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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended September 30, 2014

OR

 

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

For the transition period from                      to                     

Commission File Number: 000-54675

 

 

CARTER VALIDUS MISSION CRITICAL REIT, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland   27-1550167

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

4890 West Kennedy Blvd., Suite 650

Tampa, FL 33609

  (813) 287-0101
(Address of Principal Executive Offices; Zip Code)   (Registrant’s Telephone Number)

 

4211 West Boy Scout Blvd., Suite 500

Tampa, Florida 33607

  N/A
(Former address, if changed since last report)   (Former name and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

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

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

As of November 10, 2014, there were approximately 173,922,000 shares of common stock of Carter Validus Mission Critical REIT, Inc. outstanding.

 

 

 


Table of Contents

CARTER VALIDUS MISSION CRITICAL REIT, INC. 

(A Maryland Corporation)

TABLE OF CONTENTS

 

     Page  
PART I.  

FINANCIAL INFORMATION (Unaudited)

     3   
Item 1.  

Condensed Consolidated Financial Statements

     3   
 

Condensed Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013

     3   
 

Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September  30, 2014 and 2013

     4   
 

Condensed Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2014

     5   
 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013

     6   
 

Notes to Condensed Consolidated Financial Statements

     7   
Item 2.  

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

     26   
Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

     37   
Item 4.  

Controls and Procedures

     37   
PART II.  

OTHER INFORMATION

     38   
Item 1.  

Legal Proceedings

     38   
Item 1A.  

Risk Factors

     38   
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

     39   
Item 3.  

Defaults Upon Senior Securities

     41   
Item 4.  

Mine Safety Disclosures

     41   
Item 5.  

Other Information

     41   
Item 6.  

Exhibits

     41   
SIGNATURES      42   

 

2


Table of Contents

PART 1. FINANCIAL STATEMENTS

Item 1. Financial Statements.

CARTER VALIDUS MISSION CRITICAL REIT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

As of September 30, 2014 and December 31, 2013

(in thousands, except share amounts)

 

     (Unaudited)        
     September 30,
2014
    December 31,
2013
 
ASSETS   

Real estate:

    

Land ($4,280 and $4,280 related to VIE)

   $ 142,374      $ 92,052   

Buildings and improvements ($95,695 and $95,529 related to VIE)

     1,588,185        791,574   

Construction in process

     54,971        —     

Acquired intangible assets ($16,189 and $16,189 related to VIE)

     223,073        121,214   
  

 

 

   

 

 

 
     2,008,603        1,004,840   

Less: accumulated depreciation and amortization ($11,689 and $8,419 related to VIE)

     (59,018     (27,619
  

 

 

   

 

 

 

Total real estate, net ($104,475 and $107,579 related to VIE)

     1,949,585        977,221   

Cash and cash equivalents ($261 and $411 related to VIE)

     75,243        7,511   

Real estate-related notes receivables, net

     20,350        54,080   

Other assets ($5,372 and $3,968 related to VIE)

     52,498        25,852   
  

 

 

   

 

 

 

Total assets

   $ 2,097,676      $ 1,064,664   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY   

Liabilities:

    

Notes payable ($53,216 and $53,746 related to VIE)

   $ 387,730      $ 201,177   

Credit facility

     75,000        152,000   

Accounts payable due to affiliates ($69 and $15 related to VIE)

     9,645        696   

Accounts payable and other liabilities ($1,773 and $1,411 related to VIE)

     31,709        15,546   

Intangible lease liabilities, less accumulated amortization of $9,638 and $6,501, respectively ($14,937 and $16,410 related to VIE)

     61,991        53,962   
  

 

 

   

 

 

 

Total liabilities

     566,075        423,381   

Stockholders’ equity:

    

Preferred stock, $0.01 par value per share, 50,000,000 shares authorized; none issued and outstanding

     —          —     

Common stock, $0.01 par value per share, 300,000,000 shares authorized; 173,807,656 and 73,238,145 shares issued, respectively; 173,411,808 and 73,137,569 shares outstanding, respectively

     1,735        731   

Additional paid-in capital

     1,542,201        641,019   

Accumulated distributions in excess of earnings

     (84,177     (33,154

Accumulated other comprehensive (loss) income

     (126     600   
  

 

 

   

 

 

 

Total stockholders’ equity

     1,459,633        609,196   

Noncontrolling interests

     71,968        32,087   
  

 

 

   

 

 

 

Total equity

     1,531,601        641,283   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,097,676      $ 1,064,664   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.

 

3


Table of Contents

CARTER VALIDUS MISSION CRITICAL REIT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the Three and Nine Months Ended September 30, 2014 and 2013

(in thousands, except shares and per share amounts)

(Unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2014     2013     2014     2013  

Revenue:

        

Rental and parking revenue

   $ 38,486      $ 13,373      $ 91,287      $ 35,622   

Tenant reimbursement revenue

     4,164        2,537        10,259        6,852   

Real estate-related notes receivables interest income

     (257     1,936        2,174        4,195   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     42,393        17,846        103,720        46,669   

Expenses:

        

Rental and parking expenses

     6,108        3,155        14,429        8,526   

General and administrative expenses

     1,411        539        3,212        1,694   

Acquisition related expenses

     4,087        1,402        10,598        4,599   

Asset management fees

     4,078        457        9,538        2,083   

Depreciation and amortization

     13,002        4,727        31,275        12,591   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     28,686        10,280        69,052        29,493   

Income from operations

     13,707        7,566        34,668        17,176   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

     5,201        3,119        13,428        9,025   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     8,506        4,447        21,240        8,151   

Net income attributable to noncontrolling interests in consolidated partnerships

     (1,152     (597     (2,437     (1,437
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to common stockholders

   $ 7,354      $ 3,850      $ 18,803      $ 6,714   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss):

        

Unrealized (loss) income on interest rate swaps

     (59     (683     (2,513     732   

Reclassification of previous unrealized loss on interest rate swaps into net income

     841        189        1,787        521   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     782        (494     (726     1,253   

Comprehensive income attributable to common stockholders

   $ 8,136      $ 3,356      $ 18,077      $ 7,967   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of common shares outstanding:

        

Basic

     172,914,286        46,757,918        133,908,958        34,925,951   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     172,931,516        46,774,585        133,928,250        34,944,118   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per common share attributable to common stockholders:

        

Basic

   $ 0.04      $ 0.08      $ 0.14      $ 0.19   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.04      $ 0.08      $ 0.14      $ 0.19   
  

 

 

   

 

 

   

 

 

   

 

 

 

Distributions declared per common share

   $ 0.18      $ 0.18      $ 0.52      $ 0.52   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.

 

4


Table of Contents

CARTER VALIDUS MISSION CRITICAL REIT, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2014

(in thousands, except for share data)

(Unaudited)

 

    

 

Common Stock

    Additional
Paid in
Capital
    Accumulated
Distributions
in Excess
of Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Stockholders’
Equity
    Noncontrolling
Interests
    Total
Equity
 
     No. of
Shares
    Par
Value
             

Balance, December 31, 2013

     73,137,569      $ 731      $ 641,019      $ (33,154   $ 600      $ 609,196      $ 32,087      $ 641,283   

Issuance of common stock

     97,015,664        970        965,239        —          —          966,209        —          966,209   

Vesting of restricted stock

     8,250        —          —          —          —          —          —          —     

Issuance of common stock under the distribution reinvestment plan

     3,545,598        36        33,648        —          —          33,684        —          33,684   

Contributions from noncontrolling interests

     —          —          —          —          —          —          39,914        39,914   

Distributions to noncontrolling interests

     —          —          —          —          —          —          (2,470     (2,470

Distributions declared to common stockholders

     —          —          —          (69,826     —          (69,826     —          (69,826

Commissions on sale of common stock and related dealer-manager fees

     —          —          (90,665     —          —          (90,665     —          (90,665

Other offering costs

     —          —          (4,273     —          —          (4,273     —          (4,273

Redemption of common stock

     (295,273     (2     (2,835     —          —          (2,837     —          (2,837

Stock-based compensation

     —          —          68        —          —          68        —          68   

Other comprehensive loss

     —          —          —          —          (726     (726     —          (726

Net income

     —          —          —          18,803        —          18,803        2,437        21,240   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, September 30, 2014

     173,411,808      $ 1,735      $ 1,542,201      $ (84,177   $ (126   $ 1,459,633      $ 71,968      $ 1,531,601   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.

 

5


Table of Contents

CARTER VALIDUS MISSION CRITICAL REIT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

For the Nine Months Ended September 30, 2014 and 2013

(in thousands)

(Unaudited)

 

     Nine Months Ended
September 30,
 
     2014     2013  

Cash flows from operating activities:

    

Consolidated net income

   $ 21,240      $ 8,151   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     31,275        12,591   

Amortization of deferred financing costs

     1,893        822   

Amortization of intangible lease assets

     145        120   

Amortization of intangible lease liabilities

     (3,147     (2,917

Amortization of origination costs and commitment fees

     1,167        (236

Straight-line rent

     (11,634     (3,631

Stock-based compensation

     68        51   

Changes in operating assets and liabilities:

    

Accounts payable and other liabilities

     4,635        3,302   

Accounts payable due to affiliates

     8,949        9   

Other assets

     (1,244     (1,784
  

 

 

   

 

 

 

Net cash provided by operating activities

     53,347        16,478   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Investment in real estate

     (952,950     (233,483

Development expenditures

     (13,074     (378

Investment in real estate-deposits

     (1,560     573   

Other deposits

     —          (167

Real estate-related notes receivables advances

     (14,644     (63,650

Collections of real estate-related notes receivables

     27,500        37,300   

Origination costs net of commitment fees related to real estate-related notes receivables

     (293     (1,141
  

 

 

   

 

 

 

Net cash used in investing activities

     (955,021     (260,946
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from notes payable

     191,466        14,000   

Payments on notes payable

     (4,913     (2,422

Proceeds from credit facility

     20,000        17,500   

Payments of credit facility

     (97,000     (18,000

Payments of deferred financing costs

     (7,047     (3,763

Repurchase of common stock

     (2,837     (273

Offering costs on issuance of common stock

     (94,938     (38,508

Distributions to stockholders

     (30,312     (8,900

Proceeds from issuance of common stock

     966,209        333,331   

Payments to escrow funds

     (12,137     (2,297

Collections of escrow funds

     3,471        2,016   

Proceeds from noncontrolling interest in consolidated partnerships

     39,914        —     

Distributions to noncontrolling interests in consolidated partnerships

     (2,470     (2,331
  

 

 

   

 

 

 

Net cash provided by financing activities

     969,406        290,353   
  

 

 

   

 

 

 

Net change in cash

     67,732        45,885   

Cash and cash equivalents - Beginning of period

     7,511        4,377   
  

 

 

   

 

 

 

Cash and cash equivalents - End of period

   $ 75,243      $ 50,262   
  

 

 

   

 

 

 

Supplemental disclosure of non-cash transactions:

    

Common stock issued through distribution reinvestment plan

   $ 33,684      $ 7,452   

Net unrealized (loss) gain on interest rate swap

   $ (726   $ 1,253   

Real estate-related notes receivables converted to investment in real estate

   $ 20,000      $ —     

Accrued contingent consideration

   $ 5,030      $ —     

Supplemental cash flow disclosure:

    

Interest paid, net of interest capitalized of $1,362

   $ 12,491      $ 8,506   

The accompanying notes are an integral part of these condensed consolidated unaudited financial statements.

 

6


Table of Contents

CARTER VALIDUS MISSION CRITICAL REIT, INC. 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2014

Note 1—Organization and Business Operations

Carter Validus Mission Critical REIT, Inc., or the Company, a Maryland corporation, was incorporated on December 16, 2009 and currently is treated and qualifies as a real estate investment trust, or a REIT, under the Internal Revenue Code of 1986, as amended, or the Code, for federal income tax purposes. The Company was organized to acquire and operate a diversified portfolio of income producing commercial real estate, with a focus on the data center and medical sectors, net leased to investment grade and other creditworthy tenants, as well as to make other real estate investments that relate to such property types. The Company operates through two reportable segments – data centers and medical facilities.

On March 23, 2010, the Company filed a registration statement on Form S-11 under the Securities Act of 1933, as amended, or the Securities Act, to offer for sale to the public on a “best efforts” basis a maximum of 150,000,000 shares of common stock at a price of $10.00 per share, and up to 25,000,000 additional shares of common stock pursuant to a distribution reinvestment plan, or DRIP, under which the Company’s stockholders may elect to have distributions reinvested in additional shares at the higher of $9.50 per share or 95% of the fair market value per share as determined by the Company’s board of directors, or the Offering, for a maximum offering of up to $1,737,500,000. The registration statement for the Offering was first declared effective by the Securities and Exchange Commission, or the SEC, on December 10, 2010.

On May 16, 2014, the Company reallocated $187,500,000 in shares of common stock from the DRIP offering to the primary offering. As a result, the Company was authorized to sell a maximum of 168,750,000 shares of common stock at a price of $10.00 per share, and up to 6,250,000 additional shares of common stock pursuant to the DRIP, for a maximum offering of up to $1,746,875,000.

On June 6, 2014, the Offering terminated. The Company raised gross proceeds of approximately $1,716,046,000 in the Offering (including shares of common stock pursuant to the DRIP).

On April 14, 2014, the Company filed a registration statement on Form S-3 under the Securities Act to register $100,000,000 in shares of common stock pursuant to the DRIP, or the Second DRIP, which will offer existing stockholders a convenient method for purchasing additional shares of common stock by reinvesting cash distributions without paying any selling commissions, fees or service charges. The registration statement became effective with the SEC automatically upon filing; however, the Company did not commence offering shares pursuant to the Second DRIP until June 7, 2014 following the termination of the Offering. As of September 30, 2014, approximately 1,180,000 shares of common stock were issued pursuant to the Second DRIP. As of September 30, 2014, approximately 9,346,000 shares of common stock were remaining in the Second DRIP.

On October 11, 2013, the Company filed with the SEC a registration statement on Form S-11 under the Securities Act with respect to a proposed follow-on offering of up to $240,000,000 of shares of common stock to be offered pursuant to a primary offering, and up to $10,000,000 of shares of common stock to be offered pursuant to the DRIP, or the Follow-On Offering. On July 11, 2014, the Company withdrew the registration statement related to the Follow-On Offering. The Company did not issue any shares in connection with the Follow-On Offering as it was not declared effective by the SEC.

Substantially all of the Company’s business is conducted through Carter/Validus Operating Partnership, LP, a Delaware limited partnership, or the Operating Partnership. The Company is the sole general partner of the Operating Partnership. Carter/Validus Advisors, LLC, or the Advisor, the Company’s affiliated advisor, is the sole limited partner of the Operating Partnership.

The Advisor acts as the Company’s advisor pursuant to an advisory agreement, as amended, or the Advisory Agreement. The Advisor is responsible for managing the Company’s affairs on a day-to-day basis, identifying and making acquisitions and investments on the Company’s behalf and making recommendations as to dispositions of assets. The Company’s board of directors exercises its fiduciary duties in reviewing these recommendations and determining whether to approve or reject proposed transactions. The Advisor also provides asset management, marketing, investor relations and other administrative services on the Company’s behalf. The Advisory Agreement has a term of one-year and is reconsidered on an annual basis by the board of directors. The Company has no employees and relies upon the Advisor to provide substantially all services.

Carter Validus Real Estate Management Services, LLC, or the Property Manager, a wholly owned subsidiary of Carter/Validus REIT Investment Management Company, LLC, the Company’s sponsor, serves as the Company’s property manager. SC Distributors, LLC, or the Dealer Manager, was organized in March 2009 and served as the dealer manager for the Offering. On August 29, 2014, Validus/Strategic Capital Partners (now Strategic Capital Management Holdings, LLC), the indirect parent of the Dealer Manager, was acquired by RCS Capital Corp. There has been no impact to the operations of the Company as a result of this transaction. The Dealer Manager received compensation and fees for services related to the Offering. The Advisor, and the Property Manager received, and will receive, fees during the acquisition and operational stages and will receive fees during the liquidation stage of the Company.

Except as the context otherwise requires, “we,” “our,” “us,” and the “Company” refer to Carter Validus Mission Critical REIT, Inc., the Operating Partnership, all majority-owned subsidiaries and controlled subsidiaries.

 

7


Table of Contents

Note 2—Summary of Significant Accounting Policies

The summary of significant accounting policies presented below is designed to assist in understanding the Company’s condensed consolidated financial statements. Such condensed consolidated financial statements and the accompanying notes thereto are the representation of management. The accompanying condensed consolidated unaudited financial statements of the Company have been prepared in accordance with the generally accepted accounting principles in the United States, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal and recurring nature considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

The condensed consolidated balance sheet at December 31, 2013 has been derived from the audited consolidated financial statements at that date but does not include all of the information and notes required by GAAP for complete financial statements. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited consolidated financial statements as of and for the year ended December 31, 2013 and related notes thereto set forth in the Company’s Annual Report on Form 10-K, filed with the SEC on March 19, 2014.

