10-K/A 1 d880830d10ka.htm 10-K/A 10-K/A
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K/A

(Amendment No. 2)

 

 

(Mark One)

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

For the fiscal year ended December 31, 2013

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 001-35263

 

 

AMERICAN REALTY CAPITAL PROPERTIES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland   45-2482685

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

2325 E. Camelback Road, Suite 1100 Phoenix, AZ   85016
(Address of principal executive offices)   (Zip Code)

(800) 606-3610

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:

 

Title of each class:

 

Name of each exchange on which registered:

Common Stock, $0.01 par value per share   NASDAQ Stock Market
Series F Preferred Stock, $0.01 par value per share   NASDAQ Stock Market

Securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934.    Yes  ¨    No  x

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  ¨    No  x

Indicate by check mark whether the registrant 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

 

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

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

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant as of June 30, 2013 was $2.78 billion.

The number of outstanding shares of the registrant’s common stock on February 27, 2015 was 905,338,684 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s proxy statement previously delivered to stockholders in connection with the registrant’s 2014 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K/A.

 

 

 


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Explanatory Note

American Realty Capital Properties, Inc. (the “Company,” “its,” “we,” “our” or “us”) is filing this Amendment No. 2 on Form 10-K/A (this “Form 10-K/A”) to its Annual Report on Form 10-K for the fiscal year ended December 31, 2013, originally filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 27, 2014 (the “Original Filing”) and amended by Amendment No. 1 thereto on Form 10-K/A filed with the SEC on September 4, 2014, to restate and amend its previously-issued audited consolidated financial statements and related financial information for the fiscal years ended December 31, 2013 and 2012.

This Form 10-K/A also reflects the recasting of the Company’s historical financial statements to present the Company’s January 3, 2014 acquisition of American Realty Capital Trust IV, Inc. (“ARCT IV”), an entity previously deemed to be under common control with the Company, from the earliest period of common control. Recasted audited consolidated financial statements reflecting the Company’s acquisition of ARCT IV were originally filed with the SEC by the Company as an exhibit to its Current Report on Form 8-K dated May 20, 2014.

Concurrently with the filing of this Form 10-K/A, the Company is filing amendments to its Quarterly Reports on Form 10-Q for the fiscal periods ended March 31, 2014 and June 30, 2014 to restate and amend its previously-issued unaudited consolidated financial statements and related financial information for these periods and the comparable fiscal periods of 2013 (collectively, with this Form 10-K/A, the “Amended Filings”). The Company’s Quarterly Report on Form 10-Q for the fiscal period ended September 30, 2014, which is also being concurrently filed, includes restated and amended unaudited consolidated financial statements and related financial information for the fiscal period ended September 30, 2013.

The following sections of this Form 10-K/A contain information that has been amended where necessary to reflect the restatement and certain other events that have occurred subsequent to February 27, 2014, the date of the Original Filing:

 

    Forward-Looking Statements

 

    Part I, Item 1A. Risk Factors

 

    Part I, Item 3. Legal Proceedings

 

    Part II, Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

    Part II, Item 6. Selected Financial Data

 

    Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Certain Sections As Restated)

 

    Part II, Item 9A. Controls and Procedures

 

    Part III

 

    Part IV, Item 15. Exhibits, Financial Statement Schedules

Except as described in this Explanatory Note, the information contained in the Original Filing has not been updated to reflect any subsequent events.

Background

On October 29, 2014, the Company filed a Current Report on Form 8-K (the “October 29 8-K”) reporting that the Audit Committee of the Company’s Board of Directors (the “Audit Committee”) had concluded that the previously-issued audited consolidated financial statements and other financial information contained in the Original Filing, the previously issued unaudited financial statements and other financial information contained in the Company’s Quarterly Reports on Form 10-Q for the fiscal periods ended March 31, 2014 and June 30, 2014, and the Company’s earnings releases and other financial communications for these periods should no longer be relied upon.

 

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The Audit Committee based its conclusion on the preliminary findings of its investigation into concerns regarding accounting practices and other matters that had first been reported to it on September 7, 2014. Promptly after learning of these concerns, the Audit Committee initiated an investigation, which was conducted with the assistance of independent counsel and forensic accountants. The investigation continued after the filing of the October 29 8-K and expanded in scope beyond the concerns initially brought to the Audit Committee’s attention. Certain key findings of the investigation are presented below.

The investigation found that Adjusted Funds From Operations (“AFFO”), a non-GAAP measure presented in the Company’s SEC filings and other financial communications, was overstated for fiscal year 2011, fiscal year 2012, fiscal year 2013 (including each fiscal quarter of 2013) and, as previously disclosed in the October 29 8-K, the first two fiscal quarters of 2014. Senior management considered AFFO to be an important metric used by analysts and investors in evaluating the Company’s performance and, for the first two quarters of 2014, sought to maintain reported AFFO within the 2014 guidance range of $1.13 to $1.19 per share announced at the end of 2013. The overstatements of AFFO were due in part to errors in reflecting amounts attributable to the limited partnership interests in the Company’s operating partnership, ARC Properties Operating Partnership, L.P., held by holders other than the Company (known as non-controlling interests or “NCI”). Prior to the filing of the Quarterly Report on Form 10-Q for the first quarter of 2014, some members of senior management were aware of NCI errors but allowed the report to be filed without completing an analysis of the errors. In the Company’s Quarterly Report on Form 10-Q for the second quarter of 2014, as previously reported in the October 29 8-K, the NCI errors in the first quarter were intentionally not corrected, and other AFFO and financial statement errors were intentionally made, resulting in an overstatement of AFFO and an understatement of the Company’s net loss for the three and six months ended June 30, 2014. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Sources of Funds – Funds from Operations and Adjusted Funds from Operations (As Restated)” in Item 7 of this Form 10-K/A.

The investigation identified certain payments made by the Company to ARC Properties Advisors, LLC (the “Former Manager”) and certain affiliates of the Former Manager that were not sufficiently documented or otherwise warrant scrutiny. The Company has recovered consideration valued at approximately $8.5 million in respect of certain such payments. The Company is considering whether it has a right to seek recovery for any other such payments and, if so, its alternatives for seeking recovery. No asset has been recognized in the financial statements related to any potential recovery. See Note 19-Related Party Transactions and Arrangements (As Restated) to the consolidated financial statements in this Form 10-K/A.

The investigation found that the agreements relating to equity awards made to Nicholas S. Schorsch and Brian S. Block in connection with the transition from external to internal management of the Company contained provisions that, as drafted, were more favorable to them than the Compensation Committee of the Company’s Board of Directors (the “Compensation Committee”) had authorized. At the time the awards took effect, Mr. Schorsch was the Company’s Executive Chairman and Chief Executive Officer and Mr. Block was the Company’s Chief Financial Officer. Immediately prior to his resignation from the Company, Mr. Schorsch and the Company agreed that the terms of his equity awards should have been consistent with the Compensation Committee’s authorization. In connection with their resignations from the Company, Mr. Block relinquished all of his equity awards and Mr. Schorsch relinquished all of his equity awards other than 1,000,000 shares of restricted stock, the vesting of which was accelerated. These shares are subject to clawback by the Company if, in any proceeding, after all appeals, Mr. Schorsch is found to have breached his fiduciary duty of loyalty or is found to have committed or admits to fraud or misconduct in connection with his responsibilities as a director or officer of the Company. See “Management Changes” below.

The investigation also found material weaknesses in the Company’s internal control over financial reporting and its disclosure controls and procedures. See “Internal Control Considerations” below.

The Audit Committee believes that the scope and process of its investigation were sufficient to identify matters that could materially affect the Company’s consolidated financial statements and the calculation of AFFO.

Effects of the Restatements and Other Corrections

The restatements contained in this Form 10-K/A and the other Amended Filings correct errors in the consolidated financial statements contained in the original filings that were identified as a result of the Audit Committee investigation as well as additional errors identified as a result of a review performed by the Company’s new management. The restatements also reflect

 

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certain adjustments that the Company determined to be immaterial, both individually and in the aggregate, when the consolidated financial statements contained in the original filings were issued. In connection with the restatements, the Company has determined that it would be appropriate to reflect such adjustments. See Note 2 – Restatement of Previously Issued Financial Statements to the consolidated financial statements in this Form 10-K/A.

The Amended Filings also correct errors in the calculation of AFFO contained in the original filings that were identified as a result of the Audit Committee’s investigation or that otherwise reflect restatement adjustments. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Sources of Funds – Funds from Operations and Adjusted Funds from Operations (As Restated)” in Item 7 of this Form 10-K/A.

The following tables summarize the effect of the restatements on certain key items of the Company’s previously issued consolidated financial statements and on its previously issued calculations of AFFO and AFFO per share for the year ended December 31, 2013, the three months ended March 31, 2014 and the three and six months ended June 30, 2014 (amounts in thousands, except for per share data).

 

     Year Ended December 31, 2013  
     As Previously
Reported (1)
    As Restated      $ Change
Fav/(Unfav)
     % Change  

Selected balance sheet amounts

          

Total assets

   $ 7,807,979      $ 7,809,083       $ 1,104         0.01

Total liabilities

     5,285,446        5,310,556         (25,110      (0.48 )% 

Total equity

     2,253,234        2,229,228         (24,006      (1.07 )% 

Selected statement of operations amounts

          

Total revenues

   $ 329,878      $ 329,323       $ (555      (0.17 )% 

Total operating expenses

     640,704        665,228         (24,524      (3.83 )% 

Net loss attributable to stockholders

     (474,740     (491,499      (16,759      (3.53 )% 

Selected cash flow amounts

          

Net cash provided by operating activities

   $ 12,769      $ 11,918       $ (851      (6.66 )% 

Net cash used in investing activities

     (4,542,759     (4,541,718      1,041         0.02

Net cash provided by financing activities

     4,290,140        4,289,950         (190      —  

Net change in cash and cash equivalents

     (239,850     (239,850      —           —  

Funds from operations and adjusted funds from operations amounts - net method (2)

          

Funds from operations

   $ (263,382   $ (285,076    $ (21,694      (8.24 )% 

Adjusted funds from operations

     236,374        192,416         (43,958      (18.60 )% 

AFFO per share

     1.07 (3)      0.87         (0.20      (18.69 )% 

 

(1) The amounts reflect the recasting of the Company’s historical financial statements to present the effects of the Company’s acquisition of ARCT IV, an entity previously deemed to be under common control with the Company, as if it had been completed at inception, as previously disclosed in the Company’s Current Report on From 8-K, dated May 20, 2014.
(2) The net method is defined in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Sources of Funds – Funds from Operations and Adjusted Funds from Operations (As Restated)” in Item 7 of this Form 10-K/A.
(3) AFFO per share was not previously reported in the Original Filing, although it was reported in the earnings release related to the year ended December 31, 2013. It has been calculated utilizing the previously reported AFFO and weighted average shares of 221,378,676.

For discussion of the restatement adjustments, see Note 2 – Restatement of Previously Issued Financial Statements to the consolidated financial statements in this Form 10-K/A.

 

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     Three Months Ended March 31, 2014 (Unaudited)  
     As
Previously
Reported
     As Restated      $ Change
Fav/(Unfav)
     % Change  

Selected balance sheet amounts

           

Total assets

   $ 20,480,300       $ 20,488,095       $ 7,795         0.04

Total liabilities

     10,950,414         10,974,377         (23,963      (0.22 )% 

Total equity

     9,260,587         9,244,419         (16,168      (0.17 )% 

Selected statement of operations amounts

           

Total revenues

   $ 320,614       $ 321,154       $ 540         0.17

Total operating expenses

     512,851         482,128         30,723         5.99

Net loss attributable to stockholders

     (308,681      (291,444      17,237         5.58

Selected cash flow amounts

           

Net cash provided by operating activities

   $ (106,126    $ (122,828    $ (16,702      (15.74 )% 

Net cash used in investing activities

     (1,212,122      (1,174,407      37,715         3.11

Net cash provided by financing activities

     1,348,590         1,327,726         (20,864      (1.55 )% 

Net change in cash and cash equivalents

     30,342         30,491         149         0.49

Funds from operations and adjusted funds from operations amounts - net method (1)

           

Funds from operations

   $ (183,791    $ (137,960    $ 45,831         24.94

Adjusted funds from operations

     147,389         108,892         (38,497      (26.12 )% 

AFFO per share (2)

   $ 0.26       $ 0.19         (0.07      (26.92 )% 

 

(1) The net method is defined in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Sources of Funds – Funds from Operations and Adjusted Funds from Operations (As Restated)” in Item 7 of this Form 10-K/A.
(2) As previously disclosed in the Company’s quarterly supplemental information furnished on Form 8-K on May 8, 2014.

For discussion of the restatement adjustments, see Note 2 – Restatement of Previously Issued Financial Statements in the Company’s Quarterly Report on Form 10-Q/A for the fiscal period ended March 31, 2014.

 

    Three Months Ended June 30, 2014 (Unaudited)     Six Months Ended June 30, 2014 (Unaudited)  
    As
Previously
Reported
    As Restated     $ Change
Fav/(Unfav)
    % Change     As
Previously
Reported
    As Restated     $ Change
Fav/(Unfav)
    % Change  

Selected balance sheet amounts

               

Total assets

  $ 21,315,487      $ 21,310,496      $ (4,991     (0.02 )%    $ 21,315,487      $ 21,310,496      $ (4,991     (0.02 )% 

Total liabilities

    10,451,698        10,485,022        (33,324     (0.32 )%      10,451,698        10,485,022        (33,324     (0.32 )% 

Total equity

    10,594,490        10,556,175        (38,315     (0.36 )%      10,594,490        10,556,175        (38,315     (0.36 )% 

Selected statement of operations amounts

               

Total revenues

  $ 381,981      $ 382,178      $ 197        0.05   $ 702,595      $ 703,332      $ 737        0.10

Total operating expenses

    355,573        353,284        2,289        0.64     867,301        835,412        31,889        3.68

Net loss attributable to the Company

    (40,328     (54,720     (14,392     (35.69 )%      (349,009     (346,164     2,845        0.82

Selected cash flow amounts

               

Net cash provided by (used in) operating activities

  $ 139,911      $ 154,021      $ 14,110        10.08   $ 33,785      $ 31,193      $ (2,592     (7.67 )% 

Net cash used in investing activities

    (734,300     (777,649     (43,349     (5.90 )%      (1,946,422     (1,952,056     (5,634     (0.29 )% 

Net cash provided by financing activities

    705,012        735,941        30,929        4.39     2,053,602        2,063,667        10,065        0.49

Net change in cash and cash equivalents

    110,623        112,313        1,690        1.53     140,965        142,804        1,839        1.30

Funds from operations and adjusted funds from operations amounts - gross method (1)

               

Funds from operations

  $ 174,661      $ 156,967      $ (17,694     (10.13 )%    $ (15,115   $ 12,163      $ 27,278        180.47

Adjusted funds from operations

    205,278        185,934        (19,344     (9.42 )%      353,058        300,706        (52,352     (14.83 )% 

AFFO per share (2)

  $ 0.24      $ 0.21        (0.03     (12.50 )%    $ 0.49      $ 0.41        (0.08     (16.33 )% 

 

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(1) The gross method is defined in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Sources of Funds – Funds from Operations and Adjusted Funds from Operations (As Restated)” in Item 7 of this Form 10-K/A.
(2) As previously disclosed in the Company’s quarterly supplemental information furnished on Form 8-K on July 29, 2014.

For discussion of the restatement adjustments, see Note 2 – Restatement of Previously Issued Financial Statements in the Company’s Quarterly Report on Form 10-Q/A for the fiscal periods ended June 30, 2014.

Internal Control Considerations

In light of the findings of the Audit Committee’s investigation and a review by the Company in connection with the preparation of the restatements, the Company’s new management re-evaluated the Company’s internal control over financial reporting and its disclosure controls and procedures and concluded that they were not effective at December 31, 2013. These material weaknesses had not been remediated, and additional material weaknesses in our internal control over financial reporting existed, at March 31, 2014, June 30, 2014 and September 30, 2014. In addition, at those dates, our disclosure controls and procedures were not effective. The material weaknesses existing at December 31, 2013 and the Company’s plans for remediation are described in Part II, Item 9A – Controls and Procedures in this Form 10-K/A. The Company is committed to remediating its material weaknesses as promptly as possible. Implementation of the Company’s remediation plans has commenced and is being overseen by the Audit Committee.

Management Changes

During the fourth quarter of 2014, the following executive officers resigned from all positions with the Company and its subsidiaries: Mr. Schorsch, Executive Chairman of the Board of Directors; Mr. Block, Chief Financial Officer; David S. Kay, Chief Executive Officer and a director; Lisa E. Beeson, President and Chief Operating Officer; and Lisa P. McAlister, Chief Accounting Officer. In connection with their resignations, these individuals relinquished an aggregate of approximately 2.7 million shares of stock as well as all outstanding interests in the Company’s 2014 Outperformance Plan.

Following the resignations of Mr. Block and Ms. McAlister, the Company’s Board of Directors appointed Michael Sodo as Chief Financial Officer and Gavin B. Brandon as Chief Accounting Officer. Following the resignations of Messrs. Schorsch and Kay and Ms. Beeson, the Board of Directors appointed William G. Stanley, who had been serving as Lead Independent Director, as Interim Chairman of the Board and Interim Chief Executive Officer. The Compensation Committee has commenced a search, with the assistance of an independent search firm, for a new independent Chairman of the Board and a new Chief Executive Officer.

Regulatory Investigations and Litigation Related to this Matter

Prior to the filing of the October 29 8-K, the Audit Committee previewed for the SEC the information contained in the filing. Subsequent to the filing, the SEC provided notice that it had commenced a formal investigation and issued subpoenas calling for the production of documents. In addition, the United States Attorney’s Office for the Southern District of New York contacted counsel for the Audit Committee and counsel for the Company with respect to this matter, and the Secretary of the Commonwealth of Massachusetts issued a subpoena calling for the production of various documents. The Audit Committee and the Company are cooperating with these regulators in their investigations.

The Company and certain of its current and former directors and officers have been named as defendants in a number of lawsuits filed in response to the October 29 8-K, including class actions, derivative actions and individual actions under the federal securities laws and state common and corporate laws in both federal and state courts in New York and Maryland. For information concerning these lawsuits, see “Risk Factors – New Risk Factors” in Item 1A of this Form 10-K/A and Note 24 – Subsequent Events (As Restated) to the consolidated financial statements contained in this Form 10-K/A.

 

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AMERICAN REALTY CAPITAL PROPERTIES, INC.

For the fiscal year ended December 31, 2013

 

     Page  
Forward-Looking Statements      8   
PART I     
Item 1.  

Business

     11   
Item 1A.  

Risk Factors

     19   
Item 1B.  

Unresolved Staff Comments

     58   
Item 2.  

Properties

     58   
Item 3.  

Legal Proceedings

     63   
Item 4.  

Mine Safety Disclosure

     63   
PART II     
Item 5.  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

     64   
Item 6.  

Selected Financial Data

     71   
Item 7.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     73   
Item 7A.  

Quantitative and Qualitative Disclosures about Market Risk

     100   
Item 8.  

Financial Statements and Supplementary Data

     100   
Item 9.  

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     101   
Item 9A.  

Controls and Procedures

     101   
Item 9B.  

Other Information

     108   
PART III     
Item 10.  

Directors, Executive Officers and Corporate Governance

     110   
Item 11.  

Executive Compensation

     110   
Item 12.  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     110   
Item 13.  

Certain Relationships and Related Transactions, and Director Independence

     110   
Item 14.  

Principal Accounting Fees and Services

     110   
PART IV     
Item 15.  

Exhibits and Financial Statement Schedules

     111   
Signatures      117   
Index to Consolidated Financial Statements      F-1   

 

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Forward-Looking Statements (As Restated)

Certain statements included herein are forward-looking statements. Those statements include statements regarding the intent, belief or current expectations of American Realty Capital Properties, Inc. and members of our management team, as well as the assumptions on which such statements are based, and generally are identified by the use of words such as “may,” “will,” “seeks,” “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends,” “should” or similar expressions. Actual results may differ materially from those contemplated by such forward-looking statements. Further, forward-looking statements speak only as of the date they are made, and we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time, unless required by law. As used herein, the terms “ARCP,” “we,” “our” and “us” refer to American Realty Capital Properties, Inc., a Maryland corporation, together with our consolidated subsidiaries, including ARC Properties Operating Partnership, L.P., a Delaware limited partnership of which we are the sole general partner, which we refer to in herein as our “OP”; our “Former Manager” refers to ARC Properties Advisors, LLC, a Delaware limited liability company, our former external manager; “ARC” refers to AR Capital, LLC (formerly known as American Realty Capital II, LLC) and its affiliated companies, which formerly was our sponsor; and “the Contributor” refers to ARC Real Estate Partners, LLC, an affiliate of ARC, which contributed its 100% indirect ownership interests in the properties contributed to our OP in the formation transactions related to our initial public offering, or our IPO, described elsewhere herein, or the formation transactions. During the year ended December 31, 2013, we retained our Former Manager to manage our affairs on a day to day basis and, as a result, were generally externally managed, with the exception of certain acquisition, accounting and portfolio management services performed by our employees. 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 and since the beginning of the third quarter of 2013, we terminated the existing management agreement with our Former Manager, entered into employment and incentive compensation arrangements with our executives.

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:

 

    We have a limited operating history and limited experience operating a public company. This inexperience makes our future performance difficult to predict.

 

    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.

 

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    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 Recent Acquisitions (defined below) into our existing portfolio or with our business successfully, or may not realize the anticipated benefits within the expected timeframe 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, including pending and filed securities litigation and governmental inquiries.

 

    We may not be able to successfully acquire future properties on advantageous terms.

 

    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 fail to qualify to be treated as a real estate investment trust for U.S. federal income tax purposes (“REIT”).

 

    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.

 

    Once we resume paying a dividend in respect of our common stock, there is no guarantee that such dividend will be paid at a rate equal to or at the same frequency as our previously declared monthly dividend.

 

    Our financial condition may be affected by our recent credit rating downgrade which could impact our access to capital and the terms of potential financing.

 

    We have material weaknesses in our disclosure controls and procedures and our internal control over financial reporting and we may not be able to remediate such material weaknesses in a timely enough manner to eliminate the risks posed by such material weaknesses in future periods.

 

    Failure to timely deliver on or before March 31, 2015 our and the OP’s annual report on Form 10-K for the year ended December 31, 2014 in light of our obligations pursuant to an agreement with the lenders under the Credit Facility and pursuant to the terms of our indentures governing our senior unsecured and convertible notes could result in an event of default.

 

    We may not satisfy NASDAQ’s requirements for regaining compliance with its listing rules and, if so, NASDAQ could delist our common stock and Series F Preferred Stock.

 

All forward-looking statements should be read in light of the risks identified in Part I, Item 1A of this Form 10-K/A.

 

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We use certain defined terms throughout this document that have the following meanings:

We use the term “net lease” throughout this document. Under a net lease, the tenant occupying the leased property (usually as a single tenant) does so in much the same manner as if the tenant were the owner of the property. There are various forms of net leases, most typically classified as triple net or double net. Triple net leases typically require the tenant to pay all costs associated with a property, including real estate taxes, insurance, utilities and routine maintenance in addition to the base rent. Double net leases typically require the tenant to pay all the costs as triple net leases, but hold the landlord responsible for capital expenditures, including the repair or replacement of specific structural and/or bearing components of a property, such as the roof or structure of the building. Accordingly, the owner receives the rent “net” of these expenses, rendering the cash flow associated with the lease predictable for the term of the lease. Under a net lease, the tenant generally agrees to lease the property for a significant term and agrees that it will either have no ability or only limited ability to terminate the lease or abate rent prior to the expiration of the term of the lease as a result of real estate driven events such as casualty, condemnation or failure by the landlord to fulfill its obligations under the lease.

We use the term “modified gross lease” throughout this document. Under a modified gross lease, the commercial enterprises occupying the leased property pay base rent plus a proportional share of some of the other costs associated with the property, such as property taxes, utilities, insurance and maintenance.

We use the term “credit tenant” throughout this document. When we refer to a “credit tenant,” we mean a tenant that has entered into a lease that we determine is creditworthy and may include tenants with an investment grade or below investment grade credit rating, as determined by major credit rating agencies, or unrated tenants. To the extent we determine that a tenant is a “credit tenant” even though it does not have an investment grade credit rating, we do so based on our management’s determination that a tenant should have the financial wherewithal to honor its obligations under its lease with us. This determination is based on our management’s substantial experience closing net lease transactions and is made after evaluating all tenants’ due diligence materials that are made available to us, including financial statements and operating data.

We use the term “annualized rental income” throughout this document. When we refer to “annualized rental income,” we mean the rental income under our leases reflecting straight-line rent adjustments associated with contractual rent increases in the leases as required by generally accepted accounting principles in the United States (“U.S. GAAP”), which includes the effect of tenant concessions such as free rent, as applicable. We also use the term annualized rental income/net operating income (“NOI”) throughout this document. When we refer to “annualized rental income/NOI” for net leases, we mean rental income on a straight-line basis, which includes the effect of tenant concessions such as free rent as applicable. For modified gross leased properties, NOI is rental income on a straight-line basis, which includes the effect of tenant concessions such as free rent, as applicable, plus operating expense reimbursement revenue less property expenses.

When we refer to properties that are net leased on a “medium-term basis,” we mean properties originally leased long term (10 years or longer) that are currently subject to net leases with remaining primary lease terms of generally three to eight years, on average. When we refer to properties that are net leased on a “long-term basis,” we mean properties with remaining primary lease terms of generally 10 years or longer on average.

 

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PART I

Item 1. Business.

Overview

We were incorporated on December 2, 2010 as a Maryland corporation that qualified as a REIT for U.S. federal income tax purposes beginning in the year ended December 31, 2011. On September 6, 2011, we completed our initial public offering (our “IPO”) and our shares of common stock began trading on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “ARCP” on September 7, 2011.

We are a self-managed and self-administered real estate company that acquires, owns and operates single-tenant, free-standing 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 (i) credit tenants, which are generally large public companies with investment-grade ratings and other creditworthy tenants and (ii) governmental, quasi-governmental and not-for-profit entities. Our long-term business strategy is 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 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.

Substantially all of our business is conducted through the OP. We are the sole general partner and holder of 96.1% of the equity interests in the OP as of December 31, 2013. As of December 31, 2013, certain of our affiliates and certain unaffiliated investors are limited partners and owners of 3.3% and 0.6%, respectively, of the equity interests in the OP. Under the limited partnership agreement of the OP, after holding units of limited partner interests in the OP (“OP Units”) for a period of one year, unless otherwise consented to by us, holders of OP Units have the right to redeem the OP Units for the cash value of a corresponding number of shares of our common stock or, at our option, as general partner of the OP, a corresponding number of shares of our common stock. The remaining rights of the holders of OP Units are limited, and do not include the ability to replace the general partner or to approve the sale, purchase or refinancing of the OP’s assets.

We have advanced our investment objectives by growing our net lease portfolio through self-origination of property acquisitions and strategic mergers and acquisitions. See Note 3 — Mergers and Acquisitions to the consolidated financial statements.

As of December 31, 2013, excluding one vacant property classified as held for sale, we owned 2,559 properties consisting of 43.8 million square feet, which were 99% leased with a weighted-average remaining lease term of 9.4 years. In constructing our portfolio, we are committed to diversification (by industry, tenant and geography). As of December 31, 2013, rental revenues derived from investment grade tenants and tenants affiliated with investment grade entities as determined by a major rating agency approximated 60% (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 revenue from investment grade tenants as we further acquire properties and enter into (or assume) lease arrangements.

Completed Mergers and Major Acquisitions

The following summarizes mergers and portfolio acquisitions that have been consummated since January 1, 2013 (the “Recent 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 (the “ARCT III Merger”) with and into a subsidiary of ours. The ARCT III Merger was consummated on February 28, 2013. See Note 3 — Mergers and Acquisitions for further discussion of the ARCT III Merger.

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 (As Restated) for further discussion.

 

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GE Capital Portfolio Acquisition

On June 27, 2013, we acquired, through subsidiaries of the OP, from certain affiliates of GE Capital Corp., the equity interests in the entities that own a real estate portfolio comprised of 447 properties, (the “GE Capital Portfolio”) for a purchase price of $773.9 million, exclusive of closing costs, with no liabilities assumed. The 447 properties are subject to 409 property operating leases, as well as 38 direct financing leases.

During the year ended December 31, 2013, ARCT IV (defined below) acquired, from certain affiliates of GE Capital Corp., the equity interests in the entities that own a real estate portfolio comprised of 924 properties (the “ARCT IV GE Capital Portfolio”) for a purchase price of $1.4 billion, exclusive of closing costs, with no liabilities assumed. The 924 properties are subject to 912 property operating leases, as well as 12 direct financing leases.

CapLease, Inc. Merger

On May 28, 2013, we entered into an Agreement and Plan of Merger (the “CapLease Merger Agreement”) with CapLease, Inc., a Maryland corporation (“CapLease”), and certain subsidiaries of each company. The CapLease Merger Agreement provided for the merger of CapLease with and into a subsidiary of ours (the “CapLease Merger”). On November 5, 2013, we completed the merger with CapLease based on the terms of the CapLease Merger Agreement. See Note 3 — Mergers and Acquisitions for further discussion of the CapLease Merger.

American Realty Capital Trust IV, Inc. Merger

On July 1, 2013, we entered into an Agreement and Plan of Merger, as amended on October 6, 2013 and October 11, 2013, (the “ARCT IV Merger Agreement”) with American Realty Capital Trust IV, Inc., a Maryland corporation (“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 “ARCT IV Merger”). We consummated the ARCT IV Merger on January 3, 2014. See Note 3 — Mergers and Acquisitions for further discussion of the ARCT IV Merger.

ARCP and ARCT IV, from inception to the ARCT IV Merger date, were considered to be entities under common control. Both entities’ advisors were wholly owned subsidiaries of ARC. ARC and its related parties had ownership interests in us and in ARCT IV through the ownership of shares of common stock and other equity interests. In addition, the advisors of both entities were contractually eligible to receive potential fees for their services to both of the companies including asset management fees, incentive fees and other fees and had continued to receive fees from us prior to our transition to self-management on January 8, 2014. Due to the significance of these fees, the advisors and ultimately ARC were determined to have a significant economic interest in both companies in addition to having the power to direct the activities of the companies through advisory/management agreements, which qualified them as affiliated companies under common control in accordance with U.S. GAAP. The acquisition of an entity under common control is accounted for on the carryover basis of accounting, whereby the assets and liabilities of the companies are recorded upon the merger on the same basis as they were carried by the companies on the ARCT IV Merger date. In addition, U.S. GAAP requires us to present historical financial information as if the entities were combined from the earliest period of common control. Therefore, the accompanying financial statements including the notes thereto are presented as if the ARCT IV Merger, including the impact of the equity transactions entered to consummate the merger, had occurred at inception.

Fortress Portfolio Acquisition

On July 24, 2013, ARC and another related entity, on our behalf and certain other entities sponsored directly or indirectly by ARC, entered into a purchase and sale agreement with affiliates of funds managed by Fortress Investment Group LLC (“Fortress”) for the purchase and sale 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 was 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 us (the “Fortress Portfolio”). 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. We closed the acquisition of the remaining 79 properties in the Fortress Portfolio on January 8, 2014, 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. See Note 3 — Mergers and Acquisitions for further discussion of the Fortress Portfolio acquisition.

 

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Cole Real Estate Investments, Inc. Merger

On October 22, 2013, we entered into an Agreement and Plan of Merger (the “Cole Merger Agreement”) with Cole Real Estate Investments, Inc. (“Cole”), a Maryland corporation, and a wholly owned subsidiary of ours. The Cole Merger Agreement provided for the merger of Cole with and into a wholly owned subsidiary of ours (the “Cole Merger”). We consummated the Cole Merger on February 7, 2014 (the “Cole Acquisition Date”). See Note 3 — Mergers and Acquisitions for further discussion of the Cole Merger.

Inland Portfolio Acquisition

On August 8, 2013, ARC entered into a purchase and sale agreement with Inland American Real Estate Trust, Inc. (“Inland”) for the purchase and sale of the equity interests of 67 companies owned by Inland for an aggregate contract purchase price of $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 (the “Inland Portfolio”) were acquired, in total, by us from Inland for a purchase price of $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 December 31, 2013, we had closed on five of the 33 properties for a total purchase price of $56.4 million, exclusive of closing costs. We closed the acquisition of 27 additional properties in the Inland Portfolio subsequent to December 31, 2013. We do not consider it probable that we will close on the remaining property.

Transition to Self-Management

During the year ended December 31, 2013, we retained our Former Manager, a wholly owned subsidiary of ARC, to manage our affairs on a day-to-day basis and, as a result, we were generally externally managed, 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 was 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 the Former Manager agreed to sell us certain assets.

Under the termination agreement, the Former Manager agreed to provide services previously provided under the management agreement with the Former Manager, to the extent required by ARCP, for a tail period of 60 days following January 8, 2014 and received a payment in the amount of $10.0 million for providing such services. In addition, pursuant to a separate transition services agreement, affiliates of the Former Manager agreed to provide certain transition services, including accounting support, acquisition support, investor relations support, public relations support, human resources and administration, general human resources duties, payroll services, benefits services, treasury, insurance and risk management, information technology, telecommunications and Internet and services relating to office supplies for a 60-day term, which may be extended by ARCP. For additional services that were required by ARCP, ARCP paid an hourly rate or flat rate to be agreed on, that did not exceed market rate. See Note 19 — Related Party Transactions and Arrangements (As Restated) and Note 24 — Subsequent Events (As Restated) for further discussion.

 

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Investment Policies

Our primary business objective is to generate dependable monthly cash dividends from a consistent and predictable level of funds from operations (“FFO”) and adjusted funds from operations (“AFFO”) per share and capital appreciation associated with extending expiring leases or repositioning our properties for lease to new credit tenants upon the expiration of a net lease. After consummation of the mergers and acquisitions discussed above, we will own a portfolio that uniquely combines all entities’ portfolio of properties with stable income from high credit quality tenants, with our portfolio, which has substantial growth opportunities. Our long-term business strategy is 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 expect this investment strategy to provide for stable income from credit tenants and to provide for growth opportunities from the re-leasing of properties that are currently subject to below market leases. We intend to pursue an investment strategy that maximizes current cash flow and achieves sustainable long-term growth. We expect to achieve these objectives by acquiring net leased properties that either (a) have in-place rental rates below current average asking rents in the applicable sub-market and are located in sub-markets with stable or improving market fundamentals or (b) provide a vital location or infrastructure that is essential to the business operations of the tenant, which we believe will give incentive to the existing tenant or a new credit tenant to re-lease the property at a higher rental rate upon the expiration of the existing lease.

Primary Investment Focus

We focus on investing in properties that are net leased to (i) credit tenants, which are generally large public companies with investment grade or below investment grade ratings and (ii) governmental, quasi-governmental and not-for-profit entities. We intend to invest in properties with tenants that reflect a diversity of industries, geographies and sizes. A significant majority of our net lease investments have been and will continue to be in properties net leased to investment grade tenants, although at any particular time our portfolio may not reflect this. Our properties are primarily located in ’’Main & Main’’ locations in markets that we believe exhibit demographic trends that will support growth. We believe the diversification of our portfolio reduces the risks associated with potential adverse events that may impact any one tenant, industry, asset type or location. We believe our scale will enable us to continue to make significant acquisitions without exposing ourselves to excessive concentration risk. Our strategy encompasses receiving the majority of our revenue from investment grade tenants as we further acquire properties and enter into (or assume) lease arrangements.

Under net lease arrangements, tenants enter into long-term leases and pay most of the costs associated with the property and limited day-to-day property management by us is required. As a result, net lease companies are generally able to increase their size and scale with minimal incremental expense. This enables us to take advantage of economies of scale resulting in significant operational efficiencies as we grow. We believe that our focus on net leases has also enabled us to achieve greater tenant and geographic diversification, more stable cash flows, increased liquidity and lower cost of capital.

Investing in Real Property

We invest, and expect to continue to invest, in primarily freestanding, single-tenant retail properties net-leased to investment grade and other creditworthy tenants. When evaluating prospective investments in real property, our management will consider relevant real estate and financial factors, including the location of the property, the leases and other agreements affecting the property, the creditworthiness of major tenants, its income-producing capacity, its physical condition, its prospects for appreciation, its prospects for liquidity, tax considerations and other factors. In this regard, our management will have substantial discretion with respect to the selection of specific investments, subject to approval of our board of directors.

As of December 31, 2013, after giving effect to the properties owned by ARCT IV which we acquired on January 3, 2014, we owned nearly 2,559 double and triple-net lease assets across property types. As a percentage of rental income, as of December 31, 2013, retail properties represented 54%, office properties represented 27% and distribution properties represented 19% of our total portfolio. Our portfolio is located across 49 states, the District of Columbia and Puerto Rico. Our tenant base is comprised of approximately 486 tenants, which include well-known national as well as regional companies across 55 industries.

