and 123 properties, respectively.
Convertible Senior Notes
On May 20, 2014, the Company completed public offerings of $402.5 million aggregate principal amount of 2.875% Convertible Notes due in 2019 and $345.0 million aggregate principal amount of 3.75% Convertible Notes due in 2021. Interest on the Notes is payable semiannually in arrears on May 15 and November 15 of each year, beginning on November 15, 2014. The 2019 Notes will mature on May 15, 2019 and the 2021 Notes will mature on May 15, 2021. The Company loaned the net proceeds from the Convertible Notes Offering to the Operating Partnership in exchange for promissory notes with substantially the same terms as the Notes.
The Convertible Notes are convertible only during certain periods and, subject to certain circumstances, into cash, shares of Spirit Realty Capital's common stock, or a combination thereof. The initial conversion rate applicable to each series is 76.3636 per $1,000 principal note (equivalent to an initial conversion price of $13.10 per share of common stock, representing a 22.5% premium above the public offering price). Earlier conversion may be triggered if shares of Spirit Realty Capital common stock trade higher than the established thresholds or certain corporate events as

18

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

defined occur.
In connection with the issuance of the Convertible Notes, the Company recorded a discount of $56.7 million, which represents the estimated value of the embedded conversion option feature for each of the Convertible Notes. The discount is shown net against the aggregate gross value of the Convertible Notes on the accompanying condensed consolidated balance sheets within mortgages and notes payable, net. The equity component of the conversion feature is recorded in additional paid-in-capital, net of financing costs. The discount will be amortized to interest expense using the effective interest method over a period of approximately 5 years for the 2019 Notes and 7 years for the 2021 Notes. As of June 30, 2014, the unamortized discount was $55.8 million. The Company also incurred $19.6 million in deferred financing costs in connection with the Convertible Notes Offering. This amount has been allocated on a pro-rata basis to each of the Convertible Notes and is being amortized to interest expense over the term of each note.
Debt Extinguishment

Net proceeds raised from the concurrent public offerings were partially used to retire senior mortgage notes payable with an aggregate principal balance of $509.8 million, redeem $18.0 million of net-lease mortgage notes which were not tendered in connection with the Exchange Offer, and repay all amounts drawn against the Credit Facility. The Company defeased approximately $488.7 million aggregate principal amount of senior mortgage indebtedness included in the total above. The defeased notes had contractual interest rates of 6.59% and upcoming maturities in 2016. As a result of these transactions, the Company recognized a loss on extinguishment of debt of approximately $64.7 million.

Debt Maturities

As of June 30, 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
$
16,723

 
$
29,761

 
$
46,484

2015
32,799

 
245,794

 
278,593

2016
31,108

 
299,963

 
331,071

2017
28,389

 
905,262

 
933,651

2018
27,284

 
248,851

 
276,135

Thereafter
96,334

 
1,998,307

 
2,094,641

Total
$
232,637

 
$
3,727,938

 
$
3,960,575

Balloon payments subsequent to 2018 are as follows: $452.0 million due in 2019, $288.0 million due in 2020, $554.8 million due in 2021, $351.4 million due in 2022, $352.1 million due in 2023. As of June 30, 2014, the remaining weighted average maturity of the Company's outstanding indebtedness was 5.1 years.

The following table summarizes interest expense on the related borrowings (in thousands):
 
Three Months 
 Ended June 30,
 
Six Months 
 Ended June 30,
 
2014
 
2013
 
2014
 
2013
Interest expense – revolving credit facilities
$
1,100

 
$
271

 
$
1,820

 
$
376

Interest expense – mortgages and notes payable
53,649

 
29,615

 
107,245

 
59,086

Interest expense – other
33

 
469

 
72

 
470

Amortization of deferred financing costs
1,324

 
6,229

 
2,297

 
10,130

Amortization of debt (premium)/discount
(114
)
 
2,968

 
(1,043
)
 
