Item 1. Business.
Overview
We are a full-service real estate operating company that operates through two business segments, our real estate investment (“REI”) segment and our investment management segment, Cole Capital, as further discussed in “Note 4 - Segment Reporting” to our consolidated financial statements. Through our REI segment, we own and actively manage a diversified portfolio of 4,435 retail, restaurant, office and industrial real estate properties with an aggregate of 99.6 million square feet, of which 98.6% was leased as of December 31, 2015, with a weighted-average remaining lease term of 10.6 years. Through our Cole Capital segment, we are responsible for raising capital for and managing the affairs of certain non-traded real estate investment trusts (the “Managed REITs”) on a day-to-day basis, identifying and making acquisitions and investments on behalf of the Managed REITs, and recommending to the respective board of directors of each of the Managed REITs an approach for providing investors with liquidity. Cole Capital receives compensation and reimbursement for performing these services.
Substantially all of the REI segment’s operations are conducted through the Operating Partnership. VEREIT, Inc. is the sole general partner and holder of 97.4% of the common partnership interests in the Operating Partnership (the “OP Units”) as of December 31, 2015 with the remaining 2.6% of the OP Units owned by certain non-affiliated investors and certain former directors, officers and employees of the Former Manager (defined below). Substantially all of the Cole Capital segment’s operations are conducted through Cole Capital Advisors, Inc. (“CCA”), an Arizona corporation and a wholly owned subsidiary of the Operating Partnership. CCA is treated as a taxable REIT subsidiary (“TRS”) under Section 856 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). Prior to January 8, 2014, we were externally managed by ARC Properties Advisors, LLC (the “Former Manager”) on a day-to-day basis, with the exception of certain acquisition, accounting and portfolio management activities which were performed by our employees. In August 2013, our board of directors (the “Board of Directors” or the “Board”) determined that it was in our best interests to become self-managed, and we completed our transition to self-management on January 8, 2014. Through strategic mergers and acquisitions discussed in “Note 3 - Mergers with Real Estate Businesses,” the Company has grown significantly since incorporation.
VEREIT, Inc. was incorporated in the State of Maryland on December 2, 2010 and has elected to be treated as a REIT for U.S. federal income tax purposes. The Operating Partnership was incorporated in the State of Delaware on January 13, 2011. We operate our business in a manner that permits us to maintain our exemption from registration under the Investment Company Act of 1940, as amended (the “Investment Company Act”). VEREIT, Inc.’s shares of common stock and 6.70% Series F Cumulative Redeemable Preferred Stock (“Series F Preferred Stock”) trade on the New York Stock Exchange (the “NYSE”) under the trading symbols “VER” and “VER PRF,” respectively.
2015 Developments
Restatement and Remediation
As previously disclosed, on March 2, 2015, VEREIT, Inc. restated its consolidated financial statements and related financial information as of and for the fiscal years ended December 31, 2013 and 2012 and the interim periods ended March 31, 2014 and 2013, June 30, 2014 and 2013 and September 30, 2013, and the Operating Partnership restated its consolidated financial statements and related financial information as of and for the fiscal years ended December 31, 2013 and 2012 and the interim periods ended June 30, 2014 and 2013 (collectively, the “Restatement”) to correct errors that were identified as a result of an investigation conducted by the Company’s audit committee (the “Audit Committee Investigation”), as well as certain other errors that were identified by the Company. Management concluded that all nine material weaknesses disclosed in the Company’s Annual Report on Form 10-K, as amended, for the fiscal year ended December 31, 2014, have been fully remediated and that the Company’s disclosure controls and procedures and internal control over financial reporting were effective at December 31, 2015, as discussed in detail in Item 9A. Controls and Procedures.
Real Estate Dispositions
During the year ended December 31, 2015, the Company began the process of evaluating its portfolio to ensure appropriate tenant, geographic and industry concentration in order to manage its risk of market and credit concentration. This led to selectively disposing of assets which management believes have a lower projected growth rate than the overall portfolio, and for which concentrations by tenant, geography or industry exceed target metrics or no longer conform to the Company’s operating and investment strategies. During the year ended December 31, 2015, the Company disposed of 228 properties, including two properties owned by consolidated joint ventures, and its interest in one consolidated joint venture, whose only assets consisted of investments in three unconsolidated joint ventures, for aggregate sales price of $1.5 billion, of which the Company’s share was $1.4 billion based on its ownership interest in the respective consolidated joint ventures, resulting in consolidated proceeds of $1.0 billion after disposition fees and debt assumptions. As a result of the reduction in mortgage debt due to property dispositions and other measures taken by management, the Company improved its debt leverage ratio from 55.2% as of December 31, 2014 to 48.0% as of
December 31, 2015. The Company’s debt leverage ratio is calculated by dividing the net debt (or the Company’s outstanding principal debt balance, excluding certain U.S. GAAP adjustments, such as premiums and discounts, less all cash and cash equivalents), divided by gross real estate investments (or total gross real estate and related assets, including net investments in unconsolidated entities, investment in direct financing leases, investment securities backed by real estate and loans held for investment, net of gross intangible lease liabilities).
Dividends
On December 23, 2014, in connection with the amendments to the Credit Facility, the Company agreed to suspend the payment of dividends on its common stock until it complied with periodic financial reporting and related requirements. On March 30, 2015, the Company satisfied these financial statement and other information requirements. On August 5, 2015, the Company declared a quarterly dividend of $0.1375 per share of common stock for each of the third and fourth quarters of 2015 (representing an annualized dividend rate of $0.55 per share), which was paid on each of October 15, 2015 and January 15, 2016 to holders of record as of September 30, 2015 and December 31, 2015, respectively.
Our Series F Preferred Stock, as discussed in “Note 16 - Equity” to our consolidated financial statements, will pay cumulative cash dividends at the rate of 6.70% per annum on their liquidation preference of $25.00 per share (equivalent to $1.675 per share on an annual basis). As of December 31, 2015, there were approximately 42.8 million shares of Series F Preferred Stock (and approximately 42.8 million corresponding General Partner Series F Preferred Units) and 86,874 Limited Partner Series F Preferred Units issued and outstanding.
Management and Board Changes
During the year ended December 31, 2015, the Company underwent several changes in senior leadership. As of December 31, 2015, the executive management team consisted of Glenn J. Rufrano, Michael J. Bartolotta, Lauren Goldberg, Paul H. McDowell, William C. Miller and Thomas W. Roberts. The Board of Directors consisted of Bruce D. Frank, Hugh R. Frater, David B. Henry, Mark S. Ordan, Eugene A. Pinover, Julie G. Richardson and Mr. Rufrano.
On March 10, 2015, Leslie D. Michelson and Edward G. Rendell each tendered their resignations effective at the close of business on April 1, 2015. On March 10, 2015, the Company also announced that Hugh R. Frater was appointed to serve as the Company’s non-executive Chairman of the Board, effective on April 1, 2015, when Julie G. Richardson was also appointed an independent director. On June 17, 2015 Mark S. Ordan was appointed an independent director. On August 4, 2015, Thomas A. Andruskevich and William G. Stanley notified the Board of Directors that they would not stand for reelection at the General Partner’s 2015 annual meeting of stockholders, which was held on September 29, 2015. As such, two new independent directors: David B. Henry and Eugene A. Pinover were elected at the annual meeting.
Primary Investment Focus
We own and actively manage a diversified portfolio of retail, restaurant, office and industrial real estate assets subject to long-term net leases with creditworthy tenants. Our focus is on single-tenant, net-leased properties that are strategically located and essential to the business operations of the tenant, as well as retail properties that offer necessity and value-oriented products or services. We actively manage the portfolio by considering several metrics including property type, tenant concentration, geography, credit and key economic factors for appropriate balance and diversity. We believe that actively managing our portfolio allows us to attain the best operating results for each asset and the overall portfolio through strategic planning, implementation of these plans and responding proactively to changes and challenges in the marketplace.
Additionally, we employ a shared services model for Cole Capital’s portfolios by providing transactional and operational real estate functions. The shared services model allows our strong and experienced real estate team to be active in the markets at all times and manage complimentary portfolios.
Investment Policies
When evaluating prospective investments in or dispositions of real property, our management considers relevant real estate and financial factors, including the location of the property, the leases and other agreements affecting the property and business operations of the tenant, 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 in certain instances to the approval of the Board of Directors.
As part of our overall portfolio strategy, we seek to lease space and/or acquire properties leased to creditworthy tenants that meet our underwriting and operating guidelines. Prior to entering into any transaction, our corporate credit analysis and underwriting professionals conduct a review of a tenant’s credit quality. In addition, we consistently monitor the credit quality of our portfolio by actively reviewing the creditworthiness of certain tenants, focusing primarily on those tenants representing the greatest concentration of our portfolio. This review primarily includes an analysis of the tenant’s financial statements either quarterly, or
as frequently as the lease permits. We also consider tenant credit quality when assessing our portfolio for strategic dispositions. When we assess tenant credit quality, we: (i) review relevant financial information, including financial ratios, net worth, revenue, cash flows, leverage and liquidity; (ii) evaluate the depth and experience of the tenant’s management team; and (iii) assess the strength/growth of the tenant’s industry. On an on-going basis, we evaluate the need for an allowance for doubtful accounts arising from estimated losses that could result from the tenant’s inability to make required current rent payments and an allowance against accrued rental income for future potential losses that we deem to be unrecoverable over the term of the lease. The factors considered in determining the credit risk of our tenants include, but are not limited to: payment history; credit status and change in status (credit ratings for public companies are used as a primary metric); change in tenant space needs (i.e., expansion/downsize); tenant financial performance; economic conditions in a specific geographic region; and industry specific credit considerations. We are of the opinion that the credit risk of our portfolio is reduced by the high quality of our existing tenant base, reviews of prospective tenants’ risk profiles prior to lease execution and consistent monitoring of our portfolio to identify potential problem tenants.
Real Estate Investments
As of December 31, 2015, we owned 4,435 properties, comprised of 99.6 million square feet, located in 49 states, the District of Columbia, Puerto Rico and Canada. Our properties were 98.6% leased with a weighted-average remaining lease term of 10.6 years. There were no tenants exceeding 10% of our consolidated annualized rental income as of December 31, 2015 or 2013. As of December 31, 2014, leases with Red Lobster® restaurants represented 11.6% of our consolidated annualized rental income. As of December 31, 2015, 2014 and 2013, properties located in Texas represented 13.1%, 12.7% and 10.7%, respectively, of our consolidated annualized rental income. As of December 31, 2015, tenants in the casual dining restaurant and manufacturing industries accounted for 16.6% and 10.1%, respectively, of our consolidated annualized rental income. As of December 31, 2014, tenants in the casual dining restaurant industry accounted for 18.4% of our consolidated annualized rental income. As of December 31, 2013, tenants in the quick service restaurant and manufacturing industries accounted for 17.7% and 11.4%, respectively, of our consolidated annualized rental income.
Cole Capital®
Cole Capital sponsors and manages direct investment real estate programs, which primarily include four publicly registered, non-traded REITs, as discussed in “Note 2 - Summary of Significant Accounting Policies” to our consolidated financial statements. Cole Capital is responsible for raising capital for and managing the day-to-day affairs of the Managed REITs, identifying and making acquisitions and investments on behalf of the Managed REITs, and recommending to each of the Managed REIT’s respective board of directors an approach for providing investors with liquidity. Cole Capital serves as the dealer manager and distributes shares of common stock for certain Managed 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. Cole Capital receives compensation and reimbursement for services relating to the Managed REITs’ offerings and the investment, management, financing and disposition of their respective assets, as applicable. Cole Capital also develops new REIT offerings, including obtaining regulatory approvals from the U.S. Securities and Exchange Commission (the “SEC”), the Financial Industry Regulatory Authority, Inc. (“FINRA”) and various blue sky jurisdictions for such offerings.
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 metrics to improve over time.
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.
We also may obtain secured or unsecured debt to acquire properties, and we expect that our financing sources will include banks and institutional investment firms, including asset managers and life insurance companies. Although we intend to maintain a conservative capital structure, our charter does not contain a specific limitation on the amount of debt we may incur and the Board of Directors may implement or change target debt levels at any time without the approval of our stockholders.
We intend to continue to emphasize unsecured corporate-level or OP-level debt in our financing and to seek to reduce the percentage of our assets which are secured by mortgage loans. For information relating to our credit agreement, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
Competition
In our REI segment, we are subject to competition in the acquisition and disposition of properties and in the leasing of our properties. We compete with a number of developers, owners and operators of retail, restaurant, office and industrial real estate, many of which own properties similar to ours in the same markets in which our properties are located. 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 do not expect to encounter the same competitors in each region of the United States. Many of our competitors have greater financial and other resources than us and may have other advantages over us. 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 in connection with unsuccessful acquisitions that we will not be able to recover. Foreign investors may view the U.S. real estate market as being more stable than other international markets and may increase investments in high-quality single-tenant properties, especially in gateway cities.
In our Cole Capital segment, we also face competition in raising funds for the Managed REITs from other entities with similar investment objectives such as other non-traded REITs, publicly-traded REITs and private funds, including hedge funds.
Regulations
Our investments are subject to various federal, state, local and foreign laws, ordinances and regulations, including, among other things, health, safety and 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 material permits and approvals necessary under current law to operate our investments.
Our properties are also subject to laws such as the Americans with Disabilities Act of 1990 (“ADA”), which require that all public accommodations must meet federal requirements related to access and use by disabled persons. Some of our properties may currently be in non-compliance with the ADA. If one or more of the properties in our portfolio is not in compliance with the ADA or any other regulatory requirements, we may be required to incur additional costs to bring the property into compliance.
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, 2015, we had approximately 350 employees.
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 access them through the EDGAR database at the SEC’s website at http://www.sec.gov. In addition, copies of our filings with the SEC may be obtained from the website maintained for us at www.ir.vereit.com. We are providing our website address solely for the information of investors. We do not intend for the information contained on our website to be incorporated into this Annual Report on Form 10-K or other filings with the SEC.
Item 1A.
Item 1A. Risk Factors.
Investors should carefully consider the following factors, together with all the other information included in this Annual Report on Form 10-K, in evaluating the Company and our business. If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected, the trading price of the General Partner's securities could decline and its stockholders and/or the Operating Partnership's unitholders may lose all or part of their investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. This “Risk Factors” section contains references to our “capital stock” and to our “stockholders” and “unitholders.” Unless expressly stated otherwise, references to our “capital stock” represent the General Partner’s common stock and any class or series of its preferred stock, references to our “stockholders” represent holders of the General Partner’s common stock and any class or series of its preferred stock and references to our “unitholders” represent holders of the OP units and any class of series of the Operating Partnership’s preferred units.
Risks Related to Our Business
We are primarily dependent on single-tenant leases for our revenue and, accordingly, if we are unable to renew leases, lease vacant space, including vacant space resulting from tenant defaults, or re-lease space as leases expire on favorable terms or at all, our financial condition could be adversely affected.
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 significant tenant or multiple tenants could cause a material reduction in our revenues and operating cash flows. In addition, to the extent that we enter into a master lease with a particular tenant, the termination of such master lease could affect each property subject to the master lease, resulting in the loss of revenue from all such properties.
We cannot assure you that our leases will be renewed or that we will be able to lease or re-lease the properties on favorable terms, or at all, or that lease terminations will not cause us to sell the properties at a loss. Any of our properties that incur a vacancy could be difficult to re-lease or sell. We have and may continue to experience vacancies either by the continued default of a tenant under its lease or the expiration of one of our leases. Upon the 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, in order to retain and attract tenants. 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 the space for other uses. If the vacancies continue for a long period of time, we may suffer reduced revenues, resulting in less cash available for distribution to our stockholders and unitholders. If we are unable to renew leases, lease vacant space, including vacant space resulting from tenant defaults, or re-lease space as leases expire on favorable terms or at all, our financial condition could be adversely affected.
We are subject to tenant, geographic and industry concentrations that make us more susceptible to adverse events with respect to certain tenant, geographic areas or industries.
As of December 31, 2015, we had derived approximately:
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$118.2 million, or 9.3%, of our annualized rental income from Red Lobster®, a wholly owned subsidiary of Golden Gate Capital;
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$383.5 million, or 30.3%, of our annualized rental income from properties located in the following four states-Texas (13.1%), Illinois (6.4%), Florida (5.6%) and California (5.2%); and
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$710.0 million, or 56.1%, of our annualized rental income from tenants in the following six industries-the casual dining restaurant industry (16.6%), the manufacturing industry (10.1%), the quick service restaurant industry (9.3%), the discount retail industry (7.6%), the pharmacy retail industry (7.3%) and the finance industry (5.2%).
Any adverse change in the financial condition of a tenant to whom we may have a significant credit concentration now or in the future, or any downturn of the economy in any state or industry in which we may have a significant credit concentration now or in the future, could result in a material reduction of our cash flows or material losses to us.
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 or reimbursement of property expenses such as real estate taxes, insurance and ordinary maintenance and repairs. However, under the provisions of certain existing leases and leases that we may enter into in the future with our tenants, we may be required to pay some or all of the expenses of the property, such as the costs of environmental liabilities, roof and structural repairs, real estate taxes, 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 may be adversely affected and the amount of cash available to meet expenses and to make distributions to our stockholders and unitholders may be reduced.
Our properties may be subject to impairment charges.
We routinely 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 a downward 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. Management has recorded impairment charges related to certain properties in the year ended December 31, 2015, and may record future impairments based on actual results and changes in circumstances. Negative developments in the real estate market may cause management to reevaluate the business and macro-economic assumptions used in its impairment analysis. Changes in management’s assumptions based on actual results may have a material impact on the Company’s financial statements. See “Note 10 - Fair Value Measures” to our consolidated financial statements for a discussion of real estate impairment charges.
Real estate investments are relatively illiquid and therefore we may not be able to dispose of properties when appropriate or on favorable terms.
Real estate investments are relatively illiquid generally and may become even more illiquid during periods of economic downturn. As a result, we may not be able to sell our properties quickly or on favorable terms in response to changes in the economy or other conditions when it otherwise may be prudent to do so. In addition, certain significant expenditures generally do not change in response to economic or other conditions, including debt service obligations, real estate taxes, and operating and maintenance costs. This combination of variable revenue and relatively fixed expenditures may result, under certain market conditions, in reduced earnings. Further, as a result of the 100% prohibited transactions tax applicable to REITs, we intend to hold our properties for investment, rather than primarily for sale in the ordinary course of business, which may cause us to forgo or defer sales of properties that otherwise would be in our best interest. Therefore, we may be unable to adjust our portfolio promptly in response to economic, market or other conditions, which could adversely affect our business, financial condition, liquidity and results of operations.
Our investments in properties where the underlying tenant has below investment grade credit rating, as determined by major credit rating agencies, or unrated tenants may have a greater risk of default.
As of December 31, 2015, approximately 57.5% of our tenants were not rated or did not have an investment grade credit rating from a major ratings agency or were not affiliates of companies having an investment grade credit rating. Our investments with such tenants may have a greater risk of default and bankruptcy than investments in properties leased exclusively to investment grade tenants. When we invest in properties where the tenant does not have a publicly available credit rating, we will use certain credit assessment tools as well as rely on our own estimates of the tenant’s credit rating which includes reviewing the tenant’s financial information (i.e., financial ratios, net worth, revenue, cash flows, leverage and liquidity, if applicable). If our lender or a credit rating agency disagrees with our ratings estimates, or our ratings estimates are otherwise 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.
We may be unable to sell a property if or when we decide to do so, including as a result of uncertain market conditions, which could adversely impact our ability to make cash distributions to our stockholders and unitholders.
We expect to hold the various real properties in which we invest until such time as we decide that a sale or other disposition is appropriate given our investment business objectives. Our ability to dispose of properties on advantageous terms or at all depends on certain factors beyond our control, including competition from other sellers and the availability of attractive financing for potential buyers of our properties. We cannot predict the various market conditions affecting real estate investments which will exist at any particular time in the future. Due to the uncertainty of market conditions which may affect the disposition of our properties, we cannot assure you that we will be able to sell such properties at a profit or at all in the future. Accordingly, the extent to which our stockholders and unitholders will receive cash distributions and realize potential appreciation on our real estate investments will depend upon fluctuating market conditions. Furthermore, we may be required to expend funds to correct defects or to make improvements before a property can be sold. We cannot assure you that we will have funds available to correct such defects or to make such improvements.
Dividends paid from sources other than our cash flow from operations could affect our profitability, restrict our ability to generate sufficient cash flow from operations, and dilute stockholders’ and unitholders’ interests in us.
We may not generate sufficient cash flow from operations to pay dividends and we may in the future pay dividends from sources other than from our cash flow from operations, such as borrowings and/or the sale of assets or the proceeds from offerings of securities. We have not established any limit on the amount of borrowings and/or the sale of assets or the proceeds from an offering of securities 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.
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. In addition, funding dividends from the sale of additional securities could dilute your interest in us if we sell shares of our common stock or securities that are convertible or exercisable into shares of our common stock to third party investors. As a result, the return you realize on your investment may be reduced. Payment of dividends from these sources could affect our profitability, restrict our ability to generate sufficient cash flow from operations, and dilute stockholders’ and unitholders’ interests in us, any or all of which may adversely affect your overall return.
We could face potential adverse effects from the bankruptcies or insolvencies of tenants or from tenant defaults generally.
The bankruptcy or insolvency of our tenants may adversely affect the income produced by our properties. Under bankruptcy law, a tenant cannot be evicted solely because of its bankruptcy and has the option to assume or reject any unexpired lease. If the tenant rejects the lease, any resulting claim we have for breach of the lease (excluding collateral securing the claim) will be treated as a general unsecured claim. Our claim against the bankrupt tenant for unpaid and future rent will 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 flows and results of operations and could cause us to reduce the amount of distributions to our stockholders and unitholders.
In addition, the financial failure of, or other default in payment by, one or more of the tenants to whom we have exposure could have an adverse effect on our results of our operations. 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. If any of our tenants’ businesses experience significant adverse changes, they may 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. A default by a significant tenant or multiple tenants could cause a material reduction in our revenues and operating cash flows. In addition, if a tenant defaults, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment.
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. In a sale-leaseback transaction, we purchase a property and then lease it back to the third party 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 flows and the amount available for distributions to our stockholders and unitholders.
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 have a history of operating losses and cannot assure you that we will achieve profitability.
Since our inception in 2010, we have experienced net losses (calculated in accordance with U.S. GAAP) each fiscal year and, as of December 31, 2015, had an accumulated deficit of $3.4 billion. The extent of our future operating losses and the timing of when we will achieve profitability are uncertain, and together depend on the demand for, and value of, our portfolio of properties. We may never achieve or sustain profitability.
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 may acquire properties in the future. The acquisition of properties entails various risks, including the risks that our investments may not perform as we expect and that our cost estimates for bringing an acquired property up to market standards may prove inaccurate. Further, we expect to finance any future acquisitions through a combination of borrowings under the Credit Facility, proceeds from equity or debt offerings by the General Partner, the Operating Partnership or their subsidiaries and proceeds from property contributions and divestitures which, if unavailable, could adversely affect our cash flows.
In addition, our ability to acquire properties in the future on satisfactory terms and successfully integrate and operate such properties is subject to the following significant risks:
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we may be unable to acquire desired properties or the purchase price of a desired property may increase significantly because of competition from other real estate investors with more capital, including other real estate operating companies, REITs and investment funds, including the Managed REITs;
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we may acquire properties that are not accretive to our results upon acquisition;
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we may be unable to obtain the necessary debt or equity financing to consummate an acquisition or, if obtainable, financing may not be on satisfactory terms;
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we may need to spend more than budgeted amounts to make necessary improvements or renovations to acquired properties;
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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;
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we may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into our existing operations; and
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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.
Any of the above risks could adversely affect our business, financial condition, liquidity and results of operations.
We have assumed, and may in the future 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, certain major portfolio acquisitions and mergers and certain other property acquisitions, and expect in the future to assume existing liabilities in the event we acquire any additional properties. 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, it could adversely affect our business, financial condition, liquidity and results of operations.
We face intense competition, which may decrease or prevent increases in the occupancy and rental rates of our properties.
We are subject to competition in the leasing of our properties. We compete with numerous developers, owners and operators of retail, restaurant, industrial and office real estate, many of which have greater financial and other resources than us. Many of our competitors 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 in order to retain tenants when
such tenants’ lease expire or attract new tenants. In addition, if our competitors sell assets similar to assets we intend to divest in the same markets and/or at valuations below our valuations for comparable assets, we may be unable to divest our assets at all or at favorable pricing or on favorable terms. As a result of these actions by our competitors, our business, financial condition, liquidity and results of operations may be adversely affected.
The value of our real estate investments is subject to risks associated with our real estate assets and with the real estate industry.
Our real estate investments are subject to various risks, fluctuations and cycles in value and demand, many of which are beyond our control. Certain events may decrease our cash available for distribution to our stockholders and unitholders, as well as the value of our properties. These events include, but are not limited to:
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adverse changes in international, national or local economic and demographic conditions;
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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;
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adverse changes in financial conditions of buyers, sellers and tenants of properties;
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inability to collect rent from tenants;
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competition from other real estate investors with significant capital, including other real estate operating companies, REITs and institutional investment funds;
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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;
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increases in the supply of freestanding single-tenant properties;
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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;
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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;
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civil unrest, acts of God, including earthquakes, floods, hurricanes and other natural disasters, including extreme weather events from possible future climate change, which may result in uninsured losses, and acts of war or terrorism; and
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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 ADA.
Any or all of these factors could materially adversely affect our results of operations through decreased revenues or increased costs.
Our participation in joint ventures creates additional risks as compared to direct real estate investments, and the actions of our joint venture partners could adversely affect our operations or performance.
We have in the past participated, and may in the future participate, in joint ventures to purchase assets jointly with unaffiliated third parties or the Managed REITs. There are additional risks involved in joint venture transactions. As a co-investor in a joint venture, we may not be in a position to exercise sole decision-making authority relating to the property, joint venture, or other entity. In addition, there is the potential of our joint venture partner becoming bankrupt and the possibility of diverging or inconsistent economic or business interests of us and our partner. These diverging interests could result in, among other things, exposure to liabilities of the joint venture in excess of our proportionate share of these liabilities. The partition rights of each owner in a jointly-owned property could reduce the value of each portion of the divided property.
If we are unable to maintain effective disclosure controls and procedures and effective internal control over financial reporting, investor confidence and our stock price could be adversely affected.
Our management is responsible for establishing and maintaining effective disclosure controls and procedures and internal control over financial reporting. As previously disclosed, the Company identified certain material weaknesses in connection with the restatement of its financial statements and concluded that the Company’s disclosure controls and procedures and internal control over financial reporting were not effective at December 31, 2013 or December 31, 2014. The Company has remediated the material weaknesses as of December 31, 2015, however, there can be no guarantee as to the effectiveness of our disclosure controls and procedures and we cannot assure you that our internal control over financial reporting will not be subject to material weaknesses in the future. If we fail to maintain the adequacy of our internal controls over financial reporting and our operating internal controls, including any failure to implement required new or improved controls as a result of changes to our business or otherwise, or if we experience difficulties in their implementation, our business, results of operations and financial condition could be materially adversely affected and we could fail to meet our reporting obligations.
Government investigations relating to the findings of the Audit Committee Investigation may require time and attention from certain members of management, result in significant legal expenses, fines, and/or penalties, including indemnification obligations, and cause our business, financial condition, liquidity and results of operations to suffer.
On November 13, 2014, we received the first of two subpoenas relating to the findings of the Audit Committee Investigation from the staff of the SEC, each of which called for the production of certain 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 also 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 these matters. Subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees, among others in connection with the ongoing government investigations and potential future government inquiries, investigations or actions. These matters could require us to expend management time and could result in civil and criminal actions seeking, among other things, injunctions against us and the payment of significant fines and/or penalties, as well as requiring payment of substantial legal fees and indemnification obligations, and cause our business, financial condition, liquidity and results of operations to suffer. We can provide no assurance as to the outcome of any government investigation.
The Company and certain of our former officers and former and current directors, among others, have been named as defendants in various lawsuits related to the findings of the Audit Committee Investigation and those lawsuits may require time and attention from certain members of management, result in significant legal expenses and/or damages, including indemnification obligations, and may materially impact our business, financial condition, liquidity and results of operations.
Since the October 29, 2014 announcement of the findings of the Audit Committee Investigation and the subsequent restatement of the Company’s financial statements in March 2015, the Company and its former officers and current and former directors (along with others) have been named as defendants in 10 putative securities class action complaints in the United States District Court for the Southern District of New York, which were subsequently consolidated under the caption In re American Realty Capital Properties, Inc. Litigation, 1:15-mc-00040-AKH, multiple individual securities lawsuits and multiple derivative lawsuits. See “Note 15 - Commitments and Contingencies” to our consolidated financial statements for additional details regarding pending litigation matters related to the Audit Committee Investigation.
As a result of the various pending litigations related to the findings of the Audit Committee Investigation, we are obligated to advance certain legal expenses to and indemnify our current and former directors, officers and employees, as well as certain outside individuals and entities. In addition, any of these lawsuits may require management time and attention, result in significant legal expenses, indemnification obligations and/or damages and may materially impact the Company’s business, financial condition, liquidity and results of operations.
Our accounting policies and methods are fundamental to how we record and report our financial position and results of operations, and they require management to make estimates, judgments, and assumptions about matters that are inherently uncertain.
Our accounting policies and methods are fundamental to how we record and report our financial position and results of operations. We have identified several accounting policies as being critical to the presentation of our financial position and results of operations because they require management to make particularly subjective or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be recorded under different conditions or using different assumptions. Because of the inherent uncertainty of the estimates, judgments, and assumptions associated with these critical accounting policies, we cannot provide any assurance that we will not make subsequent significant adjustments to our consolidated financial statements. If our judgments, assumptions, and allocations prove to be incorrect, or if circumstances change, our business, financial condition, liquidity and results of operations could be adversely affected.
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 its 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. The FASB is expected to release a final standard in early 2016. 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 in general or desire to enter into leases 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. The new lease standard is expected to be effective for annual and interim periods beginning after December 31, 2018 for public companies.
We may not be able to maintain our competitive advantages if we are not able to attract and retain key personnel.
Our success depends to a significant extent on our ability to attract and retain key members of our executive team and staff. We underwent several changes in management in the past year. Our future success depends in part on the continued service of our senior management team. If there are further changes in senior leadership, such changes could be disruptive and could compromise our ability to execute our strategic plan. While we have entered into employment agreements with certain key personnel, there can be no assurance that we will be able to retain the services of individuals whose knowledge and skills are important to our businesses. Our success also depends on our ability to prospectively attract, integrate, train and retain qualified management personnel. Because the competition for qualified personnel is intense, costs related to compensation and retention could increase significantly in the future. If we were to lose a sufficient number of our key employees and were unable to replace them in a reasonable period of time, these losses could damage our business and adversely affect our results of 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 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 acquire properties or portfolios of properties through tax deferred contribution transactions, which could result in the dilution of our stockholders and unitholders, and limit our ability to sell or refinance such assets.
We have in the past and may in the future acquire properties or portfolios of properties through tax deferred contribution transactions in exchange for OP Units. Under the limited partnership agreement of the OP, as amended (the “LPA”), after holding the OP Units for a period of one year, unless otherwise consented to by the General Partner, holders of OP Units have a right to redeem the OP Units for the cash value of a corresponding number of shares of the General Partner’s common stock or, at the option of the General Partner, a corresponding number of shares of the General Partner’s common stock. This could result in the dilution of our stockholders and unitholders through the issuance of OP Units that may be exchanged for shares of our common stock. This acquisition structure may also have the effect of, among other things, reducing the amount of tax depreciation we could deduct over the tax life of the acquired properties, and may require that we agree to restrictions on our ability to dispose of, or refinance the debt on, the acquired properties in order to protect the contributors’ ability to defer recognition of taxable gain. Similarly, we may be required to incur or maintain debt we would otherwise not incur so we can allocate the debt to the contributors
to maintain their tax bases. These restrictions could limit our ability to sell or refinance an asset at a time, or on terms, that would be favorable absent such restrictions.
Risks Related to Financing
As a result of the delayed filing with the SEC of our Annual Report on Form 10-K for the year ended December 31, 2014, 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.
We did not file our Annual Report on Form 10-K for the year ended December 31, 2014 by March 2, 2015, the filing date required by the SEC. We are therefore not eligible to use a “short form” registration statement on Form S-3 to register the offer and sale of our securities until we have timely filed certain periodic reports required under the Exchange Act for 12 consecutive calendar months from the original filing due date. We have timely filed all of our periodic reports since our Annual Report on Form 10-K for the year ended December 31, 2014 and, assuming we continue to timely file our periodic reports, expect to be eligible to use a registration statement on Form S-3 beginning on April 1, 2016. Should we wish to register the offer and sale of our securities to the public before we have filed a registration statement 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.
We intend to 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 meet maturing obligations or make any additional investments.
In order to qualify as a REIT under the Internal Revenue Code, we are 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 refinance maturing obligations or make investments.
The capital and credit markets have experienced extreme volatility and disruption in recent years. Market volatility and disruption could hinder our ability to obtain new debt financing or refinance our maturing debt on favorable terms or at all or to raise debt and equity capital. Our access to capital will depend upon a number of factors, including:
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general market conditions;
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the market’s perception of our future growth potential;
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the extent of investor interest;
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analyst reports about us and the REIT industry;
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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;
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our financial performance and that of our tenants;
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our current debt levels;
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our current and expected future earnings;
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our cash flow and cash dividends, including our ability to satisfy the dividend requirements applicable to REITs; and
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the market price per share of our common stock.
If we are unable to obtain needed capital on satisfactory terms or at all, we may not be able to meet our obligations and commitments as they mature or make any additional investments.
We have substantial amounts of indebtedness outstanding, which may affect our ability to pay dividends, and may expose us to interest rate fluctuation risk and to the risk of default under our debt obligations.
As of December 31, 2015, our aggregate indebtedness was $8.1 billion. We may incur significant additional debt in the future for various purposes including, without limitation, the funding of future acquisitions, if any, capital improvements and leasing commissions in connection with the repositioning of a property and litigation expenses. At December 31, 2015, we had $1.84 billion of undrawn commitments under an unsecured credit facility (the “Credit Facility”) pursuant to a credit agreement, dated as of June 30, 2014, as amended, with Wells Fargo, National Association, as administrative agent, and other lenders party thereto (the “Credit Agreement”).
Payments of principal and interest on borrowings may leave us with insufficient cash resources to make the dividend payments necessary to maintain our REIT qualification or may otherwise impose restrictions on our ability to make distributions. Our substantial outstanding indebtedness, and the limitations imposed on us by our debt agreements, could have other significant adverse consequences, including as follows:
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our cash flow may be insufficient to meet our required principal and interest payments;
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we may be unable to borrow additional funds as needed or on satisfactory terms to fund future working capital, capital expenditures and other general corporate requirements, which could, among other things, adversely affect our ability to capitalize upon any acquisition opportunities or fund capital improvements and leasing commissions;
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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;
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we may violate restrictive covenants in our loan documents, which would entitle the lenders to accelerate our debt obligations;
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certain of the property subsidiaries’ loan documents may include restrictions on such subsidiary’s ability to make dividends to us;
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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;
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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;
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increasing our vulnerability to general adverse economic and industry conditions; and
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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 the Credit Facility), we may automatically be in default under any other loan or indenture that has cross-default provisions (including the Credit Facility), and (x) further borrowings under the Credit Facility will be prohibited, (y) outstanding indebtedness under the Credit Facility, our indenture or such other loans may be accelerated and (z) to the extent the Credit Facility, our indenture or such other loans are secured, directly or indirectly, by any properties or assets, lenders or trustees under the Credit Facility, our indenture or such other loans may foreclose on the collateral securing such indebtedness. As of December 31, 2015, we were in default on one non-recourse loan with a principal balance of $38.1 million due to our failure to pay a reserve payment required per the loan agreement. The default on the loan did not result in a cross default on our other indebtedness. Due to the default, we are currently accruing interest at the default rate of interest of 10.68% per annum. We are engaged with the servicer to complete foreclosure proceedings. For more information, see “Note 11 - Debt” to our consolidated financial statements.
In addition, increases in interest rates may impede our operating performance and payments of required debt service obligations or amounts due at maturity, or creation of additional reserves under loan agreements or indentures could adversely affect our financial condition and operating results. Further, 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 Internal Revenue Code.
The indenture governing our Senior Notes and the Credit Agreement contain restrictive covenants that limit our operating flexibility.
The indenture governing our Senior Notes and the Credit Agreement require us to meet customary negative covenants and other financial and operating covenants. The indenture governing our Senior Notes requires us to maintain financial ratios for total leverage, secured debt, debt service coverage and total unencumbered assets. In addition, the Credit Agreement requires us, among other things, to maintain a minimum tangible net worth, a maximum leverage ratio, minimum fixed charge coverage ratio, a secured leverage ratio, a total unencumbered asset value ratio, a minimum encumbered interest coverage ratio and a minimum encumbered asset value. These covenants restrict our ability to incur secured or unsecured indebtedness and may also restrict our ability to engage in certain business activities.
Our ability to comply with these and other provisions of the indenture governing our Senior Notes and the Credit Agreement 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 covenants would constitute a default under the indenture governing our Senior Notes and/or the Credit Agreement, as applicable, and would prevent
further borrowings under the Credit Agreement 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.
Our organizational documents have no limitation on the amount of indebtedness that we may incur. As a result, we may become even more 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 real estate investment ratio of approximately 45% to 55%, provided that we may exceed this amount for individual properties in select cases where attractive financing is available, our organizational documents contain no limitations on the amount of debt that we may incur. Further, our financing decisions and related decisions regarding levels of debt may be determined by our Board of Directors in its discretion without stockholder approval. As a result, we may be able to incur substantial additional debt, including secured debt, in the future, subject to us meeting the financial and operating covenants described above, which could result in us becoming highly leveraged and adversely affecting our financial condition.
Increases in interest rates would increase our debt service obligations and may adversely affect the refinancing of our existing debt and our ability to incur additional debt, which could adversely affect our financial condition.
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 our capital stock and could accordingly adversely affect our financial condition.
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. 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 any 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 before maturity. Our ability to refinance our indebtedness or obtain additional financing will depend on, among other things:
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our financial condition and market conditions at the time; and
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restrictions in the agreements governing our indebtedness.
As a result, we may not be able to refinance 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 any strategic acquisitions and alliances or capital expenditures, any of which could have a material adverse effect on our operations.
Adverse changes in our credit ratings could affect our borrowing capacity and borrowing terms.
Our Senior Notes are periodically rated by nationally recognized credit rating agencies. Our current corporate credit rating is “BB” and our issue-level rating for our Senior Notes is “BB+” with a “stable” outlook from Standard & Poor’s Rating Services. Our corporate credit and issue-level ratings for our Senior Notes were downgraded by Moody’s Investor Service, Inc. to “Ba1” with a “negative” outlook in December 2014. There can be no assurance that our ratings will not be downgraded further. The credit ratings are based on our operating performance, liquidity and leverage ratios, overall financial position, and other factors viewed by the credit rating agencies as relevant to our industry and the economic outlook in general. Our credit ratings can adversely affect the cost and availability of capital, as well as the terms of any financing we obtain. Since we depend in part on debt financing to fund our business, an adverse change in our credit ratings could have a material adverse effect on our financial condition, liquidity, results of operations and the trading price of the notes.
Risks Relating to our REI Segment
Uninsured losses or losses in excess of our insurance coverage could materially 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 select 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. There can be no assurance, however, that the insured limits on any particular policy will adequately cover an insured loss if one occurs. 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, 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.
Further, 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. If we experience 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. In addition, 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. As a result of any of the situations described above, our financial condition and cash flows may be materially and adversely affected.
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. 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.
Although all of our properties were 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.
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 and interest rate levels. 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.
We are subject to risks relating to real estate-related securities, including commercial mortgage backed securities (“CMBS”).
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 may be 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 or that income from collateral may be insufficient to meet 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 obliged parties to repay principal and interest or make distribution payments.
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 the risks listed above and all of the risks of the underlying mortgage loans. CMBS are issued by investment banks and non-regulated financial institutions, and are not insured or guaranteed by the U.S. government. The value of CMBS may 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 and may be negatively impacted by any dislocation in the mortgage-backed securities market in general.
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.
Our build-to-suit program is subject to additional risks related to properties under development.
We engage in build-to-suit programs and the 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 generally 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 also engage in development and construction activities involving existing properties, including the expansion of existing facilities (typically at the request of a tenant) or the development or build-out of vacant space at retail properties. We may advance significant amounts in connection with certain development projects.
As a result, we are subject to potential development risks and construction delays and the resultant increased costs and risks, as well as the risk of loss of certain amounts that we have advanced should a development project not be completed. To the extent that we engage in development or construction projects, we may be subject to uncertainties associated with obtaining permits or 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 developer or builder fails to perform, we may terminate the purchase, modify the construction contract or resort to legal action to compel performance (or in certain cases, we may elect to take over the project and pursue completion of the project ourselves). A developer’s or builder’s performance may also be affected or delayed by conditions beyond that party’s control. Delays in obtaining permits or 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 the loss of our investment. Although we rarely engage in construction activities relating to space that is not already leased to one or more tenants, to the extent that we do so, we may 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 a newly developed property, there is a risk that money advanced to that development company for the project may not be fully recoverable if the developer fails to successfully complete the project.
Risks Relating to our Cole Capital Segment
We may be unable to fully reestablish the distribution network which previously supported Cole Capital and its Managed REITs and/or regain the prior capital raising level of Cole Capital, which may adversely affect the financial success of Cole Capital and the Company.
Three of the four Managed REITs currently sponsored and managed by Cole Capital have ongoing initial public offerings. Following the announcement made by the Company on October 29, 2014 that certain of its financial statements could no longer be relied upon, various broker-dealers and clearing firms participating in offerings of Cole Capital’s Managed REITs suspended sales activity with Cole Capital, resulting in a significant decrease in capital raising activity and, consequently, a decline in the overall revenue generated by Cole Capital.
Cole Capital generates revenue from capital raising activity and asset management and advisory activity, the latter of which is also contingent upon successful capital raising activity as each of the Managed REITs is a blind pool whose portfolio is largely built through the deployment of proceeds raised in the respective Managed REIT’s public offering. Revenue generated from Cole Capital’s capital raising activity is received in the form of dealer manager fees, which are earned at the point of sale of the Managed REITs’ common stock and, therefore, a reduction in capital raising activity directly results in a reduction in such dealer manager fees. Cole Capital receives additional compensation, including one-time acquisition fees and ongoing advisory fees from its asset management and advisory activity. Acquisition fees are earned, in large part, when Cole Capital deploys capital raised from a Managed REIT’s public offering into real estate acquisitions on behalf of such Managed REIT. Cole Capital also receives advisory fees that are calculated based upon the value of each Managed REIT’s total invested assets. An increase in assets under management, which generally occurs as the Managed REITs raise more capital, results in increased advisory fees. Additional fees may be earned by Cole Capital following the completion of a Managed REIT’s public offering and deployment of capital therefrom and, therefore, a slowdown in capital raising activity could delay or reduce Cole Capital’s receipt of those additional fees. A description of Cole Capital’s fees is contained in “Note 18 - Related Party Transactions and Arrangements” to our consolidated financial statements. While the Company has completed the Restatement and has become current in its filings with the SEC, and certain of the broker-dealers and the clearing firms have reengaged with Cole Capital, there can be no assurance that the remaining broker-dealers participating in the public offerings of the Managed REITs will reengage with Cole Capital on a timely basis or at all. If these circumstances continue for a prolonged period of time, capital raising activity at Cole Capital will continue to be negatively affected, reducing overall fee generation at Cole Capital and, therefore, the overall financial success of Cole Capital and the Company could be adversely affected.
