STORE CAPITAL LLC - Annual Report: 2014 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

 

For the fiscal year ended December 31, 2014

or

 

 

For the transition period from                      to                     .  

Commission File No. 001-36739  

 

STORE CAPITAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

8501 East Princess Drive, Suite 190, Scottsdale, Arizona 85255

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (480) 256-1100

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

Securities Registered Pursuant to Section 12(g) of the Act: None

 

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

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ◻    No  ☒ 

 

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

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ◻    No  ◻ 

 

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

 

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

 

 

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

 

The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant, based on the closing price of a share of the registrant’s common stock on November 18, 2014 as reported on the New York Stock Exchange on such date, was approximately $616,687,500.  The registrant has elected to use November 18, 2014, which was the initial trading date on the New York Stock Exchange, as the calculation date because on June 30, 2014 (the last business day of the registrant’s most recently completed second fiscal quarter), the registrant was a privately held company.  Shares of the registrant’s common stock held by each executive officer, director and beneficial owner of more than 5% of the outstanding common stock have been excluded from the calculation, as such persons may be deemed to be affiliates.  This determination of affiliate status should not be deemed conclusive for any other purpose.  As of March 6, 2015, there were 115,210,809 shares of the registrant’s common stock outstanding.

 

Documents Incorporated by Reference

 

Portions of Part III of this Form 10-K are incorporated by reference from the registrant’s definitive proxy statement for its 2015 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission no later than 120 days after the end of the registrant’s fiscal year.

 

 

---

 

TABLE OF CONTENTS

 

 

 

 

---

 

PART I

In this Annual Report on Form 10-K (the “Annual Report”), we refer to STORE Capital Corporation, a Maryland corporation, as “we,” “us,” “our,” “the Company” or “S|T|O|R|E,” unless we specifically state otherwise or the context indicates otherwise.

Forward-Looking Statements

This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Such forward-looking statements include, without limitation, statements concerning our business and growth strategies, investment, financing and leasing activities and trends in our business, including trends in the market for long-term, triple-net leases of freestanding, single-tenant properties.   Words such as “expects,” “anticipates,” “intends,” “plans,” “likely,” “will,” “believes,” “seeks,” “estimates,” and variations of such words and similar expressions are intended to identify such forward-looking statements.  Such statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from the results of operations or plans expressed or implied by such forward-looking statements.  Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore such statements included in this Annual Report may not prove to be accurate.  In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be achieved.  For a further discussion of these and other factors that could impact future results, performance or transactions, see “Item 1A. Risk Factors” elsewhere in this Annual Report.

Forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Annual Report, and we expressly disclaim any obligation or undertaking to update or revise any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based, except to the extent otherwise required by law.

Item 1.  BUSINESS

General

S|T|O|R|E is an internally managed net‑lease real estate investment trust, or REIT, that is the leader in the acquisition, investment and management of Single Tenant Operational Real Estate, or STORE Properties, which is our target market and the inspiration for our name. A STORE Property is a real property location at which a company operates its business and generates sales and profits, which makes the location a profit center and, therefore, fundamentally important to that business.

S|T|O|R|E continues the investment activities of our senior leadership team, which has been investing in single‑tenant operational real estate for over thirty-five years.   We are one of the largest and fastest‑growing net‑lease REITs, as demonstrated by the table below, and own a large, well‑diversified portfolio that consists of investments in 947 property locations operated by 226 customers across 46 states as of December 31, 2014.  Our customers operate across a wide variety of industries within the service, retail and industrial sectors of the U.S. economy, with restaurants, early childhood education centers, health clubs, movie theaters and sporting goods stores representing the top industries in our portfolio.

---

 

Our Total Investment Portfolio at Quarter End

 

 

We have elected to be taxed as a REIT under the Internal Revenue Code, as amended, which we refer to in this Annual Report as the “Code,” commencing with our initial taxable year ended December 31, 2011. To continue to qualify as a REIT, we must continue to meet certain tests which, among other things, generally require that our assets consist primarily of real estate assets, our income be derived primarily from real estate assets, and that we distribute at least 90% of our REIT taxable income (other than our net capital gains) to our stockholders annually. 

Although we are a public company, we are a “controlled company” (within the meaning of the rules of the New York Stock Exchange, or NYSE) because a substantial portion of our common stock (approximately 71%) is owned indirectly by certain investment funds managed by Oaktree Capital Management, L.P. Oaktree is a global investment management firm specializing in alternative investments with approximately $91 billion in assets under management as of December 31, 2014.

2014 Highlights

Our Target Market

We are the leader in providing real estate financing solutions principally to middle‑market and larger businesses that own STORE Properties and operate within the broad-based service, retail and industrial sectors of the U.S. economy.  Our net‑lease solutions are designed to provide a long‑term, lower‑cost way to improve our customers’ capital structures and, thus, be a preferred alternative to real estate ownership.    We estimate the market for STORE Properties to exceed $2.3 trillion in market value and to include more than 1.5 million properties.

We define middle‑market companies as those having approximate annual gross revenues of between $20 million and $300 million, although some of our customers have annual revenues substantially in excess of $300 million.  Most of our customers do not have credit ratings, while some have ratings from rating agencies that service insurance companies or fixed‑income investors.  Most of these non-rated companies either prefer to be unrated or are simply too small to issue debt rated by a nationally recognized rating agency in a cost‑efficient manner.

Despite the market’s size, the financing marketplace for STORE Properties is highly fragmented, with few participants addressing the long‑term capital needs of middle‑market and larger non-rated companies.  While we believe our net‑lease financing solutions can add value to a wide variety of companies, we believe the largest underserved market and, therefore, our greatest opportunity is non-rated, bank‑dependent, middle‑market and larger companies that generally have less access to efficient sources of long‑term capital.