5,929

Total interest expense
$
55,992

 
$
39,552

 
$
110,391

 
$
75,991


19

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

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 $41.8 million and $23.8 million at June 30, 2014 and December 31, 2013, respectively, and are included in deferred costs and other assets, net on the accompanying condensed consolidated balance sheets.
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
 
June 30,
2014
 
December 31,
2013
Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
10,924

 
4.62
%
 
06/28/12
 
07/06/17
 
$
(80
)
 
$
(42
)
Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
6,746

 
5.75
%
 
07/17/13
 
03/01/16
 
(260
)
 
(326
)
Interest Rate Swap
 
Accounts payable, accrued expenses and other liabilities
 
$
32,400

 
3.15
%
 
07/17/13
 
09/05/15
 
(162
)
 
(178
)
Interest Rate Swaps(a)
 
Accounts payable, accrued expenses and other liabilities
 
$
61,758

 
5.14
%
 
01/02/14
 
12/13/18
 
(863
)
 
(246
)
 
 
 
 
 
 
 
 
 
 
 
 
$
(1,365
)
 
$
(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 and six months ended ended June 30, 2014 and 2013, respectively (in thousands):
 
 
Amount of (Loss) or Gain Recognized
in AOCL on Derivative
(Effective Portion)
 
 
Three Months 
 Ended June 30,
 
Six Months 
 Ended June 30,
Derivatives in Cash Flow Hedging Relationships
 
2014
 
2013
 
2014
 
2013
Interest rate swaps
 
$
(875
)
 
$
502

 
$
(1,277
)
 
$
470

 
 
 
 
 
 
 
 
 
 
 
Amount of Loss Reclassified from
AOCL into Operations
(Effective Portion)
 
 
Three Months 
 Ended June 30,
 
Six Months 
 Ended June 30,
Location of Loss Reclassified from AOCL into Operations
 
2014
 
2013
 
2014
 
2013
Interest expense
 
$
(331
)
 
$
(95
)
 
$
(654
)
 
$
(188
)
General and administrative expense
 
—

 
—

 
—

 
(22
)
 
 
 
 
 
 
 
 
 
 
 
Amount of Gain or (Loss) Recognized in
Operations on Derivative
(Ineffective Portion)
 
 
Three Months 
 Ended June 30,
 
Six Months 
 Ended June 30,
Location of (Loss) or Gain Recognized in Operations on Derivatives
 
2014
 
2013
 
2014
 
2013
General and administrative expense
 
$
(3
)
 
$
54

 
$
(3
)
 
$
54


20

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

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 June 30, 2014 and December 31, 2013, there were no termination events or events of default related to the interest rate swaps.

Note 7. Stockholders’ Equity

Issuance of Common Stock

In May 2014, the Company issued 26.5 million shares of common stock at a price of $10.69 per share, including 3.5 million shares purchased by the underwriters upon the exercise of their overallotment option. After underwriting discounts and other offering costs, net proceeds totaled $271.2 million.

During the three months ended June 30, 2014, the Company sold 1.6 million shares of its common stock at the weighted average share price of $10.70 under its ATM Program, for net proceeds of $16.3 million.
Dividends Declared
For the six months ended June 30, 2014, our Board of Directors declared the following dividends:
Declaration Date
 
Dividend Per Share
 
Record Date
 
Total Amount (1)
 
Payment Date
 
 
 
 
 
 
(in thousands)
 
 
March 18, 2014
 
$
0.16625

 
March 31, 2014
 
61,629

 
April 15, 2014
June 16, 2014
 
$
0.16625

 
June 30, 2014
 
66,299

 
July 15, 2014

(1) Excludes estimated forfeitures for dividends declared on employee restricted stock awards that are reported in general and administrative on the accompanying condensed consolidated statement of operations.
The dividend declared on June 16, 2014 was paid on July 15, 2014 and is included in accounts payable, accrued expenses and other liabilities as of June 30, 2014.