Principles of Consolidation and Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of the Company, the Operating Partnership, all majority-owned subsidiaries and controlled subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of the financial statements in conformity with GAAP necessarily 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 condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Concentration of Credit Risk and Significant Leases

As of September 30, 2014, the Company had cash on deposit, including restricted cash, in 11 financial institutions, 10 of which had deposits in excess of current federally insured levels totaling $87.3 million; however, the Company has not experienced any losses in such accounts. The Company limits its cash investments to financial institutions with high credit standing; therefore, the Company believes it is not exposed to any significant credit risk on its cash deposits. To date, the Company has experienced no loss or lack of access to cash in its accounts. Concentration of credit risk with respect to accounts receivable from tenants is limited.

As of September 30, 2014, the Company owned real estate investments in 33 metropolitan statistical areas, or MSAs, (including two real estate investments owned through consolidated partnerships), one of which accounted for 10.0% or more of rental revenue. Real estate investments located in the Dallas-Ft. Worth-Arlington, Texas area accounted for an aggregate of 18.6% of rental revenue for the nine months ended September 30, 2014.

As of September 30, 2014, the Company had one tenant that accounted for 10.0% or more of rental revenue. The leases with AT&T Services, Inc. accounted for 21.0% of rental revenue for the nine months ended September 30, 2014.

Share Repurchase Program

The Company approved a share repurchase program that allows for repurchases of shares of the Company’s common stock when certain criteria are met. The share repurchase program provides that all redemptions during any calendar year, including those upon death or a qualifying disability of a stockholder, are limited to those that can be funded with proceeds raised from the DRIP.

Repurchases of shares of the Company’s common stock are at the sole discretion of the Company’s board of directors. In addition, the Company’s board of directors, at its sole discretion, may amend, suspend, reduce, terminate or otherwise change the share repurchase program upon 30 days’ prior notice to the Company’s stockholders for any reason it determines appropriate. During the nine months ended September 30, 2014, the Company received valid redemption requests related to approximately 295,000 shares of common stock, all of which were redeemed for an aggregate purchase price of approximately $2,837,000 (an average of $9.62 per share). During the nine months ended September 30, 2013, the Company received valid redemption requests related to approximately 29,000 shares of common stock, all of which were redeemed for an aggregate purchase price of approximately $273,000 (an average of $9.41 per share).

 

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Earnings Per Share

Basic earnings per share attributable for all periods presented are computed by dividing net income attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Shares of non-vested restricted common stock give rise to potentially dilutive shares of common stock. Diluted earnings per share are computed based on the weighted average number of shares outstanding and all potentially dilutive securities. Diluted earnings per share reflect the effect of approximately 17,000 shares and 17,000 shares for the three months ended September 30, 2014 and 2013, respectively, and 19,000 shares and 18,000 shares for the nine months ended September 30, 2014 and 2013, respectively, of non-vested shares of restricted common stock that were outstanding as of such period.

Interest Capitalization

Interest incurred related to the renovation of acquired real estate investments is capitalized during the renovation period. The Company capitalized interest of approximately $831,000 and $1,362,000 for the three and nine months ended September 30, 2014, respectively, and $0 for the three and nine months ended September 30, 2013.

Recently Issued Accounting Pronouncements

In April 2014, the financial accounting standards board, or the FASB, issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, or ASU 2014-08. ASU 2014-08 changes the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the company’s operations and financial results. Examples include a disposal of a major geographic area, a major line of business, or a major equity method investment. Additionally, the new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The adoption of ASU 2014-08 is effective prospectively for reporting periods beginning on or after December 15, 2014. The Company does not expect the adoption of ASU 2014-08 to have a material effect on the Company’s condensed consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, or ASU 2014-09. The objective of ASU 2014-09 is to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and 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. ASU 2014-09 defines a five-step process to achieve this core principle, which may require more judgment and estimates within the revenue recognition process than are required under existing GAAP. The adoption of ASU 2014-09 is effective retrospectively for reporting periods beginning after December 15, 2016. Early adoption of ASU 2014-09 is not permitted. The Company is in the process of evaluating the impact ASU 2014-09 will have on the Company’s consolidated financial statements.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current financial statement presentation, with no effect on the Company’s condensed consolidated financial position or results of operations.

Note 3—Real Estate Investments

The Company reimburses the Advisor, or its affiliates, for acquisition expenses related to selecting, evaluating, acquiring and investing in properties. The reimbursement of acquisition expenses, acquisition fees and real estate commissions and other fees paid will not exceed, in the aggregate, 6.0% of the contract purchase price or total development costs of a certain acquisition, unless fees in excess of such limits are approved by a majority of the Company’s disinterested directors, including a majority of its independent directors. For the nine months ended September 30, 2014 and 2013, acquisition fees and acquisition related costs totaled $22,878,000 and $6,443,000, respectively, which did not exceed 6.0% of the purchase price of the Company’s acquisitions during such periods. Acquisition fees and expenses in connection with the acquisition of properties determined to be business combinations are expensed as incurred, including investment transactions that are no longer under consideration, and are included in acquisition related expenses in the accompanying condensed consolidated statements of comprehensive income. Acquisition fees and expenses associated with transactions determined to be an asset purchase are capitalized. The Company expensed acquisition fees and expenses of approximately $4,087,000 and $1,402,000 for the three months ended September 30, 2014 and 2013, respectively, and $10,598,000 and $4,599,000, for the nine months ended September 30, 2014 and 2013, respectively. The Company capitalized acquisition fees and expenses of approximately $7,451,000 and $1,844,000 for the three months ended September 30, 2014 and 2013, respectively, and $12,280,000 and $1,844,000 for the nine months ended September 30, 2014 and 2013, respectively.

 

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2014 Real Estate Investments

During the nine months ended September 30, 2014, the Company completed fourteen real estate acquisitions, of which eight of the real estate acquisitions were determined to be business combinations and six of the real estate acquisitions were determined to be asset acquisitions. The following table summarizes the cash paid for investments in real estate (amounts in thousands):

 

     Nine Months
Ended
September 30,
2014
 

Investments in real estate:

  

Purchase price of business combinations

   $ 469,586   

Purchase price of asset acquisitions (1)

     508,394   
  

 

 

 

Total purchase price of assets acquired

     977,980   
  

 

 

 

Non-cash transactions:

  

Real estate-related notes receivables converted to investment in real estate

     20,000   

Contingent consideration (2)

     5,030   
  

 

 

 

Cash paid for investments in real estate (3)

   $ 952,950   
  

 

 

 

 

(1) Of this amount, $53,697,000 was allocated to intangible assets.
(2) Liabilities for contingent consideration are measured at fair value each reporting period with the acquisition-date fair value included as part of the consideration transferred, and subsequent changes to fair value will be recorded within earnings. See Note 15—“Fair Value” for information about fair value measurements of contingent consideration liabilities.
(3) In connection with the acquisition of two real estate investments, the Company obtained financing of $134,000,000, with the remaining balance of the purchase price paid using cash proceeds from the Offering.

Consolidated Partnership

Bay Area Regional Medical Center

On July 11, 2014, the Company, through a majority owned consolidated subsidiary of the Operating Partnership, completed the acquisition of a medical center, or the Bay Area Regional Medical Center, located in Webster, Texas, for the purchase price of $198,000,000, plus closing costs. The acquisition of the Bay Area Regional Medical Center was funded by a $100,000,000 loan, $39,900,000 in equity investment from an unaffiliated investor in exchange for a 40% ownership interest and the Operating Partnership funded $73,847,000 in equity investment in exchange for a 60% ownership interest with net proceeds from the Offering. Upon acquisition, the Company recorded the fair value of noncontrolling interest at $39,900,000.

On July 7, 2014, the Operating Partnership entered into a limited liability agreement, or the Agreement, with the unaffiliated investor. The material terms of the Agreement provide for the following: (a) the Operating Partnership will serve as the manager of the partnership and will have exclusive and complete responsibility for the operations and management of the partnership; provided, however, that the investor has approval rights over certain major decisions; (b) the Operating Partnership, through its wholly owned subsidiary, and the investor will be entitled to a property management fee equal to 3% of their pro rata share of the net rental revenues from the property; (c) earnings are allocated to the Operating Partnership and the unaffiliated investor in proportion to their respective ownership percentage; (d) upon the request of the tenant, the Operating Partnership will contribute up to an additional $35,000,000 related to the build out of the property and upon the receipt of additional funding the ownership interest in partnership will be adjusted proportionally to each partner’s investment and (e) the investor may sell its ownership interest and the Operating Partnership has the right (but not obligation) to first purchase the investor interest at the purchase price, based on the price of percentage of ownership interest.

 

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Note 4—Acquired Intangible Assets, Net

Acquired intangible assets, net, which are included in real estate in the accompanying condensed consolidated balance sheets, consisted of the following as of September 30, 2014 and December 31, 2013 (amounts in thousands):

 

     September 30,
2014
     December 31,
2013
 

In-place leases, net of accumulated amortization of $16,816 and $7,954, respectively (with a weighted average remaining life of 15.2 years and 14.6 years, respectively)

   $ 199,796       $ 109,342   

Above-market leases, net of accumulated amortization of $439 and $294, respectively (with a weighted average remaining life of 11.6 years and 8.6 years, respectively)

     3,207         846   

Ground lease interest, net of accumulated amortization of $119 and $78, respectively (with a weighted average remaining life of 61.4 years and 62.8 years, respectively)

     2,696         2,700   
  

 

 

    

 

 

 
   $ 205,699       $ 112,888   
  

 

 

    

 

 

 

The aggregate weighted average remaining life of the acquired intangible assets was 15.8 years and 15.7 years as of September 30, 2014 and December 31, 2013, respectively.

Note 5—Other Assets

Other assets consisted of the following as of September 30, 2014 and December 31, 2013 (amounts in thousands):

 

     September 30,
2014
     December 31,
2013
 

Deferred financing costs, net of accumulated amortization of $3,643 and $1,750, respectively

   $ 11,954       $ 6,800   

Lease commissions, net of accumulated amortization of $40 and $21, respectively

     313         203   

Investments in unconsolidated partnerships

     108         116   

Accounts receivable

     2,356         1,025   

Straight-line rent receivable

     19,536         7,902   

Restricted cash held in escrow

     13,910         5,246   

Real estate escrow deposits

     250         5   

Restricted cash

     1,370         1,142   

Derivative assets

     550         644   

Accrued interest receivable from real estate-related notes receivables

     152         1,850   

Prepaid and other assets

     1,999         919   
  

 

 

    

 

 

 
   $ 52,498       $ 25,852   
  

 

 

    

 

 

 

 

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Note 6— Investment in Real Estate-Related Notes Receivables, Net

As of September 30, 2014, the Company had investments in three real estate-related notes receivables, which are loans made that the Company intends to hold to maturity. Accordingly, real estate-related notes receivables are recorded at stated principal amounts net of any discount or premium and deferred loan origination costs or fees. The related discounts or premiums are accreted or amortized over the life of the real estate-related note receivables, as applicable. The Company defers certain loan origination and commitment fees and amortizes them as an adjustment of yield over the term of the real estate-related note receivable. The related accretion of discounts and/or amortization of premiums and origination costs are recorded in interest income in the accompanying condensed consolidated statements of comprehensive income. Real estate-related notes receivables interest income for the three months ended September 30, 2014 and 2013 was $(257,000) and $1,936,000, respectively, and for the nine months ended September 30, 2014 and 2013 was $2,174,000 and $4,195,000, respectively. Real estate-related notes receivables interest income for the three months ended September 30, 2014 in the amount of $(257,000) primarily related to expenses associated with amortization of loan origination fees of $766,000 in connection with the repayment of the Bay Area Preferred Equity Loan on July 11, 2014.

As of September 30, 2014 and December 31, 2013, the aggregate balance on the Company’s investment in real estate-related notes receivables, net was $20,350,000 and $54,080,000, respectively. As of September 30, 2014, the Company had fixed rate notes receivables with interest rates ranging from 8.0% to 12.0% per annum and a weighted average interest rate of 8.6% per annum.

Real estate-related notes receivables consisted of the following as of September 30, 2014 and December 31, 2013 (amounts in thousands):

 

               Outstanding Balance as of  

Real Estate-Related Notes Receivables, Net

   Interest Rate     Maturity Date   September 30,
2014
     December 31,
2013
 

Bay Area Preferred Equity Loan (1)

     17.0 %(4)    11/30/18   $ —         $ 23,247   

Walnut Hill Property Company Loan (1),(5)

     10.0   02/28/18     —           20,327   

Medistar Loan (3)

     8.0   (2)     9,500         9,500   

MM Peachtree Holdings (1)

     12.0   12/31/21     514         514   

Landmark Loan (1),(3)

     9.0   12/17/15     10,336         492   
      

 

 

    

 

 

 
       $ 20,350       $ 54,080   
      

 

 

    

 

 

 

 

(1) Unconsolidated VIE. The maximum exposure to loss related to the Company’s variable interest in unconsolidated VIEs is limited to the outstanding balances of the respective real estate-related notes receivables. The Company may be subject to additional losses to the extent of any receivables relating to future funding.
(2) The Medistar Loan, previously known as the Walnut Hill Bridge Loan, matures upon the earlier to occur of: (i) the sale or refinancing of the property under construction for which proceeds from the loan were used and (ii) December 31, 2014.
(3) As of September 30, 2014, an affiliate of the Company had an option to purchase the respective property under construction when the construction is completed.
(4) On March 25, 2014, the Company increased the aggregate borrowing amount by $5,000,000 to $27,500,000. The additional $5,000,000 bore interest at a per annum rate equal to 10.0%. On July 11, 2014, in connection with the acquisition of the Bay Area Regional Medical Center, located in Webster, Texas, the borrower paid off the outstanding principal and accrued interest in the amount of $29,401,000 on the Bay Area Preferred Equity Loan.
(5) On February 25, 2014, in connection with the acquisition of the Walnut Hill Medical Center, located in Dallas, Texas the Company applied the Walnut Hill Property Company Loan outstanding principal amount of $20,000,000 to reduce the cash paid at acquisition.

The Company evaluates the collectability of both interest and principal on each real estate-related note receivable to determine whether it is collectible, primarily through the evaluation of the credit quality indicators, such as underlying collateral and payment history. The Company does not intend to sell its investments in real estate-related notes receivables and it is not likely that the Company will be required to sell its investments in real estate-related notes receivables before recovery of their amortized costs basis, which may be at maturity. No impairment losses were recorded related to investments in real estate-related notes receivables for the three and nine months ended September 30, 2014 and 2013. In addition, no allowances for uncollectability were recorded related to investments in real estate-related notes receivables as of September 30, 2014 and December 31, 2013.

 

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Note 7—Future Minimum Rent

The Company’s real estate assets are leased to tenants under operating leases with varying terms. The leases frequently have provisions to extend the lease agreement. The Company retains substantially all of the risks and benefits of ownership of the real estate assets leased to tenants. As of September 30, 2014, the weighted average remaining lease term was 12.5 years.

The future minimum rental income from the Company’s investments in real estate assets under non-cancelable operating leases for the three months ending December 31, 2014, and for each of the next four years ending December 31 and thereafter, are as follows (amounts in thousands):

 

Year

   Amount  

Three months ending December 31, 2014

   $ 37,552   

2015

     152,031   

2016

     154,060   

2017

     156,628   

2018

     159,735   

Thereafter

     1,744,210   
  

 

 

 
   $ 2,404,216   
  

 

 

 

Note 8—Notes Payable

During the nine months ended September 30, 2014, the Company entered into five notes payable collateralized by real estate assets in the aggregate amount of $297,316,000 as follows: on January 27, 2014, the Company originated a $20,466,000 note payable with a variable interest rate at the 30-day London interbank offered rate, or LIBOR, plus 335 basis points with a maturity date of January 26, 2019, subject to the Company’s right to two 12-month extensions; on February 25, 2014, the Company originated a $34,000,000 note payable with a variable interest rate at the 30-day LIBOR rate plus 400 basis points with a maturity date of February 25, 2019, which was fixed through an interest rate swap agreement to effectively fix the variable interest rate on the loan at 6.2% per annum; on February 26, 2014, the Company originated a $37,000,000 note payable with a variable interest rate at the 30-day LIBOR rate plus 225 basis points with a maturity date of February 26, 2019, which was fixed through an interest rate swap agreement to effectively fix the variable interest rate on the loan at 3.8% per annum. The Company has an option to draw an additional $37,000,000 under this note payable until February 26, 2015. On July 11, 2014, the Company originated a $100,000,000 note payable with a variable interest rate at the 30-day LIBOR rate plus 450 basis points for a period of eighteen months and 400 basis points after the eighteen month period with a maturity date of July 11, 2019, which $75,000,000 of the $100,000,000 was fixed through an interest rate swap agreement to effectively fix the variable interest rate on the loan at 6.3% per annum; on August 21, 2014, the Company originated a $105,850,000 note payable with a variable interest rate at the 30-day LIBOR rate plus 265 basis points with a maturity date of August 21, 2017, subject to the Company’s right to one 24-month extension. On October 1, 2014 the Company drew down $105,850,000 under this note payable.