In addition, there is no guarantee as to the Cole Capital segment’s actual results. The fair value of goodwill and intangible assets allocated to the Cole Capital segment are dependent upon actual results, including, but not limited to, the timing and aggregate amount of capital raised and deployed on behalf of the Managed REITs, which is influenced by the Company’s ability to reinstate certain selling agreements that were suspended as a result of the Audit Committee Investigation and the Restatement. If the Company is unable to reinstate certain selling agreements with broker-dealers and clearing firms on a timely basis, the fair value of goodwill and intangible assets allocated to the Cole Capital segment may be less than the respective carrying value, resulting in an impairment that could have a material adverse effect on the Company’s financial results. In addition, the actual timing of closing an offering or executing a liquidity event on behalf of a Managed REIT or the commencement of operations of newly formed REITs, which are not yet effective, may differ from the Company’s assumptions used at October 1, 2015.
During the quarter ended December 31, 2015, we recorded significant impairment charges in respect of goodwill and intangible assets allocated to the Cole Capital segment. We reassessed the expected collectability of the program development costs, based on assumptions used to calculate these impairments, and recorded additional reserves in the quarter ended December 31, 2015. Additional reserves may be recorded in subsequent periods if actual proceeds raised from the offerings and corresponding program development costs incurred differ from management’s assumptions used at December 31, 2015.
Cole Capital is subject to risks that are particular to its role as sponsor and dealer manager for direct investment program offerings.
Cole Capital, including Cole Capital Corporation, which is Cole’s broker-dealer subsidiary and 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:
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the volatility of financial markets;
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extensive governmental regulation;
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intense competition; and
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litigation.
Cole Capital’s business, which involves sponsoring and distributing interests in direct investment programs, depends 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 each 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 events 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 the Managed REITs also involves risks relating to the possibility that such programs will not receive capital at the levels and timing that are anticipated, that sufficient capital will not be raised to repay investments of cash in, and loans to, the Managed REITs needed to meet up-front costs, and that, as a result, the initial breaking of escrow and the acquisition of properties will not occur or continue, as well as risks relating to competition from sponsors of other similar programs.
FINRA rules applicable to the Managed REITs’ business, including Rule 2310 (Direct Participation Programs) which, among other things, imposes limits on total compensation to brokers in connection with an offering, and amendments to Rule 2340 (Customer Account Statements) which, when effective, will change the manner in which the value of shares in a Managed REIT are reflected on customer account statements, as well as FINRA investigations into the manner in which shares are sold by some retail brokers, may have a negative impact on the business of Cole Capital.
In addition, Cole Capital is subject to risks that are particular to its function as a wholesale broker-dealer and sponsor of the Managed 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 Cole Capital acting as a sponsor of the Managed REITs and the volume of materials that Cole Capital Corporation may provide throughout the course of an offering, much of Cole Capital’s activities 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.
Cole Capital Corporation, 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. If Cole Capital Corporation is not able to maintain adequate net capital, or its net capital falls below requirements established by the SEC, it may be subject to disciplinary action in the form of fines, censure, suspension, expulsion or the termination of business altogether. In addition, if 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 Cole Capital’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.
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. 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. Cole Capital Corporation 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 Cole Capital Corporation’s business, including through the potential implementation of a more stringent fiduciary standard for brokers and enhanced regulatory oversight over incentive compensation.
The Cole Capital segment also may be adversely affected by other evolving regulatory standards, such as those relating to suitability and supervision. Legal claims or regulatory actions against Cole Capital Corporation or any of the other entities that comprise Cole Capital also could have adverse financial effects on us or harm our reputation, which could harm our business prospects.
Cole Capital Corporation, 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 Cole Capital Corporation 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, 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. Cole Capital Corporation has established AML programs, which we subject to periodic third-party testing, but there can be no assurance of the effectiveness of these programs. Failure to comply with AML requirements could subject Cole Capital Corporation 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 Cole Capital Corporation to fines and penalties, as well as to civil action by affected parties.
We are subject to conflicts of interest relating to Cole Capital’s investment management business.
Cole Capital currently manages four Managed REITs which have investment objectives and investment strategies similar to our own. As a result, we may be seeking to acquire properties and real estate-related investments at the same time as the Managed REITs. In addition, certain of our officers are also officers of the Managed REITs and, as such, they will have duties to us as well as to the Managed REITs. We have implemented certain procedures to help manage any perceived or actual conflicts among us and the Managed REITs, including adopting an allocation policy to allocate property acquisitions among us and the Managed REITs based on the following factors:
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the investment objective of each entity;
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the anticipated operating cash flows of each entity and the cash requirements of each entity;
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the effect of the potential acquisition both on diversification of each entity’s investments by type of property, geographic area and tenant concentration;
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the amount of funds available to each entity and the length of time such funds have been available for investment;
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the policy of each entity relating to leverage of properties;
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the income tax effects of the purchase to each entity; and
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the size of the investment.
If we determine that an investment opportunity may be equally appropriate for more than one entity, then the entity that has had the longest period of time elapse since it was allocated an investment opportunity of a similar size and type (e.g., office, industrial, multi-tenant or single tenant retail) will first be offered such investment opportunity. In addition, we have a right of first refusal over two of the Managed REITs with respect to all opportunities to acquire majority single-tenant real estate and real estate-related assets or portfolios with a purchase price greater than $100.0 million. There can be no assurance that these policies will be adequate to address all of the conflicts that may arise or will address such conflicts in a manner that is favorable to us.
Further, under the advisory agreements with the Managed REITs, Cole Capital receives fees for various services, including, but not limited to, the day-to-day management of the Managed REITs and transaction-related services. The terms of these advisory agreements were not the result of arm’s length negotiations between independent parties and as a result, the terms of these agreements may not be as favorable to us as they would have been if we had negotiated these agreements with unaffiliated third parties.
Because the revenue streams from the advisory agreements Cole Capital has with the Managed REITs are subject to limitation or cancellation, any such termination could have an adverse effect on our business, results of operations and financial condition.
The advisory agreements under which Cole Capital provides services to the Managed REITs are subject to renewal on an annual basis and may generally be terminated by each Managed REIT upon 60 days’ notice to us, with or without cause. The advisory agreements with each of the four Managed REITs are scheduled to expire on November 30, 2016, unless otherwise renewed. There can be no assurance that these agreements will not expire or be otherwise terminated and any such termination could have an adverse effect on our business, financial condition and results of operations.
Risks Related to our Organization and Structure
We are a holding company with no direct operations. As a result, we rely on funds received from the Operating Partnership to pay liabilities and dividends, our stockholders’ claims will be structurally subordinated to all liabilities of the Operating Partnership and our stockholders do not have any voting rights with respect to the Operating Partnership’s activities, including the issuance of additional OP Units.
We are a holding company and conduct all of our operations through the Operating Partnership. We do not have, apart from our ownership of the Operating Partnership, any independent operations. As a result, we rely on distributions from the Operating Partnership to pay any dividends we might declare on shares of our common stock. We also rely on distributions from the Operating Partnership to meet our debt service and other obligations, including our obligations to make distributions required to maintain our REIT qualification. The ability of subsidiaries of the Operating Partnership to make distributions to the Operating Partnership, and the ability of the Operating Partnership to make distributions to us in turn, will depend on their operating results and on the terms of any loans that encumber the properties owned by them. Such loans may contain lockbox arrangements, reserve requirements, financial covenants and other provisions that restrict the distribution of funds. In the event of a default under these loans, the defaulting subsidiary would be prohibited from distributing cash. As a result, a default under any of these loans by the borrower subsidiaries could cause us to have insufficient cash to make distributions on our common stock required to maintain our REIT qualification.
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 the 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 the Operating Partnership’s and its subsidiaries’ liabilities and obligations have been paid in full.
As of December 31, 2015, we owned approximately 97.4% of the OP Units in the Operating Partnership. However, the Operating Partnership may issue additional OP Units in the future. Such issuances could reduce our ownership percentage in the Operating Partnership. Because our stockholders would not directly own any such OP Units, they would not have any voting rights with respect to any such issuances or other partnership-level activities of the Operating Partnership.
Our charter and bylaws 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. In addition, 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 the Board of Directors. The ownership limits and the other restrictions on ownership and transfer of our stock and the Board approval requirements 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.
The Board of Directors may create and issue a class or series of common or preferred stock without stockholder approval.
Subject to applicable legal and regulatory requirements, the 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. The 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. In addition, future sales of shares of our common stock or preferred stock may be dilutive to existing stockholders.
The change of control conversion feature of the Series F Preferred Stock may make it more difficult for a party to take over the Company or discourage a party from taking over the Company.
Upon the occurrence of a change of control (as defined in the Articles Supplementary for the Series F Preferred Stock) the result of which is that our common stock or the common securities of the acquiring or surviving entity are not listed on a national stock exchange, holders of the Series F Preferred Stock will have the right (unless, prior to the change of control conversion date, we have provided or provide notice of our election to redeem the Series F Preferred Stock) to convert some or all of their Series F Preferred Stock into shares of our common stock (or equivalent value of alternative consideration). The change of control
conversion feature of the Series F Preferred Stock may have the effect of discouraging a third party from making an acquisition proposal for the Company or of delaying, deferring or preventing certain change of control transactions of the Company under circumstances that stockholders may otherwise believe are in their best interests.
Certain provisions in the LPA may delay, defer or prevent unsolicited acquisitions of us.
Certain provisions in the LPA may delay or make more difficult unsolicited acquisitions of us or changes in our control. These provisions could discourage third parties from making such proposals, although some stockholders might consider such proposals, if made, desirable. These provisions include, among others:
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redemption rights of qualifying parties;
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the ability of the General Partner in some cases to amend the LPA without the consent of the limited partners;
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the right of the limited partners to consent to transfers of the general partnership interest of the General Partner and mergers or consolidations of the Company under specified limited circumstances; and
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restrictions relating to our qualification as a REIT under the Internal Revenue Code.
The LPA also contains other provisions that may have the effect of delaying, deferring or preventing 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 ARC Real Estate Partners, LLC, an affiliate of the Former Manager, to indemnify it against any adverse tax consequences if we were to sell, convey, transfer or otherwise dispose of all or any portion of the interests in the properties that were acquired by us in the formation transactions, in a taxable transaction. 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 one or more of these properties, it may be economically disadvantageous for us to do so because of these obligations. We have also agreed to make debt available for ARC Real Estate Partners, LLC to guarantee. We agreed to these provisions at the time of our IPO in order to assist ARC Real Estate Partners, LLC 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.
The Company’s fiduciary duties as sole general partner of the Operating Partnership could create conflicts of interest.
The Company has fiduciary duties to the Operating Partnership and the limited partners in the Operating Partnership, the discharge of which may conflict with the interests of its stockholders. The LPA provides that, in the event of a conflict between the duties owed by the Company’s directors to the Company and the duties that the Company owes in its capacity as the sole general partner of the Operating Partnership to the Operating Partnership’s limited partners, the Company’s directors are under no obligation to give priority to the interests of such limited partners. As a holder of OP Units, the Company will have the right to vote on certain amendments to the LPA (which require approval by a majority in interest of the limited partners, including the Company) and individually to approve certain amendments that would adversely affect the rights of the Operating Partnership’s limited partners, as well as the right to vote on mergers and consolidations of the Company in its 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 the Company’s stockholders. For example, the Company cannot adversely affect the limited partners’ rights to receive distributions, as set forth in the LPA, without their consent, even though modifying such rights might be in the best interest of the Company’s stockholders generally.
The 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 the 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, liquidity and results of operations and our ability to satisfy our debt service obligations and to make distributions to our stockholders and unitholders.
Our rights and the rights of our stockholders to take action against our directors and officers are limited under Maryland law.
Maryland law provides that a director or officer has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. In addition, Maryland law permits a Maryland corporation to include
in its charter a provision limiting the liability of its directors and officers to the corporation and its stockholders for money damages except for liability resulting from (1) actual receipt of an improper benefit or profit in money, property or services or (2) active and deliberate dishonesty established by a final judgment as being material to the cause of action. Our charter contains such a provision and limits the liability of our directors and officers to the maximum extent permitted by Maryland law. Maryland law requires us to indemnify our directors and officers for liability actually incurred in connection with any proceeding to which they may be made, or threatened to be made, a party, except to the extent that the act or omission of the director or officer was material to the matter giving rise to the proceeding and was either committed in bad faith or was the result of active and deliberate dishonesty, the director or officer actually received an improper personal benefit in money, property or services, or, in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. In addition, our charter obligates us to advance the reasonable defense costs incurred by our directors and officers. Finally, we have entered into agreements with our directors and officers pursuant to which we have agreed to indemnify them to the maximum extent permitted by Maryland law.
U.S. Federal Income and Other 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 capital stock.
We elected to be taxed as a REIT commencing with the taxable year ended December 31, 2011 and believe we have operated, and intend to operate, in a manner that has allowed us to qualify as a REIT and will allow us to continue to qualify as a REIT. However, we may terminate our REIT qualification if the 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 the 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. Accordingly, we cannot be certain that we have been or will be successful in qualifying to be taxed 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 annual income and 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 Internal Revenue Service (the “IRS”), such recharacterization would jeopardize our ability to satisfy the requirements for qualification as a REIT. Furthermore, future legislative, judicial or administrative changes to the U.S. federal income tax laws could result in our disqualification as a REIT for past or future periods.
If we fail 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 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 and, accordingly, distributions the Operating Partnership makes to its unitholders could be similarly reduced. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax.
Even if we continue to qualify as a REIT, in certain circumstances, we may incur tax liabilities that would reduce our cash available for distribution to our stockholders and unitholders.
Even if we continue to qualify as a REIT, we may be subject to U.S. federal, state and local income taxes. For example, net income from the sale of properties that are considered held for sale and not for investment (a “prohibited transaction” under the Internal Revenue Code) will be subject to a 100% tax. In addition, we may not make sufficient distributions to avoid income and excise taxes on retained income. We also may decide to retain net capital gain we earn from the sale or other disposition of our property or other assets and pay U.S. federal income tax directly on such income. In that event, our stockholders would be treated for federal income tax purposes 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 may, in certain circumstances, be required to pay an excise or penalty tax (which could be significant in amount) in order to utilize one or more relief provisions under the Internal Revenue Code to maintain our qualification as a REIT.
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 of the REIT. 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 advisory agreements with the Managed REITs. 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 their taxable income. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to ensure that the TRS is subject to an appropriate level of corporate taxation. These rules 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.
Not all taxing jurisdictions recognize the favorable tax treatment afforded to REITs under the Internal Revenue Code. As such, we may be subject to regular corporate net income taxes in certain state, local or foreign taxing jurisdictions. In addition, we, the Operating Partnership, our TRSs, and/or other entities through which we conduct our business may also be subject to state, local or foreign income, franchise, sales, transfer, excise or other taxes. Any taxes that we incur directly or indirectly will reduce our cash available for distribution to our stockholders and unitholders. Additionally, changes in state, local or foreign tax law could reduce the cash flow from certain investments made by us and could make such investments less attractive to potential buyers when we seek to liquidate such investments.
To qualify as a REIT we must meet annual distribution 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 your 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 U.S. 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 or make taxable stock dividends. Although we intend to make distributions sufficient to meet the annual distribution 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.
If the Operating Partnership or certain other subsidiaries fail to qualify as a partnership or are not otherwise disregarded for U.S. federal income tax purposes, then we would cease to qualify as a REIT.
We intend to maintain the status of the Operating Partnership as a partnership for U.S. federal income tax purposes. However, if the IRS were to successfully challenge the status of the Operating Partnership as a partnership for such purposes, it would be taxable as a corporation. This would result in our failure to qualify as a REIT and would cause us to be subject to a corporate-level tax on our income. This would substantially reduce our cash available to pay distributions and the yield on your investments. In addition, if one or more of the partnerships or limited liability companies through which the 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, then it would be subject to taxation as a corporation, thereby reducing distributions to the Operating Partnership. Such a recharacterization of a subsidiary entity could also threaten our ability to maintain our REIT qualification.
Dividends payable by REITs generally do not qualify for the reduced tax rates available for some dividends.
Currently, the maximum U.S. federal income tax rate applicable to qualified dividend income payable to U.S. stockholders that are individuals, trusts and estates is 20% (not including the net investment income tax). 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 have actually or constructively paid a “preferential dividend” to certain of our stockholders, our status as a REIT could be adversely affected.
For our taxable years that ended on or before December 31, 2014, in order for our distributions to be counted as satisfying the annual distribution requirements for REITs, and to provide us with a REIT-level tax deduction, the distributions could not have been “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. 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. 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 or reasonable cause exception with respect to preferential dividends under the Internal Revenue Code. 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 and for the four taxable years following the year of termination 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 Internal Revenue 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 or to offset certain other positions, 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 one or 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, qualified real estate assets and stock of a TRS) 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, qualified real estate assets and stock of a TRS) can consist of the securities of any one issuer, no more than 25% (20% for taxable years beginning after December 31, 2017) of the value of our total assets can be represented by securities of one or more TRSs and no more than 25% of the value of our total assets can be represented by certain debt securities of publicly offered REITs. 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 distribution to our stockholders.
Re-characterization of sale-leaseback transactions may cause us to lose our REIT status.
We may purchase properties and lease them back to the sellers of such properties. The Internal Revenue Service could challenge our characterization of certain leases in any such sale-leaseback transactions as “true leases,” which allows us to be treated as the owner of the property for U.S. federal income tax purposes. In the event that any sale-leaseback transaction is challenged and re-characterized as a financing transaction or loan for U.S. federal income tax purposes, deductions for depreciation and cost recovery relating to such property would be disallowed. If a sale-leaseback transaction were so re-characterized, we might fail to satisfy the REIT qualification “asset tests” or the “income tests” and, consequently, lose our REIT status effective with the year of re-characterization. Alternatively, such a recharacterization could cause the amount of our REIT taxable income to be recalculated, which might also cause us to fail to meet the distribution requirement for a taxable year and thus lose our REIT status.
We may incur adverse tax consequences if ARCT III, CapLease, ARCT IV or Cole failed to qualify as a REIT for U.S. federal income tax purposes.
If any of ARCT III, CapLease, ARCT IV or Cole failed to qualify as a REIT for U.S. federal income tax purposes at any time prior to such entity’s merger with us, we may inherit significant tax liabilities and could fail to qualify as a REIT.
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 capital 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 you that any such changes will not adversely affect our taxation and our
ability to qualify as a REIT or 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.
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 regular corporation. As a result, our charter provides the 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. The 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.
Non-U.S. stockholders may be subject to U.S. federal withholding tax and may be subject to U.S. federal income tax upon the disposition of our shares.
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 “U.S. real property interest” (“USRPI”) under the Foreign Investment in Real Property Tax Act of 1980 (the “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 that we are a domestically-controlled qualified investment entity. However, because our common stock is and will be publicly traded, no assurance can be given that we are or 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, 10% or less of our common stock at any time during the five-year period ending on the date of the sale. 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. We encourage you to consult your tax advisor to determine the tax consequences applicable to you if you are a non-U.S. stockholder.
Our property taxes could increase due to property tax rate changes or reassessment, which would impact our cash flows.
Even if we qualify as a REIT for federal income tax purposes, we will be required to pay some state and local taxes on our properties. The real property taxes on our properties may increase as property tax rates change or as our properties are assessed or reassessed by taxing authorities. Therefore, the amount of property taxes we pay in the future may increase substantially. If the property taxes we pay increase and if any such increase is not reimbursable under the terms of our lease, then our cash flows will be impacted, and our ability to pay expected distributions to our stockholders and unitholders could be adversely affected.
The share ownership restrictions of the Internal Revenue 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 Internal Revenue 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 Internal Revenue 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 the 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 Internal Revenue 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. The Board of Directors, in its sole discretion and upon receipt of certain representations and undertakings, may exempt a person (prospectively or retrospectively) from the ownership limits. However, the Board of Directors may not, among other limitations, grant an exemption from these ownership restrictions to any proposed transferee whose ownership, direct or indirect, 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 the 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 our stockholders.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
Our principal corporate offices are located at 2325 E. Camelback Road, Suite 1100, Phoenix, Arizona 85016. We have additional office space in New York, New York; Orlando, Florida; Austin, Texas; Glenview, Illinois; and Alpharetta, Georgia. We lease all of these offices and believe these leases are suitable for our operations for the foreseeable future.
As of December 31, 2015, we owned 4,435 properties, comprised of 99.6 million square feet located in 49 states, the District of Columbia, Puerto Rico and Canada. Our properties were 98.6% leased with a weighted-average remaining lease term of 10.6 years. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Real Estate Portfolio Metrics for a discussion of the properties we hold for rental operations and Schedule III - Real Estate and Accumulated Depreciation for a detailed listing of such properties.
Item 3.
Item 3. Legal Proceedings.
The information contained under the heading “Litigation” in “Note 15 - Commitments and Contingencies” to our consolidated financial statements is incorporated by reference into this Part I, Item 3. Except as set forth therein, as of the end of the period covered by this Annual Report on Form 10-K, we are not a party to, and none of our properties are subject to, any material pending legal proceedings.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Effective July 31, 2015, we transferred the listing of the General Partner’s common stock and Series F Preferred Stock to the NYSE from NASDAQ Global Select Market (“NASDAQ”). The General Partner’s common stock and Series F Preferred Stock now trade under the trading symbols, “VER” and “VER PRF,” respectively.
Stock Price Performance Graph
Set forth below is a line graph comparing the cumulative total stockholder return on the General Partner’s 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 All Equity REITs Index (“FTSE NAREIT All Equity REITs”) and the S&P 500 Index (“S&P 500”) for the period commencing September 6, 2011, the date of our initial public offering (the “IPO”), and ending December 31, 2015. The graph assumes an investment of $100 on September 6, 2011.
The graph above and the accompanying text are not “soliciting material,” are not deemed filed with the SEC and are not to be incorporated by reference in any filing by us under the Securities Act or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing. In addition, the stock price performance in the graph above is not indicative of future stock price performance.
Distributions
For each quarter indicated, the following table reflects the respective high and low sales prices for the General Partner’s common stock as quoted by NASDAQ or NYSE, as applicable, and the dividend or distribution declared per share of common stock or OP Unit by the General Partner or the Operating Partnership, respectively, in each such period:
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(1)
We agreed to suspend the payment of dividends on the General Partner’s common stock until the Company complied with certain periodic financial reporting and related requirements in connection with the amendments to the Credit Facility. On March 30, 2015, the Company satisfied these periodic financial reporting and related requirements. On August 5, 2015, the Board of Directors authorized the reinstatement of a dividend on our common stock.
(2)
The dividend that the General Partner pays on its common stock is equal to the distributions that the Operating Partnership makes on its OP Units pursuant to the terms of the LPA. However, the Operating Partnership did not make distributions in respect of a substantial portion of the outstanding OP Units held by its limited partners on October 15, 2015 and January 15, 2016 when the dividend on the General Partner’s common stock was paid, as further discussed in “Note 16 - Equity” in our consolidated financial statements.
On February 23, 2016, our Board of Directors declared a quarterly cash dividend of $0.1375 per share of common stock (equaling an annualized dividend rate of $0.55 per share) for the first quarter of 2016 to stockholders of record as of March 31, 2016, which will be paid on April 15, 2016. The Operating Partnership will make an equivalent distribution per OP Unit. Our future distributions may vary and will be determined by the General Partner’s Board of Directors upon the circumstances prevailing at the time, including our financial condition, operating results, estimated taxable income and REIT distribution requirements, and may be adjusted at the discretion of the Board.
As of February 19, 2016, the General Partner had approximately 4,500 registered stockholders of record of its common stock. This figure does not reflect the beneficial ownership of shares held in nominee name. There is no established trading market for the Operating Partnership's OP Units. As of February 19, 2016, there were 30 record holders of the OP Units.
Recent Sales of Unregistered Securities
Neither the General Partner nor the Operating Partnership sold any of their securities that were not registered under the Securities Act during the year ended December 31, 2015.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table shows the amount of securities remaining available for future issuance under our equity compensation plans as of December 31, 2015:
See “Note 17 - Equity-based Compensation” to our consolidated financial statements for a discussion of the Company’s equity plans.
Repurchases of Equity Securities
We are authorized to repurchase shares of the General Partner’s common stock to satisfy employee withholding tax obligations related to stock-based compensation. During the fourth quarter of 2015, the General Partner and the Operating Partnership repurchased the following shares of common stock and corresponding OP Units that were issued to the General Partner, respectively, in order to satisfy the minimum tax withholding obligation for state and federal payroll taxes on employee stock awards:
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(1) With respect to these shares, the price paid per share is based on the fair value at the time of vesting.
Item 6.
Item 6. Selected Financial Data.
The following selected financial data should be read in conjunction with the accompanying consolidated financial statements and related notes thereto and “Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this report entitled “Forward-Looking Statements.” Certain risks may cause our actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. For a discussion of such risk factors, see the section in this report entitled “Risk Factors.”
Overview
We are a full-service real estate operating company that operates through two business segments, our real estate investment segment, REI, and our investment management segment, Cole Capital, as further discussed in “Note 4 - Segment Reporting” to our consolidated financial statements. Through our REI segment, we own and actively manage a diversified portfolio of 4,435 retail, restaurant, office and industrial real estate properties with an aggregate of 99.6 million square feet, of which 98.6% was leased as of December 31, 2015, with a weighted-average remaining lease term of 10.6 years. Through our Cole Capital segment, we are responsible for raising capital for and managing the affairs of the Managed REITs on a day-to-day basis, identifying and making acquisitions and investments on behalf of the Managed REITs, and recommending to the respective board of directors of each of the Managed REITs an approach for providing investors with liquidity. Cole Capital receives compensation and reimbursement for performing these services. As of December 31, 2015, the Managed REITs and other real estate programs’ assets under management were $6.7 billion.
Restatement
The Company restated its consolidated financial statements and related financial information for the fiscal years ended December 31, 2013 and 2012 and the interim periods ended March 31, 2014 and 2013, June 30, 2014 and 2013 and September 30, 2013 and the Operating Partnership restated and amended its consolidated financial statements and related financial information as of and for the years ended December 31, 2013 and 2012 and the interim periods ended June 30, 2014 and 2013. For a discussion of reconciliations of originally reported amounts to the corresponding restated amounts, see one of the following filings made with the SEC on March 2, 2015: Amendment No. 2 to our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2013 or our Quarterly Reports on Form 10-Q/A for the quarterly periods ended March 31, 2014 and June 30, 2014. See “Note 1 - Organization” to the consolidated financial statements in this report for further explanation. The following discussion and analysis of our financial condition and results of operations is based on the restated amounts.
Mergers and Major Acquisitions
See “Note 3 - Mergers with Real Estate Businesses” to our consolidated financial statements for a discussion of the mergers consummated during the years ended December 31, 2014 and 2013 with American Realty Capital Trust III, Inc., CapLease, Inc., American Realty Capital Trust IV, Inc. and Cole Real Estate Investments, Inc.
Our Business Environment and Current Outlook
Current conditions in the global capital markets remain volatile as the world’s economic growth has been affected by geopolitical and economic events. In the United States, the overall economic environment continued to improve in 2015. The U.S. gross domestic product increased to 2.4% in 2015 and unemployment decreased 0.6% during 2015 to 5.0% for December 2015. In 2015, the Federal Reserve raised interest rates for the first time since 2006. In addition, cross-border investors deployed record levels of capital into the U.S. in 2015, increasing by more than 150% over 2014.
Economic trends and government policies affect global and regional commercial real estate markets as well as our operations directly. These include: overall economic activity and employment growth, interest rate levels, the cost and availability of credit and the impact of tax and regulatory policies.
Critical Accounting Policies and Significant Accounting Estimates
Our accounting policies have been established to conform with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires us to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Management believes that we have made these estimates and assumptions in an appropriate manner and in a way that accurately reflects our financial condition. We continually test and evaluate these estimates and assumptions using our historical knowledge of the business, as well as other factors, to ensure that they are reasonable for reporting purposes. However, actual results may differ from these estimates and assumptions. If our judgment or interpretation of the facts and circumstances relating to the various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses. We believe the following critical accounting policies govern the significant judgments and estimates used in the preparation of our financial statements, which should be read in conjunction with the more complete discussion of our accounting policies and procedures included in “Note 2 - Summary of Significant Accounting Policies” to our consolidated financial statements.
Goodwill Impairment
We evaluate goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate the carrying value, by reporting unit, may not be recoverable. The risks and uncertainties involved in applying the principles related to goodwill impairment include, but are not limited to, the following:
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We estimate the fair value of the reporting units, which we have determined is the same as our reportable segments, using discounted cash flows and relevant competitor multiples.
•
We monitor factors that may impact the fair value including market comparable company multiples, interest rates and global economic conditions.
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We use a combined income and market approach in evaluations for potential impairment, which requires management to make key assumptions related to revenue growth rate, cash flow assumptions, discount rate and selection of comparable companies.
See Note 10 - Fair Value Measures for discussion regarding our sensitivity analysis performed around these assumptions.
Intangible Asset Impairment
The Company evaluates intangible assets for impairment when an event occurs or circumstances change that indicate the carrying value may not be recoverable. The risks and uncertainties involved in applying the principles related to intangible impairment include, but are not limited to, the following:
•
We estimate fair value using a discounted cash flow model specific to the applicable Managed REITs.
•
We monitor factors that could impact fair value including the ability to timely reinstate certain selling agreements, timing of and aggregate capital raised and deployed on behalf of the Managed REITs, the actual timing of closing an offering or executing a liquidity event on behalf of a Managed REIT and operations of future managed real estate programs.
•
We utilized the income approach in evaluation for impairment, which requires management to make key assumptions related to future cash flows and a discount rate.
See Note 10 - Fair Value Measures for discussion regarding our sensitivity analysis performed around these assumptions.
Real Estate Investment Impairment
We invest in real estate assets and subsequently monitor those investments quarterly for impairment, including the review of real estate properties subject to direct financing leases. Additionally, we record depreciation and amortization related to our investments. The risks and uncertainties involved in applying the principles related to real estate investments include, but are not limited to, the following:
•
The estimated useful lives of our depreciable assets affects the amount of depreciation and amortization recognized on our investments.
•
The review of impairment indicators and subsequent determination of the undiscounted future cash flows could require us to reduce the value of assets and recognize an impairment loss.
•
The fair value of held for sale assets is estimated by management. This estimated value could result in a reduction of the carrying value of the asset.
•
Changes in assumptions based on actual results may have a material impact on the Company’s financial results.
Loans Held for Investment Impairment
We evaluate loans held for investment on a quarterly basis. As a first step in the notes receivable impairment process, we must determine, based on current information and events, if it is probable that we will be unable to collect the amounts due in accordance with the loan agreement. The risks and uncertainties involved in applying the principles related to notes receivable include, but are not limited to, the following:
•
Evaluating the financial condition and other current obligations of the borrower involve judgment in assessing their liquidity and financial stability.
Program Development Costs
We assess the collectability of the program development costs, considering the offering period and historical and forecasted sales of shares under the Managed REITs’ respective offerings and reserve for any balances considered not collectible. Additional reserves are generally recorded if actual proceeds raised from the offerings and corresponding program development costs incurred differ from management’s assumptions.The risks and uncertainties involved in applying the principles related to program development costs include, but are not limited to, the following:
•
Estimating recoverability for each program which involves an analysis of expected reimbursement revenue and projected organization and offering costs.
•
Utilizing assumptions to calculate impairment charges related to goodwill and impairment, as discussed above.
•
Assessing the impact of the change in calculations of recoverability percentages.
Consolidation of Equity Investments
We hold equity investments in unconsolidated joint ventures and each of the Managed REITs and account for these investments using the equity method of accounting as we have the ability to exercise significant influence, but not control, over operating and financial policies of these investments. We must continually evaluate these and other non-controlling interests for consolidation based on standards set forth in U.S. GAAP. For legal entities being evaluated, we must first determine whether the interests that we hold and fees we receive qualify as variable interests in the entity, as discussed in “Note 2 - Summary of Significant Accounting Policies” to our consolidated financial statements. The difference between consolidating the VIE and accounting for it using the equity method could be material to the Company’s consolidated financial statements. The risks and uncertainties involved in applying the principles related to equity investments include, but are not limited to, the following:
•
Consideration for variable interest entities involves determining their ability to finance their operations without additional subordinated financial support, whether the equity holders lack the characteristic of controlling financial interest, or whether the entity is established with non-substantive voting rights.
•
We perform significance calculations based on investments, total assets and income, on an individual basis or on an aggregated basis, by any combination of unconsolidated subsidiaries and equity-method investees.
Allocation of Purchase Price of Business Combinations, including Acquired Properties
In connection with our acquisition of properties, we allocate the purchase price to the tangible and intangible assets and
liabilities acquired based on their respective estimated fair values. Tangible assets consist of land, buildings, fixtures and tenant improvements. Intangible assets consist of above- and below- market lease values and the value of in-place leases. Our purchase price allocations are developed utilizing third-party appraisal reports, industry standards and management experience. The risks and uncertainties involved in applying the principles related to purchase price allocations include, but are not limited to, the following:
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The value allocated to land as opposed to buildings, fixtures and tenant improvements affects the amount of depreciation expense we record. If more value is attributed to land, depreciation expense is lower than if more value is attributed to buildings, fixtures and tenant improvements;
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Intangible lease assets and liabilities can be significantly affected by estimates, including market rent, lease term including renewal options at rental rates below estimated market rental rates, carrying costs of the property during a hypothetical expected lease-up period, and current market conditions and costs, including tenant improvement allowances and rent concessions; and
•
We determine whether any financing assumed is above- or below- market based upon comparison to similar financing terms for similar investment properties.
Income Taxes
As a REIT, the General Partner generally is not subject to federal income tax, with the exception of its TRS entities. However, the General Partner, including its TRS entities, and the Operating Partnership are still subject to certain state and local income and franchise taxes in the various jurisdictions in which they operate.
We provide for income taxes in accordance with current authoritative accounting and tax guidance. The tax provision or benefit related to significant or unusual items is recognized in the quarter in which those items occur. In addition, the effect of changes in enacted tax laws, rates or tax status is recognized in the quarter in which the change occurs. The risks and uncertainties involved in applying the principles related to income taxes include, but are not limited to, the following:
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Our calculations related to income taxes contain uncertainties due to judgment used to calculate tax liabilities in the application of complex tax laws and regulations across the tax jurisdictions where we operate;
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We file income tax returns in the U.S. federal jurisdiction, the Canadian federal jurisdiction and various state and local jurisdictions, and are subject to routine examinations by the respective tax authorities. We may be challenged upon review by the applicable taxing authorities, and positions we have taken may not be sustained; and
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The accounting estimates used to compute the provision for or benefit from income taxes may change as new events occur, additional information is obtained or the tax environment changes.
Recently Issued Accounting Pronouncements
Recently issued accounting pronouncements are described in “Note 2 - Summary of Significant Accounting Policies” to our consolidated financial statements.
Operating Highlights and Key Performance Indicators
2015 Activity
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Disposed of 228 properties, including two properties owned by consolidated joint ventures, and its interest in one consolidated joint venture, whose only assets consisted of investments in three unconsolidated joint ventures, for aggregate sales price of $1.5 billion, of which our share was $1.4 billion based on our ownership interest in the respective consolidated joint ventures, resulting in consolidated proceeds of $1.0 billion after disposition fees and debt assumptions.
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Decreased outstanding mortgage loans through property dispositions, mortgage loan maturities and monthly principal payments by $651.4 million during the year ended December 31, 2015, bringing the outstanding principal amount of mortgage loans to $3.0 billion at December 31, 2015.
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Reduced the maximum capacity under the Credit Facility from $3.6 billion to $3.3 billion and reduced our minimum Unencumbered Asset Value (as defined in the Credit Agreement) from $10.5 billion to $8.0 billion.
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Paid down $1.8 billion on the revolving credit facility during the year ended December 31, 2015, bringing the outstanding principal balance to $0.5 billion at December 31, 2015.
•
Declared a quarterly dividend of $0.1375 per share of common stock for the third and fourth quarters of 2015, representing an annualized dividend rate of $0.55 per share.
Real Estate Portfolio Metrics
In managing our portfolio, we are committed to diversification by property type, tenant, geography and industry. Below is a summary of our property type diversification and our top ten concentrations as of December 31, 2015, based on annualized rental income of $1.3 billion for the year ended December 31, 2015.
Our financial performance is influenced by the timing of acquisitions and dispositions and the operating performance of our real estate properties. The following table shows the property statistics of our real estate assets, excluding properties owned through our unconsolidated joint ventures as of December 31, 2015:
____________________________________
(1)
Economic occupancy rate equals the sum of square feet leased (including month-to-month) divided by total square feet.
(2)
Investment-grade tenants are those with a credit rating of BBB- or higher by Standard & Poor’s Rating Services or a credit rating of Baa3 or higher by Moody’s Investor Service, Inc. The ratings may reflect those assigned by Standard & Poor’s Rating Services or Moody’s Investor Service, Inc. to the lease guarantor or the parent company, as applicable.
The following table shows the economic metrics of our real estate assets, excluding properties owned through our unconsolidated joint ventures, as of and for the years ended December 31, 2015, 2014 and 2013:
____________________________________
(1)
Based on annualized rental income of our real estate portfolio as of December 31, 2015.
(2)
For the period beginning January 1, 2016 through December 31, 2020.
Operating Performance
In addition, management uses the following financial metrics of our business segments to assess our operating performance (dollars in thousands, except per share amounts).
____________________________________
(1)
See the “Non-GAAP Measures” section below for descriptions of our non-GAAP measures and reconciliations to the most comparable U.S. GAAP measure.
The following table presents the total assets of the Company, by segment (in thousands):
Property Financing
Our mortgage notes payable consisted of the following as of December 31, 2015, 2014 and 2013 (dollar amounts in thousands):
_______________________________________________
(1)
Mortgage notes payable have fixed rates or are fixed by way of interest rate swap arrangements. Effective interest rates ranged from 3.10% to 10.68% at December 31, 2015, 2.75% to 7.20% at December 31, 2014 and 1.83% to 6.28% at December 31, 2013.
(2)
Weighted average remaining years until maturity as of December 31, 2015, 2014, and 2013, respectively.
In addition, we have financing which is not secured by interests in real property, which is described under “Liquidity and Capital Resources.”
Future Lease Expirations
The following is a summary of lease expirations for the next 10 years and beyond at the properties we owned as of December 31, 2015 (dollar amounts and square feet in thousands):
_______________________________________________
(1) The Company has certain leases comprised of multiple properties.
Results of Operations
Revenues
The table below sets forth, for the periods presented, certain revenue information and the dollar amount change year over year (dollars in thousands):
Rental Income
2015 vs 2014 - The increase in rental income during the year ended December 31, 2015 was primarily due to the 1,107 properties acquired in 2014, including the consummation of the Cole Merger in the first quarter of 2014 and the acquisition of over 500 Red Lobster® restaurants in the third quarter of 2014, offset by the disposition of 228 properties in 2015 and 110 properties in 2014.
2014 vs 2013 - The increase in rental income during the year ended December 31, 2014 was primarily due to the net acquisition of 2,160 properties (which excludes properties that were accounted for as direct financing leases) largely through various mergers and portfolio acquisitions.
Cole Capital Revenue
Our acquisition of Cole Real Estate Investments, Inc. (the “Cole Merger”), as more fully described in “Note 3 - Mergers with Real Estate Businesses” to our consolidated financial statements, was consummated on February 7, 2014. Cole Capital’s results of operations are influenced by capital raised on behalf of the Managed REITs in offerings as well as the timing and extent of real estate asset acquisitions and assets under management, which are driven by the Managed REITs’ capital raised, cash flows provided by operations and available proceeds from debt financing.
As a result of the Audit Committee Investigation and the resulting Restatement, certain selling agreements with broker-dealers for the Managed REITs were suspended. Accordingly, our Cole Capital results of operations for the year ended December 31, 2015, as compared to the year ended December 31, 2014, reflect decreases in most revenue categories, as further discussed below. Certain selling agreements have been re-instated to date and we are in ongoing discussions with other broker-dealers that suspended their respective selling agreements. We expect to continue to secure the reinstatement of suspended selling agreements; however, there are no guarantees as to when these agreements will be reinstated, if at all.
Offering-Related Fees and Reimbursements
Offering-related fees and reimbursements include selling commissions, dealer manager fees and distribution fees earned from selling securities in the Managed REITs. The Company reallows 100% of selling commissions and may reallow all or a portion of our dealer manager and distribution fees to participating broker-dealers as a marketing and due diligence expense reimbursement, based on factors such as the volume of shares sold by such participating broker-dealers and the amount of marketing support provided by such participating broker-dealers. The following table represents offering-related fees and reimbursements as well as amounts reallowed for the years ended December 31, 2015 and 2014 (in thousands).
The net decrease in offering-related fees and reimbursements of $12.7 million for the year ended December 31, 2015 was a direct result of the decrease in capital raise related to the suspension of certain selling agreements, as discussed above. Additionally, the decrease was partly due to the closing of the offering of Cole Credit Property Trust IV, Inc. in the first quarter of 2014.
Transaction Service Fees and Reimbursements
Transaction service fees and reimbursement revenue consist primarily of acquisition and disposition fees earned from acquiring and selling properties on behalf of the Managed REITs and other real estate programs. Transaction service fees were $27.9 million for the year ended December 31, 2015 as compared to $60.7 million during the same period in 2014. Transaction-related reimbursement revenues were $2.2 million for the year ended December 31, 2015, as compared to $4.3 million during the same period in 2014. The net decrease of $34.9 million for the year ended December 31, 2015 was primarily due to decreases in acquisition fee revenue as there were less funds raised by the Managed REITs’ offerings that could be deployed into real estate acquisitions on their behalf.
Management Fees and Reimbursements
Management fees and reimbursement revenue represent advisory, asset and property management fees for operating, leasing and managing the portfolios of the Managed REITs and other real estate programs. Management fees were $46.5 million for the year ended December 31, 2015 as compared to $42.7 million during the same period in 2014. Management reimbursement revenues were $13.8 million for the year ended December 31, 2015, as compared to $8.8 million during the same period in 2014. The overall net increase in fees and reimbursements of $8.8 million for the year ended December 31, 2015 primarily related to an increase in reimbursement revenue as the Company was no longer waiving certain expenses due from the Managed REITs in 2015, as well as an increase in advisory fees due to an increase in assets under management.