 

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The following table lists the tenants whose annualized rental income, on a straight-line basis, represented greater than 10% of consolidated annualized rental income on a straight-line basis as of December 31, 2013 and 2012:

 

Tenant

   2013      2012  

Citizens Bank

             13.8

Dollar General

             12.3

FedEx

             10.2

 

* The tenants’ annualized rental income was not greater than 10% of total annualized rental income for all portfolio properties as of the period specified.

The following table lists the states where we have concentrations of properties where annual rental income, on a straight-line basis, represented greater than 10% of consolidated annualized rental income, on a straight-line basis, as of December 31, 2013 and 2012:

 

State

   2013     2012  

Texas

     10.7       

Illinois

            11.2

 

* The state’s annualized rental income was not greater than 10% of total annualized rental income for all portfolio properties as of the period specified.

We do not have any specific policy as to the amount or percentage of our assets which will be invested in any specific property, other than the requirements under REIT qualification rules. We currently anticipate that our real estate investments will continue to be diversified in multiple net leased single tenant properties and in multiple geographic markets.

Purchase and Sale of Investments

We may deliberately and strategically dispose of properties in the future and redeploy funds into new acquisitions that align with our strategic objectives. Further, on a limited and opportunistic basis, we intend to acquire and promptly resell medium-term net lease assets for immediate gain. To the extent we engage in these activities, to avoid adverse U.S. federal income tax consequences, we generally must do so through a taxable REIT subsidiary (“TRS”). In general, a TRS is treated as a regular “C corporation” and therefore must pay corporate-level taxes on its taxable income. Thus, our yield on such activities will be reduced by such taxes borne by the TRS. Our two vacant properties will be held in a TRS because we are contemplating various strategies including selling them as a means of maximizing our value from those properties.

Investments in Real Estate Mortgages

While our current portfolio consists of, and our business objectives emphasize, equity investments in real estate, we may, at the discretion of our board of directors and without a vote of our stockholders, invest in mortgages and other types of real estate interests consistent with our qualification as a REIT. We acquired $97.6 million of mortgage loans and $211.9 million of collateralized mortgage backed securities (“CMBS”), pursuant to the Cole merger and the CapLease merger. Investments in real estate mortgages run the risk that one or more borrowers may default under the mortgages and that the collateral securing those mortgages may not be sufficient to enable us to recoup our full investment. Investments in mortgages are also subject to our policy not to be treated as an “investment company” under the Investment Company Act.

 

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Securities of or Interests in Persons Primarily Engaged in Real Estate Activities and Other Issuers

Subject to the asset tests and income tests necessary for REIT qualification, we may invest in securities of other REITs, other entities engaged in real estate activities or securities of other issuers (including partnership interests, limited liability company interests, common stock and preferred stock), where such investment would be consistent with our investment objectives, including for the purpose of exercising control over such entities. There are no limitations on the amount or percentage of our total assets that may be invested in any one issuer, other than those imposed by the gross asset tests we must meet in order to qualify as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). We do not intend that our investments in securities will require us to register as an “investment company” under the Investment Company Act, and we would generally divest appropriate securities before any such registration would be required.

Build-to-Suit and Properties under Development

We are also expanding our investment activities beyond the traditional investment in completed properties with tenants in occupancy and paying rents by continuing the build-to-suit program and acquisition of properties under the development of Cole and CapLease. These programs involve acquisition of properties that are not yet developed or are under development. Through the build-to-suit program and acquisition of properties under development or that require substantial refurbishment or renovation, we seek to source investments at higher rates of return relative to completed projects. We believe that by entering into projects with established developer partners, we can provide the capital needed to get projects built, while at the same time, securing long-term investment assets for our company at yields significantly higher than those available for completed properties.

Cole Capital®

We acquired Cole Capital as part of our acquisition of Cole. Cole Capital sponsors and manages direct investment programs, which primarily includes five publicly registered, non-traded REITs. Cole Capital is responsible for managing the day-to-day affairs of the non-traded REITs, identifying and making acquisitions and investments on behalf of the non-traded REITs, and recommending to each of the respective board of directors of the non-traded REITs an approach for providing investors with liquidity. Cole Capital also develops new non-traded REIT offerings, distributes the shares of common stock for the non-traded REITs and advises them regarding offerings, manages relationships with participating broker-dealers and financial advisors and provides assistance in connection with compliance matters relating to the offerings.

Joint Ventures

We may acquire or enter into joint ventures from time to time, if we determine that doing so would be the most cost-effective and efficient means of raising capital. Equity investments may be subject to existing mortgage financing and other indebtedness or such financing or indebtedness may be incurred in connection with acquiring investments. Any such financing or indebtedness will have priority over our equity interest in such property.

Financing Policies

We rely on leverage to allow us to invest in a greater number of assets and enhance our asset returns. We expect our leverage levels to decrease over time, as a result of one or more of the following factors: scheduled principal amortization on our debt and lower leverage on new asset acquisitions. We expect to continue to strengthen our balance sheet through debt repayment or repurchase and also opportunistically grow our portfolio through new property acquisitions.

We intend to finance future acquisitions with the most advantageous source of capital available to us at the time of the transaction, which may include a combination of public and private offerings of our equity and debt securities, secured and unsecured corporate-level debt, property-level debt and mortgage financing and other public, private or bank debt. In addition, we may acquire properties in exchange for the issuance of common stock or OP Units and in many cases we may acquire properties subject to existing mortgage indebtedness.

In February 2014, we, through our OP, raised $2.55 billion in unsecured senior notes, and simultaneously with that financing, our credit agreement, which previously had been secured by pledges of interests in property-owning entities, was modified to eliminate these pledges. We intend to continue to emphasize unsecured corporate- or OP-level debt in our financing and seek to reduce the percentage of our assets which are secured by mortgage loans.

 

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When we use mortgage financing, we generally seek to finance our properties with, or acquire properties subject to, long-term, fixed-rate, non-recourse debt, effectively locking in the spread we expect to generate on our properties and isolating the default risk to solely the properties financed. Through non-recourse debt, we seek to limit the overall company exposure in the event we default on the debt to the amount we have invested in the asset or assets financed. We seek to finance our assets with “match-funded” or substantially “match-funded” debt, meaning that we seek to obtain debt whose maturity matches as closely as possible the lease maturity of the asset financed. We expect that over time the leverage on net leased properties with medium-term remaining lease durations will be approximately 45% to 55% of the property value. At December 31, 2013, our corporate leverage ratio (total debt outstanding less on-hand cash and cash equivalents divided by base purchase price of acquired properties) was 58.1%.

We also may obtain secured or unsecured debt to acquire properties, and we expect that our financing sources will include banks, institutional investment firms, including asset managers, and life insurance companies. Although we intend to maintain a conservative capital structure, with limited reliance on debt financing, our charter does not contain a specific limitation on the amount of debt we may incur and our board of directors may implement or change target debt levels at any time without the approval of our stockholders.

Lending Policies

We do not have a policy limiting our ability to make loans to other persons, although we may be so limited by applicable law, such as the Sarbanes-Oxley Act. Subject to REIT qualification rules, we may make loans to unaffiliated third parties. For example, we may consider offering purchase money financing in connection with the disposition of properties in instances where the provision of that financing would increase the value to be received by us for the property sold. We do not expect to engage in any significant lending in the future. We may choose to guarantee debt of certain joint ventures with third parties. Consideration for those guarantees may include, but is not limited to, fees, long-term management contracts, options to acquire additional ownership interests and promoted equity positions. Our board of directors may, in the future, adopt a formal lending policy without notice to or consent of our stockholders.

Dividend Policy

We intend to pay regular monthly dividends to holders of our common stock, Series D cumulative convertible preferred stock, Series F cumulative redeemable preferred stock and the units of ownership in the OP. U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its REIT taxable income.

In September 2011, our board of directors authorized, and we began paying dividends in October 2011, on the 15th day of each month to common stockholders of record at the close of business on the eighth day of such month. Since October 2011, the board of directors has authorized the following increases in our common stock dividends:

 

Declaration date

   Annualized dividend per
share
     Distribution date      Record date  

September 7, 2011

   $ 0.875         10/15/2011         10/8/2011   

February 27, 2012

   $ 0.880         3/15/2012         3/8/2012   

March 16, 2012

   $ 0.885         6/15/2012         6/8/2012   

June 27, 2012

   $ 0.890         9/15/2012         9/8/2012   

September 30, 2012

   $ 0.895         11/15/2012         11/8/2012   

November 29, 2012

   $ 0.900         2/15/2013         2/8/2013   

March 17, 2013

   $ 0.910         6/15/2013         6/8/2013   

May 28, 2013

   $ 0.940         12/13/2013         12/6/2013   

October 23, 2013*

   $ 1.000         2/15/2014         2/7/2014   

 

* The dividend increase was contingent upon, and became effective with, the close of the Cole merger, which was consummated on February 7, 2014.

 

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Commencing on May 31, 2012, we began paying cumulative dividends on the Series A convertible preferred stock monthly in arrears at the annualized rate of $0.77 per share. Commencing on August 15, 2012, we began paying cumulative dividends on the Series B convertible preferred stock monthly in arrears at an annualized rate of $0.74 per share. These dividends were discontinued when the Series A and B convertible preferred stock were converted to common stock in August 2013. Commencing in June 2013, we began paying cumulative dividends on the Series C cumulative convertible preferred stock monthly in arrears at the annualized rate of $0.9104 per share. These dividends were discontinued when the Series C cumulative convertible preferred stock was converted to common stock and cash in November 2013. Commencing in November 2013, we began paying cumulative dividends on the Series D cumulative preferred stock monthly in arrears at the annualized rate of $0.7896 per share.

We have the ability to fund dividends from any source, including borrowing funds and using the proceeds of equity and debt offerings. Dividends made by us will be authorized by our board of directors in its sole discretion out of funds legally available therefore and will be dependent upon a number of factors, including restrictions under applicable law and our capital requirements.

We and our board of directors share a similar philosophy with respect to paying our dividend. The dividend should principally be derived from cash flows generated from real estate operations. The management agreement with our Former Manager, prior to the amendment thereof in connection with the ARCT III Merger, provided for payment of the asset management fee only if the full amount of the dividends declared by us in respect of our OP Units for the six immediately preceding months is equal to or greater than the amount of our AFFO. This condition has been satisfied. Prior to when it was satisfied, our Former Manager waived such portion of its management fee that, when added to our AFFO, without regard to the waiver of the management fee, increased our AFFO so that it equaled the dividends declared by us in respect of our OP Units for the prior six months. For the year ended December 31, 2013, $9.4 million in base management fees were incurred while certain of these fees were waived by our Former Manager that were in excess of certain net income thresholds related to the Company’s operations. Subsequent to December 31, 2013, the management agreement was terminated as a result of our transition to self-management. See Note 24 — Subsequent Events for further discussion.

As our real estate portfolio matures and one-time acquisition and transaction expenses are significantly reduced, we expect cash flows from operations to cover a more significant portion of our dividends and over time to cover dividends.

Tax Status

We elected to be taxed as a REIT under Sections 856 through 860 of the Code, effective for our taxable year ended December 31, 2011. We believe that we are organized and operate in such a manner as to qualify for taxation as a REIT under the Code. We intend to continue to operate in such a manner to qualify for taxation as a REIT, but no assurance can be given that we will operate in a manner so as to qualify or remain qualified as a REIT. Pursuant to our charter, our board of directors has the authority to make any tax elections on our behalf that, in their sole judgment, are in our best interest. This authority includes the ability to elect not to qualify as a REIT for U.S. federal income tax purposes or, after qualifying as a REIT, to revoke or otherwise terminate our status as a REIT. Our board of directors has the authority under our charter to make these elections without the necessity of obtaining the approval of our stockholders. In addition, our board of directors has the authority to waive any restrictions and limitations contained in our charter that are intended to preserve our status as a REIT during any period in which our board of directors has determined not to pursue or preserve our status as a REIT.

Competition

We are subject to competition in the acquisition of properties and intense competition in the leasing of our properties. We compete with a number of developers, owners and operators of retail, restaurant, industrial and office real estate, many of which own properties similar to ours in the same markets in which our properties are located, in the leasing of our properties. We also may face new competitors and, due to our focus on single-tenant properties located throughout the United States, and because many of our competitors are locally or regionally focused, we will not encounter the same competitors in each region of the United States.

Many of our competitors have greater financial and other resources and may have other advantages over our company. Our competitors may be willing to accept lower returns on their investments and may succeed in buying the properties that we have targeted for acquisition. We may also incur costs on unsuccessful acquisitions that we will not be able to recover.

 

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Regulations

Our investments are subject to various federal, state, local and foreign laws, ordinances and regulations, including, among other things, zoning regulations, land use controls, environmental controls relating to air and water quality, noise pollution and indirect environmental impacts such as increased motor vehicle activity. We believe that we have all permits and approvals necessary under current law to operate our investments.

Environmental Matters

Under various federal, state and local environmental laws, a current owner of real estate may be required to investigate and clean up contaminated property. Under these laws, courts and government agencies have the authority to impose cleanup responsibility and liability even if the owner did not know of and was not responsible for the contamination. For example, liability can be imposed upon us based on the activities of our tenants or a prior owner. In addition to the cost of the cleanup, environmental contamination on a property may adversely affect the value of the property and our ability to sell, rent or finance the property, and may adversely impact our investment in that property.

Prior to acquisition of a property, we will obtain Phase I environmental reports, or will rely on recent Phase I environmental reports. These reports will be prepared in accordance with an appropriate level of due diligence based on our standards and generally include a physical site inspection, a review of relevant federal, state and local environmental and health agency database records, one or more interviews with appropriate site-related personnel, review of the property’s chain of title and review of historic aerial photographs and other information on past uses of the property and nearby or adjoining properties. We may also obtain a Phase II investigation which may include limited subsurface investigations and tests for substances of concern where the results of the Phase I environmental reports or other information indicates possible contamination or where our consultants recommend such procedures.

Employees

As of December 31, 2013, we had 12 employees. On January 8, 2014, we successfully completed our transition to self-management. In connection with becoming self-managed, ARCP terminated its management agreement with its external manager and certain former executives and employees of our Former Manager became our employees. Subsequent to our transition to self-management on January 8, 2014 and including employees from the consummation of the Cole Merger, we had approximately 400 employees.

Financial Information About Industry Segments

Our current business consists of owning, managing, operating, leasing, acquiring, investing in and disposing of real estate assets. All of our consolidated revenues are from our consolidated real estate properties. We internally evaluate operating performance on an individual property level and view all of our real estate assets as one industry segment, and accordingly, all of our properties are aggregated into one reportable segment. Please see Part IV, Item 15 — Exhibits and Financial Statement Schedules included elsewhere in this annual report for more detailed financial information.

Available Information

We electronically file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports, and proxy statements, with the SEC. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549, or you may obtain information by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet address at http://www.sec.gov that contains reports, proxy statements and information statements, and other information, which you may obtain free of charge. In addition, copies of our filings with the SEC may be obtained from the website maintained for us at www.arcpreit.com.

Item 1A. Risk Factors (Certain Sections Restated)

This “Risk Factors” section contains references to our “capital stock” and to our “stockholders.” Unless expressly stated otherwise, the references to our “capital stock” represent our common stock and any class or series of our preferred stock, while the references to our “stockholders” represent holders of our common stock and any class or series of our preferred stock.

 

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New Risk Factors in this Form 10-K/A

The following risk factors, which relate to the matters discussed in the Explanatory Note, have been added to this Form 10-K/A. Other than this section, “New Risk Factors in this Form 10-K/A,” the remainder of Item 1A. Risk Factors has not been updated to reflect developments since February 27, 2014, the date of the Original Filing, unless specified “as restated.” However, all Risk Factors not updated should be read in light of the information presented below.

We have not been in compliance with the requirements of the NASDAQ Stock Market for continued listing and if NASDAQ does not concur that we have adequately remedied our non-compliance, our common stock may be delisted from trading on NASDAQ, which could have a material adverse effect on us and our shareholders.

We have been delinquent in the filing of our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2014 (the “Third Quarter 10-Q”), as a result of which we have not been in compliance with the listing rules of the NASDAQ and are subject to having our stock delisted from trading on NASDAQ. We submitted a compliance plan to NASDAQ on January 12, 2015 and the staff at NASDAQ granted us an exception to file our Third Quarter 10-Q and any other delinquent SEC filings on or before April 15, 2015 in order to enable us to regain compliance with the listing rules. We are filing our Third Quarter 10-Q concurrently with this filing. As a result, we currently believe that we have adequately remedied our current non-compliance with NASDAQ’s listing rules within NASDAQ’s terms of exception. However, there can be no assurance that the NASDAQ will concur that we have remedied our current non-compliance or that we will timely file our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, in either of which case our common stock could remain subject to delisting by NASDAQ. If our common stock were delisted, there can be no assurance whether or when it would again be listed for trading on NASDAQ or any other securities exchange. In addition, the market price of our shares might decline and become more volatile, and our shareholders might find that their ability to trade in our stock would be adversely affected. Furthermore, institutions whose charters do not allow them to hold securities in unlisted companies might sell our shares, which could have a further adverse effect on the price of our stock.

 

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Our inability to file and deliver our financial statements and certain other financial deliverables required under the terms of our Credit Agreement and the indentures governing our senior unsecured notes and convertible notes has adversely affected our overall borrowing flexibility, exposed us to actual and potential consequences of default and required us to pay certain additional expenses.

As a result of our failure to deliver our financial statements for the fiscal quarter ended September 30, 2014 and certain other financial deliverables (the “Q3 2014 Financial Information”) required under the terms of the Amended and Restated Credit Agreement (the “Credit Agreement”), dated as of June 30, 2014, by and among the Company, the OP, as the borrower thereunder, the lenders party thereto (the “Lenders”) and Wells Fargo Bank, National Association, as administrative agent, the Company and the OP entered into two consent and waiver agreements with respect to the Credit Agreement. On November 12, 2014, the Company and the OP entered into the Consent and Waiver Agreement and First Amendment to Credit Agreement (the “First Consent and Waiver”), which, among other things, provided for an extension for delivery of the Q3 2014 Financial Information until the earlier of five days following the date the company files with the SEC its Third Quarter 10-Q and January 5, 2015, modified certain financial covenants in the Credit Agreement relating to the OP’s indebtedness ratios and added certain other financial maintenance covenants. Based upon our determination that we would not deliver the Q3 2014 Financial Information by January 5, 2015 in accordance with the First Consent and Waiver, the Company and the OP entered into a subsequent Consent and Waiver Agreement (the “Second Consent and Waiver”) on December 23, 2014, which provided for a further extension for delivery of the Q3 2014 Financial Information until the earlier of March 2, 2015 and 45 days following the receipt of a notice of breach or default from the applicable trustee or the requisite percentage of holders under the Company’s and the OP’s respective indentures.

The First Consent and Waiver and the Second Consent and Waiver also, among other things, (i) provided an extension for delivery of the Company’s full year 2014 audited financial statements until the earlier of the fifth day after the date that the Company files its Annual Report on Form 10-K with the SEC for the fiscal year ended December 31, 2014 and March 31, 2015, (ii) permanently reduced the maximum amount of indebtedness under the Credit Agreement to $3.6 billion, including the reduction of commitments under the Company’s revolving facilities and the elimination of a $25 million swingline facility, (iii) provided that until the date that all of the required financial information and other deliverables were delivered, no further loans or letters of credit would be requested by the Company under the Credit Agreement, other than in accordance with the cash flow forecast provided by the Company to the lenders thereunder, (iv) provided that neither the Company nor the OP would pay any dividends on, or make any other Restricted Payment (as defined in the Credit Agreement) on, its respective common equity and provided that the Company and the OP would provide additional financial and other information to the Lenders from time to time. In connection with the First Consent and Waiver and Second Consent and Waiver, the Company and OP paid certain customary fees to the consenting Lenders and agreed to reimburse certain customary expenses of the arrangers. On February 20, 2015, we entered into a third consent (the “Third Consent”) to confirm that certain revisions to the required financial deliverables were agreed with the Lenders.

In addition, in connection with our failure to timely file our Third Quarter 10-Q containing the information required to be included in respect of the OP, which is required to be delivered pursuant to the terms of the senior notes Indenture, dated February 6, 2014, by and among the OP, U.S. Bank National Association, as trustee (the “Trustee”), and the guarantors named therein (the “Indenture”), the Company engaged in discussions with counsel to an ad hoc group of note holders (the “Senior Noteholder Group”), which we have been advised then represented a majority of the aggregate principal amounts outstanding of each of the 2.000% senior notes due 2017, the 3.000% senior notes due 2019 and the 4.600% senior notes due 2024, which, in each case, were issued by the OP and guaranteed by the Company under the Indenture. On January 22, 2015, we announced that we had entered into an agreement in principle, pursuant to which the Senior Noteholder Group agreed not to issue a notice of default, prior to March 3, 2015, for the Company’s failure to timely deliver such Third Quarter 10-Q. In exchange, we agreed to sign a confidentiality agreement with the Senior Noteholder Group’s counsel, pay reasonable and documented fees and out-of-pocket expenses of such counsel up to $300,000, and amend the Indenture to provide that if we have not furnished the required third quarter 2014 information to the Trustee prior to March 3, 2015, then any notice of default in relation to our failure to timely file such information will be deemed to have been given as of January 19, 2015 for purposes of determining the period during which we can cure that failure prior to it becoming an Event of Default (as defined in the Indenture). Such agreement was subsequently definitively documented, and a supplement to the Indenture was entered into on February 9, 2015. The Third Quarter 2014 10-Q will be filed with the SEC concurrently with this filing.

 

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In addition, we announced on January 22, 2015 that we received at our Phoenix, Arizona corporate office notice (the “Notice”) from the trustee under the indentures (the “Convertible Indentures”) governing each of the 3.00% convertible senior notes due 2018 issued by us on July 29, 2013 and the 3.75% convertible senior notes due 2020 issued by us on December 10, 2013 (collectively, the “Convertible Notes”) of our failure to timely deliver our Third Quarter 10-Q, which was required to be delivered pursuant to the terms of the Convertible Indentures. Subsequent to our announcement, we learned that we also received the Notice on January 16, 2015, at an address in New York City that was formerly our principal place of business. Pursuant to the terms of the Convertible Indentures, we have 60 days following receipt of a notice of default to deliver the required financial statements, after which such failure would become an event of default under each of the Convertible Indentures. Our Third Quarter 10-Q will be filed with the SEC concurrently with this filing and such default will be cured upon such filing.

We currently expect to file our Annual Report on Form 10-K for the year ended December 31, 2014, on or prior to March 31, 2015, in compliance with the terms of our Credit Agreement, consents, waivers and amendment described above, and the indentures for our senior and convertible notes; however we cannot assure you that we will so timely file and our failure to do so could expose us to further risks associated with noncompliance with the terms of those agreements.

 

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If we fail to comply with the terms of our financing agreements, including waivers, consents and amendments thereto, were to occur, our business, financial condition, results of operations, cash flows and ability to satisfy our debt service obligations could be materially and adversely affected. In addition, any foreclosure on our properties could create taxable income without accompanying cash proceeds, which could adversely affect our ability to meet the REIT dividend requirements imposed by the Code.

The recent downgrades in our credit ratings by Standard & Poor’s and Moody’s could impact our access to capital and materially adversely affect our business and financial condition.

Our credit rating has been downgraded to a non-investment grade credit rating and there can be no assurance that it will not be downgraded further. The current downgrade, and any further downgrade, could adversely affect the amount of capital we can access, as well as the terms of any financing we obtain. Since we depend in part on debt financing to fund our growth, such an adverse change in our credit rating could have a negative effect on our financial condition and future growth and on transactions in which we must obtain debt capital at an advantageous cost.

 

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As a result of the delayed filing of our periodic reports with the SEC, we are not currently eligible to use a registration statement on Form S-3 to register the offer and sale of securities, which may adversely affect our ability to raise future capital or complete acquisitions.

We are not currently eligible to register the offer and sale of our securities using a registration statement on Form S-3 and we will not become eligible until we have timely filed certain periodic reports required under the Securities Exchange Act of 1934 for one year. There can be no assurance when we will meet this requirement, which depends upon our ability to file our periodic reports on a timely basis in the future. Should we wish to register the offer and sale of our securities to the public before we are eligible to do so on Form S-3, our transaction costs and the amount of time required to complete the transaction could increase, making it more difficult to execute any such transaction successfully and potentially having an adverse effect on our financial condition.

The Amended Credit Agreement currently prohibits us and the OP from making distributions in respect of our respective common equity and there can be no assurance as to if, when or at what rate we and the OP will resume common equity distributions.

In connection with our entry into the Second Consent and Waiver, we agreed that, until such time as we have delivered the required financial statements and provided certain other financial deliverables to the lenders under the Amended Credit Agreement, we and the OP would not make distribution payments in respect of our respective common equity. There can be no assurance as to when we will satisfy these requirements. Once we have satisfied these requirements, our Board of Directors intends to reevaluate the reinstatement of a common equity distribution for both us and the OP. There can be no assurance that the reinstated dividends will be paid at rates equal to or at the same frequency as we and the OP previously declared common equity distributions, and any future common equity distributions to be paid by us and the OP to our respective common equity holders may be affected by our reduced borrowing capacity under the Amended Credit Agreement, potentially adversely affecting our ability to make required REIT dividend payments under the Code, which could jeopardize our status as a REIT.

Government investigations may require significant management time and attention, result in significant legal expenses or damages and cause our business, financial condition, results of operations and cash flows to suffer.

On November 13, 2014, we received a formal order of investigation from the staff of the SEC, and the SEC has issued subpoenas calling for the production documents. On December 19, 2014, we received a subpoena from the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts. The U.S. Attorney’s Office for the Southern District of New York has contacted counsel for the Company and counsel for the Audit Committee. We and the Audit Committee are cooperating with these regulators in their investigations. The amount of time needed to resolve these investigations is uncertain, and we cannot predict the outcome of these investigations or whether we will face additional government investigations, inquiries or other actions related to the matters described in this Form 10-K/A. Subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees in connection with the ongoing governmental investigations and any future government inquiries, investigations or actions. These matters could require us to expend significant management time and incur significant legal and other expenses and could result in civil and criminal actions seeking, among other things, injunctions against us and the payment of significant fines and penalties by us, which could have a material adverse effect on our financial condition, business, results of operations and cash flow. If any of these governmental authorities were to commence legal action, we could be required to pay significant penalties and could become subject to injunctions, a cease and desist order and other equitable remedies. We can provide no assurance as to the outcome of any governmental investigation.

ARCP and certain of our current and former officers and directors have been named as defendants in various lawsuits and other proceedings related to the matters described in this Form 10-K/A, and those lawsuits and other proceedings may require significant management time and attention, result in significant legal expenses or damages and have an adverse effect on our business, financial condition, results of operations and cash flows.

Between October 30, 2014 and January 20, 2015, the Company and its current and former officers and directors (along with others) were named as defendants in ten putative securities class action complaints in the United States District Court for the Southern District of New York. At a February 10, 2015 status conference, the court consolidated these actions, appointed a lead plaintiff, designated the complaint filed in Teachers Insurance and Annuity Association of America v. American Realty Capital Properties, Inc., et al., No. 15-cv-0421 (AKH), as the consolidated class action complaint, and set a

 

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deadline of April 10, 2015 for the defendants to respond to the consolidated class action complaint. The consolidated class action complaint asserts claims for violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 10(b), 14(a) and 20(a) of the Securities Exchange Act of 1934 and Rules 10b-5 and 14a-9 promulgated thereunder, arising out of allegedly false and misleading statements in connection with the purchase or sale of the Company’s securities. The proposed class period runs from May 6, 2013 to October 29, 2014.

In addition, on November 25, 2014, an additional putative securities class action complaint was filed in the Circuit Court for Baltimore County, Maryland, which the Company removed to the United States District Court for the District of Maryland (Northern Division) on December 23, 2014 and seeks to have transferred to the Southern District of New York. This action asserts claims for violations of Sections 11 and 15 of the Securities Act of 1933, arising out of allegedly false and misleading statements made in connection with the Company’s securities issued in connection with the Cole Real Estate Investments, Inc. merger. The Company is not yet required to respond to this complaint.

Between November 17, 2014 and January 29, 2015, nine shareholder derivative actions, purportedly in the name and for the benefit of the Company, were filed against certain of the Company’s current and former officers and directors in the United States District Court for the Southern District of New York, the Circuit Court for Baltimore City, Maryland and the Supreme Court of the State of New York. On February 9, 2015 and February 20, 2015, three of the plaintiffs who filed actions in the New York federal court voluntarily dismissed those actions without prejudice. The remaining six actions seek money damages and other relief on behalf of the Company for, among other things, alleged breaches of fiduciary duty, abuse of control, gross mismanagement and unjust enrichment in connection with the alleged conduct underlying the claims asserted in the securities class actions negligence and breach of contract. On February 10, 2015, the New York federal court consolidated the New York federal court actions, appointed a lead plaintiff and ordered the lead plaintiff to file a consolidated amended complaint by March 10, 2015. The court also set a deadline of April 3, 2015 for the Company and defendants to respond to the consolidated amended complaint in the consolidated New York federal court action. On February 18, 2015 the parties to the New York state action entered into a stipulation setting a deadline of April 20, 2015 for the Company and defendants. The Company is not yet required to respond to the complaints in the Maryland state court actions.

On December 18, 2014, a former employee, Lisa McAlister, filed a defamation action against the Company and certain of its former officers and directors in the New York Supreme Court, captioned McAlister v. American Realty Capital Properties, Inc., et al., Index No. 162499/2014. On January 26, 2015, ARCP and defendants filed a motion to dismiss plaintiff’s complaint. Subsequently, plaintiff voluntarily dismissed her complaint.

On January 7, 2015, Ms. McAlister also filed a complaint, No. 2-4173-15-016, with the Occupational Safety and Health Administration of the United States Department of Labor. Subsequently, Ms. McAlister voluntarily withdrew her complaint.

On January 15, 2015 and February 20, 2015, the Company and certain of its former directors and officers were named as defendants in two individual securities fraud actions filed in the United States District Court for the Southern District of New York, captioned Jet Capital Master Fund, L.P. v. American Realty Capital Properties, Inc., et al., No. 15-cv-307 (AKH) (the “Jet Capital Action”) and Twin Securities, Inc. v. American Realty Capital Properties, Inc., No. 15-cv-1291 (AKH) (the “Twin Securities Action,” and together with the Jet Capital Action, the “Individual Securities Actions”). The Individual Securities Actions seek money damages and assert claims for alleged violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 10(b), 14(a), 18 and 20(a) of the Securities Exchange Act of 1934 and Rules 10b-5 and 14a-9 promulgated thereunder, as well as common law fraud under New York law in connection with the purchase of the Company’s securities. At a February 10, 2015 status conference, the court set a deadline of April 10, 2015 for the defendants to respond to the complaint in the Jet Capital Action. The defendants are not yet required to respond to the complaint in the Twin Securities Action.

We have identified material weaknesses in our disclosure controls and procedures and internal control over financial reporting. If not remediated, our failure to establish and maintain effective disclosure controls and procedures and internal control over financial reporting could result in material misstatements in our financial statements and a failure to meet our reporting and financial obligations, each of which could have a material adverse effect on our financial condition and the trading price of our common stock.

Maintaining effective internal control over financial reporting and effective disclosure controls and procedures are necessary for us to produce reliable financial statements. As discussed in Item 9A – “Controls and Procedures” of this Form 10-K/A, we have re-evaluated our internal control over financial reporting and our disclosure controls and procedures and concluded that they were not effective as of December 31, 2013. As disclosed in Item 4 of our Quarterly reports on Form 10-Q/A for the first and second quarters of 2014 and our Third Quarter 10-Q, the material weaknesses in our internal control over financial reporting at December 31, 2013 had not been remediated, and additional material weaknesses in our internal control over financial reporting existed, at March 31, 2014, June 30, 2014 and September 30, 2014. In addition, at those dates, our disclosure controls and procedures were not effective. Finally, in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, we expect to report our conclusions that our disclosure controls and procedures and internal control over financial reporting were not effective as of that date.

 

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A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

The Company is committed to remediating its material weaknesses as promptly as possible. Implementation of the Company’s remediation plans has commenced and is being overseen by the Audit Committee. However, there can be no assurance as to when these material weaknesses will be remediated or that additional material weaknesses will not arise in the future. Any failure to remediate the material weaknesses, or the development of new material weaknesses in our internal control over financial reporting, could result in material misstatements in our financial statements and cause us to fail to meet our reporting and financial obligations, which in turn could have a material adverse effect on our financial condition and the trading price of our common stock.

Risks Related to Our Properties and Operations

Our growth will partially depend upon our ability to successfully acquire future properties, and we may be unable to enter into and consummate property acquisitions on advantageous terms or our property acquisitions may not perform as we expect due to competitive conditions and other factors.

We acquire and intend to continue to acquire primarily freestanding, single tenant retail properties net leased primarily to investment grade and other credit tenants. The acquisition of properties entails various risks, including the risks that our investments may not perform as we expect, that we may be unable to quickly and efficiently integrate our new acquisitions into our existing operations and that our cost estimates for bringing an acquired property up to market standards may prove inaccurate. Further, we face significant competition for attractive investment opportunities from other well capitalized real estate investors, including both publicly-traded REITs and private institutional investment funds including REITs and funds sponsored by the PCM business and these competitors may have greater financial resources than us and a greater ability to borrow funds and acquire properties. This competition increases as investments in real estate become increasingly attractive relative to other forms of investment. As a result of competition, we may be unable to acquire additional properties as we desire or the purchase price may be significantly elevated. In addition, we expect to finance future acquisitions through a combination of borrowings under our revolving credit facility, proceeds from equity or debt offerings by us or our operating partnership or its subsidiaries and proceeds from property contributions and divestitures, which may not be available and which could adversely affect our cash flows. Any of the above risks could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common stock.

In addition, our growth strategy includes the disciplined acquisition of properties as opportunities arise. Our ability to acquire properties on satisfactory terms and successfully integrate and operate them is subject to the following significant risks:

 

    we may be unable to acquire desired properties because of competition from other real estate investors with more capital, including other real estate operating companies, REITs and investment funds;

 

    we may acquire properties that are not accretive to our results upon acquisition, and we may not successfully manage and lease those properties to meet our expectations;

 

    competition from other potential acquirers may significantly increase the purchase price of a desired property;

 

    we may be unable to generate sufficient cash from operations, or obtain the necessary debt or equity financing to consummate an acquisition or, if obtainable, financing may not be on satisfactory terms;

 

    we may need to spend more than budgeted amounts to make necessary improvements or renovations to acquired properties;

 

    agreements for the acquisition of properties are typically subject to customary conditions to closing, including satisfactory completion of due diligence investigations, and we may spend significant time and money on potential acquisitions that we do not consummate;

 

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    the process of acquiring or pursuing the acquisition of a new property may divert the attention of our management from our existing business operations;

 

    we may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into our existing operations;

 

    market conditions may result in future vacancies and lower-than-expected rental rates; and

 

    we may acquire properties without any recourse, or with only limited recourse, for liabilities, whether known or unknown, such as cleanup of environmental contamination, claims by tenants, vendors or other persons against the former owners of the properties and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.

If we cannot complete property acquisitions on favorable terms, or operate acquired properties to meet our goals or expectations, our business, financial condition, results of operations and cash flow; the per share trading price of our common stock; and our ability to satisfy our debt service obligations and to make dividends to our stockholders could be materially and adversely affected.

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, the per share trading price of our common stock and our ability to satisfy our debt service obligations.

Because we compete with a number of real estate operators in connection with the leasing of our properties, the possibility exists that one or more of our tenants will extend or renew its lease with us when the lease term expires on terms that are less favorable to us than the terms of the then-expiring lease, or that such tenant or tenants will not renew at all. Because we depend, in large part, on rental payments from our tenants, if one or more tenants renews its lease on terms less favorable to us, does not renew its lease or we do not re-lease a significant portion of the space made available due to vacancy, our financial condition, results of operations, cash flow, cash available for dividends to our stockholders, the per share trading price of our common stock and our ability to satisfy our debt service obligations could be materially adversely affected.

We are dependent on single-tenant leases for our revenue and, accordingly, lease terminations or tenant defaults could have a material adverse effect on our results of operations.