We believe the demand for our net‑lease solutions is even greater today as a result of the current bank regulatory environment.  In our view, the increased scrutiny and regulation of the banking industry over the past several years in response to the collapse of the housing and mortgage industries from 2007 to 2009, particularly with the passage of the Dodd‑Frank Wall Street Reform and Consumer Protection Act and the Basel Accords issued by the Basel Committee on Banking Supervision, have made commercial banks even less responsive to the long‑term capital needs of the middle‑market companies we target.   These companies have historically depended on commercial banks for their financing.    

S|T|O|R|E was formed to capitalize on this market opportunity and address the capital needs of middle‑market and larger non-rated companies by offering them a superior alternative to financing their profit‑center real estate with traditional mortgage or bank debt and their own equity.  We believe our opportunities include both gaining market share from the fragmented network of net‑lease capital providers and growing the market by creating demand for our net‑lease solutions that meet the long‑term real estate capital needs of these companies.

Our target market of STORE Properties is divided into three primary sectors and various sub-sectors.  The primary sectors and their proportion of our target market are service at 47%, retail at 37% and industrial at 16%.  The sub-sectors included within each primary sector are summarized in the table below.

 

---

 

Within the sub‑sectors, the market for STORE Properties is further subdivided into a wide variety of industries within the service, retail and industrial sectors, such as:

 

Many of these industries are represented within our diverse property portfolio.

Our Asset Class:  STORE Properties

Single Tenant Operational Real Estate, or STORE Properties, is a unique asset class that inspired the formation of S|T|O|R|E and our company name.  STORE Properties are profit-center real estate locations on which our tenants conduct their businesses and generate their revenues and profits.  The defining characteristic of STORE Properties is the number of payment sources:  STORE Properties have three payment sources, whereas all other commercial real estate assets have just two.

The following diagram illustrates the three sources of payment that are common among STORE Properties:

The S|T|O|R|E Credit Pyramid

 

The investment, management and capitalization competencies we have developed over more than thirty-five years, like our credit pyramid, arise from the distinctive characteristics of the large asset class of STORE Properties we address.

Our Competitive Strengths

Our objective is to build upon our market‑leading platform for the acquisition, investment and management of STORE Properties that simultaneously creates value for stockholders and customers through our five corporate competencies.  Each member of our senior leadership team is primarily responsible for one of our five competencies, which are described below:

The following table compares our tenant credit ratings (determined using Moody’s Riskcalc) with the STORE Score:

 

Our Business and Growth Strategies

Our objective is to continue to create stockholder value through sustained investment and management activities designed to grow distributable cash flows and deliver attractive risk-adjusted rates of return from a growing, diverse portfolio of STORE Properties. To accomplish this, our principal business and growth strategies are as follows:

Competition

We face competition in the acquisition and financing of STORE Properties from numerous investors, including traded and non‑traded public REITs, private equity investors and institutional investment funds, some of which have greater financial resources than we do, a greater ability to borrow funds to acquire properties and the ability to accept more risk.  We also believe that competition for real estate financing comes from middle‑market business owners themselves, many of whom have had a historic preference to own, rather than lease, the real estate they use in their businesses.  The competition we face may increase the demand for STORE Properties and, therefore, reduce the number of suitable acquisition opportunities available to us or increase the price we must pay to acquire STORE Properties.  This competition will increase if investments in real estate become more attractive relative to other forms of investment.

Employees

As of December 31, 2014, we had 50 full‑time employees, all of whom are located in our single office in Scottsdale, Arizona. None of our employees are subject to a collective bargaining agreement.  We consider our employee relations to be good.

Principal Executive Offices

Our principal offices are located at 8501 East Princess Drive, Suite 190, Scottsdale, Arizona 85255.  We currently occupy approximately 14,000 square feet of space leased from an unaffiliated third party.  We believe that our offices are adequate for our present and currently planned future operations and that adequate additional space will be available if needed in the future.

Insurance

Our leases and loan agreements typically require our tenants and borrowers to maintain insurance of the types and in the amounts that are usual and customary for similar commercial properties, including commercial general liability, fire and extended loss insurance provided by reputable companies, with commercially reasonable exclusions, deductibles and limits, all as verified by our independent insurance consultant.  

Separately, we purchase contingent liability insurance, in excess of our tenants’ and borrowers’ liability coverage, to provide us with additional security in the event of a catastrophic claim. Also, we purchase property coverage, on a case-by-case basis, where we believe such additional insurance is warranted.

Regulation

Our properties are subject to various laws and regulations, including regulations relating to fire and safety requirements, ordinances and affirmative and negative covenants and in some instances, common area obligations.  Our tenants and borrowers have primary responsibilities for compliance with these requirements pursuant to our lease and loan agreements.  We believe that each of our tenants and borrowers have the necessary permits and approvals to operate and conduct their businesses on our properties.

Environmental Matters

General.  All real property and the operations conducted on real property are subject to federal, state and local laws and regulations relating to human health and the environment. Certain of these laws and regulations may impose joint and several liability on certain statutory classes of persons, including owners or operators, for the costs of investigation or remediation of contaminated properties, regardless of fault or the legality of the original disposal.  

---

 

These laws and regulations apply to past and present business operations of our tenants and borrowers and the use, storage, handling and contracting for recycling or disposal of hazardous substances or wastes.  Our tenants and borrowers are obligated to comply with environmental laws.  Our leases and loans typically impose obligations on our tenants and borrowers to indemnify us from all or most compliance costs we may experience as a result of the environmental conditions on our properties.  If a tenant or borrower fails to, or cannot, comply we may be required to pay such costs.  We are not aware of any environmental condition with respect to any of our properties which would have a material adverse effect on our business, financial condition or results of operations.  We cannot predict whether new or more stringent laws relating to the environment will be enacted in the future or how such laws will impact the operations of businesses at our properties. Costs associated with an environmental event could be substantial.

Superlien Laws.  Under the laws of many states, contamination on a site may give rise to a lien on the site for clean‑up costs. In several states, such a lien has priority over all existing liens, including those of existing mortgages. In these states, the lien of a mortgage may lose its priority to such a “superlien.”