Operating Expenses
The table below sets forth, for the periods presented, certain operating expense information and the dollar amount change year over year (dollars in thousands):
Acquisition Related Expenses
2015 vs 2014 - Acquisition related expenses primarily consisted of legal, deed transfer and other costs related to real estate purchase transactions, including costs incurred for deals that were not consummated. The Company acquired interests in 16 commercial properties, including nine land parcels for build-to-suit development, for an aggregate purchase price of $36.3 million during the year ended December 31, 2015 as compared with the acquisition of 1,107 properties including 31 land parcels, for an aggregate purchase price of $3.8 billion during the year ended December 31, 2014. The decrease in acquisition related expenses during the year ended December 31, 2015 was primarily due to a significant decrease in acquisition activity as compared to the same period in 2014.
2014 vs 2013 - The decrease in acquisition related expenses was primarily related to the acquisitions of American Realty Capital Trust III, Inc. on February 28, 2013 (the “ARCT III Merger”) and American Realty Capital Trust IV, Inc. on January 3, 2014 (the “ARCT IV Merger”), as well as the transition to self-management on January 8, 2014. Prior to those events, the Company incurred acquisition fees and additionally reimbursed certain expenses to an affiliate of the Former Manager totaling $37.6 million for the year ended December 31, 2013, compared to $1.7 million for the year ended December 31, 2014.
Merger and Other Non-routine Transaction Related Expenses, Net of Insurance Recoveries
2015 vs 2014 - The decrease in merger and other non-routine transaction related expenses was primarily related to incurring costs relating to the Cole Merger and the ARCT IV Merger, including a $78.2 million subordinated distribution fee to an affiliate of the Former Manager upon the consummation of the ARCT IV Merger that was settled with 6.7 million OP Units to the affiliate of the Former Manager during the year ended December 31, 2014. No such fees were incurred for any mergers during the year ended December 31, 2015. However, the Company incurred $44.2 million of expenses in connection with the Audit Committee Investigation and related litigation and investigations during the year ended December 31, 2015. These expenses were offset by $11.4 million of insurance proceeds, $10.5 of which related to expenses for litigation arising from the results of the Audit Committee Investigation.
2014 vs 2013 - The decrease in merger and other non-routine transaction related expenses was primarily related to a decrease in the subordinated distribution fee incurred in connection with the ARCT IV Merger in 2014 of $78.2 million, compared to the subordinated distribution fee incurred in connection with the ARCT III Merger in 2013 of $98.4 million. In addition to such fees, the Company also incurred costs such as strategic advisory services, transfer taxes and legal fees relating to the various mergers in both 2014 and 2013.
Property Operating Expenses and Operating Expense Reimbursement
The table below sets forth, for the periods presented, the property operating expenses, net of operating expense reimbursements, and the dollar amount change year over year (dollars in thousands):
2015 vs 2014 - Property operating expenses such as taxes, insurance, ground rent and maintenance include both reimbursable and non-reimbursable property expenses. Operating expense reimbursement revenue represents reimbursements for such costs that are reimbursable by the tenants per their respective leases. Property operating expenses were $130.9 million for the year ended December 31, 2015 as compared to $137.7 million during the same period in 2014. Operating expense reimbursements were $98.6 million for the year ended December 31, 2015 as compared to $100.5 million during the same period in 2014. The net decrease of $4.9 million for the year ended December 31, 2015 was driven primarily by the disposal of our portfolio of anchored shopping centers, which generally have higher non-reimbursable operating expenses, during the fourth quarter of 2014, as well as the disposition of 228 properties in 2015.
2014 vs 2013 - Property operating expenses were $137.7 million for the year ended December 31, 2014 as compared to $23.6 million during the same period in 2013. Operating expense reimbursements were $100.5 million for the year ended December 31, 2014 as compared to $16.6 million during the same period in 2013. The net increase of $30.2 million was driven by the acquisition of significant rental income-producing properties subsequent to December 31, 2013.
Management Fees to Affiliates
2015 vs 2014 - There were no management fees to affiliates incurred during the year ended December 31, 2015 as discussed in “Note 18 - Related Party Transactions and Arrangements” to our consolidated financial statements, as we completed our transition to self-management on January 8, 2014. During the year ended December 31, 2014, we incurred fees of $13.9 million related to asset management services.
2014 vs 2013 - The Company incurred $11.7 million related to asset management services and $5.0 million of base management fees as well as $0.8 million in property management fees in 2013, totaling $17.5 million. The decrease of $3.6 million as compared to 2014 was primarily a result of the Company’s termination of the management agreement with the Former Manager, which eliminated such management fees during the year ended December 31, 2014.
General and Administrative Expenses
2015 vs 2014 - The decrease in general and administrative expense during the year ended December 31, 2015 was primarily related to a decrease in equity-based compensation of $18.8 million, from $33.3 million for the year ended December 31, 2014 to $14.5 million for the the year ended December 31, 2015, largely as a result of the forfeiture of certain awards in connection with the departure of certain officers and directors in the fourth quarter of 2014. The overall decrease in compensation and benefits is also due to the Company’s headcount reduction as compared to the same period in 2014, partially offset by the increase in severance to former employees.
2014 vs 2013 - The increase in general and administrative expense during the year ended December 31, 2014 was primarily due to the Company’s transition to self-management in January 2014 and the Cole Merger in February 2014, which significantly increased the number of employees. The additional employees and the assumption of the lease for the Company’s offices in Phoenix, Arizona resulted in an increase to compensation and related costs of $71.7 million and increased office costs such as rent and insurance of $25.3 million from 2013 to 2014. These increases were partially offset by a decrease in equity-based compensation of $66.9 million, primarily due to the Company recording $92.3 million of expenses in 2013 relating to the 2013 Advisor Multi-Year Outperformance Agreement (the “OPP”).
Depreciation and Amortization Expenses
2015 vs 2014 - The decrease in depreciation and amortization expense during the year ended December 31, 2015 was primarily related to a decrease in the amortization of the management and advisory contracts (the “Management Contracts”) with the Managed REITs of $42.6 million due to an impairment of $86.4 million recorded in the fourth quarter of 2014. Additionally, real estate depreciation and amortization expense decreased $27.0 million, primarily due to dispositions of 228 properties in 2015 and 110 properties in 2014. The Company also recorded $100.5 million of impairment charges on real estate investments from continuing operations during the year ended December 31, 2014, of which impairment charges totaling $96.7 million arose during the fourth quarter of 2014.
2014 vs 2013 - The increase in depreciation and amortization expense during the year ended December 31, 2014 was primarily related to the acquisition of 1,107 properties, as discussed above, resulting in an increase to real estate depreciation and amortization expense of $633.6 million as well amortization expense of $68.5 million recorded relating to Management Contracts that were acquired as part of the Cole Merger.
Impairments
2015 vs 2014 - The decrease in impairments during the year ended December 31, 2015 was primarily due to a decrease in the impairment of goodwill in the Cole Capital segment of $83.4 million from 2014 to 2015. The Company recorded an impairment of $223.0 million of goodwill in 2014, compared to an impairment of $139.7 million in 2015 as discussed in “Note 10 - Fair Value Measures” to our consolidated financial statements. There was also a decrease in the impairment of real estate assets of $8.7 million from an impairment of $100.5 million during the year ended December 31, 2014, as compared to an impairment of $91.8 million in 2015.
2014 vs 2013 - The increase in impairments during the year ended December 31, 2014 primarily related to the impairment of goodwill of $223.0 million and impairment of intangible assets of $86.4 million, both in the Cole Capital segment. Additionally, impairments of real estate assets increased $97.2 million to $100.5 million for the year ended December 31, 2014 as compared to $3.3 million during the same period in 2013.
Other (expense) income and tax benefit (provision)
The table below sets forth, for the periods presented, certain financial information and the dollar amount change year over year (dollars in thousands):
Interest Expense
2015 vs 2014 - The decrease in interest expense during the year ended December 31, 2015 was primarily a result of a decrease in amortization expense in relation to a 2014 cumulative adjustment of amortization for premium on a loan in default of $16.7 million. The decrease also related to the decrease in total outstanding debt balance from $10.4 billion as of December 31, 2014 to $8.1 billion as of December 31, 2015, largely due to paying down $1.8 billion on the revolving credit facility as well as the prepayment of mortgage notes payable and assumption of debt by the buyer in property dispositions as discussed in “Note 11 - Debt” to our consolidated financial statements. These decreases were partially offset by an increase of $6.9 million in interest expense on bonds that were issued in February 2014.
2014 vs 2013 - The increase in interest expense during the year ended December 31, 2014 was due to an increase in the total outstanding debt balance to $10.4 billion in 2014 compared to $4.3 billion in 2013. The increase in debt was primarily due to the assumption of mortgage notes in connection with the various mergers and portfolio acquisitions, the issuance of the corporate bonds and the increased draws on the credit facilities. Additionally, during the year ended December 31, 2014, we recorded $32.6 million in interest expense as a result of the amortization of deferred financing costs associated with the termination of the available commitments from Barclays Bank PLC and other committed parties for up to $2.1 billion in senior secured term loans (the “Barclays Facility”).
Gain (Loss) on Extinguishment and Forgiveness of Debt, Net
2015 vs 2014 - A gain on extinguishment and forgiveness of debt, net of $4.8 million was recorded for the year ended December 31, 2015, which primarily related to the foreclosure of the Company’s property in Bethseda, Maryland. During the year ended December 31, 2015, the Company also repaid an aggregate of $548.9 million of mortgage notes payable prior to maturity or assumed by the buyer in a property disposition as compared to $1.6 billion repaid prior to maturity in 2014. In connection with the extinguishments, we paid prepayment fees totaling $102,000 and $35.9 million for the years ended December 31, 2015 and 2014, respectively, which are also included in gain (loss) on extinguishment and forgiveness of debt, net in the consolidated financial statements.
2014 vs 2013 - A loss on extinguishment and forgiveness of debt of $21.9 million was recorded for the year ended December 31, 2014, which comprised of $35.9 million of prepayment fees related to the defeasance of mortgage notes payable and other corporate debt, partially offset by the write-off of $24.9 million of net premiums associated with the debt. There was no loss on extinguishment of debt recorded for the year ended December 31, 2013.
Other Income, Net
2015 vs 2014 - The decrease in other income, net during the year ended December 31, 2015 was primarily a result of a litigation settlement with RCS Capital Corporation in 2014, from which the Company received $60.0 million in connection with the unconsummated sale of Cole Capital as discussed in “Note 18 - Related Party Transactions and Arrangements” to our consolidated financial statements. The decrease also related to the decrease in interest income from investment securities, largely resulting from the sale of 15 CMBS for $158.0 million during the third quarter of 2014, as well as a decrease in interest income from mortgage notes receivable, two of which were repaid in the fourth quarter of 2014.
2014 vs 2013 - The increase in other income, net during the year ended December 31, 2014 was primarily a result of the Company recording $60.0 million received as part of the settlement agreement with RCS Capital Corporation, as discussed above. In addition, during the year ended December 31, 2014, the Company also recorded $15.9 million in interest income related to loans held for investment and CMBS, most of which were acquired in the Cole Merger.
Reserve for Loan Loss
The reserve for loan loss of $15.3 million for the year ended December 31, 2015 relates to an unsecured note from RCS Capital Corporation in connection with the unconsummated sale of Cole Capital, as discussed in “Note 18 - Related Party Transactions and Arrangements” to the consolidated financial statements. During the three months ended December 31, 2015, the Company assessed the collectability of the note and determined it was unlikely to be repaid and recorded the reserve equal to the carrying value of the note.
Gain on Disposition of Interest in Joint Venture
Gain on disposition of interest in joint venture was $6.7 million for the year ended December 31, 2015 due to the disposition of the Company’s interest in one consolidated joint venture, as discussed in “Note 6 - Real Estate Investments” to our consolidated financial statements. There was no gain on sale of joint venture recorded during the same periods in 2014 or 2013.
Loss on Derivative Instruments, Net
2015 vs 2014 - Loss on derivative instruments, net related to the ineffective portion of changes in fair value of cash flow hedges. The decrease in loss on derivative instruments, net for the year ended December 31, 2015 primarily related to the fact that we recorded a loss of $18.8 million for the year ended December 31, 2014 relating to the Series D embedded derivative, which was settled in connection with the redemption of the Series D Preferred Stock in the third quarter of 2014.
2014 vs 2013 - The decrease in loss on derivative instruments, net for the year ended December 31, 2014 as compared to the same period in 2013 was primarily related to a loss of $18.8 million recorded on the Series D embedded derivative, which was settled in connection with the redemption of the Series D Preferred Stock in 2014. We recorded a loss on derivative instruments of $67.9 million during the year ended December 31, 2013, that resulted from marking our derivate instruments to fair value.
Gain (Loss) on Investment Securities
2015 vs 2014 - There was a $65,000 gain on the sale of investment securities for the year ended December 31, 2015 compared to a gain of $6.4 million recorded in connection with the sale of the 15 CMBS we had acquired in the Cole Merger in 2014.
2014 vs 2013 - The gain on investment securities for the year ended December 31, 2014 related to a gain of $6.2 million recorded in connection with the sale of the 15 CMBS we had acquired in the Cole Merger. The loss for the year ended December 31, 2013 primarily related to a $2.3 million loss on the sale of investments in Series F 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.
Loss on Disposition of Real Estate, Net
2015 vs 2014 - The loss on disposition of real estate and held for sale assets, net was $72.3 million for the year ended December 31, 2015, which was primarily a result of the disposal of 228 properties and one property owned by a consolidated joint venture. The disposals include a portfolio of 109 Red Lobster® restaurants for an aggregate gross sales price of $425.2 million and 68 CVS properties for an aggregate gross sales price of $318.3 million as well as various other properties for a combined gain on sale of $22.6 million, offset by $98.8 million of goodwill allocated in the cost basis of such properties. The loss was also related to the classification of 17 properties as held for sale as of December 31, 2015, resulting in a loss of $3.2 million being recorded to reduce the properties down to their fair value less cost to sell.
2014 vs 2013 - The loss on disposition of real estate and held for sale assets, net for the year ended December 31, 2014 was $277.0 million, which largely consisted of loss on sale of real estate assets of $262.0 million, which included the write-off of $195.5 million of goodwill allocated to the cost basis of the Multi-tenant Portfolio. In addition, the aggregate loss for the year ended December 31, 2014 was also comprised of losses incurred in connection with the disposition of 45 single-tenant properties and 65 multi-tenant properties as well as two properties which were classified as held for sale. There was no loss on disposition of real estate and held for sale assets, net recorded for the year ended December 31, 2013.
Benefit from (Provision for) Income Taxes
2015 vs 2014 - The benefit from income taxes of $36.3 million for the year ended December 31, 2015 reflected an increase of $3.0 million from a benefit from income taxes of $33.3 million during the same period in 2014. The increased benefit primarily related to a decrease in income taxes within the REI segment.
2014 vs 2013 - The operations of Cole Capital commenced in 2014 upon consummation of the Cole Merger. As such, the provision for income taxes of $2.2 million for the year ended December 31, 2013 reflect only those within the REI segment. For the year ended December 31, 2014, the Company recorded a benefit of $33.3 million, primarily due to the loss before taxes of Cole Capital.
Non-GAAP Measures
Our results are presented in accordance with U.S. GAAP. We also disclose certain non-GAAP measures, as discussed further below. Management uses these non-GAAP financial measures in our internal analysis of results and believes these measures are useful to investors for the reasons explained below. These non-GAAP financial measures should not be considered as substitutes for any measures derived in accordance with U.S. GAAP.
Funds from Operations and Adjusted Funds from Operations
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, a non-GAAP supplemental financial performance measure, 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.
NAREIT defines FFO as net income or loss computed in accordance with U.S. GAAP, excluding gains or losses from disposition of property, depreciation and amortization of real estate assets and impairment write-downs on real estate including the pro rata share of adjustments for unconsolidated partnerships and joint ventures. Our FFO calculation complies with NAREIT’s policy described above.
In addition to FFO, we use adjusted funds from operations (“AFFO”) as a non-GAAP supplemental financial performance measure to evaluate the operating performance of the Company. AFFO, as defined by the Company, excludes from FFO non-routine items such as acquisition related costs, merger and other non-routine transactions costs, gains or losses on sale of investments, insurance and litigation settlements and recoveries and extinguishment of debt cost. We also exclude certain non-cash items such as impairments of intangibles, straight-line rental revenue, unrealized gains or losses on derivatives, reserves for loan loss, gain (loss) on the extinguishment of forgiveness of debt, non-current portion of the tax benefit (expense), equity-based compensation and amortization of intangibles, deferred financing costs, above-market lease assets and below-market lease liabilities. Management believes that excluding these costs from FFO provides investors with supplemental performance information that is consistent with the performance models and analysis used by management, and provides investors a view of the performance of our portfolio over time. AFFO allows for a comparison of the performance of our operations with other traded REITs, as AFFO, or an equivalent measure, is routinely reported by traded REITs, and we believe often used by analysts and investors for comparison purposes.
For all of these reasons, we believe FFO and AFFO, in addition to net income (loss) and cash flows from operating activities, as defined by U.S. GAAP, are helpful supplemental performance measures and useful in understanding the various ways in which our management evaluates the performance of the Company over time. However, not all REITs calculate FFO and AFFO the same way, so comparisons with other REITs may not be meaningful. FFO and AFFO should not be considered as alternatives to net income (loss) or to cash flows from operating activities, and are not intended to be used as a liquidity measure indicative of cash flow available to fund our cash needs.
AFFO may provide investors with a view of our future performance. However, because AFFO excludes items that are an important component in an analysis of the historical performance of a property, AFFO should not be construed as a historic performance measure. Neither the SEC, NAREIT, nor any other regulatory body has evaluated the acceptability of the exclusions used to adjust FFO in order to calculate AFFO and its use as a non-GAAP financial performance measure.
The table below presents FFO and AFFO for the years ended December 31, 2015, 2014 and 2013 (in thousands, except share and per share data).
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(1)
This adjustment represents the non-current portion of the tax benefit recognized in net loss in order to show only the current portion of the benefit as an impact to AFFO.
(2)
Dilutive securities include OP Units, unvested restricted shares of common stock, certain unvested restricted stock units and convertible preferred stock, as applicable.
(3)
Weighted-average shares for all periods presented exclude the effect of the convertible debt as the strike price of each convertible debt instrument is greater than the price of the General Partner’s common stock as of the end of each reporting period presented. In addition, for the year ended December 31, 2015, 1.4 million shares underlying restricted stock units that are contingently issuable have been excluded based on the Company’s level of achievement of certain performance targets through December 31, 2015.
The table below presents FFO and AFFO for the REI segment for the years ended December 31, 2015, 2014 and 2013 (in thousands, except share and per share data).
____________________________________
(1)
Dilutive securities include OP Units, unvested restricted shares of common stock, certain unvested restricted stock units and convertible preferred stock, as applicable.
(2)
Weighted-average shares for periods presented exclude the effect of the convertible debt as the strike price of each convertible debt instrument is greater than the price of the General Partner’s common stock as of the end of each reporting period presented. In addition, for the year ended December 31, 2015, 1.4 million shares underlying restricted stock units that are contingently issuable have been excluded based on the Company’s level of achievement of certain performance targets through December 31, 2015.
The table below presents FFO and AFFO for the Cole Capital segment for the years ended December 31, 2015, 2014 and 2013 (in thousands, except share and per share data).
_________________________________
(1)
This adjustment represents the non-current portion of the tax benefit recognized in net loss in order to show only the current portion of the benefit or provision as an impact to AFFO.
(2)
Dilutive securities include limited partnership interests in the Operating Partnership, unvested restricted shares of common stock, certain unvested restricted stock units and convertible preferred stock, as applicable.
(3)
Weighted-average shares for all periods presented exclude the effect of the convertible debt as the strike price of each convertible debt instrument is greater than the price of the Company’s common stock as of the end of each reporting period presented. In addition, for the three months ended December 31, 2015, 1.4 million of shares underlying restricted stock units that are contingently issuable have been excluded based on the Company’s level of achievement of certain performance targets through December 31, 2015.
Liquidity and Capital Resources
In the normal course of business, our principal demands for funds will be for the reduction of the outstanding balance of our Credit Facility and the payment of operating expenses, including legal expenses, distributions to our investors, and for the payment of principal and interest on our other outstanding indebtedness. We expect that our cash needs will be provided by proceeds from dispositions and cash flow from operations. If we are unable to satisfy our operating costs with our cash flow from operations, we may use borrowings on our line of credit to cover such obligations, as necessary.
As of December 31, 2015, we had $69.1 million of cash and cash equivalents.
Sources of Funds
Capital Markets
A primary source of liquidity for the Company has been the debt and equity capital markets, as discussed in “Note 16 - Equity” to our consolidated financial statements. However, our access to capital and terms of future financings have been adversely affected by our credit rating downgrade and loss of eligibility to register the offer and sale of our securities on a registration statement on Form S-3. Our ability to take advantage of future capital raise opportunities will depend on us continuing to timely file our periodic reports required with the SEC.
Credit Facility
Availability of Funds
We, as guarantor, and the Operating Partnership, as borrower, are parties to the Credit Facility with Wells Fargo, National Association, as administrative agent, and the other lenders party thereto.
The Credit Facility allows for maximum borrowings of $3.3 billion, consisting of a $1.0 billion term loan facility and a $2.3 billion revolving credit facility. The Credit Facility includes an accordion feature, which, if exercised in full, allows the Company to increase the aggregate commitments under the Credit Facility to $4.7 billion, subject to the receipt of such additional commitments and the satisfaction of certain customary conditions. As of December 31, 2015, a maximum of $1.8 billion was available to the Operating Partnership for future borrowings, subject to borrowing availability.
Disposition Activity
As part of our effort to optimize our real estate portfolio by focusing on holding core assets, during the year ended December 31, 2015, we disposed of 228 properties, including two properties owned by consolidated joint ventures, and one property owned by a consolidated joint venture, whose only assets consisted of investments in three unconsolidated joint ventures, for aggregate sales price of $1.5 billion, of which our share was $1.4 billion based on its ownership interest in the respective consolidated joint ventures, resulting in consolidated proceeds of $1.0 billion after disposition fees and debt assumptions. As of December 31, 2015, we also had 17 properties classified as held for sale, for which we recorded a loss of $3.2 million. We expect to continue to explore opportunities to sell additional properties as we pay off outstanding debt and reduce our borrowings under the Credit Facility, which will reduce our overall leverage and provide us further financial flexibility.
Principal Use of Funds
During the next 12 months, we expect that our cash requirements will include paying distributions to our stockholders, making scheduled interest payments on our Senior Notes, Convertible Notes (defined below), mortgage notes payable and other debt (as more fully described below) and our Credit Facility, paying legal expenses, as well as other normal recurring operating expenses.
Credit Facility
Summary and Obligations
As of December 31, 2015, our outstanding balance under the Credit Facility was $1.5 billion, following our repayment of amounts under the revolving portion of the Credit Facility during the year ended December 31, 2015 of $1.8 billion, of which $0.5 billion bore a floating interest rate of 2.04% at December 31, 2015. The remaining outstanding balance on the Credit Facility of $1.0 billion is fixed through the use of derivative instruments used to hedge interest rate volatility. Including the spread, which can vary based on our credit rating, the interest rate on this portion was 3.29% at December 31, 2015.
Th revolving credit facility generally bears interest at an annual rate of London Inter-Bank Offer Rate (“LIBOR”) plus 1.00% to 1.80% or Base Rate plus 0.00% to 0.80% (based upon our then current credit rating). “Base Rate” is defined as the highest of the prime rate, the federal funds rate plus 0.50% or a floating rate based on one month LIBOR, determined on a daily basis. The term loan facility generally bears interest at an annual rate of LIBOR plus 1.15% to 2.05%, or Base Rate plus 0.15% to 1.05% (based upon our then current credit rating). In addition, the Credit Agreement provides the flexibility for interest rate auctions, pursuant to which, at the Company’s election, the Company may request that lenders make competitive bids to provide revolving loans, which competitive bids may be at pricing levels that differ from the foregoing interest rates.
The Credit Agreement provides for monthly interest payments under the Credit Facility. In the event of default, at the election of a majority of the lenders (or automatically upon a bankruptcy event of default with respect to the OP or the General Partner), the commitments of the lenders under the Credit Facility will mature, and payment of any unpaid amounts in respect of the Credit Facility will be accelerated. The revolving credit facility and the term loan facility both terminate on June 30, 2018, in each case, unless extended in accordance with the terms of the Credit Agreement. The Credit Agreement provides for a one-year extension option with respect to each of the revolving credit facility and the term loan facility, exercisable at the Company’s election and subject to certain customary conditions, as well as certain customary “amend and extend” provisions. At any time, upon timely notice by the OP and subject to any breakage fees, the OP may prepay borrowings under the Credit Facility (subject to certain limitations applicable to the prepayment of any loans obtained through an interest rate auction, as described above). The OP incurs a fee equal to 0.15% to 0.25% per annum (based upon the General Partner’s then current credit rating) multiplied by the commitments (whether or not utilized) in respect of the revolving credit facility. In addition, the OP incurs customary administrative agent, letter of credit issuance, letter of credit fronting, extension and other fees.
Credit Facility Covenants
The Credit Facility requires restrictions on corporate guarantees, as well as the maintenance of certain financial covenants. The key financial covenants in the Credit Facility, as defined and calculated per the terms of the Credit Agreement include maintaining the following:
For the purposes of determining unencumbered asset value, the Company is permitted to include restaurant properties representing more than 30% of its unencumbered asset value in such calculation such that: (i) from July 1, 2015 to June 29, 2016, up to 40% of the unencumbered asset value may be comprised of restaurant properties; and (ii) from June 30, 2016 to December 30, 2016, up to 35% of the unencumbered asset value may be comprised of restaurant properties. From December 31, 2016, the maximum percentage of unencumbered asset value attributable to restaurant properties will be reduced back down to 30%.
The Company believes that it was in compliance with the Credit Agreement and is not restricted from accessing any borrowings under the Credit Facility as of December 31, 2015.
Corporate Bonds
Summary and Obligations
On February 6, 2014, the Operating Partnership 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 the 2019 Notes, the “Senior Notes”). The Senior Notes are guaranteed by the General Partner.
Bond Covenants
The indenture governing the Senior Notes requires that the Company be in compliance with certain key financial covenants, including maintaining the following:
There were no changes to the covenants or interest rates of our Senior Notes during the year ended December 31, 2015. As of December 31, 2015, the Company believes that it was in compliance with these covenants based on the covenant limits and calculations in place at that time.
Convertible Debt
Summary and Obligations
On July 29, 2013, the Company issued $300.0 million aggregate principal amount of convertible senior notes due 2018 (the “2018 Convertible Notes”) and, pursuant to an over-allotment exercise by the underwriters of such 2018 Convertible Notes offering, issued an additional $10.0 million aggregate principal amount of its 2018 Convertible Notes on August 1, 2013. On December 10, 2013, the Company issued an additional $287.5 million of the 2018 Convertible Notes through a reopening of the indenture governing the 2018 Convertible Notes. Also on December 10, 2013, the Company issued $402.5 million aggregate principal amount of convertible senior notes due 2020 (the “2020 Convertible Notes and together with the 2018 Convertible Notes, the “Convertible Notes”). The 2018 Convertible Notes have a weighted average interest rate of 3.00%, a conversion rate of 60.5997 and mature on
August 1, 2018 and the 2020 Convertible Notes have a weighted average interest rate of 3.75%, a conversion rate of 66.7249 and mature on December 15, 2020. The Convertible Notes are convertible into cash or shares of the Company’s common stock at the Company’s option. There were no changes to the terms of our Convertible Notes during the year ended December 31, 2015.
Mortgage Notes Payable and Other Debt
Summary and Obligations
As of December 31, 2015, we had non-recourse mortgage indebtedness of $3.0 billion, which was collateralized by 654 properties, reflecting a decrease from December 31, 2014 of $649.9 million derived primarily from our disposition activity during the period from January 1, 2015 to December 31, 2015. Our mortgage indebtedness bore interest at the weighted-average rate of 5.08% per annum and had a weighted-average maturity of 5.1 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.
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 require 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, 2015, the Company believes that it was in compliance with the debt covenants under its respective loan agreements, except for a loan in default with a principal balance of $38.1 million that is described below.
On March 6, 2015, the Company received a notice of default from the lender of a non-recourse loan, with a principal balance of $38.1 million as of December 31, 2015, due to the Company’s failure to pay a reserve payment required per the loan agreement. Due to the default, the Company is currently accruing interest at the default rate of interest of 10.68% per annum. The Company is engaged with the servicer to complete foreclosure proceedings. The default on the loan did not result in a cross default on our other indebtedness.
Restrictions on Loan Covenants
Our mortgage loan obligations generally restrict corporate guarantees and require the maintenance of financial covenants, including 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. The mortgage loan agreements contain no dividend restrictions except in the event of default or when a distribution would drive liquidity below the applicable thresholds. At December 31, 2015, the Company believes that it was in compliance with the debt covenants under the mortgage loan agreements, except for a loan in default as described above and in “Note 11 - Debt” to our consolidated financial statements.
Other Debt
Availability of Funds
As of December 31, 2015, the Company had a secured term loan from KBC Bank, N.V. with an outstanding principal balance of $33.5 million and remaining unamortized premium of $0.3 million (the “KBC Loan”). The interest coupon on the KBC Loan is fixed at 5.81% annually until its maturity in January 2018. The KBC Loan is non-recourse to the Company, subject to limited non-recourse exceptions. The KBC Loan provides for monthly payments of both principal and interest. The scheduled principal repayments subsequent to December 31, 2015 are $12.5 million, $7.7 million and $13.3 million for the years ended December 31, 2016, 2017 and 2018, respectively.
Dividends
On December 23, 2014 and in connection with amendments to the Credit Agreement, the Company agreed to suspend the payment of dividends on its common stock until we complied with certain periodic financial reporting and related requirements set forth in such amendments. On March 30, 2015, the Company satisfied these periodic financial reporting and related requirements. On August 5, 2015, the Board of Directors authorized, and the Company declared, a quarterly dividend of $0.1375 per share of common stock for each of the third and fourth quarters of 2015 (representing an annualized dividend rate of $0.55 per share), which was paid on October 15, 2015 and January 15, 2016 to holders of record as of September 30, 2015 and December 31, 2015, respectively.
Our Series F Preferred Stock, as discussed in “Note 16 - Equity” to our consolidated financial statements, will pay cumulative cash dividends at the rate of 6.70% per annum on their liquidation preference of $25.00 per share (equivalent to $1.675 per share on an annual basis). As of December 31, 2015, there were approximately 42.8 million shares of Series F Preferred Stock(and approximately 42.8 million corresponding Series F Preferred Units that were issued to the General Partner) and 86,874 Limited Partner Series F Preferred Units that were issued and outstanding.
Contractual Obligations
The following is a summary of our contractual obligations as of December 31, 2015 (in thousands):
____________________________________
(1)
As of December 31, 2015, we had $248.1 million of variable rate mortgage notes and $1.0 billion of variable rate debt on the Credit Facility effectively fixed through the use of interest rate swap agreements. We used the effective interest rates fixed under our swap agreements to calculate the debt payment obligations in future periods.
(2)
Interest payments due in future periods on the $0.5 million of variable rate debt payment obligations were calculated using a forward LIBOR curve.
Cash Flow Analysis for the year ended December 31, 2015
Operating Activities - The level of cash flows 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. During the year ended December 31, 2015, net cash provided by operating activities increased $364.1 million to $867.0 million from $502.9 million. The increase was primarily due to an increase in revenue, excluding non-cash adjustments, of $59.2 million, a decrease in merger and other transaction expenses of $87.7 million, a decrease in prepayment fees and penalties relating to debt repayment of $35.9 million and a decrease in the net change in assets and liabilities of $206.4 million.
Investing Activities - Net cash provided by investing activities for the year ended December 31, 2015 increased $3.5 billion to $932.6 million from net cash used in investing activities in 2014 of $2.6 billion. The increase in cash flow primarily related to a decrease in cash paid for real estate assets of $3.5 billion and a decrease in cash paid for real estate businesses of $756.2 million, both as a result of a decrease in acquisition activity as compared to the same period in the prior year. The increase was partially offset by a decrease in cash proceeds from the disposition of real estate assets of $589.7 million, driven primarily by the sale of the multi-tenant portfolio in 2014.
Financing Activities - Net cash used in financing activities increased $4.5 billion to $2.1 billion during the year ended December 31, 2015 from net cash provided by financing activities of $2.4 billion. The increase was primarily related to a decrease in proceeds from the issuance of corporate bonds of $2.5 billion and an increase in net payments on the Credit Facility of $1.6 billion, combined with a decrease in the proceeds from the issuance of common stock, net of offering costs, of $1.6 billion, all of which related to the fact that the Company raised more capital to fund large acquisitions in the prior period. The increase was partially offset by a decrease in distributions paid of $714.9 million.
Cash Flows for the year ended December 31, 2014
Operating Activities - During the year ended December 31, 2014, net cash provided by operating activities was $502.9 million. Cash flows provided by operating activities during the year ended December 31, 2014 were mainly due to adjusted net income of $806.6 million (net loss of $1.0 billion adjusted for non-cash items including the issuance of OP Units, depreciation and amortization, gain on sale of properties, equity-based compensation, gain on derivative instruments and gain on the early extinguishment of debt totaling $1.8 billion, in the aggregate), offset by a decrease in accounts payable and accrued expenses of $16.3 million, a decrease in prepaid and other assets of $97.1 million and a decrease in deferred rent, derivative and other liabilities of $99.9 million.
Investing Activities - Net cash used in investing activities for the year ended December 31, 2014 was $2.6 billion, primarily related to the total cash consideration of $756.2 million for the ARCT IV Merger, Cole Merger and the merger of CCPT with and into a direct subsidiary of the General Partner (the “CCPT Merger”) and $3.5 billion in the acquisition of 1,107 properties. The net cash used in investing activities was partially offset by the proceeds from the sale of properties of $1.6 billion, combined with the proceeds from the sale of investment securities of $159.8 million.
Financing Activities - Net cash provided by financing activities was $2.4 billion during the year ended December 31, 2014 related to proceeds from the issuance of corporate bonds of $2.5 billion, proceeds from mortgage notes payable of $1.0 billion and proceeds from the issuance of common stock of $1.6 billion. These inflows were partially offset by payments on mortgage notes payable of $1.1 billion, total distributions paid of $920.3 million and $116.4 million of deferred financing cost payments.
Cash Flows for the year ended December 31, 2013
Operating Activities - During the year ended December 31, 2013, net cash used in operating activities was $11.9 million. Cash flows used in operating activities during the year ended December 31, 2013 were mainly due to an adjusted net loss of $57.7 million (net loss of $507.8 million adjusted for non-cash items, including the issuance of OP Units, depreciation and amortization, amortization of deferred financing costs, equity-based compensation, loss on held for sale properties, loss on derivative instruments and gain on sale on investments of $450.2 million, in the aggregate), and a decrease in deferred costs and other assets of $19.9 million, offset by an increase in amounts due to affiliates of $43.8 million and an increase in accounts payable and accrued expenses of $20.8 million.
Investing Activities - Net cash used in investing activities for the year ended December 31, 2013 was $4.5 billion, primarily related to the acquisition of 1,739 properties with an aggregate purchase price of $3.5 billion, the total cash consideration of $878.9 million for acquisitions, the purchase of investment securities of $81.6 million, and the investment in direct financing leases of $68.6 million, partially offset by the proceeds from the sale of investment securities of $119.5 million.
Financing Activities - Net cash provided by financing activities of $4.3 billion during the year ended December 31, 2013 related to proceeds net of offering-related costs from the issuance of common stock of $2.0 billion, proceeds net of repayments from our credit facilities of $1.7 billion, $967.8 million of proceeds from the issuance of convertible debt, $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 common stock repurchases of $359.2 million, $101.2 million of deferred financing cost payments and total distributions paid of $243.1 million.
Election as a REIT
The General Partner elected to be taxed as a REIT for U.S. federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code commencing with the taxable year ended December 31, 2011. As a REIT, except as discussed below, the General Partner generally is not subject to federal income tax on taxable income that it distributes to its stockholders so long as it distributes at least 90% of its annual taxable income (computed without regard to the deduction for dividends paid and excluding net capital gains). REITs are subject to a number of other organizational and operational requirements. Even if the General Partner maintains its qualification for taxation as a REIT, it may be subject to certain state and local taxes on its income and property, federal income taxes on certain income and excise taxes on its 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 ended December 31, 2015.
The Operating Partnership is classified as a partnership for U.S. federal income tax purposes. As a partnership, the Operating Partnership is not a taxable entity for U.S. federal income tax purposes. Instead, each partner in the Operating Partnership is required to take into account its allocable share of the Operating Partnership’s income, gains, losses, deductions and credits for each taxable year. However, the Operating Partnership may be subject to certain state and local taxes on its income and property. Under the LPA, the Operating Partnership is required to conduct business in such a manner as to permit the General partner at all times to qualify as a REIT.
The Company conducts substantially all of its Cole Capital segment through a TRS. A TRS is a subsidiary of a REIT that is subject to corporate federal, state and local income taxes, as applicable. The Company’s use of a TRS enables it to engage in certain business activities while complying with the REIT qualification requirements and to retain any income generated by these businesses for reinvestment without the requirement to distribute those earnings. The Company conducts all of its business in the United States and Canada and, as a result, it files income tax returns in the U.S. federal jurisdiction, the Canadian federal jurisdiction and various state and local jurisdictions. Certain of the Company’s inter-company transactions that have been eliminated in consolidation for financial accounting purposes are also subject to taxation.
Inflation
We may be adversely impacted by inflation on any leases that do not contain indexed escalation provisions. However, net leases that require the tenant to pay its allocable share of operating expenses, including common area maintenance costs, real estate taxes and insurance, may reduce our exposure to increases in costs and operating expenses resulting from inflation.
Related Party Transactions and Agreements
In the past, we entered into certain agreements and paid certain fees or reimbursements to the Former Manager and its affiliates. As of December 31, 2014, as a result of the departure of certain executive officers (one of whom was a director) in the fourth quarter of 2014, the Former Manager and its affiliates were no longer affiliated with us. Accordingly, there have been no related party transactions to report during the year ended December 31, 2015 aside from those with the Managed REITs, as further described below.
We are contractually responsible for managing the Managed REITs’ affairs on a day-to-day basis, identifying and making acquisitions and investments on the Managed REITs’ behalf, and recommending to each of the Managed REIT’s respective board of directors an approach for providing investors with liquidity. In addition, we distribute the shares of common stock for certain of the Managed REITs and advise them regarding offerings, manage relationships with participating broker-dealers and financial advisors, and provide assistance in connection with compliance matters relating to the offerings. We receive compensation and reimbursement for services relating to the Managed REITs’ offerings and the investment, management and disposition of their respective assets, as applicable. See “Note 18 - Related Party Transactions and Arrangements” to our consolidated financial statements in this report for a further explanation of the various related party transactions, agreements and fees.
Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements that have had 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.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
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 manage 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 have limited operations in Canada and thus, are not exposed to material foreign currency fluctuations.
Interest Rate Risk
As of December 31, 2015, our debt included fixed-rate debt, including debt that has interest rates that are fixed with the use of derivative instruments, with a fair value and carrying value of $8.2 billion and $7.9 billion, respectively. 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 the fixed rate debt balance remains constant, we expect the fair value of our debt to decrease, the same way the price of a bond declines as interest rates rise. The sensitivity analysis related to our fixed-rate debt assumes an immediate 100 basis point move in interest rates from their December 31, 2015 levels, with all other variables held constant. A 100 basis point increase in market interest rates would result in a decrease in the fair value of our fixed rate debt by $181.7 million. A 100 basis point decrease in market interest rates would result in an increase in the fair value of our fixed-rate debt by $284.0 million.
As of December 31, 2015, our debt included variable-rate debt with an aggregate fair value and carrying value of $0.1 billion and $0.2 billion, respectively. The sensitivity analysis related to our variable-rate debt assumes an immediate 100 basis point move in interest rates from their December 31, 2015 levels, with all other variables held constant. A 100 basis point increase or decrease in variable interest rates on our variable-rate notes payable would increase or decrease our interest expense by $1.4 million annually.
As the information presented above includes only those exposures that existed as of December 31, 2015, it does not consider exposures or positions arising after that date. The information presented herein has limited predictive value. Future actual realized gains or losses with respect to interest rate fluctuations will depend on cumulative exposures, hedging strategies employed and the magnitude of the fluctuations.
These amounts were determined by considering the impact of hypothetical interest rate changes on our borrowing costs and assume no other changes in our capital structure.
Credit Risk
Concentrations of credit risk arise when a number of tenants are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in economic conditions. As discussed in “Item 1. Business” as well as “Item 1A. Risk Factors” the Company is subject to tenant, geographic and industry concentrations. Any downturn of the economic conditions in one or more of these tenants, states or industries could result in a material reduction of our cash flows or material losses to us.
The factors considered in determining the credit risk of our tenants include, but are not limited to: payment history; credit status and change in status (credit ratings for public companies are used as a primary metric); change in tenant space needs (i.e., expansion/downsize); tenant financial performance; economic conditions in a specific geographic region; and industry specific credit considerations. We believe that the credit risk of our portfolio is reduced by the high quality of our existing tenant base, reviews of prospective tenants’ risk profiles prior to lease execution and consistent monitoring of our portfolio to identify potential problem tenants.
Item 8.
Item 8. Financial Statements and Supplementary Data.
The information required by Item 8 is hereby incorporated by reference to our consolidated financial statements beginning on page of this document.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
I. Discussion of Controls and Procedures of the General Partner
For purposes of the discussion in this Part I of Item 9A, the “Company” refers to the General Partner.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that no controls and procedures, no matter how well designed and operated, can provide absolute assurance of achieving the desired control objectives.
In accordance with Rules 13a-15(b) and 15d-15(b) of the Exchange Act, management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures as of December 31, 2015 and determined that the disclosure controls and procedures were effective as of that date.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.
We conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and concluded that our internal control over financial reporting was effective as of December 31, 2015.
The effectiveness of our internal control over financial reporting as of December 31, 2015 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report in this Annual Report on Form 10-K.
Remediation of Material Weaknesses
Management concluded that the nine material weaknesses disclosed in the Company’s Annual Report on Form 10-K, as amended, for the fiscal year ended December 31, 2014 have been fully remediated as of December 31, 2015, as described below.
Disclosure Controls and Procedures
Material weakness - The Company’s disclosure controls and procedures were not properly designed or implemented to provide reasonable assurance that SEC filings correctly reflected the information in the Company’s records and were reviewed by senior management on a timely basis and that significant changes to SEC filings were communicated to the Audit Committee. In addition, the Company did not have appropriate controls over the formulation and disclosure of AFFO and AFFO per share guidance or the periodic re-assessment of the Company’s ability to meet its guidance.
Remediation - The Company has established a chartered disclosure committee that is responsible to ensure the timeliness, accuracy, completeness and quality of the Company’s SEC filings and other public disclosures. The Company has also enhanced and formalized the procedures for the review and approval of annual and quarterly SEC reports by the Audit Committee and management, including financial reporting sub-certification and tie-out procedures.