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 June 30, 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 June 30, 2014, the Company had commitments totaling $31.3 million, of which $28.2 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

21

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements
June 30, 2014
(Unaudited)


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 June 30, 2014 and December 31, 2013 (in thousands):
 
 
 
Fair Value Hierarchy Level
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
June 30, 2014:
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Interest rate swaps financial liabilities
$
(1,365
)
 
$
—

 
$
(1,365
)
 
$
—

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

 
$
(792
)
 
$
—

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 June 30, 2014 and December 31, 2013 (in thousands):
 
 
 
 
 
Fair Value Hierarchy Level
 
Impairment
Charges (1)
Description
Fair Value
 
Dispositions
 
Level 1
 
Level 2
 
Level 3
 
June 30, 2014:
 
 
 
 
 
 
 
 
 
 
 
Long-lived assets held and used
$
34,257

 
$
—

 
$
—

 
$
—

 
$
34,257

 
$
(17,844
)
Lease intangible assets
2,631

 
—

 
—

 
—

 
2,631

 
(3,457
)
Long-lived assets held for sale
23,110

 
—

 
—

 
—

 
23,110

 
(8,033
)
 
 
 
 
 
 
 
 
 
 
 
$
(29,334
)
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 six months ended June 30, 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.


22

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

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 June 30, 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.
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): 
 
June 30, 2014
 
December 31, 2013
 
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Loans receivable, net
$
113,321

 
$
121,670

 
$
117,721

 
$
131,587

Revolving credit facilities, net
15,528

 
15,711

 
35,120

 
34,911

Mortgages and notes payable, net
3,202,853

 
3,279,436

 
3,743,098

 
3,892,621

Convertible senior notes, net (1)
691,711

 
747,066

 
—

 
—

(1) The carrying amount of the convertible senior notes is net of an embedded conversion premium totaling $55.8 million.


Note 10. Significant Credit and Revenue Concentration

As of June 30, 2014 and December 31, 2013, the Company’s real estate investments are operated by 404 and 377 tenants, respectively, that engage in retail, service and distribution activities across various industries throughout the United States. Shopko Stores/Shopko Hometown (“Shopko”), operates in the general merchandise industry and represent the Company’s largest tenant. Total revenues from Shopko for the three months ended June 30, 2014 and 2013, contributed 13.8% and 28.9% of the Company's total revenues (from both 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 June 30, 2014 and December 31, 2013, the properties that are operated by Shopko represent approximately 13.8% and 14.4%, respectively, of the Company’s total investment portfolio.


23

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

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.
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 and six months ended June 30, 2014 and 2013, are summarized below (dollars in thousands): 
 
Three Months Ended
 
Six Months Ended
 
June 30, 2014
 
June 30, 2013
 
June 30, 2014
 
June 30, 2013
Revenues:
 
 
 
 
 
 
 
Rent
$
309

 
$
2,228

 
$
617

 
$
4,450

Non-cash rent
2

 
(143
)
 
(27
)
 
(125
)
    Other
33

 
7

 
2,950

 
7

Total revenues
344

 
2,092

 
3,540

 
4,332

Expenses:
 
 
 
 
 
 
 
General and administrative
9

 
7

 
12

 
16

Property costs
56

 
266

 
195

 
340

Interest
—

 
—

 
—

 
194

Depreciation and amortization
—

 
1,213

 
—

 
2,590

Impairments
—

 
1,786

 
—

 
3,889

Total expenses
65

 
3,272

 
207

 
7,029

Gain (loss) from discontinued operations before other income
279

 
(1,180
)
 
3,333

 
(2,697
)
Other income:
 
 
 
 
 
 
 
Gain on debt extinguishment
—

 
1,028

 
—

 
1,028

Other
—

 
22

 
—

 
45

Total other income
—

 
1,050

 
—

 
1,073

Income (loss) from discontinued operations
279

 
(130
)
 
3,333

 
(1,624
)
Gain (loss) on dispositions of assets
92

 
(191
)
 
85

 
(11
)
Total discontinued operations
$
371

 
$
(321
)
 
$
3,418

 
$
(1,635
)
 Number of properties disposed of during period (a)
3

 
4

 
5

 
10

 
 
 
 
 
 
 
 
(a) During the six months ended June 30, 2014, seven properties were sold, but only five of them were held for sale at December 31, 2013 and qualified for discontinued operations under ASU 2014-08.