CERCLA.  The federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or CERCLA, imposes strict liability on present and past “owners” and “operators” of a contaminated site for the costs of clean‑up.  A secured lender may be liable as an “owner” or “operator” of a contaminated site if agents or employees of the lender have participated in the management of such site or in the operations of the tenant.  Excluded from CERCLA’s definition of “owner” or “operator” however, is a person “who without participating in the management of the facility, holds indicia of ownership primarily to protect his security interest”.   This is the so called “secured creditor exemption.”  With respect to most of the assets in our investment portfolio, we are the owner of the real property.  However, with respect to a few of the assets in our investment portfolio, we are not the owner of the property but have a mortgage loan on the property.  In both instances, we believe we meet the secured creditor exemption.

Liability is not limited to the original or unamortized principal balance of a loan or to the value of the site securing a loan.  CERCLA provides substantial protection to lenders by defining the activities in which a lender can engage and still have the benefit of the secured creditor exemption. In order for a lender to be deemed to have participated in the management of a site, the lender must actually participate in the operational affairs of the site or our tenant or borrower. CERCLA provides that “merely having the capacity to influence, or unexercised right to control” operations does not constitute participation in management.  A lender may lose the protection of the secured creditor exemption only if it exercises decision‑making control over our tenant’s or borrower’s environmental compliance and hazardous substance handling and disposal practices, or assumes responsibility for substantially all operational functions at the site or overall management encompassing day‑to‑day decision making with regard to environmental compliance.  CERCLA also provides that a lender will continue to have the benefit of the secured creditor exemption even if it forecloses on a site, purchases it at a foreclosure sale or accepts a deed‑in‑lieu of foreclosure provided that the lender seeks to sell the site at the earliest practicable commercially reasonable time on commercially reasonable terms.

Certain Other Federal and State Laws.  Many states have statutes similar to CERCLA, and not all of those statutes provide for a secured creditor exemption.  In addition, under federal law, there is potential liability relating to hazardous wastes and underground storage tanks under the Federal Resource Conservation and Recovery Act, or RCRA.  The definition of “hazardous substances” under CERCLA specifically excludes petroleum products.  Subtitle I of RCRA governs underground petroleum storage tanks.  The protections accorded to lenders under CERCLA are also accorded to the holders of security interests in underground petroleum storage tanks if the lender does not participate in management of the underground storage tanks and is not otherwise engaged in petroleum production, refining or marketing.  It should be noted, however, that liability for cleanup of petroleum contamination may be governed by state law, which may not provide for any specific protection for secured creditors.

In a few states, transfers of some types of sites are conditioned upon cleanup of contamination prior to transfer. In these cases, a lender that becomes the owner of a site through foreclosure, deed in lieu of foreclosure or otherwise, may be required to clean up the contamination before selling or otherwise transferring the site.

Also, certain federal, state and local laws govern the removal, encapsulation or disturbance of asbestos‑containing materials, or ACMs, in the event of the remodeling, renovation or demolition of a building. Such

---

 

laws, as well as common law standards, may impose liability for releases of ACMs and may provide for third parties to seek recovery from owners or operators of sites for personal injuries associated with such releases.

Beyond statute‑based environmental liability, there exist common law causes of action (for example, actions based on nuisance or on toxic tort resulting in death, personal injury or damage to site) related to hazardous environmental conditions on a site.  While it may be more difficult to hold a lender liable in such cases, unanticipated or uninsured liabilities of our tenant or borrower may jeopardize the tenant’s or borrower’s ability to meet its lease or loan obligations.

Additional Considerations.  The cost of remediating hazardous substance contamination at a site can be substantial. If a lender becomes liable, it can bring an action for contribution against the owner or operator who created the environmental hazard, but that individual or entity may be without substantial assets.

If a lender forecloses on a mortgage secured by a site on which business operations are subject to environmental laws and regulations, the lender will be required to operate the site in accordance with those laws and regulations.  Such compliance may result in substantial expense.

In addition, a lender may be obligated to disclose environmental conditions on a site to government entities and/or to prospective buyers (including prospective buyers at a foreclosure sale or following foreclosure).  Such disclosure may decrease the amount that prospective buyers are willing to pay for the affected site, sometimes substantially, and thereby decrease the ability of the lender to recoup its investment in a loan upon foreclosure.

Emerging Growth Company Status

We currently qualify as an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies,” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a non-binding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We plan to take advantage of these exemptions for our 2015 proxy statement.

In addition, an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, or the Securities Act, for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we are choosing to “opt out” of such extended transition period, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for all public companies which are not emerging growth companies. Our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

We could remain an “emerging growth company” for up to five years after our IPO, or until the earliest of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1 billion, (ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which would occur if the market value of shares of our common stock that are held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iii) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three year period.

Available Information

We electronically file with the Securities and Exchange Commission our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, pursuant to Section 13(a) of the Exchange Act.  You may obtain a free copy of our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports on the day of filing with the SEC on our website at www.storecapital.com, or by sending an email message to info@storecapital.com.  

---

 

Item 1A.  RISK FACTORS

There are many factors that affect our business and the results of our operation, some of which are beyond our control.  The following is a description of important factors that may cause our actual results of operations in future periods to differ materially from those currently expected or discussed in forward-looking statements set forth in this Annual Report.  Forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Annual Report, and we expressly disclaim any obligation or undertaking to update or revise any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based, except to the extent otherwise required by law.

Risks Related to Our Business

Our business depends on our customers successfully operating their businesses on real estate we own or finance for them, and their failure to do so could materially and adversely affect our business.    Substantially all of our properties are leased by customers operating a business at those locations where sales and profits are generated for their businesses.  We underwrite and evaluate investment risk based on our belief that the most important, and primary, source of payment for our leases and loans is unit‑level profitability.  While a tenant may have other sources of payment to meet its obligations, we believe the success of our investments materially depends upon whether our customers successfully operate their businesses, and thus generate unit‑level profitability, at the location or locations we are acquiring or financing.  Our customers may be adversely affected by many factors beyond our control that might render one or more of their locations uneconomic.  These factors include poor management, changing demographics, a downturn in general economic conditions or changes in consumer trends that decrease demand for our customers’ products or services.  The occurrence of any of these may cause our customers to fail to pay rent when due, fail to pay real estate taxes when due, fail to pay insurance premiums when due, become insolvent or declare bankruptcy, any of which could materially and adversely affect our business.