Control Environment
Material weakness - The Company failed to implement and maintain an effective internal control environment that had appropriate processes to manage the changes in business conditions resulting from the volume and complexity of its 2013 and first quarter 2014 transactions, combined with the pressure of market expectations inherent in announcing AFFO per share guidance for 2014.
Remediation - The Company has a new executive management team and has reconstituted the board of directors. The Company is committed to establishing a culture of compliance, integrity and transparency and this commitment and expectation has been communicated to all employees. Management conducted a comprehensive review of the Company’s corporate compliance policies, entity level controls and programs and formalized documentation of key policies and procedures, as well as designed and implemented internal controls. For example, the Company designed and implemented controls to provide appropriate reviews of the Company’s significant accounting policies and estimates and formalized the processes surrounding assessing accounting adjustments and the calculation and presentation of AFFO and AFFO guidance. The Company also provided training to senior management and accounting personnel on ethics, reporting procedures and other key topics as well as a review of the Company’s whistleblower hotline policies and procedures.
Related Party Transactions and Conflicts of Interest
Material weakness - The Company did not maintain the appropriate controls to assess, authorize and monitor related party transactions, validate the appropriateness of such transactions or manage the risks arising from contractual relationships with affiliates.
Remediation - The Company has enhanced the controls related to the review and approval of potential related party transactions with directors, director nominees, executive officers, 5% shareholders and their immediate family members through the adoption of a related person transaction policy administered by the Nominating and Corporate Governance Committee. In addition, there are no ongoing business activities between the Company and the Former Manager and its affiliates.
Equity-based Compensation
Material weakness - The Company did not maintain appropriate controls over various grants of equity-based compensation.
Remediation - The Company has implemented new internal controls over the authorization, documentation, issuance, administration and accounting for equity-based compensation. The Compensation Committee approves any equity award made to an executive officer, and has delegated authority to the Chief Executive Officer to grant equity awards of a limited amount to non-executive officers. Equity-based compensation tracking and recordkeeping has been further improved through the use of equity tracking software.
Accounting Close Process
Material weakness - The Company did not have consistent policies and procedures relating to purchase accounting, accounting for gain or loss on disposition and testing for impairment.
Remediation - The Company has standardized its internal accounting close process and documented its key accounting policies and procedures, including those relating to purchase accounting, accounting for gain or loss on disposition and testing for impairment. In addition, the Company has designed and implemented internal controls within its accounting close process to ensure that closing activities, such as reconciliations, journal entry reviews and comprehensive financial analysis, are performed and reviewed timely.
Critical Accounting Estimates and Non-Routine Transactions
Material weakness - The Company did not maintain effective controls or develop standardized policies and procedures for critical accounting estimates and non-routine transactions, including management review and approval of the accounting treatment of all critical and significant estimates on a periodic basis.
Remediation - The Company has documented critical accounting policies and established internal controls in which senior management reviews and approves all critical accounting estimates and non-routine transactions as part of the financial close and reporting processes.
Cash Reconciliations and Monitoring
Material weakness - The Company did not implement appropriate controls to record payments received and to reconcile its cash receipts and bank accounts on a timely basis.
Remediation - The Company has documented treasury and accounting policies and procedures, implemented controls over identified individuals responsible for the monitoring and timely reconciliation of cash accounts and has reviewed all bank accounts associated with the Company.
Information Technology General Controls - Access, Authentication and Information Technology Environment
Material weakness - The Company did not maintain effective information technology environmental and governance controls, including controls over information systems security administration and management functions in the following areas: (a) granting and revoking user access rights; (b) timely notification of user departures; (c) periodic review of appropriateness of access rights; (d) physical access restrictions; and (e) segregation of duties.
Remediation - The Company has implemented an access management system to govern the granting and revocation of user access rights and standardized the administration of access to financially significant systems within the information technology organization.
Information Technology General Controls Over Management of Third Party Service Providers
Material weakness - The Company did not have adequate controls over the transition from an affiliate of the Former Manager of systems and infrastructure, programs, data and processes, which were significant to the Company’s financial reporting process,.
Remediation - The Information Technology department now requires all service providers to have the appropriate contracts and service level agreements in place prior to the initiation of any services.
Changes in Internal Control over Financial Reporting
Other than the remediation activities described above, there were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the year ended December 31, 2015, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
II. Discussion of Controls and Procedures of the Operating Partnership
In the information incorporated by reference into this Part II of Item 9A, the term “Company” refers to the Operating Partnership, except as the context otherwise requires.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating
the disclosure controls and procedures, we recognize that no controls and procedures, no matter how well designed and operated, can provide absolute assurance of achieving the desired control objectives.
In accordance with Rules 13a-15(b) and 15d-15(b) of the Exchange Act, management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures as of December 31, 2015 and determined that the disclosure controls and procedures were effective as of that date.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.
We conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and management has concluded that our internal control over financial reporting was effective as of December 31, 2015.
Changes in Internal Control over Financial Reporting
The information under the heading “Changes in Internal Control over Financial Reporting” in Part I of this Item 9A is incorporated herein by reference.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
VEREIT, Inc.
Phoenix, AZ
We have audited the internal control over financial reporting of VEREIT, Inc. (“the Company”) (formerly American Realty Capital Properties, Inc.) and subsidiaries (the "Company") as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2015 of the Company and our report dated February 23, 2016 expressed an unqualified opinion on those consolidated financial statements and financial statement schedules.
/s/ DELOITTE & TOUCHE LLP
February 23, 2016
Phoenix, AZ
Item 9B.
Item 9B. Other Information.
The following disclosure would have otherwise been filed in a Current Report on Form 8-K under the heading “Item 5.02. Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers.”
Effective February 23, 2016 (the “Effective Date”), VEREIT, Inc. (the “Company”) entered into new employment agreements with Paul McDowell, EVP and Chief Operating Officer (the “McDowell Employment Agreement”) and Thomas Roberts, EVP and Chief Investment Officer (the “Roberts Employment Agreement”).
Employment Agreement with Paul McDowell
The McDowell Employment Agreement supersedes and replaces in all respects that agreement entered into between Mr. McDowell and the Company on January 8, 2014, which assumed Mr. McDowell’s previous employment agreement dated as of September 24, 2013. As of the Effective Date, the agreement provides Mr. McDowell with a minimum annual base salary of $500,000 which will be subject to periodic review by the Compensation Committee (the “Compensation Committee”) of the Company’s Board of Directors. The Employment Letter provides for a target annual cash bonus (the “Target Bonus”) equal to 100% of Mr. McDowell’s then-effective base salary, subject to the achievement of performance goals established by the Compensation Committee in consultation with the Chief Executive Officer. Mr. McDowell will also be entitled to receive annual long-term incentive equity awards, as determined by the Compensation Committee in consultation with the Chief Executive Officer, on the same basis as equity awards made generally to other senior executives of the Company. On February 23, 2016, Mr. McDowell was granted a number of restricted stock units under the VEREIT, Inc. Equity Plan (the “Equity Plan”) with a fair market value equal to $875,000 determined based upon the closing price of the Company’s common stock, par value $0.01 per share, on the New York Stock Exchange on the Effective Date. Half of the award will vest in equal installments on each of the three anniversaries of the Effective Date, assuming Mr. McDowell’s continued employment, and half of the award will vest based upon Mr. McDowell’s continued employment and the achievement of certain specified performance conditions that measure total shareholder return equally against each of a specified peer group and specified market index measured from January 1, 2016 to December 31, 2018. The award will be subject to the terms and conditions of the applicable award agreements granting such award and the Equity Plan.
Mr. McDowell will be entitled to reimbursement for reasonable business expenses in accordance with the Company’s policy and reasonable travel and entertainment expenses incurred in connection with conducting Company business.
If Mr. McDowell’s employment with the Company should terminate due to his death or at the election by the Company due to his Disability (as defined in the McDowell Employment Agreement), then the Company will provide Mr. McDowell with the accrued benefits (the “Accrued Benefits”) (comprised of (i) any unpaid base salary through the termination date in accordance with the Company’s payroll practices, (ii) reimbursement for any unreimbursed business expenses incurred through the termination date in accordance with the Company’s expense reimbursement policy and (iii) all other payments or benefits to which Mr. McDowell is entitled under the terms of any applicable compensation arrangement or benefit plan or program which will be paid or provided in accordance with the terms of such arrangement, plan or program) and any accrued but unpaid annual cash bonus for the year prior to the year of termination, if applicable. In addition, any outstanding equity award granted to Mr. McDowell from the Effective Date until April 1, 2018 will vest on a pro rata basis calculated by dividing the amount of months elapsed since issuance by the applicable term of a time-based award or the performance measurement period of a performance-based award.
If Mr. McDowell’s employment with the Company should terminate at the election of the Company without Cause (as defined in the McDowell Employment Agreement), or upon a resignation by Mr. McDowell for Good Reason (as defined in the McDowell Employment Agreement), each being a “Qualifying Termination,” then the Company will pay Mr. McDowell (i) the Accrued Benefits, (ii) any accrued but unpaid annual cash bonus for the calendar year prior to the year in which termination occurs, and (iii) an amount equal to the sum of: (a) 12 months of Mr. McDowell’s then-effective base salary; and (b) the Target Bonus for the year of termination, payable in equal installments over the 12-month period following the date of the Qualifying Termination. Upon such a Qualifying Termination, Mr. McDowell will also be entitled to continued medical coverage until the earliest of: (i) one year following the date of the Qualifying Termination; and (ii) such time as Mr. McDowell secures other medical coverage. Upon a Qualifying Termination, all outstanding equity awards granted to Mr. McDowell from the Effective Date until April 1, 2018 will vest in full (performance-based restricted stock units will vest at target levels of performance) and thereafter all outstanding equity awards will vest according to their terms. In order to receive any of the payments or benefits outlined herein relating to a Qualifying Termination, Mr. McDowell must execute, and not revoke, a fully effective release of claims, substantially in the form attached to the McDowell Employment Agreement, within 45 days following the termination of his employment.
The McDowell Employment Agreement was also conditioned upon the execution of an Employee Confidentiality and Non-Competition Agreement (the “Confidentiality and Non-Competition Agreement”).
Finally, Mr. McDowell executed an indemnification agreement in substantially the same form previously executed by Glenn J. Rufrano with the Company, which was filed as Exhibit 10.2 to a Current Report on Form 8-K filed by the Company with the U.S. Securities and Exchange Commission on March 16, 2015.
Employment Agreement with Thomas Roberts
The Roberts Employment Agreement supersedes and replaces in all respects that agreement entered into between Mr. Roberts and the Company on May 11, 2015. As of the Effective Date, the Roberts Employment Agreement provides Mr. Roberts with a minimum annual base salary of $500,000 which will be subject to periodic review by the Compensation Committee. The Roberts Employment Agreement provides for a target annual cash bonus (the “Target Bonus”) equal to 100% of Mr. Roberts’ then-effective base salary, subject to the achievement of performance goals established by the Compensation Committee in consultation with the Chief Executive Officer. Mr. Roberts will also be entitled to receive annual long-term incentive equity awards, as determined by the Compensation Committee in consultation with the Chief Executive Officer, on the same basis as equity awards made generally to other senior executives of the Company. On February 23, 2016, Mr. Roberts was granted a number of restricted stock units under the Equity Plan with a fair market value equal to $1.2 million determined based upon the closing price of the Company’s common stock, par value $0.01 per share, on the New York Stock Exchange on the Effective Date. Half of the award will vest in equal installments on each of the three anniversaries of the Effective Date assuming Mr. Roberts’ continued employment, and half of the award will vest based upon Mr. Roberts’ continued employment and the achievement of certain specified performance conditions that measure total shareholder return equally against each of a specified peer group and specified market index measured from January 1, 2016 to December 31, 2018. The award will be subject to the terms and conditions of the applicable award agreements granting such award and the Equity Plan.
Mr. Roberts will be entitled to reimbursement for reasonable business expenses in accordance with the Company’s policy and reasonable travel and entertainment expenses incurred in connection with conducting Company business.
If Mr. Roberts’ employment with the Company should terminate due to his death or at the election of the Company due to his Disability (as defined in the Roberts Employment Agreement), then the Company will provide Mr. Roberts with the accrued benefits (the “Accrued Benefits”) (comprised of (i) any unpaid base salary through the termination date in accordance with the Company’s payroll practices, (ii) reimbursement for any unreimbursed business expenses incurred through the termination date in accordance with the Company’s expense reimbursement policy and (iii) all other payments or benefits to which Mr. Roberts is entitled under the terms of any applicable compensation arrangement or benefit plan or program which will be paid or provided in accordance with the terms of such arrangement, plan or program) and any accrued but unpaid annual cash bonus for the year prior to the year of termination, if applicable. In addition, any outstanding equity award granted to Mr. Roberts from the Effective Date until April 1, 2018 will vest on a pro rata basis calculated by dividing the amount of months elapsed since issuance by the applicable term of a time-based award or the performance measurement period of a performance-based award.
If Mr. Roberts’ employment with the Company should terminate at the election of the Company without Cause (as defined in the Roberts Employment Agreement), or upon a resignation by Mr. Roberts for Good Reason (as defined in the Roberts Employment Agreement), each being a “Qualifying Termination,” then the Company will pay Mr. Roberts (i) the Accrued Benefits, (ii) any accrued but unpaid annual cash bonus for the calendar year prior to the year in which termination occurs, and (iii) an amount equal to the sum of: (a) 12 months of Mr. Roberts’s then-effective base salary; and (b) the Target Bonus for the year of termination, payable in equal installments over the 12-month period following the date of the Qualifying Termination. Upon such a Qualifying Termination, Mr. Roberts will also be entitled to continued medical coverage until the earliest of: (i) one year following the date of the Qualifying Termination; and (ii) such time as Mr. Roberts secures other medical coverage. Upon a Qualifying Termination, all outstanding equity awards granted to Mr. Roberts from the Effective Date until April 1, 2018 will vest in full (performance-based restricted stock units will vest at target levels of performance) and thereafter all outstanding equity awards will vest according to their terms. In order to receive any of the payments or benefits outlined herein relating to a Qualifying Termination, Mr. Roberts must execute, and not revoke, a fully effective release of claims, substantially in the form attached to the Roberts Employment Agreement, within 45 days following the termination of his employment.
The Roberts Employment Agreement was also conditioned upon the execution of an Employee Confidentiality and Non-Competition Agreement (the “Confidentiality and Non-Competition Agreement”).
Finally, Mr. Roberts executed an indemnification agreement in substantially the same form previously executed by Glenn J. Rufrano with the Company, which was filed as Exhibit 10.2 to a Current Report on Form 8-K filed by the Company with the U.S. Securities and Exchange Commission on March 16, 2015.
The foregoing descriptions of the terms of the McDowell and Roberts Employment Agreements does not purport to be complete and is qualified in its entirety by reference to the Employment Agreements which are exhibits to the Company’s Annual Report on Form 10-K.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
This information will be contained in our definitive proxy statement for the 2016 Annual Meeting of Stockholders (the “Proxy Statement”), to be filed within 120 days following the end of our fiscal year, and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
Financial Statements
The Financial Statements are included herein at pages through.
Financial Statement Schedules
Schedule III - Real Estate and Accumulated Depreciation is included herein on pages through.
Schedule IV - Mortgage Loans Held for Investment is included herein on page.
Exhibits
The following exhibits are included in this Annual Report on Form 10-K for the fiscal year ended December 31, 2015 (and are numbered in accordance with Item 601 of Regulation S-K):
_____________________________
*
Filed herewith
**
Schedules and applicable exhibits omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish a supplemental copy of any omitted schedule to the SEC upon request.
(1)
Previously filed with the Current Report on Form 8-K filed with the SEC on December 17, 2012.
(2)
Previously filed with the Pre-Effective Amendment No. 5 to Form S-11 Registration Statement (Registration No. 333-172205) filed with the SEC on July 5, 2011.
(3)
Previously filed with the Pre-Effective Amendment No. 4 to Form S-11 Registration Statement (Registration No. 333-172205) filed with the SEC on June 13, 2011.
(4)
Previously filed with the Current Report on Form 8-K filed with the SEC on May 15, 2012.
(5)
Previously filed with the Current Report on Form 8-K filed with the SEC on July 30, 2012.
(6)
Previously filed as Annex E with the Final Prospectus Filed Pursuant to Rule 424(b)(3) with the SEC on December 4, 2013.
(7) Previously filed with the Current Report on Form 8-K filed with the SEC on May 28, 2013.
(8)
Previously filed with the Amended Current Report on Form 8-K/A filed with the SEC on June 7, 2013.
(9)
Previously filed with the Current Report on Form 8-K filed with the SEC on June 12, 2013.
(10)
Previously filed with the Current Report on Form 8-K filed with the SEC on July 2, 2013.
(11)
Previously filed with the Current Report on Form 8-K filed with the SEC on July 29, 2013.
(12)
Previously filed with the Current Report on Form 8-K filed with the SEC on November 15, 2013.
(13)
Previously filed with the Amended Current Report on Form 8-K/A filed with the SEC on December 20, 2013.
(14)
Previously filed with the Amended Current Report on Form 8-K/A filed with the SEC on September 25, 2013.
(15)
Previously filed with the First Current Report on Form 8-K filed with the SEC on October 7, 2013.
(16)
Previously filed with the Second Current Report on Form 8-K filed with the SEC on October 7, 2013.
(17)
Previously filed with the Current Report on Form 8-K filed with the SEC on October 23, 2013.
(18)
Previously filed with the Current Report on Form 8-K filed with the SEC on December 11, 2013.
(19) Previously filed with the Current Report on Form 8-K filed with the SEC on December 30, 2014.
(20)
Previously filed with the Current Report on Form 8-K filed with the SEC on January 15, 2015.
(21)
Previously filed with the Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 filed with the SEC on August 6, 2015.
(22)
Previously filed with the Current Report on Form 8-K filed with the SEC on June 4, 2015.
(23)
Previously filed with the Annual Report on Form 10-K for the year ended December 31, 2014 filed with the SEC on March 30, 2015.
(24)
Previously filed with the Registration Statement on Form 8-A filed with the SEC on January 3, 2014.
(25)
Previously filed with the Current Report on Form 8-K filed with the SEC on January 3, 2014.
(26)
Previously filed with the Quarterly Report on Form 10-Q for the quarter ended September 31, 2015 filed with the SEC on November 5, 2015.
(27)
Previously filed with the Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC on February 27, 2014.
(28)
Previously filed with the Amendment No. 2 to its Annual Report on Form 10-K/A for the year ended December 31, 2013 filed with the SEC on March 2, 2015.
(29) Previously filed with the Current Report on Form 8-K filed with the SEC on March 16, 2015.
(30) Previously filed with the Quarterly Report on Form 10-Q for the quarter ended June 30, 2014 filed with the SEC on July 29, 2014.
(31) Previously filed with the Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 filed with the SEC on March 2, 2015.
(32) Previously filed with the Quarterly Report on Form 10-Q for the quarter ended March 31, 2015 filed with the SEC on May 7, 2015.
(33) Previously filed with the Current Report on Form 8-K filed with the SEC on December 15, 2014.
(34) Previously filed with the Current Report on Form 8-K filed with the SEC on November 18, 2014.
(35) Previously filed with the Current Report on Form 8-K filed with the SEC on July 28, 2015.
(36) Previously filed with the Registration Statement on Form S-4 (Registration No. 333-197780-01) filed with the SEC on August 1, 2014.
(37)
Previously filed with the Current Report on Form 8-K filed with the SEC on July 9, 2013.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, each registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned thereunto duly authorized.
VEREIT, INC.
By:
/s/ Michael J. Bartolotta
Michael J. Bartolotta
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
VEREIT OPERATING PARTNERSHIP, L.P.
By: VEREIT, Inc., its sole general partner
By:
/s/ Michael J. Bartolotta
Michael J. Bartolotta
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Dated: February 23, 2016
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Form 10-K has been signed below by the following persons on behalf of each registrant and in the capacities and on the dates indicated.
_________________________________
*
Each person is signing in his or her capacity as an officer and/or director of VEREIT, Inc., which is the sole general partner of VEREIT Operating Partnership, L.P.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
VEREIT, Inc.
Phoenix, AZ
We have audited the accompanying consolidated balance sheet of VEREIT, Inc. (formerly American Realty Capital Properties, Inc.) and subsidiaries (the “Company”) as of December 31, 2015, and the related consolidated statements of operations, comprehensive loss, changes in equity, and cash flows for the year then ended. Our audit also included the financial statement schedules listed in the Index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of VEREIT, Inc. and subsidiaries as of December 31, 2015, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2015, based on Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 23, 2016 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
February 23, 2016
Phoenix, AZ
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Partners of
VEREIT Operating Partnership, L.P.
Phoenix, AZ
We have audited the accompanying consolidated balance sheet of VEREIT Operating Partnership, L.P. (“the Company”) (formerly ARC Properties Operating Partnership, L.P.) and subsidiaries (the “Operating Partnership”) as of December 31, 2015, and the related consolidated statements of operations, comprehensive loss, changes in equity, and cash flows for the year then ended. Our audit also included the financial statement schedules listed in the Index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Operating Partnership’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Operating Partnership is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Operating Partnership’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of VEREIT Operating Partnership L.P. and subsidiaries as of December 31, 2015, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
February 23, 2016
Phoenix, AZ
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
VEREIT, Inc.
We have audited the accompanying consolidated balance sheet of VEREIT, Inc. (a Maryland corporation) and subsidiaries (the “Company”) as of December 31, 2014, and the related consolidated statements of operations, comprehensive loss, changes in equity, and cash flows for each of the two years in the period ended December 31, 2014. Our audits of the basic consolidated financial statements included the financial statement schedules listed in the Index to Consolidated Financial Statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of VEREIT, Inc. and subsidiaries as of December 31, 2014, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
/s/ GRANT THORNTON LLP
Phoenix, Arizona
March 30, 2015, except for Note 2 regarding the adoption of ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30), as to which the date is February 23, 2016
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors of General Partner and Limited Partners
VEREIT Operating Partnership, L.P. and subsidiaries
We have audited the accompanying consolidated balance sheet of VEREIT Operating Partnership, L.P. (a Delaware partnership) and subsidiaries (collectively the “Operating Partnership”) as of December 31, 2014, and the related consolidated statements of operations, comprehensive loss, changes in equity, and cash flows for each of the two years in the period ended December 31, 2014. Our audits of the basic consolidated financial statements included the financial statement schedules listed in the Index to Consolidated Financial Statements. These financial statements and financial statement schedules are the responsibility of the Operating Partnership’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Operating Partnership’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Operating Partnership’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of VEREIT Operating Partnership, L.P. and subsidiaries as of December 31, 2014, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
/s/ GRANT THORNTON LLP
Phoenix, Arizona
March 30, 2015, except for Note 2 regarding the adoption of ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30), as to which the date is February 23, 2016
VEREIT, INC.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC.)
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share and per share data)
The accompanying notes are an integral part of these statements.
VEREIT, INC.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per share data)
_______________________________________________
(1)
Includes $1.7 million and $37.6 million of expenses incurred during the years ended December 31, 2014 and 2013, respectively, paid to affiliates. No such expenses were incurred during the year ended December 31, 2015.
(2)
Includes $137.8 million and $156.1 million of expenses incurred during the years ended December 31, 2014 and 2013, respectively, paid to affiliates. No such expenses were incurred during the year ended December 31, 2015.
(3)
Includes $16.1 million and $103.2 million of expenses incurred during the years ended December 31, 2014 and 2013, respectively, paid to affiliates. No such expenses were incurred during the year ended December 31, 2015.
(4)
Represents loss attributable to limited partners and consolidated joint venture partners.
The accompanying notes are an integral part of these statements.
VEREIT, INC.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC.)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
_______________________________________________
(1)
Represents loss attributable to limited partners and consolidated joint venture partners.
The accompanying notes are an integral part of these statements.
VEREIT, INC.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC.)
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(In thousands, except for share data)
VEREIT, INC.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC.)
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY - (Continued)
(In thousands, except for share data)
_______________________________________________
(1) Includes $2.2 million and $161.8 million issued to affiliates of the Former Manager (as defined in Note 1 - Organization) for the years ended December 31, 2014 and 2013, respectively. No such expenses were incurred during the year ended December 31, 2015.
The accompanying notes are an integral part of these statements.
VEREIT, INC.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
VEREIT, INC.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(In thousands)
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
CONSOLIDATED BALANCE SHEETS
(In thousands, except for unit data)
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per unit data)
_______________________________________________
(1)
Includes $1.7 million and $37.6 million of expenses incurred during the years ended December 31, 2014 and 2013, respectively, paid to affiliates. No such expenses were incurred during the year ended December 31, 2015.
(2)
Includes $137.8 million and $156.1 million of expenses incurred during the years ended December 31, 2014 and 2013, respectively, paid to affiliates. No such expenses were incurred during the year ended December 31, 2015.
(3)
Includes $16.1 million and $103.2 million of expenses incurred during the years ended December 31, 2014 and 2013, respectively, paid to affiliates. No such expenses were incurred during the year ended December 31, 2015.
(4)
Represents (income) loss attributable to consolidated joint venture partners.
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
_______________________________________________
(1)
Represents loss attributable to consolidated joint venture partners.
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(In thousands, except for unit data)
VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY - (Continued)
(In thousands, except for unit data)
_______________________________________________
(1)
Includes $2.2 million and $161.8 million issued to affiliates of the Former Manager (as defined in Note 1 - Organization) for the years ended December 31, 2014 and 2013, respectively. No such expenses were incurred during the year ended December 31, 2015.
The accompanying notes are an integral part of these statements.
VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(In thousands)
The accompanying notes are an integral part of these statements.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
Note 1 - Organization
VEREIT, Inc., f/k/a American Realty Capital Properties, Inc. (the “General Partner” or “VEREIT”), is a Maryland corporation, incorporated on December 2, 2010, that qualified as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning in the taxable year ended December 31, 2011. VEREIT Operating Partnership, L.P., f/k/a ARC Properties Operating Partnership, L.P. (together with its subsidiaries, the “Operating Partnership” or the “OP”), is a Delaware limited partnership of which the General Partner is the sole general partner. The board of directors authorized amendments to the General Partner’s Articles of Amendment and Restatement and the Operating Partnership’s Certificate of Limited Partnership to effect name changes from American Realty Capital Properties, Inc. and ARC Properties Operating Partnership, L.P. to VEREIT, Inc. and VEREIT Operating Partnership, L.P., respectively, which became effective July 28, 2015. VEREIT voluntarily delisted its common stock, par value $0.01 per share (“Common Stock”), and its 6.70% Series F Cumulative Redeemable Preferred Stock, par value $0.01 per share (“Series F Preferred Stock”), from the NASDAQ Global Select Market (the “NASDAQ”) following the close of trading on July 30, 2015 and transferred the listing of its Common Stock and Series F Preferred Stock to the New York Stock Exchange (the “NYSE”) effective July 31, 2015. The Common Stock and Series F Preferred Stock now trade under the trading symbols, “VER” and “VER PRF,” respectively. As used herein, the terms the “Company,” “we,” “our” and “us” refer to VEREIT, together with its consolidated subsidiaries, including the OP.
The Company is a full-service real estate operating company with investment management capabilities that operates through two reportable segments, its real estate investment (“REI”) segment and its investment management segment, Cole Capital (“Cole Capital”), as further discussed in Note 4 - Segment Reporting. Through the REI segment, the Company owns and actively manages a diversified portfolio of retail, restaurant, office and industrial real estate properties subject to long-term net leases with creditworthy tenants. The Company actively manages its portfolio considering a number of metrics including property type, concentration and key economic factors for appropriate balance and diversity. Through the Cole Capital segment, the Company is responsible for raising capital for and managing the affairs of the Managed REITs (as defined in Note 2 - Summary of Significant Accounting Policies) on a day-to-day basis, identifying and making acquisitions and investments on the Managed REITs’ behalf and recommending to the respective board of directors of each of the Managed REITs an approach for providing investors with liquidity. Cole Capital receives compensation and reimbursement for performing these services. To support both reportable segments, the Company employs a shared services model pursuant to which its personnel are integral in providing, among other things, transactional and operational functions to the Company’s owned portfolio and the Managed REITs.
Substantially all of the REI segment’s operations are conducted through the OP. VEREIT is the sole general partner and holder of 97.4% of the common equity interests in the OP as of December 31, 2015 with the remaining 2.6% of the common equity interests owned by certain unaffiliated investors and certain former directors, officers and employees of the Former Manager (defined below). Under the limited partnership agreement of the OP, as amended (the “LPA”), after holding units of limited partner interests in the OP (“OP Units”) for a period of one year, unless otherwise consented to by VEREIT, holders of OP Units have the right to redeem the OP Units for the cash value of a corresponding number of shares of VEREIT’s Common Stock or, at the option of VEREIT, a corresponding number of shares of VEREIT’s Common Stock. 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 the OP’s assets. Substantially all of the Cole Capital segment’s operations are conducted through Cole Capital Advisors, Inc. (“CCA”), an Arizona corporation and a wholly owned subsidiary of the OP. CCA is treated as a taxable REIT subsidiary (“TRS”) under Section 856 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”).
The actions of the Operating Partnership and its relationship with the General Partner are governed by the LPA. The General Partner does not have any significant assets other than its investment in the Operating Partnership. Therefore, the assets and liabilities of the General Partner and the Operating Partnership are substantially the same. Additionally, pursuant to the LPA, all administrative expenses and expenses associated with the formation, continuity, existence and operation of the General Partner incurred by the General Partner on the Operating Partnership’s behalf shall be treated as expenses of the Operating Partnership. Further, when the General Partner issues any equity instrument that has been approved by the General Partner’s board of directors, the LPA requires the Operating Partnership to issue to the General Partner equity instruments with substantially similar terms, to protect the integrity of the Company’s umbrella partnership REIT structure, pursuant to which each holder of interests in the Operating Partnership has a proportionate economic interest in the Operating Partnership reflecting its capital contributions thereto. OP Units issued to the General Partner are referred to as General Partner OP Units. OP Units issued to parties other than the General Partner are referred to as Limited Partner OP Units. The LPA also provides that the Operating Partnership issue debt with terms and provisions consistent with debt issued by the General Partner. The LPA will be amended to provide for the issuance of any additional class of equivalent equity instruments to the extent the General Partner’s board of directors authorizes the issuance of any new class of equity securities.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Prior to January 8, 2014, the Company was externally managed by ARC Properties Advisors, LLC (the “Former Manager”) on a day-to-day basis, with the exception of certain acquisition, accounting and portfolio management activities which were performed by the Company’s employees. In August 2013, the General Partner’s board of directors determined that it was in the best interests of the Company and its stockholders to become self-managed, and the Company completed its transition to self-management on January 8, 2014.
On March 2, 2015, the General Partner filed restated consolidated financial statements and related financial information as of and for the fiscal years ended December 31, 2013 and 2012 and the interim periods ended March 31, 2014 and 2013, June 30, 2014 and 2013 and September 30, 2013, and the OP restated and amended its consolidated financial statements and related financial information as of and for the fiscal years ended December 31, 2013 and 2012 and the interim periods ended June 30, 2014 and 2013 (collectively, the “Restatement”) to correct errors that were identified as a result of a previously-announced investigation conducted by the audit committee (the “Audit Committee”) of the General Partner’s board of directors (the “Audit Committee Investigation”), as well as certain other errors that were identified by the Company. In addition, the Restatement reflected corrections of certain immaterial errors and certain previously identified errors that the Company became aware of during the normal course of business and were determined to be immaterial, both individually and in the aggregate, when the consolidated financial statements were originally issued. This restated and corrected data and the restated financial statements for the year ended December 31, 2013 and the interim periods ended March 31, 2014 and 2013, June 30, 2014 and 2013 and September 30, 2013 are included in these consolidated financial statements and accompanying notes.
Note 2 - Summary of Significant Accounting Policies
Basis of Accounting
The consolidated financial statements of the Company presented herein include the accounts of the General Partner and its consolidated subsidiaries, including the OP. All intercompany transactions have been eliminated upon consolidation. The financial statements are prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”).
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company and its subsidiaries and consolidated joint venture arrangements. The portions of the consolidated joint venture arrangements not owned by the Company are presented as non-controlling interests in VEREIT’s and the OP’s consolidated balance sheets, statements of operations, statements of comprehensive income (loss) and statements of changes in equity. In addition, as described in Note 1 - Organization, certain third parties have been issued OP Units. Holders of OP Units are considered to be non-controlling interest holders in the OP and their ownership interest in the limited partner’s share is presented as non-controlling interests in VEREIT’s consolidated balance sheets, statements of operations, statements of comprehensive income (loss) and statements of changes in equity. Further, a portion of the earnings and losses of the OP are allocated to non-controlling interest holders based on their respective ownership percentages. Upon conversion of OP Units to Common Stock, any difference between the fair value of shares of Common Stock issued and the carrying value of the OP Units converted is recorded as a component of equity. As of both December 31, 2015 and 2014, there were approximately 23.8 million Limited Partner OP Units outstanding.
During the year ended December 31, 2015, the Company early adopted the U.S. Financial Accounting Standards Board (the “FASB”) Accounting Standards Update, (“ASU”) No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis (“ASU 2015-02”), as described in the “Recent Accounting Pronouncements” section below, which simplifies consolidation accounting by reducing the number of consolidation models and changing various aspects of current U.S. GAAP, including certain consolidation criteria for a variable interest entity (“VIE”). For legal entities being evaluated for consolidation, the Company must first determine whether the interests that it holds and fees it receives qualify as variable interests in the entity. A variable interest is an investment or other interest that will absorb portions of an entity’s expected losses or receive portions of the entity’s expected residual returns. The Company’s evaluation includes consideration of fees paid to the Company where the Company acts as a decision maker or service provider to the entity being evaluated. If the Company determines that it holds a variable interest in an entity, it evaluates whether that entity is a variable interest entity. VIEs are entities where investors lack sufficient equity at risk for the entity to finance its activities without additional subordinated financial support or where equity investors, as a group, lack one of the following characteristics: (a) the power to direct the activities that most significantly impact the entity’s economic performance, (b) the obligation to absorb the expected losses of the entity, or (c) the right to receive the expected returns of the entity.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
A VIE must be consolidated by its primary beneficiary, which is generally defined as the party who has a controlling financial interest in the VIE. The Company qualitatively assesses whether it is (or is not) the primary beneficiary of a VIE. Consideration of various factors include, but are not limited to, the Company’s ability to direct the activities that most significantly impact the entity’s economic performance and its obligation to absorb losses from or right to receive benefits of the VIE that could potentially be significant to the VIE. The Company consolidates any VIEs when the Company is determined to be the primary beneficiary of the VIE and the difference between consolidating the VIE and accounting for it using the equity method could be material to the Company’s consolidated financial statements. The Company continually evaluates the need to consolidate these VIEs based on standards set forth in U.S. GAAP as described above.
Reclassification
As described below, the following items previously reported have been reclassified to conform with the current period’s presentation.
The other debt balance from the prior years has been combined in the consolidated balance sheets and consolidated statements of cash flows into the captions mortgage notes payable and other debt, net and payments on mortgage notes payable and other debt, respectively. State income taxes previously included in general and administrative expenses and federal and state income taxes previously included in other income, net have been combined into the caption (provision for) benefit from income taxes in the consolidated statements of operations. Additionally, the gain on forgiveness of debt previously included in other income, net has been combined into the caption gain (loss) on extinguishment and forgiveness of debt, net.
Further, the designated derivatives, fair value adjustments line item from the prior years has been disaggregated within the consolidated statements of other comprehensive loss into the captions unrealized loss on interest rate derivatives and amount of loss reclassified from accumulated other comprehensive loss into income as interest expense. These captions were previously included within the notes to consolidated financial statements.
Lastly, in connection with the Company’s early adoption of the FASB ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, as discussed in the “Recent Accounting Pronouncements” section below, the Company has applied the new guidance retrospectively and modified the presentation of debt issuance costs related to a recognized debt liability to be presented on the consolidated balance sheets as a direct deduction from the carrying amount of the related debt liability (specifically relating to mortgage notes payable, other debt, corporate bonds, convertible debt and the term portion of the credit facility for the Company), rather than presenting the costs as an asset, for all periods presented. The amounts reclassified from the rent and tenant receivables and other assets, net line item to the respective debt liability on the Company’s consolidated balance sheets as of December 31, 2015 and 2014 are $62.7 million and $88.0 million, respectively.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Critical Accounting Policies and Significant Accounting Estimates”, management makes significant estimates regarding goodwill and intangible asset impairments, real estate investment impairment, loans held for investment, program development costs, allocation of purchase price of business combinations and income taxes as well as the consolidation of equity investments.
Real Estate Investments
The Company records acquired real estate at cost and makes assessments as to the useful lives of depreciable assets. The Company considers 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 intangible lease assets.
Assets Held for Sale
Upon classifying a real estate investment as held for sale, the Company will no longer recognize depreciation expense related to the depreciable assets of the property. Assets held for sale are recorded at the lower of carrying value or estimated fair value, less the estimated cost to dispose of the assets. As of December 31, 2015, 17 properties were classified as held for sale. As of
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
December 31, 2014, two properties were classified as held for sale, which were sold during the first quarter of 2015. See Note 6 - Real Estate Investments for further discussion regarding properties held for sale.
If circumstances arise that the Company previously considered unlikely and, as a result, the Company decides not to sell a property previously classified as held for sale, the Company will reclassify the property as held and used. The Company measures and records a property that is reclassified as held and used at the lower of (i) its carrying value before the property was classified as held for sale, adjusted for any depreciation expense that would have been recognized had the property been continuously classified as held and used or (ii) the estimated fair value at the date of the subsequent decision not to sell.
Development Activities
Project costs and expenses, which include interest expense, associated with the development, construction and lease-up of a real estate project are capitalized as construction in progress. Once the development and construction of the building is substantially completed, the amounts capitalized to construction in progress are transferred to (i) land and (ii) buildings, fixtures and improvements and are depreciated over their respective useful lives.
Investment in Unconsolidated Entities
Unconsolidated Joint Ventures
Investment in unconsolidated joint ventures as of December 31, 2015 and 2014 consisted of the Company’s interest in three joint ventures that owned three properties and the Company’s interest in six joint ventures that owned six properties, respectively, (the “Unconsolidated Joint Ventures”). As of December 31, 2015 and 2014, the Company owned aggregate equity investments of $52.8 million and $94.2 million, respectively, in the Unconsolidated Joint Ventures. The Company accounts for the Unconsolidated Joint Ventures using the equity method of accounting as the Company has the ability to exercise significant influence, but not control, over operating and financial policies of these investments. The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the joint ventures’ earnings and distributions. The Company records its proportionate share of net income from the Unconsolidated Joint Ventures in other income, net in the consolidated statements of operations. During the years ended December 31, 2015 and 2014, the Company recognized $2.3 million and $1.5 million, respectively, of net income from the Unconsolidated Joint Ventures. See Note 6 - Real Estate Investments for further discussion on investments in Unconsolidated Joint Ventures.
Managed REITs
In conjunction with its Cole Merger (defined below), the Company acquired equity interests in the following publicly registered, non-traded REITs: Cole Credit Property Trust IV, Inc. (“CCPT IV”); Cole Corporate Income Trust, Inc. (“CCIT”); Cole Real Estate Income Strategy (Daily NAV), Inc. (“INAV”); Cole Office & Industrial REIT (CCIT II), Inc. (“CCIT II”); Cole Credit Property Trust V, Inc. (“CCPT V”); and other real estate offerings in registration (collectively with CCPT IV, CCIT, INAV and CCIT II, the “Managed REITs”). As of December 31, 2015 and 2014, the Company owned aggregate equity investments of $4.1 million and $3.9 million, respectively, in the Managed REITs and other affiliated offerings. On January 29, 2015, CCIT merged with Select Income REIT and was no longer managed by Cole Capital. Prior to the CCPT Acquisition Date (defined below), Cole Credit Property Trust, Inc., a Maryland corporation (“CCPT”), was a Managed REIT and accounted for using the equity method. As of the CCPT Acquisition Date, the Company had a de minimis equity investment in CCPT. The Company accounts for these investments using the equity method of accounting which requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the respective Managed REIT’s earnings and distributions. The Company records its proportionate share of net income from the Managed REITs in other income, net in the consolidated statements of operations. During the years ended December 31, 2015 and 2014, the Company recognized $46,000 of net income and $1.6 million of net loss, respectively, from the Managed REITs. See Note 18 - Related Party Transactions and Arrangements for further discussion on the Managed REITs.
Allocation of Purchase Price of Business Combinations including Acquired Properties
In accordance with the guidance for business combinations, the Company determines whether a transaction or other event is a business combination. If the transaction is determined to be a business combination, the Company determines 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 acquired company are recorded on the same basis as they were carried by the acquired company on the merger date. All other business combinations are accounted for by applying the acquisition method of accounting. Under the acquisition method, the Company recognizes the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquired entity at fair value. In addition, the Company evaluates the
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
existence of goodwill or a gain from a bargain purchase. The Company expenses acquisition related costs and fees associated with business combinations and asset acquisitions.
The Company allocates the purchase price of acquired properties and businesses accounted for under the acquisition method of accounting to tangible and identifiable intangible assets and liabilities acquired based on their respective fair values. Tangible assets include land, buildings, fixtures and tenant improvements on an as-if vacant basis. The Company utilizes 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 and liabilities include amounts allocated to acquired leases for above-market and below-market lease rates and the value of in-place leases.
Amounts allocated to buildings, fixtures and improvements are based on cost segregation studies performed by independent third parties or the Company’s analysis of comparable properties in its 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 the Company in its 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, the Company includes 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. The Company also estimates 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 renewal periods. Above-market leases are amortized as a reduction to rental income over the remaining terms of the respective leases. Below-market leases are amortized as an increase to rental income over the remaining terms of the respective leases, including any bargain renewal periods.
The fair value of investments and debt are valued using techniques consistent with those disclosed in Note 10 - Fair Value Measures, depending on the nature of the investment or debt. The fair value of all other assumed assets and liabilities is based on the best information available.
The value of in-place leases is amortized over the initial term of the respective leases, which range primarily from two to 20 years. If a tenant terminates its lease, then 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, the Company utilizes 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. The Company also considers 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.
Leasehold Improvements and Property and Equipment
The Company leases its corporate office facilities under operating leases. Leasehold improvements related to these are recorded at cost less accumulated amortization. Leasehold improvements are amortized over the lesser of the estimated useful life or remaining lease term.
Property and equipment, which primarily include computer hardware and software, are stated at cost less accumulated depreciation. Property and equipment are depreciated on a straight-line method over the estimated useful lives of the assets, which range from five to seven years. The Company reassesses the useful lives of its property and equipment and adjusts the future monthly depreciation expense based on the new useful life, as applicable. If the Company disposes of an asset, the asset and related accumulated depreciation are written off upon disposal.
Goodwill
In the case of a business combination, after identifying all tangible and intangible assets and liabilities, the excess consideration paid over the fair value of the assets and liabilities acquired and assumed, respectively, represents goodwill. Goodwill that arose as a result of the Company’s mergers and acquisitions was recorded in the Company’s consolidated financial statements.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
In the event the Company disposes of a property that constitutes a business under U.S. GAAP, the Company will allocate a portion of the REI segment’s goodwill to that property in determining the gain or loss on the disposal of the property. The amount of goodwill allocated to the business will be based on the relative fair value of the business to the fair value of the reporting unit. The REI segment and the Cole Capital segment each comprise one reporting unit.