We focus our investment activities on ownership of freestanding, single-tenant commercial properties that are net leased to a single tenant. Therefore, the financial failure of, or other default in payment by, a single tenant under its lease is likely to cause a significant reduction in our operating cash flows from that property and a significant reduction in the value of the property, and could cause a significant reduction in our revenues. If a lease is terminated or defaulted on, we may experience difficulty or significant delay in re-leasing such property, or we may be unable to find a new tenant to re-lease the vacated space, which could result in us incurring a loss. The current economic conditions may put financial pressure on and increase the likelihood of the financial failure of, or other default in payment by, one or more of the tenants to whom we have exposure.

The 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.

Our ability to generate cash from operations is dependent on the rents that we are able to charge and collect from our tenants. While we evaluate the creditworthiness of our tenants by reviewing available financial and other pertinent information, there can be no assurance that any tenant will be able to make timely rental payments or avoid defaulting under its lease. At any time, our tenants may experience an adverse change in their business. For example, the downturn in the global economy that commenced in 2008 may have adversely affected, or may in the future adversely affect, one or more of our tenants. If any of our tenants’ business experience significant adverse changes, they may decline to extend or renew leases upon expiration, fail to make rental payments when due, close a number of stores, exercise early termination rights (to the extent such rights are available to the tenant) or declare bankruptcy. If a tenant defaults, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment.

 

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If any of the foregoing were to occur, it could result in the termination of the tenant’s leases and the loss of rental income attributable to the terminated leases. If a lease is terminated or defaulted on, we may be unable to find a new tenant to re-lease the vacated space at attractive rents or at all, which would have a material adverse effect on our results of operations and our financial condition. Furthermore, the consequences to us would be exacerbated if one of our major tenants were to experience an adverse development in their business that resulted in them being unable to make timely rental payments or to default under their lease. The occurrence of any of the situations described above would have a material adverse effect on our results of operations and our financial condition.

If a sale-leaseback transaction is re-characterized in a tenant’s bankruptcy proceeding, our financial condition could be adversely affected.

We have entered and may continue to enter into sale-leaseback transactions, whereby we would purchase a property and then lease the same property back to the person from whom we purchased it. In the event of the bankruptcy of a tenant, a transaction structured as a sale-leaseback may be re-characterized as either a financing or a joint venture, either of which outcomes could adversely affect our financial condition, cash flow and the amount available for distributions to our stockholders.

If the sale-leaseback were re-characterized as a financing, we might not be considered the owner of the property, and as a result would have the status of a creditor in relation to the tenant. In that event, we would no longer have the right to sell or encumber our ownership interest in the property. Instead, we would have a claim against the tenant for the amounts owed under the lease, with the claim arguably secured by the property. The tenant/debtor might have the ability to propose a plan restructuring the term, interest rate and amortization schedule of its outstanding balance. If confirmed by the bankruptcy court, we could be bound by the new terms and prevented from foreclosing our lien on the property. If the sale-leaseback were re-characterized as a joint venture, our lessee and we could be treated as co-venturers with regard to the property. As a result, we could be held liable, under some circumstances, for debts incurred by the lessee relating to the property.

We are subject to tenant geographic concentrations that make us more susceptible to adverse events with respect to certain geographic areas.

We are subject to geographic concentrations, the most significant of which, as of December 31, 2013, on a pro forma basis (including the properties acquired in the Cole Merger and the acquisitions of the Fortress Portfolio and Inland Portfolio after December 31, 2013), are the following:

 

    $59.5 million, or 10.7%, of our annualized rental income came from properties located in Texas (1);

 

    $35.1 million, or 6.3%, of our annualized rental income came from properties located in Illinois (1);

 

    $34.8 million, or 6.3%, of our annualized rental income came from properties located in Pennsylvania (1);

 

    $32.1 million, or 5.8%, of our annualized rental income came from properties located in Florida (1); and

 

    $28.8 million, or 5.2%, of our annualized rental income came from properties located in California (1).

 

(1) Figures were adjusted in order to apply the carryover basis of accounting to include the effects of the merger with ARCT IV, an entity previously deemed to be under common control with the Company, as if it had been completed at the beginning of the period presented.

Any downturn of the economies in one or more of these states, or in any other state in which we, may have a significant credit concentration in the future, could result in a material reduction of our cash flows or material losses to us.

 

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Our net leases may require us to pay property-related expenses that are not the obligations of our tenants.

Under the terms of the majority of our net leases, in addition to satisfying their rent obligations, our tenants are responsible for the payment of real estate taxes, insurance and ordinary maintenance and repairs. However, under the provisions of certain leases and leases that we may enter into in the future with our tenants, including leases of multi-tenant properties acquired in the Cole Merger, we may be required to pay some expenses, such as the costs of environmental liabilities, roof and structural repairs, insurance, certain non-structural repairs and maintenance. If our properties incur significant expenses that must be paid by us under the terms of our leases, our business, financial condition and results of operations will be adversely affected and the amount of cash available to meet expenses and to make dividends to holders of our capital stock may be reduced.

Net leases may not result in fair market lease rates over time, which could negatively impact our income and reduce the amount of funds available to make distributions to stockholders.

The vast majority of our rental income comes from net leases, which generally provide the tenant greater discretion in using the leased property than ordinary property leases, such as the right to freely sublease the property, to make alterations in the leased premises and to terminate the lease prior to its expiration under specified circumstances. Furthermore, net leases typically have longer lease terms and, thus, there is an increased risk that contractual rental increases in future years will fail to result in fair market rental rates during those years. As a result, our income and distributions to our stockholders could be lower than they would otherwise be if we did not engage in net leases.

Long-term leases with tenants may not result in fair value over time.

Long-term leases do not allow for significant changes in rental payments and do not expire in the near term. If we do not accurately judge the potential for increases in market rental rates when negotiating these long-term leases, significant increases in future property operating costs, to the extent not covered under the net leases could result in us receiving less than fair value from these leases. These circumstances would adversely affect our revenues and funds available for distribution to our stockholders.

Any of our properties that incurs a vacancy could be difficult to sell or re-lease.

One or more of our properties may incur a vacancy either by the continued default of a tenant under its lease or the expiration of one of our leases. Certain of our properties may be specifically suited to the particular needs of a tenant (e.g., a retail bank branch or distribution warehouse) and major renovations and expenditures may be required in order for us to re-lease vacant space for other uses. We may have difficulty obtaining a new tenant for any vacant space we have in our properties, including our presently vacant property. If the vacancies continue for a long period of time, we may suffer reduced revenues, resulting in less cash available to be distributed to stockholders. In addition, the resale value of a property could be diminished because the market value of a particular property will depend principally upon the value of the leases of such property.

Our properties may be subject to impairment charges.

We periodically evaluate our real estate investments for impairment indicators. The judgment regarding the existence of impairment indicators is based on factors such as market conditions, tenant performance and legal structure. For example, the early termination of, or default under, a lease by a tenant may lead to an impairment charge. Since our investment focus is on properties net leased to a single tenant, the financial failure of, or other default in payment by, a single tenant under its lease may result in a significant impairment loss. If we determine that an impairment has occurred, we would be required to make an adjustment to the net carrying value of the property, which could have a material adverse effect on our results of operations in the period in which the impairment charge is recorded.

 

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Our real estate investments are relatively illiquid and therefore we may not be able to dispose of properties when appropriate or on favorable terms.

The real estate investments made, and to be made, by us are relatively difficult to sell quickly. Return of capital and realization of gains, if any, from an investment generally will occur upon disposition or refinancing of a property. In addition, the Code imposes restrictions on the ability of a REIT to dispose of properties that are not applicable to other types of real estate companies. We may be unable to realize our investment objectives by disposition or refinancing of a property at attractive prices within any given period of time or may otherwise be unable to complete any exit strategy. In particular, these risks could arise from weakness in or even the lack of an established market for a property, changes in the financial condition or prospects of prospective purchasers, changes in national or international economic conditions, and changes in laws, regulations or fiscal policies of jurisdictions in which the property is located.

Our investments in properties backed by below investment grade credits will have a greater risk of default.

As of December 31, 2013, on a pro forma basis (including the properties acquired in the Cole Merger and the acquisitions of the Fortress Portfolio and the Inland Portfolio after December 31, 2013), 40% of our annualized rental income is derived from tenants who do not have investment grade credit ratings from a major ratings agency or are not affiliates of companies having an investment grade credit rating. We also may invest in other properties in the future where the tenant is not rated or the tenant’s credit rating is below investment grade. These investments will have a greater risk of default and bankruptcy than investments in properties leased exclusively to investment grade tenants.

Our investments in properties where the underlying tenant does not have a publicly available credit rating will expose us to certain risks.

When we invest in properties where the underlying tenant does not have a publicly available credit rating, we will rely on our own estimates of the tenant’s credit rating. If our lender or a credit rating agency disagrees with our ratings estimates, or our ratings estimates are inaccurate, we may not be able to obtain our desired level of leverage or our financing costs may exceed those that we projected. This outcome could have an adverse impact on our returns on that asset and hence our operating results.

Dividends paid from sources other than our cash flow from operations, particularly from proceeds of financings, will result in us having fewer funds available for the acquisition of properties and other real estate-related investments and may dilute stockholders’ interests in us, which may adversely affect our ability to fund future dividends with cash flow from operations and may adversely affect stockholders’ overall return.

Our cash flows provided by operations were $11.9 million (as restated) for the year ended December 31, 2013. For the year ended December 31, 2013, our dividends paid of $234.9 million (as restated) were partially funded from cash flows from operations and through $4.3 billion (as restated) from proceeds of financing activities. Additionally, we may in the future pay dividends from sources other than from our cash flow from operations.

Even after our acquisition of properties during 2013 and the ARCT IV Merger, the Cole Merger and the acquisitions of the Fortress Portfolio and the Inland Portfolio, we may not generate sufficient cash flow from operations to pay dividends. Our inability to acquire additional properties or other real estate-related investments may result in a lower return on your investment than you expect. If we have not generated sufficient cash flow from our operations and other sources, such as from borrowings, and/or the sale of additional securities to fund distributions, we may use the proceeds from offerings of securities. Moreover, our board of directors may change our dividend distribution policy, in its sole discretion, at any time. Dividends made from offering proceeds are a return of capital to stockholders, from which we will have already paid offering expenses in connection with the applicable offering. We have not established any limit on the amount of proceeds from an offering that may be used to fund dividends, except that, in accordance with our organizational documents and Maryland law, we may not make dividend distributions that would: (1) cause us to be unable to pay our debts as they become due in the usual course of business; (2) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences; or (3) jeopardize our ability to qualify as a REIT.

 

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If we fund dividends from the proceeds of offerings of securities, we will have less funds available for acquiring properties or other real estate-related investments. As a result, the return you realize on your investment may be reduced. Funding dividends from borrowings could restrict the amount we can borrow for investments, which may affect our profitability. Funding dividends with the sale of assets or the proceeds of offerings of securities may affect our ability to generate cash flows. Funding dividends from the sale of additional securities could dilute your interest in us if we sell shares of our common stock or securities convertible or exercisable into shares of our common stock to third party investors. Payment of dividends from the mentioned sources could restrict our ability to generate sufficient cash flow from operations, affect our profitability and/or affect the dividends payable to you upon a liquidity event, any or all of which may have an adverse effect on your investment.

We disclose FFO and adjusted funds from operations (AFFO”), a non-GAAP financial measure, including in documents filed with the SEC; however, AFFO is not equivalent to our net income or loss as determined under GAAP, and you should consider GAAP measures to be more relevant to our operating performance.

We use and disclose to investors FFO and AFFO, which is a non-GAAP financial measure. See ’’Management’s Discussion and Analysis of Financial Condition and Results of Operations - Funds from Operations and Adjusted Funds from Operations.’’ FFO and AFFO are not equivalent to our net income or loss as determined in accordance with GAAP, and investors should consider GAAP measures to be more relevant to evaluating our operating performance. FFO and AFFO and GAAP net income differ because one or both FFO and AFFO exclude gains and losses from the sale of property, plus depreciation and amortization, merger related and other non-routine transaction costs, acquisition-related fees and expenses and other non cash charges.

Because of the differences between FFO and AFFO and GAAP net income or loss, FFO and AFFO may not be accurate indicators of our operating performance, especially during periods in which we are acquiring properties. In addition, AFFO is not necessarily indicative of cash flow available to fund cash needs and investors should not consider FFO and AFFO as alternatives to cash flows from operations, as an indication of our liquidity, or as indicative of funds available to fund our cash needs, including our ability to make distributions to our stockholders.

Neither the SEC nor any other regulatory body has passed judgment on the acceptability of the adjustments that we use to calculate FFO and AFFO. Also, because not all companies calculate FFO and AFFO the same way, comparisons with other companies may not be meaningful.

Operating expenses of our properties will reduce our cash flow and funds available for future distributions.

For certain of our properties, including multi-tenant properties acquired in the Cole Merger, we are responsible for some or all of the operating costs of the property. In some of these instances, our leases require the tenant to reimburse us for all or a portion of these costs, either in the form of an expense reimbursement or increased rent. Our reimbursement may be limited to a fixed amount or a specified percentage annually. To the extent operating costs exceed our reimbursement, our returns and net cash flows from the property and hence our overall operating results and cash flows could be materially adversely affected.

We would face potential adverse effects from tenant defaults, bankruptcies or insolvencies.

The bankruptcy of our tenants may adversely affect the income generated by our properties. If our tenant files for bankruptcy, we generally cannot evict the tenant solely because of such bankruptcy. In addition, a bankruptcy court could authorize a bankrupt tenant to reject and terminate its lease with us. In such a case, our claim against the tenant for unpaid and future rent would be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease, and it is unlikely that a bankrupt tenant would pay in full amounts it owes us under the lease. Any shortfall resulting from the bankruptcy of one or more of our tenants could adversely affect our cash flow and results of operations.

 

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We have assumed, and expect in the future to continue to assume, liabilities in connection with our property acquisitions, including unknown liabilities.

We have assumed existing liabilities some of which may have been unknown or unquantifiable at the time of the transaction related to our formation transactions, our Recent Acquisitions and certain other property acquisitions, and expect in the future to continue to assume existing liabilities related to our property acquisitions. Unknown liabilities might include liabilities for cleanup or remediation of undisclosed environmental conditions, claims of tenants or other persons dealing with the sellers prior to our acquisition of the properties, tax liabilities, employment-related issues, and accrued but unpaid liabilities whether incurred in the ordinary course of business or otherwise. If the magnitude of such unknown liabilities is high, either singly or in the aggregate, they could adversely affect our business, financial condition, results of operations, cash flow, per share trading price of our common stock and ability to satisfy our debt service obligations and to make distributions to our stockholders.

We face intense competition, which may decrease or prevent increases in the occupancy and rental rates of our properties.

We compete with numerous developers, owners and operators of retail, industrial and office real estate, many of which own properties similar to ours in the same markets in which our properties are located. If one of our properties becomes vacant and our competitors (which would include funds sponsored by us) offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose existing or potential tenants and we may be pressured to reduce our rental rates below those we currently charge or to offer substantial rent abatements. As a result, our financial condition, results of operations, cash flow, per share trading price of our common stock and ability to satisfy our debt service obligations and to make dividends to our stockholders may be adversely affected.

Our operating performance and value are subject to risks associated with our real estate assets and with the real estate industry.

Our real estate investments are subject to various risks and fluctuations and cycles in value and demand, many of which are beyond our control. Certain events may decrease cash available for dividends, as well as the value of our properties. These events include, but are not limited to:

 

    adverse changes in international, national or local economic and demographic conditions such as the recent global economic downturn;

 

    vacancies or our inability to rent space on favorable terms, including possible market pressures to offer tenants rent abatements, tenant improvements, early termination rights or tenant-favorable renewal options

 

    adverse changes in financial conditions of buyers, sellers and tenants of properties;

 

    inability to collect rent from tenants;

 

    competition from other real estate investors with significant capital, including other real estate operating companies, REITs and institutional investment funds;

 

    reductions in the level of demand for commercial space generally, and freestanding net leased properties specifically, and changes in the relative popularity of our properties;

 

    increases in the supply of freestanding single-tenant properties;

 

    fluctuations in interest rates, which could adversely affect our ability, or the ability of buyers and tenants of our properties, to obtain financing on favorable terms or at all;

 

    increases in expenses, including, but not limited to, insurance costs, labor costs, energy prices, real estate assessments and other taxes and costs of compliance with laws, regulations and governmental policies, all of which have an adverse impact on the rent a tenant may be willing to pay us in order to lease one or more of our properties; and

 

    changes in, and changes in enforcement of, laws, regulations and governmental policies, including, without limitation, health, safety, environmental, zoning and tax laws, governmental fiscal policies and the Americans with Disabilities Act of 1990.

 

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In addition, periods of economic slowdown or recession, such as the recent global economic downturn, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or an increased incidence of defaults under existing leases. If we cannot operate our properties to meet our financial expectations, our business, financial condition, results of operations, cash flow, market price of our common stock and ability to satisfy our debt service obligations and to pay dividends to our stockholders could be materially and adversely affected. We cannot assure you that we will achieve our return objectives.

A potential change in U.S. accounting standards regarding operating leases may make the leasing of our properties less attractive to our potential tenants, which could reduce overall demand for our leasing services.

Under current authoritative accounting guidance for leases, a lease is classified by a tenant as a capital lease if the significant risks and rewards of ownership are considered to reside with the tenant. Under capital lease accounting for a tenant, both the leased asset and liability are reflected on their balance sheet. If the lease does not meet any of the criteria for a capital lease, the lease is considered an operating lease by the tenant, and the obligation does not appear on the tenant’s balance sheet; rather, the contractual future minimum payment obligations are only disclosed in the footnotes thereto. Thus, entering into an operating lease can appear to enhance a tenant’s balance sheet in comparison to direct ownership. The Financial Accounting Standards Board (the “FASB”) and the International Accounting Standards Board (the “IASB”) conducted a joint project to re-evaluate lease accounting. In August 2010, the FASB and the IASB jointly released exposure drafts of a proposed accounting model that would significantly change lease accounting. Based on comments received, a revised exposure was released in May 2013. Changes to the accounting guidance could affect both our accounting for leases as well as that of our current and potential tenants. These changes may affect how our real estate leasing business is conducted. For example, if the accounting standards regarding the financial statement classification of operating leases are revised, then companies may be less willing to enter into leases with us in general or desire to enter into leases with us with shorter terms because the apparent benefits to their balance sheets could be reduced or eliminated. This in turn could make it more difficult for us to enter into leases on terms we find favorable.

We will rely on external sources of capital to fund future capital needs, and if we encounter difficulty in obtaining such capital, we may not be able to make future acquisitions necessary to grow our business or meet maturing obligations.

In order to qualify as a REIT under the Code, we will be required, among other things, to distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income as calculated in accordance with U.S. GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. Because of this dividend requirement, we may not be able to fund, from cash retained from operations, all of our future capital needs, including capital needed to make investments and to satisfy or refinance maturing obligations.

We expect to rely on external sources of capital, including debt and equity financing, to fund future capital needs. However, the U.S. and global economic slowdown that commenced in 2008 has resulted in a capital environment characterized by limited availability, increasing costs and significant volatility. If we are unable to obtain needed capital on satisfactory terms or at all, we may not be able to make the investments needed to expand our business, or to meet our obligations and commitments as they mature.

Any additional debt we incur will increase our leverage. Our access to capital will depend upon a number of factors over which we have little or no control, including:

 

    general market conditions;

 

    the market’s perception of our growth potential;

 

    our current debt levels;

 

    our current and expected future earnings;

 

    our cash flow and cash dividends; and

 

    the market price per share of our common stock.

 

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We may not be in a position to take advantage of attractive investment opportunities for growth if we are unable to access the capital markets on a timely basis on favorable terms.

Our ability to sell equity to expand our business will depend, in part, on the market price of our common stock, and our failure to meet market expectations with respect to our business could negatively affect the market price of our common stock and limit our ability to sell equity.

The availability of equity capital to us will depend, in part, on the market price of our common stock, which, in turn, will depend upon various market conditions and other factors that may change from time to time, including:

 

    the extent of investor interest;

 

    our ability to satisfy the dividend requirements applicable to REITs;

 

    the general reputation of REITs and the attractiveness of their equity securities in comparison to other equity securities, including securities issued by other real estate-based companies;

 

    our financial performance and that of our tenants;

 

    analyst reports about us and the REIT industry;

 

    general stock and bond market conditions, including changes in interest rates on fixed-income securities, which may lead prospective purchasers of our common stock to demand a higher annual yield from future dividends;

 

    a failure to maintain or increase our dividend, which is dependent, to a large part, on FFO, which, in turn, depends upon increased revenue from additional acquisitions and rental increases; and

 

    other factors such as governmental regulatory action and changes in REIT tax laws.

Our failure to meet market expectations with regard to future earnings and cash dividends would likely adversely affect the market price of our common stock and, as a result, the availability of equity capital to us.

We have substantial amounts of indebtedness outstanding, which may affect our ability to make dividends, may expose us to interest rate fluctuation risk and may expose us to the risk of default under our debt obligations.

As of December 31, 2013, our aggregate indebtedness was approximately $4.3 billion (as restated). Subsequent to December 31, 2013, we incurred $2.6 billion of indebtedness pursuant to an offering of senior notes in February 2014. After giving effect to the financing and the use of proceeds therefrom, on a pro forma basis (including the properties acquired in the ARCT IV Merger, the Cole Merger and the acquisitions of the Fortress Portfolio and Inland Portfolio after December 31, 2013), our aggregate indebtedness was $10.3 billion. We may incur significant additional debt for various purposes including, without limitation, the funding of future acquisitions, capital improvements and leasing commissions in connection with the repositioning of a property.

We intend to incur additional indebtedness in the future, including borrowings under our existing $2.72 billion credit facility (as of December 31, 2013, under which we have undrawn commitments of $1.9 million (as restated) at February 26, 2014 and which contains an “accordion” feature to allow us, under certain circumstances, to increase the commitments thereunder by $280.0 million). At February 26, 2014, we had $0.8 billion (as restated) of outstanding borrowings under this credit facility.

Payments of principal and interest on borrowings may leave us with insufficient cash resources to make the dividends currently contemplated or necessary to maintain our REIT qualification. Our substantial outstanding indebtedness, and the limitations imposed on us by our debt agreements, could have other significant adverse consequences, including as follows:

 

    our cash flow may be insufficient to meet our required principal and interest payments;

 

    we may be unable to borrow additional funds as needed or on satisfactory terms, which could, among other things, adversely affect our ability to capitalize upon emerging acquisition opportunities or meet needs to fund capital improvements and leasing commissions;

 

    we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness;

 

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    we may be forced to dispose of one or more of our properties, possibly on disadvantageous terms;

 

    we may violate restrictive covenants in our loan documents, which would entitle the lenders to accelerate our debt obligations;

 

    certain of the property subsidiaries’ loan documents may include restrictions on such subsidiary’s ability to make dividends to us;

 

    we may be unable to hedge floating-rate debt, counterparties may fail to honor their obligations under our hedge agreements, these agreements may not effectively hedge interest rate fluctuation risk, and, upon the expiration of any hedge agreements, we would be exposed to then-existing market rates of interest and future interest rate volatility;

 

    we may default on our obligations and the lenders or mortgagees may foreclose on our properties that secure their loans and receive an assignment of rents and leases;

 

    increasing our vulnerability to general adverse economic and industry conditions;

 

    limiting our ability to obtain additional financing to fund future working capital, capital expenditures and other general corporate requirements;

 

    requiring the use of a substantial portion of our cash flow from operations for the payment of principal and interest on indebtedness, thereby reducing our ability to use our cash flow to fund working capital, acquisitions, capital expenditures and general corporate requirements;

 

    limiting our flexibility in planning for, or reacting to, changes in our business and industry; and

 

    putting us at a disadvantage compared to our competitors with less indebtedness.

If we default under a loan or indenture (including any default in respect of the financial maintenance and negative covenants contained in our credit facility), we may automatically be in default under any other loan or indenture that has cross-default provisions (including our credit facility), and further borrowings under our credit facility will be prohibited, outstanding indebtedness under our credit facility, our indenture or such other loans may be accelerated, and to the extent our credit facility, our indenture or such other loans are secured, directly or indirectly by any properties or assets, lenders or trustees under our credit facility, our indenture or such other loans may foreclose on the collateral securing such indebtedness as a result. In addition, increases in interest rates may impede our operating performance and put us at a competitive disadvantage. Further, payments of required debt service or amounts due at maturity, or creation of additional reserves under loan agreements or indentures, could adversely affect our financial condition and operating results.

If any one of these events were to occur, our business, financial condition, results of operations, cash flow, per share trading price of our common stock and ability to satisfy our debt service obligations and to make dividends to our stockholders could be materially and adversely affected. In addition, any foreclosure on our properties could create taxable income without accompanying cash proceeds, which could adversely affect our ability to meet the REIT dividend requirements imposed by the Code. See also “Our inability to file and deliver our financial statements and certain other financial deliverables required under the terms of our Credit Agreement and the indentures governing our senior unsecured notes and convertible notes has adversely affected our overall borrowing flexibility, exposed us to actual and potential consequences of default and required us to pay certain additional expenses.”

Our existing loan agreements contain, and future financing arrangements will likely contain, restrictive covenants relating to our operations, which could limit our ability to make distributions to our stockholders. (As Restated)

We are subject to certain restrictions pursuant to the restrictive covenants of our outstanding indebtedness, which may affect our dividend and operating policies and our ability to incur additional debt. Indentures and loan documents evidencing our existing indebtedness contain, and loan documents entered into in the future will likely contain, certain operating covenants that limit our ability to further incur indebtedness or discontinue insurance coverage. In addition, future agreements may contain, and any future company credit facilities and indentures likely will contain, financial covenants, including certain coverage ratios, and negative covenants, including limitations on our ability to incur secured and unsecured debt, make dividends, sell all or substantially all of our assets, and engage in mergers and consolidations and certain acquisitions. Specifically, our ability to make distributions may be limited by our credit facility, pursuant to which our distributions may not exceed the greater of (i) 105% of our FFO, as adjusted for certain items, the most significant of which are acquisition and merger related expenses, in 2013, and 95% thereafter or (ii) the amount required for us to qualify and maintain our status as a REIT. Covenants under any future indebtedness may restrict our ability to pursue certain business initiatives or certain acquisition transactions. In addition, failure to meet any of these covenants, including the financial coverage ratios, could cause

 

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an event of default under or accelerate some or all of our indebtedness, which would have a material adverse effect on us. See “The Amended Credit Agreement currently prohibits us and the OP from making distributions in respect of our respective common equity and there can be no assurance as to if, when or at what rate we and the OP will resume common equity distributions” and Note 24 — Subsequent Events (As Restated) for further discussion.

The indenture governing our senior notes and the credit agreement governing our credit facility contain restrictive covenants that limit our operating flexibility.

The indenture governing our senior notes and the agreement governing our credit facility require us to meet specified financial and operating covenants, including financial maintenance covenants with respect to maximum consolidated leverage ratio, maximum secured recourse indebtedness, minimum fixed charge coverage, minimum borrowing base interest coverage, maximum secured leverage, minimum tangible net worth and maximum variable rate indebtedness and borrowing base asset value ratio. In addition, our credit facility contains certain customary negative covenants that restrict the ability of our OP to incur secured and unsecured indebtedness. These covenants may restrict our ability to expand or fully pursue our business strategies. Our ability to comply with these and other provisions of the indenture governing our senior notes and the credit agreement governing our credit facility may be affected by changes in our operating and financial performance, changes in general business and economic conditions, adverse regulatory developments or other events adversely impacting us. Any failure to comply with these financial maintenance covenants and negative covenants would constitute a default under our credit facility and/or senior note indenture, as applicable and would prevent further borrowings under our credit facility, and could cause those and other obligations to become due and payable. If any of our indebtedness is accelerated, we may not be able to repay it. See also “Our inability to file and deliver our financial statements and certain other financial deliverables required under the terms of our Credit Agreement and the indentures governing our senior unsecured notes and convertible notes has adversely affected our overall borrowing flexibility, exposed us to actual and potential consequences of default and required us to pay certain additional expenses.”

Our organizational documents have no limitation on the amount of indebtedness that we may incur. As a result, we may become highly leveraged in the future, which could adversely affect our financial condition.

Our business strategy contemplates the use of both secured and unsecured debt to finance long-term growth. While we intend to limit our indebtedness to maintain an overall net debt to gross asset value of approximately 45% to 55%, provided that we may exceed this amount for individual properties in select cases where attractive financing is available, our governing documents contain no limitations on the amount of debt that we may incur, and our board of directors may change our financing policy at any time without stockholder approval. As a result, we may be able to incur substantial additional debt, including secured debt, in the future, which could result in an increase in our debt service and harm our financial condition.

Increases in interest rates would increase our debt service costs, may adversely affect any future refinancing of our debt and our ability to incur additional debt, and could adversely affect our financial condition, cash flow and results of operations.

Certain of our borrowings bear interest at variable rates, and we may incur additional variable-rate debt in the future. Increases in interest rates would result in higher interest expenses on our existing unhedged variable rate debt, and increase the costs of refinancing existing debt or incurring new debt. Additionally, increases in interest rates may result in a decrease in the value of our real estate and decrease the market price of ARCP’s common stock and could accordingly adversely affect our financial condition, cash flow and results of operations.

 

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A downgrade in our credit ratings could materially adversely affect our business and financial condition.

We received credit ratings for our senior notes from Moody’s Investor Service, Inc. and Standard & Poor’s Rating Services. We plan to manage our operations to maintain these credit ratings with a capital structure consistent with or better than our current profile, but there can be no assurance that we will be able to maintain the current credit ratings. Any downgrades in terms of ratings or outlook by any of the noted rating agencies could have a material adverse impact on our cost and availability of capital, which could in turn have a material adverse impact on our financial condition, results of operations and liquidity and the trading price of the notes. Credit ratings are not recommendations to purchase, hold or sell the notes. Additionally, credit ratings may not reflect the potential effect of risks relating to the structure or marketing of the notes.

We may not be able to generate sufficient cash flow to meet our debt service obligations.

Our ability to make payments on and to refinance our indebtedness, and to fund our operations, working capital and capital expenditures, depends on our ability to generate cash in the future. To a certain extent, our cash flow is subject to general economic, industry, financial, competitive, operating, legislative, regulatory and other factors, many of which are beyond our control.

We cannot assure you that our business will generate sufficient cash flow from operations or that future sources of cash will be available to us in an amount sufficient to enable us to pay amounts due on our indebtedness or to fund our other liquidity needs.

Additionally, if we incur additional indebtedness in connection with future acquisitions or development projects or for any other purpose, our debt service obligations could increase. We may need to refinance all or a portion of our indebtedness or before maturity. Our ability to refinance our indebtedness or obtain additional financing will depend on, among other things:

 

    our financial condition and market conditions at the time; and

 

    restrictions in the agreements governing our indebtedness.

As a result, we may not be able to refinance any of our indebtedness on commercially reasonable terms, or at all. If we do not generate sufficient cash flow from operations, and additional borrowings or refinancings or proceeds of asset sales or other sources of cash are not available to us, we may not have sufficient cash to enable us to meet all of our obligations. Accordingly, if we cannot service our indebtedness, we may have to take actions such as seeking additional equity, or delaying strategic acquisitions and alliances or capital expenditures, any of which could have a material adverse effect on our operations. We cannot assure you that we will be able to effect any of these actions on commercially reasonable terms, or at all.

The continued recovery of real estate markets from the recent recession is dependent upon forecasted moderate economic growth which, if significantly slower than expected, could have a negative impact on the performance of our investment portfolio.

The U.S. economy is in its fourth year of recovery from a severe global recession and the commercial real estate markets stabilized and began to recover in 2011. Based on moderate economic growth in the future, and historically low levels of new supply in the commercial real estate pipeline, a stronger recovery is forecasted for all property sectors over the next two years. Nevertheless, this ongoing economic recovery remains fragile, and could be slowed or halted by significant external events. As a result, real estate markets could perform lower than expected as a result of reduced tenant demand. A severe weakening of the economy or a renewed recession could also lead to higher tenancy default and vacancy rates, which could create an oversupply of rentable space, increased property concessions and tenant improvement expenditures and reduced rental rates to maintain occupancies. There can be no assurance that our real estate investments will not be adversely impacted by a severe slowing of the economy or renewed recession. Tenant defaults, fluctuations in interest rates, limited availability of capital and other economic conditions beyond our control could negatively impact our portfolio and decrease the value of your investment.

 

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Uninsured losses or losses in excess of our insurance coverage could adversely affect our financial condition and cash flows, and there can be no assurance as to future costs and the scope of coverage that may be available under insurance policies.

We carry comprehensive liability, fire, extended coverage, business interruption and rental loss insurance covering all of the properties in our portfolio under a blanket insurance policy with policy specifications, limits and deductibles customarily carried for similar properties. In addition, we carry professional liability and directors’ and officers’ insurance. We have selected policy specifications and insured limits that we believe are appropriate and adequate given the relative risk of loss, the cost of the coverage and industry practice. We do not carry insurance for certain losses, including, but not limited to, losses caused by riots or war. Certain types of losses may be either uninsurable or not economically insurable, such as losses due to earthquakes, riots or acts of war. Should an uninsured loss occur, we could lose both our investment in and anticipated profits and cash flow from a property. If any such loss is insured, we may be required to pay a significant deductible on any claim for recovery of such a loss prior to our insurer being obligated to reimburse us for the loss, or the amount of the loss may exceed our coverage for the loss. In addition, future lenders may require such insurance, and our failure to obtain such insurance could constitute a default under our loan agreements. In addition, we may reduce or discontinue terrorism, earthquake, flood or other insurance on some or all of our properties in the future if the cost of premiums for any of these policies exceeds, in our judgment, the value of the coverage discounted for the risk of loss. Our title insurance policies may not insure for the current aggregate market value of our portfolio, and we do not intend to increase our title insurance coverage as the market value of our portfolio increases. As a result, our business, financial condition, results of operations, cash flow, per share trading price of our common stock and ability to satisfy our debt service obligations and to make dividends to our stockholders may be materially and adversely affected.

If we or one or more of our tenants experiences a loss that is uninsured or which exceeds policy limits, we could lose the capital invested in the damaged properties as well as the anticipated future cash flows from those properties. In addition, if the damaged properties are subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if these properties were irreparably damaged.

If any of our insurance carriers becomes insolvent, we could be adversely affected.

We carry several different lines of insurance, placed with several large insurance carriers. If any one of these large insurance carriers were to become insolvent, we would be forced to replace the existing insurance coverage with another suitable carrier, and any outstanding claims would be at risk for collection. In such an event, we cannot be certain that we would be able to replace the coverage at similar or otherwise favorable terms. Replacing insurance coverage at unfavorable rates and the potential of uncollectible claims due to carrier insolvency could adversely affect our results of operations and cash flows.

Terrorism and other factors affecting demand for our properties could harm our operating results.

The strength and profitability of our business depends on demand for and the value of our properties. Future terrorist attacks in the United States, such as the attacks that occurred in New York and Washington, D.C. on September 11, 2001, and other acts of terrorism or war could have a negative impact on our operations. Such terrorist attacks could have an adverse impact on our business even if they are not directed at our properties. In addition, the terrorist attacks of September 11, 2001 have substantially affected the availability and price of insurance coverage for certain types of damages or occurrences, and our insurance policies for terrorism include large deductibles and co-payments. The lack of sufficient insurance for these types of acts could expose us to significant losses and could have a negative impact on our operations.

Cybersecurity risks and cyber incidents may adversely affect our business by causing a disruption to our operations, a compromise or corruption of our confidential information, and/or damage to our business relationships, all of which could negatively impact our financial results.

A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information resources. These incidents may be an intentional attack or an unintentional event and could involve gaining unauthorized access to our information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. The result of these incidents may include disrupted operations, misstated or

 

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unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance costs, litigation and damage to our tenant and investor relationships. As our reliance on technology has increased, so have the risks posed to our information systems, both internal and those we have outsourced. We have implemented processes, procedures and internal controls to help mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness of the nature and extent of a risk of a cyber incident, do not guarantee that our financial results, operations, business relationships or confidential information will not be negatively impacted by such an incident.

We may be required to make significant capital expenditures to improve our properties in order to retain and attract tenants, causing a decline in operating revenue and reducing cash available for debt service and distributions to stockholders.

Upon expiration of leases at our properties, we may be required to make rent or other concessions to tenants, or accommodate requests for renovations, build-to-suit remodeling and other improvements. As a result, we may have to make significant capital or other expenditures in order to retain tenants whose leases expire and to attract new tenants. Additionally, we may need to raise capital to make such expenditures. If we are unable to do so or capital is otherwise unavailable, we may be unable to make the required expenditures. This could result in non-renewals by tenants upon expiration of their leases, which would result in declines in revenue from operations and reduce cash available for debt service and dividends to stockholders.

Difficult conditions in the commercial real estate markets may cause us to experience market losses related to our holdings, and these conditions may not improve in the near future.