24

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

Note 12. Supplemental Cash Flow Information
 
Six Months Ended
June 30,
 
2014
 
2013
Supplemental Disclosures of Non-Cash Investing and Financing Activities:
(in thousands)
Distributions declared and unpaid
$
(66,299
)
 
$
(26,514
)
Reduction of debt through sale of certain real estate properties
—

 
974

Real estate properties acquired under 1031 exchange
20,784

 
—

Embedded conversion premium of convertible notes
(56,740
)
 
—

Reduction of debt, net of assets surrendered to lender
—

 
1,028

Accrued equity offering costs
(250
)
 
—

Accrued deferred financing costs
(281
)
 
(9,814
)

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 June 30, 2014, 2.6 million shares remained available for award under the Plan.
Restricted Shares of Common Stock
During the six months ended June 30, 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 these grants. As of June 30, 2014, approximately 2.0 million non-vested restricted shares of common stock were outstanding.
Performance Share Awards
During the six months ended June 30, 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 June 30, 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 1.1 million shares, in the aggregate. In addition, approximately $0.4 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.



25

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

Stock compensation
For the three and six months ended June 30, 2014, the Company recognized $3.0 million and $5.5 million, respectively, in stock-based compensation expense, which is included in general and administrative expenses in the accompanying condensed consolidated statements of operations. For the three and six months ended June 30, 2013, the Company recognized $1.8 million and $3.6 million, respectively in stock-based compensation expense.
As of June 30, 2014 and December 31, 2013, the remaining unamortized stock-based compensation expense, including amounts relating to the performance awards, totaled $17.4 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.

Note 14. Loss Per Share
Loss per share has been computed using the two-class method. Loss per common share under the two-class method is 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 loss from continuing operations and net loss attributable to common stockholders in the computation of loss per share for each.

The table below is a reconciliation of the numerator and denominator used in the computation of basic and diluted loss per share (dollars in thousands):
 
Three Months 
 Ended June 30,
 
Six Months Ended 
 June 30,
 
2014
 
2013
 
2014
 
2013
Basic and diluted loss:
 
 
 
 
 
 
 
Loss from continuing operations
$
(88,902
)
 
$
(11,348
)
 
$
(79,432
)
 
$
(18,366
)
(Loss) gain on dispositions of assets
(1,290
)
 
—

 
432

 
—

Less: income attributable to unvested restricted stock
(334
)
 
(352
)
 
(667
)
 
(698
)
Loss used in basic and diluted income (loss) per share from continuing operations
(90,526
)
 
(11,700
)
 
(79,667
)
 
(19,064
)
Income (loss) from discontinued operations
371

 
(321
)
 
3,418

 
(1,635
)
Net loss attributable to common stockholders used in basic and diluted income (loss) per share
$
(90,155
)
 
$
(12,021
)
 
$
(76,249
)
 
$
(20,699
)
 
 
 
 
 
 
 
 
Basic and diluted weighted average shares of common stock outstanding:
 
 
 
 
 
 
 
Weighted average shares of common stock outstanding
383,810,017

 
161,598,986

 
377,209,471

 
161,599,476

Less: unvested weighted average shares of restricted stock
(2,034,814
)
 
(2,168,860
)
 
(1,943,238
)
 
(2,173,701
)
Weighted average number of shares outstanding used in basic and diluted loss per share
381,775,203

 
159,430,126

 
375,266,233

 
159,425,775

 
 
 
 
 
 
 
 
Potentially dilutive shares of common stock
 
 
 
 
 