Impairments
Real Estate Assets
The Company performs quarterly impairment review procedures, primarily through continuous monitoring of events and changes in circumstances that could indicate the carrying value of its real estate assets may not be recoverable. Impairment indicators that the Company considers include, but are not limited to, decrease in net operating income, bankruptcy or other credit concerns of a property’s major tenant or tenants, such as history of late payments, rental concessions and other factors, as well as significant decreases in a property’s revenues due to lease terminations, vacancies, co-tenancy clauses or reduced lease rates. When impairment indicators are identified or if a property is considered to have a more likely than not probability of being disposed of within the next 12 to 24 months, the Company assesses the recoverability of the assets by determining whether the carrying value of the assets will be recovered through the undiscounted future cash flows expected from the use of the assets and their eventual disposition. In the event that such expected undiscounted future cash flows do not exceed the carrying value, the Company will adjust the real estate assets to their respective fair values and recognize an impairment loss. Generally, fair value is determined using a discounted cash flow analysis and recent comparable sales transactions. The Company recorded impairment charges of $91.8 million related to 202 properties for the year ended December 31, 2015 and impairment charges of $100.5 million related to 16 properties for the year ended December 31, 2014. The assumptions and uncertainties utilized in the evaluation of the impairment of real estate assets are discussed in detail in Note 10 - Fair Value Measures. See also Note 6 - Real Estate Investments for further discussion regarding real estate investment activity.
Goodwill
The Company evaluates goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate the carrying value, by reporting unit, may not be recoverable. The Company’s annual testing date is during the fourth quarter. The Company tests goodwill for impairment by first comparing the carrying value of net assets to the fair value of each reporting unit. If the fair value is determined to be less than the carrying value or if qualitative factors indicate that it is more likely than not that goodwill is impaired, a second step is performed to compute the amount of impairment as the difference between the fair value of goodwill and the carrying value. The Company estimates the fair value of the reporting units using discounted cash flows and relevant competitor multiples. The evaluation of goodwill for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions. While the Company believes its assumptions are reasonable, there are no guarantees as to actual results. Changes in assumptions based on actual results may have a material impact on the Company’s financial results. The Company recorded impairment charges to goodwill of $139.7 million and $223.1 million related to the Cole Capital reporting unit for the years ended December 31, 2015 and 2014, respectively. The assumptions and uncertainties utilized in the evaluation of the impairment of goodwill are discussed in detail in Note 10 - Fair Value Measures. Goodwill activity by segment is also discussed in Note 5 - Goodwill and Other Intangibles.
Intangible Assets
The Company evaluates intangible assets for impairment when an event occurs or circumstances change that indicate the carrying value may not be recoverable. The Company tests intangible assets for impairment by first comparing the carrying value of the asset group to the undiscounted future cash flows expected from the use of the assets and their eventual disposition. In the event that such expected undiscounted future cash flows do not exceed the carrying value, the Company will adjust the intangible assets to their respective fair values and recognize an impairment loss.
The Company’s intangible assets primarily consist of management and advisory contracts that the Company has with certain Managed REITs. The Company will estimate the fair value of the intangible assets using a discounted cash flow model specific to the applicable Managed REITs. The evaluation of intangible assets for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions. While the Company believes its assumptions are reasonable, there are no guarantees as to actual results. Changes in assumptions based on actual results may have a material impact on the Company’s financial results. The Company recorded impairment charges to intangible assets of $73.7 million and $86.4 million for the years ended December 31, 2015 and 2014, respectively. The assumptions and uncertainties utilized in the evaluation of the impairment of intangibles are discussed in detail in Note 10 - Fair Value Measures. Intangible assets are also discussed in Note 5 - Goodwill and Other Intangibles.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Investment in Unconsolidated Entities
The Company is required to determine whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of any of its investment in the unconsolidated entities. If an event or change in circumstance has occurred, the Company is required to evaluate its investment in the unconsolidated entity for potential impairment and determine if the carrying value of its investment exceeds its fair value. An impairment charge is recorded when an impairment is deemed to be other-than-temporary. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until the carrying value is fully recovered. The evaluation of an investment in an unconsolidated entity for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions. The use of different judgments and assumptions could result in different conclusions. No impairments of unconsolidated entities were identified during the years ended December 31, 2015 and 2014.
Leasehold Improvements and Property and Equipment
Leasehold improvements and property and equipment are reviewed for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If this review indicates that the carrying value of the asset is not recoverable, the Company records an impairment loss, measured at fair value by estimated discounted cash flows or market appraisals. The evaluation of leasehold improvements and property and equipment for potential impairment requires the Company’s management to exercise significant judgment and to make certain assumptions. The use of different judgments and assumptions could result in different conclusions. No impairments of leasehold improvements and property and equipment were identified during the years ended December 31, 2015 and 2014.
Cash and Cash Equivalents
Cash and cash equivalents include cash in bank accounts, as well as investments in highly-liquid money market funds with original maturities of three months or less. The Company deposits cash with several high quality financial institutions. These deposits are guaranteed by the Federal Deposit Insurance Company (“FDIC”) up to an insurance limit of $250,000. At times, the Company’s cash and cash equivalents may exceed federally insured levels. Although the Company bears risk on amounts in excess of those insured by the FDIC, it has not experienced and does not anticipate any losses due to the high quality of the institutions where the deposits are held.
Restricted Cash
The Company had $59.8 million and $62.7 million, respectively, in restricted cash as of December 31, 2015 and 2014. Restricted cash primarily consists of reserves related to lease expirations, as well as maintenance, structural and debt service reserves. Included in restricted cash at December 31, 2015 was $47.9 million in lender reserves and $11.9 million held in restricted lockbox accounts. Included in restricted cash at December 31, 2014 was $36.9 million in lender reserves and $25.8 million held in restricted lockbox accounts. As part of certain debt agreements, rent from certain of the Company’s tenants is deposited directly into a lockbox account, from which the monthly debt service payments are disbursed to the lender and the excess funds are then disbursed to the Company.
Investment in Direct Financing Leases
The Company has acquired certain properties that are subject to leases that qualify as direct financing leases in accordance with U.S. GAAP due to the significance of the lease payments from the inception of the leases compared to the fair value of the property or due to bargain purchase options. Investments in direct financing leases represent the fair value of the remaining lease payments on the leases and the estimated fair value of any expected residual property value at the end of the lease term. The fair value of the remaining lease payments is estimated using a discounted cash flow analysis based on interest rates that would represent the Company’s incremental borrowing rate for similar types of debt. The expected residual property value at the end of the lease term is estimated using market data and assessments of the remaining useful lives of the properties at the end of the lease terms, among other factors. Income from direct financing leases is calculated using the effective interest method over the remaining term of the lease.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Loans Held for Investment
The Company classifies its loans as long-term investments as the Company intends to hold the loans for the foreseeable future or until maturity. Loan investments are carried on the Company’s consolidated balance sheets at amortized cost (unpaid principal balance adjusted for unearned discount or premium and loan origination fees), net of any allowance for loan losses. Discounts or premiums and loan origination fees are amortized as a component of interest income using the effective interest method over the life of the loan. From time to time, the Company may determine to sell a loan in which case it must reclassify the asset as held for sale. Loans held for sale are carried at the lower of cost or estimated fair value. As of December 31, 2015 and 2014, the Company owned 10 and 14 loans held for investment, respectively.
The Company evaluates its loan investments for possible impairment on a quarterly basis. The Company evaluated the collectability of an unsecured note due from an affiliate of the Former Manager during the three months ended December 31, 2015, as discussed in Note 8 - Loans Held for Investment and Note 18 - Related Party Transactions and Arrangements. The Company focused on assessing the liquidity of the borrower, the lien position of the note and the contractual obligations of the borrower. Based on the analysis, the Company concluded that it was unlikely that the unsecured note will be repaid and recorded a reserve for loan loss equal to the $15.3 million carrying value of the note for the three months ended December 31, 2015.
Commercial Mortgage-Backed Securities
The Company classifies all of its commercial mortgage-backed securities (“CMBS”) as available for sale for financial accounting purposes. Under U.S. GAAP, securities classified as available for sale are carried on the consolidated balance sheet at fair value with the net unrealized gains or losses included in accumulated other comprehensive income (loss), a component of stockholders’ equity. Any premiums or discounts on securities are amortized as a component of interest income using the effective interest method.
The Company estimates fair value on all securities investments quarterly based on a variety of inputs. Under applicable accounting guidance, securities where the fair value is less than the Company’s cost are deemed impaired and, therefore, must be measured for other-than-temporary impairment. If an impaired security (i.e., fair value below cost) is intended to be sold or required to be sold prior to expected recovery of the impairment loss, the full amount of the loss must be charged to earnings as an other-than-temporary impairment. Otherwise, temporary impairment losses are charged to other comprehensive income (loss).
In estimating credit or other-than-temporary impairment losses, management considers a variety of factors, including (1) the financial condition and near-term prospects of the credit, including credit rating of the security and the underlying tenant and an estimate of the likelihood, amount and expected timing of any default, (2) whether the Company expects to hold the investment for a period of time sufficient to allow for anticipated recovery in fair value, (3) the length of time and the extent to which the fair value has been below cost, (4) current market conditions, (5) expected cash flows from the underlying collateral and an estimate of underlying collateral values, and (6) subordination levels within the securitization pool. These estimates are highly subjective and could differ materially from actual results. From the period the Company acquired the CMBS through December 31, 2015, the Company had no other-than-temporary impairment losses. See Note 7 - Investment Securities, at Fair Value for further discussion.
Deferred Financing Costs
Deferred financing costs represent commitment fees, legal fees and other costs associated with obtaining commitments for financing. As discussed in “Reclassifications” and “Recent Accounting Pronouncements” in this note, the Company historically presented the costs as an asset for the respective financing agreements. These costs were amortized to interest expense over the terms of the respective financing agreements using the effective interest method. Unamortized deferred financing costs were written off when the associated debt was refinanced or repaid before maturity. Pursuant to FASB ASU 2015-03, the presentation of all deferred financing costs, other than those associated with the revolving credit facility, has been reclassified such that the debt issuance costs related to a recognized debt liability is presented on the consolidated balance sheets as a direct deduction from the carrying amount of the related debt liability rather than as an asset. The presentation of deferred financing costs relating to the revolving credit facility, however, is not addressed in the guidance and the Company has not reclassified such costs. As such, the Company’s current and corresponding prior period total deferred financing costs, net in the accompanying consolidated balance sheets and as discussed in Note 9 - Rent and Tenant Receivables and Other Assets, Net relate only to the revolving credit facility and the historical presentation, amortization and treatment of unamortized costs are still applicable. As of December 31, 2015 and 2014, the Company had $26.1 million and $38.2 million, respectively, of deferred financing costs, net of accumulated amortization, related to the revolving credit facility. Costs incurred in seeking financial transactions that do not close are expensed in the period in which it is determined the financing will not close.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
During the year ended December 31, 2015 and 2014, the Company wrote off $0.5 million and $6.6 million, respectively, of deferred financing costs upon early repayment of various mortgages which are included in extinguishment of debt, net in the accompanying consolidated statements of operations. During the year ended December 31, 2014, the Company also wrote off $64.2 million of deferred financing costs in connection with the execution of the various credit facility amendments and certain financing arrangements that did not close, primarily the termination of the available commitments from Barclays Bank PLC and other committed parties for up to $2.1 billion in senior secured term loans (the “Barclays Facility”), which is included in interest expense in the accompanying consolidated statements of operations.
Convertible Debt
On July 29, 2013, the Company issued $300.0 million of Convertible Senior Notes due 2018 (the “2018 Convertible Notes”) and, pursuant to an over-allotment exercise by the underwriters of such 2018 Convertible Notes offering, issued an additional $10.0 million of its 2018 Convertible Notes on August 1, 2013. On December 10, 2013, the Company issued an additional $287.5 million of the 2018 Convertible Notes through a reopening of the indenture relating to the 2018 Convertible Notes. Also on December 10, 2013, the Company issued $402.5 million of Convertible Senior Notes due 2020 (the “2020 Convertible Notes and, together with the 2018 Convertible Notes, the “Convertible Notes”). The 2018 Convertible Notes mature on August 1, 2018 and the 2020 Convertible Notes mature on December 15, 2020. The Convertible Notes are convertible into cash or shares of the Company’s Common Stock at the Company’s option. In accordance with U.S GAAP, the Convertible 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 respective 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 respective term of the Convertible Notes.
Derivative Instruments
The Company may use derivative financial instruments to hedge all or a portion of the interest rate risk associated with its 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 the Company’s operating and financial structure as well as to hedge specific anticipated transactions.
The Company records all derivatives on the consolidated balance sheets at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has 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. The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.
The accounting for subsequent changes in the fair value of these derivatives depends on whether each has been designated and qualifies for hedge accounting treatment. If the Company elects 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.
Revenue Recognition - REI
The Company’s revenues, which primarily consist of 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. When the Company acquires a property, the term of each existing lease is considered to commence as of the acquisition date for the purposes of this calculation. Since many of the leases provide for rental increases at specified intervals, straight-line basis accounting requires the Company to record a receivable, and include in revenues, unbilled rent receivables that the Company will only receive if the tenant makes all rent
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
payments required through the expiration of the initial term of the lease. Straight-line rent receivables are included in rent and tenant receivables and other assets, net, in the consolidated balance sheets. See Note 9 - Rent and Tenant Receivables and Other Assets, Net. Cost recoveries from tenants are included in operating expense reimbursements in the consolidated statements of operations in the period the related costs are incurred. The Company defers the revenue related to lease payments received from tenants in advance of their due dates. As of December 31, 2015 and 2014, the Company had $67.2 million and $57.8 million, respectively, of deferred rental income, which is included in deferred rent, derivative, and other liabilities in the consolidated balance sheets.
The Company continually reviews receivables related to rent and unbilled rent receivables and determines 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 uncertain, the Company will record an increase in the allowance for uncollectible accounts in the consolidated balance sheets or record a direct write-off of the receivable in the consolidated statements of operations. As of December 31, 2015 and 2014, the Company maintained an allowance for uncollectible accounts of $6.6 million and $2.5 million, respectively.
Revenue Recognition - Cole Capital
Revenue consists of securities sales commissions and dealer manager fees, real estate acquisition fees, property management fees, advisory fees, asset management fees and performance fees for services relating to the Managed REITs’ offerings and the investment and management of their respective assets, in accordance with the respective dealer manager and advisory agreements. The Company records revenue related to acquisition fees, securities sales commissions and dealer manager fees upon completion of a transaction and advisory, asset and property management fees as services are performed. The Company also earns property management, asset management and disposition fees from certain joint ventures and other real estate programs. The Company is also reimbursed for certain costs incurred in providing these services. Securities sales commissions and dealer manager reimbursements are recorded as revenue as the expenses are incurred, as long as reimbursement is reasonably assured. The Company, in its sole discretion, may reallow all or a portion of its dealer manager fee to such participating broker-dealers as a marketing and due diligence expense reimbursement, based on factors such as the volume of shares issued by such participating broker-dealers and the amount of marketing support provided by such participating broker-dealers. Refer to Note 18 - Related Party Transactions and Arrangements for further discussion.
Contingent Rental Income
The Company owns certain properties that have associated leases that require the tenant to pay contingent rental income based on a percentage of the tenant’s sales after the achievement of certain sales thresholds, which may be monthly, quarterly or annual targets. As a lessor, the Company defers the recognition of contingent rental income until the specified target that triggers the contingent rental income is achieved, or until such sales upon which percentage rent is based are known.
Program Development Costs
The Company pays for organization, registration and offering expenses associated with the sale of common stock of the Managed REITs, as further discussed in Note 18 - Related Party Transactions and Arrangements. The reimbursement of these expenses by the Managed REITs is limited to a certain percentage of the proceeds raised from their offerings, in accordance with their respective advisory agreements and charters. Such expenses paid by the Company on behalf of the Managed REITs in excess of these limits that are expected to be collected are recorded as program development costs, which are included in rent and tenant receivables and other assets, net on the consolidated balance sheets. The Company assesses the collectability of the program development costs, considering the offering period and historical and forecasted sales of shares under the Managed REITs’ respective offerings and reserves for any balances considered not collectible. Additional reserves are generally recorded if actual proceeds raised from the offerings and corresponding program development costs incurred differ from management’s assumptions. During the three months ended December 31, 2015 and 2014, the Company assessed the expected collectability of the program development costs based on assumptions used to evaluate goodwill and intangible asset impairments and recorded additional reserves for uncollectible amounts of $11.3 million and $13.1 million, respectively, which was recorded to general and administrative expenses in the consolidated statements of operations.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Acquisition Related Expenses and Merger and Other Non-routine Transaction Related Expenses
All costs incurred as a result of a business combination are classified as acquisition related expenses or merger and other non-routine transaction related expenses and expensed as incurred. Acquisition related expenses include legal and other transaction related costs incurred in connection with self-originated acquisitions, including purchases of portfolios. In addition, indirect costs, such as internal salaries, that are tracked and documented in a manner that clearly indicate that the activities driving the cost directly relate to activities necessary to complete, or effect, self-originating purchases are classified as acquisition related expenses.
Similar costs incurred in relation to mergers, which are not considered self-originating purchases, and other non-routine transaction related expenses are included in merger and other non-routine transactions in the consolidated statements of operations. Merger and other non-routine transaction related expenses include the following costs (amounts in thousands):
___________________________________
(1)
Includes all fees and costs associated with the Audit Committee Investigation and various litigations and investigations prompted by the results of the Audit Committee Investigation, including fees and costs incurred pursuant to the Company’s indemnification obligations.
(2)
For the year ended December 31, 2015, legal fees and expenses primarily relate to fees incurred in connection with a legal matter resolved in early 2014, which the Company received invoices for in 2015.
(3)
Prior period legal fees and expenses were impacted by the reclassifications, as described above, to conform to the manner of presentation in the current period.
Due from Affiliates
The Company receives or may be entitled to receive compensation and reimbursement for services primarily relating to the Managed REITs’ offerings and the investment, management, financing and disposition of their respective assets. Refer to Note 18 - Related Party Transactions and Arrangements for further explanation.
Equity-based Compensation
The Company has an equity-based incentive award plan for non-executive directors, officers, other employees and independent contractors who are providing services to the Company, as applicable, and a non-executive director restricted share plan, which are accounted for under the guidance for share-based payments. The expense for such awards is recognized over the vesting period or when the requirements for exercise of the award have been met. See Note 17 - Equity-based Compensation for additional information on these plans.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Per Share Data
Income (loss) per basic share of Common Stock is calculated by dividing net income (loss) less dividends on unvested restricted shares of Common Stock and dividends on preferred stock by the weighted-average number of shares of Common Stock issued and outstanding during such period. Diluted income (loss) per share of Common Stock considers the effect of potentially dilutive shares of Common Stock outstanding during the period.
Reportable Segments
The Company has concluded that it has two reportable segments as it has organized its operations into two segments for management and internal financial reporting purposes, REI and Cole Capital. The identification of reportable segments requires the Company’s management to exercise certain judgments. Refer to Note 4 - Segment Reporting for further discussion.
Income Taxes
The General Partner currently qualifies and has elected to be taxed as a REIT for U.S. federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code. As a REIT, except as discussed below, the General Partner generally is not subject to federal income tax on taxable income that it distributes to its stockholders so long as it distributes at least 90% of its annual taxable income (computed without regard to the deduction for dividends paid and excluding net capital gains). REITs are subject to a number of other organizational and operational requirements. Even if the General Partner maintains its qualification for taxation as a REIT, it may be subject to certain state and local taxes on its income and property, federal income taxes on certain income and excise taxes on its undistributed income.
The OP is classified as a partnership for U.S. federal income tax purposes. As a partnership, the OP is not a taxable entity for U.S. federal income tax purposes. Instead, each partner in the OP is required to take into account its allocable share of the OP’s income, gains, losses, deductions and credits for each taxable year. However, the OP may be subject to certain state and local taxes on its income and property.
As of December 31, 2015, the OP and the General Partner had no material uncertain income tax positions. The tax years subsequent to and including the fiscal year ended December 31, 2011 remain open to examination by the major taxing jurisdictions to which the OP, the General Partner, American Realty Capital Trust III, Inc. (“ARCT III”), CapLease, Inc. (“CapLease”), American Realty Capital Trust IV, Inc., (“ARCT IV”), Cole Real Estate Investments, Inc. (“Cole”) and Cole Credit Property Trust, Inc. are subject.
Under the LPA, the OP is to conduct business in such a manner as to permit the General Partner at all times to qualify as a REIT.
The Company conducts substantially all of its Cole Capital segment through a TRS. A TRS is a subsidiary of a REIT that is subject to corporate federal, state and local income taxes, as applicable. The Company’s use of a TRS enables it to engage in certain business activities while complying with the REIT qualification requirements and to retain any income generated by these businesses for reinvestment without the requirement to distribute those earnings. The Company conducts all of its business in the United States and Canada and, as a result, it files income tax returns in the U.S. federal jurisdiction, the Canadian federal jurisdiction and various state and local jurisdictions. Certain of the Company’s inter-company transactions that have been eliminated in consolidation for financial accounting purposes are also subject to taxation.
The Company provides for income taxes in accordance with current authoritative accounting and tax guidance. The tax provision or benefit related to significant or unusual items is recognized in the quarter in which those items occur. In addition, the effect of changes in enacted tax laws, rates or tax status is recognized in the quarter in which the change occurs. The accounting estimates used to compute the provision for or benefit from income taxes may change as new events occur, additional information is obtained or the tax environment changes.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Recent Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes the revenue recognition requirements in Revenue Recognition, Accounting Standards Codification (“ASC”) (Topic 605) and requires an entity to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, an amendment to ASU 2014-09 was issued to defer the effective date for all entities by one year. For public business entities, certain not-for-profit entities and certain employee benefit plans, the guidance should be applied to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company is currently evaluating the impact of the new standard on its financial statements.
In February 2015, the FASB issued ASU No. 2015-02, which eliminates the deferral of Financial Accounting Standard (“FAS”) No.167, Amendments to FASB Interpretation No. 46(R), modifies the evaluation of whether limited partnerships and similar legal entities are variable or voting interest entities, eliminates the presumption that the general partner should consolidate a limited partnership, modifies the consolidation analysis for reporting entities that are involved with variable interest entities, particularly those that have fee arrangements and related party relationships, and provides a scope exception for reporting entities with interests in legal entities that operate as registered money market funds. These changes require re-evaluation of the consolidation conclusion for certain entities and require the Company to revise its analysis regarding the consolidation or deconsolidation of such entities. ASU 2015-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015, with early adoption permitted. As disclosed above, the Company elected to early adopt ASU 2015-02 during the third quarter of 2015. The adoption had no material impact on the interests in joint venture arrangements, Managed REITs and other arrangements and therefore had no impact on the previous or current reporting periods’ statements of financial position, results of operations, or retained earnings.
In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30). The update requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability rather than presenting the costs as an asset. Amortization of the issuance costs is to be treated as interest expense. The previous requirement to recognize debt issuance costs as deferred charges conflicts with the guidance in FASB Concepts Statement No. 6, “Elements of Financial Statements,” which states that debt issuance costs are similar to debt discounts and in effect reduce the proceeds of borrowing, thereby increasing the effective interest rate. FASB Concepts Statement No. 6 further states that debt issuance costs cannot be an asset because they provide no future economic benefit. After the update is adopted, debt disclosures will include the face amount of the debt liability and the effective interest rate. For public companies, ASU 2015-03 is effective for fiscal years beginning after December 15, 2015, and is to be applied retrospectively to all prior periods presented in the financial statements, with early adoption permitted. The Company elected to early adopt this guidance during the fourth quarter of 2015. An entity is required in the year of adoption to provide certain disclosures about the change in accounting principle, including the nature of and reason for the change, the transition method, a description of the prior-period information that has been retrospectively adjusted and the effect of the change on the financial statement line items. See the reclassification discussion above for further information.
The guidance in ASU 2015-03 does not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. Given the absence of such authoritative guidance, ASU 2015-15 states that an entity may defer presenting debt issuance costs as an asset and subsequently amortizing that deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. This update became effective upon announcement on June 18, 2015. As such, the Company’s evaluation of the guidance concludes that all debt issuance costs will be netted against debt, with the exception of costs related to the revolving line of credit, due to its variability.
In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805). The update eliminates the requirement that an acquirer in a business combination account for measurement period adjustments retrospectively. Instead, an acquirer will recognize a measurement period adjustment during the period in which it determines the amount of the adjustment, including the effect on earnings of any amounts it would have recorded in previous periods if the accounting had been completed at the acquisition date. The ASU is effective for public business entities for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for any interim and annual financial statements that have not yet been issued. The ASU is applied prospectively to adjustments to provisional amounts that occur after the effective date. The amendment will be considered by the Company for any future business combinations.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
In January 2016, the FASB, issued ASU 2016-01, Financial Instruments (Subtopic 825-10), which requires all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee). The amendments in this update also require an entity to present separately in other comprehensive income, the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, the amendments in this update require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company is currently evaluating the impact that this new guidance will have on its financial statements.
Note 3 - Mergers with Real Estate Businesses
American Realty Capital Trust III, Inc. Merger
On December 14, 2012, the Company entered into an Agreement and Plan of Merger (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 the Company (the “ARCT III Merger”). The ARCT III Merger was consummated on February 28, 2013 (the “ARCT III Merger Date”).
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 that became vested, was converted into the right to receive (i) 0.95 of a share of the Company’s common stock (the “ARCT III Exchange Ratio”) or (ii) $12.00 in cash. In addition, each outstanding unit of equity ownership of ARCT III’s operating partnership (the “ARCT III OP”) was converted into the right to receive 0.95 of the same class of unit of equity ownership in the OP.
Upon the closing of the ARCT III Merger, the Company paid an aggregate of $350.4 million in cash for holders holding 29.2 million in shares that elected cash consideration, or 16.5% of the then outstanding holders of shares of ARCT III’s common stock (which was equivalent to 27.7 million shares of the Company’s Common Stock based on the ARCT III Exchange Ratio). In addition, 140.7 million shares of the Company’s common stock were issued in exchange for 148.1 million shares of ARCT III’s common stock adjusted for the ARCT III Exchange Ratio. In accordance with the LPA, the OP issued a corresponding number of General Partner OP Units to the Company when the Company issued Common Stock to former common stockholders of ARCT III.
Upon the consummation of the ARCT III Merger, American Realty Capital Trust III Special Limited Partner, LLC (the “ARCT III Special Limited Partner”), the holder of the special limited partner interest in the ARCT III OP, was entitled to subordinated distributions of net sales proceeds from the ARCT III OP, which resulted in the issuance of units of limited partner interests in the ARCT III OP. After applying the ARCT III Exchange Ratio, this distribution resulted in the issuance of an additional 7.3 million OP Units to affiliates of the Former Manager. The parties had agreed that such OP Units would be subject to a minimum one-year holding period from the date of issuance before being redeemable by the holder for cash or, at the option of the Company, Common Stock of the Company.
Also in connection with the ARCT III Merger, the Company entered into an agreement with the Former Manager and its affiliates to internalize certain functions performed by them prior to the ARCT III Merger, reduce certain fees paid to affiliates and pay certain merger related fees. See Note 18 - Related Party Transactions and Arrangements.
Accounting Treatment for the ARCT III Merger
The Company 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 the Company and ARCT III through the ownership of shares of common stock and other equity interests. In addition, the advisors of the Company and ARCT III were contractually eligible to receive potential fees for their services to both companies, including asset management fees, incentive fees and other fees, and continued to receive fees from the Operating Partnership, on behalf of the Company, prior to the Company’s transition to self-management. 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 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 the Company
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
to present historical financial information as if the merger had occurred as of the earliest period of common control. Therefore, the accompanying consolidated financial statements, including the notes thereto, are presented as if the ARCT III Merger had occurred at the earliest period presented.
CapLease, Inc. Merger
On May 28, 2013, the Company 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 the Company (the “CapLease Merger”).
On November 5, 2013, the Company consummated the CapLease Merger. Pursuant to the terms of the CapLease Merger Agreement, each outstanding share of common stock of CapLease, other than shares owned by the Company, 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 the Company, 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, each outstanding unit of equity ownership of CapLease’s operating partnership, other than units owned by CapLease, the OP, or any other of their respective wholly owned subsidiaries, 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 CapLease’s common and preferred shareholders.
Accounting Treatment for the CapLease Merger
The CapLease Merger has been accounted for under the acquisition method of accounting in accordance with U.S. GAAP. Under the acquisition method of accounting, the assets acquired and liabilities assumed from CapLease were recorded, as of the acquisition date, at their respective fair values. Any excess of purchase price over the fair values was recorded as goodwill. Results of operations for CapLease are included in the Company’s consolidated financial statements from the date of acquisition.
Purchase Price Allocation of the CapLease Merger
The purchase price includes a cash payment of $920.7 million, which was funded by the Company through additional borrowings under its revolving credit facility and the credit facility assumed from CapLease.
Initially, the purchase price for the acquisition was allocated to assets acquired and liabilities assumed based on their preliminary fair values. During the three months ended December 31, 2014, we identified certain measurement period adjustments that impacted the provisional accounting, which decreased the fair value of the identifiable mortgage notes payable assumed by the Company in the amount of $27.3 million, resulting in a $27.3 million increase in goodwill. The following table summarizes the fair values of the assets acquired and liabilities assumed in the CapLease Merger as of the CapLease Merger date (in thousands):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The fair value of real estate investments and below-market leases were estimated by the Company with the assistance of third-party valuation firms. The estimated fair values of these assets and liabilities totaled $2.0 billion and $57.1 million, respectively, as of the date of the CapLease Merger. The ascribed value of the non-controlling interest was estimated based on the fair value at the CapLease Merger date of the percentage ownership of The Woodlands, Texas development activity not held by the Company.
The fair values of the remaining CapLease assets and liabilities were calculated in accordance with the Company’s policy on purchase price allocation, as discussed in Note 2 - Summary of Significant Accounting Policies.
Goodwill of $65.5 million was assigned to the REI segment. The goodwill recognized is attributed to the enhancement of the Company’s year-round rental revenue stream, expected synergies and the assembled work force at CapLease.
American Realty Capital Trust IV, Inc. Merger
On July 1, 2013, the General Partner entered into an Agreement and Plan of Merger, as amended (the “ARCT IV Merger Agreement”), with ARCT IV, and certain subsidiaries of each company. The ARCT IV Merger Agreement provided for the merger of ARCT IV with and into a subsidiary of the OP (the “ARCT IV Merger”). The ARCT IV Merger was consummated on January 3, 2014 (the “ARCT IV Merger Date”).
Pursuant to the terms of the ARCT IV Merger Agreement, 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 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 (each, an “ARCT IV OP Unit”), other than ARCT IV OP Units held by 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 a Limited Partner OP Unit and (iii) 0.5937 of a Limited Partner OP Unit designated as Series F Preferred Units (“Limited Partner Series F OP Units”). In total, the Operating Partnership, on the Company’s behalf, paid $651.4 million in cash, the Company issued 36.9 million shares of Common Stock and 42.2 million shares of Series F Preferred Stock to the former ARCT IV shareholders, and the Operating Partnership issued 0.7 million units of Limited Partner Series F OP units and 0.6 million Limited Partner OP Units to the former 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 Limited Partner OP Units, resulting in the OP issuing 1.2 million Limited Partner OP Units. In accordance with the LPA, the OP issued a corresponding number of General Partner OP Units and General Partner Series F Preferred Units to the Company when shares of the Company’s Common Stock and Series F Preferred Stock were issued to former common stockholders of ARCT IV, respectively.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
On January 3, 2014, the OP entered into a contribution and exchange agreement with the ARCT IV OP, the ARCT IV Special Limited Partner and ARC Real Estate Partners, LLC (“ARC Real Estate”), an entity under common ownership with the Former Manager. The ARCT IV Special Limited Partner was entitled to receive certain distributions from the ARCT IV OP, including the subordinated distribution of net sales proceeds resulting from an “investment liquidity event” (as defined in the agreement of limited partnership of the ARCT IV OP). The ARCT IV Merger constituted an “investment liquidity event,” as a result of which the ARCT IV Special Limited Partner, in connection with management’s successful attainment of the 6.0% performance hurdle and the return to ARCT IV’s stockholders of $358.3 million in addition to their initial investment, received a subordinated distribution of net sales proceeds from the ARCT IV OP equal to $63.2 million. Pursuant to the contribution and exchange agreement, the ARCT IV Special Limited Partner contributed its interest in the ARCT IV OP, inclusive of the subordinated distribution proceeds received, to the ARCT IV OP in exchange for 2.8 million equity units of the ARCT IV OP, based on a price per share of $22.50. The fair value of these units at date of issuance was $78.2 million and has been included in merger and other non-routine transactions in the accompanying consolidated statements of operations for the year ended December 31, 2014. Upon consummation of the ARCT IV Merger, these equity units were immediately converted to 6.7 million Limited Partner OP Units after application of the exchange ratio of 2.3961 per ARCT IV OP Unit. In conjunction with the ARCT IV Merger Agreement, the ARCT IV Special Limited Partner agreed to a minimum two-year holding period for these Limited Partner OP Units before being redeemable by the holder for cash or, at the option of the General Partner, the Common Stock of the Company.
In addition, as part of the contribution and exchange agreement, ARC Real Estate contributed $750,000 in cash to the ARCT IV OP, effective prior to the consummation of the ARCT IV Merger, in exchange for ARCT IV OP Units. Upon the consummation of the ARCT IV Merger, these equity units converted at an exchange ratio of 2.3961 Limited Partner OP Units per ARCT IV OP Unit, resulting in the Operating Partnership issuing 0.1 million Limited Partner OP Units to ARC Real Estate.
Accounting Treatment for the ARCT IV Merger
The Company 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 the Company and ARCT IV through the ownership of shares of common stock, OP Units 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 the OP prior to the Company’s transition to self-management. 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 the Company to present historical financial information as of the earliest period of common control. Therefore, the accompanying consolidated financial statements, including the notes thereto, are presented as if the ARCT IV Merger, including the impact of the equity transactions entered into to consummate the merger, had occurred at the earliest period presented.
Cole Real Estate Investments, Inc. Merger
On October 22, 2013, the Company and a wholly owned subsidiary entered into an agreement and plan of merger (the “Cole Merger Agreement”) with Cole Real Estate Investments, Inc. (“Cole”), a publicly traded Maryland corporation. The Cole Merger Agreement provided for the merger of Cole with and into a wholly owned subsidiary of the Company (the “Cole Merger”). The Cole Merger was consummated 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 and performance stock units that vested in conjunction with the Cole Merger, other than shares owned by the Company, any subsidiary of the Company or any wholly owned subsidiary of Cole, was converted into the right to receive either (i) 1.0929 shares of the Company’s Common Stock (the “Stock Consideration”) or (ii) $13.82 in cash (the “Cash Consideration” and together with the Stock Consideration, the “Merger Consideration”). Holders of approximately 98% of outstanding Cole shares elected to receive the Stock Consideration and holders of approximately 2% of outstanding Cole shares elected to receive the Cash Consideration, pursuant to the terms of the Cole Merger Agreement, resulting in the Company issuing approximately 520.8 million shares of Common Stock and paying $181.8 million in cash to Cole’s shareholders based on their elections. In accordance with the LPA, the Operating Partnership issued a corresponding number of General Partner OP Units to the Company when shares of the Company’s Common Stock were issued to former common stockholders of Cole.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
In addition, the Company issued approximately 2.8 million shares of Common Stock, in the aggregate, to certain executives of Cole pursuant to letter agreements entered into between the Company and such individuals, concurrently with the execution of the Cole Merger Agreement. Additionally, effective as of the Cole Acquisition Date, the Company issued, but had not yet allocated, 0.4 million shares with dividend equivalent rights commensurate with the Company’s Common Stock. In accordance with the LPA, the Operating Partnership issued a corresponding number of General Partner OP Units to the Company when shares of the Company’s Common Stock were issued to former executives of Cole.
The fair value of the consideration transferred at the Cole Acquisition Date totaled $7.5 billion and consisted of the following (in thousands):
The fair value of the 520.8 million shares of Common Stock issued, excluding those shares of Common Stock transferred to former Cole executives, was determined based on the closing market price of the Company’s Common Stock on the Cole Acquisition Date.
Accounting Treatment for the Cole Merger
The Cole 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 Cole were recorded as of the acquisition date at their respective fair values. Any excess of purchase price over the fair values was recorded as goodwill. Results of operations for Cole are included in the Company’s consolidated financial statements subsequent to the Cole Acquisition Date.
Purchase Price Allocation of Cole Merger
Initially, the purchase price for the acquisition was allocated to assets acquired and liabilities assumed based on their preliminary fair values. During the three months ended December 31, 2014, we identified certain measurement period adjustments that impacted the provisional accounting, which decreased the fair value of the identifiable management and advisory contracts with the Managed REITs and corresponding deferred tax liability by $80.4 million and $30.7 million, respectively, and an increase of $49.6 million to goodwill as of the Cole Acquisition Date. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the Cole Acquisition Date (in thousands):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The fair values of real estate investments, including acquired lease intangibles, and below-market lease liabilities allocated to the REI segment were estimated by the Company with the assistance of a third-party valuation firm. The estimated fair values of these assets and liabilities total $9.0 billion and $212.4 million, respectively. The recorded values represent the estimated fair values related to such assets and liabilities.
Goodwill of $1.7 billion was assigned to the REI segment. The goodwill recognized was attributed to the enhancement of the Company’s year-round rental revenue stream, realized and expected synergies, the impact of the merger on lowering the Company’s cost of capital, as well as the benefits of critical mass, improved portfolio diversification and enhanced access to capital markets. Goodwill of $608.5 million was assigned to the Cole Capital segment. The goodwill was primarily supported by management’s belief that Cole Capital brings an established management platform with numerous strategic benefits including growth from new income streams and the ability to offer new products. None of the goodwill is expected to be deductible for income tax purposes.
The fair value of the remaining Cole assets and liabilities were calculated in accordance with the Company’s policy on purchase price allocation, as disclosed in Note 2 - Summary of Significant Accounting Policies.
The amounts of revenue and net income related to Cole property acquisitions and Cole Capital included in the accompanying consolidated statements of operations from the Cole Acquisition Date to the period ended December 31, 2014 was $814.8 million and $47.3 million respectively.
The unaudited pro forma information in Note 6 - Real Estate Investments is presented as if Cole had been included in the consolidated results of the Company for the entire period ended December 31, 2014.
Cole Credit Property Trust, Inc. Merger
On March 17, 2014, the Company and a wholly owned subsidiary entered into an Agreement and Plan of Merger (the “CCPT Merger Agreement”) with CCPT. The CCPT Merger Agreement provided for the merger of CCPT with and into a direct subsidiary of the Company (the “CCPT Merger”). The CCPT Merger was consummated on May 19, 2014 (the “CCPT Acquisition Date”). The fair value of the consideration transferred at the CCPT Acquisition Date totaled $73.2 million, which was paid in cash.
Pursuant to the CCPT Merger Agreement, the Company commenced a cash tender offer to purchase all of the outstanding shares of common stock of CCPT (the “CCPT Common Stock”) (other than shares owned by CCPT, the Company or any subsidiary of the Company), upon the terms and subject to the conditions set forth in the Offer to Purchase, dated March 31, 2014, and the related Letter of Transmittal (together with any amendments or supplements to the foregoing, the “Offer”), at a price of $7.25 per share (the “Offer Price”), net to the seller in cash, without interest, less any applicable withholding tax. On May 19, 2014, the Company accepted for payment and paid for all shares of CCPT Common Stock that were validly tendered in the Offer. As of the
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
expiration of the Offer, a total of 7,735,069 shares of CCPT Common Stock were validly tendered and not withdrawn, representing approximately 77% of the shares of CCPT Common Stock outstanding.
Immediately following the acceptance for payment and payment for the shares of CCPT Common Stock that were validly tendered in the Offer, the Company exercised its option (the “Top-Up Option”), granted pursuant to the CCPT Merger Agreement, to purchase, at a price per share equal to the Offer Price, 13,457,874 newly issued shares of CCPT Common Stock (collectively, the “Top-Up Shares”). The Top-Up Shares, taken together with the shares of CCPT Common Stock owned, directly or indirectly, by the Company and its subsidiaries immediately following the acceptance for payment and payment for the shares of CCPT Common Stock that were validly tendered in the Offer, constituted one share more than 90% of the outstanding shares of CCPT Common Stock (after giving effect to the issuance of all shares subject to the Top-Up Option), the applicable threshold required to effect a short-form merger under applicable Maryland law without stockholder approval.
Following the consummation of the Offer and the exercise of the Top-Up Option, in accordance with the CCPT Merger Agreement, the Company completed its acquisition of CCPT by effecting a short-form merger under Maryland law, pursuant to which CCPT was merged with and into a subsidiary of the Company, with the subsidiary surviving the merger as a wholly owned subsidiary of the Company. The CCPT Merger became effective following the filing of the Articles of Merger with the State Department of Assessments and Taxation of Maryland and the filing of the Certificate of Merger with the Secretary of State of the State of Delaware with an effective date of May 19, 2014 (the “Effective Time”).
At the Effective Time, each share of CCPT Common Stock not purchased in the Offer (other than shares held by CCPT, the Company or any subsidiary of the Company, which were automatically canceled and retired and ceased to exist) was converted into the right to receive an amount, in cash and without interest, equal to the Offer Price.
Accounting Treatment for the CCPT Merger
The CCPT 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 CCPT were recorded as of the acquisition date at their respective fair values. Any excess of purchase price over the fair values was recorded as goodwill. Results of operations for CCPT are included in the Company’s consolidated financial statements subsequent to the CCPT Acquisition Date.
Fair Value of Consideration Transferred
The fair value of the consideration transferred at the CCPT Acquisition Date totaled $73.2 million, which was paid in cash. The acquisition was funded by the Company through additional borrowings under its revolving credit facility.
Purchase Price Allocation of CCPT Acquisition
The consideration transferred pursuant to the CCPT Merger Agreement was allocated to the assets acquired and liabilities assumed based upon their preliminary estimated fair values as of the CCPT Acquisition Date. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as of the CCPT Acquisition Date (in thousands):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The fair value of real estate investments, including acquired lease intangibles, and below-market lease liabilities were estimated by the Company with the assistance of a third party valuation firm. The estimated fair value of these assets and liabilities total $159.5 million and $1.8 million, respectively. The recorded values represent the estimated fair values related to such assets and liabilities.
The fair value of the remaining CCPT assets and liabilities were calculated in accordance with the Company’s policy on purchase price allocation, as disclosed in Note 2 - Summary of Significant Accounting Policies.
The amounts of revenue and net loss related to the CCPT Merger included in the accompanying consolidated statements of operations from the CCPT Acquisition Date to the period ended December 31, 2014 were $8.2 million and $1.8 million, respectively.