Our results of operations are materially affected by conditions in the real estate markets, the financial markets and the economy generally and may cause commercial real estate values, including the values of our properties, and market rental rates, including rental rates that we are able to charge, to decline significantly. Recent economic and credit market conditions have contributed to increased volatility and diminished expectations for real estate markets, as well as adversely impacted inflation, energy costs, geopolitical issues and the availability and cost of credit, and may continue to do so going forward. The further deterioration of the real estate market may cause us to record losses on our assets, reduce the proceeds we receive upon sale or refinance of our assets or adversely impact our ability to lease our properties. Declines in the market values of our properties may adversely affect our results of operations and credit availability, which may reduce earnings and, in turn, cash available for dividends to our stockholders. Economic and credit market conditions may also cause one or more of the tenants to whom we have exposure to fail or default in their payment obligations, which could cause us to record material losses or a material reduction in our cash flows.

Because we own real property, we are subject to extensive environmental regulation, which creates uncertainty regarding future environmental expenditures and liabilities.

Environmental laws regulate, and impose liability for, releases of hazardous or toxic substances into the environment. Under various provisions of these laws, an owner or operator of real estate, such as us, is or may be liable for costs related to soil or groundwater contamination on, in, or migrating to or from its property. In addition, persons who arrange for the disposal or treatment of hazardous or toxic substances may be liable for the costs of cleaning up contamination at the disposal site. Such laws often impose liability regardless of whether the person knew of, or was responsible for, the presence of the hazardous or toxic substances that caused the contamination. The presence of, or contamination resulting from, any of these substances, or the failure to properly remediate them, may adversely affect our ability to sell or lease our property or to borrow using such property as collateral. In addition, persons exposed to hazardous or toxic substances may sue us for personal injury damages. For example, certain laws impose liability for release of or exposure to asbestos-containing materials and contamination from past operations or from off-site sources. As a result, in connection with our current or former ownership, operation, management and development of real properties, we may be potentially liable for investigation and cleanup costs, penalties, and damages under environmental laws.

 

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Although all of our properties were, at the time they were acquired by our predecessor, subjected to preliminary environmental assessments, known as Phase I assessments, by independent environmental consultants that identify certain liabilities, Phase I assessments are limited in scope, and may not include or identify all potential environmental liabilities or risks associated with the property. Further, any environmental liabilities that arose since the date the studies were done would not be identified in the assessments. Unless required by applicable laws or regulations, we may not further investigate, remedy or ameliorate the liabilities disclosed in the Phase I assessments.

We cannot assure you that these or other environmental studies identified all potential environmental liabilities, or that we will not incur material environmental liabilities in the future. If we do incur material environmental liabilities in the future, we may face significant remediation costs, and we may find it difficult to sell any affected properties.

Our PCM business, which was acquired from Cole, is subject to risks that are particular to their role as sponsor and dealer manager for direct investment program offerings.

Our PCM business, including Cole Capital Corporation, which was Cole’s broker-dealer subsidiary and is a wholesale broker-dealer registered with the SEC and a member firm of FINRA, is subject to various risk and uncertainties that are common in the securities industry. Such risks and uncertainties include:

 

    the volatility of financial markets;

 

    extensive governmental regulation;

 

    litigation; and

 

    intense competition.

Our PCM business, which involves sponsoring and distributing interests in direct investment programs, will depend on a number of factors including our ability to enter into agreements with broker-dealers and independent investment advisors who will sell interests to their clients, our success in investing the proceeds of our offering, managing the properties acquired and generating cash flow to make distributions to investors in our direct investment programs and our success in entering into liquidity event for the direct investment programs. We are subject to competition from other sponsors and dealer-managers of direct investment programs and other investments, and there can be no assurance that this business will be successful.

Sponsorship of non-traded REITs also involves risks relating to the possibility that such programs will not receive capital at the levels and timing that are anticipated and that sufficient capital will not be raised to repay investments of cash in, and loans to, such non-traded REITs needed to meet up-front costs, the initial breaking of escrow and the acquisition of properties will not be made, as well as risks relating to competition from other sponsors of other similar programs.

In addition, our PCM business is subject to risks that are particular to its function as a wholesale broker-dealer and sponsoring non-traded REITs. For example, the broker-dealer provides substantial promotional support to broker-dealers selling a particular offering, including by providing sales literature, forums, webinars, press releases and other mass forms of communication. Due to our PCM business acting as a sponsor of non-traded REITs and the volume of materials that Cole Capital Corporation may provide throughout the course of an offering, much of which may be scrutinized by regulators. We and Cole Capital Corporation may be exposed to significant liability under federal and state securities laws. Additionally, Cole Capital Corporation may be subject to fines and suspension from the SEC and FINRA.

Failure to comply with the net capital requirements could subject us to sanctions imposed by the SEC or FINRA.

Our broker-dealer subsidiary is required to maintain certain levels of minimum net capital subject to the SEC’s net capital rule. The net capital rule is designed to measure the general financial integrity and liquidity of a broker-dealer. Compliance with the net capital rule limits those operations of broker-dealers that require the intensive use of their capital, such as underwriting commitments and principal trading activities. The rule also limits the ability of securities firms to pay dividends or make payments on certain indebtedness, such as subordinated debt, as it matures. FINRA may enter the offices of a broker-dealer at any time, without notice, and calculate the firm’s net capital. If the calculation reveals a deficiency in net capital, FINRA may immediately restrict or suspend certain or all the activities of a broker-dealer. Our broker-dealer subsidiary may not be able to maintain adequate net capital, or its net capital may fall below requirements established by the SEC, and it may be subject to disciplinary action in the form of fines, censure, suspension, expulsion or the termination of business altogether. In addition, if

 

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these net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require the intensive use of capital would be limited. A large operating loss or charge against net capital could adversely affect our broker-dealer’s ability to expand or even maintain its present levels of business, which could have a material adverse effect on its business of sponsoring and distributing interests in direct investment programs. In addition, our broker-dealer subsidiary may become subject to net capital requirements in other foreign jurisdictions in which it operates. We cannot predict its future capital needs or its ability to obtain additional financing.

Broker-dealers and other financial services firms are subject to extensive regulations and increased scrutiny.

The financial services industry is subject to extensive regulation by U.S. federal, state and international government agencies, as well as various self-regulatory agencies. Recent turmoil in the financial markets has contributed to significant rule changes, heightened scrutiny of the conduct of financial services firms and increasing penalties for rule violations. Our broker-dealer subsidiary may be adversely affected by new laws or rules or changes in the interpretation of existing rules or more rigorous enforcement. Significant new rules are developing under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Some of these rules could impact our broker-dealer subsidiary’s business, including through the potential implementation of a more stringent fiduciary standard for brokers and enhanced regulatory oversight over incentive compensation.

Our broker-dealer subsidiary also may be adversely affected by other evolving regulatory standards, such as those relating to suitability and supervision. Legal claims or regulatory actions against our broker-dealer subsidiary also could have adverse financial effects on us or harm our reputation, which could harm our business prospects.

Our broker-dealer subsidiary, which is registered as a broker-dealer under the Exchange Act and is a member of FINRA, is subject to regulation, examination and supervision by the SEC, FINRA, other self-regulatory organizations and state securities regulators. Broker-dealers are subject to regulations that cover all aspects of the securities business, including sales practices, use and safekeeping of clients’ funds and securities’ capital adequacy, record-keeping and the conduct and qualification of officers, employees and independent contractors. Failure by our broker-dealers to comply with applicable laws or regulations could result in censures, penalties or fines, the issuance of cease and desist orders, the suspension or expulsion from the securities industry of any such broker-dealer, or its officers, employees or independent contractors or other similar adverse consequences. Additionally, the adverse publicity arising from the imposition of sanctions could harm our reputation and cause us to lose existing clients or fail to gain new clients.

Financial services firms are also subject to rules and regulations relating to the prevention and detection of money laundering. The USA PATRIOT Act of 2001 mandates that financial institutions, including broker-dealers and investment advisors, establish and implement anti-money laundering (“AML”) programs reasonably designed to achieve compliance with the Bank Secrecy Act of 1970 and the rules thereunder. Financial services firms must maintain AML policies, procedures and controls, designate an AML compliance officer to oversee the firm’s AML program, implement appropriate employee training and provide for annual independent testing of the program. Our broker-dealer subsidiary has established AML programs but there can be no assurance of the effectiveness of these programs. Failure to comply with AML requirements could subject our broker-dealer subsidiary to disciplinary sanctions and other penalties. Financial services firms must also comply with applicable privacy and data protection laws and regulations, including SEC Regulation S-P and applicable provisions of the 1999 Gramm-Leach-Bliley Act, the Fair Credit Reporting Act of 1970 and the 2003 Fair and Accurate Credit Transactions Act. Any violations of laws and regulations relating to the safeguarding of private information could subject our broker-dealer subsidiary to fines and penalties, as well as to civil action by affected parties.

 

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We are subject to risks relating to mortgage loans, bridge loans, mezzanine loans, CMBS and real estate-related securities.

In connection with the Cole and Caplease Mergers, we acquired interests in mortgage loans, bridge loans, mezzanine loans, CMBS and other types of real estate-related securities. In addition, we may continue to make similar investments, which will subject us to risks relating to these types of loans and securities.

We are subject to risks relating to mortgage, bridge or mezzanine loans.

Investing in mortgage, bridge or mezzanine loans involves risk of defaults on those loans caused by many conditions beyond our control, including local and other economic conditions affecting real estate values, interest rate changes, rezoning, and failure by the borrower to maintain the property. If there are defaults under these loans, we may not be able to repossess and sell quickly any properties securing such loans. An action to foreclose on a property securing a loan is regulated by state statutes and regulations and is subject to many of the delays and expenses of any lawsuit brought in connection with the foreclosure if the defendant raises defenses or counterclaims. In the event of default by a mortgagor, these restrictions, among other things, may impede our ability to foreclose on or sell the mortgaged property or to obtain proceeds sufficient to repay all amounts due to us on the loan, which could reduce the value of our investment in the defaulted loan. In addition, investments in mezzanine loans involve a higher degree of risk than long-term senior mortgage loans secured by income-producing real property because the investment may become unsecured as a result of foreclosure on the underlying real property by the senior lender.

We are subject to risks relating to real estate-related securities in general.

Investments in real estate-related securities involve special risks relating to the particular issuer of the securities, including the financial condition and business outlook of the issuer. Issuers of real estate-related equity securities generally invest in real estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments discussed herein, including risks relating to rising interest rates.

Real estate-related securities are often unsecured and also may be subordinated to other obligations of the issuer. As a result, investments in real estate-related securities are subject to risks of (1) limited liquidity in the secondary trading market in the case of unlisted or thinly traded securities, (2) substantial market price volatility resulting from changes in prevailing interest rates in the case of traded equity securities, (3) subordination to the prior claims of banks and other senior lenders to the issuer, (4) the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could cause the issuer to reinvest redemption proceeds in lower yielding assets, (5) the possibility that earnings of the issuer may be insufficient to meet its debt service and distribution obligations and (6) the declining creditworthiness and potential for insolvency of the issuer during periods of rising interest rates and economic slowdown or downturn. These risks may adversely affect the value of outstanding real estate-related securities and the ability of the issuers thereof to repay principal and interest or make distribution payments.

We may not have the expertise necessary to maximize the return on our investment in real estate-related securities. If we determine that it is advantageous to us to make the types of investments in which we do not have experience, we intend to employ persons, engage consultants or partner with third parties that have, in our opinion, the relevant expertise necessary to assist us in evaluating, making and administering such investments.

 

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We are subject to risks relating to CMBS.

CMBS are securities that evidence interests in, or are secured by, a single commercial mortgage loan or a pool of commercial mortgage loans. Accordingly, these securities are subject to all of the risks of the underlying mortgage loans. In a rising interest rate environment, the value of CMBS may be adversely affected when payments on underlying mortgages do not occur as anticipated, resulting in the extension of the security’s effective maturity and the related increase in interest rate sensitivity of a longer-term instrument. The value of CMBS may also change due to shifts in the market’s perception of issuers and regulatory or tax changes adversely affecting the mortgage securities market as a whole. In addition, CMBS are subject to the credit risk associated with the performance of the underlying mortgage properties. CMBS are issued by investment banks, not financial institutions, and are not insured or guaranteed by the U.S. government.

CMBS are also subject to several risks created through the securitization process. Subordinate CMBS are paid interest only to the extent that there are funds available to make payments. To the extent the collateral pool includes delinquent loans, there is a risk that interest payments on subordinate CMBS will not be fully paid. Subordinate CMBS are also subject to greater credit risk than those CMBS that are more highly rated. In certain instances, third-party guarantees or other forms of credit support can reduce the credit risk.

The value of CMBS can be negatively impacted by any dislocation in the mortgage-backed securities market in general. Currently, the mortgage-backed securities market is suffering from a severe dislocation created by mortgage pools that include sub-prime mortgages secured by residential real estate. Sub-prime loans often have high interest rates and are often made to borrowers with credit scores that would not qualify them for prime conventional loans. In recent years, banks made a great number of the sub-prime residential mortgage loans with high interest rates, floating interest rates, interest rates that reset from time to time and/or interest-only payment features that expire over time. These terms, coupled with rising interest rates, have caused an increasing number of homeowners to default on their mortgages. Purchasers of mortgage-backed securities collateralized by mortgage pools that include risky sub-prime residential mortgages have experienced severe losses as a result of the defaults and such losses have had a negative impact on the CMBS market.

Our build-to-suit program is subject to additional risks related to properties under development.

The businesses we acquired in each of the Cole and CapLease Mergers engage in build-to-suit programs and acquisition of properties under development. In connection with these businesses, we enter into purchase and sale arrangements with sellers or developers of suitable properties under development or construction. In such cases, we are obligated to purchase the property at the completion of construction, provided that the construction conforms to definitive plans, specifications, and costs approved by us in advance. We may continue this business.

As a result, we are subject to potential development risks and construction delays and the resultant increased costs and risks. If we engage in development or construction projects, we will be subject to uncertainties associated with re-zoning for development, environmental concerns of governmental entities and/or community groups, and the builder’s ability to build in conformity with plans, specifications, budgeted costs and timetables. If a builder fails to perform, we may resort to legal action to rescind the purchase or the construction contract or to compel performance. A builder’s performance may also be affected or delayed by conditions beyond the builder’s control. Delays in completion of construction could also give tenants the right to terminate preconstruction leases. We may incur additional risks if we make periodic progress payments or other advances to builders before they complete construction. These and other such factors can result in increased project costs or loss of our investment. In addition, we will be subject to normal lease-up risks relating to newly constructed projects. We also will rely on rental income and expense projections and estimates of the fair market value of property upon completion of construction when agreeing upon a price at the time we acquire the property. If these projections are inaccurate, we may pay too much for a property and our return on our investment could suffer. If we contract with a development company for newly developed properties, we anticipate that it will be obligated to pay a substantial earnest money deposit at the time of contracting to acquire such properties. In the case of properties to be developed by a development company, we anticipate that it will be required to close the purchase of the property upon completion of the development of the property. At the time of contracting and the payment of the earnest money deposit, the development company typically will not have acquired title to any real property and there is a risk that its earnest money deposit made to the development company may not be fully refunded.

 

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Risks Related to Our Organization and Structure

The supermajority voting requirements applicable to our board of directors in connection with our consolidation, merger, sale of all or substantially all of our assets or our engaging in a share exchange will limit our independent directors’ ability to influence such corporate matters.

Our charter provides that we may not consolidate, merge, sell all or substantially all of our assets or engage in a share exchange, unless such actions are approved by the affirmative vote of at least two-thirds of our board of directors. This concentrated control limits the ability of our independent directors to influence such corporate matters and could delay, deter or prevent a change of control transaction that might otherwise involve a premium for our shares of common stock or otherwise be in the best interests of our stockholders. Additionally, the market price of our common stock could be adversely affected because of the imbalance of control.

Our charter, the partnership agreement of our operating partnership and Maryland law contain provisions that may delay or prevent a change of control transaction.

Our charter, subject to certain exceptions, limits any person to actual or constructive ownership of no more than 9.8% in value of the aggregate of our outstanding shares of stock and not more than 9.8% (in value or in number of shares, whichever is more restrictive) of any class or series of our shares of stock. Our board of directors, in its sole discretion and upon receipt of certain representations and undertakings, may exempt a person (prospectively or retroactively) from the ownership limits. However, our board of directors may not, among other limitations, grant an exemption from the ownership limits to any person whose ownership, direct or indirect, in excess of the 9.8% ownership limit would cause us to fail to qualify as a REIT. The ownership limits and the other restrictions on ownership and transfer of our stock contained in our charter may delay or prevent a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.

Tax protection provisions on certain properties could limit our operating flexibility.

We have agreed with the Contributor, an affiliate of ARC, to indemnify it against adverse tax consequences if we were to sell, convey, transfer or otherwise dispose of all or any portion of the interests in the continuing properties acquired by us in the formation transactions, in a taxable transaction. However, we can sell these properties in a taxable transaction if we pay the Contributor cash in the amount of its tax liabilities arising from the transaction and tax payments. These tax protection provisions apply until September 6, 2021, which is the 10th anniversary of the closing of our IPO. Although it may be in our stockholders’ best interest that we sell a property, it may be economically disadvantageous for us to do so because of these obligations. We have also agreed to make debt available for the Contributor to guarantee. We agreed to these provisions in order to assist the Contributor in preserving its tax position after its contribution of its interests in our initial properties. As a result, we may be required to incur and maintain more debt than we would otherwise.

Tax consequences to holders of OP units upon a sale or refinancing of our properties may cause the interests of our principals to differ from the interests of our other stockholders.

As a result of the unrealized built-in gain that may be attributable to one or more of the contributed properties at the time of contribution in connection with the formation transactions, some holders of OP units, including the Contributor, an affiliate of ARC, may experience different tax consequences than holders of our capital stock upon the sale or refinancing of the properties owned by our operating partnership, including disproportionately greater allocations of items of taxable income and gain upon a realization event. As those holders will not receive a correspondingly greater distribution of cash proceeds, they may have different objectives regarding the appropriate pricing, timing and other material terms of any sale or refinancing of certain properties, or whether to sell or refinance such properties at all, than those that would be in the best interests of our stockholders taken as a whole.

We continue to rely on services provided by our Former Manager for certain administrative services.

While we have terminated our management agreement with our Former Manager, our Former Manager continues to provide us with certain administrative services, including transaction management services, under agreements which continue in effect following our transition to self-management. Affiliates of our Former Manager have not agreed to dedicate specific personnel to providing these services. Accordingly, we continue to rely on affiliates of the Former Manager for services required to execute our business plan.

 

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We are a holding company with no direct operations. As a result, we rely on funds received from our operating partnership to pay liabilities and dividends, our stockholders’ claims will be structurally subordinated to all liabilities of our operating partnership and our stockholders do not have any voting rights with respect to our operating partnership’s activities, including the issuance of additional OP units.

We are a holding company and conduct all of our operations through our operating partnership. We do not have, apart from our ownership of our operating partnership, any independent operations. As a result, we rely on distributions from our operating partnership to pay any dividends we might declare on shares of our common stock. We also rely on distributions from our operating partnership to meet any of our obligations, including tax liability on taxable income allocated to us from our operating partnership (which might make distributions to the company not equal to the tax on such allocated taxable income).

In addition, because we are a holding company, stockholders’ claims will be structurally subordinated to all existing and future liabilities and obligations (whether or not for borrowed money) of our operating partnership and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, claims of our stockholders will be satisfied only after all of our and our operating partnership’s and its subsidiaries’ liabilities and obligations have been paid in full.

As of December 31, 2013, we owned approximately 96.1% of the OP units in our operating partnership. However, our operating partnership may issue additional OP units in the future. Such issuances could reduce our ownership percentage in our operating partnership. Because our stockholders will not directly own any OP units, they will not have any voting rights with respect to any such issuances or other partnership-level activities of our operating partnership.

Our board of directors may create and issue a class or series of common or preferred stock without stockholder approval.

Our board of directors is empowered under our charter to amend our charter from time to time to increase or decrease the aggregate number of shares of our stock or the number of shares of stock of any class or series that we have authority to issue, to designate and issue from time to time one or more classes or series of stock and to classify or reclassify any unissued shares of our common stock or preferred stock without stockholder approval. Our board of directors may determine the relative preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications or terms or conditions of redemption of any class or series of stock issued. As a result, we may issue series or classes of stock with voting rights, rights to dividends or other rights, senior to the rights of holders of our capital stock. The issuance of any such stock could also have the effect of delaying or preventing a change of control transaction that might otherwise be in the best interests of our stockholders.

Certain provisions in the partnership agreement of our operating partnership may delay or prevent unsolicited acquisitions of us.

Provisions in the partnership agreement of our operating partnership may delay or make more difficult unsolicited acquisitions of us or changes in our control. These provisions could discourage third parties from making proposals involving an unsolicited acquisition of us or change of our control, although some stockholders might consider such proposals, if made, desirable. These provisions include, among others:

 

    redemption rights of qualifying parties;

 

    transfer restrictions on the OP units;

 

    the ability of the general partner in some cases to amend the partnership agreement without the consent of the limited partners;

 

    the right of the limited partners to consent to transfers of the general partnership interest of the general partner and mergers or consolidations of our company under specified limited circumstances; and

 

    restrictions relating to our qualification as a REIT under the Code.

 

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Our charter and bylaws and the partnership agreement of our operating partnership also contain other provisions that may delay, defer or prevent a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.

Certain rights which are reserved to our stockholders may allow third parties to enter into business combinations with us that are not in the best interest of the stockholders without negotiating with our board of directors.

Certain provisions of the Maryland General Corporation Law (the “MGCL”) may have the effect of requiring a third party seeking to acquire us to negotiate with our board of directors, including:

 

    “business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our outstanding voting stock or an affiliate or associate of our company who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of our then outstanding stock) or an affiliate of an interested stockholder for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter imposes special appraisal rights and stockholder supermajority voting requirements on these combinations; and

 

    “control share” provisions that provide that “control shares” of our company (defined as shares which, when aggregated with other shares controlled by the stockholder (except solely by virtue of a revocable proxy), entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of issued and outstanding “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.

As permitted by the MGCL, our board of directors has by resolution exempted business combinations (1) between us and any person, provided that such business combination is first approved by our board of directors (including a majority of directors who are not affiliates or associates of such person) and (2) between us and ARC, our Former Manager, our operating partnership or any of their respective affiliates. Consequently, the five-year prohibition and the supermajority vote requirements will not apply to such business combinations. As a result, any person described above may be able to enter into business combinations with us that may not be in the best interest of our stockholders without compliance by us with the supermajority vote requirements and other provisions of the statute. This resolution, however, may be altered or repealed in whole or in part at any time by our board of directors. If this resolution is repealed, or our board of directors does not otherwise approve a business combination with a person other than ARC, our Former Manager, our operating partnership or any of their respective affiliates, the statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.

Pursuant to a provision in our bylaws, we have opted out of the control share provisions of the MGCL. However, we may, by amendment to our bylaws, opt in to the control shares provisions of the MGCL in the future.

Additionally, Title 3, Subtitle 8 of the MGCL permits our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement certain takeover defenses, such as a classified board, some of which we do not yet have. These provisions may have the effect of inhibiting a third-party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control of us under the circumstances that otherwise could provide our stockholders with the opportunity to realize a premium over the then current market price.

 

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Our fiduciary duties as sole general partner of our operating partnership could create conflicts of interest.

We are the sole general partner of our operating partnership, and, as such, will have fiduciary duties to our operating partnership and the limited partners in the operating partnership, the discharge of which may conflict with the interests of our stockholders. The limited partnership agreement of our operating partnership provides that, in the event of a conflict between the duties owed by our directors to our company and the duties that we owe, in our capacity as the sole general partner of our operating partnership, to such limited partners, our directors are under no obligation to give priority to the interests of such limited partners. In addition, those persons holding OP units will have the right to vote on certain amendments to the limited partnership agreement (which require approval by a majority in interest of the limited partners, including us) and individually to approve certain amendments that would adversely affect their rights, as well as the right to vote on mergers and consolidations of us in our capacity as sole general partner of the operating partnership in certain limited circumstances. These voting rights may be exercised in a manner that conflicts with the interests of our stockholders. For example, we cannot adversely affect the limited partners’ rights to receive distributions, as set forth in the limited partnership agreement, without their consent, even though modifying such rights might be in the best interest of our stockholders generally.

We had never operated as a REIT prior to making our initial REIT election for the year ended December 31, 2011 and have only recently begun operating as a public company and, therefore, we cannot assure you that we will successfully and profitably operate our business in compliance with the regulatory requirements applicable to REITs and to public companies.

We had never operated as a REIT prior to making our initial REIT election for the year ended December 31, 2011. Also, we have only operated as a public company beginning the date of the closing of our IPO on September 6, 2011. In addition, certain members of our board of directors and certain of our executive officers have no experience in operating a publicly traded REIT that is traded on a securities exchange other than in connection with our operations. We cannot assure you that we will be able to successfully operate our company as a REIT or a publicly traded company, including satisfying the requirements to timely meet disclosure requirements and complying with the Sarbanes-Oxley Act, including implementing effective internal controls. Failure to maintain our qualification as a REIT or comply with other regulatory requirements would have an adverse effect on our business, financial condition, results of operations, cash flow, per share trading price of our common stock and ability to satisfy our debt service obligations and to make distributions to our stockholders.

Our board of directors may change significant corporate policies without stockholder approval.

Our investment, financing, borrowing and dividend policies and our policies with respect to other activities, including growth, debt, capitalization and operations, will be determined by our board of directors. These policies may be amended or revised at any time and from time to time at the discretion of the board of directors without a vote of our stockholders. In addition, the board of directors may change our policies with respect to conflicts of interest provided that such changes are consistent with applicable legal requirements. A change in these policies could have an adverse effect on our business, financial condition, results of operations, cash flow, per share trading price of our common stock and ability to satisfy our debt service obligations and to make distributions to our stockholders.

 

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ARCP may incur adverse tax consequences if ARCT III , CapLease, ARCT IV or Cole has failed qualify as a REIT for U.S. federal income tax purposes.

If ARCT III, CapLease, ARCT IV or Cole has failed to qualify as a REIT for U.S. federal income tax purposes at any time prior to the ARCT III Merger, the CapLease Merger, the ARCT IV Merger and the Cole Merger, respectively, ARCP may inherit significant tax liabilities and could lose ARCP’s REIT status should disqualifying activities continue after the mergers.

We could incur liability as a result of a lawsuit to which Cole is subject in connection with the merger between Cole and Cole Holdings Corporation (Cole Holdings), pursuant to which Cole became a self-managed REIT.

Three outstanding putative class action and/or derivative lawsuits, which were filed earlier this year, assert claims for breach of fiduciary duty, abuse of control, corporate waste, unjust enrichment, aiding and abetting breach of fiduciary duty and other claims relating to the merger between a wholly owned subsidiary of Cole and Cole Holdings, pursuant to which Cole became a self-managed REIT. The Court in one of the lawsuits has granted defendants’ motion to dismiss with prejudice, but the plaintiffs have filed a notice of appeal of this dismissal. The other two lawsuits, which also purport to assert claims under the Securities Act, are pending in the United States District Court for the District of Arizona. Defendants filed a motion to dismiss both complaints on January 10, 2014.

Whether or not any plaintiffs’ claims are successful, this type of litigation is often expensive and diverts management’s attention and resources, which could adversely affect our operations.

We could incur liability as a result of an adverse judgment in litigation challenging one or more of our Recent Acquisitions, including the Cole Merger and the Caplease Merger and the ARCT III Merger.

Stockholders of Cole have filed lawsuits and may file additional lawsuits challenging the Cole Merger, which name and may name ARCP as a defendant. To date, eleven such lawsuits have been filed. Two putative class actions have been filed in in the U.S. District Court of Arizona, captioned as: (i) Wunsch v. Cole Real Estate Investment, Inc., et al.; and (ii) Sobon v. Cole Real Estate Investments, Inc., et al. Eight other putative stockholder class action lawsuits have been filed in the Circuit Court for Baltimore City, Maryland, captioned as: (i) Operman v. Cole Real Estate Investments, Inc., et al.; (ii) Branham v. Cole Real Estate Investments, Inc., et al.; (iii) Wilfong v. Cole Real Estate Investments, Inc., et al.; (iv) Polage v. Cole Real Estate Investments, Inc., et al.; (v) Flynn v. Cole Real Estate Investments, Inc., et al.; (vi) Corwin v. Cole Real Estate Investments, Inc., et al.; (vii) Green v. Cole Real Estate Investments, Inc., et al.; and (viii) Morgan v. Cole Real Estate Investments, Inc., et al. (collectively, the ‘‘Baltimore Actions’’). All of these lawsuits name ARCP, Cole and the Cole board of directors as defendants. All of the named plaintiffs claim to be Cole stockholders and purport to represent all holders of Cole’s stock. Each complaint generally alleges that the individual defendants breached fiduciary duties owed to plaintiff, the other public stockholders of Cole and to Cole, and that certain entity defendants aided and abetted those breaches. In addition, certain lawsuits claim that the individual defendants breached their duty of candor to our stockholders and the Branham, Polage and Flynn lawsuits assert claims derivatively against the individual defendants for their alleged breach of fiduciary duties owed to Cole. The Polage lawsuit also asserts derivative claims for waste of corporate assets and unjust enrichment. The eight Baltimore Actions were consolidated on December 12, 2013. The Wunsch and Sobon lawsuits, which were consolidated by court order on January 17, 2014, also allege that the joint proxy statement filed in relation to the Cole Merger contains materially incomplete and misleading disclosures in violation of Sections 14(a) and 20(a) of the Exchange Act. Among other remedies, the complaints seek money damages, costs and attorneys’ fees.

 

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On January 10, 2014, solely to avoid the costs, risks, and uncertainties inherent in litigation and without admitting any liability or wrongdoing, ARCP, Cole and the other named defendants in the Baltimore Actions entered into a memorandum of understanding with the plaintiffs in the Baltimore Actions to settle the cases. The memorandum of understanding contemplates that the parties will enter into a stipulation of settlement. The stipulation of settlement will be subject to customary conditions, including court approval following notice to ARCP’s and Cole’s stockholders. In the event that the parties enter into a stipulation of settlement, a hearing will be scheduled by the court to consider the fairness, reasonableness, and adequacy of the settlement. In the event the settlement is finally approved by the court, it will resolve and release all claims in all actions that were or could have been brought challenging any aspect of the Cole Merger, the Cole Merger Agreement and any disclosure made in connection therewith, among other claims, pursuant to terms that will be disclosed to stockholders prior to final approval of the settlement. In addition, in connection with the settlement, the parties contemplate that plaintiff’s counsel in the Baltimore Actions will file a petition in the court for an award of attorneys’ fees and expenses to be paid by ARCP, which the defendants may oppose. ARCP will pay or cause to be paid any attorneys’ fees and expenses awarded by the court. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the court will approve the settlement even if the parties were to enter into such stipulation. In such event, the proposed settlement as contemplated by the memorandum of understanding may be terminated.

One additional putative class action has been filed in the Supreme Court of New York, captioned as: Realistic Partners v. Schorsch et al. (the ‘‘Realistic Partners Action’’). This lawsuit names ARCP, the ARCP board of directors and Cole as defendants. The named plaintiff claims to be an ARCP stockholder and purports to represent all holders of ARCP’s stock. The complaint generally alleges that ARCP and the individual defendants breached a fiduciary duty of candor allegedly owed to plaintiff and to the other public stockholders of ARCP, and that Cole aided and abetted those breaches. On January 17, 2014, solely to avoid the costs, risks, and uncertainties inherent in litigation and without admitting any liability or wrongdoing, ARCP, Cole and the other named defendants in the Realistic Partners Action entered into a memorandum of understanding with the plaintiff in the Realistic Partners Action to settle the case. The memorandum of understanding contemplates that the parties will enter into a stipulation of settlement. The stipulation of settlement will be subject to customary conditions, including court approval following notice to ARCP’s and Cole’s stockholders. In the event that the parties enter into a stipulation of settlement, a hearing will be scheduled by the court to consider the fairness, reasonableness, and adequacy of the settlement. In the event the settlement is finally approved by the court, it will resolve and release all claims in all actions that were or could have been brought challenging any aspect of the Cole Merger, the Cole Merger Agreement, and any disclosure made in connection therewith, among other claims, pursuant to terms that will be disclosed to stockholders prior to final approval of the settlement. In addition, in connection with the settlement, the parties contemplate that plaintiff’s counsel in the Realistic Partners Action will file a petition in the court for an award of attorneys’ fees and expenses to be paid by ARCP, which the defendants may oppose. ARCP will pay or cause to be paid any attorneys’ fees and expenses awarded by the court. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the court will approve the settlement even if the parties were to enter into such stipulation. In such event, the proposed settlement as contemplated by the memorandum of understanding may be terminated.

A number of lawsuits by CapLease’s stockholders have been challenging the CapLease Merger, some of which name ARCP and the OP as defendants. Additionally, a lawsuit was commenced on behalf of holders of a series of CapLease’s preferred stock in connection with the CapLease Merger alleging that the conversion of such preferred stock pursuant to the terms of the CapLease Merger Agreement was prohibited by the Articles Supplementary classifying and designating such preferred stock.

 

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After the announcement of the ARCT III Merger Agreement, Randell Quaal filed a putative class action lawsuit on January 30, 2013 against the Company, the OP, ARCT III, ARCT III OP, the members of the board of directors of ARCT III and certain subsidiaries of the Company in the Supreme Court of the State of New York. In February 2013, the parties agreed to a memorandum of understanding regarding settlement of all claims asserted on behalf of the alleged class of ARCT III stockholders. In connection with the settlement contemplated by the memorandum of understanding, the class action and all claims asserted therein will be dismissed, subject to court approval. If the parties enter into a stipulation of settlement, a hearing will be scheduled at which the court will consider the fairness, reasonableness and adequacy of the settlement. There can be no assurance that the parties will ultimately enter into a stipulation of settlement, that the court will approve any proposed settlement, or that any eventual settlement will be under the same terms as those contemplated by the memorandum of understanding, therefore any losses that may be incurred to settle this matter are not determinable.

We cannot assure you as to the outcome of these lawsuits, including the costs associated with defending these claims or any other liabilities that may be incurred in connection with the litigation or settlement of these claims. Whether or not any plaintiffs’ claims are successful, this type of litigation is often expensive and diverts management’s attention and resources, which could adversely affect the operation of our business.

Our future results will suffer if we do not effectively manage our expanded portfolio and operations following the Recent Acquisitions.

Following the Recent Acquisitions, we have an expanded portfolio and operations and likely will continue to expand its operations through additional acquisitions and other strategic transactions, some of which may involve complex challenges. Our future success will depend, in part, upon our ability to manage our expansion opportunities, integrate new operations into our existing business in an efficient and timely manner, successfully monitor our operations, costs, regulatory compliance and service quality, and maintain other necessary internal controls. We cannot assure you that our expansion or acquisition opportunities will be successful, or that we will realize the expected operating efficiencies, cost savings, revenue enhancements, synergies or other benefits.

ARCP has a history of operating losses and cannot assure you that it will achieve profitability.

Since ARCP’s inception in 2010, ARCP has experienced net losses (calculated in accordance with GAAP) each fiscal year and, as of December 31, 2013, had an accumulated deficit of $878.0 million (as restated). The extent of ARCP’s future operating losses and the timing of when ARCP will achieve profitability are uncertain, and depends on the demand for, and value of, ARCP’s portfolio of properties and ARCP may never achieve or sustain profitability.

ARCP may be unable to integrate the recently acquired GE Capital, Fortress and Inland Portfolios into ARCP’s existing portfolio or CapLease’s, ARCT IV’s and Cole’s businesses with ARCP’s business successfully and realize the anticipated synergies and related benefits of the Mergers, and acquisition of the GE Capital Portfolio and other pending acquisitions or do so within the anticipated timeframe.

ARCP’s consummation of the CapLease Merger, the ARCT IV Merger and the Cole Merger, involves the combination of companies that, prior to the consummation thereof, operated as independent companies. Additionally, ARCP recently acquired the GE Capital, Fortress and Inland Portfolios. ARCP may be required to devote significant management attention and resources to integrating ARCP’s business practices and operations with those of CapLease, ARCT IV and Cole and the acquired GE Capital, Inland and Fortress Portfolios as well as the Inland Portfolio. Potential difficulties ARCP may encounter in the integration process include the following:

 

    the inability to successfully combine ARCP’s business with CapLease’s, ARCT IV’s or Cole’s business or the GE Capital, Inland and Fortress Portfolios into ARCP’s portfolio, in each case in a manner that permits the combined company to achieve the anticipated cost savings, which would result in the anticipated benefits of the mergers and the acquisition of the Inland and Fortress Portfolios not being realized in the timeframe anticipated or at all;

 

    the complexities associated with managing the combined business out of several different locations and integrating personnel from the two companies;

 

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    the additional complexities of combining companies with different histories, cultures, potential regulatory restrictions, markets and tenant bases;

 

    the failure to retain ARCP’s key employees or those of any of ARCT IV, CapLease or Cole;

 

    the inability to divest certain CapLease or Cole assets not fundamental to ARCP’s business;

 

    potential unknown liabilities and unforeseen increased expenses, delays or regulatory conditions associated with the combinations; and

 

    performance shortfalls as a result of the diversion of management’s attention caused by completing the Mergers and acquisition of the Inland and Fortress Portfolios and integrating operations.

