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ARCP > SEC Filings for ARCP > Form 10-Q on 29-Jul-2014All Recent SEC Filings

Show all filings for AMERICAN REALTY CAPITAL PROPERTIES, INC.

Form 10-Q for AMERICAN REALTY CAPITAL PROPERTIES, INC.


29-Jul-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements of American Realty Capital Properties, Inc. (the "Company") and the notes thereto. As used herein, the terms "we," "our" and "us" refer to American Realty Capital Properties, Inc., a Maryland corporation, and, as required by context, including its operating partnership and its subsidiaries. Prior to becoming self-managed as of January 8, 2014, the Company was externally managed by ARC Properties Advisors, LLC (the "Former Manager"), a Delaware limited liability company and wholly owned subsidiary of AR Capital, LLC ("ARC"). Capitalized terms used herein, but not otherwise defined, shall have the meaning ascribed to those terms in "Part I - Financial Information," including the Notes to the Consolidated Financial Statements contained therein.
Forward-Looking Statements
This Quarterly Report on Form 10-Q includes forward-looking statements that reflect our expectations and projections about our future results, performance, prospects and opportunities. We have attempted to identify these forward-looking statements by using words such as "may," "will," "expects," "anticipates," "believes," "intends," "should," "estimates," "could" or similar expressions. These forward-looking statements are based on information currently available to us and are subject to a number of known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. These factors include, among other things, those discussed below. We do not undertake publicly to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required to satisfy our obligations under federal securities law.
The following are some of the risks and uncertainties, although not all risks and uncertainties, that could cause our actual results to differ materially from those presented in our forward-looking statements:
• The competition for the type of properties we desire to acquire may cause our dividends and the long-term returns of our investors to be lower than they otherwise would be.

• We may be unable to renew leases, lease vacant space or re-lease space as leases expire on favorable terms or at all, which could have a material adverse effect on our financial condition, results of operations, cash flow, cash available for dividends to our stockholders, per share trading price of our common stock and our ability to satisfy our debt service obligations.

• We depend on tenants for our revenue, and, accordingly, our revenue is dependent upon the success and economic viability of our tenants.

• Failure by any major tenant with leases in multiple locations to make rental payments to us, because of a deterioration of its financial condition or otherwise, or the termination or non-renewal of a lease by a major tenant, would have a material adverse effect on us.

• We are subject to tenant industry concentrations that make us more susceptible to adverse events with respect to certain industries.

• Increases in interest rates could increase the amount of our debt payments and limit our ability to pay dividends to our stockholders.

• We may be unable to make scheduled payments on our debt obligations.

• We may not generate cash flows sufficient to pay our dividends to stockholders, and as such we may be forced to borrow at higher rates to fund our operations.

• We may be unable to pay or maintain cash dividends or increase dividends over time.

• We may be affected by the incurrence of additional secured or unsecured debt.

• We may be adversely affected by increases in interest rates or a failure to maintain our OP's credit rating.

• We may not be able to integrate the assets and businesses acquired in our recent acquisitions, including the Red Lobsterฎ acquisition, into our existing portfolio or with our business successfully, or may not realize the anticipated benefits within the expected time frame or at all.

• We may not be able to effectively manage or dispose of assets acquired in connection with our recent acquisitions that do not fit within our target assets.

• We may not be able to effectively manage our expanded portfolio and operations following our recent acquisitions.

• We may be affected by risks associated with current and future litigation.


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• We may not be able to successfully acquire future properties on advantageous terms and the performance of such properties may not perform as expected.

• We may not be able to achieve and maintain profitability.

• We are subject to risks associated with lease terminations, tenant defaults, bankruptcies and insolvencies and tenant credit, geographic and industry concentrations.

• We could be subject to unexpected costs or unexpected liabilities that may arise from our recent acquisitions.

• We may not be able to consummate the sale of the Multi-Tenant Portfolio on the terms anticipated, or at all.

• We may fail to qualify to be treated as a REIT for U.S. federal income tax purposes.

• We may be deemed to be an investment company under the Investment Company Act of 1940, as amended, (the "Investment Company Act") and thus subject to regulation under the Investment Company Act.

• Certain of our executive officers and the executive officers of the non-traded REITs advised by Cole Capital have obligations to, and financial interests in non-traded REITs and businesses sponsored by ARC and owned by RCS Capital Corporation, which may compete with our businesses; therefore, such individuals will be subject to conflicts of interest and may owe their time and attention to such competing businesses.