Our investments are and are expected to continue to be concentrated in the single‑tenant, middle‑market sector, and if the demand of single‑tenant, middle‑market companies for net‑lease financing fails to increase or decreases, or if the supply of net‑lease financing increases in this sector, we could be materially and adversely affected.    Our target market is middle‑market companies that operate their businesses out of one or more locations that generate unit‑level profitability for the business.  Historically, many companies prefer to own, rather than lease, the real estate they use in their businesses.  A failure to increase demand for our products by, among other ways, failing to convince middle‑market companies to sell and lease back their STORE Properties, or a decrease in the demand of middle‑market companies to rent STORE Properties or an increase in the availability of STORE Properties for rent could materially and adversely affect us.

If we do not have sufficient access to debt and equity, we will be unable to continue to grow by acquiring STORE Properties.    As a REIT, we are required to distribute at least 90% of our REIT taxable income, determined without regard to the dividends‑paid deduction and excluding any net capital gain, each year to our stockholders.  As a result, our ability to retain earnings to fund acquisitions or make any capital expenditures, if required, will be limited.  Our long‑term ability to grow through additional investments will be limited if we cannot obtain additional debt or equity financing.  We cannot guarantee that debt or equity financing will be available to us in the future, or that we will be able to obtain it on favorable terms.

We depend on the asset‑backed securities market and the commercial mortgage‑backed securities market for our long‑term debt financing.  We depend on, and we likely will continue to depend on, the asset‑backed securities, or ABS, and the CMBS markets for our long‑term debt financing.  Substantially all of the long‑term debt on our balance sheet has been obtained from debt offerings in the ABS and CMBS markets. The ABS debt is issued by bankruptcy remote, special purpose entities that we or our subsidiaries own.  These special purpose entities issue multiple series of investment‑grade ABS notes from time to time as additional collateral is added to the collateral pool.  Our CMBS debt is generally in the form of first mortgage debt incurred by other special purpose entities that we or our subsidiaries own.  Our ABS and CMBS debt is generally non‑recourse.  However, there are customary limited exceptions to recourse for matters such as fraud, misrepresentation, gross negligence or willful misconduct, misapplication of payments, bankruptcy and environmental liabilities.

---

 

In the event of a disruption in the financial markets for ABS or CMBS debt, our ability to obtain long‑term debt may be materially and adversely affected.  As a result, we may acquire real estate assets at a lower than anticipated growth rate, or we may be unable to acquire additional real estate assets.  In addition, this disruption may affect our return on equity as a result of the decrease in the availability of long‑term debt or leverage for us.  Furthermore, a reduction in the difference, or spread, between the rate we earn on our assets and the rate we pay on our liabilities (primarily our long‑term debt), which would occur if the interest rates available to us on future debt issuances increase faster than the lease rates we can charge our customers on STORE Properties we acquire and lease back to them, could have a material and adverse effect on our financial condition.

Failure to mitigate our exposure to interest rate volatility changes may materially and adversely affect us.  We attempt to mitigate our exposure to interest rate risk by entering into long‑term fixed-rate financing through the combination of periodic debt offerings under STORE Master Funding, our ABS conduit, through discrete non‑recourse secured borrowings, through insurance company and bank borrowings, by laddering our borrowing maturities and by using leases that generally provide for rent escalations during the term of the lease.  However, the weighted average term of our borrowings does not match the weighted average term of our investments, and the methods we employ to mitigate our exposure to changes in interest rates involve risks, including the risk that the debt markets are volatile and tend to reflect the conditions of the then‑current economic climate.  Our efforts may not be effective in reducing our exposure to interest rate changes.  Failure to effectively mitigate our exposure to changes in interest rates may materially and adversely affect us by increasing our cost of capital and reducing the net returns we earn on our portfolio.

A significant portion of our assets have been pledged to secure the borrowings of our subsidiaries.    A significant portion of our investment portfolio consists of assets owned by our consolidated, bankruptcy remote, special purpose entity subsidiaries that have been pledged to secure the long‑term borrowings of those subsidiaries.  As of December 31, 2014, the total outstanding principal balance of non‑recourse debt obligations of our consolidated special purpose entity subsidiaries was $1.3 billion, and approximately $1.9 billion in assets held by those subsidiaries had been pledged to secure those borrowings.  We or our other consolidated subsidiaries are the equity owners of these special purpose entities, meaning we are entitled to the excess cash flows after debt service and all other required payments are made on the debt of these entities.    If our subsidiaries fail to make the required payments on this indebtedness, distributions of excess cash flow to us may be reduced or suspended and the indebtedness may become immediately due and payable.  If the subsidiaries are unable to pay the accelerated indebtedness, the pledged assets could be foreclosed upon and distributions of excess cash flow to us may be suspended or terminated.  In this case, our ability to make distributions to our stockholders could be materially and adversely affected.

Loss of our key personnel could materially impair our ability to operate successfully.    As an internally managed company, our ability to achieve our investment objectives and to make distributions to our stockholders depends upon the performance of our senior leadership team. We rely on our senior leadership team to, among other things, identify and consummate acquisitions, design and implement our financing strategies, manage our investments and conduct our day‑to‑day operations.  In particular, our success depends upon the performance of Mr. Volk, our Chief Executive Officer, and other members of our senior leadership team.

We cannot guarantee the continued employment of any of the members of our senior leadership team, who may choose to leave our company for any number of reasons, such as other business opportunities, differing views on our strategic direction or other personal reasons.  We rely on the experience, efforts and abilities of these individuals, each of whom would be difficult to replace.  The employment agreements we have entered into with each of these executives do not guarantee their continued service to us.  The loss of services of one or more members of our senior leadership team, or our inability to attract and retain highly qualified personnel, could adversely affect our business, diminish our investment opportunities and weaken our relationships with lenders, business partners, existing and prospective tenants and industry personnel, all of which could materially and adversely affect us.