Notes payable consisted of the following as of September 30, 2014 and December 31, 2013 (amounts in thousands):

 

     September 30,
2014
     December 31,
2013
 

Fixed rate notes payable

   $ 135,002       $ 137,049   

Variable rate notes payable

     45,009         —     

Variable rate notes payable fixed through interest rate swaps

     207,719         64,128   
  

 

 

    

 

 

 

Total notes payable

   $ 387,730       $ 201,177   
  

 

 

    

 

 

 

As of September 30, 2014, the notes payable had interest rates ranging from 3.5% to 6.3% and a weighted average interest rate of 5.1%. The notes payable mature on various dates from August 2016 through April 2022.

 

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The following is a summary of the change in carrying amounts of notes payable for the nine months ended September 30, 2014 and 2013 (amounts in thousands):

 

     Nine Months Ended
September 30,
 
     2014     2013  

Beginning balance

   $ 201,177      $ 156,847   

Additions:

    

Notes payable originations

     191,466        14,000   

Deductions:

    

Scheduled principal payments on notes payable

     (4,913     (2,422
  

 

 

   

 

 

 

Ending Balance

   $ 387,730      $ 168,425   
  

 

 

   

 

 

 

The principal payments due on the notes payable for the three months ending December 31, 2014, and for each of the next four years ending December 31 and thereafter, are as follows (amounts in thousands):

 

Year

   Principal
Payments
     Balloon
Payments
     Amount  

Three months ending December 31, 2014

   $ 2,620       $ —         $ 2,620   

2015

     10,799         —           10,799   

2016

     10,797         13,441         24,238   

2017

     10,161         74,325         84,486   

2018

     8,299         45,405         53,704   

Thereafter

     6,422         205,461         211,883   
  

 

 

    

 

 

    

 

 

 
   $ 49,098       $ 338,632       $ 387,730   
  

 

 

    

 

 

    

 

 

 

Note 9—Credit Facility

On May 28, 2014, the Operating Partnership amended certain agreements related to the Company’s credit facility, or the KeyBank Credit Facility, to include American Momentum Bank, RBS Citizens, N.A., and United Community Bank as lenders and to increase the maximum commitments available under the KeyBank Credit Facility from $225,000,000 to an aggregate of up to $365,000,000, consisting of a $290,000,000 revolving line of credit, with a maturity date of May 28, 2017, subject to the Operating Partnership’s right to a 12-month extension, and $75,000,000 in term loans, with a maturity date of May 28, 2018, subject to the Operating Partnership’s right to a 12-month extension. The new and existing lenders agreed to make the loans on an unsecured basis (previously all loans were secured by a perfected first priority lien and security interest on the mortgaged properties). The proceeds of loans made under the KeyBank Credit Facility may be used to finance the acquisition of real estate investments, capital expenditures with respect to real estate and for general corporate working capital purposes. The KeyBank Credit Facility can be increased to $500,000,000 under certain circumstances.

In connection with the amendment to the KeyBank Credit Facility, the annual interest rate payable under the KeyBank Credit Facility was decreased to, at the Operating Partnership’s option, either (a) LIBOR, plus an applicable margin ranging from 1.75% to 2.25% (the margin rate was previously set at a range from 2.25% to 3.00%), which is determined based on the overall leverage of the Operating Partnership; or (b) a base rate, which means, for any day, a fluctuating rate per annum equal to the prime rate for such day, plus an applicable margin ranging from 0.75% to 1.25% (the margin rate was previously set at a range from 1.00% to 1.75%), which is determined based on the overall leverage of the Operating Partnership. Additionally, the requirement to pay a fee on the unused portion of the lenders’ commitments under the KeyBank Credit Facility was reduced from 0.30% per annum to 0.25% per annum if the average daily amount outstanding balance under the KeyBank Credit Facility is less than 50% of the lenders’ commitments, and from 0.20% per annum to 0.15% per annum if the average daily amount outstanding under the KeyBank Credit Facility is greater than 50% of the lenders’ commitments. The unused fee is payable quarterly in arrears.

In connection with the KeyBank Credit Facility, the Operating Partnership entered into interest swap agreements with KeyBank National Association to effectively fix LIBOR on $55,000,000 out of $75,000,000 of the term loans. The weighted average rate of the fixed portion of the term loans of the KeyBank Credit Facility was 0.91%, resulting in an interest rate ranging from 2.66% to 3.16% per annum. The revolving line of credit and the term loans can be prepaid prior to maturity without penalty; provided, however, that any portion of the term loans that is prepaid may not be reborrowed, and the Operating Partnership may be subject to a breakage fee under the swap agreements, if applicable.

 

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The actual amount of credit available under the KeyBank Credit Facility is a function of certain loan-to-cost, loan-to-value, debt yield and debt service coverage ratios. The credit available to the Operating Partnership under the KeyBank Credit Facility will be a maximum principal amount of the value of the assets that are included in the unencumbered pool. During the nine months ended September 30, 2014, the Company paid down $97,000,000 under the KeyBank Credit Facility. As of September 30, 2014, the total unencumbered pool availability under the KeyBank Credit Facility was $365,000,000. As of September 30, 2014, the Company had an outstanding balance of $75,000,000 under the KeyBank Credit Facility and had an aggregate unencumbered pool availability of $290,000,000.

Note 10—Intangible Lease Liabilities, Net

Intangible lease liabilities, net consisted of the following as of September 30, 2014 and December 31, 2013 (amounts in thousands):

 

     September 30,
2014
     December 31,
2013
 

Below-market leases, net of accumulated amortization of $9,616 and $6,501, respectively (with a weighted average remaining life of 17.6 years and 18.5 years, respectively)

   $ 56,688       $ 53,962   

Ground leasehold liabilities, net of accumulated amortization of $22 and $0, respectively (with a weighted average remaining life of 44.4 years and 0 years, respectively)

     5,303         —     
  

 

 

    

 

 

 
     61,991         53,962   
  

 

 

    

 

 

 

The aggregate weighted average remaining life of intangible lease liabilities was 19.9 years and 18.5 years as of September 30, 2014 and December 31, 2013, respectively.

Note 11—Commitments and Contingencies

Litigation

In the ordinary course of business, the Company may become subject to litigation or claims. As of September 30, 2014, there were, and currently there are, no material pending legal proceedings to which the Company is a party.

Note 12—Related-Party Transactions and Arrangements

Certain affiliates of the Company received fees and compensation in connection with the Offering and will continue to receive fees during the acquisition, management and sale of the assets of the Company. The Dealer Manager received a selling commission of up to 7.0% of gross offering proceeds. In addition, the Dealer Manager received up to 2.75% of gross offering proceeds as a dealer manager fee. The Dealer Manager, in its sole discretion, re-allowed all or a portion of its dealer manager fee to participating broker-dealers as a marketing and due diligence expense reimbursement. The Company paid the Dealer Manager approximately $61,871,000 and $13,556,000 for the three months ended September 30, 2014 and 2013, respectively, and $90,665,000 and $30,904,000 for the nine months ended September 30, 2014 and 2013, respectively, for selling commissions and dealer manager fees in connection with the Offering. On June 6, 2014, the Offering terminated.

Organization and offering expenses were paid by the Advisor, or its affiliates, on behalf of the Company. The Advisor was reimbursed for actual expenses incurred up to 15.0% of the gross offering proceeds (including selling commissions and the dealer manager fee from the sale of shares of the Company’s common stock in the Offering, other than shares of common stock sold pursuant to the DRIP). For the three months ended September 30, 2014 and 2013, the Company reimbursed $144,000 and $3,068,000, respectively, and for the nine months ended September 30, 2014 and 2013, the Company reimbursed $1,135,000 and $7,604,000, respectively, in offering expenses to the Advisor, or its affiliates. Other organization expenses were expensed as incurred and offering costs are reported in the accompanying condensed consolidated statement of stockholders’ equity.

The Company pays the Advisor, or its affiliates, an acquisition and advisory fee in the amount of 2.0% of the contract purchase price of each asset or loan the Company acquires or originates. In addition, the Company reimburses the Advisor for all acquisition expenses it incurs on the Company’s behalf, but only to the extent the total amount of all acquisition fees and acquisition expenses is limited to 6.0% of the contract purchase price. For the three months ended September 30, 2014 and 2013, the Company incurred $9,379,000 and $2,615,000, respectively, and for the nine months ended September 30, 2014 and 2013, the Company incurred $18,684,000 and $4,633,000, respectively, in acquisition fees to the Advisor, or its affiliates. During the three months ended September 30, 2014 and 2013, the Company paid $136,000 and $707,000, respectively, and for the nine months ended September 30, 2014 and 2013, the Company paid $293,000 and $1,004,000, respectively, in advisory fees to the Advisor, or its affiliates, related to investments in notes receivables.

The Company incurs an annual asset management fee of 1.0% of the aggregate asset value plus costs and expenses incurred by the Advisor in providing asset management services. The fee is payable monthly in an amount equal to 0.08333% of the aggregate asset value as of the last day of the immediately preceding month. For the three months ended September 30, 2014 and 2013, the Advisor recognized $4,078,000 and $457,000, respectively, in asset management fees, net of asset management fees waived. For the nine months ended September 30, 2014 and 2013, the Advisor recognized $9,538,000 and $2,083,000, respectively, in asset management fees, net of asset management fees waived. For the three months ended September 30, 2014 and 2013, the Advisor

 

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waived irrevocably, without recourse, $0 and $682,000, respectively, in asset management fees. For the nine months ended September 30, 2014 and 2013, the Advisor waived irrevocably, without recourse, $0 and $862,000, respectively, in asset management fees. For the three and nine months ended September 30, 2014, the Advisor deferred receipt of asset management fees because the Company’s modified funds from operations did not exceed its distributions. As of September 30, 2014 the Advisor deferred receipt of asset management fees in the amount of $8,963,000.

The Company reimburses the Advisor for all expenses it paid or incurred in connection with the services provided to the Company, subject to certain limitations. The Company will not reimburse the Advisor for personnel costs in connection with services for which the Advisor receives an acquisition and advisory fee or a disposition fee. For the three months ended September 30, 2014 and 2013, the Advisor incurred $410,000 and $285,000, respectively, and for the nine months ended September 30, 2014 and 2013, the Advisor incurred $1,279,000 and $738,000, respectively, in operating expenses on the Company’s behalf. For the three months ended September 30, 2014 and 2013, the Company reimbursed $438,000 and $239,000, respectively, and for the nine months ended September 30, 2014 and 2013 the Company reimbursed $1,364,000 and $710,000, respectively, in operating expenses to the Advisor.

The Company has no direct employees. The employees of the Advisor and other affiliates provide services to the Company related to acquisition, property management, asset management, accounting, investor relations, and all other administrative services. If the Advisor, or its affiliates, provides a substantial amount of services, as determined by a majority of the Company’s independent directors, in connection with the sale of one or more properties, the Company will pay the Advisor up to one-half of the brokerage commission paid, but in no event to exceed an amount equal to 2.0% of the contract sales price of each property sold. In no event will the combined real estate commission paid to the Advisor, its affiliates and unaffiliated third parties exceed 6.0% of the contract sales price. In addition, after investors have received a return on their net capital contributions and an 8.0% cumulative non-compounded annual return, then the Advisor is entitled to receive 15.0% of the remaining net sale proceeds. As of September 30, 2014, the Company did not incur any disposition fees or any subordinated sale fees to the Advisor, or its affiliates.

Upon listing of the Company’s common stock on a national securities exchange, a listing fee equal to 15.0% of the amount by which the market value of the Company’s outstanding stock plus all distributions paid by the Company prior to listing exceeds the sum of the total amount of capital raised from investors and the amount of cash flow necessary to generate an 8.0% cumulative, non-compounded annual return to investors will be paid to the Advisor. As of September 30, 2014, the Company did not incur any listing fees.

The Company pays the Property Manager leasing and management fees in connection with the rental, leasing, operation and management of the Company’s properties. Such fees equal 3.0% of gross revenues from single-tenant properties and 4.0% of gross revenues from multi-tenant properties. The Company will reimburse the Property Manager and its affiliates for property-level expenses that any of them pay or incur on the Company’s behalf, including salaries, bonuses and benefits of persons employed by the Property Manager and its affiliates, except for the salaries, bonuses and benefits of persons who also serve as one of the Company’s executive officers. The Property Manager and its affiliates may subcontract the performance of their duties to third parties and pay all or a portion of the property management fee to the third parties with whom they contract for these services. If the Company contracts directly with third parties for such services at customary market fees, the Company will pay the Property Manager an oversight fee equal to 1.0% of the gross revenues of the property managed. In no event will the Company pay the Property Manager, the Advisor, or its affiliates, both a property management fee and an oversight fee with respect to any particular property. The Company may pay the Property Manager a separate fee for the one-time initial rent-up, lease renewals or leasing-up of newly constructed properties in an amount not to exceed the fee customarily charged in arm’s length transactions by others rendering similar services in the same geographic area for similar properties as determined by a survey of brokers and agents in such area. For the three months ended September 30, 2014 and 2013, the Company incurred $1,482,000 and $374,000, respectively, and for the nine months ended September 30, 2014 and 2013, the Company incurred $3,113,000 and $982,000, respectively, in property management fees to the Property Manager. 

Accounts Payable Due to Affiliates

The following amounts were outstanding due to affiliates as of September 30, 2014 and December 31, 2013 (amounts in thousands):

 

Entity

  

Fee

   September 30,
2014
     December 31,
2013
 

Carter/Validus Advisors, LLC and its affiliates

   Acquisition costs    $ 4       $ 1   

Carter/Validus Advisors, LLC and its affiliates

   Asset management fees      8,963         102   

Carter Validus Real Estate Management Services, LLC

   Property management fees      319         105   

Carter/Validus Advisors, LLC and its affiliates

   General and administrative costs      140         235   

Carter/Validus Advisors, LLC and its affiliates

   Offering costs      —           253   

Carter/Validus Advisors, LLC and its affiliates

   Leasing fees      219         —     
     

 

 

    

 

 

 
      $ 9,645       $ 696   
     

 

 

    

 

 

 

 

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Note 13—Business Combinations

During the nine months ended September 30, 2014, the Company completed the acquisition of 100% fee simple interest in eight real estate investments (four data centers and four medical facilities) that were determined to be business combinations, comprised of ten buildings. The aggregate purchase price of the acquisitions determined to be business combinations was $469,586,000, plus closing costs, including $5,030,000 of contingent consideration.

The following table summarizes the acquisitions determined to be business combinations during the nine months ended September 30, 2014:

 

Property Description

   Date
Acquired
     Ownership
Percentage
 

Cypress Pointe Surgical Hospital

     03/14/2014         100

Milwaukee Data Center

     03/28/2014         100

Charlotte Data Center

     04/28/2014         100

Chicago Data Center

     05/20/2014         100

Rhode Island Rehabilitation Healthcare Facility

     08/28/2014         100

Select Medical Portfolio

     08/29/2014         100

Alpharetta Data Center

     09/05/2014         100

Lafayette Surgical Hospital

     09/19/2014         100

Results of operations for the acquisitions determined to be business combinations are reflected in the accompanying condensed consolidated statements of comprehensive income for the nine months ended September 30, 2014 for the period subsequent to the acquisition date of each property. For the period from the acquisition date through September 30, 2014, the Company recognized $12,832,000 of revenues and a net loss of $5,718,000 for its business combination acquisitions. In addition, during the nine months ended September 30, 2014, the Company incurred aggregate non-recurring charges related to acquisition fees and costs of $10,277,000 in connection with acquisitions determined to be business combinations, which are included in the accompanying condensed consolidated statements of comprehensive income.