 
 
Unvested shares of restricted stock
911,962

 
950,097

 
800,773

 
838,293

Unvested performance shares
708,823

 
—

 
703,262

 
—

Stock options
4,416

 
—

 
4,830

 
—

Total
1,625,201

 
950,097

 
1,508,865

 
838,293


26

SPIRIT REALTY CAPITAL, INC.
Notes to Condensed Consolidated Financial Statements - (continued)
June 30, 2014
(Unaudited)

The Company intends to satisfy its exchange obligation for the principal amount of the Convertible Notes to the exchange note holders entirely in cash. As the Company intends to settle the principal amount of the Convertible Notes in cash, the "if-converted" method to include convertible debt in diluted EPS is not applicable and the treasury stock method is being used. As the Company's stock price is below the conversion price, there are no potentially dilutive shares associated with the Convertible Notes.



27
Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward-looking Statements

This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Exchange Act. When used in this quarterly report, the words “estimate,” “anticipate,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “seek,” “approximately” or “plan,” or the negative of these words and phrases or similar words or phrases that are predictions of or indicate future events or trends and that do not relate solely to historical matters are intended to identify forward-looking statements. You can also identify forward-looking statements by discussions of strategy, plans or intentions of management.

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

•
general business and economic conditions;
•
continued volatility and uncertainty in the credit markets and broader financial markets, including potential fluctuations in the consumer price index;
•
our success in implementing our business strategy and our ability to identify, underwrite, finance, consummate, integrate and manage diversifying acquisitions or investments;
•
the nature and extent of future competition;
•
increases in our costs of borrowing as a result of changes in interest rates and other factors;
•
our ability to access debt and equity capital markets;
•
our ability to pay down, refinance, restructure and/or extend our indebtedness as it becomes due;
•
our ability and willingness to renew our leases upon expiration of the leases and our ability to reposition our properties on the same or better terms in the event such leases expire and are not renewed by the tenants or in the event we exercise our rights to replace an existing tenant upon default;
•
the impact of any financial, accounting, legal or regulatory issues or litigation that may affect us or our major tenants;
•
other risks inherent in the real estate business, including tenant defaults, potential liability relating to environmental matters, illiquidity of real estate investments and potential damages from natural disasters;
•
our ability and willingness to maintain our qualification as a REIT due to economic, market, legal, tax or other considerations;
•
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.


28
Table of Contents

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 “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 and a wholly-owned subsidiary are the sole limited partner and own the remaining 99.0% of the 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 June 30, 2014, our undepreciated gross investment in real estate and loans totaled approximately $7.55 billion, representing investment in 2,369 properties, including properties securing our mortgage loans. Of this amount, 98.5% consisted of our gross investment in real estate, representing ownership of 2,224 properties, and the remaining 1.5% consisted of commercial mortgage and equipment loans receivable secured by 145 properties or related assets. As of June 30, 2014, our owned properties were approximately 98.7% 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 10.1 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 years. As of June 30, 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 second quarter ended June 30, 2014, Spirit Realty Capital:
•
Recognized revenues of $151.8 million, more than double the revenues reported in the second quarter of 2013 largely due to the Merger completed on July 17, 2013.
•
Generated Adjusted Funds from Operations (AFFO) of $0.20 per share, Funds from Operations (FFO) of less than $0.01 per share, and net loss of $0.24 per share.
•
Closed 24 real estate transactions and invested $207.7 million (including $1.2 million follow on investments in existing properties) which added 86 properties to our portfolio, earning an initial cash yield of approximately 7.72% under leases with an average remaining term of 18.0 years.
•
Strengthened the balance sheet and acquisition capacity by:
◦
Issuing $402.5 million of 2.875% Convertible Senior Notes due 2019 and $345.0 million of 3.75% Convertible Senior Notes due 2021, resulting in net proceeds of approximately $726.2 million.
◦
Completing a secondary offering of 26,450,000 shares of common stock, resulting in net proceeds of approximately $271.2 million.
◦
Establishing an at-the-market program (ATM) allowing for the periodic issuance of its common stock which raised $16.6 million on 1.6 million shares sold during the quarter.
◦
Completing an exchange offer for $912.4 million outstanding principal balance of certain net-lease mortgage notes issued under its Spirit Master Funding Program, with each class of new notes having a rating of "A+" by Standard & Poor's Rating Services (S&P).
◦
Extinguishing $527.8 million of debt with a weighted average interest rate of 6.54% and weighted average remaining term of 25 months.