All forward-looking statements should be read in light of the risks identified in Part II, Item 1A of this Quarterly Report on Form 10-Q. Overview
We were incorporated on December 2, 2010 as a Maryland corporation that qualified as a real estate investment trust for U.S. federal income tax purposes beginning in the taxable year ended December 31, 2011. On September 6, 2011, we completed our IPO and our shares of common stock began trading on the NASDAQ Global Select Market ("NASDAQ") under the symbol "ARCP." Our business operates in two business segments, Real Estate Investment ("REI") and our private capital management business, Cole Capital ("Cole Capital"). Through our REI segment, we acquire, own and operate single-tenant, freestanding commercial real estate properties, primarily subject to net leases with high credit quality tenants. We focus on investing in properties that are net leased to credit tenants, which are generally large public companies with investment-grade ratings and other creditworthy tenants. Our long-term business strategy is to continue to acquire a diverse portfolio consisting of approximately 70% long-term leases and 30% medium-term leases, with an average remaining lease term of 10 to 12 years. We seek to acquire granular, self -originated single-tenant net lease assets, which may be purchased through sale-leaseback transactions, small portfolios and built-to-suit opportunities, to the extent they are appropriate in terms of capitalization rate and scale.We expect this investment strategy to provide for stable income from credit tenants and to provide for growth opportunities from re-leasing of current below market leases. We have advanced our investment objectives by growing our net lease portfolio through strategic mergers and acquisitions.
As a result of the Cole Merger, in addition to operating a diverse portfolio of core commercial real estate investments, we are responsible for managing the Managed REITs' affairs on a day-to-day basis, identifying and making acquisitions and investments on the Managed REITs' behalf, and recommending to each of the Managed REIT's respective board of directors an approach for providing investors with liquidity. We receive compensation and reimbursement for services relating to the Managed REITs' offerings and the investment, management, financing and disposition of their respective assets, as applicable. Furthermore, in order to avoid a potential adverse impact on our status as a REIT, we conduct substantially all of our investment management business through a wholly owned subsidiary of the OP, Cole Capital Advisors, Inc. ("CCA"), which we and CCA jointly elected to treat as a TRS for federal income tax purposes. Prior to January 8, 2014, we retained our Former Manager to manage our affairs on a day-to-day basis with the exception of certain acquisition, accounting and portfolio management services performed by our employees. In August 2013, our board of directors determined that it is in the best interests of us and our stockholders to become self-managed and we completed our transition to self-management on January 8, 2014. In connection with becoming self-managed, we terminated the existing management agreement with our Former Manager, entered into employment and incentive compensation arrangements with our executives and acquired from our Former Manager certain assets necessary for our operations. On June 11, 2014, the OP, through indirect subsidiaries of the OP (the "Sellers"), entered into an agreement of purchase and sale (the "Agreement") with BRE DDR Retail Holdings III LLC (the "Purchaser"), an entity indirectly jointly owned by affiliates of Blackstone Real Estate Partners VII L.P. and DDR Corp., by which the Sellers have agreed to sell to the Purchaser and the Purchaser has agreed to purchase from the Sellers 67 multi-tenant properties and nine single-tenant properties and the adjacent land and related property (the "Multi-Tenant Portfolio").