The following table summarizes management’s allocation of the fair value of the acquisitions determined to be business combinations during the nine months ended September 30, 2014 (amounts in thousands):

 

     Total  

Land

   $ 21,656   

Buildings and improvements

     409,131   

In-place leases

     45,621   

Tenant improvements

     1,803   

Above-market leases

     2,505   
  

 

 

 

Total assets acquired

     480,716   
  

 

 

 

Below-market leases

     (5,842

Ground leasehold liabilities

     (5,288
  

 

 

 

Total liabilities acquired

     (11,130
  

 

 

 

Net assets acquired

   $ 469,586   
  

 

 

 

Assuming the business combinations described above had occurred on January 1, 2013, pro forma revenues, net income and net income attributable to common stockholders would have been as follows for the three and nine month periods below (amounts in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2014      2013      2014      2013  

Pro forma basis:

           

Revenues

   $ 45,110       $ 30,803       $ 125,144       $ 90,065   

Net income

   $ 12,812       $ 10,416       $ 37,760       $ 28,479   

Net income attributable to common stockholders

   $ 11,660       $ 9,820       $ 35,323       $ 27,041   

The pro forma information for the three and nine months ended September 30, 2014 was adjusted to exclude $4,236,000 and $10,277,000, respectively, of acquisition expenses recorded during such periods. The pro forma information is presented for informational purposes only and may not be indicative of what actual results of operations would have been had the transactions occurred at the beginning of 2013, nor is it necessarily indicative of future operating results.

 

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Note 14—Segment Reporting

The Company aggregates data centers and medical facilities into two operating segments for reporting purposes. The Company’s investments in data centers and medical facilities are based on certain underwriting assumptions and operating criteria, which are different for data centers and medical facilities. Management reviews the performance and makes operating decisions based on these two reportable segments. There were no intersegment sales or transfers during the three and nine months ended September 30, 2014 and 2013.

The Company evaluates performance based on net operating income of the combined properties in each segment. Net operating income, a non-GAAP financial measure, is defined as total revenues, less rental expenses, which excludes depreciation and amortization, general and administrative expenses, acquisition related expenses, asset management fees, interest expense and interest income. The Company believes that segment net operating income serves as a useful supplement to net income because it allows investors and management to measure unlevered property-level operating results and to compare operating results to the operating results of other real estate companies and between periods on a consistent basis. Segment net operating income should not be considered as an alternative to net income determined in accordance with GAAP as an indicator of financial performance, and accordingly, the Company believes that in order to facilitate a clear understanding of the consolidated historical operating results, segment profit should be examined in conjunction with net income as presented in the accompanying condensed consolidated financial statements and data included elsewhere in this Quarterly Report on Form 10-Q.

Interest income, general and administrative expenses, acquisition related expenses, asset management fees, depreciation and amortization and interest expense are not allocated to individual segments for purposes of assessing segment performance.

Non-segment assets primarily consist of corporate assets including cash and cash equivalents, real estate and escrow deposits, deferred financing costs, real estate-related notes receivables and other assets not attributable to individual properties.

Summary information for the reportable segments during the three and nine months ended September 30, 2014 and 2013 are as follows (amounts in thousands):

 

     Data
Centers
    Medical
Facilities
    Three Months
Ended
September 30,
2014
 

Revenue:

      

Rental, parking and tenant reimbursement revenue

   $ 24,752      $ 17,898      $ 42,650   

Expenses:

      

Rental and parking expenses

     (5,123     (985     (6,108
  

 

 

   

 

 

   

 

 

 

Segment net operating income

   $ 19,629      $ 16,913        36,542   
  

 

 

   

 

 

   

 

 

 

Revenue:

      

Real estate-related notes receivables interest expense

         (257

Expenses:

      

General and administrative expenses

         (1,411

Acquisition related expenses

         (4,087

Asset management fees

         (4,078

Depreciation and amortization

         (13,002
      

 

 

 

Income from operations

         13,707   

Interest expense

         (5,201
      

 

 

 

Net income

       $ 8,506   
      

 

 

 

 

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Table of Contents
     Data
Centers
    Medical
Facilities
    Three Months
Ended
September 30,
2013
 

Revenue:

      

Rental, parking and tenant reimbursement revenue

   $ 10,042      $ 5,868      $ 15,910   

Expenses:

      

Rental and parking expenses

     (2,770     (385     (3,155
  

 

 

   

 

 

   

 

 

 

Segment net operating income

   $ 7,272      $ 5,483        12,755   
  

 

 

   

 

 

   

 

 

 

Revenue:

      

Real estate-related notes receivables interest income

         1,936   

Expenses:

      

General and administrative expenses

         (539

Acquisition related expenses

         (1,402

Asset management fees

         (457

Depreciation and amortization

         (4,727
      

 

 

 

Income from operations

         7,566   

Interest expense

         (3,119
      

 

 

 

Net income

       $ 4,447   
      

 

 

 

 

     Data
Centers
    Medical
Facilities
    Nine Months
Ended
September 30,
2014
 

Revenue:

      

Rental, parking and tenant reimbursement revenue

   $ 60,569      $ 40,977      $ 101,546   

Expenses:

      

Rental and parking expenses

     (12,104     (2,325     (14,429
  

 

 

   

 

 

   

 

 

 

Segment net operating income

   $ 48,465      $ 38,652        87,117   
  

 

 

   

 

 

   

 

 

 

Revenue:

      

Real estate-related notes receivables interest income

         2,174   

Expenses:

      

General and administrative expenses

         (3,212

Acquisition related expenses

         (10,598

Asset management fees

         (9,538

Depreciation and amortization

         (31,275
      

 

 

 

Income from operations

         34,668   

Interest expense

         (13,428
      

 

 

 

Net income

       $ 21,240   
      

 

 

 

 

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Table of Contents
     Data
Centers
    Medical
Facilities
    Nine Months
Ended
September 30,
2013
 

Revenue:

      

Rental, parking and tenant reimbursement revenue

   $ 28,079      $ 14,395      $ 42,474   

Expenses:

      

Rental and parking expenses

     (7,554     (972     (8,526
  

 

 

   

 

 

   

 

 

 

Segment net operating income

   $ 20,525      $ 13,423        33,948   
  

 

 

   

 

 

   

 

 

 

Revenue:

      

Real estate-related notes receivables interest income

         4,195   

Expenses:

      

General and administrative expenses

         (1,694

Acquisition related expenses

         (4,599

Asset management fees

         (2,083

Depreciation and amortization

         (12,591
      

 

 

 

Income from operations

         17,176   

Interest expense

         (9,025
      

 

 

 

Net income

       $ 8,151   
      

 

 

 

Assets by reportable segments as of September 30, 2014 and December 31, 2013 are as follows (amounts in thousands):

 

     September 30,
2014
     December 31,
2013
 

Assets by segment:

     

Data centers

   $ 1,080,021       $ 639,009   

Medical facilities

     931,380         358,584   

All other

     86,275         67,071   
  

 

 

    

 

 

 

Total assets

   $ 2,097,676       $ 1,064,664   
  

 

 

    

 

 

 

Capital additions by reportable segments for the nine months ended September 30, 2014 and 2013 are as follows (amounts in thousands):

 

     Nine Months Ended
September 30,
 
     2014      2013  

Capital additions by segment:

     

Data centers

   $ 438,539       $ 99,600   

Medical facilities

     527,485         134,261   

All other

     —           —     
  

 

 

    

 

 

 

Total capital additions

   $ 966,024       $ 233,861   
  

 

 

    

 

 

 

Note 15—Fair Value

Notes payable – Fixed Rate— The estimated fair value of notes payable – fixed rate measured using quoted prices and observable inputs from similar liabilities (Level 2) was approximately $136,920,000 and $139,142,000 as of September 30, 2014 and December 31, 2013, respectively, as compared to the carrying value of $135,002,000 and $137,049,000 as of September 30, 2014 and December 31, 2013, respectively.

Notes payable – Variable— The estimated fair value of notes payable – variable rate fixed through interest rate swap agreements (Level 2) was approximately $212,376,000 and $62,835,000 as of September 30, 2014 and December 31, 2013, respectively, as compared to the carrying value of $207,719,000 and $64,128,000 as of September 30 2014 and December 31, 2013, respectively. The carrying value of the notes payable – variable was $45,009,000 and $0 as of September 30, 2014 and December 31, 2013, respectively, which approximated its fair value.

 

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KeyBank Credit Facility— The carrying value of the KeyBank Credit Facility – variable was $20,000,000 and $97,000,000, which approximated its fair value, as of September 30, 2014 and December 31, 2013, respectively. The estimated fair value of the KeyBank Credit Facility – variable rate fixed through interest rate swap agreements (Level 2) was approximately $52,458,000 and $51,922,000 as of September 30, 2014 and December 31, 2013, respectively, as compared to the carrying value of $55,000,000 and $55,000,000 as of September 30, 2014 and December 31, 2013, respectively.

Real estate-related notes receivables, net— The estimated fair value of the real estate-related notes receivables, net was $20,350,000 and $58,176,000 as of September 30, 2014 and December 31, 2013, respectively, as compared to the carrying value of $20,350,000 and $54,080,000 as of September 30, 2014 and December 31, 2013, respectively. The fair value of the Company’s real estate-related notes receivables is estimated using significant unobservable inputs not based on market activity, but rather through particular valuation techniques (Level 3). The fair value was measured based on the income approach valuation methodology, which requires certain judgments to be made by management.

Contingent consideration— The Company has contingent obligations to transfer cash payments to the former owner in conjunction with a certain acquisition if specified future operational objectives are met over future reporting periods. Liabilities for contingent consideration will be measured at fair value each reporting period, with the acquisition-date fair value included as part of the consideration transferred, and subsequent changes in fair value recorded in earnings as acquisition related expenses.

The estimated fair value and the carrying value of the contingent consideration was $5,030,000 of the fair value hierarchy, as of September 30, 2014, which is reported in the accompanying condensed consolidated balance sheets in accounts payable and other liabilities. The Company uses an income approach to value the contingent consideration liability, which is determined based on the present value of probability-weighted future cash flows. The Company has classified the contingent consideration liability as Level 3 of the fair value hierarchy due to the lack of relevant observable market data over fair value inputs such as probability-weighting for payment outcomes. Increases in the assessed likelihood of a high payout under a contingent consideration arrangement contributes to increases in the fair value of the related liability. Conversely, decreases in the assessed likelihood of a higher payout under a contingent consideration arrangement contributes to decreases in the fair value of the related liability. Changes in assumptions could have an impact on the payout of contingent consideration arrangements with a maximum payout of $5,030,000 in cash and a minimum payout of $0, as of September 30, 2014.

Derivative instruments— Considerable judgment is necessary to develop estimated fair values of financial instruments. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize, or be liable for, on disposition of the financial instruments. The Company has determined that the majority of the inputs used to value its interest rate swaps fall within Level 2 of the fair value hierarchy. The credit valuation adjustment associated with these instruments utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company and the respective counterparty. However, as of September 30, 2014, 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 its interest rate swaps. As a result, the Company determined that its interest rate swaps valuation in its entirety is classified in Level 2 of the fair value hierarchy.

 

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In accordance with the fair value hierarchy described above, the following table shows the fair value of the Company’s financial assets and liabilities that are required to be measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 (amounts in thousands):

 

     September 30, 2014  
     Fair Value Hierarchy     Total Fair
Value
 
     Quoted Prices in Active
Markets for Identical
Assets (Level 1)
     Significant Other
Observable
Inputs (Level 2)
    Significant
Unobservable
Inputs (Level 3)
   

Assets:

         

Derivative assets

   $ —         $ 550      $ —        $ 550   
  

 

 

    

 

 

   

 

 

   

 

 

 

Total assets at fair value

   $ —         $ 550      $ —        $ 550   
  

 

 

    

 

 

   

 

 

   

 

 

 

Liabilities:

         

Derivative liabilities

   $ —         $ (676   $ —        $ (676

Contingent consideration obligations

     —           —          (5,030     (5,030
  

 

 

    

 

 

   

 

 

   

 

 

 

Total liabilities at fair value

   $ —         $ (676   $ (5,030   $ (5,706
  

 

 

    

 

 

   

 

 

   

 

 

 

 

     December 31, 2013  
     Fair Value Hierarchy      Total Fair
Value
 
     Quoted Prices in Active
Markets for Identical
Assets (Level 1)
     Significant Other
Observable
Inputs (Level 2)
    Significant
Unobservable
Inputs (Level 3)
    

Assets:

          

Derivative assets

   $ —         $ 644      $ —         $ 644   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total assets at fair value

   $ —         $ 644      $ —         $ 644   
  

 

 

    

 

 

   

 

 

    

 

 

 

Liabilities:

          

Derivative liabilities

   $ —         $ (44   $ —         $ (44
  

 

 

    

 

 

   

 

 

    

 

 

 

Total liabilities at fair value

   $ —         $ (44   $ —         $ (44
  

 

 

    

 

 

   

 

 

    

 

 

 

The following table provides a roll-forward of the fair value of recurring Level 3 fair value measurements for the three and nine months ended September 30, 2014 and 2013 (amounts in thousands):

 

     Three Months
Ended
September 30,
     Nine Months
Ended
September 30,
 
     2014        2013        2014        2013    

Liabilities:

           

Contingent consideration obligations:

           

Beginning balance

   $ 5,030       $ —         $ —         $ —     

Additions to contingent consideration obligations

     —           —           5,030         —     

Adjustment to contingent consideration obligations

     —           —           —           —     

Total (gains) losses included in earnings (1)

     —           —           —           —     

Settlements of contingent consideration obligations

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance

   $ 5,030       $ —         $ 5,030       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Unrealized (gains) losses still held (2)

   $ —         $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Changes in the fair value of contingent consideration obligations are reported in acquisition related expenses in the accompanying condensed consolidated statements of comprehensive income.
(2) Represents the unrealized losses or gains recorded in earnings or other comprehensive income (loss) during the period for liabilities classified as Level 3 that are still held at the end of the period.

 

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Note 16—Derivative Instruments and Hedging Activities

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 this objective, 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, and that qualify, as cash flow hedges is recorded in accumulated other comprehensive income (loss) in the accompanying condensed consolidated statement of stockholders’ equity and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the nine months ended September 30, 2014, such derivatives were used to hedge the variable cash flows associated with variable rate debt. The ineffective portion of changes in fair value of the derivatives is recognized directly in earnings. During the three and nine months ended September 30, 2014 and 2013, no gains or losses were recognized due to ineffectiveness of hedges of interest rate risk.

Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the next twelve months, the Company estimates that an additional $3,146,000 will be reclassified from accumulated other comprehensive income (loss) as an increase to interest expense.

See Note 15—“Fair Value” for a further discussion of the fair value of the Company’s derivative instruments.

The following table summarizes the notional amount and fair value of the Company’s derivative instruments (amounts in thousands):

 

Derivatives
Designated as
Hedging
Instruments
  Balance
Sheet Location
  Effective Dates   Maturity Dates   September 30, 2014     December 31, 2013  
        Outstanding
Notional
Amount
   

 

Fair Value of

    Outstanding
Notional
Amount
   

 

Fair Value of

 
          Asset     (Liability)       Asset     (Liability)  
Interest rate

swaps

  Other assets/Accounts
payable and other
liabilities
  10/12/2012 to
07/11/2014
  10/11/2017 to
07/11/2019
  $ 262,719     $ 550      $ (676   $ 119,128     $ 644      $ (44

Accounting for changes in the fair value of a derivative instrument depends on the intended use and designation of the derivative instrument. The Company designated the interest rate swaps as cash flow hedges to hedge the variability of the anticipated cash flows on its variable rate notes payable. The change in fair value of the effective portion of the derivative instrument that is designated as a hedge is recorded in other comprehensive income (loss), or OCI, in the accompanying condensed consolidated statements of comprehensive income.

The table below summarizes the amount of gain or losses recognized on interest rate derivatives designated as cash flow hedges for the three and nine months ended September 30, 2014 and 2013 (amounts in thousands):

 

     Three Months
Ended
September 30,
    Nine Months
Ended
September 30,
 

Derivatives in Cash Flow Hedging Relationships (Interest Rate Swaps)

   2014     2013     2014     2013  

Amount of (loss) income recognized in OCI on derivatives (effective portion)

   $ (59   $ (683   $ (2,513   $ 732   

Amounts reclassified from accumulated other comprehensive income (loss) (effective portion)

   $ 841      $ 189      $ 1,787      $ 521   

Credit Risk-Related Contingent Features

The Company has agreements with each of its derivative counterparties that contain cross-default provisions, whereby if the Company defaults on certain of its unsecured indebtedness, then the Company could also be declared in default on its derivative obligations, resulting in an acceleration of payment thereunder.