The unaudited pro forma information in Note 6 - Real Estate Investments is presented as if CCPT had been included in the consolidated results of the Company for the entire year ended December 31, 2014.
Abandoned Spin-off of Multi-Tenant Shopping Center Portfolio; Sale to Blackstone/DDR Joint Venture
On March 13, 2014, the Company announced its intention to spin off its multi-tenant shopping center business (the “MT Spin-off”) into a publicly traded REIT, American Realty Capital Centers, Inc., which was expected to operate under the name “ARCenters” and to trade on the NASDAQ Global Market under the symbol “ARCM.” The OP was expected to retain 25% ownership of ARCM. The MT Spin-off was expected to be effectuated through a pro rata taxable special distribution of one share of ARCM common stock for every 10 shares of the Company’s common stock and every 10 OP Units held by third parties in the OP. On April 4, 2014, ARCM filed a Registration Statement on Form 10 to register ARCM’s common stock, par value $0.01 per share, pursuant to Section 12(b) of the Exchange Act so that, upon consummation of the MT Spin-off, shares of ARCM received by holders of the Company’s common stock, or OP Units, as applicable, could freely trade their newly received ARCM common stock. ARCM was expected to be externally managed by the Company.
On May 21, 2014, the Company announced that it had reassessed its plans for the multi-tenant shopping center portfolio and entered into a letter of intent to sell such portfolio to an affiliate of Blackstone Real Estate Partners VII L.P. (“Blackstone”), expecting to finalize pertinent documentation related thereto within 30 days of such date. The properties included in such sale were the same properties that would have been spun off into ARCM and, consequently, the Company abandoned its proposed spin-off at such time. On June 11, 2014, indirect subsidiaries of the Company entered into an Agreement of Purchase and Sale with BRE DDR Retail Holdings III LLC (the “Blackstone/DDR Joint Venture”), an entity indirectly jointly owned by affiliates of Blackstone and DDR Corp. (“DDR”), pursuant to which the parties subsequently consummated the sale of the Company’s multi-tenant shopping center portfolio. See Note 6 - Real Estate Investments for further discussion on the sale of the properties, which closed on October 17, 2014.
Note 4 - Segment Reporting
The Company has two reportable segments as it has organized its operations into two segments for management and internal financial reporting purposes, REI and Cole Capital, as further discussed below.
REI - Through its REI segment, the Company owns and actively manages a diversified portfolio of retail, restaurant, office and industrial real estate properties subject to long-term net leases with creditworthy tenants. As of December 31, 2015, the
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Company owned 4,435 properties comprising 99.6 million square feet of retail and commercial space located in 49 states, the District of Columbia, Puerto Rico and Canada, which includes properties owned through consolidated joint ventures. The rentable space at these properties was 98.6% leased with a weighted-average remaining lease term of 10.6 years. In addition, as of December 31, 2015, the Company owned 10 CMBS and 10 loans held for investment.
Cole Capital - Through its Cole Capital segment, the Company is responsible for managing the day-to-day affairs of the Managed REITs, raising capital for those Managed REITs still in offering, identifying and making acquisitions and investments on the Managed REITs’ behalf and recommending to the respective board of directors of each of the Managed REITs an approach for providing investors with liquidity. Cole Capital serves as the dealer manager and distributes shares of common stock for certain Managed 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. Cole Capital receives compensation and reimbursement for services relating to the Managed REITs’ offerings and the investment, management, financing and disposition of their respective assets, as applicable. Cole Capital also develops new REIT offerings and assists in obtaining regulatory approvals from the SEC, the Financial Industry Regulatory Authority, Inc. and various blue sky jurisdictions for such offerings.
The Company allocates certain operating expenses, such as legal fees, employee related costs and benefits and general overhead expenses between its operating segments. The following tables present a summary of the comparative financial results and total assets for each segment (in thousands):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Note 5 - Goodwill and Other Intangibles
Goodwill
In connection with the CapLease Merger and the Cole Merger, the Company recorded goodwill as a result of the merger consideration exceeding the net assets acquired. The goodwill recorded as a result of the Cole Merger was allocated between the Company’s two segments, the REI segment and the Cole Capital segment.
In the event the Company disposes of a property that constitutes a business under U.S. GAAP, the Company will allocate a portion of the REI segment’s goodwill to that property in determining the gain or loss on the disposal of the property. The amount of goodwill allocated to the property will be based on the relative fair value of the property to the fair value of the REI segment. Future property acquisitions that constitute a business will be integrated into the REI segment and therefore will also be allocated goodwill upon disposition.
The Company evaluates goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate the carrying value, by reporting unit, may not be recoverable. The analysis performed for the annual goodwill test during the three months ended December 31, 2015 resulted in an impairment charge of $139.7 million in the Cole Capital reporting unit. See Note 10 - Fair Value Measures for a discussion of the Company’s accounting policies regarding impairments of goodwill.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The following table summarizes the Company’s goodwill activity by segment from January 1, 2013 to December 31, 2015 (in thousands):
_______________________________________________
(1)
Included in loss on disposition of real estate, net, in the consolidated statements of operations.
Intangible Assets
The intangible assets primarily consisted of management and advisory contracts that the Company has with certain Managed REITs, which are subject to an estimated useful life of approximately four years.
In connection with the annual goodwill impairment test, the fair value of the intangible assets were analyzed during the three months ended December 31, 2015. Based on this analysis, the Company concluded that the carrying value of the intangible assets exceeded the fair value and an impairment charge of $73.7 million was recorded. Prior to the impairment, the Company recorded $22.5 million of amortization expenses related to the intangible assets and $3.4 million subsequent to the impairment. The estimated amortization expense is expected to be $26.1 million, $16.6 million, $4.0 million for each of the years ending December 31, 2016, 2017, 2018, respectively, and $3.8 million for the nine months ended September 30, 2019. See Note 2 - Summary of Significant Accounting Policies for a discussion of the Company’s accounting policies regarding impairments of intangible assets. The intangible assets were $50.8 million and $150.4 million, net of accumulated amortization of $3.4 million and $16,000, respectively, as of December 31, 2015 and 2014.
Intangible Lease Assets and Liabilities
Intangible lease assets and liabilities of the Company consisted of the following as of December 31, 2015 and 2014 (amounts in thousands, except weighted-average useful life):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The following table provides the projected amortization expense and adjustments to rental income related to the intangible lease assets and liabilities for the next five years as of December 31, 2015 (amounts in thousands):
Note 6 - Real Estate Investments
The Company acquired controlling financial interests in 16 commercial properties, including nine land parcels for build-to-suit development, for an aggregate purchase price of $36.3 million during the year ended December 31, 2015. During the year ended December 31, 2014, the Company acquired controlling interests in 1,107 commercial properties, including a sale-leaseback transaction of 522 Red Lobster® restaurants and 20 other branded restaurant properties and 31 land parcels, but excluding the properties acquired in the Cole Merger, CCPT Merger and the ARCT IV Merger, for an aggregate purchase price of $3.8 billion. During the year ended December 31, 2013, the Company acquired controlling interests in 1,739 properties, excluding the properties acquired in the Caplease Merger, for an aggregate purchase price of $3.5 billion.
The following table presents the allocation of the fair values of the assets acquired and liabilities assumed during the periods presented (in thousands):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The following table presents unaudited pro forma information as if all of the Company’s acquisitions in 2014, including the Cole Merger, the ARCT IV Merger and the CCPT Merger, as discussed in Note 3 - Mergers with Real Estate Businesses, were completed on January 1, 2013 for each period presented below. These amounts have been calculated after applying the Company’s accounting policies and adjusting the results of acquisitions to reflect the additional depreciation and amortization and interest expense that would have been charged had the acquisitions occurred on January 1, 2013. Additionally, the unaudited pro forma net loss attributable to stockholders was adjusted to exclude acquisition related expenses of $38.8 million and $76.1 million for the years ended December 31, 2014 and 2013, respectively, and merger and other non-routine transaction related expenses of $200.5 million and $210.5 million for the years ended December 31, 2014 and 2013, respectively. Data below is presented in thousands.
The following table presents unaudited pro forma information as if the Company’s acquisitions in 2013, including the CapLease Merger discussed in Note 3 - Mergers with Real Estate Businesses, during the year ended December 31, 2013 had been consummated on January 1, 2012. These amounts have been calculated after applying the Company's accounting policies and adjusting the results of acquisitions to reflect the additional depreciation and amortization and interest expense that would have been charged had the acquisitions occurred on January 1, 2012. Additionally, the unaudited pro forma net loss attributable to stockholders was adjusted to exclude acquisition related expenses of $76.1 million and $45.1 million for the years ended December 31, 2013 and 2012, respectively, and merger and other transaction related expenses of $278.3 million and $2.6 million for the years ended December 31, 2013 and 2012, respectively (amounts in thousands).
Future Lease Payments
The following table presents future minimum base rent payments due to the Company over the next five years and thereafter. 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 (in thousands):
____________________________________
(1)
37 properties are subject to direct financing leases and, therefore, revenue is recognized as direct financing lease income on the discounted cash flows of the lease payments. Amounts reflected are the minimum base rental cash payments due to the Company under the lease agreements on these respective properties.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Investment in Direct Financing Leases, Net
The components of the Company’s net investment in direct financing leases as of December 31, 2015 and 2014 are as follows (in thousands):
Development Activities
The Company has contracted with a developer to complete a portfolio of build-to-suit development projects, of which 31 have been completed as of December 31, 2015, for an aggregate cost of $45.1 million to date and the remaining six projects are expected to be completed within the next 12 months. Pursuant to the agreement between the Company and the developer, the Company will acquire the respective land parcel for each development and subsequently pay a fixed construction draw until the project is complete. During the year ended December 31, 2015, two other build-to-suit and expansion projects were completed and placed into service for an aggregate cost of $55.0 million. During the years ended December 31, 2015 and 2014, the Company capitalized $1.2 million and $0.3 million, respectively, of interest expense associated with development projects.The Company is also in the process of completing four other build-to-suit, redevelopment and expansion projects, which are expected to increase its revenue as a result of the additional square footage and improvement of the quality of the properties. Below is a summary of the construction commitments as of December 31, 2015 (dollar amounts in thousands):
_______________________________________________
(1)
The Company is contractually committed to fund a developer $1.9 million to complete the remaining six build-to-suit developments.
(2)
Excludes tenant improvement costs incurred in accordance with existing leases. As of December 31, 2015, $2.8 million of tenant improvement costs were included in land and construction in progress in the consolidated financial statements.
Property Dispositions and Held for Sale Assets
During the year ended December 31, 2015, the Company disposed of 228 properties, including two properties owned by consolidated joint ventures, for aggregate sales price of $1.4 billion, resulting in consolidated proceeds of $966.1 million after debt assumptions and closing costs. The Company recorded a loss of $72.3 million related to the sales,which included $98.8 million of goodwill allocated in the cost basis of such properties, which is included in loss on disposition of real estate, net in the accompanying consolidated statements of operations. During the year ended December 31, 2015, the Company also had one property that had been foreclosed upon with a net book value of $38.2 million at the time of foreclosure. During the year ended December 31, 2014, the Company disposed of 45 single-tenant properties and 65 anchored shopping center properties for aggregate proceeds of $1.6 billion. The Company has no continuing involvement with these properties. The dispositions were not classified as discontinued operations for any period presented.
During the year ended December 31, 2015, the Company also disposed of its interest in one consolidated joint venture, whose only assets consisted of investments in three unconsolidated joint ventures, for an aggregate gross sales price of $77.5 million, of which the Company’s share was $69.8 million based on its ownership interest, resulting in consolidated proceeds of $43.0 million after debt repayment and closing costs. The debt obligation of the consolidated joint venture was held by an unconsolidated entity. The Company recorded a gain of $6.7 million related to the sale of the consolidated joint venture, which is included in gain on disposition of interest in joint venture in the accompanying consolidated statements of operations.
As of December 31, 2014, there were two properties classified as held for sale, both of which were sold during the year ended December 31, 2015. As of December 31, 2015, there were 17 properties (the “2015 Held for Sale Properties”) classified as held for sale. The 2015 Held for Sale Properties are estimated to be sold in the next 12 months as part of the Company’s portfolio management strategy. To reflect the 2015 Held for Sale Properties’ fair values less cost to sell, the Company recorded a loss of $3.2 million, which included $2.1 million of goodwill allocated in the cost basis of such properties, for the year ended December
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
31, 2015. The loss on properties held for sale is included in loss on disposition of real estate, net in the accompanying consolidated statements of operations.
Multi-tenant Shopping Center Portfolio Sale
On October 17, 2014, the Company completed the sale of a portfolio consisting of 64 multi-tenant properties and seven single-tenant properties (the “Multi-tenant Portfolio”) for $1.9 billion to the Blackstone/DDR Joint Venture. The disposition to Blackstone and DDR provided $1.3 billion of net proceeds, of which $1.2 billion were used to reduce the Company’s leverage by paying down the Company’s line of credit. In connection with the sale, $542.8 million of secured mortgage debt was either repaid or assumed by the Blackstone/DDR Joint Venture, providing the Company with $1.3 billion in net proceeds and resulting in a net loss on sale of $262.0 million, which includes $195.5 million of goodwill allocation.
The Multi-tenant Portfolio was not classified as discontinued operations for any periods presented, however, the Company has determined that the Multi-tenant Portfolio is an individually significant component of the Company. The following table summarizes the operating income from continued operations of the Multi-Tenant Portfolio for the year ended December 31, 2014 and 2013 (in thousands):
Impairment of Real Estate Investments
The Company performs quarterly impairment review procedures, primarily through continuous monitoring of events and changes in circumstances that could indicate the carrying value of its real estate assets may not be recoverable. See Note 2 - Summary of Significant Accounting Policies for a discussion on the Company’s accounting policies regarding impairment of real estate assets.
During the years ended December 31, 2015 and 2014, real estate assets with carrying values totaling $340.0 million and $199.5 million, respectively, were deemed to be impaired and their carrying values were reduced to their estimated fair values of $248.3 million and $99.0 million, respectively, resulting in impairment charges of $91.8 million and $100.5 million, respectively.
Unconsolidated Joint Ventures
As of December 31, 2015, the Company had interests in three unconsolidated joint ventures with aggregate equity investments of $52.8 million, which had interests in three properties comprising 0.9 million of square feet of retail and office space (the “Unconsolidated Joint Ventures”). The Company accounts for the Unconsolidated Joint Ventures using the equity method of accounting as discussed in detail in Note 2 - Summary of Significant Accounting Policies.
The following is a summary of the Company’s percentage ownership and carrying amount related to each of the Unconsolidated Joint Ventures as of December 31, 2015 (dollar amounts in thousands):
_______________________________________________
(1)
The Company’s ownership interest in this table reflects its legal ownership interest. Legal ownership may, at times, not equal the Company’s economic interest in the listed properties because of various provisions in certain joint venture agreements regarding distributions of cash flow based on capital account balances, allocations of profits and losses and payments of preferred returns. As a result, the Company’s actual economic interest (as distinct from its legal ownership interest) in certain of the properties could fluctuate from time to time and may not wholly align with its legal ownership interests.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
(2)
The total carrying amount of the investments is greater than the underlying equity in net assets by $10.0 million. This difference relates to a purchase price allocation of goodwill and a step up in fair value of the investment assets acquired in connection with the Cole Merger. The step up in fair value was allocated to the individual investment assets and is being amortized in accordance with the Company’s depreciation policy.
Tenant Concentration
As of December 31, 2015, there were no tenants exceeding 10% of the Company’s consolidated annualized rental income. Annualized rental income is rental revenue under the Company’s leases on operating properties reflecting straight-line rent adjustments associated with contractual rent increases in the leases as required by U.S. GAAP, which includes the effect of any tenant concessions, such as free rent, and excludes any contingent rent, such as percentage rent.
Geographic Concentration
As of December 31, 2015, properties located in Texas represented 13.1% of the Company’s consolidated annualized rental income. There were no other geographic concentrations exceeding 10% of the Company’s consolidated annualized rental income as of December 31, 2015.
Industry Concentration
As of December 31, 2015, tenants in the restaurant - casual dining and manufacturing industries accounted for 16.6% and 10.1% of the Company’s consolidated annualized rental income, respectively. There were no other industry concentrations exceeding 10% of the Company’s consolidated annualized rental income as of December 31, 2015.
Note 7 - Investment Securities, at Fair Value
Investment securities are considered available-for-sale and, therefore, increases or decreases in the fair value of these investments are recorded in accumulated other comprehensive income (loss) as a component of equity in the consolidated balance sheets unless the securities are considered to be other-than-temporarily impaired at which time the losses are reclassified to expense.
The following tables detail the unrealized gains and losses on investment securities as of December 31, 2015 and 2014 (in thousands):
As of December 31, 2015 and 2014, the Company owned 10 CMBS with an estimated aggregate fair value of $53.3 million and $58.6 million, respectively. The Company generally receives monthly payments of principal and interest on the CMBS. As of December 31, 2015, the Company earned interest on the CMBS at rates ranging between 5.88% and 8.95%. As of December 31, 2015, the fair value of three CMBS were below their amortized cost. The Company believes that none of the unrealized losses on investment securities are other-than-temporary as management expects the Company will receive all contractual principal and interest related to these investments.
The scheduled maturity of the Company’s CMBS as of December 31, 2015 is as follows (in thousands):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Note 8 - Loans Held for Investment
Unsecured Note Reserve
During the three months ended December 31, 2015, the Company assessed the collectability of an unsecured note held with an affiliate of the Former Manager after December’s debt service payment was not paid. The Company assessed the liquidity of the borrower, the lien position of the note and the other obligations of the borrower. Based on the analysis, the Company concluded that it was unlikely that the unsecured note will be repaid and recorded a reserve for loan loss equal to the $15.3 million carrying value of the note for the three months ended December 31, 2015.
Mortgage Notes Receivable
As of December 31, 2015, the Company owned 10 mortgage notes receivable with a weighted-average interest rate of 6.3% and weighted-average years to maturity of 13.7 years. The following table details the mortgage notes receivable as of December 31, 2015 (dollar amounts in thousands):
The Company’s mortgage notes receivable are comprised primarily of fully-amortizing or nearly fully-amortizing first mortgage loans. The Company has one mortgage note receivable where the Company does not receive monthly payments of principal and interest but rather the interest is capitalized into the outstanding balance that is due at maturity. The mortgage notes receivable are primarily on commercial real estate, each leased to a single tenant. Therefore, the Company’s monitoring of the credit quality of its mortgage notes receivable is focused primarily on an analysis of the tenant, including review of tenant quality and ratings, trends in the tenant’s industry and general economic conditions and an analysis of measures of collateral coverage, such as an estimate of the loan-to-value ratio (principal amount outstanding divided by the estimated value of the property) and its remaining term until maturity.
The following table summarizes the scheduled aggregate principal payments due to the Company on the mortgage notes receivable subsequent to December 31, 2015 (in thousands):
____________________________________
(1) Includes additional $3.8 million of interest that will be capitalized into the outstanding balance of the mortgage note receivable subsequent to December 31, 2015.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Note 9 - Rent and Tenant Receivables and Other Assets, Net
Rent and tenant receivables and other assets, net consisted of the following as of December 31, 2015 and 2014 (in thousands):
___________________________________
(1)
Allowance for doubtful accounts was $6.6 million and $2.5 million as of December 31, 2015 and 2014, respectively.
(2)
Accumulated amortization for deferred costs related to the revolving credit facility were $19.4 million and $10.8 million as of December 31, 2015 and 2014, respectively.
(3)
Amortization expense for leasehold improvements totaled $2.2 million, $1.3 million and $7,000 for the years ended December 31, 2015, 2014 and 2013, respectively. Accumulated amortization was $2.6 million and $1.2 million as of December 31, 2015 and 2014, respectively. Depreciation expense for property and equipment totaled $2.1 million, $1.6 million and $5,000 for the years ended December 31, 2015, 2014 and 2013, respectively. Accumulated depreciation was $3.7 million and $1.6 million as of December 31, 2015 and 2014, respectively.
(4)
As of December 31, 2015 and 2014, the Company had reserves of $34.8 million and $13.1 million, respectively, relating to the program development costs.
Note 10 - Fair Value Measures
The Company determines fair value based on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment. U.S. GAAP guidance defines three levels of inputs that may be used to measure fair value:
Level 1 - Quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset and liability or can be corroborated with observable market data for substantially the entire contractual term of the asset or liability.
Level 3 - Unobservable inputs reflect the entity’s own assumptions about the assumptions that market participants would use in the pricing of the asset or liability and are consequently not based on market activity, but rather through particular valuation techniques.
The determination of where an asset or liability falls in the hierarchy requires significant judgment and considers factors specific to the asset or liability. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company evaluates its hierarchy disclosures each quarter and depending on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. Changes in the type of inputs may result in a reclassification for certain assets. There were no transfers between Level 1, Level 2 or Level 3 of the fair value hierarchy during the year ended December 31, 2015. The Company expects that changes in classifications between levels will be infrequent.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Items Measured at Fair Value on a Recurring Basis
The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2015 and 2014, aggregated by the level in the fair value hierarchy within which those instruments fall (in thousands):
CMBS - The Company’s CMBS are carried at fair value and are valued using Level 3 inputs. The Company used estimated non-binding quoted market prices from the trading desks of financial institutions that are dealers in such securities for similar CMBS tranches that actively participate in the CMBS market. Broker quotes are only indicative of fair value and may not necessarily represent what the Company would receive in an actual trade for the applicable instrument. Management determines that the prices are representative of fair value through its knowledge of and experience in the market. The significant unobservable input used in valuing the CMBS is the discount rate or market yield used to discount the estimated future cash flows expected to be received from the underlying investment, which include both future principal and interest payments. Significant increases or decreases in the discount rate or market yield would result in a decrease or increase in the fair value measurement. The following risks are included in the consideration and selection of discount rates or market yields: risk of default, rating of the investment and comparable company investments.
Derivatives - The valuation of derivative instruments is determined using a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, as well as observable market-based inputs, including interest rate curves and implied volatilities. In addition, credit valuation adjustments are incorporated into the fair values to account for the Company’s potential nonperformance risk and the performance risk of the counterparties.
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with those derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of December 31, 2015, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
The fair value of short-term financial instruments such as cash and cash equivalents, restricted cash, due to affiliates and accounts payable approximate their carrying value in the accompanying consolidated balance sheets due to their short-term nature and are classified as Level 1 under the fair value hierarchy.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The following are reconciliations of the changes in assets and (liabilities) with Level 3 inputs in the fair value hierarchy for the years ended December 31, 2015 and 2014 (in thousands):
The fair values of the Company’s financial instruments that are not reported at fair value in the consolidated balance sheets are reported below (dollar amounts in thousands):
_______________________________________________
(1)
Current and prior period liabilities’ carrying and fair values exclude net deferred financing costs, as discussed in Note 2 - Summary of Significant Accounting Policies.
Loans held for investment - The fair value of the Company’s fixed-rate loan portfolio is estimated with a discounted cash flow analysis, utilizing scheduled cash flows and discount rates estimated by management to approximate market interest rates.
Mortgage notes payable and other debt and credit facilities - The fair value is estimated by an independent third party using a discounted cash flow analysis, based on management’s estimates of observable market interest rates.
Convertible debt and corporate bonds - The fair value is estimated based on current pricing marks received from an independent third party.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Items Measured at Fair Value on a Non-Recurring Basis (Including Impairment Charges)
Certain financial and nonfinancial assets and liabilities are measured at fair value on a nonrecurring basis and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. The Company’s process for identifying and recording impairment related to real estate assets, goodwill and intangible assets is discussed in Note 2 - Summary of Significant Accounting Policies.
Real Estate Assets
As discussed in Note 6 - Real Estate Investments, during the year ended December 31, 2015, real estate assets related to 202 properties were deemed to be impaired and their carrying values were reduced to their estimated fair value of $248.3 million, resulting in impairment charges of $91.8 million. During the year ended December 31, 2014, real estate assets related to 16 properties were deemed to be impaired and their carrying values were reduced to their estimated fair values of $99.0 million, resulting in impairment charges of $100.5 million. The Company estimates fair values using Level 3 inputs and using a combined income and market approach, specifically using discounted cash flow analysis and recent comparable sales transactions. The evaluation of real estate assets for potential impairment requires the Company’s management to exercise significant judgment and to make certain key assumptions, including, but not limited to, the following: (1) capitalization rate; (2) discount rates; (3) number of years property will be held; (4) property operating expenses; and (5) re-leasing assumptions including number of months to re-lease, market rental income and required tenant improvements. There are inherent uncertainties in making these estimates such as market conditions and performance and sustainability of the Company’s tenants. For our impairment tests for the real estate assets during the year ended December 31, 2015, we used a range of discount rates from of 7.3% to 9.0% and capitalization rates from 7.5% to 18.0%.
The following table presents the impairment charges by asset class recorded during the years ended December 31, 2015 and 2014 (dollar amounts in thousands):
Goodwill and Intangible Assets
The Company recorded goodwill impairment charges to the Cole Capital reporting unit of $139.7 million and $223.1 million for the years ended December 31, 2015 and 2014, respectively. The Company also tested the goodwill allocated to the REI reporting unit for impairment during the years ended December 31, 2015 and 2014. The carrying values of the REI reporting unit were $17.4 billion and $19.3 billion at the 2015 and 2014 measurement dates, respectively, which exceeded the fair values by 13.0% and 5.5%, respectively. As such, no goodwill impairment was recorded during the years ended December 31, 2015 and 2014 to the REI reporting unit. In connection with the annual goodwill impairment test, the fair value of the intangible assets were also analyzed, as discussed in Note 5 - Goodwill and Other Intangibles. Based on this analysis, impairment charges of $73.7 million and $86.4 million were recorded for the years ended December 31, 2015 and 2014, respectively.
The Company estimated the fair value of the two reporting units, REI and Cole Capital, using both the income and market approach in evaluating goodwill for impairment. The assumptions utilized in the income approach include, but are not limited to, revenue growth rates, future cash flows and a discount rate. For our most recent impairment test for the intangible assets during the three moths ended December 31, 2015, we used a discount rate of 12.5%.The assumptions utilized in the market approach include, but are not limited to, future cash flows, the selection of comparable companies and measures of operating results and pricing multiples. AFFO and EBITDA multiples for market comparable companies were used to estimate the fair value of the REI and Cole Capital reporting units, respectively, by applying those multiples to the projected financial information prepared by management.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The uncertainties associated with the fair value assumptions for Cole Capital include, but are not limited to: (i) the Company’s ability to timely reinstate certain selling agreements that were suspended as a result of the Audit Committee Investigation and the resulting restatements, (ii) the timing and extent of capital raised and deployed on behalf of the Managed REITs, (iii) the actual timing of closing an offering or executing a liquidity event on behalf of a Managed REIT, and (iv) operations of future managed real estate programs. The uncertainties associated with the fair value assumptions for the goodwill allocated to the REI reporting unit are the same as the uncertainties for real estate assets.
If all other assumptions were held constant, increasing the discount rate by 1.0% for Cole Capital would increase the goodwill impairment charge by approximately $13.7 million or 9.8% and would increase the intangible assets impairment charge by approximately $1.3 million or 1.8%. If all other assumptions were held constant, increasing the discount rate by 1.0% would decrease the carrying value in excess of fair value of the REI reporting unit from 13.0% to 3.5%.
Note 11 - Debt
As of December 31, 2015, the Company had $8.1 billion of debt outstanding, including net premiums and net deferred financing costs, with a weighted-average years to maturity of 3.8 years and a weighted-average interest rate of 3.75%. The following table summarizes the carrying value of debt as of December 31, 2015 and 2014, and the debt activity for the year ended December 31, 2015 (in thousands):
____________________________________
(1)
“Debt Issuances, Net” includes the incurrence and reclassification of certain costs associated with deferred financing costs.
(2)
Net premiums on mortgage notes payable and other debt were recorded upon the assumption of the respective debt instruments in relation to the various mergers and acquisitions. Amortization of these net premiums is recorded as a reduction to interest expense over the remaining term of the respective debt instruments using the effective-interest method.
(3)
Discounts on the corporate bonds and convertible debt were recorded based upon the fair value of the respective debt instruments as of the respective issuance dates. Amortization of these discounts is recorded as an increase to interest expense over the remaining term of the respective debt instruments using the effective-interest method.
(4)
Deferred costs relate to the term portion of the credit facility, as discussed in Note 2 - Summary of Significant Accounting Policies.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Mortgage Notes Payable
The Company’s mortgage notes payable consisted of the following as of December 31, 2015 (dollar amounts in thousands):
____________________________________
(1)
Gross carrying value is gross real estate assets, including investment in direct financing leases, net of gross real estate liabilities.
(2)
Weighted-average interest rate for variable-rate debt represents the interest rate in effect as of December 31, 2015.
(3)
Includes $248.1 million of variable-rate debt fixed by way of interest rate swap arrangements.
(4)
The table above does not include loan amounts associated with the Unconsolidated Joint Ventures of $103.3 million, none of which is recourse to the Company. These loans represent secured fixed and variable rates ranging from 2.24% to 5.20% and maturities ranging from April 2016 to July 2021, with a weighted-average interest rate of 2.95% and a weighted-average years to maturity of 1.9 years as of December 31, 2015.
The Company’s mortgage loan agreements generally restrict corporate guarantees and require the maintenance of financial covenants, including maintenance of certain financial ratios (such as specified debt to equity and debt service coverage ratios). The mortgage loan agreements contain no dividend restrictions except in the event of default or when a distribution would drive liquidity below the applicable thresholds. At December 31, 2015, the Company believes it was in compliance with the debt covenants under the mortgage loan agreements, except for a loan in default that is described below, and had no restrictions on the payment of dividends.
During the year ended December 31, 2015, an aggregate of $548.9 million of mortgage notes payable was repaid prior to maturity or assumed by the buyer in a property disposition. In connection with the extinguishments, the Company paid prepayment penalties and fees totaling $0.1 million for the year ended December 31, 2015, which are included in gain (loss) on extinguishment and forgiveness of debt, net in the accompanying consolidated statements of operations. During the year ended December 31, 2014, an aggregate of $1.6 billion of mortgage notes payable and $0.1 billion of other corporate debt were repaid prior to maturity. Prepayment fees related to mortgage notes payable totaled $35.9 million, which are included in gain (loss) on extinguishment and forgiveness of debt, net in the accompanying consolidated statements of operations. In addition, the Company paid $11.4 million during the year ended December 31, 2014 for the settlement of interest rate swaps that were associated with certain mortgage notes payable that were repaid prior to maturity, which approximated the fair value of the interest rate swaps and which are included in loss on derivative instruments, net in the accompanying consolidated statements of operations.
The Company wrote off the deferred financing costs and net premiums associated with these mortgage notes payable, which resulted in a gain of $41,000 during the year ended December 31, 2015. During the year ended December 31, 2014, a gain of $18.3 million was recorded in relation to the write-off of deferred financing costs and net premiums related to mortgage notes payable, while an additional loss of $4.3 million was recorded in relation to similar write-offs related to other corporate debt. These costs are included in gain (loss) on extinguishment and forgiveness of debt, net in the accompanying consolidated statements of operations. The mortgage notes payable repaid during the year ended December 31, 2015 had a weighted-average interest rate of 4.39% and a weighted-average remaining term of 13.3 years at the time of extinguishment.
On January 13, 2015, a substantially vacant office building in Bethesda, Maryland was foreclosed upon after the Company elected to stop making debt service payments on the related non-recourse loan with an outstanding balance of $53.8 million as of December 31, 2014. As a result of the foreclosure, the Company forfeited its right to the property and was relieved of all obligations on the non-recourse loan. During the year ended December 31, 2015, the Company recorded a gain on the forgiveness of debt of $4.9 million, which is included in gain (loss) on extinguishment and forgiveness of debt, net in the accompanying consolidated statements of operations.
On March 6, 2015, the Company received a notice of default from the lender of a non-recourse loan, with a principal balance of $38.1 million as of December 31, 2015, due to the Company’s failure to pay a reserve payment required per the loan agreement. The default on the loan did not result in a cross default on our other indebtedness. Due to the default, the Company is currently accruing interest at the default rate of interest of 10.68% per annum. The Company is engaged with the servicer to complete foreclosure proceedings.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The following table summarizes the scheduled aggregate principal repayments due on mortgage notes subsequent to December 31, 2015 (in thousands):
____________________________________
(1)
Includes $38.1 million of mortgage notes in connection with the default from the lender of a non-recourse loan discussed above.
Other Debt
As of December 31, 2015, the Company had a secured term loan from KBC Bank, N.V. with an outstanding principal balance of $33.5 million and remaining unamortized premium of $0.3 million (the “KBC Loan”). The interest coupon on the KBC Loan is fixed at 5.81% annually until its maturity in January 2018. The KBC Loan is non-recourse to the Company, subject to limited non-recourse exceptions. The KBC Loan provides for monthly payments of both principal and interest. The scheduled principal repayments subsequent to December 31, 2015 are $12.5 million, $7.7 million and $13.3 million for the years ended December 31, 2016, 2017 and 2018, respectively.
The KBC Loan is secured by various investment assets held by the Company. The following table is a summary of the outstanding balance and carrying value of the collateral by asset type as of December 31, 2015 (in thousands):
Corporate Bonds
As of December 31, 2015, the OP had $2.55 billion aggregate principal amount of senior unsecured notes outstanding comprised of 2.00% senior notes due 2017 (the “2017 Senior Notes”), 3.00% senior notes due 2019 (the “2019 Senior Notes”) and 4.60% senior notes due 2024 (the “2024 Senior Notes” and, together with the 2017 Senior Notes and the 2019 Senior Notes, (the “Senior Notes”). The following table presents the three senior notes with their respective terms (dollar amounts in thousands):
The Senior Notes are guaranteed by the General Partner. The OP may redeem all or a part of any series of the Senior Notes at any time, at its option, for the redemption prices set forth in the indenture governing the Senior Notes. With respect to the 2019 Senior Notes and the 2024 Senior Notes, if such Senior Notes are redeemed on or after January 6, 2019 with respect to the 2019 Senior Notes, or November 6, 2023 with respect to the 2024 Senior Notes, the redemption price will equal 100% of the principal amount of the Senior Notes of the applicable series to be redeemed, plus accrued and unpaid interest on the amount being redeemed to, but excluding, the applicable redemption date. The Senior Notes are registered under the Securities Act of 1933, as amended, and are freely transferable. The Company believes it was in compliance with the covenants pursuant to the indenture governing the Senior Notes as of December 31, 2015.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
On January 22, 2015, the Company entered into an agreement in principle with an ad hoc group of holders (the “Senior Noteholder Group”) of the Senior Notes, by which the Senior Noteholder Group agreed not to issue a notice of default due to the Company’s failure to timely deliver certain financial statements in 2014. In exchange, the Company agreed to sign a confidentiality agreement with the Senior Noteholder Group’s counsel and pay reasonable and documented fees and out-of-pocket expenses of such counsel up to $300,000. The Company and the OP filed the required financial statements with the SEC on March 2, 2015.
Convertible Debt
As of December 31, 2015, the OP had two tranches of Convertible Notes with an outstanding aggregate balance of $1.0 billion, comprised of the 2018 Convertible Notes and 2020 Convertible Notes. The Convertible Notes are identical to the General Partner’s registered issuance of the same amount of notes to various purchasers in a public offering. The following table presents each of the 2018 Convertible Notes and the 2020 Convertible Notes listed below with their respective terms (dollar amounts in thousands):
____________________________________
(1)
Conversion rate represents the amount of the General Partner OP Units per $1,000 principal amount.
In connection with any permissible conversion election made by the holders of the identical convertible notes issued by the General Partner, the General Partner may elect to convert the 2018 Convertible Notes into cash, General Partner OP Units or a combination thereof, in limited circumstances prior to February 1, 2018 and may convert the 2018 Convertible Notes at any time into such consideration on or after February 1, 2018. Additionally, the General Partner may elect to convert the 2020 Convertible Notes into cash, General Partner OP Units or a combination thereof, in limited circumstances prior to June 15, 2020, and may convert the 2020 Convertible Notes at any time into such consideration on or after June 15, 2020. The Company believes it was in compliance with the covenants pursuant to the indenture governing the Convertible Notes as of December 31, 2015.
On January 22, 2015, the Company received a notice from the trustee of the indentures (the “Convertible Indentures”) governing each of the Convertible Notes of the Company’s failure to timely deliver certain financial statements in 2014. Pursuant to the terms of the Convertible Indentures, the Company had 60 days following its 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. The Company and the OP filed the required financial statements with the SEC on March 2, 2015.
Credit Facility
The General Partner, as guarantor, and the OP, as borrower, are parties to an unsecured credit facility (the “Credit Facility”) pursuant to a credit agreement, dated as of June 30, 2014, as amended, with Wells Fargo, National Association (“Wells Fargo”), as administrative agent and other lenders party thereto (the “Credit Agreement”).
In 2014, the General Partner, as guarantor, and the OP, as borrower entered into certain agreements with respect to the Credit Agreement which provided for, among other things, an extension of the delivery date of certain financial statements and other deliverables, the suspension of the payment of dividends until such financial statements and other deliverables were provided and a reduction to the maximum amount of indebtedness under the Credit Agreement to $3.6 billion. In connection with the agreements, the Company agreed to pay certain customary fees to the consenting lenders and agreed to reimburse certain customary expenses of the arrangers. The Company and the OP filed the required financial statements with the SEC on March 2, 2015.
On July 31, 2015, the General Partner and the OP entered into the Second Amendment to Credit Agreement (the “Second Amendment”) with Wells Fargo and other lenders party to the Credit Agreement. Pursuant to the Second Amendment, the maximum capacity under the Credit Facility was reduced from $3.6 billion to $3.3 billion, which included a reduction in the size of the $2.45 billion revolving credit facility to $2.3 billion and the elimination of the $150.0 million multicurrency revolving credit facility. The maximum aggregate dollar amount of letters of credit that may be outstanding at any one time under the Credit Facility was reduced from $50.0 million to $25.0 million.
In respect of financial covenants, the Second Amendment reduced the Company’s minimum Unencumbered Asset Value (as defined in the Credit Agreement) from $10.5 billion to $8.0 billion. For the purposes of determining Unencumbered Asset Value, the Company is permitted to include restaurant properties representing more than 30% of its Unencumbered Asset Value in such
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
calculation such that: (i) from July 1, 2015 to June 29, 2016, up to 40% of the Unencumbered Asset Value may be comprised of restaurant properties; and (ii) from June 30, 2016 to December 30, 2016, up to 35% of the Unencumbered Asset Value may be comprised of restaurant properties. From December 31, 2016, the maximum percentage of Unencumbered Asset Value attributable to restaurant properties will be reduced back down to 30%. In connection with the Second Amendment, the Company agreed to pay certain customary fees to the consenting lenders and agreed to reimburse customary expenses of the arrangers, which are recorded as deferred financing costs and included in rent and tenant receivables and other assets, net in the accompanying consolidated balance sheets.
As of December 31, 2015, the Credit Facility allowed for maximum borrowings of $3.3 billion, consisting of a $1.0 billion term loan facility and a $2.3 billion revolving credit facility. The outstanding balance on the Credit Facility was $1.5 billion, of which $0.5 billion bore a floating interest rate of 2.04%, at December 31, 2015. The remaining outstanding balance on the Credit Facility of $1.0 billion is, in effect, fixed through the use of derivative instruments used to hedge interest rate volatility. Including the spread, which can vary based on the General Partner’s credit rating, the interest rate on this portion was 3.29% at December 31, 2015. As of December 31, 2015, a maximum of $1.8 billion was available to the OP for future borrowings, subject to borrowing availability.
The revolving credit facility generally bears interest at an annual rate of LIBOR plus 1.00% to 1.80% or Base Rate plus 0.00% to 0.80% (based upon the General Partner’s then current credit rating). “Base Rate” is defined as the highest of the prime rate, the federal funds rate plus 0.50% or a floating rate based on one month LIBOR, determined on a daily basis. The term loan facility generally bears interest at an annual rate of LIBOR plus 1.15% to 2.05%, or Base Rate plus 0.15% to 1.05% (based upon the General Partner’s then current credit rating). In addition, the Credit Agreement provides the flexibility for interest rate auctions, pursuant to which, at the Company’s election, the Company may request that lenders make competitive bids to provide revolving loans, which competitive bids may be at pricing levels that differ from the foregoing interest rates.
The Credit Agreement provides for monthly interest payments under the Credit Facility. In the event of default, at the election of the majority of the lenders (or automatically upon a bankruptcy event of default with respect to the OP or the General Partner), the commitments of the lenders under the Credit Facility will mature, and payment of any unpaid amounts in respect of the Credit Facility will be accelerated. The revolving credit facility and the term loan facility both terminate on June 30, 2018, in each case, unless extended in accordance with the terms of the Credit Agreement. The Credit Agreement provides for a one-year extension option with respect to each of the revolving credit facility and the term loan facility, exercisable at the Company’s election and subject to certain customary conditions, as well as certain customary “amend and extend” provisions. At any time, upon timely notice by the OP and subject to any breakage fees, the OP may prepay borrowings under the Credit Facility (subject to certain limitations applicable to the prepayment of any loans obtained through an interest rate auction, as described above). The OP incurs a fee equal to 0.15% to 0.25% per annum (based upon the General Partner’s then current credit rating) multiplied by the commitments (whether or not utilized) in respect of the revolving credit facility. In addition, the OP incurs customary administrative agent, letter of credit issuance, letter of credit fronting, extension and other fees.
The Credit Facility requires restrictions on corporate guarantees, as well as the maintenance of financial covenants, including the maintenance of certain financial ratios (such as specified debt to equity and debt service coverage ratios) and the maintenance of a minimum net worth. The key financial covenants in the Credit Facility, as defined and calculated per the terms of the Credit Agreement, include maintaining (i) a maximum leverage ratio less than or equal to 60%, (ii) a minimum fixed charge coverage ratio of at least 1.5x, (iii) a secured leverage ratio less than or equal to 45%, (iv) a total unencumbered asset value ratio less than or equal to 60%, (v) a minimum tangible net worth covenant of at least $5.5 billion, (vi) a minimum unencumbered interest coverage ratio of at least 1.75x and (vii) a minimum unencumbered asset value of at least $8.0 billion. The Company believes it was in compliance with the Credit Agreement and is not restricted from accessing any borrowings under the Credit Facility as of December 31, 2015.
Note 12 - Derivatives and Hedging Activities
Risk Management Objective of Using Derivatives
The Company may use derivative financial instruments, including interest rate swaps, caps, options, floors and other interest rate derivative contracts, to hedge all or a portion of the interest rate risk associated with its borrowings. The principal objective of such arrangements is to minimize the risks and/or costs associated with the Company’s operating and financial structure as well as to hedge specific anticipated transactions. The Company does not intend to utilize derivatives for purposes other than interest rate risk management. The use of derivative financial instruments carries certain risks, including the risk that the counterparties to these contractual arrangements are not able to perform under the agreements. To mitigate this risk, the Company only enters into derivative financial instruments with counterparties with high credit ratings and with major financial institutions with which
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
the Company and its affiliates may also have other financial relationships. The Company does not anticipate that any of the counterparties will fail to meet their obligations.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
The effective portion of changes in the fair value of derivatives designated that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the year ended December 31, 2015, such derivatives were used to hedge the variable cash flows associated with variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the next 12 months, the Company estimates that an additional $4.7 million will be reclassified from other comprehensive income to interest expense.