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As of June 30, 2014, we owned 3,966 properties consisting of 106.8 million square feet, which were 98.8% leased with a weighted average remaining lease term of 9.9 years. In constructing our portfolio, we are committed to diversification by industry, tenant and geography. As of June 30, 2014, rental revenues derived from investment grade tenants and tenants affiliated with investment grade entities as determined by a major rating agency approximated 49% (we have attributed the rating of each parent company to its wholly owned subsidiary for purposes of this disclosure). Our strategy encompasses receiving the majority of our REI revenue from investment grade tenants as we further acquire properties and enter into, or assume, lease arrangements. Completed Mergers and Major Acquisitions American Realty Capital Trust III, Inc. Merger On December 14, 2012, we entered into an Agreement and Plan of Merger (the "ARCT III Merger Agreement") with American Realty Capital Trust III, Inc. ("ARCT III") and certain subsidiaries of each company. The ARCT III Merger Agreement provided for the merger of ARCT III with and into a subsidiary of ours (the "ARCT III Merger"). The ARCT III Merger was consummated on February 28, 2013. Also in connection with the ARCT III Merger, we entered into an agreement with ARC and its affiliates to internalize certain functions performed by them prior to the ARCT III Merger, reduce certain fees paid to affiliates, purchase certain corporate assets and pay certain merger related fees. See Note 19 - Related Party Transactions and Arrangements to our consolidated financial statements in this Quarterly Report on Form 10-Q for further discussion. CapLease, Inc. Merger
On May 28, 2013, we entered into the CapLease Merger Agreement with CapLease and certain subsidiaries of each company. The CapLease Merger Agreement provided for the merger of CapLease with and into a subsidiary of the Company. On November 5, 2013, the Company completed the merger with CapLease pursuant to the CapLease Merger Agreement.
American Realty Capital Trust IV, Inc. Merger On July 1, 2013, we entered into the ARCT IV Merger Agreement with ARCT IV and certain subsidiaries of each company. The ARCT IV Merger Agreement provided for the merger of ARCT IV with and into a subsidiary of the OP. The Company consummated the ARCT IV Merger on January 3, 2014. Fortress Portfolio Acquisition
On July 24, 2013, ARC and another related entity, on behalf of us and certain other entities sponsored directly or indirectly by ARC, entered into a purchase and sale agreement with affiliates of funds managed by Fortress for the purchase of 196 properties owned by Fortress, for an aggregate contract purchase price of $972.5 million, subject to adjustments set forth in the purchase and sale agreement and exclusive of closing costs, which were allocated to us based on the pro rata fair value of the properties acquired by us relative to the fair value of all 196 properties to be acquired from Fortress. Of the 196 properties, 120 properties were allocated to and assigned by us. On October 1, 2013, we closed on 41 of the 120 properties with a total purchase price of $200.3 million, exclusive of closing costs. During the six months ended June 30, 2014, we closed the acquisition of the remaining 79 properties in the Fortress Portfolio for an aggregate contract purchase price of $400.9 million, exclusive of closing costs. The total purchase price of the Fortress Portfolio was $601.2 million, exclusive of closing costs.
Inland Portfolio Acquisition
On August 8, 2013, ARC and another related entity, on behalf of us and certain other entities sponsored directly or indirectly by ARC, entered into a purchase and sale agreement with Inland for the purchase of the equity interests of 67 companies owned by Inland for an aggregate contract purchase price of approximately $2.3 billion, subject to adjustments set forth in the purchase and sale agreement and exclusive of closing costs. Of the 67 companies, the equity interests of 10 companies were acquired, in total, by us from Inland for a purchase price of approximately $501.0 million, subject to adjustments set forth in the purchase and sale agreement and exclusive of closing costs, which was allocated to us based on the pro rata fair value of the Inland Portfolio relative to the fair value of all 67 companies to be acquired from Inland by us and the other entities sponsored directly or indirectly by ARC. The Inland Portfolio is comprised of 33 properties. As of June 30, 2014, we had closed on 32 of the 33 properties for a total purchase price of $288.2 million, exclusive of closing costs. The Company will not close on the remaining one property. Cole Real Estate Investments, Inc. Merger On October 22, 2013, we entered into the Cole Merger Agreement with Cole. The Cole Merger Agreement provided for the merger of Cole with and into a wholly owned subsidiary of ours. We consummated the Cole Merger on February 7, 2014. Cole Credit Property Trust, Inc. Merger
On March 17, 2014, we entered into the CCPT Merger Agreement with CCPT. The CCPT Merger Agreement provided for the merger of CCPT with and into a wholly owned subsidiary the OP. We consummated the CCPT Merger on May 19, 2014.


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Purchase Agreement for Red Lobster Portfolio On May 16, 2014, we entered into a master purchase agreement to acquire over 500 properties, substantially all of which are operating as Red Lobsterฎ restaurants from a third party. The transaction is structured as a sale-leaseback in which we will purchase and immediately lease the portfolio back to the third party pursuant to the terms of multiple master leases. The purchase price is approximately $1.5 billion, exclusive of closing costs and related expenses. The acquisition will provide annual rental income of $152.0 million. Approximately 93.5% of the master leases will be structured with a 25-year initial term and approximately 6.5% will have a weighted average 18.7-year initial term. On July 28, 2014, the Company closed on 492 of the properties and expects to close on the remaining 29 properties early in the third quarter of 2014. Results of Operations
As a result of the Cole Merger, we evaluate our operating results by our two business segments, REI and Cole Capital. REI Segment
Our results of operations are influenced by the timing of acquisitions and the operating performance of our real estate investments. The following table shows the property statistics of our real estate assets, including consolidated joint ventures, as of June 30, 2014 and 2013:

June 30,
2014 2013
Number of commercial properties (1) 3,966 1,766 Approximate rentable square feet (in millions) (2) 106.8 25.3 Percentage of rentable square feet leased 98.8 % 100 %



(1) Excludes properties owned through the Unconsolidated Joint Ventures.