In addition, the Company is exposed to credit risk in the event of non-performance by its derivative counterparties. The Company believes it mitigates its credit risk by entering into agreements with credit-worthy counterparties. The Company records credit risk valuation adjustments on its interest rate swaps based on the respective credit quality of the Company and the counterparty. As of September 30, 2014, the fair value of derivatives in a net liability position, including accrued interest but excluding any adjustment for nonperformance risk related to these agreements, was $988,000. As of September 30, 2014, there were no termination events or events of default related to the interest rate swaps.

 

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Tabular Disclosure Offsetting Derivatives

The Company has elected not to offset derivative positions in its condensed consolidated financial statements. The following table presents the effect on the Company’s financial position had the Company made the election to offset its derivative positions as of September 30, 2014 and December 31, 2013 (amounts in thousands):

 

Offsetting of Derivative Assets

 
     Gross Amounts
of Recognized
Assets
     Gross Amounts
Offset in the
Balance Sheet
     Net Amounts of
Assets Presented in
the Balance Sheet
     Gross Amounts Not Offset in the Balance Sheet      Net
Amount
 
              Financial Instruments
Collateral
     Cash Collateral     

September 30, 2014

   $ 550       $ —         $ 550       $ —         $ —         $ 550   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2013

   $ 644       $ —         $ 644       $ —         $ —         $ 644   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Offsetting of Derivative Liabilities

 
     Gross Amounts
of Recognized
Liabilities
     Gross Amounts
Offset in the
Balance Sheet
     Net Amounts of
Liabilities Presented
in the Balance Sheet
     Gross Amounts Not Offset in the Balance Sheet      Net
Amount
 
              Financial Instruments
Collateral
     Cash Collateral     

September 30, 2014

   $ 676       $ —         $ 676       $ —         $ —         $ 676   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2013

   $ 44       $ —         $ 44       $ —         $ —         $ 44   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company reports derivatives in the accompanying condensed consolidated balance sheets as other assets and accounts payable and other liabilities.

Note 17—Accumulated Other Comprehensive Income (Loss)

The following table presents a roll forward of amounts recognized in accumulated other comprehensive income (loss) by component for the nine months ended September 30, 2014 (amounts in thousands):

 

     Unrealized
Loss on
Derivative
Instruments
    Accumulated
Other
Comprehensive
Income (Loss)
 

Balance as of December 31, 2013

   $ 600      $ 600   

Other comprehensive loss before reclassification

     (2,513     (2,513

Amounts reclassified from accumulated other comprehensive income (loss) to net income (effective portion)

     1,787        1,787   
  

 

 

   

 

 

 

Other comprehensive loss

     (726     (726
  

 

 

   

 

 

 

Balance as of September 30, 2014

   $ (126   $ (126
  

 

 

   

 

 

 

The following table presents reclassifications out of accumulated other comprehensive income (loss) for the nine months ended September 30, 2014 (amounts in thousands):

 

Details about Accumulated Other
Comprehensive Income (Loss)
Components

   Amounts Reclassified from
Accumulated Other Comprehensive
Income (Loss) to Net Income
     Affected Line Items in the Condensed
Consolidated Statements of
Comprehensive Income

Interest rate swap contracts

   $ 1,787       Interest expense
  

 

 

    

 

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Note 18—Subsequent Events

Distributions Paid

On October 1, 2014, the Company paid aggregate distributions of $9,980,000 ($4,504,000 in cash and $5,476,000 in shares of the Company’s common stock pursuant to the DRIP), which related to distributions declared for each day in the period from September 1, 2014 through September 30, 2014. On November 3, 2014, the Company paid aggregate distributions of $10,343,000 ($4,663,000 in cash and $5,680,000 in shares of the Company’s common stock pursuant to the DRIP), which related to distributions declared for each day in the period from October 1, 2014 through October 31, 2014.

Chicago Data Center Loan

In connection with a loan originated on August 25, 2014, on October 1, 2014 the Company drew down $105,850,000 under this note payable.

Acquisition of Alpharetta Data Center II

On October 31, 2014, the Company completed the acquisition of a 100% fee simple interest in a data center, or the Alpharetta Data Center II, for a purchase price of $56,700,000, plus closing costs. The Company financed the purchase of the Alpharetta Data Center II using net proceeds from the Offering. The Alpharetta Data Center II is leased to a single tenant. With respect to this acquisition, the Company had not completed its initial fair value-based purchase allocation; it is therefore impractical to provide pro-forma information.

Distributions Declared

On November 6, 2014, the board of directors of the Company approved and declared a distribution to the Company’s stockholders of record as of the close of business on each day of the period commencing on December 1, 2014 and ending on February 28, 2015. The distributions will be calculated based on 365 days in the calendar year and equal to $0.001917808 per share of common stock, which will be equal to an annualized distribution rate of 7.0%, assuming a purchase price of $10.00 per share. The distributions declared for each record date in the December 2014, January 2015 and February 2015 periods will be paid in January 2015, February 2015 and March 2015, respectively. The distributions will be payable to stockholders from legally available funds therefor.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements, the notes thereto, and the other unaudited financial data included elsewhere in this Quarterly Report on Form 10-Q. The following discussion should also be read in conjunction with our audited consolidated financial statements, and the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the Securities and Exchange Commission, or the SEC, on March 19, 2014, or the 2013 Annual Report on Form 10-K.

The terms “we,” “our,” “us,” and the “Company” refer to Carter Validus Mission Critical REIT, Inc., Carter/Validus Operating Partnership, LP, all majority-owned subsidiaries and controlled subsidiaries.

Forward-Looking Statements

Certain statements contained in this Quarterly Report on Form 10-Q, other than historical facts, include forward-looking statements that reflect our expectations and projections about our future results, performance, prospects and opportunities. Such statements include, in particular, statements about our plans, strategies, and prospects and are subject to certain risks and uncertainties, as well as known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as “may,” “will,” “would,” “could,” “should,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our management’s view only as of the date this Quarterly Report on Form 10-Q is filed with the Securities and Exchange Commission, or the SEC. We make no representation or warranty (express or implied) about the accuracy of any such forward-looking statements contained in this Quarterly Report on Form 10-Q, and we do not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. See Item 1A. “Risk Factors” of our 2013 Annual Report on Form 10-K for a discussion of some, although not all, of the risks and uncertainties that could cause actual results to differ materially from those presented in our forward-looking statements.

Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with the generally accepted accounting principles in the United States, or GAAP. The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates. These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

Overview

We were formed on December 16, 2009 under the laws of Maryland to acquire and operate a diversified portfolio of income producing commercial real estate. We may also invest in real estate related securities. We are a real estate investment trust, or a REIT, under the Internal Revenue Code of 1986, as amended, or the Code, for federal income tax purposes.

On March 23, 2010, we filed a registration statement on Form S-11 under the Securities Act of 1933, as amended, or the Securities Act, to conduct a best efforts initial public offering, or the Offering, in which we were offering to the public up to 150,000,000 shares of common stock at a price of $10.00 per share in our primary offering and up to 25,000,000 additional shares pursuant to a distribution reinvestment plan, or DRIP, under which our stockholders may elect to have distributions reinvested in additional shares at the higher of $9.50 per share or 95% of the of the fair market value per share as determined by our board of directors, for a maximum offering of up to $1,737,500,000. The SEC first declared our registration statement effective as of December 10, 2010.

On May 16, 2014, we reallocated 18,750,000 shares of common stock from the DRIP offering to the primary portion of the Offering. As a result of this reallocation, we were authorized to sell a maximum of 168,750,000 shares of common stock at a price of $10.00 per share, and up to 6,250,000 additional shares of common stock pursuant to the DRIP, under which our stockholders may elect to have distributions reinvested in additional shares at the higher of $9.50 per share or 95% of the of the fair market value per share as determined by our board of directors, for a maximum offering of up to $1,746,875,000.

On June 6, 2014, the Offering terminated. We raised $1,716,046,000 in gross proceeds from the Offering (including proceeds from the DRIP) before offering expenses, selling commissions and dealer manager fees.

On October 11, 2013, we filed with the SEC a registration statement on Form S-11 under the Securities Act with respect to a proposed follow-on offering of up to $240,000,000 of shares of common stock to be offered pursuant to a primary offering, and up to $10,000,000 of shares of common stock to be offered pursuant to the DRIP, or the Follow-On Offering. On July 11, 2014, we withdrew the registration statement related to the Follow-On Offering. We did not issue any shares in connection with the Follow-On Offering as it was not declared effective by the SEC.

 

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On April 14, 2014, we filed a registration statement on Form S-3 under the Securities Act to register $100,000,000 in shares of common stock pursuant to the Second DRIP, which will offer existing stockholders a convenient method for purchasing additional shares of common stock by reinvesting cash distributions without paying any selling commissions, fees or service charges. The registration statement became effective with the SEC automatically upon filing; however, we did not commence offering shares pursuant to the Second DRIP until June 7, 2014 following the termination of the Offering. As of September 30, 2014, approximately 1,180,000 shares of common stock were issued pursuant to the Second DRIP. As of September 30, 2014, approximately 9,346,000 shares of common stock were remaining in the Second DRIP.

Substantially all of our operations are conducted through Carter/Validus Operating Partnership, LP, or our Operating Partnership. We are externally advised by Carter/Validus Advisors, LLC or our Advisor, pursuant to an advisory agreement, or the Advisory Agreement, between us and our Advisor, which is our affiliate. Our Advisor supervises and manages our day-to-day operations and selects the properties and real estate-related investments we acquire, subject to the oversight and approval of our board of directors. Our Advisor also provides marketing, sales and client services on our behalf. Our Advisor engages affiliated entities to provide various services to us. Our Advisor is managed by and is a subsidiary of our sponsor, Carter/Validus REIT Investment Management Company, LLC. We have no paid employees.

We currently operate through two reportable segments – data centers and medical facilities. As of September 30, 2014, we had completed acquisitions of 45 real estate investments (including two real estate investments owned through consolidated partnerships) comprised of 67 buildings and parking facilities and approximately 5,544,000 square feet of gross leasable area (excluding parking facilities), for an aggregate purchase price of $1,921,052,000. As of September 30, 2014, we had also invested in real estate-related notes receivables in the aggregate principal amount outstanding of $20,274,000.

Critical Accounting Policies

Our critical accounting policies were disclosed in our 2013 Annual Report on Form 10-K. There have been no material changes to our critical accounting policies as disclosed therein.

Interim Unaudited Financial Data

Our accompanying condensed consolidated financial statements have been prepared by us in accordance with GAAP in conjunction with the rules and regulations of the SEC. Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, our accompanying condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. Our accompanying condensed consolidated financial statements reflect all adjustments, which are, in our view, of a normal recurring nature and necessary for a fair presentation of our financial position, results of operations and cash flows for the interim period. Interim results of operations are not necessarily indicative of the results to be expected for the full year; such full year results may be less favorable. Our accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our 2013 Annual Report on Form 10-K.

Qualification as a REIT

To maintain our qualification as a REIT, we must meet certain organizational and operational requirements, including a requirement to currently distribute at least 90.0% of our REIT taxable income to stockholders. As a REIT, we generally are not subject to federal income tax on taxable income that we distribute to our stockholders.

If we fail to maintain our qualification as a REIT in any taxable year, we will then be subject to federal income taxes on our taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year during which qualification is lost unless the Internal Revenue Service grants us relief under certain statutory provisions. Such an event could have a material adverse effect on our net income and net cash available for distribution to our stockholders.

Recently Issued Accounting Pronouncements

For a discussion of recently issued accounting pronouncements, see Note 2—“Summary of Significant Accounting Policies—Recently Issued Accounting Pronouncements” to our condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q.

Segment Reporting

The Company reports its financial performance based on two reporting segments. See Note 14—“Segment Reporting” to the condensed consolidated financial statements for additional information on the Company’s two reporting segments.

 

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Results of Operations

Our results of operations are influenced by the timing of acquisitions, the operating performance of our real estate investments and our investments in real estate-related notes receivables. As of September 30, 2014, we owned 45 real estate investments, 43 of which were placed in operations. As of September 30, 2013, we owned 27 real estate investments, all of which were placed in operations. In addition, we had investments in real estate-related notes receivables, net of $20,350,000 and $54,080,000, respectively, as of September 30, 2014 and December 31, 2013.

Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013

Revenue. Revenue increased $24,547,000 to $42,393,000 for the three months ended September 30, 2014, as compared to $17,846,000 for the three months ended September 30, 2013. Revenue consisted of rental and parking revenue, tenant reimbursement revenue and real estate-related notes receivables interest income. Rental and parking revenue increased $25,113,000 to $38,486,000 for the three months ended September 30, 2014, as compared to $13,373,000 for the three months ended September 30, 2013, and tenant reimbursement revenue increased $1,627,000 to $4,164,000 for the three months ended September 30, 2014, as compared to $2,537,000 for the three months ended September 30, 2013. The increase in rental and parking revenue and tenant reimbursement revenue was primarily due to owning 43 operating real estate investments with leases in-place as of September 30, 2014 as compared to 27 operating real estate investments with leases in-place as of September 30, 2013. Real estate-related notes receivables interest income decreased $2,193,000 to $(257,000) for the three months ended September 30, 2014, as compared to $1,936,000 for the three months ended September 30, 2013. The decrease was primarily due to a decrease in real estate-related notes receivables income of $1,411,000 and loan commitment fees of $45,000 and an increase in loan origination fees of $737,000, which primarily related to expenses associated with amortization of loan origination fees in connection with the repayment of the Bay Area Preferred Equity Loan on July 11, 2014.

Rental and Parking Expenses. Rental and parking expenses increased $2,953,000 to $6,108,000 for the three months ended September 30, 2014, as compared to $3,155,000 for the three months ended September 30, 2013. The increase was primarily due to owning 43 operating real estate investments with leases in-place as of September 30, 2014, as compared to 27 operating real estate investments with leases in-place as of September 30, 2013, which resulted in increased utility costs of $1,012,000, increased property management fees of $1,108,000, increased administrative costs of $329,000, increased real estate taxes of $262,000 and increased other rental and parking expenses of $242,000.

General and Administrative Expenses. General and administrative expenses increased $872,000 to $1,411,000 for the three months ended September 30, 2014, as compared to $539,000 for the three months ended September 30, 2013. The increase was primarily due to an increase in allocated personnel costs and allocated overhead costs, which resulted in increased personnel costs and professional fees of $202,000, increased other administrative expenses of $592,000 and increased state taxes of $78,000.

Acquisition Related Expenses. Acquisition related expenses increased $2,685,000 to $4,087,000 for the three months ended September 30, 2014, as compared to $1,402,000 for the three months ended September 30, 2013. The increase primarily related to acquisition fees and expenses associated with the purchase of four real estate investments for an aggregate purchase price of $181,756,000 acquired during the three months ended September 30, 2014, which were determined to be business combinations. Acquisition fees and expenses associated with transactions determined to be business combinations are expensed as incurred. For the three months ended September 30, 2013, acquisition fees and expenses related to the acquisitions of four real estate investments for an aggregate purchase price of $46,702,000 that were determined to be business combinations. Pursuant to the advisory agreement, we pay an acquisition fee to our Advisor of 2.0% of the contract purchase price of each property or asset acquired. We also reimburse our Advisor for acquisition expenses incurred in the process of acquiring a property or in the origination or acquisition of a loan other than for personnel costs for which our Advisor receives acquisition fees.

Asset Management Fees. Asset management fees increased $3,621,000 to $4,078,000 for the three months ended September 30, 2014, as compared to $457,000 for the three months ended September 30, 2013. The increase in asset management fees related to an increase in the weighted average real estate-related investments of $943,258,000 as of September 30, 2014, compared to $346,228,000 as of September 30, 2013. For the three months ended September 30, 2014 and 2013, the Advisor waived irrevocably, without recourse, asset management fees of $0 and $682,000, respectively. For the three months ended September 30, 2014, the Advisor deferred receipt of $4,094,000 in asset management fees because the Company’s modified funds from operations did not exceed its distributions.

Depreciation and Amortization. Depreciation and amortization increased $8,275,000 to $13,002,000 for the three months ended September 30, 2014, as compared to $4,727,000 for the three months ended September 30, 2013. The increase was primarily due to an increase in the weighted average depreciable basis of real estate properties of $1,056,048,000 as of September 30, 2014, compared to $388,444,000 as of September 30, 2013.