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•
Declared cash dividends for the second quarter of $0.16625 per share, which equates to an annualized dividend of $0.6650 per share.
•
Maintained essentially full occupancy at 99%.

For the six months ended June 30, 2014:
•
Generated revenues of $295.8 million, more than double the revenues reported in the second quarter of 2013 primarily the result of our Merger.
•
Generated AFFO of $0.41 per share, FFO of $0.20 per share and net loss of $0.20 per share.
•
Invested $365.5 million (including $1.8 million in follow on investments in existing properties) with an initial cash yield of 7.76% and an average remaining lease term of 15.5 years. Added 190 properties to our portfolio through new investments.
•
Raised over $1 billion through a combination of registered offerings of common stock and unsecured convertible notes.
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 June 30, 2014, 98.7% of our owned properties (based on number of properties) were occupied.
For the three months ended June 30, 2014, Shopko contributed 13.8% of our total revenue. Walgreen Company (“Walgreens”), our next largest tenant, contributed 3.9% of our total revenue for the three months ended June 30, 2014. Because a significant portion of our revenues are derived from rental revenues received from Shopko and Walgreens, defaults, breaches or delay in payment of rent by these tenants may materially and adversely affect us.
Without giving effect to the exercise of tenant renewal options, the weighted average remaining term of our leases as of June 30, 2014 was 10.1 years (based on annual rent). Approximately 11.5% of our leases (based on annual rent) as of June 30, 2014 will expire prior to January 1, 2018. 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 June 30, 2014, approximately 85% of our single tenant 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 43.2% of our annual rent is attributable to master leases, where multiple properties are leased to a single tenant on an “all or none”

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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 June 30, 2014, we had an approximately $4.0 billion principal balance outstanding of largely secured, fixed-rate mortgage notes payable and borrowings under our revolving credit facilities. As of June 30, 2014, the weighted average stated interest rate on our fixed and variable-rate debt, excluding non-utilization fees, the amortization of deferred financing costs and debt discounts/premiums, was approximately 5.06%. 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 six months ended June 30, 2014, non-cash interest expense recognized on our revolving credit facilities, mortgages and notes payable totaled approximately $1.3 million and our non-utilization fee on our Credit Facility was $0.6 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.
Transaction Costs
As we acquire properties, we may incur transaction costs that we may be required to expense. For properties acquired with in-place leases, we allocate the purchase price of real estate to the tangible and intangible assets and liabilities based on their estimated fair values and acquisition costs are expensed as incurred. For properties acquired in connection with a sale leaseback, transaction costs are capitalized and amortized over the term of the lease as reduction to rental revenue. As a result, acquisition transaction costs may vary between periods depending on the nature of the acquisition.
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

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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.

Results of Operations
Comparison of the Three Months Ended June 30, 2014 to Three Months Ended June 30, 2013
The following discussion includes the results of our continuing operations as summarized in the table below:
 
Three Months Ended June 30,
 
2014
 
2013
 
 Change
 
 %
 
 (In Thousands)
 
 
Revenues:
 
 
 
 
 
 
 
Rentals
$
143,142

 
$
70,050

 
$
73,092

 
104.3
 %
Interest income on loans receivable
1,821

 
1,128

 
693

 
61.4
 %
Earned income from direct financing leases
838

 
—

 
838

 
NM

Tenant reimbursement income
2,921

 
—

 
2,921

 
NM