For all these reasons, our stockholders should be aware that it is possible that the integration process following the Recent Acquisitions could result in the distraction of our management, the disruption of our ongoing business or inconsistencies in our services, standards, controls, procedures and policies, any of which could adversely affect our ability to maintain relationships with tenants, vendors and employees or to achieve the anticipated benefits of such transactions, or could otherwise adversely affect the business and our financial results.

ARCP cannot assure our stockholders that it will be able to continue paying distributions at the same rate as in the past. (As Restated)

ARCP will reevaluate a reinstatement of the dividend on its common stock at a rate that is in line with its industry peers. ARCP’s stockholders may not receive the same distributions for various reasons, including the following:

 

    ARCP may determine to change its current dividend rate;

 

    as a result of the mergers and the issuance of shares of ARCP’s common and preferred stock in connection with the mergers, the total amount of cash required for ARCP to pay distributions at its current rate will increase;

 

    ARCP may not have enough cash to pay such distributions due to changes in ARCP’s cash requirements, capital spending plans, cash flow or financial position;

 

    decisions on whether, when and in which amounts to make any future distributions will remain at all times entirely at the discretion of the ARCP Board, which reserves the right to change ARCP’s dividend practices at any time and for any reason;

 

    ARCP may desire to retain cash to maintain or improve its credit ratings;

 

    the amount of distributions that ARCP’s subsidiaries may distribute to ARCP may be subject to restrictions imposed by state law, restrictions that may be imposed by state regulators and restrictions imposed by the terms of any current or future indebtedness that these subsidiaries may incur;

 

    ARCP is subject to certain restrictions on borrowing and on paying dividends on its common stock pursuant to the Amended Credit Agreement.

ARCP’s stockholders have no contractual or other legal right to distributions or dividends that have not been declared.

Our net income per share and FFO per share in the near term may decrease as a result of us becoming self-managed.

We completed our transition to self-management in January 2014. While we will no longer bear the external costs of the various fees and expenses paid to our Former Manager, subsequent to becoming self-managed, net income per share and FFO per share in the near term may decrease as a result of us becoming self-managed, due to increased expenses related to being self-managed, including expenses for compensation and benefits of our officers and other employees, which previously were paid by our Former Manager. Therefore, the exact amount of savings to us, if any, from becoming self-managed cannot reasonably be estimated. If the expenses we assume as a result of us becoming self-managed are higher than we anticipate, our net income per share and FFO per share may be lower as a result of us becoming self-managed than we otherwise would have been, potentially causing our net income per share and FFO per share to decrease.

 

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In connection with us becoming self-managed, we may become exposed to risks to which we have not historically been exposed.

In connection with us becoming self-managed, we may be exposed to risks to which we have not historically been exposed. Excluding the effect of the eliminated asset management and other fees previously paid to our Former Manager and its affiliates, our direct overhead, on a consolidated basis, will increase as a result of us becoming self-managed. Prior to us becoming self-managed, the responsibility for such overhead was borne by our Former Manager.

Prior to us becoming self-managed, we did not have separate facilities, communications and information systems nor did we directly employ very many employees; our Former Manager formerly provided such amenities. As a result of us becoming self-managed, we now will lease office space, have our own communications and information systems and directly employ a staff. Any failure of our employees or infrastructure to provide these services after self-management could adversely affect our operations. Our business is highly dependent on communications and information systems. Any failure or interruption of our systems could have a material adverse effect on our financial condition and operating results. Additionally, as a direct employer, we will be subject to those potential liabilities that are commonly faced by employers, such as workers disability and compensation claims, potential labor disputes and other employee-related liabilities and grievances, and we will bear the costs of the establishment and maintenance of such plans.

Furthermore, pursuant to our Recent Acquisitions, we will also be combining the facilities and personnel of the companies acquired pursuant to our Recent Acquisitions. In particular, as a result of the Cole Merger, we will significantly increase the number of our employees, including the addition of employees who will become our senior officers, and significantly increase the facilities at which our business operates. We will face potential difficulties in effecting our self-management and integrating these businesses, including those described under “ –ARCP may be unable to integrate the recently acquired GE Capital, Fortress and Inland Portfolios into ARCP’s existing portfolio or CapLease’s, ARCT IV’s and Cole’s businesses with ARCP’s business successfully and realize the anticipated synergies and related benefits of the Mergers, and acquisition of the GE Capital Portfolio and other pending acquisitions or do so within the anticipated timeframe.”

U.S. Federal Income Tax Risks

Our failure to remain qualified as a REIT would subject us to U.S. federal income tax and potentially state and local tax, and would adversely affect our operations and the market price of our common stock.

We have qualified to be taxed as a REIT commencing with the taxable year ended December 31, 2011 and intend to operate in a manner that would allow us to continue to qualify as a REIT. However, we may terminate our REIT qualification if our board of directors determines that not qualifying as a REIT is in our best interests, or inadvertently. Our qualification as a REIT depends upon our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. We structured our activities in a manner designed to satisfy all requirements for qualification as a REIT. However, the REIT qualification requirements are extremely complex and interpretation of the U.S. federal income tax laws governing qualification as a REIT is limited. Furthermore, any opinion of our counsel, including tax counsel, as to our eligibility to remain qualified as a REIT is not binding on the IRS and is not a guarantee that we will continue to qualify as a REIT. Accordingly, we cannot be certain that we will be successful in operating so we can remain qualified as a REIT. Our ability to satisfy the asset tests depends on our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the REIT income or quarterly asset requirements also depends on our ability to successfully manage the composition of our income and assets on an ongoing basis. Accordingly, if certain of our operations were to be recharacterized by the IRS, such recharacterization would jeopardize our ability to satisfy all requirements for qualification as a REIT. Furthermore, future legislative, judicial or administrative changes to the U.S. federal income tax laws could be applied retroactively, which could result in our disqualification as a REIT.

 

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If we fail to continue to qualify as a REIT for any taxable year and we do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax on our taxable income at corporate rates. In addition, we would generally be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT qualification. Losing our REIT qualification would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability. In addition, distributions to stockholders would no longer qualify for the dividends paid deduction, and we would no longer be required to make distributions. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax.

Even with our REIT qualification, in certain circumstances, we may incur tax liabilities that would reduce our cash available for distribution to our stockholders.

Even with our REIT qualification, we may be subject to U.S. federal, state and local income taxes. For example, net income from the sale of properties that are “dealer” properties sold by a REIT (a “prohibited transaction” under the Code) will be subject to a 100% tax. We may not make sufficient dividends to avoid excise taxes applicable to REITs. Similarly, if we were to fail an income test (and did not lose our REIT status because such failure was due to reasonable cause and not willful neglect) we would be subject to tax on the income that does not meet the income test requirements. We also may decide to retain net capital gain we earn from the sale or other disposition of our property and pay U.S. federal income tax directly on such income. In that event, our stockholders would be treated as if they earned that income and paid the tax on it directly. However, stockholders that are tax-exempt, such as charities or qualified pension plans, would have no benefit from their deemed payment of such tax liability unless they file U.S. federal income tax returns and thereon seek a refund of such tax. We also will be subject to corporate tax on any undistributed REIT taxable income. We also may be subject to state and local taxes on our income or property, including franchise, payroll and transfer taxes, either directly or at the level of our operating partnership or at the level of the other companies through which we indirectly own our assets, such as TRSs, which are subject to full U.S. federal, state, local and foreign corporate-level income taxes. Any taxes we pay directly or indirectly will reduce our cash available for distribution to our stockholders.

To qualify as a REIT we must meet annual dividend requirements, which may force us to forgo otherwise attractive opportunities or borrow funds during unfavorable market conditions. This could delay or hinder our ability to meet our investment objectives and reduce our stockholders overall return.

In order to qualify as a REIT, we must distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income as calculated in accordance with GAAP), determined without regard to the deduction for dividends paid and excluding any net capital gain. We will be subject to U.S. federal income tax on our undistributed taxable income and net capital gain and to a 4% nondeductible excise tax on any amount by which dividends we pay with respect to any calendar year are less than the sum of (a) 85% of our ordinary income, (b) 95% of our capital gain net income and (c) 100% of our undistributed income from prior years. These requirements could cause us to distribute amounts that otherwise would be spent on investments in real estate assets and it is possible that we might be required to borrow funds, possibly at unfavorable rates, or sell assets to fund these dividends. Although we intend to make dividends sufficient to meet the annual dividend requirements and to avoid U.S. federal income and excise taxes on our earnings while we qualify as a REIT, it is possible that we might not always be able to do so.

 

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Certain of our business activities are potentially subject to the prohibited transaction tax, which could reduce the return on our stockholders’ investments.

For so long as we qualify as a REIT, our ability to dispose of property during the first few years following acquisition may be restricted to a substantial extent as a result of our REIT qualification. Under applicable provisions of the Code regarding prohibited transactions by REITs, while we qualify as a REIT, we will be subject to a 100% penalty tax on any gain recognized on the sale or other disposition of any property (other than foreclosure property) that we own, directly or through any subsidiary entity, including our operating partnership, but generally excluding our TRSs, that is deemed to be inventory or property held primarily for sale to customers in the ordinary course of a trade or business. Whether property is inventory or otherwise held primarily for sale to customers in the ordinary course of a trade or business depends on the particular facts and circumstances surrounding each property. While we qualify as a REIT, we intend to avoid the 100% prohibited transaction tax by (a) conducting activities that may otherwise be considered prohibited transactions through a TRS (but such TRS will incur corporate rate income taxes with respect to any income or gain recognized by it), (b) conducting our operations in such a manner so that no sale or other disposition of an asset we own, directly or through any subsidiary, will be treated as a prohibited transaction or (c) structuring certain dispositions of our properties to comply with the requirements of the prohibited transaction safe harbor available under the Code for properties that, among other requirements have been held for at least two years. However, despite our present intention, no assurance can be given that any particular property we own, directly or through any subsidiary entity, including our operating partnership, but generally excluding our TRSs, will not be treated as inventory or property held primarily for sale to customers in the ordinary course of a trade or business.

Our TRSs are subject to corporate-level taxes and our dealings with our TRSs may be subject to 100% excise tax.

A REIT may own up to 100% of the stock of one or more TRSs. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 25% of the value of a REIT’s assets may consist of stock or securities of one or more TRSs.

A TRS may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT, including gross income from operations pursuant to management contracts. We may use TRSs generally to hold properties for sale in the ordinary course of business or to hold assets or conduct activities that we cannot conduct directly as a REIT. Our TRSs will be subject to applicable U.S. federal, state, local and foreign income tax on its taxable income. In addition, the TRS rules limits the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. The rules which are applicable to us as a REIT also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis.

If our operating partnership failed to qualify as a partnership or was not otherwise disregarded for U.S. federal income tax purposes, we would cease to qualify as a REIT.

We intend to maintain the status of our operating partnership as a partnership for U.S. federal income tax purposes. However, if the IRS were to successfully challenge the status of our operating partnership as a partnership for such purposes, it would be taxable as a corporation. In such event, this would reduce the amount of dividends that our operating partnership could make to us. This would also result in our failing to qualify as a REIT, and becoming subject to a corporate level tax on our income. This substantially would reduce our cash available to pay dividends and the yield on our stockholders’ investments. In addition, if any of the partnerships or limited liability companies through which our operating partnership owns its properties, in whole or in part, loses its characterization as a partnership and is otherwise not disregarded for U.S. federal income tax purposes, it would be subject to taxation as a corporation, thereby reducing dividends to the operating partnership. Such a recharacterization of an underlying property owner could also threaten our ability to maintain our REIT qualification.

We may choose to make distributions in our own stock, in which case stockholders may be required to pay U.S. federal income taxes in excess of the cash dividends stockholders receive.

In connection with our qualification as a REIT, we are required to distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income as calculated in accordance with U.S. GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain. In order to satisfy this requirement, we may make

 

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distributions that are payable in cash and/or shares of our common stock (which could account for up to 80% of the aggregate amount of such distributions) at the election of each stockholder. Taxable stockholders receiving such distributions will be required to include the full amount of such distributions as ordinary dividend income to the extent of our current or accumulated earnings and profits, as determined for U.S. federal income tax purposes. As a result, U.S. stockholders may be required to pay U.S. federal income taxes with respect to such distributions in excess of the cash portion of the distribution received. Accordingly, U.S. stockholders receiving a distribution of our shares may be required to sell shares received in such distribution or may be required to sell other stock or assets owned by them, at a time that may be disadvantageous, in order to satisfy any tax imposed on such distribution. If a U.S. stockholder sells the stock that it receives as part of the distribution in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the distribution, depending on the market price of our stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such distribution, including in respect of all or a portion of such distribution that is payable in stock, by withholding or disposing of part of the shares included in such distribution and using the proceeds of such disposition to satisfy the withholding tax imposed. In addition, if a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividend income, such sale may put downward pressure on the market price of our common stock.

Various tax aspects of such a taxable cash/stock distribution are uncertain and have not yet been addressed by the IRS. No assurance can be given that the IRS will not impose requirements in the future with respect to taxable cash/stock distributions, including on a retroactive basis, or assert that the requirements for such taxable cash/stock distributions have not been met.

The taxation of distributions to our stockholders can be complex; however, dividends that we make to our stockholders generally will be taxable as ordinary income.

Dividends that we make to our taxable stockholders out of current and accumulated earnings and profits (and not designated as capital gain dividends or qualified dividend income) generally will be taxable as ordinary income. However, a portion of our dividends may (1) be designated by us as capital gain dividends generally taxable as long-term capital gain to the extent that they are attributable to net capital gain recognized by us, (2) be designated by us as qualified dividend income generally to the extent they are attributable to dividends we receive from our TRSs, or (3) constitute a return of capital generally to the extent that they exceed our accumulated earnings and profits as determined for U.S. federal income tax purposes. A return of capital is not taxable, but has the effect of reducing the basis of a stockholder’s investment in our common stock.

Dividends payable by REITs generally do not qualify for the reduced tax rates available for some dividends.

Currently, the maximum tax rate applicable to qualified dividend income payable to U.S. stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs, however, generally are not eligible for this reduced rate. Although this does not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common stock. Tax rates could be changed in future legislation.

If we were considered to actually or constructively pay a “preferential dividend” to certain of our stockholders, our status as a REIT could be adversely affected.

In order to qualify as a REIT, we must distribute annually to our stockholders at least 90% of our REIT taxable income (which does not equal net income as calculated in accordance with U.S. GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain. In order for distributions to be counted as satisfying the annual distribution requirements for REITs, and to provide us with a REIT-level tax deduction, the distributions must not be “preferential dividends.” A dividend is not a preferential dividend if the distribution is pro rata among all outstanding shares of stock within a particular class, and in accordance with the preferences among different classes of stock as set forth in our organizational documents. Currently, there is uncertainty as to the IRS’s position regarding whether certain arrangements that REITs have with their stockholders could give rise to the inadvertent payment of a preferential dividend (e.g., the pricing methodology for stock purchased under a distribution reinvestment plan inadvertently causing a greater than 5% discount on the price of such stock

 

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purchased). While we believe that our operations have been structured in such a manner that we will not be treated as inadvertently paying preferential dividends, there is no de minimis exception with respect to preferential dividends. Therefore, if the IRS were to take the position that we inadvertently paid a preferential dividend, we may be deemed either to (a) have distributed less than 100% of our REIT taxable income and be subject to tax on the undistributed portion, or (b) have distributed less than 90% of our REIT taxable income and our status as a REIT could be terminated for the year in which such determination is made if we were unable to cure such failure.

Complying with REIT requirements may limit our ability to hedge our liabilities effectively and may cause us to incur tax liabilities.

The REIT provisions of the Code may limit our ability to hedge our liabilities. Any income from a hedging transaction we enter into to manage risk of interest rate changes, price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets, if properly identified under applicable Treasury Regulations, does not constitute “gross income” for purposes of the 75% or 95% gross income tests. To the extent that we enter into other types of hedging transactions, the income from those transactions will likely be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, we may need to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRSs would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in a TRS generally will not provide any tax benefit, except for being carried forward against future taxable income of such TRS.

Complying with REIT requirements may force us to forgo or liquidate otherwise attractive investment opportunities.

To qualify as a REIT, we must ensure that we meet the REIT gross income tests annually and that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets, including certain mortgage loans and certain kinds of mortgage-related securities. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 25% of the value of our total assets can be represented by securities of one or more TRSs. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate assets from our portfolio or not make otherwise attractive investments in order to maintain our qualification as a REIT. These actions could have the effect of reducing our income and amounts available for dividend to our stockholders.

The ability of our board of directors to revoke our REIT qualification without stockholder approval may subject us to U.S. federal income tax and reduce dividends to our stockholders.

Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. While we elected to be qualified to be taxed as a REIT, we may terminate our REIT election if we determine that qualifying as a REIT is no longer in the best interests of our stockholders. If we cease to be a REIT, we would become subject to U.S. federal income tax on our taxable income and would no longer be required to distribute most of our taxable income to our stockholders, which may have adverse consequences on our total return to our stockholders and on the market price of our common stock.

 

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We may be subject to adverse legislative or regulatory tax changes that could increase our tax liability, reduce our operating flexibility and reduce the market price of our common stock.

In recent years, numerous legislative, judicial and administrative changes have been made in the provisions of U.S. federal income tax laws applicable to investments similar to an investment in shares of our common stock. Additional changes to the tax laws are likely to continue to occur, and we cannot assure our stockholders that any such changes will not adversely affect the taxation of a stockholder. Any such changes could have an adverse effect on an investment in our shares or on the market value or the resale potential of our assets. Our stockholders are urged to consult with their tax advisor with respect to the impact of recent legislation on their investment in our shares and the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our shares. Our stockholders should also note that our counsel’s tax opinion is based upon existing law, applicable as of the date of its opinion, all of which will be subject to change, either prospectively or retroactively.

Although REITs generally receive better tax treatment than entities taxed as regular corporations, it is possible that future legislation would result in a REIT having fewer tax advantages, and it could become more advantageous for a company that invests in real estate to elect to be treated for U.S. federal income tax purposes as a corporation. As a result, our charter provides our board of directors with the power, under certain circumstances, to revoke or otherwise terminate our REIT election and cause us to be taxed as a regular corporation, without the vote of our stockholders. Our board of directors has fiduciary duties to us and our stockholders and could only cause such changes in our tax treatment if it determines in good faith that such changes are in the best interest of our stockholders.

The share ownership restrictions of the Code for REITs and the 9.8% share ownership limit in our charter may inhibit market activity in our shares of stock and restrict our business combination opportunities.

In order to qualify as a REIT, five or fewer individuals, as defined in the Code, may not own, actually or constructively, more than 50% in value of our issued and outstanding shares of stock at any time during the last half of each taxable year, other than the first year for which a REIT election is made. Attribution rules in the Code determine if any individual or entity actually or constructively owns our shares of stock under this requirement. Additionally, at least 100 persons must beneficially own our shares of stock during at least 335 days of a taxable year for each taxable year, other than the first year for which a REIT election is made. To help insure that we meet these tests, among other purposes, our charter restricts the acquisition and ownership of our shares of stock.

Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT while we so qualify. Unless exempted by our board of directors, for so long as we qualify as a REIT, our charter prohibits, among other limitations on ownership and transfer of shares of our stock, any person from beneficially or constructively owning (applying certain attribution rules under the Code) more than 9.8% in value of the aggregate of our outstanding shares of stock and more than 9.8% (in value or in number of shares, whichever is more restrictive) of any class or series of our shares of stock. Our board of directors may not grant an exemption from these restrictions to any proposed transferee whose ownership in excess of the 9.8% ownership limit would result in the termination of our qualification as a REIT. These restrictions on transferability and ownership will not apply, however, if our board of directors determines that it is no longer in our best interest to continue to qualify as a REIT or that compliance with the restrictions is no longer required in order for us to continue to so qualify as a REIT.

These ownership limits could delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of the stockholders.

Non-U.S. stockholders will be subject to U.S. federal withholding tax and may be subject to U.S. federal income tax on dividends received from us and upon the disposition of our shares.

Subject to certain exceptions, dividends received from us will be treated as dividends of ordinary income to the extent of our current or accumulated earnings and profits. Such dividends ordinarily will be subject to U.S. withholding tax at a 30% rate, or such lower rate as may be specified by an applicable income tax treaty, unless the dividends are treated as “effectively connected” with the conduct by the non-U.S. stockholder of a U.S. trade or business. Pursuant to the Foreign Investment in Real Property Tax Act of 1980, or FIRPTA, capital gain dividends attributable to sales or exchanges of “U.S. real property

 

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interests,” or USRPIs, generally will be taxed to a non-U.S. stockholder as if such gain were effectively connected with a U.S. trade or business. However, a capital gain dividend will not be treated as effectively connected income if (a) the dividend is received with respect to a class of stock that is regularly traded on an established securities market located in the United States; and (b) the non-U.S. stockholder does not own more than 5% of the class of our stock at any time during the one year period ending on the date the dividend is received. We anticipate that our shares will be “regularly traded” on an established securities market for the foreseeable future, although, no assurance can be given that this will be the case.

Gain recognized by a non-U.S. stockholder upon the sale or exchange of our common stock generally will not be subject to U.S. federal income taxation unless such stock constitutes a USRPI under FIRPTA. Our common stock will not constitute a USRPI so long as we are a “domestically-controlled qualified investment entity.” A domestically-controlled qualified investment entity includes a REIT if at all times during a specified testing period, less than 50% in value of such REIT’s stock is held directly or indirectly by non-U.S. stockholders. We believe, but cannot assure our stockholders, that we will be a domestically-controlled qualified investment entity, and because our common stock will be publicly traded, no assurance can be given that we will be a domestically-controlled qualified investment entity.

Even if we do not qualify as a domestically-controlled qualified investment entity at the time a non-U.S. stockholder sells or exchanges our common stock, gain arising from such a sale or exchange would not be subject to U.S. taxation under FIRPTA as a sale of a USRPI if: (a) our common stock is “regularly traded,” as defined by applicable Treasury regulations, on an established securities market, and (b) such non-U.S. stockholder owned, actually and constructively, 5% or less of our common stock at any time during the five-year period ending on the date of the sale. We encourage our stockholders to consult their tax advisor to determine the tax consequences applicable to them if they are non-U.S. stockholders.

Potential characterization of dividends or gain on sale may be treated as unrelated business taxable income to tax-exempt investors.

If (a) we are a “pension-held REIT,” (b) a tax-exempt stockholder has incurred (or is deemed to have incurred) debt to purchase or hold our common stock, or (c) a holder of common stock is a certain type of tax-exempt stockholder, dividends on, and gains recognized on the sale of, common stock by such tax-exempt stockholder may be subject to U.S. federal income tax as unrelated business taxable income under the Code.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

General

As of December 31, 2013, after giving effect to the properties owned by ARCT IV which we acquired on January 3, 2014, we owned 2,559 properties, comprised of 43.8 million square feet and located in 49 states, the District of Columbia and Puerto Rico, excluding one vacant property classified as held for sale. Our properties were 99% occupied with a weighted-average remaining lease term of 9.4 years as of December 31, 2013.

 

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Industry Distribution (As Restated)

The following table details the industry distribution of our portfolio as of December 31, 2013 (dollars in thousands):

 

Industry

   Number of
Leases
     Square Feet      Square Feet as
a % of Total
Portfolio
    Annualized
Rental Income
     Annualized Rental
Income as a % of
Total Portfolio
 

Administrative & Support Services - Employment & Office Maintenance

     2         129,999         0.3   $ 504         0.1

Agricultural - Crop Farming

     1         107,520         0.3     770         0.1

Billboard

     5         —           —       46         —  

Education - Other

     1         194,665         0.4     1,734         0.3

Entertainment & Recreation - Fitness

     1         45,906         0.1     1,319         0.2

Finance - Banking

     263         1,643,951         3.8     38,717         7.0

Finance - Credit Card & Consumer Lending

     6         350,948         0.8     5,424         1.0

Finance - Investment, Securities & Commodity

     6         555,860         1.3     9,927         1.8

Government & Public Services - Other

     21         663,031         1.5     18,544         3.3

Healthcare - Dental

     2         5,834         —       100         —  

Healthcare - Emergency & Medical Centers

     38         496,645         1.1     9,091         1.6

Healthcare - Labratories & Diagnostics

     2         243,117         0.6     3,077         0.6

Healthcare - Medical

     1         22,708         0.1     506         0.1

Healthcare - Other

     1         227,467         0.5     3,347         0.6

Information & Communications - Telecommunications

     5         399,653         0.9     6,915         1.3

Insurance - Life

     3         131,113         0.3     2,215         0.4

Insurance - Medical

     1         100,352         0.2     4,233         0.8

Insurance - Property

     10         977,675         2.2     13,787         2.5

Logistics - Packaging

     1         221,035         0.5     1,480         0.3

Logistics - Postal & Delivery Services

     43         2,605,673         5.9     26,498         4.8

Manufacturing - Aircraft & Aerospace

     5         875,083         2.0     14,694         2.7

Manufacturing - Consumer Products

     10         4,440,909         10.1     13,755         2.5

Manufacturing - Food

     6         3,892,811         8.9     18,986         3.4

Manufacturing - Machinery & Heavy Equipment

     1         552,960         1.3     2,353         0.4

Manufacturing - Medical

     4         409,051         0.9     7,453         1.3

Manufacturing - Motor Vehicle

     2         957,042         2.2     3,828         0.7

Manufacturing - Other

     1         307,275         0.7     2,340         0.4

Mining & Natural Resources - Petroleum, Gas & Coal

     1         308,586         0.7     5,338         1.0

Other Services - Automotive

     2         11,518         —       234         —  

Other Services - Beauty Salons & Spas

     1         1,288         —       21         —  

Other Services - Non-Profit Organizations

     1         9,513         —       228         —  

Other Services - Other

     1         150,000         0.3     1,056         0.2

Parking

     1         8,400         —       1         —  

Professional Services - Administrative & Management Consulting

     6         1,458,581         3.3     20,638         3.7

Professional Services - Advertising

     16         558,036         1.3     6,236         1.1

Professional Services - Media

     2         216,285         0.5     2,817         0.5

Professional Services - Other

     1         16,352         —       313         0.1

Professional Services - Research & Development

     1         223,912         0.5     695         0.1

Restaurants - Casual Dining

     214         1,395,247         3.2     39,584         7.1

 

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Industry

   Number of
Leases
     Square Feet      Square Feet as
a % of Total
Portfolio
    Annualized
Rental Income
     Annualized Rental
Income as a % of
Total Portfolio
 

Restaurants - Family Dining

     104         543,271         1.2     13,022         2.4

Restaurants - Premium Dining

     1         9,354         —       98         —  

Restaurants - Quick Service Restaurant

     1,095         3,427,178         7.8     98,262         17.7

Retail - Apparel & Jewelry

     3         1,324,855         3.0     12,843         2.3

Retail - Automotive

     68         516,771         1.2     7,809         1.4

Retail - Department Stores

     1         88,408         0.2     858         0.2

Retail - Discount

     425         4,850,625         11.2     41,806         7.5

Retail - Gas & Convenience

     37         160,850         0.4     8,553         1.5

Retail - Grocery & Supermarket

     17         2,112,054         4.8     15,831         2.9

Retail - Home & Garden

     18         3,247,129         7.4     20,707         3.7

Retail - Home Furnishings

     22         136,396         0.3     3,896         0.7

Retail - Pharmacy

     109         1,457,596         3.3     36,000         6.5

Retail - Specialty (Other)

     2         315,230         0.7     1,920         0.4

Retail - Sporting Goods

     5         292,645         0.7     3,459         0.6

Retail - Warehouse Clubs

     1         108,532         0.3     883         0.2

Utilities - Power Generation

     1         9,353         —       239         —  

Vacant

     —           318,245         0.8     —           —  
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
  2,598      43,834,493      100.0 $ 554,990      100.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Geographical Distribution

The following table details the geographic distribution of our portfolio as of December 31, 2013 (dollars in thousands):

 

State/Possession

   Number of
Properties
     Square Feet      Square Feet as a %
of Total Portfolio
    Annualized Rental
Income
     Annualized Rental
Income as a % of
Total Portfolio
 

Alabama

     100         985,161         2.2   $ 20,873         3.8

Alaska

     1         2,805         —       121         —  

Arizona

     30         196,128         0.4     4,481         0.8

Arkansas

     71         506,813         1.2     5,142         0.9

California

     37         2,931,471         6.7     28,769         5.2

Colorado

     29         738,801         1.7     13,923         2.5

Connecticut

     15         60,437         0.1     1,922         0.3

Delaware

     4         12,369         —       286         0.1

District of Columbia

     1         3,210         —       44         —  

Florida

     149         2,209,983         5.0     32,125         5.8

Georgia

     133         980,469         2.2     17,263         3.1

Idaho

     14         101,853         0.2     3,429         0.6

Illinois

     100         2,285,588         5.2     35,092         6.3

Indiana

     69         3,994,003         9.1     24,799         4.5

Iowa

     32         824,716         1.9     6,278         1.1

Kansas

     34         1,654,772         3.8     11,094         2.0

Kentucky

     56         1,260,977         2.9     11,625         2.1

Louisiana

     60         492,457         1.1     9,507         1.7

Maine

     5         298,114         0.7     3,909         0.7

Maryland

     15         502,064         1.1     3,775         0.7

Massachusetts

     29         1,148,866         2.6     11,722         2.1

 

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State/Possession

   Number of
Properties
     Square Feet      Square Feet as a %
of Total Portfolio
    Annualized Rental
Income
     Annualized Rental
Income as a % of
Total Portfolio
 

Michigan

     121         1,100,961         2.5   $ 19,636         3.5

Minnesota

     24         300,507         0.7     2,643         0.5

Mississippi

     51         1,423,664         3.2     9,965         1.8

Missouri

     115         1,128,639         2.6     13,616         2.5

Montana

     5         55,377         0.1     795         0.1

Nebraska

     12         650,154         1.5     6,494         1.2

Nevada

     14         116,743         0.3     2,628         0.5

New Hampshire

     13         94,237         0.2     1,885         0.3

New Jersey

     14         615,352         1.4     12,653         2.3

New Mexico

     26         161,456         0.4     4,295         0.8

New York

     56         555,634         1.3     12,619         2.3

North Carolina

     110         1,616,820         3.7     20,004         3.6

North Dakota

     5         39,248         0.1     1,052         0.2

Ohio

     145         2,933,976         6.7     22,740         4.1

Oklahoma

     37         769,462         1.8     9,829         1.8

Oregon

     12         54,677         0.1     679         0.1

Pennsylvania

     111         3,098,552         7.1     34,789         6.3

Puerto Rico

     3         87,550         0.2     2,429         0.4

Rhode Island

     13         161,642         0.4     3,260         0.6

South Carolina

     78         812,541         1.9     10,749         1.9

South Dakota

     5         84,414         0.2     781         0.1

Tennessee

     95         787,940         1.8     13,933         2.5

Texas

     312         3,795,939         8.7     59,481         10.7

Utah

     6         23,527         0.1     692         0.1

Vermont

     4         15,432         —       336         0.1

Virginia

     73         1,011,320         2.3     18,842         3.4

Washington

     13         405,633         0.9     8,660         1.6

West Virginia

     33         167,244         0.4     3,440         0.6

Wisconsin

     60         516,631         1.2     8,735         1.6

Wyoming

     9         58,164         0.1     1,151         0.2
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
  2,559      43,834,493      100.0 $ 554,990      100.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Property Type

The following table details the property type of our portfolio as of December 31, 2013 (dollars in thousands):

 

Property Type

   Number of
Properties
     Square Feet      Square Feet as a %
of Total Portfolio
    Annualized Rental
Income
     Annualized Rental
Income as a % of
Total Portfolio
 

Retail

     2,381         15,026,368         34.3   $ 301,524         54.3

Office

     102         9,006,915         20.6     145,060         26.1

Distribution

     66         19,561,645         44.6     106,830         19.3

Parking Lot

     1         8,400         —       1         —  

Billboard

     5         —           —       48         —  

Industrial

     4         231,165         0.5     1,527         0.3
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
  2,559      43,834,493      100.0 $ 554,990      100.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

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Property Financing

Our mortgage notes payable consist of the following as of December 31, 2013 and 2012 (dollar amounts in thousands):

 

     Encumbered Properties      Outstanding Loan Amount      Weighted-Average
Effective Interest Rate (1)
    Weighted-Average
Maturity (2)
 

December 31, 2013

     177       $ 1,258,661         3.42     3.41   

December 31, 2012

     164       $ 265,118         4.28     5.51   

 

(1) Mortgage notes payable have fixed rates or are fixed by way of interest rate swap arrangements. Effective interest rates range from 1.83% to 6.28% at December 31, 2013 and 3.32% to 6.13% at December 31, 2012.
(2) Weighted-average remaining years until maturity as of December 31, 2013 and 2012, respectively.

As part of the CapLease Merger, we assumed a secured credit facility with Wells Fargo, National Association (the “Secured Credit Facility”), which had commitments of up to $150.0 million at December 31, 2013. The Secured Credit Facility was fully drawn with $150.0 million outstanding at December 31, 2013.

The borrowings under the Secured Credit Facility bear interest at an annual rate of one-month LIBOR or LIBOR based on an interest period of one, three or six months, at our election, plus an applicable margin of 2.75%, payable quarterly in arrears. The Secured Credit Facility matures on December 31, 2014 and may be prepaid, in whole or in part, without premium or penalty, at our option, at any time.

In addition, we have financing, which is not secured by interests in real property, which is described under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Future Minimum Lease Payments

The following table presents future minimum base rental cash payments due to us over the next 10 years. These amounts exclude contingent rent payments, as applicable, that may be collected from certain tenants based on provisions related to sales thresholds and increases in annual rent based on exceeding certain economic indexes among other items (amounts in thousands):

 

     Future Minimum
Base Rent Payments
 

2014

   $ 527,965   

2015

     517,861   

2016

     501,637   

2017

     464,615   

2018

     428,389   

2019

     399,486   

2020

     378,893   

2021

     347,657   

2022

     318,967   

2023

     263,388   

Thereafter

     1,036,460   
  

 

 

 
$ 5,185,318   
  

 

 

 

 

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Future Lease Expirations

The following is a summary of lease expirations for the next 10 years at the properties we own as of December 31, 2013 (dollar amounts in thousands):

 

Year of Expiration

   Number of Leases
Expiring
     Square Feet      Square Feet as a % of
Total Portfolio
    Annualized Rental
Income Expiring
     Annualized Rental
Income Expiring as a
% of Total Portfolio
 

2014

     95         1,312,901         3.00   $ 13,519         2.44

2015

     134         1,949,644         4.45     22,094         3.98

2016

     122         1,798,220         4.10     27,373         4.93

2017

     225         4,363,294         9.95     51,443         9.27

2018

     189         1,842,608         4.20     28,955         5.22

2019

     115         970,126         2.21     23,806         4.29

2020

     128         1,511,798         3.45     26,845         4.84

2021

     103         3,204,582         7.31     30,108         5.42

2022

     180         6,786,771         15.48     52,309         9.43

2023

     132         3,726,446         8.50     40,485         7.29
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
  1,423      27,466,390      62.65 $ 316,937      57.11
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Item 3. Legal Proceedings (As Restated)

The information contained in Note 16 – Commitments and Contingencies – “Litigation” of our notes to consolidated financial statements included in this Form 10-K/A is incorporated by reference into this Item 3. Also, refer to Note 24 – Subsequent Events (As Restated) included in this Form 10-K/A for further discussion on legal proceedings.

Item 4. Mine Safety Disclosures

Not applicable.

 

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PART II

Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. (As Restated)

Market Information

Our common stock is currently traded on the NASDAQ under the symbol “ARCP”. Set forth below is a line graph comparing the cumulative total stockholder return on our common stock, based on the market price of the common stock and assuming reinvestment of dividends, with the FTSE National Association of Real Estate Investment Trusts Equity Index (“NAREIT”) and the S&P 500 Index (“S&P 500”) for the period commencing September 6, 2011, the date of our IPO, and ending December 31, 2013. The graph assumes an investment of $100 on September 6, 2011.