We have a limited operating history, and our past experience may not be sufficient to allow us to successfully operate as a public company going forward.  We commenced business in May 2011.  We cannot assure you that our past experience will be sufficient to successfully operate our company as a publicly traded company, including the requirements to timely meet disclosure requirements of the Securities Exchange Act of 1934, as amended, and comply with the Sarbanes‑Oxley Act.  We  are required to develop and implement disclosure and control systems and procedures to satisfy our periodic and current reporting requirements under applicable U.S. Securities and Exchange

---

 

Commission, or SEC, regulations and comply with the NYSE listing standards, and this transition could place a significant strain on our management systems, infrastructure and other resources.  Failure to operate successfully as a public company could materially and adversely affect us.

Our success depends in part on the creditworthiness of our customers, and we lease most of our properties to non-rated customers.  Our underwriting and risk‑management procedures that we use to evaluate a potential customer’s credit risk may be faulty, deficient or otherwise fail to accurately reflect the risk of our investment.    Our customers are mostly middle‑market companies, which generally are not rated by a nationally recognized rating agency.  We use external and internal tools to evaluate risk and predict the risk of default.  When we review a potential investment, we view our sources of payment to be, in order of priority, unit‑level profitability, tenant credit quality and residual real estate valuation.  Additionally, we review a potential customer’s management team and the macroeconomic trends of the industry in which that customer operates.  We evaluate the risk of company insolvency using a third‑party model, Moody’s Analytics RiskCalc, which is a model for predicting private company defaults based on Moody’s Analytics Credit Research Database and which provides us an Estimated Default Frequency, or EDF, for each of our customers.  We then estimate the risk of lease or loan rejection by assigning a probability of termination based on the unit‑level fixed charge coverage ratio, or unit FCCRs, at the property or properties we own.  We then estimate the long‑term default risk of an investment by multiplying the EDF score by our estimated probability that our lease will be rejected in bankruptcy, which we call the “STORE Score.”

Our methods may not adequately assess the risk of an investment.  Moody’s Analytics RiskCalc, our methodology of estimating probability of lease rejection and the STORE Score may be inaccurate, incomplete or otherwise fail to adequately assess default risk.  An EDF score from Moody’s Analytics RiskCalc is not the same as a published credit rating and lacks the extensive company participation that is typically involved when a rating agency publishes a rating.  EDF scores and FCCRs are calculated based on financial information provided to us by our customers and prospective customers without independent verification by us.  The probability of lease rejection we assign an investment based on unit FCCR or other factors may be inaccurate.  Moreover, the risks we have identified as our principal risks may omit significant risks to our investments.  If our underwriting procedures fail to properly assess the unit‑level profitability, tenant or corporate credit risk or real estate value of potential investments, then we may invest in properties that result in tenant defaults, and we may be unable to recover our investment by re‑leasing or selling the related property, which could materially and adversely affect our operating results and financial position.

The bankruptcy or insolvency of any of our tenants could result in the termination of such tenant’s lease and material losses to us.    A tenant bankruptcy or insolvency could diminish the rental revenue we receive from that property or could force us to “take back” a property as a result of a default or a rejection of the lease by a tenant in bankruptcy.  Any claims against bankrupt tenants for unpaid future rent would be subject to statutory limitations that would likely result in our receipt, if at all, of rental revenues that are substantially less than the contractually specified rent we are owed under their leases.  In addition, any claim we have for unpaid past rent will likely not be paid in full.  If a tenant becomes bankrupt or insolvent, federal law may prohibit us from evicting such tenant based solely upon such bankruptcy or insolvency.  We may also be unable to re‑lease a terminated or rejected space or re‑lease it on comparable or more favorable terms.

Many of our tenants lease multiple properties from us under master leases.  Bankruptcy laws afford certain protections to a tenant that may also affect the master lease structure.  Subject to certain restrictions, a tenant under a master lease generally is required to assume or reject the master lease as a whole, rather than making the decision on a property‑by‑property basis.  This prevents the tenant from assuming only the better performing properties and terminating the master lease with respect to the poorer performing properties.  If these tenants are considering filing for bankruptcy protection, we may find it necessary to agree to amend their master leases to remove certain underperforming properties rather than risk the tenant rejecting the entire master lease in bankruptcy.  Whether or not a bankruptcy court will require a master lease to be assumed or rejected as a whole depends upon a “facts and circumstances” analysis.  A bankruptcy court will consider a number of factors, including the parties’ intent, the nature and purpose of the relevant documents, whether there was separate and distinct consideration for each property included in the master lease, the provisions contained in the relevant documents and applicable state law.  If a bankruptcy court allows a master lease to be rejected in part, certain underperforming leases related to properties we own could be rejected by the tenant in bankruptcy, thereby adversely affecting payments derived from the properties.  As a result, tenant bankruptcies could materially and adversely affect us.

---

 

Our financial monitoring, periodic site inspections and selective property sales may fail to mitigate the risk of customer defaults, and if a customer defaults, we may experience difficulty or a significant delay in re‑leasing or selling the property.    Our portfolio‑management activities, including financial monitoring, periodic site inspections and selective property sales, may be insufficient to prevent or reduce the frequency of tenant defaults.    If a tenant defaults, it will likely cause a significant or complete reduction in our revenue from that property for some time. If a defaulting tenant is unable to recover financially, we may have to re‑lease or sell the property.  Re‑leasing or selling properties may take a significant amount of time, during which the property might have a negative cash flow to us and we may incur other related expenses.  We may also have to renovate the property, reduce the rent or provide an initial rent abatement or other incentive to attract a potential tenant or buyer before we can re‑lease or sell the property. During this period, we likely will incur ongoing expenses for property maintenance, taxes, insurance and other costs.  Therefore, tenant defaults could materially and adversely affect us.