As of December 31, 2015 and 2014, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk (dollar amounts in thousands):
_______________________________________________
(1)
During the year ended December 31, 2015, the Company settled an interest rate swap in connection with the prepayment of certain mortgage notes payable. Mortgage notes payable repaid prior to maturity or assumed by the buyer in property dispositions are discussed in detail in Note 11 - Debt.
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification in the consolidated balance sheets as of December 31, 2015 and 2014 (in thousands):
In January 2014, the Company entered into an interest rate lock agreement with a notional amount of $250.0 million (the “Treasury Lock Agreement”). The Treasury Lock Agreement, which had an original maturity date of February 12, 2014, was entered into to hedge part of the Company’s interest rate exposure associated with the variability in future cash flows attributable to changes in the 10-year U.S. treasury rates related to the planned issuance of debt securities in conjunction with the Cole Merger. In connection with the Company’s offering of Senior Notes in February 2014, the Company settled the Treasury Lock Agreement for $3.9 million, which was accounted for as a cash flow hedge, recorded to other comprehensive loss and will be amortized into earnings over the 10-year term of the Treasury Lock. The Company recognized $0.4 million of interest expense for the year ended December 31, 2015 related to the Treasury Lock Agreement.
Derivatives Not Designated as Hedging Instruments
Derivatives not designated as hedges are not speculative and are used to manage the Company’s exposure to interest rate movements and other identified risks but do not meet the requirements to be classified as hedging instruments. A loss of $1.5 million related to the change in the fair value of derivatives not designated as hedging instruments and other ineffectiveness was recorded directly in earnings for the year ended December 31, 2015. The Company recorded a loss of $10.6 million for the year ended December 31, 2014.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
As of December 31, 2015 and 2014, the Company had the following outstanding interest rate derivative that was not designated as a qualifying hedging relationship (dollar amounts in thousands):
The table below presents the fair value of the Company’s derivative financial instrument not designated as a hedge as well as its classification in the consolidated balance sheets as of December 31, 2015 and December 31, 2014 (in thousands):
Tabular Disclosure of Offsetting Derivatives
The table below details a gross presentation, the effects of offsetting and a net presentation of the Company’s derivatives as of December 31, 2015 and December 31, 2014 (in thousands). The net amounts of derivative assets or liabilities can be reconciled to the tabular disclosure of fair value. The tabular disclosure of fair value provides the location that derivative assets and liabilities are presented in the accompanying consolidated balance sheets.
Credit Risk Related Contingent Features
The Company has agreements with each of its derivative counterparties that contain a provision specifying that if the Company either defaults or is capable of being declared in default on any of its indebtedness, the Company could also be declared in default on its derivative obligations.
As of December 31, 2015, the fair value of the interest rate derivatives in a net liability position, including accrued interest but excluding any adjustment for nonperformance risk related to these agreements, was $8.5 million. As of December 31, 2015, the Company has not posted any collateral related to these agreements and was not in breach of any provisions in these agreements. If the Company had breached any of these provisions, it could have been required to settle its obligations under the agreements at their aggregate termination value of $8.5 million at December 31, 2015.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Note 13 - Supplemental Cash Flow Disclosures
Supplemental cash flow information was as follows for the years ended December 31, 2015 and 2014 (in thousands):
Note 14 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consisted of the following as of December 31, 2015 and 2014 (in thousands):
Note 15 - Commitments and Contingencies
Litigation
The Company is involved in various routine legal proceedings and claims incidental to the ordinary course of its business. There are no material legal proceedings pending against the Company, except as follows:
Government Investigations and Litigation Relating to the Audit Committee Investigation
On October 29, 2014, the Company filed a Current Report on Form 8-K (the “October 29 8-K”) reporting the Audit Committee’s conclusion, based on the preliminary findings of its investigation, that certain previously issued consolidated financial statements of the Company, including those included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2014 and June 30, 2014, and related financial information should no longer be relied upon. Prior to that filing, the Audit Committee previewed for the SEC the information contained in the filing. Subsequent to that filing, the SEC provided notice that it had commenced a formal investigation and issued subpoenas calling for the production of various 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.
As discussed below, the Company and certain of its former officers and current and former directors have been named as defendants in a number of lawsuits filed following 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, Maryland and Arizona.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Between October 30, 2014 and January 20, 2015, the Company and certain of its former officers and current and former directors, among other individuals and entities, were named as defendants in ten putative securities class action complaints filed in the United States District Court for the Southern District of New York (the “SDNY Actions”). The Court subsequently consolidated the SDNY Actions under the caption In re American Realty Capital Properties, Inc. Litigation, No. 15-MC-00040 (AKH) (the “SDNY Consolidated Securities Class Action”). Following motions to dismiss filed by the defendants, which were granted in part and denied in part, the lead plaintiff filed an amended class action complaint on December 11, 2015, which asserted claims for violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Certain defendants, including the Company filed motions to dismiss the second amended class action complaint (or portions thereof) on February 12, 2016.
In addition, on November 25, 2014, the Company and certain of its former officers and current and former directors were named as defendants in a putative securities class action complaint filed in the Circuit Court for Baltimore County, Maryland, captioned Wunsch v. American Realty Capital Properties, Inc., et al., No. 03-C-14-012816 (the “Wunsch Action”). On December 23, 2014, the Company removed the action to the United States District Court for the District of Maryland and on April 15, 2015, the Maryland court transferred the Wunsch Action to the United States District Court for the Southern District of New York. On December 15, 2015, the Wunsch Action was consolidated with the SDNY Consolidated Securities Class Action.
In January 2015, the Company and certain of its former directors and officers were named as defendants in an individual securities fraud action 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”). The Jet Capital Action seeks money damages and asserts claims for alleged violations of Sections 10(b), 18 and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, as well as common law fraud under New York law in connection with the purchase of the Company’s securities. On April 17, 2015, the plaintiff filed an amended complaint. On October 27, 2015, the court denied defendants’ motions to dismiss the complaint and all defendants filed answers to the complaint by December 18, 2015.
The Company, certain of its former officers and current and former directors, and the OP (in addition to several other individuals and entities) have also been named as defendants in two additional individual securities fraud actions filed in the United States District Court for the Southern District of New York, captioned Twin Securities, Inc. v. American Realty Capital Properties, Inc., et al., No. 15-cv-1291 (the “Twin Securities Action”) and HG Vora Special Opportunities Master Fund, Ltd v. American Realty Capital Properties, Inc., et al., No. 15-cv-4107 (the “HG Vora Action”). The Twin Securities Action and the HG Vora Action seek money damages and assert claims for alleged violations of 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, Sections 11, 12(a)(2), and 15 of the Securities Act of 1933, as well as common law fraud under New York law in connection with the purchase of the Company’s securities. The Company and defendants are not yet required to respond to the complaints in either of these actions.
On October 27, 2015, the Company and certain of its former officers, the OP, and other entities were named as defendants in an individual securities fraud action filed in the United States District Court for the District of Arizona, captioned Vanguard Specialized Funds, et al. v. VEREIT, Inc. et al., No. 15-cv-02157 (ESW) (the “Vanguard Action”). The Vanguard Action seeks money damages and asserts claims for alleged 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 Vanguard Action also asserts claims under Arizona law pursuant to the Arizona Consumer Fraud Act and seeks punitive damages thereunder. On January 21, 2016, the Company filed a motion to transfer the Vanguard Action to the United States District Court for the Southern District of New York and a motion to.dismiss the complaint.
On October 27 and October 28, 2015, the Company and certain of its former officers, the OP, and other entities were named as defendants in four individual securities fraud actions filed in the United States District Court for the Southern District of New York: BlackRock ACS US Equity Tracker Fund, et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08464 (the “BlackRock Action”); PIMCO Funds: PIMCO Diversified Income Fund, et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08466 (the “PIMCO Action”); Clearline Capital Partners LP, et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08467 (the “Clearline Action”); and Pentwater Equity Opportunities Master Fund Ltd., et al. v. American Realty Capital Properties, Inc. et al., No. 15-cv-08510 (the “Pentwater Action”). All four actions seek money damages arising out of allegedly false and misleading statements in connection with the purchase or sale of the Company’s securities. The BlackRock Action and the PIMCO Action assert claims for alleged violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The BlackRock Action also asserts claims under Section 14(a) of the Securities Exchange Act of 1934 and Rule 14a-9 promulgated thereunder. The Clearline Action and the Pentwater Action assert claims under Sections 10(b), 18(a) and 20(a) of the Securities Exchange Act of 1934 and Rule
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
10b-5 promulgated thereunder. The Clearline Action and the Pentwater Action also assert a claim for common law fraud under New York law and seek punitive damages thereunder. The Company is not yet required to respond to the complaints in these actions.
On October 28, 2015, the Company and certain of its former officers and directors (among other individuals and entities) were named as defendants in a putative securities class action complaint filed in the United States District Court for the Southern District of New York: IRA FBO John Esposito v. American Realty Capital Properties, Inc. et al., No. 15-cv-08508 (the “Esposito Action”). The Esposito Action seeks money damages and asserts claims for alleged violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 14(a) of the Securities Exchange Act of 1934 and Rule 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 Company is not yet required to respond to the complaint in the Esposito Action.
On July 31, 2015, the Company and certain of its former officers and current and former directors were named as defendants in a shareholder derivative action filed in the United States District Court for the Southern District of New York, captioned Witchko v. Schorsch, et al., No. 15-cv-06043 (AKH) (the “Witchko Action”). The Witchko Action asserts claims under Section 14 of the Exchange Act arising out of allegedly false and misleading statements made in the Company’s proxy statements and the incorporation by reference of allegedly false and misleading financial statements. The Witchko Action also seeks money damages and other relief on behalf of the Company, for, among other things, alleged breach of fiduciary duty, abuse of control and unjust enrichment. On October 15, 2015, the Company and other defendants filed motions to dismiss the Witchko Action due to plaintiff’s failure to plead facts, as required under Maryland law, demonstrating that the Board’s decision to refuse plaintiff’s pre-suit demand was wrongful and not a protected business judgment.
On October 30, 2015, the Company and certain of its former officers and directors were named as defendants in a shareholder derivative action filed in the United States District Court for the Southern District of New York, captioned Serafin, et al. v. Schorsch, et al., No. 15-cv-08563 (the “Serafin Action”). The Serafin Action seeks money damages and other relief on behalf of the Company for, among other things, alleged breach of fiduciary duty and contribution and indemnification. The court has consolidated the Witchko Action and the Serafin Action (together “the SDNY Derivative Action”) and the plaintiffs have designated the complaint filed in the Witchko Action as the complaint in the SDNY Derivative Action. On February 12, 2016, the Company and other defendants filed a motion to dismiss the SDNY Derivative Action due to plaintiffs’ failure to plead facts, as required under Maryland law, demonstrating that the Board’s decision to refuse plaintiff’s pre-suit demand was wrongful and not a protected business judgment. Other defendants also filed motions to dismiss for failure to state a claim.
On December 3, 2015, the Company and certain of its former officers and directors were named as defendants in a shareholder derivate action filed in the Circuit Court for Baltimore City in Maryland, captioned Frampton v. Schorsch, et al., No. 24-C-15-006269 (the “Frampton Action”). The Frampton Action seeks money damages and other relief on behalf of the Company for, among other things, alleged breaches of fiduciary duty and contribution and indemnification. The Company is required to respond to the complaint by March 7, 2016.
The Company has not reserved amounts for any of the litigation or investigation matters referenced above either because we have not concluded that a loss is probable in the matter or because we believe that any probable loss or range of loss is not reasonably estimable at this time.
ARCT III Litigation Matters
After the announcement of the merger agreement with American Realty Capital Trust III, Inc. (“ARCT III”) in December 2012 (the “ARCT III Merger Agreement”), a putative class action lawsuit was filed in January 2013 against the Company, the OP, ARCT III, ARCT III’s operating partnership, members of the board of directors of ARCT III and certain subsidiaries of the Company in Supreme Court in the State of New York, captioned Qual v. American Realty Capital Properties, et al., No. 650329/2013. The plaintiff alleged, among other things, that the ARCT III board breached its fiduciary duties in connection with the transactions contemplated under the ARCT III Merger Agreement. 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. The proposed settlement terms required certain additional disclosures related to the merger, which were included in a Current Report on Form 8-K filed by ARCT III with the SEC on February 21, 2013. On January 28, 2016, plaintiffs voluntarily dismissed their lawsuit without prejudice.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
CapLease Litigation Matters
Following the announcement of the merger agreement with CapLease in May 2013, a number of lawsuits were filed by CapLease stockholders, the following of which remain pending:
On June 25, 2013, a putative class action and derivative lawsuit was filed in the Circuit Court for Baltimore City against the Company, the OP, CapLease, and members of the CapLease board of directors, among others, captioned Tarver v. CapLease, Inc., et al., No. 24-C-13-004176 (the “Tarver Action”). The complaint alleged, among other things, that the merger agreement was the product of breaches of fiduciary duty by the CapLease directors because the transaction purportedly did not provide for full and fair value for the CapLease shareholders and was not the result of a competitive bidding process, the merger agreement allegedly contained coercive deal protection measures and the merger was purportedly approved as a result of improper self-dealing by certain defendants who would receive certain alleged employment compensation benefits and continued employment pursuant to the merger agreement. The complaint also alleged that CapLease, the Company, the OP and others aided and abetted the CapLease directors’ alleged breaches of fiduciary duty.
In August 2013, counsel in the Tarver Action filed a motion for a stay in the Baltimore Court, informing the court that the plaintiff had agreed to join and participate in the prosecution of other actions concerning the CapLease transaction then pending in a New York court (which were subsequently dismissed). The stay was granted by the Baltimore Court and the parties have engaged in no subsequent activity in the Tarver Action.
In October 2013, a putative class action lawsuit was filed in the Circuit Court for Baltimore City against the Company, the OP, CapLease, and members of the CapLease board of directors, among others, captioned Poling v. CapLease, Inc., et al., No. 24-C-13-006178 (the “Poling Action”). The complaint alleged that the merger agreement breached the terms of the CapLease 8.375% Series B Cumulative Redeemable Preferred Stock (“Series B”) and the terms of the 7.25% Series C Cumulative Redeemable Preferred Stock (“Series C”) and was in violation of the Series B Articles Supplementary and the Series C Articles Supplementary. The complaint alleged claims for breach of contract and breach of fiduciary duty against the CapLease entities and the CapLease board of directors, and that the Company, the OP and Safari Acquisition, LLC aided and abetted CapLease and the CapLease directors’ alleged breach of contract and breach of fiduciary duty.
In December 2013, all Defendants filed a motion to dismiss the Poling Action, which was granted by the court in May 2015. Plaintiff filed a notice of appeal on June 4, 2015. The appeal is pending.
Cole Litigation Matters
Two actions filed in March and April 2013 in the United States District Court for the District of Arizona, assert shareholder class action claims under the Securities Act of 1933, along with claims for breach of fiduciary duty, abuse of control, corporate waste, and unjust enrichment, among others, relating to the merger between a wholly owned subsidiary of Cole and Cole Holdings Corporation, pursuant to which Cole became a self-managed REIT; Schindler v. Cole Holdings Corp., et al., 13-cv-00712; and Carter v. Cole Holdings Corp., et al., 13-cv-00629. Defendants filed a motion to dismiss both complaints in January 2014. Both of those lawsuits have been stayed by the Court pursuant to a joint request made by all parties pending final approval of the Consolidated Maryland Cole Merger Action described below.
To date, a number of lawsuits have been filed in connection with the Cole Merger, the following of which remain pending. Between October and November 2013, eight putative stockholder class action or derivative lawsuits were filed in the Circuit Court for Baltimore City, Maryland, which were consolidated in December 2013, under the caption Polage v. Cole Real Estate Investments, Inc., et al., 24-c-13-006665 (the “Consolidated Maryland Cole Merger Action”).
These lawsuits named the Company, Cole and Cole’s board of directors as defendants, and certain of the actions also named CREInvestments, LLC, a Maryland limited liability company and a wholly-owned subsidiary of Cole, as a defendant. Each complaint generally alleged, among other things, that the individual defendants breached fiduciary duties owed to stockholders of Cole in connection with the Cole Merger, and that certain entity defendants aided and abetted those breaches. The breach of fiduciary duty claims asserted included claims that the Cole Merger did not provide for full and fair value for the Cole shareholders and was the product of an “inadequate sale process,” that the Cole Merger Agreement contained coercive deal protection measures and that the Cole Merger Agreement and the Cole Merger were approved as a result of, or in a manner which facilitated, improper self-dealing by certain defendants.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
In January 2014, the parties to the Consolidated Maryland Cole Merger Action entered into a memorandum of understanding regarding settlement of all claims asserted on behalf of the alleged class of Cole stockholders. The proposed settlement terms required Cole to make certain additional disclosures related to the Cole Merger and contemplated that the parties would enter into a stipulation of settlement, subject to customary conditions, including confirmatory discovery and court approval following notice to Cole’s stockholders. In August 2014, the parties in the Consolidated Maryland Cole Merger Action executed a Stipulation and Release and Agreement of Compromise and Settlement (the “Stipulation”) and the Baltimore Circuit Court entered an Order on Preliminary Approval of Derivative and Class Action Settlement and Class Action Certification and scheduled a final settlement hearing.
In December 2014, the parties in the Consolidated Maryland Cole Merger Action executed an Amended Stipulation and Release and Agreement of Compromise and Settlement (the “Amended Stipulation”) modifying the Stipulation. In January 2015, the Baltimore Circuit Court issued an order approving the class settlement pursuant to the terms of the Amended Stipulation. Under the terms of the approved settlement, defendants paid a settlement amount of $14.0 million, half of which was to be used for class counsel’s attorney’s fees. One objector pursued an appeal of the settlement order. That appeal was denied on February 1, 2016.
In December 2013, Realistic Partners filed a putative class action lawsuit against the Company and the then-members of its board of directors in the Supreme Court for the State of New York, captioned Realistic Partners v. American Realty Capital Partners, et al., No. 654468/2013. Cole was later added as a defendant. The plaintiff alleged, among other things, that the board of the Company breached its fiduciary duties in connection with the transactions contemplated under the Cole Merger Agreement and that Cole aided and abetted those breaches. In January 2014, the parties entered into a memorandum of understanding regarding settlement of all claims asserted on behalf of the alleged class of the Company’s stockholders. The proposed settlement terms required the Company to make certain additional disclosures related to the Cole Merger, which were included in a Current Report on Form 8-K filed by the Company with the SEC on January 17, 2014. The memorandum of understanding also contemplated that the parties would enter into a stipulation of settlement, which would be subject to customary conditions, including confirmatory discovery and court approval following notice to the Company’s stockholders, and provided that the defendants would not object to a payment of up to $625,000 for attorneys’ fees. If the parties enter into a stipulation of settlement, which has not occurred, 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.
Contractual Lease Obligations
The following table reflects the minimum base rent payments due from the Company over the next five years and thereafter for certain ground lease obligations, which are substantially reimbursable by our tenants, and office lease obligations (in thousands):
Purchase Commitments
Cole Capital enters into purchase and sale agreements and deposits funds into escrow towards the purchase of real estate assets, most of which are expected to be assigned to one of the Managed REITs at or prior to the closing of the respective acquisition. As of December 31, 2015, Cole Capital was a party to seven purchase and sale agreements with unaffiliated third-party sellers to purchase a 100% interest in nine properties, subject to meeting certain criteria, for an aggregate purchase price of $59.2 million, exclusive of closing costs. As of December 31, 2015, Cole Capital had $1.3 million of property escrow deposits held by escrow agents in connection with these future property acquisitions, which may be forfeited if the transactions are not completed under certain circumstances. Cole Capital will be reimbursed by the assigned Managed REIT for amounts escrowed when the property is assigned to the respective Managed REIT.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Environmental Matters
In connection with the ownership and operation of real estate, the Company may potentially be liable for costs and damages related to environmental matters. The Company has not been notified by any governmental authority of any non-compliance, liability or other claim, and is not aware of any other environmental condition, in each case, that it believes will have a material adverse effect on the results of operations.
Note 16 - Equity
Common Stock and General Partner OP Units
The General Partner is authorized to issue up to 1.5 billion shares of Common Stock. As of December 31, 2015, the General Partner had approximately 904.9 million shares of Common Stock issued and outstanding.
Additionally, the Operating Partnership had approximately 904.9 million General Partner OP Units issued and outstanding as of December 31, 2015, corresponding to the General Partner’s outstanding shares of Common Stock.
Preferred Stock and Preferred OP Units
Series A and Series B Convertible Preferred Stock
During the year ended December 31, 2013, the Company converted all 545,454 outstanding shares of its Series A Convertible Preferred Stock and all 283,018 outstanding shares of Series B Convertible Preferred Stock into 829,629 shares of the Company’s common stock, which included dividends on the Series A Convertible Preferred Stock.
Convertible Obligation to Series C Convertible Preferred Stockholders
During the year ended December 31, 2013, the Company issued, through a private placement, 28.4 million shares of Series C Convertible Preferred Stock (the “Series C Stock”) for gross proceeds of $445.0 million. Due to an unconditional obligation to either redeem or convert the Series C Stock into a variable number of shares of common stock that is predominantly based on a fixed monetary amount, the preferred securities were classified as an obligation under U.S. GAAP and were presented in the consolidated balance sheets as a liability prior to their settlement in November 2013. During the year ended December 31, 2013, the Company converted the Series C Stock, in accordance with the terms of the original agreement, into 1.4 million shares of common stock with the remaining balance of Series C Stock settled in cash consideration of $441.4 million.
Contingent Valuation Rights
During the year ended December 31, 2013, the Company issued to certain stockholders of common stock and Series C Stock contingent value rights.
Changes in the fair value of the contingent valuation rights obligation subsequent to issuance date were recorded as a loss on derivatives in the consolidated statements of operations. For the year ended December 31, 2013, the Company recorded a loss on the contingent valuation rights obligation of $69.7 million, which represented the amount settled during 2013.
Series D Preferred Stock
During the year ended December 31, 2013, the Company entered into definitive purchase agreements pursuant to which it agreed to issue Convertible Preferred Stock (“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 the Company’s merger with CapLease, via a private placement. Pursuant to the definitive purchase agreements, the Company issued approximately 21.7 million shares of Series D Preferred 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 paid dividends at the rate of 5.81% per annum on its face amount of $13.59 per share (equivalent to $0.79 per share on an annualized basis). The Company redeemed all outstanding Series D Preferred Stock and Units on September 2, 2014 for $316.1 million in cash.
Prior to the redemption, the Company concluded that the conversion option qualifies as a derivative and should be bifurcated from the host instrument. At issuance, the conversion option had a fair value of $18.7 million. As of December 31, 2013, the fair value of the conversion option had a fair value of $16.7 million. The Company recorded the change in fair value of $2.0 million in loss on derivative instruments in the consolidated statements of operations for the year ended December 31, 2013. The Company
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
recorded a loss of $13.6 million upon redemption of the conversion option in loss on derivative instruments, net in the consolidated statements of operations for the year ended December 31, 2014.
Series F Preferred Stock
On January 3, 2014, in connection with the ARCT IV Merger, 42.2 million shares of Series F Preferred Stock were issued, resulting in the Operating Partnership concurrently issuing 42.2 million General Partner Series F preferred units (“General Partner Series F Preferred Units”) to the General Partner, and 700,000 Series F Preferred Units (“Limited Partner Series F Preferred Units”) to holders of each outstanding unit of American Realty Capital Operating Partnership IV, L.P. (the “ARCT IV Operating Partnership”) (each, an “ARCT IV OP Unit”). As of December 31, 2015, there were approximately 42.8 million shares of Series F Preferred Stock (and approximately 42.8 million corresponding General Partner Series F Preferred Units) and 86,874 Limited Partner Series F Preferred Units issued and outstanding.
The Series F Preferred Stock will pay cumulative cash dividends at the rate of 6.70% per annum on their liquidation preference of $25.00 per share (equivalent to $1.675 per share on an annual basis). The Series F Preferred Stock is not redeemable by the Company before the fifth anniversary of the date on which such Series F Preferred Stock was issued (the “Initial Redemption Date”), except under circumstances intended to preserve the General Partner’s status as a REIT for federal and/or state income tax purposes and except upon the occurrence of a change of control. On and after the Initial Redemption Date, the General Partner may, at its option, redeem shares of the Series F Preferred Stock, in whole or from time to time in part, at a redemption price of $25.00 per share plus, subject to exceptions, any accrued and unpaid dividends thereon to the date fixed for redemption. The shares of Series F Preferred Stock have no stated maturity, are not subject to any sinking fund or mandatory redemption and will remain outstanding indefinitely unless the General Partner redeems or otherwise repurchases them or they become convertible and are converted into Common Stock (or, if applicable, alternative consideration). The Series F Preferred Stock traded on the NASDAQ under the symbol “ARCPP” through July 30, 2015. The Series F Preferred Stock began trading on the NYSE under the symbol “VER PRF” on July 31, 2015. The Series F Preferred Units contain the same terms as the Series F Preferred Stock.
For federal income tax purposes, distributions to stockholders are characterized as ordinary dividends, capital gain distributions, or nontaxable distributions. Nontaxable distributions will reduce U.S stockholders’ basis (but not below zero) in their shares. The following table shows the character of the Series F Preferred Stock distributions we paid on a percentage basis for the years ended December 31, 2015 and 2014:
Limited Partner OP Units
As of December 31, 2015 and 2014, the Operating Partnership had approximately 23.8 million of Limited Partner OP Units outstanding.
On March 11, 2015, the Company received redemption requests totaling approximately 13.1 million OP Units ($126.7 million based on a redemption price of $9.65) from certain affiliates of the Former Manager. The Company believes it has potential claims against recipients of those OP Units and has engaged in discussions with affiliates of the Former Manager regarding the redemption requests. Pending any resolution, the Company does not currently intend to satisfy any of the redemption requests. In light of the potential claims, the OP did not pay distributions in respect of a substantial portion of the outstanding Limited Partner OP Units on October 15, 2015 and January 15, 2016, when the Common Stock dividend was otherwise paid.
Public Offerings
On May 28, 2014, the General Partner closed on a public offering of 138.0 million shares of Common Stock at a price of $12.00 per share. The net proceeds to the General Partner were $1.6 billion after deducting underwriting discounts, commissions and offering-related expenses. Concurrently, the Operating Partnership issued the General Partner 138.0 million General Partner OP Units.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Common Stock Dividends
On December 23, 2014, in connection with the amendments to the Credit Facility, the Company agreed to suspend payment of dividends on its Common Stock until it complied with certain financial statement delivery and other information requirements. On March 30, 2015, the Company satisfied these financial statement and other information requirements. On August 5, 2015, the Company declared a quarterly dividend of $0.1375 per share of Common Stock for each of the third and fourth quarters of 2015 (representing an annualized dividend rate of $0.55 per share) which was paid on October 15, 2015 and January 15, 2016 to holders of record as of September 30, 2015 and December 31, 2015, respectively.
For federal income tax purposes, distributions to stockholders are characterized as ordinary dividends, capital gain distributions, or nontaxable distributions. Nontaxable distributions will reduce U.S stockholders’ basis (but not below zero) in their shares. The following table shows the character of the common stock distributions we paid on a percentage basis for the years ended December 31, 2015, 2014 and 2013:
Common Stock Repurchases
Under the General Partner’s Equity Plan (defined below), individuals have the option to have the General Partner repurchase shares vesting from awards made under the Equity Plan in order to satisfy the minimum federal and state tax withholding obligations. During the year ended December 31, 2015, the General Partner repurchased 268,414 shares to satisfy the federal and state tax withholding on behalf of employees.
Share Repurchase Programs
ARCT III’s and ARCT IV’s boards of directors had adopted Share Repurchase Programs (the “ARCT III SRP” and the “ARCT IV SRP”, respectively, and collectively, the “SRPs”) that enabled stockholders to offer their shares to ARCT III and ARCT IV, respectively, for repurchase in limited circumstances. The SRPs permitted investors to sell their shares back to ARCT III or ARCT IV, as applicable, after they had held them for at least one year, subject to the significant conditions and limitations described below.
When a stockholder requested repurchases and the repurchases were approved by ARCT III’s or ARCT IV’s board of directors, as applicable, it reclassified such obligation from equity to a liability based on the settlement value of the obligation. Upon the ARCT III Merger, the ARCT III SRP was terminated. Upon the ARCT IV Merger, the ARCT IV SRP was terminated. As of December 31, 2015, there were 87 cumulative repurchase requests and 188,075 cumulative shares repurchased at an average price per share of $10.46. During the years ended December 31, 2015 and 2014, the Company did not repurchase any shares of common stock under the SRP. During the year ended December 31, 2013, the Company had 11 repurchase requests and 4,956 shares repurchased at an average price per share of $24.98.
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 paid in cash at $12.00 per share, which was equivalent to 27.7 million shares of the Company’s 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 the Company’s Common Stock at the ARCT III Exchange Ratio, resulting in an additional 140.7 million shares of the Company’s Common Stock outstanding after the exchange. On August 20, 2013, the Company’s board of directors reauthorized its $250.0 million share repurchase program, which was originally authorized in February 2013.
Note 17 - Equity-based Compensation
Equity Plan
The General Partner has adopted an equity plan (the “Equity Plan”), which provides for the grant of stock options, stock appreciation rights, restricted shares of Common Stock (“Restricted Shares”), restricted stock units (“Restricted Stock Units”),
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
dividend equivalent rights and other stock-based awards to the General Partner’s and its affiliates’ non-executive directors, officers and other employees and advisors or consultants who are providing services to the General Partner or its affiliates. To date, the General Partner has granted fully vested shares of Common Stock, Restricted Shares, Restricted Stock Units and Deferred Stock Units (defined below) under the Equity Plan. Restricted Shares provide for rights identical to those of Common Stock. Restricted Stock Units do not provide for any rights of a common stockholder prior to the vesting of such Restricted Stock Units. In accordance with U.S. GAAP, Restricted Shares are considered issued and outstanding. As is the case when fully vested shares of Common Stock are issued from the Equity Plan, for each Restricted Share awarded under the Equity Plan, the Operating Partnership issues a General Partner OP Unit to the General Partner with identical terms. Upon vesting of Restricted Stock Units, the Operating Partnership issues a General Partner OP Unit to the General Partner for each share of Common Stock issued as a result of such vesting.
The General Partner authorized and reserved a total number of shares equal to 10.0% 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. As of December 31, 2015, the General Partner had cumulatively awarded under its Equity Plan approximately 4.2 million Restricted Shares, net of the forfeiture of 3.5 million Restricted Shares through that date, 2.1 million Restricted Stock Units, net of the forfeiture of 0.3 million Restricted Stock Units through that date, and 0.1 million Deferred Stock Units, collectively representing approximately 6.3 million shares of Common Stock. Accordingly, as of such date, approximately 86.5 million additional shares were available for future issuance.
During the years ended December 31, 2015 and 2014, the General Partner awarded 5,634 and 165,838 shares of Common Stock, respectively. The fair value of the awards was determined using the closing stock price on the grant date and expensed in full on the grant date. The Company recorded $0.1 million and $2.0 million of compensation expense related to the awards for the years ended December 31, 2015 and 2014, respectively, which is recorded in general and administrative expense in the accompanying consolidated statements of operations.
Restricted Shares
The Company has issued Restricted Shares to certain employees and non-executive directors beginning in 2011 through December 31, 2015. In addition, the Company issued Restricted Shares to employees of affiliates of the Former Manager prior to 2015. The fair value of the Restricted Shares granted to employees under the Equity Plan is generally determined using the closing stock price on the grant date and is expensed over the requisite service period on a straight-line basis. The fair value of Restricted Shares granted to non-executive directors and employees of affiliates of the Former Manager under the Equity Plan was measured based upon the fair value of goods or services received or the equity instruments granted, whichever was more reliably determinable, and was expensed in full at the date of grant.
During the years ended December 31, 2015, 2014 and 2013, the Company recorded $3.9 million, $29.7 million and $8.0 million, respectively, of compensation expense related to the Restricted Shares, which is recorded in general and administrative expense in the accompanying consolidated statements of operations. As of December 31, 2015, there is $6.7 million of unrecognized compensation expense related to the Restricted Shares with a weighted-average remaining term of 2.8 years.
The following table details the activity of the Restricted Shares during the years ended December 31, 2015, 2014 and 2013:
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Time-Based Restricted Stock Units
During the year ended December 31, 2015, the General Partner awarded Restricted Stock Units to certain employees that will vest if the recipient maintains his/her employment over the requisite service period (the “Time-Based Restricted Stock Units”). The fair value of the Time-Based Restricted Stock Units granted to employees under the Equity Plan is generally determined using the closing stock price on the grant date and is expensed over the requisite service period on a straight-line basis, which is generally three years. During the year ended December 31, 2015, the Company recorded $1.8 million of compensation expense related to the Time-Based Restricted Stock Units, which is recorded in general and administrative expense in the accompanying consolidated statements of operations. There were no compensation expenses related to the Time-Based Restricted Stock Units recorded for the years ended December 31, 2014 and 2013. As of December 31, 2015, there is $4.1 million of unrecognized compensation expense related to the Time-Based Restricted Stock Units with a weighted-average remaining term of 2.3 years.
Deferred Stock Units
During the year ended December 31, 2015, the General Partner awarded Deferred Stock Units to non-executive directors under the Equity Plan (the “Deferred Stock Units”). Each Deferred Stock Unit represents the right to receive one share of Common Stock. The Deferred Stock Units provide for immediate vesting and will be settled with Common Stock on the earlier of the date on which the respective director separates from the Company or the third anniversary of the grant date. The fair value of the Deferred Stock Units is determined using the closing stock price on the grant date and is expensed in full on the grant date. During the year ended December 31, 2015, the Company recorded $0.8 million of expense related to the Deferred Stock Units, which is recorded in general and administrative expense in the accompanying consolidated statements of operations. There were no compensation expenses related to the Deferred Stock Units recorded for the years ended December 31, 2014 and 2013. As of December 31, 2015, there is no unrecognized compensation expense related to the Deferred Stock Units.
The following table details the activity of the Time-Based Restricted Stock Units and Deferred Stock Units during the year ended December 31, 2015. There was no such activity for the years ended December 31, 2014 and 2013.
Market-Based Restricted Stock Units
During the year ended December 31, 2015, the General Partner awarded Restricted Stock Units to certain employees under the Equity Plan that are contingent upon the Common Stock reaching a certain market price (the “Market-Based Restricted Stock Units”). The Market-Based Restricted Stock Units would have vested on December 31, 2015 if the employee was still employed as of such date and if the closing price of the Common Stock exceeded $10 per share for 20 consecutive trading days (the “Market Condition”) prior to December 31, 2015. As of December 31, 2015, the Market Conditions were not satisfied.
If the Market Condition is achieved subsequent to December 31, 2015 but prior to December 31, 2017, the Market-Based Restricted Stock Units will vest on the date the Market Condition is satisfied, provided the recipient has maintained his/her continuous employment for the required period. If the Market Condition is not satisfied by December 31, 2017, the Market-Based Restricted Stock Units will become null and void. The fair value and derived service period of the Market-Based Restricted Stock Units as of their grant date is determined using a Monte Carlo simulation, which takes into account multiple input variables that determine the probability of satisfying the Market Condition. The method requires the input of assumptions, including the future dividend yield and expected volatility of the Common Stock. Compensation expense relating to the awards that are expected to vest upon achieving the Market Condition is recognized on a straight-line basis over the derived service period regardless of whether the Market Condition is satisfied, provided that the requisite service condition has been achieved. The amount of periodic expense recognized is based upon the estimated forfeiture rate, which is updated according to actual forfeiture activity. During the year ended December 31, 2015, the Company recorded $6.0 million of expense related to the Market-Based Restricted Stock Units which is recorded in general and administrative expense in the accompanying consolidated statements of operations. There were no such expenses related to the Market-Based Restricted Stock Units for the years ended December 31, 2014 and 2013. As of December 31, 2015, there is no unrecognized compensation expense related to the Market-Based Restricted Stock Units.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Long-Term Incentive Awards
During the year ended December 31, 2015, the General Partner awarded long-term incentive-based Restricted Stock Units (the “LTI Target Awards”) to certain employees under the Equity Plan. Vesting of the LTI Target Awards is based upon the General Partner’s level of achievement of total stockholder return (“TSR”), including both share price appreciation and Common Stock dividends, as measured equally against a market index and against a peer group for the period from April 1, 2015 through December 31, 2017 (“LTI Performance Period”).
The fair value and derived service period of the LTI Target Awards as of their grant date is determined using a Monte Carlo simulation which takes into account multiple input variables that determine the probability of satisfying the required TSR, as outlined in the award agreements. This method requires the input of assumptions, including the future dividend yield, the expected volatility of the Common Stock and the expected volatility of the market index constituents and the peer group. Compensation expense relating to awards that are expected to vest based upon the General Partner’s expected TSR is recognized on a straight-line basis over the derived service period regardless of whether the necessary TSR is attained, provided that the requisite service condition has been achieved. The amount of periodic expense recognized is based upon the estimated forfeiture rate, which is updated according to actual forfeiture activity. During the year ended December 31, 2015, the Company recorded $1.9 million of expense related to the LTI Target Awards, which is recorded in general and administrative expense in the accompanying consolidated statements of operations. There were no such expenses related to the LTI Target Awards for the years ended December 31, 2014 and 2013. As of December 31, 2015, there is $5.4 million of unrecognized compensation expense related to the LTI Target Awards with a weighted-average remaining term of 1.9 years
The following table details the activity of the unvested Market-Based Restricted Stock Units and the LTI Target Awards during the year ended December 31, 2015. There was no such activity for the years ended December 31, 2014 and 2013.
Director Stock Plan
The General Partner adopted the Non-Executive Director Stock Plan (the “Director Stock Plan”), which provided for the grant of Restricted Shares of Common Stock to each of the General Partner’s non-executive directors. As of December 31, 2014, a total of 99,000 shares of Common Stock was reserved for issuance under the Director Stock Plan and the General Partner had awarded 45,000 of such shares. As of December 31, 2015, all shares awarded by the General Partner have vested and there was no activity within the Director Stock Plan during the year ended December 31, 2015. In accordance with the LPA, the Operating Partnership issued an equal number of General Partner OP Units when the General Partner awarded shares under the Director Stock Plan.
The fair value of these Restricted Shares, as well as the corresponding General Partner OP Units issued by the Operating Partnership, under the Director Stock Plan is determined based upon the closing stock price on the grant date.
Multi-Year Outperformance Plans
Upon consummation of the ARCT III Merger, the Company entered into the 2013 Advisor Multi-Year Outperformance Agreement (the “OPP”) with the Former Manager, whereby the Former Manager was able to earn compensation upon the attainment of stockholder value creation targets.
Under the OPP, the Former Manager was granted long-term incentive plan units of the OP (“LTIP Units”), which could be earned or forfeited based on the General Partner’s total return to stockholders, as defined by the OPP, for the three-year period that commenced on December 11, 2012.
Pursuant to previous authorization from the General Partner’s board of directors, as a result of the termination of the management agreement with the Former Manager, all of the approximately 8.2 million LTIP Units were deemed vested and convertible into OP Units upon the consummation of the Company’s transition to self-management on January 8, 2014 and were converted into OP Units on such date. There are no awards outstanding under the OPP and the OPP has been terminated.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
During the years ended December 31, 2014 and 2013, the Operating Partnership recorded expenses of $1.6 million and $92.3 million, respectively, for the LTIP Units under the OPP, which is recorded in general and administrative expense in the accompanying consolidated statements of operations. As of December 31, 2014, all LTIP Units under the OPP were earned and $93.9 million of the expense was allocated to the non-controlling interest on the consolidated balance sheet.
On October 3, 2013, the General Partner’s board of directors approved a multi-year outperformance plan (the “2014 OPP”), which became effective upon the General Partner’s transition to self-management on January 8, 2014. Under the 2014 OPP, individual agreements were entered into between the General Partner and the participants selected by the General Partner’s board of directors (the “Participants”) that set forth the Participant’s participation percentage in the 2014 OPP and the number of LTIP Units of the OP subject to the award (“OPP Agreements”). Under the 2014 OPP and the OPP Agreements, the Participants were eligible to earn performance-based bonus awards equal to the Participant’s participation percentage of a pool that is funded up to a maximum award opportunity of approximately 5% of the General Partner’s equity market capitalization at the time of the approval of the 2014 OPP which, following the Audit Committee’s and Company’s review, was determined to be $120.0 million, not the $218.1 million pool which had been used originally to calculate and report the awards issued to the Participants.
During the three months ended December 31, 2014, all of the Participants in the 2014 OPP departed from the Company and forfeited all of their interests in the 2014 OPP. As such, all equity-based compensation expense related to the 2014 OPP was reversed in the three months ended December 31, 2014 and no expense was recorded during the year ended December 31, 2015. During the year ended December 31, 2014, the Company recorded a total payable for distributions on LTIP units related to the OPP and 2014 OPP of $6.9 million.
The Compensation Committee of the General Partner’s board of directors (the “Compensation Committee”) elected to terminate the 2014 OPP on April 23, 2015, which had zero LTIP Units outstanding following the departures of the Participants in the fourth quarter of 2014. During the first quarter of 2015, the Compensation Committee, with input from its independent compensation consultant, elected to adopt the LTI Target Award structure described above.
Note 18 - Related Party Transactions and Arrangements
Prior to January 8, 2014, the Former Manager managed the Company’s affairs on a day-to-day basis, with the exception of certain acquisition, accounting and portfolio management services performed by employees of the Company. In August 2013, the Company’s board of directors determined that it was in the best interest of the Company and its stockholders to become self-managed, and the Company transitioned to self-management on January 8, 2014. In connection with becoming self-managed, the General Partner terminated the management agreement with the Former Manager and the General Partner and the OP entered into employment and incentive compensation arrangements with certain former executives.
In 2014, the Company, ARCT III and ARCT IV incurred commissions, fees and expenses payable to the Former Manager and its affiliates including Realty Capital Securities, LLC (“RCS”), RCS Advisory Services, LLC (“RCS Advisory”), AR Capital, LLC (“ARC”), ARC Advisory Services, LLC (“ARC Advisory”), American Realty Capital Advisors III, LLC (the “ARCT III Advisor”), American Realty Capital Advisors IV, LLC (the “ARCT IV Advisor”), American National Stock Transfer, LLC (“ANST”) and ARC Real Estate Partners, LLC (“ARC Real Estate”). As a result of the departures of certain officers and directors in December 2014, the Former Manager and its affiliates are no longer affiliated with the Company.