Comparison to Cumulative Total Return

 

LOGO

For each calendar quarter indicated, the following table reflects respective high, low and closing sales prices for the common stock as quoted by NASDAQ and the dividends paid per share in each such period:

 

     First
Quarter
2012
     Second
Quarter
2012
     Third
Quarter
2012
     Fourth
Quarter
2012
     First
Quarter
2013
     Second
Quarter
2013
     Third
Quarter
2013
     Fourth
Quarter
2013
 

High

   $ 11.65       $ 11.34       $ 12.50       $ 13.48       $ 14.92       $ 18.05       $ 15.36       $ 13.94   

Low

   $ 10.39       $ 10.00       $ 10.43       $ 11.94       $ 12.45       $ 13.99       $ 12.13       $ 12.16   

Close

   $ 11.34       $ 10.40       $ 12.50       $ 13.24       $ 14.67       $ 15.26       $ 12.20       $ 12.85   

Dividends paid per share

   $ 0.219       $ 0.220       $ 0.222       $ 0.223       $ 0.225       $ 0.226       $ 0.228       $ 0.230   

Holders

As of February 25, 2014, we had 766,128,817 shares of common stock outstanding held by 9,449 stockholders of record.

Dividends

We have elected to qualify as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2011. As a REIT, we are required to distribute at least 90% of our REIT taxable income to our stockholders annually, computed without regard to the dividends paid deduction and excluding net capital gain. Our distributions are paid on a

 

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monthly basis as directed by our board of directors. Monthly cash distributions are paid based on daily record and distribution declaration dates so our investors will be entitled to be paid distributions beginning no more than a month from the day that they are admitted as stockholders. All distributions are recorded as a reduction of stockholders’ equity. From a tax perspective, 22.3% and 54.5% of the amounts distributed by us during the years ended December 31, 2013, and 2012, respectively, represented a return of capital, and 77.7% and 45.5% of our dividends represented ordinary income for the years ended December 31, 2013 and 2012, respectively. On a per share basis, dividends of $0.7045 and $0.2022 were a return of capital and ordinary income, respectively, for the year ended December 31, 2013. Dividends of $0.4820 and $0.4020 were a return of capital and ordinary income, respectively, for the year ended December 31, 2012. Distributions that are a return of capital are deferred for the purpose of being subject to income tax. During the years ended December 31, 2013 and 2012, monthly distributions totaled $231.4 and $73.0, respectively. As of December 31, 2013, cash used to pay our distributions is generated from cash received from operating activities and financing activities (as reported on a U.S. GAAP basis). The amount of dividends payable to our common stockholders is determined by our board of directors and is dependent on a number of factors, including funds available for dividends, financial condition, capital expenditure requirements, as applicable, and annual dividend requirements needed to qualify and maintain our status as a REIT under the Code. Operating cash flows are expected to increase as additional properties are acquired in our investment portfolio.

The following is a chart of quarterly distributions declared and paid in respect of our common stock during the years ended December 31, 2013 and 2012 and through the date of the Original Filing (in thousands):

 

     Total Distributions Paid  

2014:

  

January and February (1)

   $ 101,450   

2013:

  

1st Quarter

     40,485   

2nd Quarter

     49,882   

3rd Quarter

     66,674   

4th Quarter

     74,311   
  

 

 

 

Total 2013

$ 231,352   
  

 

 

 

2012:

1st Quarter

  4,427   

2nd Quarter

  12,110   

3rd Quarter

  24,807   

4th Quarter

  31,681   
  

 

 

 

Total 2012

$ 73,025   
  

 

 

 

 

(1) Pursuant to the Cole Merger Agreement, we paid a stub period dividend to our stockholders who were record holders on February 6, 2014 for the period since their most recent record date through the last business day prior to the closing of the Cole Merger. The amount paid for such stub period was $0.08113 per share and totaled $19.7 million, and is included above.

 

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Our board of directors’ philosophy is that dividends should principally be derived from cash flows generated from real estate operations. In order to improve our operating cash flows and our ability to pay dividends from operating cash flows, we agreed to waive certain fees including asset management and incentive fees prior to our transition to self-management. Base management fees incurred during the year ended December 31, 2013 were $9.4 million while $6.0 million of such fees were waived by our Former Manager that were in excess of certain net income thresholds related to the Company’s operations. No incentive fees have been incurred or paid to the Former Manager since inception. The fees that were waived relating to the activity during 2013 are not deferrals and accordingly, will not be paid. Because the Former Manager waived certain fees that we owed, cash flow from operations that would have been used to pay such fees to the Former Manager was available to pay dividends to our stockholders. See Note 19 — Related Party Transactions and Arrangements (As Restated) for further information on fees paid to and forgiven by our Former Manager. Subsequent to December 31, 2013, we completed our transition to self-management and will no longer pay such fees to the Former Manager. See Note 24 — Subsequent Events (As Restated) for further discussion. The management agreement with the Former Manager was terminated effective January 8, 2014.

As our real estate portfolio matures, we expect cash flows from operations to cover our dividends.

Our board of directors authorized and we declared the following annualized dividends per share payable monthly, in cash, on the 15th day of each month to stockholders of record at the close of business on the eighth day of such month.

 

Declaration date

   Annualized dividend
per share
     Distribution date      Record date  

September 7, 2011

   $ 0.875         10/15/2011         10/8/2011   

February 27, 2012

   $ 0.880         3/15/2012         3/8/2012   

March 16, 2012

   $ 0.885         6/15/2012         6/8/2012   

June 27, 2012

   $ 0.890         9/15/2012         9/8/2012   

September 30, 2012

   $ 0.895         11/15/2012         11/8/2012   

November 29, 2012

   $ 0.900         2/15/2013         2/8/2013   

March 17, 2013

   $ 0.910         6/15/2013         6/8/2013   

May 28, 2013

   $ 0.940         12/13/2013         12/6/2013   

October 23, 2013 (1)

   $ 1.000         2/15/2014         2/7/2014   

 

(1) The dividend increase was contingent upon, and became effective with, the close of the Cole merger, which was consummated on February 7, 2014.

Our existing loan agreements contain, and future financing arrangements will likely contain, restrictive covenants that could limit our ability to make distributions to our stockholders. Specifically, our ability to make distributions may be limited by our Credit Facility, pursuant to which our distributions may not exceed the greater of (i) 105% of our FFO, as adjusted for certain items, the most significant of which are acquisition and merger related expenses, in 2013, and 95% thereafter (ii) the amount required for us to qualify and maintain our status as a REIT.

Distribution payments are dependent on the availability of funds. Our board of directors may reduce the amount of dividends paid or suspend dividend payments at any time and therefore dividend payments are not assured. The dividends paid in respect of our common stock for the year ended December 31, 2013 were $231.4 million.

 

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Share Based Compensation Plans

Equity Plan

We have adopted the American Realty Capital Properties, Inc. Equity Plan (the “Equity Plan”), which provides for the grant of stock options, restricted shares of common stock, restricted stock units, dividend equivalent rights and other equity-based awards to our and our affiliates’ non-executive directors, officers and other employees and advisors and consultants who are providing services to us or our affiliates.

We authorized and reserved a total number of shares equal to 10% of the total number of issued and outstanding shares of common stock (on a fully diluted basis assuming the redemption of all OP Units for shares of common stock) to be issued at any time under the Equity Plan for equity incentive awards.

Director Stock Plan

We have adopted the American Realty Capital Properties, Inc. Non-Executive Director Stock Plan (the “Director Stock Plan”), which provides for the grant of restricted shares of common stock to each of our independent directors, each of whom is a non-executive director. Awards of restricted stock will vest ratably over a five-year period following the date of grant in increments of 20% per annum, subject to the director’s continued service on the board of directors, and shall provide for “distribution equivalents” with respect to this restricted stock, whether or not vested, at the same time and in the same amounts as distributions are paid to the stockholders. At December 31, 2013, a total of 99,000 shares of common stock are reserved for issuance under the Director Stock Plan.

The fair value of restricted common stock awards under the Equity Plan and Director Stock Plan is determined on the grant date using the closing stock price on NASDAQ that day. The fair value of restricted common stock awarded to non-employees under the Equity Plan is measured based upon the fair value of goods or services received or the equity instruments granted, whichever is more reliably determinable.

ARCT III Restricted Share Plan

ARCT III had an employee and director incentive restricted share plan (the “RSP”), which provided for the automatic grant of 3,000 restricted shares of common stock to each of its independent directors, without any further action by ARCT III’s board of directors or its stockholders, on the date of initial election to the board of directors and on the date of each annual stockholder’s meeting thereafter. Restricted stock issued to independent directors vested over a five-year period following the date of grant in increments of 20% per annum. The RSP provided ARCT III with the ability to grant awards of restricted shares to its directors, officers and employees (if ARCT III ever had employees), employees of ARCT III’s Advisor and its affiliates, employees of entities that provided services to ARCT III, directors of the ARCT III Advisor or of entities that provided services to ARCT III, certain consultants to ARCT III and the ARCT III Advisor and its affiliates or to entities that provided services to ARCT III.

Immediately prior to the effective time of the ARCT III Merger, each then-outstanding share of ARCT III restricted stock fully vested. All shares of ARCT III common stock then-outstanding as a result of the full vesting of shares of ARCT III restricted stock, and the satisfaction of any applicable withholding taxes, had the right to receive a number of shares of our common stock based on the ARCT III Exchange Ratio.

 

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The following tables detail the restricted shares activity within the Equity Plan, Director Stock Plan and RSP during the years ended December 31, 2013, 2012 and 2011:

Restricted Share Awards

 

    Equity Plan     RSP & Director Stock Plan  
    Number of
Restricted Common
Shares
    Weighted-Average
Issue Price
    Number of
Restricted Common
Shares
    Weighted-Average
Issue Price
 

Awarded, January 1, 2011

    —        $ —          —        $ —     

Granted

    167,400        12.50        14,700        11.50   
 

 

 

   

 

 

   

 

 

   

 

 

 

Awarded December 31, 2011

  167,400      12.50      14,700      11.50   

Granted

  93,683      10.65      30,634      10.45   

Forfeited

  (1,174   10.65      (13,650   11.54   
 

 

 

   

 

 

   

 

 

   

 

 

 

Awarded December 31, 2012

  259,909      11.84      31,684      10.47   

Granted

  932,527      13.82      20,768      14.58   

Forfeited

  (1,085   12.85      (3,000   12.99   
 

 

 

   

 

 

   

 

 

   

 

 

 

Awarded December 31, 2013

  1,191,351    $ 13.39      49,452    $ 12.04   
 

 

 

   

 

 

   

 

 

   

 

 

 

Unvested Restricted Shares

 

    Equity Plan     RSP & Director Stock Plan  
    Number of
Restricted Common
Shares
    Weighted-Average
Issue Price
    Number of
Restricted Common
Shares
    Weighted-Average
Issue Price
 

Unvested, January 1, 2011

    —        $ —          —        $ —     

Granted

    167,400        12.50        14,700        11.50   

Vested

    (27,900     12.50        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Unvested, December 31, 2011

  139,500      12.50      14,700      11.50   

Granted

  93,683      10.65      30,634      10.45   

Vested

  (59,556   12.38      (2,370   11.88   

Forfeited

  (1,174   10.65      (13,650   11.54   
 

 

 

   

 

 

   

 

 

   

 

 

 

Unvested, December 31, 2012

  172,453      11.55      29,314      10.35   

Granted

  932,527      13.82      20,768      14.58   

Vested

  (172,453   11.55      (28,207   11.03   

Forfeited

  (1,085   12.85      (3,000   12.99   
 

 

 

   

 

 

   

 

 

   

 

 

 

Unvested, December 31, 2013

  931,442    $ 13.82      18,875    $ 13.52   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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For the years ended December 31, 2013, 2012 and 2011, compensation expense for restricted shares under the above plans was $8.0 million, $1.2 million and $0.2 million, respectively. In addition, the Company recognized $2.7 million as a distribution to its Former Manager, which is included in consideration to Former Manager for internalization in the accompanying consolidated statements of changes in equity.

Multi-Year Outperformance Plan

Upon consummation of the ARCT III Merger, the Company entered into the 2013 Advisor Multi-Year Outperformance Agreement (the “OPP”) with its Former Manager, whereby its Former Manager was able to potentially earn compensation upon the attainment of stockholder value creation targets.

Under the OPP, the Company’s Former Manager was granted 8,241,101 long term incentive plan units (“LTIP Units”) of the OP, which are earned or forfeited based on the Company’s total return to stockholders (including both share price appreciation and common stock distributions) (“Total Return”), for the three-year period consisting of:

 

    Absolute Component: 4% of any excess Total Return attained above an absolute hurdle of 7% for each annual measurement period, non-compounded, 14% for the interim measurement period and 21% for the full performance period; and

 

    Relative Component: 4% of any excess Total Return attained above the Total Return for the performance period of a peer group comprised of the following companies: CapLease, Inc.; EPR Properties; Getty Realty Corporation; Lexington Realty Trust; National Retail Properties, Inc.; and Realty Income Corporation.

The award will be funded (“OPP Pool”) up to a maximum award opportunity equal to 5% of our equity market capitalization at the ARCT III Merger date of $2.1 billion (the “OPP Cap”). Awards under the OPP are dependent on achieving an annual hurdle that commenced December 11, 2012, an interim (two-year) hurdle and then the aforementioned three-year hurdle ending on December 31, 2015.

In order to further ensure that the interests of our Former Manager are aligned with our investors, the Relative Component is subject to a ratable sliding scale factor as follows:

 

    100% will be earned if we attain a median Total Return of at least 6% for each annual measurement period, non-compounded, at least 12% for the interim measurement period, and at least 18% for the full performance period;

 

    50% will be earned if we attain a median Total Return of at least 0% for each measurement period;

 

    0% will be earned if we attain a median Total Return of less than 0% for each measurement period; and

 

    a percentage from 50% to 100% calculated by linear interpolation will be earned if our median Total Return is between 0% and the percentage set for each measurement period.

For each year during the performance period a portion of the OPP Cap equal to a maximum of up to 1.25% of the Company’s equity market capitalization of $2.1 billion will be “locked-in” based upon the attainment of the performance hurdles set forth above for each annual measurement period. In addition, a portion of the OPP Cap equal to a maximum of up to 3% of the Company’s equity market capitalization will be “locked-in” based upon the attainment of the performance hurdles set forth above for the interim measurement period, which if achieved, will supersede and negate any prior “locked-in” portion based upon annual performance through the first and second valuation dates on December 31, 2013 and 2014, respectively (i.e., a maximum award opportunity equal to a maximum of up to 3% of the Company’s equity market capitalization may be “locked-in” through December 31, 2014). Since certain awards under the OPP plan are dependent on the comparison of the Company’s current market capitalization to the Company’s market capitalization at the inception of plan, the issuance of additional common shares by the Company may result in higher awards.

Following the performance period, the Absolute Component and the Relative Component will be calculated separately and then added together to determine the aggregate award earned under the OPP, which in no event may exceed the OPP Cap. The OPP Pool will be used to determine the number of LTIP Units that vest. Any unvested LTIP Units will be immediately forfeited on December 31, 2015. At December 31, 2013, 100% of the OPP Pool has been allocated.

 

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Pursuant to previous authorization of the Company’s board of directors, as a result of the termination of the management agreement with the Former Manager, all 8,241,101 LTIP Units vested upon the consummation of the Company’s transition to self-management on January 8, 2014.

Our Former Manager is entitled to receive a tax gross-up in the event that any amounts paid to it under the OPP constitute “parachute payments” as defined in Section 280G of the Code.

During the year ended December 31, 2013,we recorded expenses of $92.3 million for the OPP, which is included in the general and administrative in the consolidated statements of operations. As of December 31, 2013, 2.3 million LTIP Units were earned and $32.7 million of the expense was locked-in and has been included in non-controlling interests on the consolidated balance sheets. The remaining $59.6 million expense has been accrued and is included in due to affiliates in the consolidated balance sheet as of December 31, 2013.

New Multi-Year Outperformance Plan

On October 21, 2013, the Company approved a multi-year outperformance plan (the “New OPP”), to be effective as of the Company’s transition to self-management, which occurred on January 8, 2014. Under the New OPP, individual agreements will be entered into between the Company and the participants selected by the Company’s board of directors (the “Participants”) that set forth the Participant’s participation percentage in the New OPP and the number of LTIP Units subject to the award (“OPP Agreements”). Under the OPP Agreements, the Participants will be eligible to earn performance-based bonus awards equal to the Participant’s participation percentage of a pool that will be funded up to a maximum award opportunity (the “New OPP Cap”) equal to approximately 5% of the Company’s equity market capitalization (“the Initial Market Cap”) on October 1, 2013. Subject to the New OPP Cap, the pool will equal an amount to be determined based on the Company’s achievement of total return to stockholders, including both share price appreciation and common stock distributions (“Total Return”), for a three-year performance period (the “Performance Period”); each 12-month period during the Performance Period (each an “Annual Period”) and the initial 24-month period of the Performance Period (the “Interim Period”), as follows:

 

     Performance
Period
   Annual Period    Interim Period

Absolute Component: 4% of any excess Total Return attained above an absolute hurdle measured from the beginning of such period:

   21%    7%    14%

Relative Component: 4% of any excess Total Return attained above the median Total Return for the performance period of the Peer Group(1), subject to a ratable sliding scale factor as follows based on achievement of cumulative Total Return measured from the beginning of such period:

        

  100% will be earned if cumulative Total Return achieved is at least:    18%    6%    12%

  50% will be earned if a cumulative Total Return achieved is:    0%    0%    0%

  0% will be earned if cumulative Total Return achieved is less than:    0%    0%    0%

  a percentage from 50% to 100% calculated by linear interpolation will be earned if cumulative Total Return achieved is if between:    0% - 18%    0% - 6%    0% - 12%

 

(1) The “Peer Group” is comprised of the following companies: EPR Properties; Getty Realty Corporation; Lexington Realty Trust; National Retail Properties, Inc.; Realty Income Corporation; and Spirit Realty Capital, Inc.

The Participant’s will be entitled to receive a tax gross-up in the event that any amounts paid to the Participant under the New OPP constitute “parachute payments” as defined in Section 280G of the Code. The LTIP Units granted under the New OPP represent units of equity ownership in the OP that are structured as a profits interest therein. Subject to the Participant’s continued service through each vesting date, 1/3 of any earned LTIP Units will vest on each of the third, fourth and fifth anniversaries of October 1, 2013. The Participant will be entitled to receive distributions on their LTIP Units to the extent provided for in the limited partnership agreement of the OP, as amended from time to time.

Use of Proceeds from Sales of Registered Securities; Unregistered Sales of Equity Securities

On April 19, 2013, we issued approximately 38,300 shares of our common stock upon the conversion of limited partner interests in the OP (the “OP Unit Conversion”) at a purchase price of $16.23, for an aggregate purchase price of approximately $0.6 million.

 

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On June 7, 2013, we closed on a private placement transaction for the sale and issuance of approximately 29.4 million shares of our common stock, par value $0.01 per share, at a purchase price of $15.47 per share, for an aggregate purchase price of $455.0 million (the “Common Stock Transaction”).

Concurrently with the closing of the Common Stock Transaction, we closed on a private placement transaction for the sale of approximately 28.4 million shares of a 5.81% convertible preferred stock designated as Series C Convertible Preferred Stock, at a purchase price of $15.67 per share, for an aggregate purchase price of $445.0 million (the “Preferred Stock Transaction”). After deducting for fees and expenses, the aggregate net proceeds from (i) the Common Stock Transaction were approximately $453.0 million and (ii) the Preferred Stock Transaction were approximately $443.0 million, for aggregate net proceeds from both transactions of approximately $896.0 million.

The shares of common stock and Series C Convertible Preferred Stock offered and sold pursuant to the OP Unit Conversion, the Common Stock Transaction and the Preferred Stock Transaction were sold pursuant to an exemption from registration under Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.

On June 11, 2013, we issued approximately 560,900 shares of our common stock upon the conversion of limited partner interests in the OP at a purchase price of $14.56, for an aggregate purchase price of approximately $5.4 million.

On August 5, 2013, we issued 546,611 shares of our common stock upon the conversion of 545,454 shares of Series A Preferred Stock. An additional 1,157 shares of common stock were issued in lieu of unpaid dividends.

On August 13, 2013, we issued 283,018 shares of our common stock upon the conversion of 283,018 shares of Series B Preferred Stock.

On September 15, 2013, we entered into definitive purchase agreements pursuant to which we agreed to issue Series D Preferred Stock, par value $0.01 per share, and common stock, par value $0.01 per share, to certain institutional holders promptly following the close of our merger with CapLease, via a private placement. Pursuant to the definitive purchase agreements, we issued approximately 21.7 million shares of Series D Preferred Stock and 15.1 million shares of common stock, for gross proceeds of $288.0 million and $186.0 million, respectively, on November 12, 2013. The Series D Preferred Stock has a 5.81% coupon on its liquidation preference of $13.59 per share (equivalent to $0.79 per share on an annualized basis).

All the net proceeds from our equity offerings were contributed to our OP in exchange for OP units. Our operating partnership has primarily used the net proceeds from our issuance of common and preferred stock to acquire single-tenant, freestanding commercial real estate primarily subject to net leases with high credit quality tenants. As of December 31, 2013, we have used the net proceeds from the issuance of common and preferred stock, revolving credit facility, and debt financings to purchase 1,329 properties with an aggregate purchase price of $5.2 billion. We did not use any proceeds from any registered offering during the fourth quarter of 2013.

Item 6. Selected Financial Data. (As Restated)

The following selected financial data should be read in conjunction with the accompanying consolidated financial statements and related notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” below. The Company has restated its consolidated balance sheets as of December 31, 2013 and 2012 and its consolidated statements of operations, consolidated statements of comprehensive loss and consolidated statements of changes in equity for the years ended December 31, 2013 and 2012, along with certain related notes. In addition, the Company has restated its consolidated statement of cash flows for the year ended December 31, 2013. For discussion of the restatement adjustments, see Note 2 — Restatement of Previously Issued Financial Statements to the consolidated financial statements. In addition, on January 3, 2014, we acquired ARCT IV, and together, we were considered to be entities under common control because the entities’ advisors were wholly-owned subsidiaries of ARC. Accordingly, the financial statements have been recast in applying the carryover basis of accounting to include ARCT IV from the earliest period of common control. See Note 1 — Organization for further explanation.

 

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Balance sheet data (amounts in thousands):

 

     December 31,  
     2013
(As Restated)
     2012
(As Restated)
     2011      2010  

Total real estate investments, at cost

   $ 7,459,142       $ 1,875,615       $ 209,326       $ —     

Total assets

   $ 7,809,083       $ 2,182,195       $ 221,578       $ 279   

Mortgage notes payable, net

   $ 1,301,114       $ 265,118       $ 35,320       $ —     

Senior secured revolving credit facility

   $ —         $ 124,604       $ 42,407       $ —     

Senior corporate credit facilities

   $ 1,819,800       $ —         $ —        

Convertible debt, net

   $ 972,490       $ —         $ —         $ —     

Other debt

   $ 104,804       $ —            $ —     

Due to affiliates

   $ 103,434       $ 1,522       $ —         $ —     

Total liabilities

   $ 5,310,556       $ 513,435       $ 80,790       $ 279   

Total equity

   $ 2,229,228       $ 1,668,760       $ 140,788       $ —     

Operating data, cash flow data and per share data (amounts in thousands except share and per share data):

 

     Year ended December 31,      Period from December 2,
2010 (Date of Inception)

to December 31, 2010
 
     2013
(As Restated)
     2012
(As Restated)
     2011     

Operating data:

           

Total revenues

   $ 329,323       $ 67,207       $ 3,970       $ —     

Acquisition related

   $ 76,113       $ 45,070       $ 3,898       $ —     

Merger and other non-routine transactions

   $ 210,543       $ 2,603       $ —         $ —     

Property operating

   $ 23,616       $ 3,522       $ 220       $ —     

Management fees to affiliates

   $ 17,462       $ 212       $ —         $ —     

General and administrative

   $ 123,172       $ 5,458       $ 749       $ —     

Depreciation and amortization

   $ 210,976       $ 40,957       $ 2,097       $ —     

Operating loss

   $ (335,905    $ (30,615    $ (2,994    $ —     

Interest expense

   $ (105,548    $ (11,856    $ (960    $ —     

Loss on derivative instruments, net

   $ (67,946    $ —         $ (2   

Loss from continuing operations

   $ (507,781    $ (41,492    $ (3,952    $ —     

Net loss attributable to non-controlling interests

   $ 16,316       $ 585       $ 105       $ —     

Net loss attributable to stockholders

   $ (491,499    $ (41,652    $ (4,699    $ —     

Cash flow data: (2)

           

Net cash flows provided (used in) by operating activities

   $ 11,918       $ 9,440       $ (257    $ —     

Net cash flows used in investing activities

   $ (4,541,718    $ (1,701,422    $ (89,981    $ —     

Net cash flows provided by financing activities

   $ 4,289,950       $ 1,965,226       $ 109,569       $ —     

Per share data:

           

Basic net income (loss) per share from continuing operations attributable to stockholders

   $ (2.41    $ (0.40    $ (1.04    $ —     

Diluted net income (loss) per share attributable to stockholders

   $ (2.41    $ (0.41    $ (1.26    $ —     

Annualized distributions declared per common share

   $ 0.91       $ 0.89       $ 0.88       $ —     

Weighted-average number of common shares outstanding (1)

     205,341,431         103,306,366         3,720,351         —     

 

(1) For the years ended December 31, 2013, 2012, 2011 and the period ended December 31, 2010, the effect of certain OP Units outstanding, LTIP Units, unvested restricted shares and convertible preferred shares were excluded from the weighted-average share calculation as the effect would be anti-dilutive.
(2) Cash Flow data has been restated for only the year ended December 31, 2013

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. (Certain Sections Restated or Corrected)

The following discussion and analysis should be read in conjunction with the accompanying financial statements of American Realty Capital Properties, Inc. (the “Company” or “ARCP”) 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, to ARC Properties Operating Partnership, L.P. (the “OP”), a Delaware limited partnership and its subsidiaries. As of December 31, 2013, ARCP was still externally managed by ARC Properties Advisors, LLC (our “Former Manager”), a Delaware limited liability company and a wholly owned subsidiary of AR Capital, LLC (“ARC”).

Restatement and Recast

As discussed in the Explanatory Note to this Form 10-K/A and Note 2 — Restatement of Previously Issued Financial Statements to the consolidated financial statements, we are restating our consolidated financial statements and related financial information for the years ended December 31, 2013 and 2012. In addition, on January 3, 2014, we acquired ARCT IV, and together we were considered to be entities under common control because the entities’ advisors were wholly-owned subsidiaries of ARC. Accordingly, the financial statements have been recast in applying the carryover basis of accounting to include ARCT IV. See Note 1 —Organization to the consolidated financial statements for further explanation. The following discussion and analysis of our financial condition and results of operations is based on the restated and recasted amounts. Further, certain events occurred subsequent to December 31, 2013 through the filing date of this Form 10-K/A. Refer to Note 24 — Subsequent Events (As Restated) to the consolidated financial statements for further explanation.

Overview

We were incorporated on December 2, 2010, as a Maryland corporation that qualified as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning in the 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.”

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 (i) credit tenants, which are generally large public companies with investment-grade ratings and other creditworthy tenants and (ii) governmental, quasi-governmental and not-for-profit entities. Our long-term business strategy is 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 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. See Note 3 — Mergers and Acquisitions to the consolidated financial statements for further discussion.

Substantially all of our business is conducted through our OP. We are the sole general partner and holder of 96.1% of the equity interest in the OP as of December 31, 2013. Certain affiliates of ours and certain unaffiliated investors are limited partners and owners of 3.3% and 0.6%, respectively, of the equity interest in our OP. After holding units of limited partner interests in our OP (“OP Units”) for a period of one year, holders of OP Units have the right to convert limited partner interests in the OP for the cash value of a corresponding number of shares of our common stock or, at the option of our OP, a corresponding number of shares of our common stock, as allowed by the limited partnership agreement of our OP. The remaining rights of the holders of OP Units are limited, however, and do not include the ability to replace the general partner or to approve the sale, purchase or refinancing of our OP’s assets.

 

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During the year ended December 31, 2013, we retained our Former Manager to manage our affairs on a day-to-day basis and, as a result, were generally externally managed, 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 was 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 and entered into employment and incentive compensation arrangements with our executives. The Former Manager agreed to sell us certain assets. See Note 19 — Related Party Transactions and Arrangements (As Restated) and Note 24 — Subsequent Events (As Restated) to the consolidated financial statements for further discussion.

As of December 31, 2013, excluding one vacant property classified as held for sale, we owned 2,559 properties consisting of 43.8 million square feet that were 99% leased with a weighted-average remaining lease term of 9.4 years. In constructing our portfolio, we are committed to diversification (industry, tenant and geography). As of December 31, 2013, rental revenues derived from investment grade tenants and tenants affiliated with investment grade entities, as determined by major credit rating agencies, approximated 60% (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 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 the ARCT III Merger Agreement with 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 was consummated on February 28, 2013.

Pursuant to the terms and subject to the conditions set forth in the ARCT III Merger Agreement, each outstanding share of common stock of ARCT III, including restricted shares which became vested, was converted into the right to receive (i) 0.95 of a share of our common stock, or (ii) $12.00 in cash. In addition, each outstanding unit of equity ownership of the ARCT III OP was converted into the right to receive 0.95 of the same class of unit of equity ownership in our OP.

Upon the closing of the ARCT III Merger, on February 28, 2013, 29.2 million shares, or 16.5% of the then outstanding shares of ARCT III’s common stock were received in cash consideration at $12.00 per share, which is equivalent to 27.7 million shares of our common stock based on the ARCT III Exchange Ratio. In addition, 148.1 million shares of ARCT III’s common stock were converted to shares of our common stock at the Exchange Ratio, resulting in an additional 140.7 million shares of our common stock outstanding after the exchange.

Upon the consummation of the ARCT III Merger, American Realty Capital Trust III Special Limited Partner, LLC, the holder of the special limited partner interest in the ARCT III OP, was entitled to subordinated distributions of net sales proceeds from ARCT III OP which resulted in the issuance of units of limited partner interests in the ARCT III OP, when after applying the Exchange Ratio, resulted in the issuance of an additional 7.3 million OP Units to affiliates of our Former Manager. The parties had agreed that such OP Units would be subject to a minimum one-year holding period before being exchangeable into our common stock.

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 (As Restated).

 

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Accounting Treatment of the ARCT III Merger

We and ARCT III, from inception to the ARCT III Merger date, were considered to be entities under common control. Both entities’ advisors were wholly owned subsidiaries of ARC. ARC and its related parties had significant ownership interests in us and had significant ownership of ARCT III through the ownership of shares of common stock and other equity interests. In addition, the advisors of both entities were contractually eligible to charge potential fees for their services to both of the companies including asset management fees, incentive fees and other fees and continue to charge fees to us. Due to the significance of these fees, the advisors and ultimately ARC was determined to have a significant economic interest in both companies in addition to having the power to direct the significant activities of the companies through advisory/management agreements, which qualified them as affiliated companies under common control in accordance with U.S. GAAP. The acquisition of an entity under common control is accounted for on the carryover basis of accounting whereby the assets and liabilities of the companies are recorded upon the merger on the same basis as they were carried by the companies on the ARCT III Merger date. In addition, U.S. GAAP requires us to present historical financial information as if the merger had occurred as of the earliest period of common control. Therefore, the accompanying financial statements including the notes thereto are presented as if the ARCT III Merger had occurred at inception.

GE Capital Portfolio Acquisition

On June 27, 2013, we, through subsidiaries of the OP, acquired, from certain affiliates of GE Capital Corp., the equity interests in the entities that own a real estate portfolio comprised of 447 properties, (the “GE Capital Portfolio”) for a purchase price of $773.9 million exclusive of closing costs. The 447 properties are subject to 409 property operating leases, as well as 38 direct financing leases.

During the year ended December 31, 2013, ARCT IV acquired, from certain affiliates of GE Capital Corp., the equity interests in the entities that own a real estate portfolio comprised of 924 properties (the “ARCT IV GE Capital Portfolio”) for a purchase price of $1.4 billion, exclusive of closing costs, with no liabilities assumed. The 924 properties are subject to 912 property operating leases, as well as 12 direct financing leases.

CapLease, Inc. Merger

On May 28, 2013, we entered into an Agreement and Plan of Merger (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 ours.

On November 5, 2013, we completed the merger with CapLease based on the terms of the CapLease Merger Agreement. Pursuant to the terms set forth in the CapLease Merger Agreement, at the effective time of the CapLease Merger, each outstanding share of common stock of CapLease, other than shares owned by us, CapLease or any of their respective wholly owned subsidiaries, was converted into the right to receive $8.50. Each outstanding share of preferred stock of CapLease, other than shares owned by us, CapLease or any of their respective wholly owned subsidiaries, was converted into the right to receive an amount in cash, equal to the sum of $25.00 plus all accrued and unpaid dividends on such shares of preferred stock. In addition, in connection with the merger of CapLease, LP with and into the OP (the “CapLease Partnership Merger”), each outstanding unit of equity ownership of CapLease’s operating partnership other than units owned by CapLease or any wholly owned subsidiary of CapLease was converted into the right to receive $8.50. Shares of CapLease’s outstanding restricted stock were accelerated and became fully vested, and restricted stock and any outstanding performance shares were fully earned and received $8.50 per share. In total, cash consideration of $920.7 million was paid to the common and preferred stockholders of CapLease.

Accounting Treatment for the CapLease Merger

The CapLease Merger has been accounted for under the acquisition method of accounting under U.S. GAAP. Under the acquisition method of accounting, the assets acquired and liabilities assumed from CapLease have been recorded as of the acquisition date at their respective fair values. Any excess of purchase price over the fair values has been recorded as goodwill. Results of operations for CapLease will be included in our consolidated financial statements from the date of acquisition. See Note 6 — CapLease Acquisition (As Restated).

 

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American Realty Capital Trust IV, Inc. Merger

On July 1, 2013, we entered into 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. We consummated the ARCT IV Merger on January 3, 2014.

Pursuant to the terms of the ARCT IV Merger Agreement, as amended, each outstanding share of common stock of ARCT IV, including unvested restricted shares that vested in conjunction with the ARCT IV Merger, was exchanged for (i) $9.00 in cash, (ii) 0.5190 of a share of the Company’s common stock (the “ARCT IV Exchange Ratio”) and (iii) 0.5937 of a share of a new series of preferred stock of the Company designated as the 6.70% Series F Cumulative Redeemable Preferred Stock (“Series F Preferred Stock”) and each outstanding unit of ARCT IV’s operating partnership (“ARCT IV OP Unit”), other than ARCT IV OP Units held by the American Realty Capital Trust IV Special Limited Partner, LLC, (the “ARCT IV Special Limited Partner”) and American Realty Capital Advisors IV, LLC (the “ARCT IV Advisor”) was exchanged for (i) $9.00 in cash, (ii) 0.5190 of an OP Unit and (iii) 0.5937 of a OP Unit designated as Series F Preferred Units (“Series F OP Units”). In total, the Company paid $651.4 million in cash, issued 36.9 million shares of common stock and 42.2 million shares of Series F Preferred Stock, and issued 0.7 million units of Series F OP units and 0.6 million OP Units to the former ARCT IV shareholders and ARCT IV OP Unit holders in connection with the consummation of the ARCT IV Merger. In addition, each outstanding ARCT IV Class B Unit (as defined below) and each outstanding ARCT IV OP Unit held by the ARCT IV Special Limited Partner and the ARCT IV Advisor was converted into 2.3961 OP Units, resulting in the Company issuing 1.2 million OP Units.

In connection with the ARCT IV Merger and pursuant to the terms of the agreement of limited partnership of ARCT IV’s operating partnership, ARCT IV’s external advisor received subordinated distributions of net sales proceeds in an approximate amount of $63.2 million. Such subordinated distributions of net sales proceeds were paid in the form of equity units of ARCT IV’s operating partnership that were automatically converted into 6.7 million OP Units. Upon the consummation of the ARCT IV Merger, the OP Units had a fair value of $78.2 million and are subject to a minimum two-year holding period from the date of issuance before being exchangeable into our common stock.