(2) Includes square feet of the buildings on land that are subject to ground leases.

Comparison of the Three Months Ended June 30, 2014 to the Three Months Ended June 30, 2013
Total Real Estate Investment Revenue
REI revenue increased approximately $289.7 million to $344.6 million for the three months ended June 30, 2014, compared to $54.9 million for the three months ended June 30, 2013. Our REI revenue consisted primarily of rental income from net leased commercial properties, which accounted for 91% and 96% of total REI revenue during the three months ended June 30, 2014 and 2013, respectively. Rental Income
Rental income increased approximately $262.1 million to $314.8 million for the three months ended June 30, 2014, compared to $52.7 million for the three months ended June 30, 2013. The increase was primarily due to our net acquisition of 2,153 properties (which excludes 47 properties that are accounted for as direct financing leases) primarily through various mergers and portfolio acquisitions subsequent to June 30, 2013.
Direct Financing Lease Income
Direct financing lease income of $1.2 million was recognized for the three months ended June 30, 2014. Direct financing lease income was primarily driven by our net acquisition of 47 properties comprised of $62.1 million of net investments subject to direct financing leases acquired at the end of or subsequent to the second quarter of 2013. As such, we had no direct financing lease income during the three months ended June 30, 2013. Operating Expense Reimbursements
Operating expense reimbursements increased by approximately $26.2 million to $28.5 million for the three months ended June 30, 2014 compared to $2.3 million for the three months ended June 30, 2013. Operating expense reimbursements represent reimbursements for taxes, property maintenance and other charges contractually due from the tenant per the respective lease. Operating expense reimbursements increases were driven by our net acquisition of 2,153 properties subsequent to June 30, 2013.


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We also review our stabilized operating results from properties that we owned for the entirety of both the current and prior year reporting periods, referred to as "same store." Cash same store rents on the 815 properties held for the full period in each of the three months ended June 30, 2014 and 2013 increased $0.2 million, or 0.5%, to $44.5 million compared to $44.3 million for the three months ended June 30, 2013, respectively. Same store annualized average rental income per square foot was $9.67 at June 30, 2014 compared to $9.62 at June 30, 2013.
Acquisition Related Expenses
Acquisition related expenses decreased approximately $28.8 million to $8.5 million for the three months ended June 30, 2014, compared to $37.3 million for the three months ended June 30, 2013. During the three months ended June 30, 2014, acquisition costs consisted of legal costs, deed transfer costs and other costs related to real estate purchase transactions. In addition to the costs above, during the three months ended June 30, 2013, we paid acquisition fees to our Former Manager for acquisitions by ARCT IV. In conjunction with the ARCT IV Merger, it was agreed that our Former Manager would no longer charge acquisition fees.
Merger and Other Transaction Related Expenses Costs related to various mergers, as well as other transaction costs increased approximately $6.9 million to $13.3 million for the three months ended June 30, 2014, compared to $6.4 million for the three months ended June 30, 2013. The increase in merger and other transaction related expenses was primarily associated with costs incurred for the CCPT Merger and the pending disposition of the Multi-Tenant Portfolio.
Property Operating Expenses
Property operating expenses increased approximately $36.3 million to $39.4 million for the three months ended June 30, 2014, compared to $3.1 million for the three months ended June 30, 2013. The increase was primarily due to increased property taxes, utilities, repairs and maintenance and insurance expenses relating to the net acquisition of 2,153 rental income-producing properties subsequent to June 30, 2013. The primary property operating expense items are property taxes and repairs and maintenance. General and Administrative Expenses
General and administrative expenses increased approximately $4.6 million to $7.0 million for the three months ended June 30, 2014, compared to $2.4 million for the three months ended June 30, 2013. The increase in general and administrative expenses was primarily driven by an increase in the REI segment's allocation of compensation expense due to becoming self-managed on January 8, 2014. General and administrative expenses primarily included the REI segment's share of employee compensation and benefits, including legal, accounting and professional fees and escrow and trustee fees.
Equity Based Compensation Expense
Equity based compensation increased approximately $5.8 million to $9.3 million for the three months ended June 30, 2014, compared to $3.5 million for the three months ended June 30, 2013. The increase was primarily due to equity based compensation expenses related to the multi-year outperformance plan (the "New OPP"), which was entered into upon the Company's transition to self-management on January 8, 2014, as well as an increase in the amortization of restricted stock for the awards granted subsequent to June 30, 2013. Depreciation and Amortization Expense
Depreciation and amortization expenses increased approximately $200.4 million to $234.2 million for the three months ended June 30, 2014, compared to $33.8 million for the three months ended June 30, 2013. The increase in depreciation and amortization was primarily driven by our net acquisition 2,153 properties subsequent to June 30, 2013.
Interest Expense, Net
Interest expense, net increased approximately $88.6 million to $99.7 million for the three months ended June 30, 2014, compared to $11.1 million during the three months ended June 30, 2013. The increase in interest expense was due to an increase in the average debt balance of $10.0 billion for the three months ended June 30, 2014 compared to $888.6 million for the three months ended June 30, 2013. The increase in debt was primarily due to the assumption of mortgage notes in connection with the various mergers and portfolio acquisitions and the issuance of the corporate bonds. The average annualized interest rate on all debt, including the effect of derivative instruments used to hedge the effects of interest rate volatility but excluding amortization of deferred financing costs and non-usage fees, for the three months ended June 30, 2014 and 2013 was 3.72% and 3.48%, respectively.