Interest Expense. Interest expense increased $2,082,000 to $5,201,000 for the three months ended September 30, 2014, as compared to $3,119,000 for the three months ended September 30, 2013. The increase was due to increased interest expense on notes payable and the KeyBank Credit Facility (as defined below) of $2,732,000, and increased amortization expense of debt issue costs of $432,000, offset by increased interest income earned on deposits at banks in the amount of $251,000 and capitalized interest of $831,000. The increase in interest expense on notes payable and the KeyBank Credit Facility of $2,732,000 was due to having an

 

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outstanding balance on notes payable in the amount of $387,730,000 and an outstanding balance on the KeyBank Credit Facility of $75,000,000 as of September 30, 2014, as compared to an outstanding balance on notes payable in the amount of $168,425,000 and an outstanding balance on the KeyBank Credit Facility of $55,000,000 as of September 30, 2013. As of September 30, 2014 and 2013, the weighted average interest rate on notes payable and the KeyBank Credit Facility was 4.7%.

Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013

Revenue. Revenue increased $57,051,000 to $103,720,000 for the nine months ended September 30, 2014, as compared to $46,669,000 for the nine months ended September 30, 2013. Revenue consisted of rental and parking revenue, tenant reimbursement revenue and real estate-related notes receivables interest income. Rental and parking revenue increased $55,665,000 to $91,287,000 for the nine months ended September 30, 2014, as compared to $35,622,000 for the nine months ended September 30, 2013, and tenant reimbursement revenue increased $3,407,000 to $10,259,000 for the nine months ended September 30, 2014, as compared to $6,852,000 for the nine months ended September 30, 2013. The increase in rental and parking revenue and tenant reimbursement revenue was primarily due to owning 43 operating real estate investments with leases in-place as of September 30, 2014, as compared to 27 operating real estate investments with leases in-place as of September 30, 2013. Real estate-related notes receivables interest income decreased $2,021,000 to $2,174,000 for the nine months ended September 30, 2014, compared to $4,195,000 for the nine months ended September 30, 2013. The decrease was primarily due to a decrease in real estate-related notes receivables income of $618,000 and loan commitment fees of $689,000 and an increase in origination fees of $714,000, which primarily related to expenses associated with amortization of loan origination fees in connection with the repayment of the Bay Area Preferred Equity Loan on July 11, 2014.

Rental and Parking Expenses. Rental and parking expenses increased $5,903,000 to $14,429,000 for the nine months ended September 30, 2014, as compared to $8,526,000 for the nine months ended September 30, 2013. The increase was primarily due to owning 43 operating real estate investments with leases in-place as of September 30, 2014, as compared to 27 operating real estate investments with leases in-place as of September 30, 2013, which resulted in increased utility costs of $2,098,000, increased real estate taxes of $403,000, increased property management fees of $2,131,000, increased administrative costs of $896,000 and increased other rental and parking expenses of $375,000 for such period.

General and Administrative Expenses. General and administrative expenses increased $1,518,000 to $3,212,000 for the nine months ended September 30, 2014, as compared to $1,694,000 for the nine months ended September 30, 2013. The increase was primarily due to an increase in allocated personnel costs and allocated overhead costs, which resulted in increased personnel costs and professional fees of $633,000, increased state taxes of $135,000 and increased other administrative expenses of $750,000.

Acquisition Related Expenses. Acquisition related expenses increased $5,999,000 to $10,598,000 for the nine months ended September 30, 2014, as compared to $4,599,000 for the nine months ended September 30, 2013. The increase primarily related to acquisition fees and expenses associated with the purchase of eight real estate investments for an aggregate purchase price of $469,586,000 acquired during the nine months ended September 30, 2014, which were determined to be business combinations. Acquisition fees and expenses associated with transactions determined to be business combinations are expensed as incurred. For the nine months ended September 30, 2013, acquisition fees and expenses related to the acquisitions of eleven real estate investments for an aggregate purchase price of $147,602,000 that were determined to be business combinations. Pursuant to the advisory agreement, we pay an acquisition fee to our Advisor of 2.0% of the contract purchase price of each property or asset acquired. We also reimburse our Advisor for acquisition expenses incurred in the process of acquiring a property or in the origination or acquisition of a loan other than for personnel costs for which our Advisor receives acquisition fees.

Asset Management Fees. Asset management fees increased $7,455,000 to $9,538,000 for the nine months ended September 30, 2014, as compared to $2,083,000 for the nine months ended September 30, 2013. The increase in asset management fees related to an increase in the weighted average real estate-related investments of $943,258,000 as of September 30, 2014, compared to $346,228,000 as of September 30, 2013. For the nine months ended September 30, 2014 and 2013, the Advisor waived irrevocably, without recourse, asset management fees of $0 and $862,000, respectively. For the nine months ended September 30, 2014, the Advisor deferred receipt of $8,963,000 in asset management fees because the Company’s modified funds from operations did not exceed its distributions.

Depreciation and Amortization. Depreciation and amortization increased $18,684,000 to $31,275,000 for the nine months ended September 30, 2014, as compared to $12,591,000 for the nine months ended September 30, 2013. The increase was primarily due to an increase in the weighted average depreciable basis of real estate properties of $1,056,048,000 as of September 30, 2014, compared to $388,444,000 as of September 30, 2013.

Interest Expense. Interest expense increased $4,403,000 to $13,428,000 for the nine months ended September 30, 2014, as compared to $9,025,000 for the nine months ended September 30, 2013. The increase was due to increased interest expense on notes payable and the KeyBank Credit Facility of $5,144,000 and increased amortization expense of debt issue costs of $1,071,000, offset by increased interest income earned on deposits at banks in the amount of $450,000 and capitalized interest of $1,362,000. The increase in interest expense on notes payable and the KeyBank Credit Facility of $5,144,000 was due to having an outstanding balance on notes payable in the amount of $387,730,000 and an outstanding balance on the KeyBank Credit Facility of $75,000,000 as of September 30, 2014, as compared to an outstanding balance on notes payable in the amount of $168,425,000 and an outstanding balance on the KeyBank Credit Facility of $55,000,000 as of September 30, 2013. As of September 30, 2014 and 2013, the weighted average interest rate on notes payable and the KeyBank Credit Facility was 4.7%.

 

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Organization and Offering Costs

We reimbursed our Advisor or its affiliates for organization and offering costs it incurred on our behalf, but only to the extent the reimbursement did not cause the selling commissions, the dealer manager fee and the other organization and offering costs incurred by us to exceed 15% of gross offering proceeds as of the date of the reimbursement. As of September 30, 2014, since inception, we paid approximately $156,519,000 in selling commissions and dealer manager fees to our dealer manager and we reimbursed our Advisor or its affiliates approximately $14,207,000 in offering expenses, and incurred approximately $3,900,000 of other organization and offering costs. Other organizational and offering costs (other than selling commissions and dealer manager fees) were approximately $18,107,000, or 1.06%, of total gross offering proceeds which were $1,716,046,000.

Other organization costs were expensed as incurred and selling commissions and dealer manager fees were charged to stockholders’ equity as the amounts related to raising capital. For a further discussion of other organization and offering costs, see Note 12—“Related-Party Transactions and Arrangements” to the condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q.

Real Estate-Related Notes Receivables, Net

We have invested, and may continue to invest, in notes receivables, including first mortgage loans, real estate-related bridge loans, construction loans and mezzanine loans. As of September 30, 2014, we had investments in three real estate-related notes receivables, which are intended to be held to maturity. As of September 30, 2014, the aggregate balance on the investments in real estate-related notes receivables, net was $20,350,000.

Liquidity and Capital Resources

Our principal demands for funds are for real estate and real estate-related investments, for the payment of acquisition related costs, capital expenditures, operating expenses, distributions and redemptions to stockholders and principal and interest on any current and any future indebtedness. Generally, cash needs for items other than acquisitions and acquisition related costs will be generated from operations of our current and future investments. We expect to utilize funds from the Second DRIP and future proceeds from secured and unsecured financings to complete future real estate-related investments. The Offering terminated on June 6, 2014. We expect to meet future cash needs for real estate-related investments from cash flows from operations and from debt financings. In addition, cash paid for distributions will be reduced due to the Second DRIP. The sources of our operating cash flows will be provided by the rental income received from current and future tenants of our leased properties. We raised $1,716,046,000 in gross proceeds from the Offering (including proceeds from the DRIP) before offering expenses, selling commissions and dealer manager fees.

Short-term Liquidity and Capital Resources

On a short-term basis, our principal demands for funds will be for the acquisition of real estate and real estate-related notes and investments and payments of tenant improvements, acquisition related costs, operating expenses, distributions, and interest and principal payments on current and future debt financings. We expect to meet our short-term liquidity requirements through net cash flows provided by operations, proceeds from the Second DRIP, as well as secured and unsecured borrowings from banks and other lenders to finance our expected future acquisitions. We expect our operating cash flows to increase as we acquire additional properties.

Long-term Liquidity and Capital Resources

On a long-term basis, our principal demands for funds will be for the acquisition of real estate and real estate-related investments and payments of tenant improvements, acquisition related costs, operating expenses, distributions and redemptions to stockholders, and interest and principal payments on current and future indebtedness.

We expect that substantially all cash flows from operations will be used to pay distributions to our stockholders after certain capital expenditures, however, we may use other sources to fund distributions, as necessary, such as, borrowing on the KeyBank Credit Facility and/or future borrowings on unencumbered assets. To the extent cash flows from operations are lower due to fewer properties being acquired or lower than expected returns on the properties held, distributions paid to stockholders may be lower. We expect that substantially all net cash flows from the Offering or debt financings will be used to fund acquisitions, certain capital expenditures identified at acquisition, repayments of outstanding debt or distributions to our stockholders in excess of cash flows from operations.

Capital Expenditures

We estimate that we will require approximately $1.8 million in expenditures for capital improvements over the next 12 months. We cannot provide assurances, however, that actual expenditures will not exceed these estimated expenditure levels. As of September 30, 2014, we had $2.7 million of restricted cash in lender controlled escrow reserve accounts for such capital expenditures.

 

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KeyBank Credit Facility

As of September 30, 2014, the maximum principal amount available under the KeyBank Credit Facility was $365,000,000, consisting of a $290,000,000 revolving line of credit, with a maturity date of May 28, 2017, subject to the Operating Partnership’s right to a 12-month extension, and $75,000,000 in term loans, with a maturity date of May 28, 2018, subject to the Operating Partnership’s right to a 12-month extension. The KeyBank Credit Facility can be increased to $500,000,000 under certain circumstances. Generally, proceeds of the KeyBank Credit Facility are used to acquire our real estate properties. See Note 9—“Credit Facility.”

The actual amount of credit available under the KeyBank Credit Facility is a function of certain loan-to-cost, loan-to-value, debt yield and debt service coverage ratios contained in the KeyBank Loan Agreement. The unencumbered pool availability under the KeyBank Credit Facility is equal to the maximum principal amount of the value of the assets that are included in the unencumbered pool. As of September 30, 2014, we had drawn down $75,000,000 under the KeyBank Credit Facility and we had an aggregate unencumbered pool availability of $290,000,000. The KeyBank Credit Facility agreement contains various affirmative and negative covenants that are customary for credit facilities and transactions of this type, including limitations on the incurrence of debt and limitations on distributions by the properties that are included in the unencumbered pool for the KeyBank Credit Facility in the event of a default. The KeyBank Credit Facility agreement also imposes the following financial covenants: (i) a maximum property value requirement; (ii) a maximum ratio of liabilities to asset value; (iii) a maximum daily distribution covenant; (iv) a minimum number of unencumbered pool properties in the unencumbered pool; (v) a minimum consolidated net worth; and (vi) a minimum unencumbered pool actual debt service coverage ratio. In addition, the KeyBank Credit Facility agreement includes events of default that are customary for credit facilities and transactions of this type. We believe we were in compliance with all financial covenant requirements at September 30, 2014.

Cash Flows

Operating Activities. During the nine months ended September 30, 2014, net cash provided by operations increased $36,869,000 to $53,347,000, as compared to $16,478,000 for the nine months ended September 30, 2013. The change was primarily due to our 2013 and 2014 acquisitions, which resulted in an increase in operating income from our properties, coupled with the deferral of asset management fees.

Investing Activities. Net cash used in investing activities increased $694,075,000 to $955,021,000 for the nine months ended September 30, 2014, as compared to $260,946,000 for the nine months ended September 30, 2013. The increase was primarily due to the acquisition of 14 commercial real estate investments for an aggregate purchase price of $952,950,000 during the nine months ended September 30, 2014, compared to the acquisition of 13 commercial real estate investments for an aggregate purchase price of $233,483,000 including acquisition costs capitalized related to asset acquisitions, during the nine months ended September 30, 2013; offset by a change in real estate-related notes receivables, net of $39,206,000 to $12,856,000 for the nine months ended September 30, 2014, compared to ($26,350,000) net, for the nine months ended September 30, 2013.

Financing Activities. Net cash provided by financing activities increased $679,053,000 to $969,406,000 for the nine months ended September 30, 2014, as compared to $290,353,000 for the nine months ended September 30, 2013. The change was primarily due to an increase in net proceeds from the issuance of common stock of $576,448,000, an increase in proceeds from noncontrolling interest in consolidated partnerships of $39,914,000, an increase in net borrowings on the credit facility and notes payable of $98,475,000; offset by an increase in net escrow funds of $8,385,000, an increase in distributions to noncontrolling interests in consolidated partnerships of $139,000, an increase in payments of deferred financing costs of $3,284,000, an increase in distributions to stockholders of $21,412,000 and an increase in repurchase of common stock of $2,564,000.

 

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Distributions

The amount of distributions payable to our stockholders is determined by our board of directors and is dependent on a number of factors, including funds available for distribution, financial condition, capital expenditure requirements and annual distribution requirements needed to maintain our status as a REIT under the Code. Our board of directors may reduce the amount of distributions paid or suspend distribution payments at any time and therefore distribution payments are not assured. Our Advisor may also defer, suspend and/or waive fees and expense reimbursements if we have not generated sufficient cash flow from our operations and other sources to fund distributions. Additionally, our organizational documents permit us to pay distributions from unlimited amounts of any source, and we may use sources other than operating cash flows to fund distributions, including proceeds from our Offering, which may reduce the amount of capital we ultimately invest in properties or other permitted investments.

We have funded distributions with operating cash flows from our properties and offering proceeds raised in our Offering. To the extent that we do not have taxable income, distributions paid will be considered a return of capital to stockholders. The following table shows distributions paid during the nine months ended September 30, 2014 and 2013:

 

     Nine Months
Ended
September 30,
2014
          Nine Months
Ended
September 30,
2013
        

Distributions paid in cash - common stockholders

   $ 30,312,000       $ 8,900,000     

Distributions reinvested (shares issued)

     33,684,000         7,452,000     
  

 

 

     

 

 

    

Total distributions

   $ 63,996,000 (1)      $ 16,352,000     
  

 

 

     

 

 

    

Source of distributions:

         

Cash flows provided by operations (2)

   $ 30,312,000       47   $ 8,900,000        54

Offering proceeds from issuance of common stock pursuant to the DRIP (2)

     33,684,000       53     7,452,000        46
  

 

 

   

 

 

   

 

 

    

 

 

 

Total sources

   $ 63,996,000       100   $ 16,352,000        100
  

 

 

   

 

 

   

 

 

    

 

 

 

 

(1) Total distributions declared but not paid as of September 30, 2014 were $10.0 million for common stockholders. These distributions were paid on October 1, 2014.
(2) Percentages were calculated by dividing the respective source amount by the total sources of distributions.

For the nine months ended September 30, 2014, we paid and declared distributions of approximately $64.0 million to common stockholders including shares issued pursuant to the DRIP, as compared to FFO (as defined below) and MFFO (as defined below) for the nine months ended September 30, 2014 of $47.1 million and $44.9 million, respectively. The payment of distributions from sources other than FFO or MFFO may reduce the amount of proceeds available for investment and operations or cause us to incur additional interest expense as a result of borrowed funds.

 

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Contractual Obligations

As of September 30, 2014, we had approximately $462,730,000 of debt outstanding, of which $387,730,000 related to notes payable and $75,000,000 related to the Key Bank Credit Facility. See Note 8—“Notes Payable” and Note 9—“Credit Facility” to the condensed consolidated financial statements that are a part of this Quarterly Report on Form 10-Q for certain terms of the debt outstanding. Our contractual obligations as of September 30, 2014 were as follows (amounts in thousands):

 

     Less than
1 Year
     1-3 Years      3-5 Years      More than
5 Years
     Total  

Principal payments — fixed rate debt

   $ 2,736       $ 30,285       $ 50,536       $ 51,445       $ 135,002   

Interest payments — fixed rate debt

     6,313         12,963         7,178         7,039         33,493   

Principal payments — variable rate debt fixed through interest rate swap agreements (1)

     5,708         13,107         243,904         —           262,719   

Interest payments — variable rate debt fixed through interest rate swap agreements (2)

     11,415         24,939         14,509         —           50,863   

Principal payments — variable rate debt

     1,356         3,237         60,416         —           65,009   

Interest payments — variable rate debt

     2,081         4,407         2,881         —           9,369   

Commitments — real estate-related notes receivables

     3,850         —           —           —           3,850   

Contingent consideration (3)

     —           5,030         —           —           5,030   

Tenant improvements

     39,643         11,477         1,718         —           52,838   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 73,102       $ 105,445       $ 381,142       $ 58,484       $ 618,173   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) As of September 30, 2014, we had an aggregate of $262.7 million outstanding on notes payable and borrowings under the KeyBank Credit Facility that were fixed through the use of interest rate swap agreements.
(2) We used the fixed rates under our interest rate swap agreements as of September 30, 2014 to calculate the debt payment obligations in future periods.
(3) Contingent consideration represents our best estimate of the cash payments we will be obligated to make under contingent consideration arrangements with a former owner of a property we acquired if specified operating objectives are achieved by the acquired entity. Our maximum cash payment under this arrangement is $5,030,000 in 2016.