As leases expire, we may be unable to renew those leases or re‑lease the space on favorable terms or at all.    Our success depends in part upon our ability to cause our properties to be occupied and generating revenue.  As of December 31, 2014, leases and loans representing approximately 10% of our annualized base rent and interest will expire prior to 2025.  We cannot guarantee you that we will be able to renew leases or re‑lease space (i) without an interruption in the rental revenue from those properties, (ii) at or above our current rental rates, or (iii) without having to offer substantial rent abatements, tenant improvement allowances, early termination rights or below‑market renewal options.  The difficulty, delay and cost of renewing leases, re‑leasing space and leasing vacant space could materially and adversely affect us.

The geographic concentration of our properties could make us vulnerable to an economic downturn, regulatory changes or acts of nature in those areas, resulting in a decrease in our revenues or other negative impacts on our results of operations.    As of December 31, 2014, the five states from which we derive the largest amount of our annualized base rent and interest were Texas (13.6%), Illinois (6.9%), Georgia (6.0%), Tennessee (5.9%), and Florida (5.0%).    As a result of these concentrations, the conditions of local economies and real estate markets, changes in state or local governmental rules and regulations, acts of nature and other factors in these states could result in a decrease in the demand for the products offered by the businesses operating on the properties in those states, which would have an adverse impact on our customers’ revenues, costs and results of operations, thereby adversely affecting their ability to meet their obligations to us.

As we continue to acquire properties, we may decrease or fail to increase the diversity of our portfolio.    We have broad authority to invest in any STORE Property that we may identify in the future.  As we continue to acquire properties, our portfolio may become less diverse by tenant, industry or geographic area.  If our portfolio becomes less diverse, the trading price of our common stock may fall, as our business will be more sensitive to the bankruptcy or insolvency of fewer tenants, to changes in consumer trends of a particular industry and to a general economic downturn in a particular geographic area.

A decrease in demand for restaurant space or a downturn in the restaurant industry could materially and adversely affect us.  As of December 31, 2014, real estate investments operated by customers in the restaurant industry represented approximately 28.1% of the dollar amount of our investment portfolio and 27.9% of our annualized base rent and interest, and, in the future, it is likely we will acquire additional restaurant properties.  Because the restaurant industry represents a significant portion of our portfolio, a downturn in the restaurant industry may have a material adverse effect on us.

We have investments in industries that depend upon discretionary spending by consumers.  A reduction in the willingness or ability of consumers to use their discretionary income in the businesses of our customers and potential customers could reduce the demand for our net‑lease solutions.  Most of our portfolio is leased to or financed with customers operating service or retail businesses on our property locations.  Restaurants, early childhood education centers, health clubs, movie theaters and sporting goods stores represent the largest industries in our portfolio; and Gander Mountain, Ashley Furniture HomeStore, Applebee’s, Popeyes Louisiana Kitchen and Starplex Cinemas represent the largest concepts in our portfolio.  The success of most of these businesses depends on the willingness of consumers to use discretionary income to purchase their products or services.  A downturn in the economy could cause consumers to reduce their discretionary spending, which may have a material adverse effect on us.

---

 

Some of our tenants are subject to government regulation and rely on government funding, which could adversely impact their ability to make timely lease payments to us.  The industries in which some of our tenants operate are subject to government regulation, and these businesses may depend, to various extents, on government funding or reimbursements. For example, tenants in the education industry often rely extensively on local, state and federal government funding for their students’ tuition payments. In addition, tenants in the healthcare and childcare‑related industries typically receive local, state or federal funding, subsidies or reimbursements. The amount and timing of these various fundings, subsidies and reimbursements depend on various factors beyond our or our tenants’ control, including government budgets and policies and political issues. Some of these tenants also must satisfy certain licensure or certification requirements in order to qualify for government funding, subsidies or reimbursements. If these tenants fail to satisfy these requirements or otherwise fail to receive government funding, when and as needed, including as a result of tightened government budgets, revised funding policies or otherwise, their cash flow could be materially affected causing them to default on our leases, which could adversely impact our business. As we continue to grow our investment portfolio, we may continue to invest in these industries and expand our business into other industries that operate in highly regulated environments and rely significantly on payments from government payors. Changes in regulatory requirements or government funding policies affecting our tenants may result in lease defaults, which would reduce our revenues and harm our results of operations and financial position.

We may be unable to identify and complete acquisitions of suitable properties, and the competition for acquisitions may reduce the number of acquisitions we can complete, either of which may impede our growth and the continued diversification of our portfolio.    Our ability to continue to acquire suitable properties may be constrained by numerous factors, including the following:

If any of these risks occur, we may be materially and adversely affected.

Insurance on our properties, which our tenants are typically required to maintain, may not adequately cover all losses, and uninsured losses could materially and adversely affect us.    Our leases and loan agreements typically require that our tenants and borrowers maintain insurance of the types and in the amounts that are usual and customary for similar types of commercial property, as reviewed by our independent insurance consultant.  Under certain circumstances, however, we may permit certain tenants and borrowers to self‑insure.  Depending on the location of the property, losses of a catastrophic nature, such as those caused by earthquakes or floods, may be covered by insurance policies that are held by our tenants with limitations, such as large deductibles or co‑payments that a tenant may not be able to meet.

In addition, factors such as inflation, changes in building codes and ordinances, environmental considerations and others, including terrorism or acts of war, may make any insurance proceeds we receive insufficient to repair or

---

 

replace a property if it is damaged or destroyed.  In that situation, the insurance proceeds we receive may not be adequate to restore our economic position with respect to the affected real property.  In the event we experience a substantial or comprehensive loss of any of our properties, we may not be able to rebuild such property to its existing specifications without significant capital expenditures, which may exceed any amounts received pursuant to insurance policies, as reconstruction or improvement of such a property would likely require significant upgrades to meet zoning and building code requirements.  The loss of our capital investment in, or anticipated future returns from, our properties due to material uninsured losses could materially and adversely affect us.