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Other Income (Expense), Net
Other income (expense) decreased approximately $4.3 million to an expense of $3.1 million for the three months ended June 30, 2014, compared to income of $1.2 million for the three months ended June 30, 2013. Other income (expense) primarily consisted of state and franchise taxes of $2.8 million for the three months ended June 30, 2014. During the three months ended June 30, 2013, we recorded $1.2 million in income from investments. Gain (Loss) on Derivative Instruments, Net Gain on derivative instruments for the three months ended June 30, 2014 was $21.9 million, which primarily related to marking the Series D Preferred Stock embedded derivative to fair value. The gain was partially offset by a loss on derivative instruments resulting from marking our derivative instruments to fair value. We recorded a loss on derivative instruments of $40,000 during the three months ended June 30, 2013 that resulted from marking our derivate instruments to fair value.
Loss on Contingent Value Rights
During the three months ended June 30, 2013, we recorded a loss on contingent value rights of of $31.1 million. The loss pertains to the fair value of our obligation to pay certain holders of common stock contingent value rights and preferred stock contingent value rights for the difference between the value of our shares on certain measurement dates and the value of the shares at the time of issuance as set forth in the respective contingent value rights agreements. We did not have any such loss during the six months ended June 30, 2014 as the contingent value rights were settled in the fourth quarter of 2013. Gain on Disposition of Properties, Net
During the three months ended June 30, 2014, we recorded a gain on the sale of eight properties of $1.5 million. We did not sell any properties during the three months ended June 30, 2013.
Gain on Sale of Investment Securities
No investment securities were sold during the three months ended June 30, 2013 or 2014.
Comparison of the Six Months Ended June 30, 2014 to the Six Months Ended June 30, 2013
Total Real Estate Investment Revenue
REI revenue increased approximately $513.3 million to $611.1 million for the six months ended June 30, 2014, compared to $97.8 million for the six months ended June 30, 2013. Our REI revenue consisted primarily of rental income from net leased commercial properties, which accounted for 92% and 96% of total REI revenue during the six months ended June 30, 2014 and 2013, respectively. Rental Income
Rental income increased approximately $465.6 million to $559.3 million for the six months ended June 30, 2014, compared to $93.7 million for the six months ended June 30, 2013. The increase was primarily due to our net acquisition of 2,153 properties (which excludes 47 properties that are accounted for as direct financing leases) primarily through various mergers and portfolio acquisitions subsequent to June 30, 2013.
Direct Financing Lease Income
Direct financing lease income of $2.2 million was recognized for the six months ended June 30, 2014. Direct financing lease income was primarily driven by our net acquisition of 47 properties comprised of $62.1 million of net investments subject to direct financing leases acquired at the end of or subsequent to the second quarter of 2013. As such, we had no direct financing lease income during the six months ended June 30, 2013.
Operating Expense Reimbursements
Operating expense reimbursements increased by approximately $45.4 million to $49.6 million for the six months ended June 30, 2014 compared to $4.2 million for the six months ended June 30, 2013. Operating expense reimbursements represent reimbursements for taxes, property maintenance and other charges contractually due from the tenant per their respective leases. Operating expense . . .

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