Accounting Treatment of the ARCT IV Merger

We and ARCT IV were considered to be entities under common control. Both entities’ advisors are wholly owned subsidiaries of ARC. ARC and its related parties had ownership interests in us and ARCT IV through the ownership of shares of common stock and other equity interests. In addition, the advisors of both entities were contractually eligible to charge potential fees for their services to both of the companies including asset management fees, incentive fees and other fees and will continue to charge fees to us following the ARCT IV Merger. Due to the significance of these fees, the advisors and ultimately ARC were determined to have a significant economic interest in both companies in addition to having the power to direct the activities of the companies through advisory/management agreements, which qualified them as affiliated companies under common control in accordance with U.S. GAAP. The acquisition of an entity under common control is accounted for on the carryover basis of accounting whereby the assets and liabilities of the companies are recorded upon the merger on the same basis as they were carried by the companies on the ARCT IV Merger date. In addition, U.S. GAAP requires us to present historical financial information as if the entities were combined as of the earliest period of common control. Therefore, the accompanying financial statements including the notes thereto are presented as if the ARCT IV Merger had occurred at inception.

 

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Fortress Portfolio Acquisition

On July 24, 2013, ARC and another related entity, on our behalf and certain other entities sponsored directly or indirectly by ARC, entered into a purchase and sale agreement with affiliates of funds managed by Fortress Investment Group LLC (“Fortress”) for the purchase and sale 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 us (the “Fortress Portfolio”). 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. We closed the acquisition of the remaining 79 properties in the Fortress Portfolio on January 8, 2014, 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. During the year ended December 31, 2013, we deposited $72.2 million into escrow in relation to the Fortress Portfolio, which has been included in prepaid expenses and other assets in the consolidated balance sheet as of December 31, 2013.

Cole Real Estate Investments, Inc. Merger

On October 22, 2013, we entered into an agreement and plan of merger (the “Cole Merger Agreement”) with Cole Real Estate Investments, Inc. (“Cole”), a Maryland corporation, and a wholly owned subsidiary of ours. The Cole Merger Agreement provided for the merger of Cole with and into the wholly owned subsidiary (the “Cole Merger”). We consummated the Cole Merger on February 7, 2014 (the “Cole Acquisition Date”).

Pursuant to the terms of the Cole Merger Agreement, each share of common stock of Cole issued and outstanding immediately prior to the effectiveness of the Cole Merger, including unvested restricted stock units (“RSUs”) and performance stock units that vested in conjunction with the Cole Merger was converted into the right to receive either (i) 1.0929 shares of our common stock, par value $0.01 per share, (the “Stock Consideration”) or (ii) $13.82 in cash (the “Cash Consideration” and together with the Stock Consideration, the “Merger Consideration”). Approximately 98% of all outstanding Cole holders received Stock Consideration and approximately 2% of outstanding Cole shares elected to receive Cash Consideration, pursuant to the terms of the Cole Merger Agreement, resulting in the issuance of approximately 520.8 million shares of our common stock and paying $181.8 million to holders of Cole shares based on their elections.

In addition, the Company issued approximately 2.8 million shares of our common stock, in the aggregate, to certain executives of Cole pursuant to letter agreements entered into between us and such individuals concurrently with the execution of the Cole Merger Agreement, as previously disclosed. Additionally, effective as of the Cole Acquisition Date, we issued, but have not yet allocated, 0.4 million shares with dividend equivalent rights commensurate with the our common stock.

We are in the process of gathering certain additional information in order to finalize our assessment of the fair value of the consideration transferred; thus, the fair values of currently recorded assets and liabilities are subject to change. The estimated fair value of the consideration transferred at the Cole Acquisition Date totaled approximately $7.5 billion and consisted of the following (in thousands):

 

     As of Cole Acquisition
Date (Preliminary)
 

Estimated Fair Value of Consideration Transferred:

  

Cash

   $ 181,775   

Common stock

     7,285,868   
  

 

 

 

Total consideration transferred

$ 7,467,643   
  

 

 

 

The fair value of the 520.8 million shares of common stock issued, excluding those common shares transferred to former Cole executives, was determined based on the closing market price of our common stock on the Cole Acquisition Date.

 

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Accounting Treatment for the Cole Merger

The Cole Merger will be accounted for under the acquisition method of accounting under U.S. GAAP. Under the acquisition method of accounting, the assets acquired and liabilities assumed from Cole will be recorded as of the acquisition date at their respective fair values. Any excess of purchase price over the fair values will be recorded as goodwill. Results of operations for Cole will be included in our consolidated financial statements from the date of acquisition.

Inland Portfolio Acquisition

On August 8, 2013, ARC entered into a purchase and sale agreement with Inland American Real Estate Trust, Inc. (“Inland”) for the purchase and sale of the equity interests of 67 companies owned by Inland for an aggregate contract purchase price of $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 (the “Inland Portfolio”) will be acquired, in total, by us from Inland for a purchase price of $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 December 31, 2013, we had closed on five of the 33 properties for a total purchase price of $56.4 million, exclusive of closing costs. We closed the acquisition of 27 additional properties in the Inland Portfolio subsequent to December 31, 2013. We do not consider it probable that we will close on the remaining property.

The operating results for the year ended December 31, 2013 do not include the impact of the Cole Merger and the acquisitions of the Fortress and Inland Portfolios, which closed after December 31, 2013, and do not include the other recent organic acquisitions that were acquired subsequent to December 31, 2013. Accordingly, the operating results in 2013 are not indicative of our future operating results.

Significant Accounting Estimates and Critical Accounting Policies

Set forth below is a summary of the significant accounting estimates and critical accounting policies that management believes are important to the preparation of our financial statements. Certain of our accounting estimates are particularly important for an understanding of our financial position and results of operations and require the application of significant judgment by our management. As a result, these estimates are subject to a degree of uncertainty. These significant accounting estimates include:

Revenue Recognition

Upon the acquisition of real estate, certain properties will have leases where minimum rent payments increase during the term of the lease. We will record rental revenue for the full term of each lease on a straight-line basis. When we acquire a property, the term of existing leases is considered to commence as of the acquisition date for the purposes of this calculation. Cost recoveries from tenants are included in tenant reimbursement income in the period the related costs are incurred, as applicable.

Our revenues, which are derived primarily from rental income, include rents that each tenant pays in accordance with the terms of each lease reported on a straight-line basis over the initial term of the lease. Since many of the leases provide for rental increases at specified intervals, straight-line basis accounting requires us to record a receivable, and include in revenues, unbilled rent receivables that we will only receive if the tenant makes all rent payments required through the expiration of the initial term of the lease. We defer the revenue related to lease payments received from tenants in advance of their due dates.

We continually review receivables related to rent and unbilled rent receivables and determine collectability by taking into consideration 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 in which the property is located. In the event that the collectability of a receivable is in doubt, we will record an increase in the allowance for uncollectible accounts or record a direct write-off of the receivable in the consolidated statements of operations and comprehensive loss. As of December 31, 2013, we recorded an allowance for uncollectible accounts of $187,000. As of December 31, 2012, we determined that no allowance for uncollectible accounts was necessary.

 

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Real Estate Investments

We record acquired real estate at cost and make assessments as to the useful lives of depreciable assets. We consider the period of future benefit of the asset to determine the appropriate useful lives. Depreciation is computed using a straight-line method over the estimated useful life of 40 years for buildings, five to 15 years for building fixtures and improvements and the remaining lease term for acquired intangible lease assets.

Allocation of Purchase Price of Business Combinations and Acquired Assets

In accordance with the guidance for business combinations, we determine whether a transaction or other event is a business combination. If the transaction is determined to be a business combination, we determine if the transaction is considered to be between entities under common control. The acquisition of an entity under common control is accounted for on the carryover basis of accounting whereby the assets and liabilities of the companies are recorded upon the merger on the same basis as they were carried by the companies on the merger date. All other business combinations are accounted for by applying the acquisition method of accounting. Under the acquisition method, we recognize the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquired entity. In addition, we evaluate the existence of goodwill or a gain from a bargain purchase. We will immediately expense acquisition-related costs and fees associated with business combinations and asset acquisitions.

We allocate the purchase price of acquired properties and business combinations accounted for under the acquisition method of accounting to tangible and identifiable intangible assets acquired based on their respective fair values to tangible and identifiable intangible assets acquired based on their respective fair values. Tangible assets include land, buildings, equipment and tenant improvements on an as-if vacant basis. We utilize various estimates, processes and information to determine the as-if vacant property value. Estimates of value are made using customary methods, including data from appraisals, comparable sales, discounted cash flow analysis and other methods. Identifiable intangible assets include amounts allocated to acquired leases for above-market and below-market lease rates and the value of in-place leases.

Amounts allocated to land, buildings, equipment and fixtures are based on cost segregation studies performed by independent third-parties or on our analysis of comparable properties in our portfolio.

The aggregate value of intangible assets related to in-place leases is primarily the difference between the property valued with existing in-place leases adjusted to market rental rates and the property valued as if vacant. Factors considered by us in our analysis of the in-place lease intangibles include an estimate of carrying costs during the expected lease-up period for each property, taking into account current market conditions and costs to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up period, which typically ranges from six to 18 months. We also estimate costs to execute similar leases including leasing commissions, legal and other related expenses.

Above-market and below-market in-place lease values for owned properties are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between the contractual amounts to be paid pursuant to the in-place leases and management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease, including any bargain option renewal periods. The capitalized above-market lease intangibles are amortized as a decrease to rental income over the remaining term of the lease. The capitalized below-market lease values are amortized as an increase to rental income over the remaining term, including any bargain option renewal periods. In determining the amortization period for below-market lease intangibles, we initially will consider, and periodically evaluate on a quarterly basis, the likelihood that a lessee will execute the renewal option. The likelihood that a lessee will execute the renewal option is determined by taking into consideration 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 in which the property is located.

The fair value of investments and debt are valued using techniques consistent with those disclosed in Note 10 — Fair Value of Financial Instruments (As Restated), depending on the nature of the investment or debt. The fair value of all other assumed assets and liabilities based on the best information available.

 

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The value of in-place leases is amortized to expense over the initial term of the respective leases, which range primarily from two to 20 years. If a tenant terminates its lease and the unamortized portion of the in-place lease value is charged to expense.

In making estimates of fair values for purposes of allocating purchase price, we utilize a number of sources, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property and other market data. We also consider information obtained about each property as a result of its pre-acquisition due diligence, as well as subsequent marketing and leasing activities, in estimating the fair value of the tangible and intangible assets acquired and intangible liabilities assumed.

Derivative Instruments

We may use derivative financial instruments to hedge all or a portion of the interest rate risk associated with our borrowings. Certain of the techniques used to hedge exposure to interest rate fluctuations may also be used to protect against declines in the market value of assets that result from general trends in debt markets. The principal objective of such agreements is to minimize the risks and/or costs associated with our operating and financial structure as well as to hedge specific anticipated transactions.

We record all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. We may enter into derivative contracts that are intended to economically hedge certain of our risk, even though hedge accounting does not apply or we elect not to apply hedge accounting.

The accounting for subsequent changes in the fair value of these derivatives depends on whether each has been designed and qualifies for hedge accounting treatment. If we elect not to apply hedge accounting treatment, any changes in the fair value of these derivative instruments is recognized immediately in gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive loss. If the derivative is designated and qualifies for hedge accounting treatment the change in the estimated fair value of the derivative is recorded in other comprehensive income (loss) to the extent that it is effective. Any ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings.

Recently Issued Accounting Pronouncements

Recently issued accounting pronouncements are described in Note 4 — Summary of Significant Accounting Policies (As Restated).

Results of Operations (As Restated)

As of December 31, 2013, we owned 2,559 properties with an aggregate original base purchase price of $7.4 billion, excluding one vacant property classified as held for sale. As of December 31, 2013, the 2,559 properties comprised 43.8 million square feet that were 99% leased. As of December 31, 2012, we owned 702 properties with an aggregate original base purchase price of $1.9 billion, excluding one vacant property classified as held for sale. As of December 31, 2012, the 702 properties comprised 15.8 million square feet that were 100% leased. Accordingly, our results of operations for the year ended December 31, 2013 as compared to the year ended December 31, 2012 reflect significant increases in most categories.

 

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Comparison of the Year Ended December 31, 2013 to the Year Ended December 31, 2012

Rental Income

Rental income increased $245.2 million to $310.5 million for the year ended December 31, 2013 compared to $65.3 million for the year ended December 31, 2012. Rental income was driven by our acquisition of 1,807 properties, which excludes 50 properties that are accounted for as direct financing leases, acquired during the year ended December 31, 2013 for an aggregate purchase price of $5.5 billion. The annualized rental income per square foot of the properties at December 31, 2013 was $12.66 with a weighted-average remaining lease term of 9.4 years, compared to $9.59 per square foot at December 31, 2012.

Our properties are generally leased from two to twenty years and 60% are leased to investment grade tenants and affiliates of investment grade tenants, as determined by major credit rating agencies. Cash same store rents on the 129 properties held for the full period in each of the years ended December 31, 2013 and 2012 increased $0.2 million, or 1.3%, to $16.2 million compared to $16.0 million for the years ended December 31, 2013 and 2012, respectively. Same store annualized average rental income per square foot was $11.37 at December 31, 2013 compared to $11.23 at December 31, 2012.

Direct Financing Lease Income

Direct financing lease income of $2.2 million was recognized for the year ended December 31, 2013. Direct financing lease income was primarily driven by our 2013 acquisition of 50 properties comprised of $66.1 million of net investments subject to direct financing leases during the year ended December 31, 2013.

Operating Expense Reimbursements

Operating expense reimbursements increased by $14.7 million to $16.6 million for the year ended December 31, 2013 compared to $1.9 million for the year ended December 31, 2012. Operating expense reimbursements represent reimbursements for taxes, property maintenance and other charges contractually due from tenants per their respective leases. Operating expense reimbursements were driven by our acquisition of 1,807 properties since December 31, 2012.

Acquisition Related Expenses

Acquisition related costs increased by $31.0 million to $76.1 million for the year ended December 31, 2013 compared to $45.1 million for the year ended December 31, 2012. Acquisition expenses mainly consisted of acquisition fees, legal costs, deed transfer costs and other costs related to real estate purchase transactions. The increase is driven by our acquisition of 1,807 properties during the year ended December 31, 2013 compared to 573 during the year ended December 31, 2012. This increase was offset by the agreement with our Former Manager in conjunction with the ARCT III Merger, where it was agreed that our Former Manager would no longer charge acquisition fees. Subsequent to December 31, 2013, the management agreement was terminated as a result of our transition to self-management. See Note 24 — Subsequent Events (As Restated) for further discussion.

Merger and Other Non-routine Transactions

Expenses related to various mergers, as well as other non-routine transaction expenses, increased by $207.9 million to $210.5 million for the year ended December 31, 2013 compared to $2.6 million for the year ended December 31, 2012. Upon the consummation of the ARCT III Merger, an affiliate of ARCT III received a subordinated incentive distribution upon the attainment of certain performance hurdles. For the year ended December 31, 2013, $98.4 million was recorded for this fee, which was settled in 7.3 million OP Units issued to the affiliate. During the year ended December 31, 2013, the Company incurred $62.3 million of strategic advisory services, $16.0 million of legal fees and $8.9 million of transfer taxes relating to the various mergers and acquisitions. In addition, merger and other non-routine transaction related expenses for the year ended December 31, 2013 included $24.9 million in post-transaction support fees, printing fees, proxy services and other costs associated with entering into and completing the various mergers and acquisitions. During the year ended December 31, 2012, the $2.6 million of merger and other non-routine transaction related expenses consisted of legal fees related to the merger with ARCT III announced in December 2012. See Note 4 — Summary of Significant Accounting Policies (As Restated) for a breakdown of costs.

 

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The Audit Committee’s investigation identified certain payments made by us to the Former Manager and its affiliates that were not sufficiently documented or that otherwise warrant scrutiny. The Company is considering whether it has a right to seek recovery for any other such payments and, if so, its alternatives for seeking recovery. No asset has been recognized in the financial statements related to any potential recovery. See Note 19 — Related Party Transactions and Arrangements (As Restated) for further discussion.

Property Operating Expenses

Property expenses increased by $20.1 million to $23.6 million for the year ended December 31, 2013 compared to $3.5 million for the year ended December 31, 2012. These costs relate to expenses associated with maintaining certain properties, including real estate taxes, ground lease rent, insurance and repairs and maintenance expenses. The increase in property expenses are primarily due to our acquisition of properties with modified gross leases subsequent to December 31, 2012, and an increased number of properties for which we pay expenses, which are reimbursed by the tenant.

Management Fees to Affiliates

Prior to the consummation of the ARCT III Merger, we paid our Former Manager an annual base management fee equal to 0.50% per annum of the average unadjusted book value of our real estate assets, calculated and payable monthly in advance, provided that the full amount of the distributions we have declared for the six immediately preceding months is equal to or greater than certain net income thresholds related to our operations. Subsequent to the consummation of the ARCT III Merger, we paid our Former Manager an annual base management fee equal to 0.50% per annum for up to $3.0 billion of unadjusted book value of assets and 0.40% of unadjusted book value of assets greater than $3.0 billion. For the years ended December 31, 2013 and 2012, our Former Manager waived base management fees earned of $6.1 million and $1.8 million, respectively.

We may have been required to pay our Former Manager a quarterly incentive fee, equal to the difference between (1) the product of (a) 20% and (b) the excess of our annualized core earnings (as defined in the management agreement with our Former Manager) over the product of (i) the weighted-average number of shares multiplied by the weighted-average issuance price per share of common stock (ii) 8% and (2) the sum of any incentive compensation paid to the our Former Manager with respect to the first three calendar quarters of the previous 12-month period. One half of each quarterly installment of the incentive fee may have been payable in shares of common stock. The remainder of the incentive fee may have been payable in cash. No incentive fees were earned for the years ended December 31, 2013 and 2012, respectively. Subsequent to December 31, 2013, the management agreement was terminated as a result of our transition to self-management. See Note 24 — Subsequent Events (As Restated) for further discussion.

Management fees to affiliates increased by $17.3 million to $17.5 million for the year ended December 31, 2013 compared to $0.2 million for the year ended December 31, 2012. Of the $17.3 million, $5.0 million related to base management fees, $11.7 million related to ARCT III asset management fees settled in OP Units upon the closing of the ARCT III Merger and for services performed during a 60-day period following the ARCT III Merger and $0.8 million related to property management services. For the year ended December 31, 2012, the Former Manager waived all but $0.2 million of base management fees.

General and Administrative Expenses

General and administrative expenses increased by $117.7 million to $123.2 million for the year ended December 31, 2013 compared to $5.5 million for the year ended December 31, 2012. General and administrative expenses increased as a result of higher professional fees, such as legal fees, accountant fees and financial printer services fees, insurance expense, salary-related expenses and board member compensation to support our increased real estate portfolio.

Also, included in general and administrative expenses is equity-based compensation expense, which increased by $99.1 million to $100.3 million for the year ended December 31, 2013 compared to $1.2 million for the year ended December 31, 2012. Equity-based compensation expenses for the current year primarily included expenses for the OPP, which was entered into upon consummation of the ARCT III Merger, as well as the amortization of restricted stock. During the year ended December 31, 2013, we recorded equity-based compensation of $92.3 million for the OPP, of which $59.6 million related to accelerating the vesting of OP units in relation to our transition to self-management and $32.7 million of the expense was locked in based on OPP provisions. During the year ended December 31, 2012, equity-based compensation expense related only to the amortization of restricted stock.

 

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Depreciation and Amortization Expense

Depreciation and amortization expense increased by $170.0 million to $211.0 million for the year ended December 31, 2013 compared to $41.0 million for the year ended December 31, 2012. The increase in depreciation and amortization expense was driven by our acquisition of 1,807 properties since December 31, 2012 for an aggregate purchase price of $3.5 billion.

Impairment of Real Estate

For the year ended December 31, 2013, we recorded an impairment loss of $3.3 million. No impairments were recorded for the year ended December 31, 2012. After reviewing our portfolio for impairment indicators, we performed a recoverability test as of the dates on which the indicators existed. Certain properties failed the recoverability test, as such a fair value analysis was performed to determine the amount of impairment. An impairment loss was calculated based on the difference between the carrying amount of each property and the estimated fair value of each property as of the respective measurement dates.

Interest Expense

Interest expense increased by $93.6 million to $105.5 million for the year ended December 31, 2013 compared to $11.9 million for the year ended December 31, 2012. The increase in interest expense was due to increases in debt balances used to fund portfolio acquisitions, partially offset by a decrease in the weighted-average annualized interest rate on borrowings. The weighted-average debt balances for the years ended December 31, 2013 and 2012 were $1.8 billion and $205.1 million, respectively. The weighted-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 years ended December 31, 2013 and 2012 was 3.40% and 4.16%, respectively.

Our interest expense in future periods will vary based on our level of future borrowings, which will depend on the level of proceeds raised in offerings, our credit rating, the cost of borrowings, and the opportunity to acquire real estate assets which meet our investment objectives.

Other Income, Net

Other income increased by $2.8 million to $3.8 million for the year ended December 31, 2013 compared to other income of $1.0 million for the year ended December 31, 2012. The increase is primarily related to income earned on investments in redeemable preferred stock, senior notes and common stock, all of which were sold as of December 31, 2013, and investment income on certain assets acquired from CapLease during the fourth quarter of the year ended December 31, 2013.

Loss on Derivative Instruments, Net

Loss on the fair value of derivative instruments for the year ended December 31, 2013 was $67.9 million, which primarily consisted of a loss on contingent value rights. The loss pertains to the fair value of our obligation to pay certain preferred and common stockholders 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 by the contingent value rights agreement. The obligations were settled in full during the year ended December 31, 2013. The loss was partially offset by a gain on derivative instruments resulting from marking our derivative instruments to fair value. No gain or loss on derivative instruments was recorded during the year ended December 31, 2012.

Loss on Sale of Investment in Affiliates

Loss on sale of investment in affiliates for the year ended December 31, 2013 was $0.4 million resulting from the sale of our investment in a real estate fund sponsored by ARC purchased during the year ended December 31, 2013. No loss on the sale of investment in such funds was recorded during the year ended December 31, 2012.

 

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Loss on Sale of Investments

Loss on sale of investment securities, net for the year ended December 31, 2013 of $1.8 million primarily related to a $2.3 million loss on the sale of investments in redeemable preferred stock, senior notes and common stock, all of which were purchased in 2013 and sold as of December 31, 2013, partially offset by a $0.5 million gain on sale of investments in redeemable preferred stock, all of which were purchased in 2012 and sold as of December 31, 2013. The Company did not sell any investment securities during the year ended December 31, 2012.

Net Loss from Discontinued Operations

Net loss from discontinued operations decreased by $0.7 million to a net loss of approximately $34,000 for the year ended December 31, 2013 compared to a net loss of $0.7 million for the year ended December 31, 2012. As of December 31, 2013 and 2012, we classified one property as held for sale on the consolidated balance sheets and reported in discontinued operations on the consolidated statements of operations and comprehensive loss. The net losses from discontinued operations during each year were primarily due to impairment on the held for sale property representing the difference between the carrying value and estimated proceeds from the sale of the property less estimated selling costs.

Comparison of the Year Ended December 31, 2012 to Year Ended December 31, 2011

Rental Income

Rental income increased by $61.5 million to $65.3 million for the year ended December 31, 2012 compared to $3.8 million for the year ended December 31, 2011. Rental income was driven by our acquisition of 573 properties during the year ended December 31, 2012 for an aggregate purchase price of $1.7 billion, as well as revenue for a full year from the 129 properties held as of December 31, 2011. The annualized rental income per square foot of the properties at December 31, 2012 was $9.59 with a weighted-average remaining lease term of 10.4 years, compared to $11.59 per square foot at December 31, 2011. There were no properties held for sale for the full period in each of the years ended December 31, 2012 and 2011.

Operating Expense Reimbursements

Operating expense reimbursements increased by $1.7 million to $1.9 million for the year ended December 31, 2012 compared to $0.2 million for the year ended December 31, 2011. Operating expense reimbursements represent reimbursements for taxes, property maintenance and other charges contractually due from tenants per their respective leases. Operating expense reimbursements were driven by our acquisition of 573 properties during the year ended December 31, 2012 as well as reimbursements for a full year from the 129 properties held as of December 31, 2011.

Acquisition Related Expenses

Acquisition related expenses increased by $41.2 million to $45.1 million for the year ended December 31, 2012 compared to $3.9 million for the year ended December 31, 2011. The increase is driven by our acquisition of 573 properties during the year ended December 31, 2012 compared to 69 during the year ended December 31, 2011. Acquisition and related costs represent the costs related to the acquisition of properties. Acquisition costs mainly consisted of legal costs, deed transfer costs and other costs related to real estate purchase transactions.

Merger and Other Non-routine Transaction Expenses

During the year ended December 31, 2012, expenses related to the merger with ARCT III announced in December 2012 and other transaction costs were $2.6 million. These costs primarily consisted of legal fees, accountant fees and other costs associated with entering into the ARCT III merger agreement. There were no such merger expenses incurred during the year ended December 31, 2011.

Property Expenses

Property expenses increased by $3.3 million to $3.5 million for the year ended December 31, 2012 compared to $0.2 million for the year ended December 31, 2011. These expenses relate to costs associated with maintaining certain properties, including real estate taxes, ground lease rent, insurance and repairs and maintenance expenses. The increase in property expenses is mainly due to our acquisition of properties with modified gross leases during the year ended December 31, 2012 and an increased number of properties for which we pay expenses, which are reimbursed by the tenant.

 

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Management Fees to Affiliates

We paid our Former Manager an annual base management fee equal to 0.50% per annum of the average unadjusted book value of our real estate assets, calculated and payable monthly in advance, provided that the full amount of the distributions we have declared for the six immediately preceding months is equal to or greater than certain net income thresholds related to our operations. Our Former Manager waived such portion of its management fee in excess of such thresholds. For the years ended December 31, 2012 and 2011, our Former Manager waived base management fees earned of $1.8 million and $0.3 million, respectively.

We were required to pay our Former Manager a quarterly incentive fee, calculated based on 20% of the excess our annualized core earnings (as defined in the management agreement with our Former Manager) over the weighted-average number of shares multiplied by the weighted-average price per share of common stock. One half of each quarterly installment of the incentive fee would be payable in shares of common stock. The remainder of the incentive fee would be payable in cash. No incentive fees were earned for the years ended December 31, 2012 and 2011, respectively.

Management fees to affiliates were $0.2 million for the year ended December 31, 2012, compared to no such fees for the year ended December 31, 2011, which was the result of decisions by the Former Manager to not waive base management fees of $0.2 million in 2012 whereas the Former Manager waived all fees in 2011.

General and Administrative Expenses

General and administrative expenses increased by $4.8 million to $5.5 million for the year ended December 31, 2012 compared to $0.7 million for the year ended December 31, 2011. General and administrative expenses increased primarily as a result of higher professional fees, such as legal fees, accountant fees and financial printer services fees, insurance expense and board member compensation to support our increased real estate portfolio.

Depreciation and Amortization Expense

Depreciation and amortization expense increased by $38.9 million to $41.0 million for the year ended December 31, 2012 compared to $2.1 million for the year ended December 31, 2011. The increase in depreciation and amortization expense was driven by our acquisition of 573 properties during the year ended December 31, 2012 for an aggregate purchase price of $1.7 billion as well as depreciation and amortization expense for a full year from the 129 properties held as of December 31, 2011.

Interest Expense

Interest expense increased by $10.9 million to $11.9 million for the year ended December 31, 2012 compared to $1.0 million for the year ended December 31, 2011. The increase primarily related to the increase in debt balances used to fund portfolio acquisitions as the outstanding balance on our senior secured revolving credit facility increased by $82.2 million during the year ended December 31, 2012. Interest expense also related to outstanding mortgage notes payable, which increased $229.8 million during the year ended December 31, 2012, partially offset by a slightly lower weighted-average effective interest rate during 2012 as compared to 2011.

Our interest expense in future periods will vary based on our level of future borrowings, which will depend on the level of proceeds raised in offerings, our credit ratings, the cost of borrowings, and the opportunity to acquire real estate assets which meet our investment objectives.

Other Income, Net

Other income increased by $1.0 million to $1.0 million for the year ended December 31, 2012 compared to approximately $4,000 for the year ended December 31, 2011. The increase was primarily due to income on investment securities purchased during the year ended December 31, 2012.

 

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Net Loss from Discontinued Operations

Net loss from discontinued operations decreased by $0.2 million to $0.7 million for the year ended December 31, 2012 compared to $0.9 million for the year ended December 31, 2011. As of the year ended December 31, 2012 and 2011, we had one and two vacant properties, respectively, classified as held for sale on the consolidated balance sheets and reported in discontinued operations on the consolidated statements of operations and comprehensive loss. The net losses from discontinued operations during each year were primarily due to impairments on the held for sale properties representing the difference between the carrying value and estimated proceeds from the sale of the properties less estimated selling costs. On July 3, 2012, one of the properties was sold for $0.6 million of net proceeds.

Cash Flows for the Year Ended December 31, 2013 (As Restated)

During the year ended December 31, 2013, net cash provided by operating activities was $11.9 million. The level of cash flows used in or provided by operating activities is affected by acquisition and transaction costs, the timing of interest payments, as well as the receipt of scheduled rent payments. Cash flows provided by operating activities during the year ended December 31, 2013 included adjusted net loss of 43.9 million (net loss of $507.8 million adjusted for non-cash items, the most significant of which were depreciation and amortization expense, the issuance of operating partnership units, equity-based compensation, and the loss on extinguishment of Series C Stock, which totaled to $446.3 million, in the aggregate). In addition, we incurred a one-time expense related to the loss in the extinguishment of Series C Convertible Preferred Stock (“Series C Stock”) of $13.7 million. Cash inflows included an increase in accounts payable and accrued expenses of $20.8 million and an increase in deferred rent and other liabilities of $8.6 million, partially offset by an increase in prepaid and other assets of $19.9 million.

Net cash used in investing activities for the year ended December 31, 2013 of $4.5 billion primarily related to the investment in real estate assets and the CapLease Merger of $4.4 billion, deposits for real estate investments of $101.9 million, the purchase of investment securities of $81.6 million and investments in direct financing leases of $68.6 million, partially offset by the proceeds from the sales of investment securities of $119.5 million.

Net cash provided by financing activities was $4.3 billion during the year ended December 31, 2013. This was primarily driven by the issuance of stock and debt during the year, most notably $2.0 billion of proceeds net of offering-related costs from the issuance of common stock, $1.7 billion of proceeds, net of repayments, from our credit facilities, $967.8 million of proceeds from the issuance of convertible debt and $288.0 million of proceeds from the issuance of Series D Preferred Stock and $30.9 million of contributions from non-controlling interest holders. These inflows were partially offset by cash outflows, the most significant of which were common stock repurchases of $359.2 million, total distributions paid of $243.1 million, payments of deferred financing costs of $101.2 million and payments on mortgage notes and other debt of $15.1 million.

Cash Flows for the Year Ended December 31, 2012

During the year ended December 31, 2012, net cash provided by operating activities was $9.4 million. The level of cash flows used in or provided by operating activities is affected by acquisition and transaction costs, the timing of interest payments, as well as the receipt of scheduled rent payments. Cash flows provided by operating activities during the year ended December 31, 2012 was primarily due to an increase in adjusted net income of $2.7 million (net loss of $42.2 million adjusted for non-cash items, the most significant of which were depreciation and amortization expense and equity-based compensation, which totaled $44.4 million, in the aggregate). Cash inflows included an increase in accounts payable and accrued expenses of $8.3 million and in increase in deferred rent and other liabilities of $3.5 million, partially offset by an increase in prepaid and other assets of $5.1 million.

Net cash used in investing activities for the year ended December 31, 2012 was $1.7 billion, primarily related to an increase in investment in real estate assets paid for with cash of $1.7 billion and the purchase of investment securities of $41.7 million.

Net cash provided by financing activities of $2.0 billion during the year ended December 31, 2012 primarily related to cash inflows from the issuances of stock and debt, most notably $1.7 billion of proceeds net of offering-related costs from the issuance of common and preferred stock, $229.8 million of proceeds from mortgage notes payable and $82.2 million of proceeds from our senior secured revolving credit facility. These inflows were partially offset by cash outflows, most notably by total distributions paid of $38.3 million and payments related to deferred financing costs of $14.0 million.

 

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Liquidity and Capital Resources

In the normal course of business, our principal demands for funds will continue to be for property acquisitions, either directly or through investment interests, for the payment of operating expenses, distributions to our investors and for the payment of principal and interest on our outstanding indebtedness. We expect to meet our future short-term operating liquidity requirements through net cash provided by our current property operations. Management expects that our properties will generate sufficient cash flow to cover all operating expenses and the payment of a monthly distribution. The majority of our net leases contain contractual rent escalations during the primary term of the lease. Other potential future sources of capital include proceeds from secured or unsecured financings from banks or other lenders, proceeds from offerings, including our ATM program, proceeds from the sale of properties and undistributed funds from operations. With the stabilization of the investment portfolio, we expect to significantly increase the amount of cash flow generated from operating activities in future periods. Such increased cash flow will positively impact the amount of funds available for dividends.

As of December 31, 2013, we had $52.7 million of cash and cash equivalents.

Sources of Funds

Funds from Operations and Adjusted Funds from Operations (As Corrected)

Due to certain unique operating characteristics of real estate companies, as discussed below, the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”), an industry trade group, has promulgated a measure known as funds from operations (“FFO”), which we believe to be an appropriate supplemental measure to reflect the operating performance of a REIT. The use of FFO is recommended by the REIT industry as a supplemental performance measure. FFO is not equivalent to our net income or loss as determined under U.S. GAAP.

We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004 (the “White Paper”). The White Paper defines FFO as net income or loss computed in accordance with U.S. GAAP, excluding gains or losses from sales of property, depreciation and amortization of real estate assets and impairment write-downs. These adjustments also include the Company’s pro rata share of unconsolidated partnerships and joint ventures. Our FFO calculation complies with NAREIT’s policy described above.

The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time, especially if such assets are not adequately maintained or repaired and renovated as required by relevant circumstances and/or is requested or required by lessees for operational purposes in order to maintain the value disclosed. We believe that, since real estate values historically rise and fall with market conditions, including inflation, interest rates, the business cycle, unemployment and consumer spending, presentations of operating results for a REIT using historical accounting for depreciation may be less informative. Historical accounting for real estate involves the use of U.S. GAAP. Any other method of accounting for real estate such as the fair value method cannot be construed to be any more accurate or relevant than the comparable methodologies of real estate valuation found in U.S. GAAP. Nevertheless, we believe that the use of FFO, which excludes the impact of real estate related depreciation and amortization, provides a more complete understanding of our performance to investors and to management, and when compared year over year, reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income. However, FFO and adjusted funds from operations (“AFFO”), as described below, should not be construed to be more relevant or accurate than the current U.S. GAAP methodology in calculating net income or in its applicability in evaluating our operating performance. The method utilized to evaluate the value and performance of real estate under U.S. GAAP should be construed as a more relevant measure of operational performance and considered more prominently than the non-GAAP FFO and AFFO measures and the adjustments to U.S. GAAP in calculating FFO and AFFO.

 

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We consider FFO and AFFO useful indicators of the performance of a REIT. Because FFO calculations exclude such factors as depreciation and amortization of real estate assets and gains or losses from sales of operating real estate assets (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates), they facilitate comparisons of operating performance between periods and between other REITs in our peer group. Accounting for real estate assets in accordance with U.S. GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves.

Changes in the accounting and reporting promulgations under GAAP (for acquisition fees and expenses from a capitalization/depreciation model to an expensed-as-incurred model) that were put into effect in 2009 and other changes to GAAP accounting for real estate subsequent to the establishment of NAREIT’s definition of FFO have prompted an increase in cash-settled expenses, specifically acquisition fees and expenses for all industries as items that are expensed under GAAP, that are typically accounted for as operating expenses. Management believes these fees and expenses do not affect our overall long-term operating performance. While certain companies may experience significant acquisition activity, other companies may not have significant acquisition activity and management believes that excluding costs such as merger and transaction costs and acquisition related costs from property operating results provides useful information to investors and provides information that improves the comparability of operating results with other companies who do not have significant merger or acquisition activities. AFFO is not equivalent to our net income or loss as determined under GAAP, and AFFO may not be a useful measure of the impact of long-term operating performance if we continue to have such activities in the future.

We exclude certain income or expense items from AFFO that we consider more reflective of investing activities, other non-cash income and expense items and the income and expense effects of other activities that are not a fundamental attribute of our business plan. These items include unrealized gains and losses, which may not ultimately be realized, such as gains or losses on derivative instruments, gains and losses on investments and early extinguishment of debt. In addition, by excluding non-cash income and expense items such as amortization of above and below market leases, amortization of deferred financing costs, straight-line rent, net direct financing lease adjustments and equity-based compensation from AFFO we believe we provide useful information regarding income and expense items which have no cash impact and do not provide us liquidity or require our capital resources. By providing AFFO, we believe we are presenting useful information that assists investors and analysts to better assess the sustainability of our ongoing operating performance without the impacts of transactions that are not related to the ongoing profitability of our portfolio of properties. We also believe that AFFO is a recognized measure of sustainable operating performance by the REIT industry. Further, we believe AFFO is useful in comparing the sustainability of our operating performance with the sustainability of the operating performance of other real estate companies that are not as involved in activities which are excluded from our calculation. Investors are cautioned that AFFO should only be used to assess the sustainability of our operating performance excluding these activities, as it excludes certain costs that have a negative effect on our operating performance during the periods in which these costs are incurred.