Changes in zoning laws may prevent us from restoring a property in the event of a substantial casualty loss.    Due to changes, among other things, in applicable building and zoning ordinances and codes, or zoning laws, affecting certain of our properties that have come into effect after the construction of the properties, certain properties may not comply fully with current zoning laws, including use, parking and setback requirements, but may qualify as permitted non‑conforming uses.  Such changes may limit our or our tenant’s ability to restore the premises of a property to its previous condition in the event of a substantial casualty loss with respect to the property or the ability to refurbish, expand or renovate such property to remain compliant.  If we are unable to restore a property to its prior use after a substantial casualty loss, we may be unable to re‑lease the space at a comparable rent or sell the property at an acceptable price, which may materially and adversely affect us.

Some of our customers operate under franchise or license agreements, which, if terminated or not renewed prior to the expiration of their leases with us, would likely impair their ability to pay us rent.    As of December 31, 2014, 20% of our customers operated under franchise or license agreements.  Generally, franchise agreements have terms that end earlier than the respective expiration dates of the related leases.  In addition, a tenant’s or borrower’s rights as a franchisee or licensee typically may be terminated and the tenant or borrower may be precluded from competing with the franchisor or licensor upon termination.  Usually, we have no notice or cure rights with respect to such a termination and have no rights to assignment of any such franchise agreement.  This may have an adverse effect on our ability to mitigate losses arising from a default on any of our leases or loans.  A franchisor’s or licensor’s termination or refusal to renew a franchise or license agreement would likely have a material adverse effect on the ability of the tenant or borrower to make payments under its lease or loan, which could materially and adversely affect us.

A small percentage of the businesses operating on our properties have limited operating histories, which increases the risk that the tenants operating those businesses may default on rent payments to us. As of December 31, 2014, 29 of the 947 properties in our investment portfolio had been open for less than 12 months or were under construction.  The businesses operating on these properties, whether newly constructed or recently opened, may not perform as anticipated, and the tenant may become unable to pay rent to us, which may materially and adversely affect us.

If a tenant defaults under either the ground lease or mortgage loan of a hybrid lease, we may be required to take judicial or administrative action or begin foreclosure proceedings before we can re‑lease or sell the property.    As of December 31, 2014, 4.7% of our annualized base rent and interest was derived from hybrid leases.  A hybrid lease is a modified sale‑leaseback transaction, where the customer sells us their land, leases the land back from us under a ground lease and we simultaneously make a mortgage loan to the customer secured by the improvements the customer continues to own.  If a customer defaults under a hybrid lease, we may: (1) evict the customer under the ground lease and assume ownership of the improvements; or (2) if required by a court, foreclose on the mortgage loan that is secured by the improvements.  Under a ground lease, we as ground lessor generally become the owner of the improvements on the land at lease maturity or if the tenant defaults.  It is possible that a court could require us to foreclose on the mortgage secured by the improvements rather than simply evicting the defaulting tenant under the ground lease.  If foreclosure is required rather than simple eviction, we might encounter delays and expenses in obtaining possession of the land and improvements, which in turn could delay our ability to sell or re‑lease the property in a prompt manner, which could materially and adversely affect us.

We are subject to risks related to owning commercial real estate that could reduce the value of our properties.    The value of our investments in commercial real estate is subject to the following risks, among others:

---

 

The occurrence of any of the risks described above may cause the value of our real estate to decline, which could materially and adversely affect us.

Global market and economic conditions may materially and adversely affect us and our tenants.    Our business is sensitive to changes in the overall economic conditions that impact our customers’ financial condition and financing practices.  Adverse economic conditions such as high unemployment levels, interest rates, tax rates and fuel and energy costs may impact the results of our tenants’ operations, which may impact their ability to meet their obligations to us. During periods of economic slowdown, such as the global and U.S. economic downturn of 2008 and 2009, which resulted in increased unemployment, large‑scale business failures and tight credit markets, demand for real estate may decline, resulting in lower rents we can charge or an increased number of defaults under our existing leases.  Accordingly, a decline in economic conditions could materially and adversely affect us.

Illiquidity of real estate investments and restrictions imposed by the Code could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition.    Some of the real estate investments we have made and expect to make in the future may be difficult to sell quickly.  Therefore, our ability to promptly sell one or more properties in our portfolio in response to changing economic, financial or investment conditions could be limited.  In particular, these risks could arise from weaknesses in or even the lack of an established market for a property, changes in the financial condition or prospects of prospective purchasers, changes in national or international economic conditions, such as the most recent economic downturn, and changes in laws, regulations or fiscal policies of the jurisdiction in which our properties are located.

In addition, the Code imposes restrictions on a REIT’s ability to dispose of properties, which restrictions are not applicable to other types of real estate companies.  In particular, the tax laws applicable to REITs effectively require that we hold our properties for investment, rather than primarily for sale in the ordinary course of business, which may cause us to forgo or defer sales of properties that otherwise would be in our best interest.  Therefore, we may not be able to vary our portfolio in response to economic or other conditions promptly or on favorable terms, which may materially and adversely affect our operations, cash flow and ability to pay distributions on our common stock.

Inflation may materially and adversely affect us and our tenants. We may experience periods when inflation is greater than the increases in rent provided by many of our leases, in which event rent increases will not keep up with the rate of inflation.  If this occurs, we will not have the source of internal growth we expect.  Also, increased costs may have an adverse impact on our tenants if increases in their operating expenses exceed increases in revenue, which may adversely affect our customers’ ability to satisfy their financial obligations to us.

Property vacancies could result in significant capital expenditures.    The loss of a tenant, either through lease expiration or tenant bankruptcy or insolvency, may require us to spend significant amounts of capital to renovate the property before it is suitable for a new tenant and cause us to incur significant costs in the form of ongoing expenses for property maintenance, taxes, insurance and other expenses.  Many of the leases we enter into or acquire are for properties that are especially suited to the particular business of the tenants operating on those properties.  Because these properties have been designed or physically modified for a particular tenant, if the current lease is terminated or not renewed, we may be required to renovate the property at substantial costs, decrease the rent we charge or provide other concessions to re‑lease the property.  In addition, if we are required to sell the property, we may have difficulty selling it to a party other than the tenant due to the special purpose for which the property may have been designed or modified.  This potential illiquidity may limit our ability to quickly modify our portfolio in response to changes in economic or other conditions, including tenant demand. These limitations may materially and adversely affect us.