The Audit Committee Investigation identified certain payments made by the Company to the Former Manager and its affiliates that were not sufficiently documented or that otherwise warranted scrutiny. As of December 31, 2014, the Company had recovered consideration valued at $8.5 million in respect of 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. The Company believes it has potential claims against recipients of certain OP Units and has engaged in discussions with affiliates of the Former Manager regarding pending redemption requests. Prior to any resolution, the Company does not currently intend to satisfy any of the redemption requests. See Note 16 - Equity for further discussion. As of December 31, 2015, no asset has been recognized in the accompanying consolidated financial statements related to any potential recovery.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The following table summarizes the related party fees and expenses incurred by the Company, ARCT III and ARCT IV by category and the aggregate amounts contained in such categories for the periods presented (in thousands). During the year ended December 31, 2015, there were no material transactions with the Former Manager or any of the Former Manager’s affiliates.
The following sections below further expand on the summarized related party transactions listed above. Unless otherwise indicated, all of the related party fees and expenses discussed below were incurred and recognized during the years ended December 31, 2014 and 2013. No such expenses were incurred during the year ended December 31, 2015.
Offering Related Costs
The Company, ARCT III and ARCT IV recorded commissions, fees and offering cost reimbursements for services provided to the Company, ARCT III and ARCT IV, as applicable, by affiliates of the Former Manager during the periods indicated (in thousands):
RCS served as the dealer-manager of ARCT III’s initial public offering and ARCT IV’s initial public offering and received fees and compensation in connection with those transactions. RCS received a selling commission of 7% of gross offering proceeds before reallowance of commissions earned by participating broker-dealers and 3% of the gross proceeds from the sale of common stock, before reallowance to participating broker-dealers, as a dealer manager fee in each of the initial public offerings. In addition, the Company reimbursed RCS for services relating to the Company’s at-the-market equity program during 2014. Offering related costs are included in offering costs in the accompanying consolidated statements of changes in equity. No fees were incurred during the year ended December 31, 2015 in connection with these transactions.
Acquisition Related Expenses
During the year ended December 31, 2014, the Company paid a fee of $1.0 million (equal to 0.25% of the contract purchase price) to RCS for strategic advisory services related to the Company’s acquisition of certain properties from Fortress Investment Group LLC and $0.6 million (equal to 0.25% of the contract purchase price) to RCS related to the Company’s acquisition of certain properties from Inland American Real Estate Trust, Inc. No such fees were incurred during the year ended December 31, 2015 in connection with these transactions.
Separate from acquisition fees related to the acquisition of certain properties in the GE Capital portfolio discussed below, the Company, ARCT III and ARCT IV paid acquisition fees to the Former Manager and its affiliates equal to 1.0% of the contract purchase price, inclusive of indebtedness, of each property acquired by the Company, ARCT III or ARCT IV, as applicable. The Company, ARCT III and ARCT IV additionally reimbursed certain expenses as permitted under the advisory agreements. These fees and reimbursements (as applicable), totaled $12.3 million during the year ended December 31, 2013. The Company and ARCT III were no longer required to pay these fees as of the ARCT III Merger, except for those properties in the Company’s acquisition
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
pipeline as of that date. ARCT IV incurred these fees throughout 2013. No such fees were incurred by the Company during the years ended December 31, 2015 and 2014.
During the year ended December 31, 2013, the Company paid a fee of $1.9 million (equal to 0.25% of the contract purchase price) to RCS and reimbursed expenses of $6.1 million to ARC related to the Company’s acquisition of certain properties in the GE Capital portfolio. No such fees were incurred by the Company during the years ended December 31, 2015 and 2014.
During the year ended December 31, 2013, ARCT IV incurred and paid a fee of $3.5 million (equal to 0.25% of the contract price) to RCS and also paid an acquisition fee of $13.8 million to the Former Manager and its affiliates related to the Company’s acquisition of certain properties in the GE Capital portfolio. No such fees were incurred during the year ended December 31, 2015 in connection with these transactions.
Merger and Other Non-routine Transactions
The Company, ARCT III and ARCT IV incurred fees and expenses payable to the Former Manager and its affiliates for services related to mergers and other non-routine transactions, as discussed below.
The tables below show fees and expenses attributable to each merger and other non-routine transaction during the years ended December 31, 2014 and 2013 (in thousands). No related party transactions classified as merger and other non-routine transactions in the accompanying consolidated statements of operations were incurred during the year ended December 31, 2015.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Merger Related Costs
ARCT III Merger
The Company and ARCT III incurred and paid $0.3 million to ARC Advisory and $0.4 million to RCS Advisory for expense reimbursements in connection with the ARCT III Merger during the year ended December 31, 2013.
ARCT IV Merger
The Company entered into an agreement with RCS under which RCS agreed to provide strategic and financial advisory services to the Company in connection with the ARCT IV Merger. The Company paid $7.7 million (equal to 0.25% of the transaction value) upon the consummation of the ARCT IV Merger and reimbursed out of pocket expenses of $0.6 million pursuant to this agreement during the year ended December 31, 2013.
The Company entered into an agreement with RCS, RCS Advisory and ANST under which they agreed to provide financial advisory and information agent services in connection with the ARCT IV Merger and the related proxy solicitation seeking approval from the Company’s stockholders in connection with such merger. The agreement provided that these services included facilitation of the preparation, distribution and accumulation of proxy materials, stockholder, analyst and financial advisor communications and consultation on materials and communications made to the public and regulatory agencies regarding the ARCT IV Merger. However, effective October 6, 2013, pursuant to the first amendment to the ARCT IV Merger Agreement, a vote by the Company’s stockholders was no longer required. The Company paid $0.6 million in fees pursuant to this agreement during the year ended December 31, 2013.
ARCT IV entered into an agreement with RCS under which RCS agreed to provide strategic and financial advisory services to assist ARCT IV with its alternatives for a potential liquidity event. ARCT IV paid $7.7 million (equal to 0.25% of the transaction value) upon the consummation of the ARCT IV Merger and reimbursed out of pocket expenses of $0.8 million during the year ended December 31, 2013.
ARCT IV entered into an agreement with ARC Advisory and RCS Advisory under which they agreed to provide legal support services up to the date that ARCT IV entered into the ARCT IV Merger Agreement. ARCT IV paid $0.5 million in fees pursuant to this agreement during the year ended December 31, 2013.
ARCT IV entered into an agreement with RCS, RCS Advisory, and ANST under which they agreed to provide advisory and information agent services in connection with the ARCT IV Merger and the related proxy solicitation seeking approval of such merger by ARCT IV’s stockholders. The agreement provided that these services included facilitation of the preparation, distribution and accumulation of proxy materials, stockholder, analyst and financial advisor communications and consultation on materials and communications made to the public and regulatory agencies regarding the ARCT IV Merger. ARCT IV paid $0.8 million in fees and reimbursed $0.2 million of expenses pursuant to this agreement during the year ended December 31, 2013.
The Company and ARCT IV incurred and paid $0.5 million to RCS Advisory for expense reimbursements in connection with the ARCT IV Merger during the year ended December 31, 2013.
Pursuant to ARCT IV’s advisory agreement with the ARCT IV Advisor, ARCT IV agreed to pay the ARCT IV Advisor a brokerage commission on the sale of property in connection with the ARCT IV Merger. At the time of the ARCT IV Merger, ARCT IV paid $8.4 million to the ARCT IV Advisor in connection with this agreement. These commissions were included in merger and other non-routine transactions in the accompanying consolidated statements of operations for the year ended December 31, 2014.
Cole Merger
The Company entered into an agreement with RCS under which RCS agreed to provide strategic and financial advisory services to the Company in connection with the Cole Merger. The Company agreed to pay a fee equal to 0.25% of the transaction value upon the consummation of the transaction and reimburse out of pocket expenses. The Company incurred and recognized $14.2 million in expense from this agreement in each year ended December 31, 2014 and 2013.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Pursuant to the transaction management services agreement, dated December 9, 2013, the Company and the OP paid RCS Advisory an aggregate fee of $2.9 million on January 8, 2014, in connection with providing the following services: transaction management support related to the Cole Merger up to the date of the transaction management services agreement and ongoing transaction management support, marketing support, due diligence coordination and event coordination up to the date of the termination of the transaction management services agreement. The transaction management services agreement expired on the consummation of the Company’s transition to self-management on January 8, 2014.
CapLease Merger
The Company entered into an agreement with RCS under which RCS agreed to provide strategic and financial advisory services to the Company in connection with the CapLease Merger. The Company paid a fee equal to 0.25% of the transaction value and reimbursed out of pocket expenses. The Company incurred and paid $5.6 million in fees pursuant to this agreement during the year ended December 31, 2013. The Company incurred and paid an additional $0.2 million to ARC Advisory and $3.6 million to RCS Advisory for expense reimbursements in connection with the CapLease Merger during the year ended December 31, 2013.
Multi-tenant Spin-off
The Company entered into an agreement with RCS, under which RCS agreed to provide strategic and financial advisory services to the Company in connection with a spin-off of the Company’s multi-tenant shopping center business. During the year ended December 31, 2014, the Company incurred $1.8 million of such fees, which are included in merger and other non-routine transactions in the accompanying consolidated statements of operations.
Other Non-routine Transactions
ARCT III Merger Subordinated Distribution Fee
On February 28, 2013, the OP entered into a contribution and exchange agreement with the ARCT III OP and the ARCT III Special Limited Partner, the holder of the special limited partner interest in the ARCT III OP. The ARCT III Special Limited Partner was entitled to receive certain distributions from ARCT III OP, including a subordinated distribution of net sales proceeds resulting from an “investment liquidity event” (as defined in the agreement of limited partnership of ARCT III OP). The ARCT III Merger constituted an “investment liquidity event,” due to the attainment of the 6.0% performance hurdle and the return to ARCT III’s stockholders in addition to their initial investment. Pursuant to the contribution and exchange agreement, the ARCT III Special Limited Partner contributed its interest in the ARCT III OP, inclusive of the $98.4 million subordinated distribution proceeds received, to the ARCT III OP in exchange for 7.6 million ARCT III OP Units. Upon consummation of the ARCT III Merger, these ARCT III OP Units were immediately converted into 7.3 million OP Units after application of the ARCT III Exchange Ratio. The Company recorded an expense of $98.4 million during the year ended December 31, 2013 in connection with this transaction. In conjunction with the ARCT III Merger Agreement, the ARCT III Special Limited Partner agreed to hold its OP Units for a minimum of one year before converting them into shares of the Company’s Common Stock.
ARCT IV Merger Subordinated Distribution Fee
On January 3, 2014, the OP entered into a contribution and exchange agreement with the ARCT IV OP, American Realty Capital Trust IV Special Limited Partner, LLC (the “ARCT IV Special Limited Partner”) and ARC Real Estate.The ARCT IV Special Limited Partner was entitled to receive certain distributions from the ARCT IV OP, including the subordinated distribution of net sales proceeds resulting from an “investment liquidity event” (as defined in the agreement of limited partnership of the ARCT IV OP). The ARCT IV Merger constituted an “investment liquidity event,” due to the attainment of the 6.0% performance hurdle and the return to ARCT IV’s stockholders of $358.3 million in addition to their initial investment. Pursuant to the contribution and exchange agreement, the ARCT IV Special Limited Partner contributed its interest in the ARCT IV OP, inclusive of the $78.2 million of subordinated distribution proceeds received, to the ARCT IV OP in exchange for 2.8 million ARCT IV OP Units. Upon consummation of the ARCT IV Merger, these ARCT IV OP Units were immediately converted into 6.7 million OP Units after application of the applicable ARCT IV Exchange Ratio. In conjunction with the ARCT IV Merger Agreement, the ARCT IV Special Limited Partner agreed to hold its OP Units for a minimum of two years before converting them into shares of the Company’s Common Stock.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Furniture, Fixtures and Equipment and Other Assets
The Company entered into three agreements with affiliates of the Former Manager and the Former Manager (the “Sellers”), as applicable, pursuant to which, the Sellers sold the OP certain furniture, fixtures and equipment and other assets (“FF&E”) used by the Sellers in connection with managing the property-level business and operations and accounting functions of the Company and the OP. The Company incurred and recorded $15.8 million and $5.8 million to purchase the FF&E and other assets during the years ended December 31, 2014 and 2013, respectively. The Company has concluded that there was no evidence of the receipt and it could not support the value of the FF&E and other assets. As such, the Company expensed the amount originally capitalized and recognized the expense in merger and other non-routine transactions during the fourth quarter of 2014.
Other Fees and Expenses
In connection with the closing of the Cole Merger, the Company paid $2.9 million to RCS Advisory during the year ended December 31, 2014. No such expenses were incurred during the years ended December 31, 2015 and 2013.
Legal Fees and Expenses
On December 12, 2012, ARCT III and the OP entered into a legal services reimbursement agreement with ARC Advisory to provide legal support services through the date of the ARCT III Merger. ARCT III incurred expenses of $0.5 million in connection with this agreement in 2013. Additional expenses of $0.5 million were paid to ARC Advisory during 2013 as reimbursement for litigation services.
Personnel Costs and Other Reimbursements
The Company, ARCT III and ARCT IV incurred expenses of and paid $2.5 million to RCS Advisory and $0.2 million to ANST for personnel costs and reimbursements in connection with non-recurring transactions during the year ended December 31, 2014. No such expenses were incurred during the years ended December 31, 2015 and 2013.
Post-Transaction Support Services
ARCT III entered into an agreement with ARC Advisory under which ARC Advisory agreed to provide support services including legal, accounting, marketing, human resources and information technology, among other services, until the earlier of the ARCT III Merger closing date or one year (and an agreed upon period of up to 60 days following the ARCT III Merger). ARCT III paid $2.0 million in fees pursuant to this agreement during the year ended December 31, 2013. No such expense was incurred during the years ended December 31, 2015 and 2014 in connection with this agreement.
ARCT IV entered into an agreement with ARC Advisory and RCS Advisory under which they agreed to provide support services including legal, accounting, marketing, human resources and information technology, among other services, until the earlier of the ARCT IV Merger closing date or one year (and an agreed upon period of up to 60 days following the ARCT IV Merger). ARCT IV incurred $2.0 million in expenses pursuant to this agreement during the year ended December 31, 2013.
In connection with its entry into the ARCT IV Merger Agreement, ARCT IV agreed to pay additional asset management fees, which totaled $1.3 million, net of credits received from affiliates during the year ended December 31, 2014. No such fees were incurred during the years ended December 31, 2015 and 2014.
Effective January 8, 2014, 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, insurance and risk management, information technology, telecommunications and Internet and services relating to office supplies. The Company paid $10.0 million to the Former Manager on January 8, 2014. This arrangement was in effect for a 60-day term beginning on January 8, 2014.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Management Fees to Affiliates
The Company, ARCT III and ARCT IV recorded fees and reimbursements for services provided by the Former Manager and its affiliates related to the operations of the Company, ARCT III and ARCT IV during the years ended December 31, 2014 and 2013 (in thousands). No such fees were incurred during the year ended December 31, 2015.
Base Management Fees to the Former Manager
Prior to the termination of the management agreement, the Company paid the Former Manager an annual base management fee equal to 0.50% per annum of average unadjusted book value of the Company’s real estate assets, calculated and payable monthly in advance, for the value of assets up to $3.0 billion and 0.40% per annum for the unadjusted book value of assets over $3.0 billion. The management fee was generally payable in cash; however in lieu of cash, on January 21, 2014, the Former Manager agreed to settle all outstanding balances in stock, resulting in the Company issuing 388,461 shares of Common Stock to the Former Manager. Prior to the ARCT III Merger, the Former Manager was entitled to an annual base management fee equal to 0.50% per annum for the unadjusted book value of assets with no asset threshold limitations. The Company incurred expenses of $5.0 million that were not waived during the year ended December 31, 2013. The Former Manager waived the portion of its management fee in excess of certain net income thresholds related to the Company’s operations during certain periods in 2013. These waived fees totaled $6.1 million during the year ended December 31, 2013. No such fees were incurred or waived during the years ended December 31, 2015 and 2014.
Asset Management Fees
ARCT III
Effective July 1, 2012, as payment for asset management fees, ARCT III issued (subject to periodic approval by its board of directors) to the ARCT III Advisor performance-based restricted partnership units of the ARCT III OP designated as “ARCT III Class B units,” which were intended to be profits interests and to vest, and no longer be subject to forfeiture, at such time as: (x) the value of ARCT III OP’s assets plus all distributions that equaled or exceeded the total amount of capital contributed by investors plus a 6.0% cumulative, pre-tax, non-compounded annual return thereon (the “economic hurdle”); and (y) a liquidity event had occurred.
The ARCT III Advisor received distributions on unvested ARCT III Class B units equal to the distribution rate received on ARCT III common stock. In 2013, the ARCT III board of directors approved issuance of 603,599 ARCT III Class B units to the ARCT III Advisor for asset management services it provided. The performance condition related to these ARCT III Class B units was satisfied upon the completion of the ARCT III Merger and as a result a $9.4 million expense was recorded during the year ended December 31, 2013. The 748,621 ARCT III Class B units converted into ARCT III OP Units, which converted on a one-to-one basis, into 711,190 OP Units after the application of the ARCT III Exchange Ratio.
In connection with a 60-day extension of the advisory agreement which was executed in order to facilitate the smooth transition of advisory services following the consummation of the ARCT III Merger, the Company incurred and paid additional asset management fees of $2.3 million during 2013. No fees were incurred during the years ended December 31, 2015 and 2014.
ARCT IV
In connection with the asset management services provided by the ARCT IV Advisor, ARCT IV issued (subject to periodic approval by ARCT IV’s board of directors) to the ARCT IV Advisor performance-based restricted partnership units of the ARCT IV OP designated as “ARCT IV Class B Units,” which were intended to be profit interests and to vest, and no longer be subject to forfeiture, at such time as: (x) the value of the ARCT IV OP’s assets plus all distributions equaled or exceeded the total amount of capital contributed by investors plus a 6.0% cumulative, pre-tax, non-compounded annual return thereon (the “economic hurdle”); (y) any one of the following occurs: (1) the termination of the advisory agreement by an affirmative vote of a majority of the
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Company’s independent directors without cause; (2) a listing; or (3) another liquidity event; and (z) the ARCT IV Advisor was still providing advisory services to ARCT IV.
The calculation of the ARCT IV asset management fees was equal to: (i) 0.1875% of the cost of ARCT IV’s assets; divided by (ii) the value of one share of ARCT IV common stock as of the last day of such calendar quarter. When approved by the board of directors, the ARCT IV Class B Units were issued to the ARCT IV Advisor quarterly in arrears pursuant to the terms of the ARCT IV Operating Partnership agreement. During the year ended December 31, 2013, ARCT IV’s board of directors approved the issuance of 492,483 ARCT IV Class B Units to the ARCT IV Advisor in connection with this arrangement. As of December 31, 2013, ARCT IV did not consider achievement of the performance condition to be probable and no expense was recorded at that time. The ARCT IV Advisor received distributions on unvested ARCT IV Class B Units equal to the distribution rate received on the ARCT IV common stock. The performance condition related to the 498,857 ARCT IV Class B Units, which includes units issued for the period of January 1, 2014 through the ARCT IV Merger Date, was satisfied upon the completion of the ARCT IV Merger. These ARCT IV Class B Units immediately converted into OP Units at the 2.3961 exchange ratio and the Company recorded an expense of $13.9 million based on the fair value of the ARCT IV Class B Units during the year ended December 31, 2014. No expense was recognized during the year ended December 31, 2015.
General and Administrative Expenses
The Company, ARCT III and ARCT IV recorded general and administrative expenses as shown in the table below for services provided by the Former Manager and its affiliates related to the operations of the Company, ARCT III and ARCT IV during the periods indicated (in thousands):
Advisory Fees and Reimbursements
The Company, ARCT III and ARCT IV agreed to pay certain fees and reimbursements during the years ended December 31, 2014 and 2013 to the Former Manager and its affiliates, as applicable, for their out-of-pocket costs, including without limitation, legal fees and expenses, due diligence fees and expenses, other third party fees and expenses, costs of appraisals, travel expenses, nonrefundable option payments and deposits on properties not acquired, accounting fees and expenses, title insurance premiums and other closing costs, personnel costs and miscellaneous expenses relating to the selection, acquisition and due diligence of properties or general operation of the Company. During the years ended December 31, 2014 and 2013, these expenses totaled $2.0 million and $5.6 million, respectively. No such expenses were incurred during the year ended December 31, 2015.
Equity Awards
Upon consummation of the ARCT III Merger, the Company entered into the OPP with the Former Manager. The OPP gave the Former Manager the opportunity to earn compensation upon the attainment of certain stockholder value creation targets. The Company recorded an expense of $32.7 million for the valuation of the award through December 31, 2013 and an additional expense of $59.6 million due to the accelerated vesting of the OPP. This total expense of $92.3 million is included in general and administrative expenses in the accompanying consolidated statements of operations during the year ended December 31, 2013. Additionally, during the year ended December 31, 2014, $1.6 million was recorded in general and administrative expenses as equity-based compensation relating to the change in total return to stockholders used in computing the number of LTIP units earned between December 31, 2013 and January 8, 2014.
As a result of the ARCT III Merger, certain restricted shares held by employees of affiliates of the Former Manager were fully vested. This expense of $2.0 million is included in general and administrative expense in the accompanying consolidated statements of operations during the year ended December 31, 2013. During the year ended December 31, 2013, the Company granted 620,000 restricted share awards to employees of affiliates of the Former Manager as compensation for certain services. These were separate grants and the grant date fair values for these issuances were $4.5 million in February 2013 and $4.4 million in July 2013, respectively.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Separately, as a result of the ARCT III Merger and the termination of the management agreement with the Former Manager, certain restricted shares held by employees of affiliates of the Former Manager were fully vested. This aggregate expense of $5.3 million is included in general and administrative expense in the accompanying consolidated statements of operations for the year ended December 31, 2013.
During the year ended December 31, 2014, the Company granted 796,075 restricted share awards to employees of affiliates of the Former Manager as compensation for certain services and 87,702 restricted stock awards to two directors who were affiliates of the Former Manager. The grant date fair value of the awards of $12.5 million for the year ended December 31, 2014 was recorded in general and administrative expenses in the accompanying consolidated statements of operations. No such expenses or grants were made to employees of affiliates of the Former Manager during the year ended December 31, 2015.
Indirect Affiliate Expenses
The Company incurred fees and expenses payable to affiliates of the Former Manager or payable to a third party on behalf of affiliates of the Former Manager for amenities related to certain buildings, as explained below. These expenses are depicted in the table below for the periods indicated (in thousands):
Audrain Building
During the year ended December 31, 2013, a wholly owned subsidiary of ARC Real Estate purchased a historic building in Newport, Rhode Island (“Audrain”) with plans to renovate the second floor to serve as offices for certain executives of the Company, the Former Manager and affiliates of the Former Manager. An affiliate of the Former Manager requested that invoices relating to the second floor renovation and tenant improvements and all building operating expenses either be reimbursed by the Company to ARC Advisory or be paid directly to the contractors and vendors. During the year ended December 31, 2013, the Company paid $27,000 for architectural costs relating to the renovation directly to a third party. During the year ended December 31, 2014, the Company incurred $8.7 million for tenant improvements and furniture and fixtures relating to the renovation directly to third parties.
In addition, on October 4, 2013, the Company entered into a lease agreement with a subsidiary of ARC Real Estate for a term of 15 years with annual base rent of $0.4 million requiring monthly payments beginning on that date. As there were tenants occupying the building when it was purchased, these tenants subleased their premises from the Company until their leases terminated. During the years ended December 31, 2014 and 2013, the Company incurred and paid $0.3 million and $0.1 million, respectively, for base rent, which was partially offset by $17,000 and $55,000, respectively, of rental revenue received from the subtenants during the years ended December 31, 2014 and 2013, respectively. No rental revenue was received during the year ended December 31, 2015.
As a result of findings of the Audit Committee Investigation, the Company terminated this lease agreement and was reimbursed for the tenant improvements and furniture costs incurred by the Company, totaling $8.5 million, during the year ended December 31, 2014. Reimbursement was made by delivery and retirement of 916,423 OP Units held by an affiliate of the Former Manager. The Company never moved into or occupied the building.
American National Stock Transfer, LLC Office Build-out
During the year ended December 31, 2014, as a result of the Cole Merger, the Company worked to develop a partnership with ANST. Plans were made to move ANST to part of the Cole Capital office building in 2014. In order to accommodate the ANST employees, the Cole Capital office building was remodeled. During the year ended December 31, 2014, the Company paid $0.5 million directly to third parties for leasehold improvements and furniture and fixtures relating to the renovation.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
ANST never moved into the building. The Company is considering its options with regard to recovery of such payments, although no decisions have been made at this time. No asset has been recognized in the financial statements related to any potential recovery.
Shared Office Space
During the year ended December 31, 2014, the Company paid $1.8 million to an affiliate of the Former Manager for rent, leasehold improvements and furniture and fixtures related to offices in New York, Pennsylvania, and North Carolina where certain of the Company’s employees shared office space with an affiliate of the Former Manager. The Company no longer occupies the office space.
Additional Related Party Transactions
The following related party transactions were not included in the tables above.
Tax Protection Agreement
The Company is party to a tax protection agreement with ARC Real Estate, which contributed its 100% indirect ownership interests in 63 of the Company’s properties to the Operating Partnership in the formation transactions related to the Company’s initial public offering. Pursuant to the tax protection agreement, the Company has agreed to indemnify ARC Real Estate for its tax liabilities (plus an additional amount equal to the taxes incurred as a result of such indemnity payment) attributable to its built-in gain, as of the closing of the formation transactions, with respect to its interests in the contributed properties (other than two vacant properties contributed), if the Company sells, conveys, transfers or otherwise disposes of all or any portion of these interests in a taxable transaction on or prior to September 6, 2021. The sole and exclusive rights and remedies of ARC Real Estate under the tax protection agreement will be a claim against the Operating Partnership for ARC Real Estate’s tax liabilities as calculated in the tax protection agreement, and ARC Real Estate shall not be entitled to pursue a claim for specific performance or bring a claim against any person that acquires a protected property from the Operating Partnership in violation of the tax protection agreement.
Investment from the ARCT III Special Limited Partner
In connection with the ARCT III Merger, the ARCT III Special Limited Partner invested $0.8 million in the ARCT III OP and was subsequently issued 56,797 OP Units in respect thereof upon the closing of the ARCT III Merger after giving effect to the ARCT III Exchange Ratio. This investment is included in non-controlling interests in the accompanying consolidated balance sheets.
Investment from the ARCT IV Special Limited Partner
In connection with the ARCT IV Merger, the ARCT IV Special Limited Partner invested $0.8 million in the ARCT IV OP and was subsequently issued 79,870 OP Units in respect thereof upon the closing of the ARCT IV Merger after giving effect to the ARCT IV Exchange Ratio. This investment is included in non-controlling interests in the accompanying consolidated balance sheets.
Investment in an Affiliate of the Former Manager
During the year ended December 31, 2013, the Company invested $10.0 million in a real estate fund advised by an affiliate of the Former Manager, American Real Estate Income Fund, which invests primarily in equity securities of other publicly traded REITs, and subsequently reinvested dividends totaling $0.1 million in the fund. During the fourth quarter of 2013, the Company sold a portion of such investments with an original cost of $8.5 million at a loss of $0.4 million, resulting in a remaining investment of $1.5 million as of December 31, 2013. As of December 31, 2014, the Company sold substantially all of its investment, with a remaining investment value of less than $0.1 million. As of December 31, 2015, the Company sold all of its investments in the fund.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Cole Capital
Cole Capital is contractually responsible for managing the Managed REITs’ affairs on a day-to-day basis, identifying and making acquisitions and investments on the Managed REITs’ behalf, and recommending to the respective board of directors of each of the Managed REITs an approach for providing investors with liquidity. In addition, the Company distributes the shares of common stock for certain Managed 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. The Company receives compensation and reimbursement for services relating to the Managed REITs’ offerings and the investment, management and disposition of their respective assets, as applicable.
Offering-Related Revenue
The Company generally receives a selling commission and dealer manager or distribution fee based on the gross offering proceeds related to the sale of shares of the Managed REITs’ common stock in their primary offerings, before reallowance of commissions earned by participating broker-dealers. The Company has reallowed 100% of selling commissions earned to participating broker-dealers. The Company, in its sole discretion, may reallow all or a portion of its dealer manager fee to such participating broker-dealers as a marketing and due diligence expense reimbursement, based on factors such as the volume of shares issued by such participating broker-dealers and the amount of marketing support provided by such participating broker-dealers. No selling commissions or dealer manager fees are paid to the Company or other broker-dealers with respect to shares issued under the respective Managed REIT’s distribution reinvestment plan, under which the stockholders may elect to have distributions reinvested in additional shares.
All other organization and offering expenses associated with the sale of the Managed REITs’ common stock are paid for in advance by the Company and subject to reimbursement by the Managed REITs, up to certain limits in accordance with their respective advisory agreements and charters. As these costs are incurred, they are recorded as reimbursement revenue, up to the respective limit, and are included in offering-related revenues in the financial results for Cole Capital. Expenses paid on behalf of the Managed REITs in excess of these limits that are expected to be collected based on future estimated offering proceeds are recorded as program development costs, which are included in rent and tenant receivables and other assets, net in the accompanying consolidated balance sheets. The Company assesses the collectability of the program development costs, considering the offering period and historical and forecasted sales of shares under the Managed REITs’ respective offerings and reserves for any balances considered not collectible. Additional reserves are generally recorded if actual proceeds raised from the offerings and corresponding program development costs incurred differ from management’s assumptions. During the three months ended December 31, 2015 and 2014 the Company assessed the expected collectability of the program development costs based on assumptions used to evaluate the goodwill and intangible asset impairments and recorded additional reserves for uncollectible amounts of $11.3 million and $13.1 million, respectively, which are recorded in general and administrative expenses in the accompanying statements of operations. As of December 31, 2015 and 2014, the Company had organization and offering costs each of $12.9 million, which were net of reserves of $34.8 million and $13.1 million, respectively.
The following table shows the offering fee summary information for the Managed REITs as of December 31, 2015:
_______________________________________________
(1)
The Company reallows 100% of selling commissions earned to participating broker-dealers.
(2)
The Company may reallow all or a portion of its dealer manager fee or applicable distribution fee to participating broker-dealers as a marketing and due diligence expense reimbursement.
(3)
In connection with the INAV offering, the Company receives selling commissions, an asset-based dealer manager fee and/or an asset-based distribution fee, all based on the net asset value for each class of common stock.
(4)
CCPT IV’s offering closed April 4, 2014.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Transaction Service Revenue
The Company earns acquisition fees related to the acquisition, development or construction of properties on behalf of certain of the Managed REITs. In addition, the Company is reimbursed for acquisition expenses incurred in the process of acquiring properties up to certain limits per the respective advisory agreement. The Company is not reimbursed for personnel costs in connection with services for which it receives acquisition fees or real estate commissions. In addition, the Company may earn disposition fees related to the sale of one or more properties, including those held indirectly through joint ventures, on behalf of a Managed REIT and other affiliates.
The following table shows the transaction-related fees for the Managed REITs and other real estate programs as of December 31, 2015:
_______________________________________________
(1)
Percent taken on gross purchase price.
(2)
Performance fee paid only under the following circumstances: (i) if shares are listed on a national securities exchange; (ii) if the respective Managed REIT is sold or the assets are liquidated; or (iii) upon termination of the advisory agreement. In connection with such events, the performance fee will only be earned upon the return to investors of their net capital invested and an 8% annual cumulative, non-compounded return (6% in the case of CCPT V).
Management Service Revenue
The Company earns advisory and asset and property management fees from certain Managed REITs and other real estate programs. The Company may also be reimbursed for expenses incurred in providing advisory and asset and property management services, subject to certain limitations. In addition, the Company earns a performance fee relating to INAV for any year in which the total return on stockholders’ capital exceeds 6% per annum on a calendar year basis.
The following table shows the management fees for the Managed REITs as of December 31, 2015:
_______________________________________________
(1)
Annualized fee based on the average monthly invested assets or net asset value, if available.
(2)
Performance fee paid for any year in which the total return on stockholders’ capital exceeds 6% per annum on a calendar year basis.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The table below reflects the revenue earned from the Managed REITs (including closed programs, as applicable) and joint ventures for the years ended December 31, 2015 and 2014 (in thousands). No such revenues were earned in 2013.
___________________________________
(1)
The Company reallows 100% of selling commissions earned to participating broker-dealers.
(2)
During the years ended December 31, 2015 and 2014, the Company reallowed $2.0 million and $9.2 million, respectively, of dealer manager fees to participating broker dealers as a marketing and due diligence expense reimbursement.
(3)
The Company earned a disposition fee of $4.4 million on behalf of CCIT when it merged with Select Income REIT on January 29, 2015 and a $0.6 million disposition fee in connection with the sale of one property owned by a consolidated joint venture.
(4) Total related party revenues excludes fees earned from 1031 real estate programs of $5.3 million and $1.4 million for the years ended December 31, 2015 and 2014, respectively.
Investment in the Managed REITs
As of December 31, 2015, the Company owned aggregate equity investments of $4.1 million in the Managed REITs. The Company accounts for these investments using the equity method of accounting, which requires the investment to be initially recorded at cost and subsequently adjusted for the Company’s share of equity in the respective Managed REIT’s earnings and distributions. The Company records its proportionate share of net income from the Managed REITs in other income, net in the consolidated statements of operations. During the years ended December 31, 2015 and 2014, the Company recognized $46,000 of net income and $1.6 million of net loss, respectively, from the Managed REITs.
The table below presents certain information related to the Company’s investments in the Managed REITs as of December 31, 2015 (carrying amount in thousands):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Unconsummated Sale of Cole Capital to RCS Capital Corporation
On October 1, 2014, the Company announced that it had entered into a purchase agreement, pursuant to which RCS Capital Corporation (“RCAP”) would acquire Cole Capital for at least $700.0 million. As part of the transaction, the Company would be entitled to an earn-out of up to an additional $130.0 million based upon Cole Capital’s 2015 earnings before income taxes, depreciation and amortization. On November 3, 2014, the Company received notice from RCAP purporting to terminate the agreement. On December 4, 2014, the Company issued a press release announcing that it had entered into a settlement agreement with RCAP that resolved their dispute relating to the agreement.
The settlement included: $42.7 million in cash paid by RCAP to the Company; a $15.3 million unsecured note issued by RCAP to the Company; and a release of the Company from its obligation to pay $2.0 million to RCAP for services performed in relation to the Company’s Common Stock offering in 2014. This settlement is included in other income, net in the accompanying consolidated statements of operations. The Company and RCAP also agreed to work together to terminate, unwind or otherwise discontinue all agreements, arrangements and understandings between the two parties and any of their respective subsidiaries. See Note 8 - Loans Held for Investment for further discussion on the unsecured note and the Company’s recent inclusion of the entire amount of the note in reserve for loan loss in the accompanying consolidated statements of operations.
Due to Affiliates
Due to affiliates, as reported in the accompanying consolidated balance sheets, of $0.2 million and $0.6 million as of December 31, 2015 and 2014, respectively, related to amounts due to the Managed REITs for expense reimbursements.
Due from Affiliates
As of December 31, 2015 and 2014, $60.6 million and $86.1 million, respectively, was expected to be collected from affiliates, including balances from the Managed REITs’ lines of credit, as well as balances for services provided by the Company and expenses subject to reimbursement by the Managed REITs in accordance with their respective advisory and property management agreements. The Company had a balance of $10.6 million due from the Managed REITs as of December 31, 2015 for services provided by the Company for which we expect to be reimbursed in accordance with the Managed REITs’ respective advisory and property management agreements. The balance is included in due from affiliates in the accompanying consolidated balance sheets.
As of December 31, 2015, the Company had revolving line of credit agreements in place with CCIT II and CCPT V (the “Affiliate Lines of Credit”) that provide for maximum borrowings of $60.0 million to each of CCIT II and CCPT V. The Affiliate Lines of Credit bear interest at variable rates of one-month LIBOR plus 2.20%. The line of credit with CCPT V matures in March 2016. Subsequent to December 31, 2015, the Company extended the maturity date of the CCIT II line of credit to June 30, 2016 and reduced the maximum borrowing to $30.0 million. As of each of December 31, 2015 and 2014, there was $50.0 million outstanding on the Affiliate Lines of Credit. Additionally, the Company had a revolving line of credit agreement with INAV that matured in December 2015. There was no balance outstanding on INAV’s line of credit at the time of maturity.
Note 19 - Net Loss Per Share/Unit
The General Partner’s unvested Restricted Shares contain non-forfeitable rights to dividends and are considered to be participating securities in accordance with U.S. GAAP and, therefore, are included in the computation of earnings per share under the two-class computation method. Under the two-class computation method, net losses are not allocated to participating securities unless the holder of the security has a contractual obligation to share in the losses. The unvested Restricted Shares are not allocated losses as the awards do not have a contractual obligation to share in losses of the General Partner. The two-class computation method is an earnings allocation formula that determines earnings per share for each class of shares of Common Stock and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Net Loss Per Share
The following is a summary of the basic and diluted net loss per share computation for the General Partner for the years ended December 31, 2015, 2014 and 2013 (dollar amounts in thousands, except for share and per share data):
As of December 31, 2015, approximately 23.8 million OP Units were outstanding, which are convertible into an equal number of shares of Common Stock, and approximately 3.3 million of unvested Restricted Shares and unvested Restricted Stock Units were excluded from the calculation of diluted net loss per share as the effect would have been antidilutive.
Net Loss Per Unit
The following is a summary of the basic and diluted net loss per unit computation for the OP for the years ended December 31, 2015, 2014 and 2013 (dollar amounts in thousands, except for unit and per unit data):
As of December 31, 2015, approximately 3.3 million shares of unvested restricted units were excluded from the calculation of diluted net loss per unit as the effect would have been antidilutive.
Note 20 - Income Taxes
As a REIT, the General Partner generally is not subject to federal income tax, with the exception of its TRS entities. However, the General Partner, including its TRS entities, and the Operating Partnership are still subject to certain state and local income and franchise taxes in the various jurisdictions in which they operate.
Cole Capital Income Taxes
Based on the above, Cole Capital’s business, substantially all of which is conducted through a TRS, recognized a benefit of $39.9 million and $40.6 million for the years ended December 31, 2015 and 2014, respectively, which are included in benefit from (provision for) income taxes in the accompanying consolidated statements of operations. No benefit from or provision for income taxes was recognized for the year ended December 31, 2013 as the Company did not commence operations for Cole Capital until 2014.
REI Income Taxes
The REI segment recognized a provision for income taxes for the years ended December 31, 2015, 2014 and 2013 of $3.6 million, $7.3 million and $2.2 million, respectively, which are included in benefit from (provision for) income taxes in the accompanying consolidated statements of operations.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
The following table presents the reconciliation of the benefit from income taxes with the amount computed by applying the statutory federal income tax rate to loss before income taxes for the years ended December 31, 2015, 2014 and 2013 (in thousands):
The following table presents the components of the (benefit from) provision for income taxes for the years ended December 31, 2015, 2014 and 2013 (in thousands):
The components of the net deferred tax assets (liabilities) as of December 31, 2015 and December 31, 2014, which are included in the accompanying consolidated balance sheet, are as follows (in thousands):
The Company had no unrecognized tax benefits as of or during the years ended December 31, 2015, 2014 and 2013. Any interest and penalties related to unrecognized tax benefits would be recognized in (provision for) benefit from income taxes in the accompanying consolidated statements of operations. The Company files income tax returns in the U.S. federal jurisdiction, Canadian federal jurisdiction and various state and local jurisdictions, and is subject to routine examinations by the respective tax authorities. With few exceptions, the Company is no longer subject to federal or state examinations by tax authorities for years before 2011.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
Note 21 - Quarterly Results (Unaudited)
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2015 for VEREIT (in thousands, except share and per share amounts):
_______________________________________________
(1)
The sum of the quarterly net loss per share amounts do not agree to the full year net loss per share amounts. The Company calculates net loss per share based on the weighted-average number of outstanding shares of Common Stock during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2015 for the OP (in thousands, except share and per share amounts):
_______________________________________________
(1)
The sum of the quarterly net loss per unit amounts do not agree to the full year net loss per unit amounts. The Company calculates net loss per unit based on the weighted-average number of outstanding unit during the reporting period. The average number of units fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2014 for VEREIT (in thousands, except share and per share amounts):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015 - (Continued)
_______________________________________________
(1)
The sum of the quarterly net loss per share amounts do not agree to the full year net loss per share amounts. The Company calculates net loss per share based on the weighted-average number of outstanding shares of Common Stock during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
Presented below is a summary of the unaudited quarterly financial information for the year ended December 31, 2014 for the OP (in thousands, except share and per share amounts):
_______________________________________________
(1)
The sum of the quarterly net loss per unit amounts do not agree to the full year net loss per unit amounts. The Company calculates net loss per unit based on the weighted-average number of outstanding unit during the reporting period. The average number of units fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters.
Note 22 - Subsequent Events
The following events occurred subsequent to December 31, 2015:
Real Estate Investment Activity
From January 1, 2016 through February 23, 2016, the Company disposed of 36 properties for an aggregate gross sales price of $148.3 million and an estimated gain of $15.2 million.
Common Stock Dividend
On February 23, 2016, the Company’s board of directors declared a quarterly cash dividend of $0.1375 per share of common stock (equaling an annualized dividend rate of $0.55 per share) for the first quarter of 2016 to stockholders of record as of March 31, 2016, which will be paid on April 15, 2016. An equivalent distribution by the Operating Partnership is applicable per OP unit.
Preferred Stock Dividend
On February 23, 2016, the Company’s board of directors declared a monthly cash dividend to holders of the Series F Preferred Stock for April 2016 through June 2016 in respect to the periods included in the table below. The corresponding record and payment dates for each month's Series F Preferred Stock dividend are also shown in the table below. The dividend for the Series F Preferred Stock accrues daily on a 360-day annual basis equal to an annualized dividend rate of $1.675 per share, or $0.1395833 per 30-day month.
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2015 (in thousands)
_______________________________________________
(1)
Initial costs exclude subsequent impairment charges.
(2)
Consists of the cost of improvements and acquisition costs subsequent to acquisition, including legal fees, appraisal fees, title costs, related professional fees, condemnations, easements and impairment charges.
(3)
Intangible lease assets, net of accumulated amortization of $1.8 billion are not reflected in the table above.
(4)
The tax basis of aggregate land, buildings and improvements as of December 31, 2015 was $14.7 billion.
(5)
The accumulated depreciation column excludes $446.8 million of amortization associated with intangible lease assets.
(6)
Depreciation is computed using the straight-line method over the estimated useful lives of up to 40 years for buildings, five to 15 years for building fixtures and improvements.
The following is a reconciliation of the gross real estate activity for the years ended December 31, 2015, 2014 and 2013 (amounts in thousands):
The following is a reconciliation of the accumulated depreciation for the years ended December 31, 2015, 2014 and 2013 (amounts in thousands):
VEREIT, INC. AND VEREIT OPERATING PARTNERSHIP, L.P.
(F/K/A AMERICAN REALTY CAPITAL PROPERTIES, INC. AND ARC PROPERTIES OPERATING PARTNERSHIP, L.P.)
SCHEDULE IV - MORTGAGE LOANS HELD FOR INVESTMENT
December 31, 2015 (in thousands)
_______________________________________________
(1) Zero coupon rate with balloon payment due at maturity.