Off-Balance Sheet Arrangements

As of September 30, 2014, we had no off-balance sheet arrangements.

Related-Party Transactions and Arrangements

We have entered into agreements with our Advisor and its affiliates, whereby we agreed to pay certain fees to, or reimburse certain expenses of, our Advisor, or its affiliates, for acquisition fees and expenses, organization and offering expenses, sales commissions, dealer manager fees, asset and property management fees and reimbursement of operating costs. Refer to Note 12—“Related-Party Transactions and Arrangements” to our condensed consolidated unaudited financial statements included in this Quarterly Report on Form 10-Q for a detailed discussion of the various related-party transactions and agreements.

Funds from Operations and Modified Funds from Operations

One of our objectives is to provide cash distributions to our stockholders from cash generated by our operations. The purchase of real estate assets and real estate-investments, and the corresponding expenses associated with that process, is a key operational feature of our business plan in order to generate cash from operations. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts, or NAREIT, an industry trade group, has promulgated a measure known as funds from operations, or FFO, which we believe is an appropriate supplemental measure to reflect the operating performance of a REIT. The use of FFO is recommended by the REIT industry as a supplemental performance measure. FFO is not equivalent to our net income (loss) as determined under GAAP.

We define FFO, consistent with NAREIT’s definition, as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from sales of property and asset impairment write-downs, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnership and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect FFO on the same basis.

 

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We, along with the others in the real estate industry, consider FFO to be an appropriate supplemental measure of a REIT’s operating performance because it is based on a net income (loss) analysis of property portfolio performance that excludes non-cash items such as depreciation and amortization and asset impairment write-downs, which we believe provides a more complete understanding of our performance to investors and to our management, and when compared year over year, reflects the impact on our operations from trends in occupancy.

Historical accounting convention (in accordance with GAAP) for real estate assets requires companies to report its investment in real estate at its carrying value, which consists of capitalizing the cost of acquisitions, development, construction, improvements and significant replacements, less depreciation and amortization and asset impairment write-downs, if any, which is not necessarily equivalent to the fair market value of its investment in real estate assets.

The historical accounting convention requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time, which could be the case if such assets are not adequately maintained or repaired and renovated as required by relevant circumstances and/or as requested or required by lessees for operational purposes in order to maintain the value disclosed. We believe that, since fair value of real estate assets historically rises and falls with market conditions including, but not limited to, inflation, interest rates, the business cycle, unemployment and consumer spending, presentations of operating results for a REIT using historical accounting for depreciation could be less informative.

In addition, we believe it is appropriate to disregard asset impairment write-downs as it is a non-cash adjustment to recognize losses on prospective sales of real estate assets. Since losses from sales of real estate assets are excluded from FFO, we believe it is appropriate that asset impairment write-downs in advancement of realization of losses should be excluded. Impairment write-downs are based on negative market fluctuations and underlying assessments of general market conditions, which are independent of our operating performance, including, but not limited to, a significant adverse change in the financial condition of our tenants, changes in supply and demand for similar or competing properties, changes in tax, real estate, environmental and zoning law, which can change over time. When indicators of potential impairment suggest that the carrying value of real estate and related assets may not be recoverable, we assess the recoverability by estimating whether we will recover the carrying value of the asset through undiscounted future cash flows and eventual disposition (including, but not limited to, net rental and lease revenues, net proceeds on the sale of property and any other ancillary cash flows at a property or group level under GAAP). If based on this analysis, we do not believe that we will be able to recover the carrying value of the real estate asset, we will record an impairment write-down to the extent that the carrying value exceeds the estimated fair value of the real estate asset. Testing for indicators of impairment is a continuous process and is analyzed on a quarterly basis. Investors should note, however, that determinations of whether impairment charges have been incurred are based partly on anticipated operating performance, because estimated undiscounted future cash flows from a property, including estimated future net rental and lease revenues, net proceeds on the sale of the property, and certain other ancillary cash flows, are taken into account in determining whether an impairment charge has been incurred. While impairment charges are excluded from the calculation of FFO as described above, investors are cautioned that due to the fact that impairments are based on estimated future undiscounted cash flows and that we intend to have a relatively limited term of our operations, it could be difficult to recover any impairment charges through the eventual sale of the property. No impairment losses have been recorded to date.

In developing estimates of expected future cash flow, we make certain assumptions regarding future market rental income amounts subsequent to the expiration of current lease arrangements, property operating expenses, terminal capitalization and discount rates, the expected number of months it takes to re-lease the property, required tenant improvements and the number of years the property will be held for investment. The use of alternative assumptions in the future cash flow analysis could result in a different determination of the property’s future cash flows and a different conclusion regarding the existence of an asset impairment, the extent of such loss, if any, as well as the carrying value of the real estate asset.

Publicly registered, non-listed REITs, such as ours, typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operations. While other start up entities may also experience significant acquisition activity during their initial years, we believe that publicly registered, non-listed REITs are unique in that they have a limited life with targeted exit strategies within a relatively limited time frame after the acquisition activity ceases. We will use the proceeds raised in our offering to acquire real estate assets and real estate-related investments, and we intend to begin the process of achieving a liquidity event (i.e., listing of our shares of common stock on a national securities exchange, a merger or sale, the sale of all or substantially all of our assets, or another similar transaction) within five years after the completion of our offering stage, which is generally comparable to other publicly registered, non-listed REITs. Thus, we do not intend to continuously purchase real estate assets and intend to have a limited life. Due to these factors and other unique features of publicly registered, non-listed REITS, the Investment Program Association, or the IPA, an industry trade group, has standardized a measure known as modified funds from operations, or MFFO, which we believe to be another appropriate supplemental measure to reflect the operating performance of a publicly registered, non-listed REIT. MFFO is a metric used by management to evaluate sustainable performance and dividend policy. MFFO is not equivalent to our net income (loss) as determined under GAAP.

We define MFFO, a non-GAAP measure, consistent with the IPA’s definition: FFO further adjusted for the following items included in the determination of GAAP net income (loss); acquisition fees and expenses; amounts related to straight-line rental income and amortization of above and below intangible lease assets and liabilities; accretion of discounts and amortization of premiums on debt investments; mark-to-market adjustments included in net income; nonrecurring gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity

 

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accounting, adjustments related to contingent purchase price obligations where such adjustments have been included in the derivation of GAAP net income, and after adjustments for a consolidated and unconsolidated partnership and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. Our MFFO calculation complies with the IPA’s Practice Guideline, described above. In calculating MFFO, we exclude paid and accrued acquisition fees and expenses that are reported in our condensed consolidated statements of comprehensive income (loss), amortization of above and below-market leases, amounts related to straight-line rents (which are adjusted in order to reflect such payments from a GAAP accrual basis to closer to an expected to be received cash basis of disclosing the rent and lease payments); and the adjustments of such items related to noncontrolling interests in the Operating Partnership. The other adjustments included in the IPA’s guidelines are not applicable to us.

Since MFFO excludes acquisition fees and expenses, it should not be construed as a historic performance measure. Acquisition fees and expenses are paid in cash by us, and we have not set aside or put into escrow any specific amount of proceeds from our offerings to be used to fund acquisition fees and expenses. Acquisition fees and expenses include payments to our Advisor or its affiliates and third parties. Such fees and expenses will not be reimbursed by our Advisor or its affiliates and third parties, and therefore if there are no further proceeds from the sale of shares of our common stock to fund future acquisition fees and expenses, such fees and expenses will need to be paid from either additional debt, operational earnings or cash flows, net proceeds from the sale of properties, or from ancillary cash flows. As a result, the amount of proceeds available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds. Nevertheless, our Advisor or its affiliates will not accrue any claim on our assets if acquisition fees and expenses are not paid from the proceeds of our offerings. Under GAAP, acquisition fees and expenses related to the acquisition of properties determined to be business combinations are expensed as incurred, including investment transactions that are no longer under consideration, and are included in acquisition related expenses in the accompanying condensed consolidated statements of comprehensive income (loss) and acquisition fees and expenses associated with transactions determined to be an asset purchase are capitalized.

All paid and accrued acquisition fees and expenses have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of other properties are generated to cover the purchase price of the real estate asset, these fees and expenses and other costs related to such property. In addition, MFFO may not be an indicator of our operating performance, especially during periods in which properties are being acquired.

In addition, certain contemplated non-cash fair value and other non-cash adjustments are considered operating non-cash adjustments to net income (loss) in determining cash flows from operations in accordance with GAAP.

We use MFFO and the adjustments used to calculate it in order to evaluate our performance against other publicly registered, non-listed REITs, which intend to have limited lives with short and defined acquisition periods and targeted exit strategies shortly thereafter. As noted above, MFFO may not be a useful measure of the impact of long-term operating performance if we do not continue to operate in this manner. We believe that our use of MFFO and the adjustments used to calculate it allow us to present our performance in a manner that reflects certain characteristics that are unique to publicly registered, non-listed REITs, such as their limited life, limited and defined acquisition period and targeted exit strategy, and hence the use of such measures may be useful to investors. For example, acquisition fees and expenses are intended to be funded from the proceeds of our offering and other financing sources and not from operations. By excluding acquisition fees and expenses, the use of MFFO provides information consistent with management’s analysis of the operating performance of its real estate assets. Additionally, fair value adjustments, which are based on the impact of current market fluctuations and underlying assessments of general market conditions, but can also result from operational factors such as rental and occupancy rates, may not be directly related or attributable to our current operating performance. By excluding such charges that may reflect anticipated and unrealized gains or losses, we believe MFFO provides useful supplemental information.

Presentation of this information is intended to assist management and investors in comparing the operating performance of different REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO and MFFO are not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income (loss) as an indication of our performance, as an indication of our liquidity, or indicative of funds available to fund our cash needs, including our ability to make distributions to our stockholders. FFO and MFFO should be reviewed in conjunction with other measurements as an indication of our performance. MFFO has limitations as a performance measure in an offering such as ours where the price of a share of common stock is stated value and there is no asset value determination during the offering stage for a period thereafter. MFFO may be useful in assisting management and investors in assessing the sustainability of operating performance in future operating periods, and in particular, after the offering and acquisition stages are complete and net asset value is disclosed. MFFO is not a useful measure in evaluating net asset value since impairment write-downs are taken into account in determining net asset value but not in determining MFFO.

FFO and MFFO, as described above, should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income (loss) or in its applicability in evaluating our operational performance. The method used to evaluate the value and performance of real estate under GAAP should be construed as a more relevant measure of operation performance and considered more prominently than the non-GAAP FFO and measures and the adjustments to GAAP in calculating FFO and MFFO. MFFO has not been scrutinized to the level of other similar non-GAAP performance measures by the SEC or any other regulatory body.

 

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The following is a reconciliation of net income/(loss) attributable to controlling interests, which is the most directly comparable GAAP financial measure, to FFO and MFFO for the three and nine months ended September 30, 2014 and 2013 (in thousands, except share data):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2014     2013     2014     2013  

Net income attributable to common stockholders

   $ 7,354      $ 3,850      $ 18,803      $ 6,714   

Adjustments:

        

Depreciation and amortization - real estate

     13,002        4,727        31,275        12,591   

Noncontrolling interests’ share of the above adjustments related to the consolidated partnerships

     (1,294     (826     (2,956     (2,469
  

 

 

   

 

 

   

 

 

   

 

 

 

FFO

   $ 19,062      $ 7,751      $ 47,122      $ 16,836   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjustments:

        

Acquisition related expenses (1)

   $ 4,087      $ 1,402      $ 10,598      $ 4,599   

Amortization of above and below-market leases (2)

     (1,043     (958     (3,002     (2,797

Straight-line rents (3)

     (5,044     (1,311     (11,634     (3,631

Noncontrolling interests’ share of the above adjustments related to the consolidated partnerships

     828 (4)      509 (5)      1,791 (6)      1,538 (7) 
  

 

 

   

 

 

   

 

 

   

 

 

 

MFFO

   $ 17,890      $ 7,393      $ 44,875      $ 16,545   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding - basic

     172,914,286        46,757,918        133,908,958        34,925,951   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding - diluted

     172,931,516        46,774,585        133,928,250        34,944,118   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per common share - basic

   $ 0.04      $ 0.08      $ 0.14      $ 0.19   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per common share - diluted

   $ 0.04      $ 0.08      $ 0.14      $ 0.19   
  

 

 

   

 

 

   

 

 

   

 

 

 

FFO per common share - basic

   $ 0.11      $ 0.17      $ 0.35      $ 0.48   
  

 

 

   

 

 

   

 

 

   

 

 

 

FFO per common share - diluted

   $ 0.11      $ 0.17      $ 0.35      $ 0.48   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) In evaluating investments in real estate assets, management differentiates the costs to acquire the investment from the operations derived from the investment. Such information would be comparable only for publicly registered, non-listed REITs that have completed their acquisitions activities and have other similar operating characteristics. By excluding expensed acquisition related expenses, management believes MFFO provides useful supplemental information that is comparable for each type of real estate investment and is consistent with management’s analysis of the investing and operating performance of our properties. Acquisition fees and expenses include payments in cash to our Advisor and third parties. Acquisition fees and expenses incurred in a business combination, under GAAP, are considered operating expenses and as expenses included in the determination of net income (loss), which is a performance measure under GAAP. All paid and accrued acquisition fees and expenses will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of properties are generated to cover the purchase price of the property, these fees and expenses and other costs related to the property.
(2) Under GAAP, certain intangibles are accounted for at cost and reviewed at least annually for impairment, and certain intangibles are assumed to diminish predictably in value over time and are amortized, similar to depreciation and amortization of real estate-related assets that are excluded from FFO. However, because real estate values and market lease rates historically rise or fall with market conditions, management believes that by excluding charges related to amortization of these intangibles, MFFO provides useful supplemental information on the performance of the real estate.
(3) Under GAAP, rental revenue is recognized on a straight-line basis over the terms of the related lease (including rent holidays if applicable). This may result in income recognition that is significantly different than the underlying contract terms. By adjusting for the change in deferred rent receivables, MFFO may provide useful supplemental information on the realized economic impact of lease terms, providing insight on the expected contractual cash flows of such lease terms, and aligns with our analysis of operating performance.
(4) Of this amount, $468,000 related to straight-line rents, $364,000 related to above and below-market leases and $(4,000) related to acquisition expenses.
(5) Of this amount, $145,000 related to straight-line rents and $364,000 related to above and below-market leases.
(6) Of this amount, $702,000 related to straight-line rents, $1,093,000 related to above and below-market leases and $(4,000) related to acquisition expenses.
(7) Of this amount, $445,000 related to straight-line rents and $1,093,000 related to above and below-market leases.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. In pursuing our business plan, the primary market risk to which we are exposed is interest rate risk.

We have obtained variable rate debt financing to fund certain property acquisitions, and we are exposed to changes in the one-month LIBOR. Our objectives in managing interest rate risks seek to limit the impact of interest rate changes on operations and cash flows, and to lower overall borrowing costs. To achieve these objectives we will borrow primarily at interest rates with the lowest margins available and, in some cases, with the ability to convert variable interest rates to fixed rates.

We have entered, and may continue to enter, into derivative financial instruments, such as interest rate swaps, in order to mitigate our interest rate risk on a given variable rate financial instrument. To the extent we do, we are exposed to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. When the fair value of a derivative contract is negative, we owe the counterparty and, therefore, it does not possess credit risk. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. We manage the market risk associated with interest rate contracts by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. We have not entered, and do not intend to enter, into derivative or interest rate transactions for speculative purposes. We may also enter into rate-lock arrangements to lock interest rates on future borrowings.