In addition, we exclude certain interest expenses related to securities that are convertible to common stock as the shares are assumed to have converted to common stock in our calculation of weighted-average common shares-fully diluted.

 

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In calculating AFFO, we exclude expenses, which under GAAP are characterized as operating expenses in determining operating net income. These expenses are paid in cash by us, and therefore such funds will not be available to distribute to investors. All paid and accrued merger and acquisition fees and certain other expenses negatively impact our operating performance during the period in which expenses are incurred or properties are acquired and will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of other properties are generated to cover the purchase price of the property and certain other expenses. Therefore, AFFO may not be an accurate indicator of our operating performance, especially during periods in which mergers are being consummated or properties are being acquired or certain other expenses are being incurred. AFFO that excludes such costs and expenses would only be comparable to companies that did not have such activities. Further, under GAAP, certain contemplated non-cash fair value and other non-cash adjustments are considered operating non-cash adjustments to net income in determining cash flow from operating activities. In addition, we view fair value adjustments as items which are unrealized and may not ultimately be realized. We view both gains and losses from fair value adjustments as items which are not reflective of ongoing operations and are therefore typically adjusted for when assessing operating performance. Excluding income and expense items detailed above from our calculation of AFFO provides information consistent with management’s analysis of the operating performance of the properties. Additionally, fair value adjustments, which are based on the impact of current market fluctuations and underlying assessments of general market conditions, but can also result from operational factors such as rental and occupancy rates, may not be directly related or attributable to our current operating performance. By excluding such changes that may reflect anticipated and unrealized gains or losses, we believe AFFO provides useful supplemental information.

As a result, we believe that the use of FFO and AFFO, together with the required U.S. GAAP presentations, provide a more complete understanding of our performance relative to our peers and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities.

FFO and AFFO are non-GAAP financial measures and do not represent net income as defined by U.S. GAAP. FFO and AFFO do not represent cash flows from operations as defined by U.S. GAAP, are not indicative of cash available to fund all cash flow needs and liquidity, including our ability to pay distributions and should not be considered as alternatives to net income, as determined in accordance with U.S. GAAP, for purposes of evaluating our operating performance. Other REITs may not define FFO in accordance with the current NAREIT definition (as we do) or may interpret the current NAREIT definition differently than we do and/or calculate AFFO differently than we do. Consequently, our presentation of FFO and AFFO may not be comparable to other similarly titled measures presented by other REITs.

As discussed in the Explanatory Note to this Form 10-K/A, the investigation conducted by the Audit Committee concluded that the Company erroneously calculated AFFO and/or AFFO per share for the years ended December 31, 2013, 2012 and 2011 due in part to errors in reflecting non-controlling interests. We are now presenting the restated FFO and AFFO using two methods: 1) we calculate FFO and AFFO on a gross basis, whereby we start with net income attributable to both the stockholders and the non-controlling interest holders, and then adjust net income by the gross reported amounts of the items being adjusted (“Gross Method”); and 2) we calculate FFO and AFFO on a net basis, whereby we start with net income attributable only to the stockholders, and adjust net income by only the stockholders’ portion of the applicable items (“Net Method”). For presentation of the Net Method, the company has included the gross amounts of each adjustment on their respective line items and adjusted for the proportionate share which is attributable to non-controlling interest on a separate line item within FFO and AFFO.

The calculation of AFFO per share follows the same logic. Under the Gross Method, AFFO is divided by a share number that takes into account the dilutive effect of units held by the non-controlling interest holders; under the Net Method, AFFO is divided by a share number that reflects only the dilutive effects of common shares. While the two methods generally result in the same per share value, the treatment of certain dilutive securities may result in different per share values under the respective methods.

 

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The tables below reflect the two methods of calculating FFO and AFFO for the years ended December 31, 2013, 2012 and 2011 (in thousands, except share and per share data).

Net Method

 

     Year Ended December 31,  
     2013     2012     2011  
     (As Corrected)     (As Corrected)     (As Corrected)  

Net loss attributable to stockholders

   $ (491,499   $ (41,652   $ (4,699

Loss on disposition of properties a

     —          600        815   

Depreciation and amortization of real estate assets a

     210,976        40,957        2,097   

Impairment of real estate a

     3,346        —          —     

Proportionate share of adjustments for non-controlling interests (1)

     (7,899     (719     (64
  

 

 

   

 

 

   

 

 

 

FFO attributable to stockholders

  (285,076   (814   (1,851

Acquisition related b

  76,113      45,070      3,898   

Merger and other non-routine transactions b

  210,543      2,603      —     

Loss on sale of investment securities b

  2,206      —        —     

Loss on derivative instruments, net b

  67,946      —        2   

Interest on convertible obligation to preferred investors b

  10,802      —        —     

Interest premiums and discounts on debt, net and settlement of convertible obligation to preferred investors b

  12,072      —        —     

Amortization of above- and below-market lease assets and liabilities b

  (178   118      —     

Net direct financing lease adjustments b

  496      —        —     

Amortization and write off of deferred financing costs b

  29,161      1,985      186   

Other amortization and non-cash charges b

  172      46      14   

Straight-line rent b

  (15,272   (2,212   (240

Non-cash equity compensation expense b

  100,261      1,197      191   

Proportionate share of adjustments for non-controlling interests (2)

  (16,830   (622   (89
  

 

 

   

 

 

   

 

 

 

AFFO attributable to stockholders

$ 192,416    $ 47,371    $ 2,111   
  

 

 

   

 

 

   

 

 

 

Weighted-average shares outstanding - basic (3)

  205,341,431      103,306,366      3,720,351   

Effect of dilutive securities

  16,037,245      528,919      61,318   
  

 

 

   

 

 

   

 

 

 

Weighted-average shares outstanding - diluted (4)

  221,378,676      103,835,285      3,781,669   

AFFO attributable to stockholders per diluted share

$ 0.87    $ 0.46    $ 0.56   

 

(1) Includes proportionate share attributable to non-controlling interests of the adjustments denoted with “a”.
(2) Includes proportionate share attributable to non-controlling interests of the adjustments denoted with “b”.
(3) Weighted-average shares for the year ended December 31, 2013 are adjusted as if the acquisition of all outstanding shares of ARCT IV common stock for cash in conjunction with the ARCT IV Merger had been completed at inception.
(4) Weighted-average shares for the year ended December 31, 2013 excludes the effect of the convertible debt as the effect would be antidilutive.

 

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Gross Method

 

     Year Ended December 31,  
     2013     2012     2011  
     (As Corrected)     (As Corrected)     (As Corrected)  

Net loss (in accordance with U.S. GAAP)

   $ (507,815   $ (42,237   $ (4,804

Loss on disposition of properties

     —          600        815   

Depreciation and amortization of real estate assets

     210,976        40,957        2,097   

Impairment of real estate

     3,346        —          —     
  

 

 

   

 

 

   

 

 

 

FFO

  (293,493   (680   (1,892

Acquisition related

  76,113      45,070      3,898   

Merger and other non-routine transactions

  210,543      2,603      —     

Loss on sale of investment securities

  2,206      —        —     

Loss on derivative instruments, net

  67,946      —        2   

Interest on convertible obligation to preferred investors

  10,802      —        —     

Interest premiums and discounts on debt, net and settlement of convertible obligation to preferred investors

  12,072      —        —     

Amortization of above- and below-market lease assets and liabilities

  (178   118      —     

Net direct financing lease adjustments

  496      —        —     

Amortization and write off of deferred financing costs

  29,161      1,985      186   

Other amortization and non-cash charges

  172      46      14   

Straight-line rent

  (15,272   (2,212   (240

Non-cash equity compensation expense

  100,261      1,197      191   
  

 

 

   

 

 

   

 

 

 

AFFO

$ 200,829    $ 48,127    $ 2,159   
  

 

 

   

 

 

   

 

 

 

Weighted-average shares outstanding - basic (1)

  205,341,431      103,306,366      3,720,351   

Dilutive effect of restricted share awards

  25,223,423      1,316,197      160,688   
  

 

 

   

 

 

   

 

 

 

Weighted-average shares outstanding - diluted (2)

  230,564,854      104,622,563      3,881,039   

AFFO per share

$ 0.87    $ 0.46    $ 0.56   

 

(1) Weighted-average shares for the year ended December 31, 2013 are adjusted as if the acquisition of all outstanding shares of ARCT IV common stock for cash in conjunction with the ARCT IV Merger had been completed at inception.
(2) Weighted-average shares for the year ended December 31, 2013 excludes the effect of the convertible debt as the effect would be antidilutive.

 

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The following tables present the combined impact of all changes to the applicable line items in the Company’s previously issued FFO and AFFO presentations using the Net Method for the years ended December 31, 2013, 2012 and 2011 (amounts in thousands):

Net Method

 

    Year Ended December 31, 2013  
    As Previously
Reported (1)
    Methodology
Adjustments (2)
    Error
Corrections (3)
    As Corrected  

Net loss attributable to stockholders

  $ (474,740   $ —        $ (16,759   $ (491,499

(Gain) loss on held for sale properties a

    (14     —          14        —     

Depreciation and amortization a

    211,372        (46 ) (6)      (350     210,976   

Impairment of real estate a

    —          —          3,346        3,346   

Proportionate share of adjustments for non-controlling interests (4)

    —          (7,789     (110     (7,899
 

 

 

   

 

 

   

 

 

   

 

 

 

FFO attributable to stockholders

  (263,382   (7,835   (13,859   (285,076

Acquisition related b

  76,136      —        (23   76,113   

Merger and other non-routine transactions b

  278,319      —        (67,776   210,543   

Loss on sale of investment securities b

  2,206      —        —        2,206   

Loss on derivative instruments, net b

  67,946      —        —        67,946   

Interest on convertible obligation to preferred investors b

  10,802      —        —        10,802   

Interest premiums and discounts on debt, net and settlement of convertible obligations to preferred investors b

  12,072      —        —        12,072   

Amortization of above- and below- market lease assets and liabilities b

  (178   —        —        (178

Net direct financing lease adjustments b

  —        496  (7)    —        496   

Amortization and write off of deferred financing costs b

  26,895      —        2,266      29,161   

Other amortization and non-cash charges b

  —        172  (6)(7)    —        172   

Straight-line rent b

  (15,058   (214 ) (8)    —        (15,272

Non-cash equity compensation expense b

  34,962      —        65,299      100,261   

Operating fees to affiliate b

  5,654      (5,654 ) (9)    —        —     

Proportionate share of adjustments for non-controlling interests (5)

  —        (16,944   114      (16,830
 

 

 

   

 

 

   

 

 

   

 

 

 

AFFO attributable to stockholders

$ 236,374    $ (29,979 $ (13,979 $ 192,416   
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average shares outstanding — diluted

  221,378,676      —        —        221,378,676   

AFFO attributable to the stockholders per share

$ 1.07  (8)  $ (0.14 $ (0.06 $ 0.87   

 

(1) The numbers in this column reflect the recasting of the Company’s historical financial statements to present the effects of the Company’s acquisition of ARCT IV, an entity previously deemed to be under common control with the Company, as if it had been completed at inception, as previously disclosed in the Company’s Current Report on Form 8-K, dated May 20, 2014.
(2) The adjustments in this column reflect the “Net Method” for adjusting for non-controlling interests and certain other methodology adjustments.
(3) The adjustments in this column reflect the restatement. See Note 2 — Restatement of Previously Issued Financial Statements to the consolidated financial statements for further explanation on adjustments.
(4) Includes proportionate share attributable to non-controlling interests of the adjustments denoted with “a”.
(5) Includes proportionate share attributable to non-controlling interests of the adjustments denoted with “b”.
(6) Reclassification between line items to properly show non-real estate related amortization below in AFFO.
(7) In reviewing its AFFO methodology, the Company has determined that it is appropriate to include certain adjustments that were not included in the previously reported AFFO calculation. These adjustments include $496,000 for net direct financing lease adjustments and $126,000 for straight line rent expense.
(8) AFFO per share was not previously reported in the Original Filing although it was has been calculated utilizing the previously reported adjusted funds from operations and weighted average shares of 221,378,676.

 

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(8) The original Filing presented this line item net of the proportionate share for non-controlling interest. A “gross up” adjustment has been made to include the amount attributable to non-controlling interest in order to show all proportionate adjustments for non-controlling interests on one line item called “Proportionate share of adjustments for non-controlling interest.”
(9) In reviewing its AFFO methodology, the Company has determined that it was not appropriate to adjust for operating fees incurred to affiliates as these expenses represent operating expenses that are typical for the industry.

 

     Year Ended December 31, 2012  
     As Previously
Reported (1)
     Methodology
Adjustments (2)
    Error
Corrections (3)
     As Corrected  

Net loss attributable to stockholders

   $ (41,936    $ —        $ 284       $ (41,652

Loss on held for sale properties a

     600         —          —           600   

Depreciation and amortization a

     41,003         (46 ) (6)      —           40,957   

Proportionate share of adjustments for non-controlling interests (4)

     —           (719     —           (719
  

 

 

    

 

 

   

 

 

    

 

 

 

FFO attributable to stockholders

  (333   (765   284      (814

Acquisition related b

  45,070      —        —        45,070   

Merger and other non-routine transactions b

  2,603      —        —        2,603   

Amortization of above- and below- market lease assets and liabilities b

  110      8  (7)    —        118   

Amortization of deferred financing costs b

  1,985      —        —        1,985   

Other amortization and non-cash charges b

  —        46  (6)    —        46   

Straight-line rent b

  (2,165   (47 ) (7)    —        (2,212

Non-cash equity compensation expense b

  1,197      —        —        1,197   

Operating fees to affiliate b

  212      (212 ) (8)    —        —     

Proportionate share of adjustments for non-controlling interests (5)

  —        (622   —        (622
  

 

 

    

 

 

   

 

 

    

 

 

 

AFFO attributable to stockholders

$ 48,679    $ (1,592 $ 284    $ 47,371   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) The numbers in this column reflect the recasting of the Company’s historical financial statements to present the effects of the Company’s acquisition of ARCT IV, an entity previously deemed to be under common control with the Company, as if it had been completed at inception, as previously disclosed in the Company’s Current Report on Form 8-K, dated May 20, 2014.
(2) The adjustments in this column reflect the “Net Method” for adjusting for non-controlling interests and certain other methodology adjustments.
(3) The adjustments in this column reflect the restatement. See Note 2 — Restatement of Previously Issued Financial Statements to the consolidated financial statements for further explanation on adjustments.
(4) Includes proportionate share attributable to non-controlling interests of the adjustments denoted with “a”.
(5) Includes proportionate share attributable to non-controlling interests of the adjustments denoted with “b”.
(6) Reclassification between line items to properly show non-real estate related amortization below in AFFO.
(7) The previously reported AFFO calculation presented this line item net of the proportionate share for non-controlling interest. A “gross up” adjustment has been made to include the amount attributable to non-controlling interest in order to show all proportionate adjustments for non-controlling interests on one line item called “Proportionate share of adjustments for non-controlling interest.”
(8) In reviewing its AFFO methodology, the Company has determined that it was not appropriate to adjust for operating fees incurred to affiliates as these expenses represent operating expenses that are typical for the industry.

 

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     Year Ended December 31, 2011  
     As Previously
Reported (1)
     Methodology
Adjustments (2)
    As Corrected  

Net loss attributable to stockholders

   $ (4,699    $ —        $ (4,699

Loss on held for sale properties a

     815         —          815   

Depreciation and amortization a

     2,111         (14 ) (5)      2,097   

Proportionate share of adjustments for non-controlling interests (3)

     —           (64 ) (2)(3)      (64
  

 

 

    

 

 

   

 

 

 

FFO attributable to stockholders

  (1,773   (78   (1,851

Acquisition related b

  3,898      —        3,898   

Loss on derivative instruments b

  2      —        2   

Amortization of deferred financing costs b

  186      —        186   

Other amortization and non-cash charges b

  —        14  (5)    14   

Straight-line rent b

  (229   (11 ) (6)    (240

Non-cash equity compensation expense b

  191      —        191   

Proportionate share of adjustments for non-controlling interests (4)

  —        (89 ) (2)(4)    (89
  

 

 

    

 

 

   

 

 

 

AFFO attributable to stockholders

$ 2,275    $ (164 $ 2,111   
  

 

 

    

 

 

   

 

 

 

 

(1) The numbers in this column reflect the recasting of the Company’s historical financial statements to present the effects of the Company’s acquisition of ARCT IV, an entity previously deemed to be under common control with the Company, as if it had been completed at inception, as previously disclosed in the Company’s Current Report on Form 8-K, dated May 20, 2014.
(2) The adjustments in this column reflect the “Net Method” for adjusting for non-controlling interests and certain other methodology adjustments.
(3) Includes proportionate share attributable to non-controlling interests of the adjustments denoted with “a”.
(4) Includes proportionate share attributable to non-controlling interests of the adjustments denoted with “b”.
(5) Reclassification between line items to properly show non-real estate related depreciation and amortization below FFO.
(6) The previously reported AFFO calculation presented this line item net of the proportionate share for non-controlling interest. A “gross up” adjustment has been made to include the amount attributable to non-controlling interest in order to show all proportionate adjustments for non-controlling interests on one line item called “Proportionate share of adjustments for non-controlling interest.”

 

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Capital Markets

The following are our equity offerings of common stock during the year ended December 31, 2013 (dollar amounts in millions):

 

Type of offering

  Closing Date   Number of Shares (1)     Gross Proceeds  

Registered follow-on offering

  January 29, 2013     2,070,000      $ 26.8   

ATM

  January 1 - April 17, 2013     553,300        8.9   

Private placement offering

  June 7, 2013     29,411,764        455.0   

Private placement offering

  November 12, 2013     15,126,498        186.0   
   

 

 

   

 

 

 

Total - Year end December 31, 2013

  47,161,562    $ 676.7   
   

 

 

   

 

 

 

 

(1) Excludes 140.7 million shares of common stock that were issued to the stockholders of ARCT III’s common stock in conjunction with the ARCT III Merger.

On August 1, 2012, we filed a $500.0 million universal shelf registration statement and a resale registration statement with the SEC. Each registration statement became effective on August 17, 2012. As of December 31, 2013, we had issued 2.1 million shares of common stock through a registered follow on offering and an ATM offering under the $500.0 million universal shelf registration statement. No preferred stock, debt or equity-linked security had been issued under the universal shelf registration statement. The resale registration statement, as amended, registers the resale of up to 1,882,248 shares of common stock issued in connection with any future conversion of certain currently outstanding restricted shares, convertible preferred stock or limited partnership interests in the OP. As of December 31, 2013, no common stock had been issued under the resale registration statement.

On March 14, 2013, we filed a universal automatic shelf registration statement and achieved well-known seasoned issuer (“WKSI”) status. As a result of the delayed filing of certain of our periodic reports with the SEC, we are not currently eligible to use a shelf registration statement for the offer and sale of our securities.

In January 2013, we commenced an “at the market” equity offering program (“ATM”) in which we may from time to time offer and sell shares of our common stock having an aggregate offering proceeds of up to $60.0 million. The shares will be issued pursuant to our $500.0 million universal shelf registration statement.

In addition to our common stock offerings, on June 7, 2013, we issued 28.4 million shares convertible preferred stock (the “Series C Shares”) for gross proceeds of $445.0 million. On November 12, 2013, we converted all outstanding Series C Shares into our common stock. Pursuant to the Series C Articles Supplementary, the number of shares of common stock that could be issued upon conversion of Series C Shares was limited to an exchange cap. Therefore, we converted 1.1 million Series C Shares into 1.4 million shares of our common stock. With respect to the 27.3 million Series C Shares for which we could not issue shares of our common stock upon conversion due to the exchange cap, we paid holders of Series C Shares an aggregate cash amount equal to approximately $441.4 million in exchange for such Series C Shares. Based on our share price on the conversion date, the total settlement value was $458.8 million. See Note 12 — Other Debt in the consolidated financial statements for a description of the conversion features of the Series C Convertible Preferred Stock.

On September 15, 2013, we entered into definitive purchase agreements pursuant to which we agreed to issue Series D Preferred Stock, par value $0.01 per share, and common stock, par value $0.01 per share, to certain institutional holders promptly following the close of our merger with CapLease. Pursuant to the definitive purchase agreements, we issued approximately 21.7 million shares of Series D Preferred Stock and 15.1 million shares of common stock, for gross proceeds of $288.0 million and $186.0 million, respectively, on November 12, 2013.

Upon consummation of the ARCT IV merger on January 3, 2014, 42.2 million shares of Series F Preferred Stock were issued to ARCT IV stockholders. There were no shares issued and outstanding of Series F Preferred Stock as of December 31, 2013. See Note 17 — Preferred and Common Stock (As Restated) in the consolidated financial statements for a description of the Series D Preferred Stock and Series F Preferred Stock.

See Note 24 — Subsequent Events (As Restated) for significant subsequent events.

 

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Availability of Funds from Credit Facilities (As Restated)

We and our OP are parties to a credit facility with Wells Fargo, National Association , as administrative agent and other lenders party thereto (the “Credit Facility”).

At December 31, 2013, the Credit Facility has commitments of $2.4 billion. The Credit Facility has an accordion feature, which, if exercised in full, would allow us to increase borrowings under the Credit Facility to $3.0 billion, subject to additional lender commitments and borrowing base availability.

At December 31, 2013, the Credit Facility contains a $940.0 million term loan facility and a $1.5 billion revolving credit facility, of which $940.0 million and $119.8 million was outstanding, respectively. Loans under the Credit Facility are priced at the applicable rate (at our election, either a floating interest rate based on one month LIBOR, determined on a daily basis, or LIBOR for a period of one, three or six months), plus 2.25% to 3.00%, decreasing to 1.60% to 2.20% upon the satisfaction of certain conditions set forth in the credit agreement relating to the credit facility), based upon our current leverage. To the extent that we receive an investment grade credit rating as determined by a major credit rating agency, and upon the satisfaction of certain other conditions set forth in the credit agreement relating to the Credit Facility, at our election, advances under the revolving credit facility will be priced at the applicable rate plus 0.90% to 1.75% and term loans will be priced at the applicable rate plus 1.15% to 2.00%, in each case, based upon our then current investment grade credit rating.

The Credit Facility provides for monthly interest payments. Upon the occurrence of an event of default, the agent acting at the request or with the consent of lenders holding a majority of the loans and commitments under the Credit Facility, may declare the Credit Facility commitments to be terminated, and may accelerate the payment on any unpaid principal amount of all outstanding loans. We have guaranteed the obligations under the Credit Facility. The revolving credit facility will terminate on February 14, 2017 and the term loan facility will terminate on February 14, 2018, in each case, unless extended in accordance with the terms of the credit facility. At any time, upon timely notice by us, we may prepay borrowings under the credit facility. We incur an unused fee of 0.15% to 0.25% per annum on the unused amount of the revolving credit commitments, based on our usage of the revolving credit facility, which unused fee will decrease 0.12% to 0.35% per annum, based upon our then current investment grade credit rating, to the extent we have elected for the interest rate margin applicable to the outstanding advances under the credit facility to be governed by our credit rating as set forth above. To the extent that any delayed draw commitments remain undrawn, we will incur an unused fee of 0.25% per annum on the unused amount of such commitments. The Credit Facility also required us to maintain certain property available for collateral as a condition to funding, but this requirement was eliminated pursuant to an amendment effective February 7, 2014. See also “Our inability to file and deliver our financial statements and certain other financial deliverables required under the terms of our Credit Agreement and the indentures governing our senior unsecured notes has adversely affected our overall borrowing flexibility, exposed us to the possibility of default and required us to pay certain additional expenses,” for a description of certain provisions of our Amended Credit Agreement which have subsequently become effective. Refer to Note 24 – Subsequent Events (As Restated) included in this Amendment No. 2 to Annual Report on Form 10-K/A for further discussion on significant recent events.

Principal Use of Funds

Acquisitions

Generally, cash needs for property acquisitions will be met through proceeds from the public or private offerings of debt and equity and other financings. We may also from time to time enter into other agreements with third parties whereby third parties will make equity investments in specific properties or groups of properties that we acquire.

We evaluate potential acquisitions of real estate and real estate-related assets and engage in negotiations with sellers and borrowers. Investors and stockholders should be aware that after a purchase contract is executed that contains specific terms the property will not be purchased until the successful completion of due diligence and negotiation of final binding agreements. During this period, we may decide to temporarily invest any unused proceeds from equity offerings in certain investments that could yield lower returns than the properties. These lower returns may affect our ability to make distributions.

 

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We financed the aggregate purchase prices of the recent mergers and acquisitions discussed in Note 3 — Mergers and Acquisitions in part through the assumption of outstanding indebtedness, and expect to finance the balance of the aggregate purchase prices through a combination of available cash on hand from: (a) a portion of the $676.7 million in gross proceeds for the year ended December 31, 2013 from the sale of shares of ARCP common stock and convertible preferred stock in separate previously disclosed private placement transactions; (b) a portion of the $967.8 million in net proceeds from the sale of the Notes; (c) funds available from the issuance of common stock through our current ATM or any successor program thereto; (d) financing available under our credit facility; and (e) additional alternative financing arrangements, as needed, from the issuance of additional common stock, preferred securities or other debt, equity or equity-linked financings.

Dividends

The amount of dividends payable to our stockholders is determined by our board of directors and is dependent on a number of factors, including funds available for dividends, financial condition, capital expenditure requirements, as applicable, and annual dividend requirements needed to qualify and maintain our status as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). Operating cash flows are expected to increase as additional properties are acquired in our investment portfolio.

We and our board of directors share a similar philosophy with respect to paying our dividends. The dividends should principally be derived from cash flows generated from real estate operations. In order to improve our operating cash flows and our ability to pay dividends from operating cash flows, our Former Manager has in the past agreed to waive certain fees including management and incentive fees. The fees that were waived relating to the activity are not deferrals and accordingly, will not be paid. Because our Former Manager waived certain fees that we owed, cash flow from operations that would have been used to pay such fees to our Former Manager was available to pay dividends to our stockholders. See Note 19 — Related Party Transactions and Arrangements (As Restated) in the consolidated financial statements within this report for further information on fees paid to and forgiven by our Former Manager. Subsequent to December 31, 2013, we completed our transition to self-management and will no longer pay such fees to our Former Manager. See Note 24 — Subsequent Events (As Restated) for further discussion.

As our real estate portfolio matures, we expect cash flows from operations to cover our dividends.

The following table shows the sources for the payment of dividends to common stockholders for the year ended December 31, 2013 (dollars in thousands):

 

     Three Months Ended  
     March 31, 2013     June 30, 2013     September 30, 2013     December 31, 2013  
     Dividends     % of
Dividends
    Dividends     % of
Dividends
    Dividends     % of
Dividends
    Dividends     % of
Dividends
 

Dividends:

                

Distributions paid in cash

   $ 40,485        $ 49,882        $ 66,674        $ 74,311     

Distributions reinvested

     7,498          13,121          4,949          —       
  

 

 

     

 

 

     

 

 

     

 

 

   
$ 47,983    $ 63,003    $ 71,623    $ 74,311   
  

 

 

     

 

 

     

 

 

     

 

 

   

Sources of dividends:

Cash flows provided by operations (1)

$ —        —   $ 5,674      9.0 $ 16,976      23.7 $ 29,254      39.4

Proceeds from issuances of common stock

  3,185      6.6   12,794      20.3   23,938      33.4   —        —  

Proceeds from financing activities

  37,300      77.8   31,414      49.9   25,760      36.0   45,057      60.6

Common stock issued under the DRIP

  7,498      15.6   13,121      20.8   4,949      6.9   —        —  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total sources of dividends

$ 47,983      100.0 $ 63,003      100.0 $ 71,623      100.0 $ 74,311      100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to stockholders (in accordance with U.S. GAAP)

$ (143,880 $ (69,603 $ (80,201 $ (197,815
  

 

 

     

 

 

     

 

 

     

 

 

   

 

(1) Dividends paid from cash provided by operations are derived from cash flows from operations (U.S. GAAP basis) for the year ended December 31, 2013. Cash flows provided by operations include $76.1 million (as restated) of acquisition related expenses and $210.5 million (as restated) of merger and other non-routine transaction related expenses incurred during the year ended December 31, 2013. If we had not incurred such acquisition and merger related costs, our cash flows from operations would have sourced all dividend payments during the year ended December 31, 2013.

 

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Loan Obligations

At December 31, 2013, our leverage ratio (net debt, excluding debt convertible to common stock, divided by enterprise value) was 58.3%.

The payment terms of our loan obligations vary. In general, only interest amounts are payable monthly with all unpaid principal and interest due at maturity. Some of our loan agreements stipulate that we comply with specific reporting and financial covenants mainly related to debt coverage ratios and loan to value ratios. Each loan that has these requirements has specific ratio thresholds that must be met. As of December 31, 2013, we were in compliance with the debt covenants under our loan agreements.

As of December 31, 2013, we had non-recourse mortgage indebtedness of $1.3 billion which was collateralized by 177 properties. Our mortgage indebtedness bore interest at weighted-average rate of 3.42% per annum and had a weighted-average maturity of 3.41 years. We may in the future incur additional mortgage debt on the properties we currently own or use long-term non-recourse financing to acquire additional properties in the future.

As of December 31, 2013, there was $1.1 billion outstanding on the Credit Facility, of which $554.8 million bore a floating interest rate of 3.17%, and for $515.0 million of the Credit Facility’s floating base interest rate is fixed through the use of derivative instruments used to hedge interest rate volatility. Including the spread, which can vary based on our leverage, interest on this portion was 3.85% at December 31, 2013. At December 31, 2013, there was up to $1.9 billion available to us for future borrowings, subject to additional lender commitments and borrowing availability. In addition, we had $760.0 million outstanding under the Senior Secured Credit Facility.

Our loan obligations require the maintenance of financial covenants, as well as restrictions on corporate guarantees, the maintenance of certain financial ratios (such as specified debt to equity and debt service coverage ratios) as well as the maintenance of a minimum net worth. At December 31, 2013 and 2012, we were in compliance with the debt covenants under all of our loan obligations.

Convertible Senior Note Offering

On July 29, 2013, the Company issued $300.0 million of Convertible Senior Notes (the “2018 Notes”) and, pursuant to an over-allotment exercise by the underwriters of such 2018 Notes offering, issued an additional $10.0 million of its 2018 Notes on August 1, 2013. On December 10, 2013, the Company issued an additional $287.5 million of the 2018 Notes through a reopening of the 2018 Notes indenture agreement. Also on December 10, 2013, the Company issued $402.5 million of Convertible Senior Notes (the “2020 Notes,” collectively with the 2018 Notes, the “Convertible Notes”). The 2018 Notes mature August 1, 2018 and the 2020 Notes mature on December 15, 2020. The Convertible Notes are convertible to cash or shares of the Company’s common stock at the Company’s option. In accordance with U.S GAAP, the notes are accounted for as a liability with a separate equity component recorded for the conversion option. A liability was recorded for the Convertible Notes on the issuance date at fair value based on a discounted cash flow analysis using current market rates for debt instruments with similar terms. The difference between the initial proceeds from the Convertible Notes and the estimated fair value of the debt instruments resulted in a debt discount, with an offset recorded to additional paid-in capital representing the equity component. The debt discount is being amortized to interest expense over the expected lives of the Convertible Notes.

Refer to Note 24 – Subsequent Events (As Restated) included in this Amendment No. 2 to Annual Report on Form 10-K/A for further discussion on significant recent events.

Bond Offering

On February 6, 2014, the OP issued, in a private offering, $2.55 billion aggregate principal amount of senior unsecured notes consisting of $1.3 billion aggregate principal amount of 2.00% senior notes due 2017 (the “2017 Notes”), $750.0 million aggregate principal amount of 3.00% senior notes due 2019 (the “2019 Notes”) and $500.0 million aggregate principal amount of 4.60% senior notes due 2024 (the “2024 Notes,” and, together with the 2017 Notes and 2019 Notes, the “Notes”). The Notes are guaranteed by the Company. The Company used a portion of the net proceeds to partially fund the cash consideration, fees and expenses relating to Cole Merger and repayment of Cole’s credit facility. The Company used the remaining portion of the net proceeds from the offering to repay $900.0 million outstanding under the OP’s senior credit facility and for other general corporate purposes.

 

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Refer to Note 24 – Subsequent Events (As Restated) included in this Amendment No. 2 to Annual Report on Form 10-K/A for further discussion on significant recent events.

Contractual Obligations

The following is a summary of our contractual obligations, including contractual lease obligations, as of December 31, 2013 (in thousands):

 

     Total      2014      2015 – 2016      2017 – 2018      Thereafter  

Principal payments due on mortgage notes payable

   $ 1,258,661       $ 86,933       $ 677,200       $ 293,869       $ 200,659   

Interest payments due on mortgage notes payable

     204,982         63,581         82,666         25,064         33,671   

Principal payments due on senior corporate credit facilities

     1,819,800         —           —           1,819,800         —     

Interest payments due on senior corporate credit facilities

     186,585         47,048         94,095         45,442         —     

Principal payments due on secured credit facility

     150,000         150,000         —           —           —     

Interest payments due on secured credit facility

     4,410         4,410         —           —           —     

Principal payments due on convertible debt

     1,000,000         —           —           597,500         402,500   

Interest payments due on convertible debt

     187,235         33,019         66,038         58,619         29,559   

Principal payments due on other debt

     108,316         12,851         24,378         40,157         30,930   

Interest payments due on other debt

     65,659         6,808         11,469         6,802         40,580   

Payments due on lease obligations

     84,441         4,541         8,657         7,456         63,787   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

$ 5,070,089    $ 409,191    $ 964,503    $ 2,894,709    $ 801,686   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Contractual Lease Obligations

The following table reflects the minimum base rental cash payments due from the Company over the next five years and thereafter for certain ground and office lease obligations (amounts in thousands):

 

     Future Minimum
Lease Payments
 

2014

   $ 4,541   

2015

     4,443   

2016

     4,214   

2017

     4,244   

2018

     3,212   

Thereafter

     63,787   
  

 

 

 
$ 84,441   
  

 

 

 

Election as a REIT

We elected to be taxed as a REIT under Sections 856 through 860 of the Code commencing with the taxable year ended December 31, 2011. If we continue to qualify for taxation as a REIT, we generally will not be subject to federal corporate income tax to the extent we distribute our REIT taxable income to our stockholders, and so long as we distribute at least 90% of our REIT taxable income, computed without regard to the dividends paid deduction and excluding net capital gain. REITs are subject to a number of other organizational and operational requirements. Even if we qualify for taxation as a REIT, we may be subject to certain state and local taxes on our income and property, and federal income and excise taxes on our undistributed income. We believe we are organized and operating in such a manner as to qualify to be taxed as a REIT for the taxable year ending December 31, 2013.

Inflation

We may be adversely impacted by inflation on any leases that do not contain indexed escalation provisions. In addition, our net leases may require the tenant to pay its allocable share of operating expenses, including common area maintenance costs, real estate taxes and insurance. This may reduce our exposure to increases in costs and operating expenses resulting from inflation.

 

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Related-Party Transactions and Agreements

We have entered into agreements with affiliates, whereby we pay or have paid in the past certain fees or reimbursements to ARC, our Former Manager or their affiliates for acquisition fees and expenses, organization and offering costs, asset management fees and reimbursement of operating costs and have in the past paid sales commissions and dealer manager fees. See Note 19 — Related Party Transactions and Arrangements (As Restated) in our financial statements included in this report for a discussion of the various related-party transactions, agreements and fees. 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. See Note 24 — Subsequent Events (As Restated) to the consolidated financial statements for further discussion.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

The market risk associated with financial instruments and derivative financial instruments is the risk of loss from adverse changes in market prices or interest rates. Our market risk arises primarily from interest rate risk relating to variable-rate borrowings. To meet our short and long-term liquidity requirements, we borrow funds at a combination of fixed and variable rates. Our interest rate risk management objectives are to limit the impact of interest rate changes in earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time, we may enter into interest rate hedge contracts such as swaps, collars and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We would not hold or issue these derivative contracts for trading or speculative purposes. We do not have any foreign operations and thus we are not exposed to foreign currency fluctuations.

As of December 31, 2013, our debt included fixed-rate debt, including debt that has interest rates that are fixed with the use of derivative instruments, with a carrying and fair value of $2.9 billion. Changes in market interest rates on our fixed rate debt impact fair value of the debt, but they have no impact on interest incurred or cash flow. For instance, if interest rates rise 100 basis points and our fixed rate debt balance re