As of September 30, 2014, we had eight fixed rate notes payable in the aggregate amount of $135.0 million, five variable rate notes payable in the aggregate amount of $133.2 million that were fixed through interest rate swap agreements, one variable rate note payable in the aggregate amount of $20.2 million, one note payable in the aggregate amount of $99.3 million, of which $74.5 million was fixed through an interest rate swap agreement and $24.8 million was variable rate and $75.0 million borrowed under the KeyBank Credit Facility, of which $55.0 million was fixed through interest rate swap agreements and $20.0 million was variable rate. As of September 30, 2014, the weighted average interest rate on notes payable and the KeyBank Credit Facility was 4.7%.

As of September 30, 2014, $65.0 million of the $462.7 million total debt outstanding was subject to variable interest rates with a weighted average interest rate of 3.41% per annum. As of September 30, 2014, an increase of 50 basis points in the market rates of interest would have resulted in a change in interest expense of $0.3 million per year, assuming all of our derivatives remained effective hedges.

As of September 30, 2014, we had nine interest rate swap agreements outstanding, which mature on various dates from October 2017 through July 2019, with an aggregate notional amount under the swap agreements of $262.7 million and an aggregate settlement value of $(0.5) million. The settlement value of these interest rate swap agreements is dependent upon existing market interest rates and swap spreads. As of September 30, 2014, an increase of 50 basis points in the market rates of interest would have resulted in an increase to the settlement value of these interest rate swaps of $4.2 million. These interest rate swaps were designated as hedging instruments.

We do not have any foreign operations and thus we are not exposed to foreign currency fluctuations.

Item 4. Controls and Procedures.

(a) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, an evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q was conducted under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures, as of September 30, 2014, were effective.

(b) Changes in internal control over financial reporting. There were no changes in internal control over financial reporting that occurred during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION 

Item 1. Legal Proceedings.

We are not a party to any material pending legal proceedings.

Item 1A. Risk Factors.

There have been no material changes from the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC on March 19, 2014, except as noted below.

Distributions paid from sources other than our cash flow from operations will result in us having fewer funds available for the acquisition of properties and other real estate-related investments, which may adversely affect our ability to fund future distributions with cash flow from operations and may adversely affect your overall return.

We have paid, and may continue to pay, distributions from sources other than from our cash flows from operations. For the nine months ended September 30, 2014, our cash flows provided by operations of approximately $53.3 million was a shortfall of $10.7 million, or 16.7%, of our distributions paid (total distributions were approximately $64.0 million, of which $30.3 million was cash and $33.7 million was reinvested in shares of our common stock pursuant to our DRIP) during such period and such shortfall was paid from proceeds from the Offering. For the year ended December 31, 2013, our cash flows provided by operations of approximately $25.7 million was a shortfall of $0.7 million, or 2.7%, of our distributions paid (total distributions were approximately $26.4 million, of which $14.2 million was cash and $12.2 million was reinvested in shares of our common stock pursuant to our DRIP) during such period and such shortfall was paid from proceeds from the Offering. Additionally, we may in the future pay distributions from sources other than from our cash flows from operations. Until we acquire additional properties or other real estate-related investments, we may not generate sufficient cash flows from operations to pay distributions. Our inability to acquire additional properties or other real estate-related investments may result in a lower return on your investment than you expect.

We do not have any limits on the sources of funding distribution payments to our stockholders. We may pay, and have no limits on the amounts we may pay, distributions from any source, such as from borrowings, the sale of assets, the sale of additional securities, advances from our advisor, our advisor’s deferral, suspension and/or waiver of its fees and expense reimbursements and offering proceeds. Funding distributions from borrowings could restrict the amount we can borrow for investments, which may affect our profitability. Funding distributions with the sale of assets may affect our ability to generate cash flows. Funding distributions from the sale of additional securities could dilute your interest in us if we sell shares of our common stock to third party investors. If we fund distributions from the proceeds of our Offering, we will have less funds available for acquiring properties or real estate-related investments. Our inability to acquire additional properties or real estate-related investments may have a negative effect on our investors’ ability to generate sufficient cash flow from operations to pay distributions. As a result, the return investors may realize on their investment may be reduced and investors who invest in us before we generate significant cash flow may realize a lower rate of return than later investors. Payment of distributions from any of the mentioned sources could restrict our ability to generate sufficient cash flow from operations, affect our profitability and/or affect the distributions payable upon a Liquidity Event, any or all of which may have an adverse effect on an investment in us.

As a result of the termination of the Offering, the following risk factors, which are included in our Annual Report on Form 10-K, are no longer material and are hereby deleted:

 

    Our dealer manager has limited experience in public offerings, which may affect the amount of funds it raises in the Offering.

 

    The offering price for our shares is not based on the book value or net asset value of our current expected investments or our current or expected operating income.

 

    Payment of fees and reimbursements to our Advisor and their affiliates reduces cash available for investment and distribution.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Unregistered Sales of Equity Securities

During the three months ended September 30, 2014, we did not sell any equity securities that were not registered or otherwise exempt under the Securities Act of 1933, as amended.

Use of Public Offering Proceeds

On December 10, 2010, our Registration Statement on Form S-11 (File No. 333-165643), covering a public offering of up to 175.0 million shares of common stock, was declared effective under the Securities Act. We were offering a maximum of 150.0 million shares of common stock for $10.00 per share and up to 25.0 million shares of common stock pursuant to the DRIP for $9.50 per share, for a maximum offering of up to $1,737.5 million. On May 16, 2014, we reallocated 18.8 million shares of common stock from the DRIP offering to the primary portion of the Offering. As a result of this reallocation, the Offering offered up to a maximum of 168.8 million shares of common stock for $10.00 per share and up to 6.2 million shares of common stock pursuant to the DRIP for $9.50 per share, for a maximum offering of up to $1,746.9 million.

On June 6, 2014, we terminated the Offering. We had received subscriptions for gross proceeds of approximately $1,716.0 million. From the offering proceeds, we paid $36.2 million in acquisition fees to our Advisor, $11.7 million in acquisition related costs and $14.2 million in organization and offering costs to our Advisor and to SC Distributors as of September 30, 2014. With the remaining offering proceeds, joint venture equity and indebtedness, we acquired $1,896.6 million in total gross real estate. In addition, we invested an aggregate of $112.1 million in real estate-related notes receivables. As of September 30, 2014, a total of $48.9 million in distributions were reinvested in, and 5.2 million shares of common stock were issued, pursuant to the DRIP.

On October 11, 2013, we filed with the SEC a registration statement on Form S-11 under the Securities Act with respect to the Follow-On Offering of up to $240,000,000 of shares of common stock to be offered pursuant to a primary offering, and up to $10,000,000 of shares of common stock to be offered pursuant to the DRIP. On July 11, 2014, we withdrew the registration statement related to the Follow-On Offering. We did not issue any shares in connection with the Follow-On Offering as it was not declared effective by the SEC.

On April 14, 2014, we filed a registration statement on Form S-3 under the Securities Act to register $100,000,000 in shares of common stock pursuant to the Second DRIP, which will offer existing stockholders a convenient method for purchasing additional shares of common stock by reinvesting cash distributions without paying any selling commissions, fees or service charges. The registration statement became effective with the SEC automatically upon filing; however, we did not commence offering shares pursuant to the Second DRIP until June 7, 2014 following the termination of our offering. As of September 30, 2014, approximately 1,180,000 shares of common stock were issued pursuant to the Second DRIP. As of September 30, 2014, approximately 9,346,000 shares of common stock were remaining in the Second DRIP.

Share Repurchase Program

Effective as of December 10, 2010, our board of directors adopted a share repurchase program that enables our stockholders to sell their shares to us in limited circumstances. Our share repurchase program permits stockholders to sell their shares back to us after they have held them for at least one year, subject to certain conditions and limitations. We will limit the number of shares repurchased during any calendar year to 5.0% of the number of shares of our common stock outstanding on December 31 of the previous calendar year. In addition, the share repurchase program provides that all redemptions during any calendar year, including those upon death or a qualifying disability of a stockholder, are limited to those that can be funded with proceeds raised from the DRIP. Our board of directors has the right, in its sole discretion, to waive such holding requirement in the event of the death or qualifying disability of a stockholder, other involuntary exigent circumstances, such as bankruptcy, or a mandatory requirement under a stockholder’s IRA.

Prior to establishing the estimated value of our shares and unless the shares are being redeemed in connection with a stockholder’s death or qualifying disability (as defined below), the price per share that we will pay to repurchase shares of our common stock will be as follows:

 

    for stockholders who have continuously held their shares of our common stock for at least one year, the price will be 92.5% of the amount stockholder paid for each share;

 

    for stockholders who have continuously held their shares of our common stock for at least two years, the price will be 95.0% of the amount stockholder paid for each share;

 

    for stockholders who have continuously held their shares of our common stock for at least three years, the price will be 97.5% of the amount stockholder paid for each share; and

 

    for stockholders who have held their shares of our common stock for at least four years, the price will be 100.0% of the amount a stockholder paid continuously for each such share (in each case, as adjusted for any stock dividends, combinations, splits, recapitalizations and the like with respect to our common stock).

 

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During the three months ended September 30, 2014, we fulfilled the following redemption requests pursuant to our share repurchase program:

 

Period   Total Number of 
Shares Redeemed
    Average 
Price Paid per
Share
    Total Numbers of Shares
Purchased as Part of Publicly
Announced Plans and Programs
    Approximate Dollar Value
of Shares Available that may yet
be Redeemed under the Program
07/01/2014   07/31/2014     30,330     $ 9.37       30,330     (1)
08/01/2014   08/31/2014     25,886     $ 9.82       25,886     (1)
09/01/2014   09/30/2014     118,605     $ 9.67       118,605     (1)
   

 

 

     

 

 

   

Total

    174,821         174,821    
   

 

 

     

 

 

   

 

(1) A description of the maximum number of shares that may be redeemed under our share repurchase program is included in the narrative preceding this table. During the three months ended September 30, 2014, we redeemed approximately $1,686,000 of common stock, which represented all redemption requests received in good order and eligible for redemption through the September 30, 2014 redemption date.

 

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Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

The exhibits listed on the Exhibit Index (following the signatures section of this Quarterly Report on Form 10-Q) are filed herewith, or incorporated by reference.

 

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SIGNATURES 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

   

CARTER VALIDUS MISSION CRITICAL REIT, INC.

(Registrant)

Date: November 14, 2014     By   /S/    JOHN E. CARTER        
     

John E. Carter

Chief Executive Officer and President

(Principal Executive Officer)

Date: November 14, 2014     By   /S/    TODD M. SAKOW        
     

Todd M. Sakow

Chief Financial Officer

(Principal Financial Officer)

 

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EXHIBIT INDEX 

Pursuant to Item 601(a)(2) of Regulation S-K, this Exhibit Index immediately precedes the exhibits.

The following exhibits are included, or incorporated by reference, in this Quarterly Report on Form 10-Q for the nine months ended September 30, 2014 (and are numbered in accordance with Item 601 of Regulation S-K).

 

Exhibit
No:

    
    3.1    Articles of Amendment and Restatement (incorporated by reference to Registrant’s Pre-Effective Registration Statement on Form S-11, Commission File No. 333-165643, filed on November 16, 2010)
    3.2    First Amendment to Articles of Amendment and Restatement (incorporated by reference to Registrant’s Current Report on Form 8-K filed on March 31, 2011)
    3.3    Bylaws of Carter Validus Mission Critical REIT, Inc. (incorporated by reference to Registrant’s Pre-Effective Registration Statement on Form S-11, Commission No. 333-165643, filed on March 23, 2010)
    3.4    Agreement of Limited Partnership of Carter/Validus Operating Partnership, LP (included as Exhibit 10.5 to the Registration Statement on Form S-11 (Registration No. 333-165643) filed on November 16, 2010, and incorporated herein by reference)
    4.1    Distribution Reinvestment Plan (included as Appendix A to the prospectus dated April 14, 2014 attached to the Registration Statement on Form S-3, filed on April 14, 2014)
    4.2    Carter Validus Mission Critical REIT, Inc. 2010 Restricted Share Plan (included as Exhibit 10.1 to our Current Report on Form 8-K filed on March 24, 2011, and incorporated herein by reference)
    4.3    Form of Restricted Stock Award Agreement (included as Exhibit 10.6 to the Registration Statement on Form S-11 Registration No. 333-165643 filed on June 25, 2010, and incorporated herein by reference)
  10.1    Joinder Agreement by HC-42570 South Airport Road, LLC, to KeyBank National Association, as Agent, dated March 14, 2014 (included as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on March 19, 2014, and incorporated herein by reference)
  10.2    Assignment of Leases and Rents by HC-42570 South Airport Road, LLC to KeyBank National Association, dated March 14, 2014 (included as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on March 19, 2014, and incorporated herein by reference)
  10.3    Act of Mortgage, Security Agreement and Assignment of Leases and Rents by HC-42570 South Airport Road, LLC, as Mortgagor, to KeyBank National Association, as Agent, dated March 14, 2014 (included as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on March 19, 2014, and incorporated herein by reference)
  10.4    Joinder Agreement by DC-1805 Center Park Drive, LLC, to KeyBank National Association, as Agent, dated April 28, 2014 (included as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on April 30, 2014, and incorporated herein by reference)
  10.5    Assignment of Leases and Rents by DC-1805 Center Park Drive, LLC to KeyBank National Association, dated April 28, 2014 (included as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on April 30, 2014, and incorporated herein by reference)
  10.6    Deed of Trust, Security Agreement, Assignment of Leases and Rents and Fixture Filing by DC-1805 Center Park Drive, LLC, as Grantor, to KeyBank National Association, as Beneficiary, dated April 28, 2014 (included as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on April 30, 2014, and incorporated herein by reference)
  10.7    Purchase Agreement, dated April 4, 2014, between Ascent CH2, LLC and Carter Validus Properties, LLC (included as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on May 21, 2014, and incorporated herein by reference)
  10.8    Assignment of Purchase Agreement, dated May 14, 2014, between Carter Validus Properties, LLC, as Assignor, and DC-505 North Railroad Avenue, LLC, as Assignee (included as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on May 21, 2014, and incorporated herein by reference)

 

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  10.9   Assignment and Assumption of Leases, dated May 20, 2014, between Ascent CH2, LLC, as Assignor, and DC-505 North Railroad Avenue, LLC, as Assignee (included as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on May 21, 2014, and incorporated herein by reference)
  10.10   Second Amended and Restated Credit Agreement, by and among Carter/Validus Operating Partnership, LP, Carter Validus Mission Critical REIT, Inc., the guarantors and the lenders party thereto, dated May 28, 2014 (included as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on May 29, 2014, and incorporated herein by reference)
  10.11   Joinder Agreement by DC-1099 Walnut Ridge Drive, LLC, to KeyBank National Association, as Agent, dated July 22, 2014 (included as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on July 28, 2014, and incorporated herein by reference)
  10.12   Joinder Agreement by HC-116 Eddie Dowling Highway, LLC, to KeyBank National Association, as Agent, dated August 28, 2014 (included as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on September 2, 2014, and incorporated herein by reference)
  10.13   Joinder Agreement by DC-1001 Windward Concourse, LLC, to KeyBank National Association, as Agent, dated September 5, 2014 (included as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on September 11, 2014, and incorporated herein by reference)
  10.14   Joinder Agreement by HCP-Dermatology Associates, LLC, to KeyBank National Association, as Agent, dated September 15, 2014 (included as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on September 17, 2014, and incorporated herein by reference)
  10.15   Joinder Agreement by HC-1101 Kaliste Saloom Road, LLC, to KeyBank National Association, as Agent, dated September 19, 2014 (included as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on September 24, 2014, and incorporated herein by reference)
  10.16   Joinder Agreement by DC-615 North 48TH Street, LLC, to KeyBank National Association, as Agent, dated September 23, 2014 (included as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on September 24, 2014, and incorporated herein by reference)
  10.17   Joinder Agreement by DC-8521 East Princess Drive, LLC, to KeyBank National Association, as Agent, dated September 23, 2014 (included as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on September 24, 2014, and incorporated herein by reference)
  10.18   Joinder Agreement by HCP-Select Medical, LLC, to KeyBank National Association, as Agent, dated September 23, 2014 (included as Exhibit 10.4 to the Registrant’s Current Report on Form 8-K filed on September 24, 2014, and incorporated herein by reference)
  31.1*   Certification of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31.2*   Certification of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32.1**   Certification of Chief Executive Officer and Chief Financial Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*   XBRL Instance Document
101.SCH*   XBRL Taxonomy Extension Schema Document
101.CAL*   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*   XBRL Taxonomy Extension Label Linkbase Document
101.PRE*   XBRL Taxonomy Extension Presentation Linkbase Document

 

* Filed herewith.
** Furnished herewith in accordance with Item 601(b)(32) of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

 

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