---

 

The loss of a borrower or the failure of a borrower to make loan payments on a timely basis will reduce our revenues and may cause us to incur substantial costs, which could lead to losses on our investments and reduced returns to our stockholders.    From time to time, we make or assume commercial mortgage loans.  We have also made a limited amount of investments on properties we own or finance in the form of loans secured by equipment or other fixtures owned by our customers.  The success of our loan investments materially depends on the financial stability of our borrowers.  The success of our borrowers depends on each of their individual businesses and their industries, which could be affected by economic conditions in general, changes in consumer trends and preferences and other factors over which neither they nor we have control.  A default of a borrower on its loan payments to us that would prevent us from earning interest or receiving a return of the principal of our loan could materially and adversely affect us.  In the event of a default, we may also experience delays in enforcing our rights as lender and may incur substantial costs in collecting the amounts owed to us and in liquidating any collateral.

Foreclosure and other similar proceedings used to enforce payment of real estate loans are generally subject to principles of equity, which are designed to relieve the indebted party from the legal effect of that party’s default.  Foreclosure and other similar laws may limit our right to obtain a deficiency judgment against the defaulting party after a foreclosure or sale.  The application of any of these principles may lead to a loss or delay in the payment on loans we hold, which in turn could reduce the amounts we have available to make distributions.  Further, in the event we have to foreclose on a property, the amount we receive from the foreclosure sale of the property may be inadequate to fully pay the amounts owed to us by the borrower and our costs incurred to foreclose, repossess and sell the property, which could materially and adversely affect us.

Our investments in mortgage loans may be affected by unfavorable real estate market conditions, which could decrease the value of those loans.    As of December 31, 2014, we had investments in mortgage loans having an aggregate unpaid principal balance of $65 million.  Investments in mortgage loans are subject to the risk of default by the borrowers and interest‑rate risks.  To the extent we incur delays in liquidating defaulted mortgage loans, we may not be able to obtain all amounts due to us under such loans.  Further, the values of the properties securing the mortgage loans may not remain at the levels existing on the dates of origination of those mortgage loans or the dates of our investment in the loans.  If the values of the underlying properties decline, the value of the collateral securing our mortgage loans will also decline, and if we were to foreclose on any of the properties securing the mortgage loans, we may not be able to sell or lease them for an amount equal to the unpaid amounts due to us under the mortgage loans.  As a result, defaults on mortgage loans in which we may invest may materially and adversely affect us.

Compliance with the Americans with Disabilities Act and fire, safety and other regulations may require us to make significant unanticipated expenditures that could materially and adversely affect us.    Our properties are subject to the Americans with Disabilities Act, or ADA.  Under the ADA, all public accommodations must meet federal requirements related to access and use by disabled persons.  Compliance with the ADA could require us to modify the properties we own or may purchase to remove architectural and communication barriers in order to make our properties readily accessible to and usable by disabled individuals, and may restrict renovations on our properties.  Failure to comply with the ADA could result in the imposition of fines or an award of damages to private litigants, as well as the incurrence of the costs of making modifications to attain compliance.  Future legislation could impose additional obligations or restrictions on our properties.  Our tenants and borrowers are generally responsible to maintain and repair our properties pursuant to our lease and loan agreements, including compliance with the ADA and other similar laws and regulations, but we could be held liable as the owner of the property for their failure to comply with the ADA or other similar laws and regulations.  Any required changes could involve greater expenditures than anticipated or the changes might be made on a more accelerated basis than anticipated, either of which could adversely affect the ability of our tenants to cover such costs.  If we are subject to liability under the ADA or similar laws and regulations as an owner and our tenants are unable to cover the cost of compliance or if we are required to expend our own funds to comply with the ADA or similar laws and regulations, we could be materially and adversely affected.

In addition, our properties are subject to various laws and regulations relating to fire, safety and other regulations, and in some instances, common‑area obligations.  Our tenants and borrowers have primary responsibility for compliance with these requirements pursuant to our lease and loan agreements.  Our tenants and borrowers may not have the financial ability to fully comply with these regulations.  If our tenants and borrowers are unable to comply with these regulations, they may be unable to pay rent on time or may default, or we may have to make substantial capital expenditures to comply with these regulations, which we may not be able to recoup from our tenants and

---

 

borrowers.  We may also face owner liability for failure to comply with these regulations, which may lead to the imposition of fines or an award of damages to private litigants.  Therefore, the failure of our tenants and borrowers to comply with these regulations could materially and adversely affect us.

The costs of compliance with or liabilities related to environmental laws may materially and adversely affect us.  Our properties may be subject to known and unknown environmental liabilities under various federal, state and local laws and regulations relating to human health and the environment.  Certain of these laws and regulations may impose joint and several liability on certain statutory classes of persons, including owners or operators, for the costs of investigation or remediation of contaminated properties.  These laws and regulations apply to past and present business operations on the properties, and the use, storage, handling and recycling or disposal of hazardous substances or wastes.  We may face liability regardless of our knowledge of the contamination, the timing of the contamination, the cause of the contamination or the party responsible for the contamination of the property.  Our leases and loans typically impose obligations on our tenants and borrowers to indemnify us from all or most compliance costs we may experience as a result of the environmental conditions on our properties, but if a tenant or borrower fails to, or cannot, comply, we may be required to pay such costs.  We cannot predict whether in the future, new or more stringent environmental laws will be enacted or how such laws will impact the operations of businesses on our properties.  Costs associated with an adverse environmental event could be substantial, and the potential liability as to any of our properties is generally not limited under such laws and regulations and could significantly exceed the value of such property.

Under the laws of many states, contamination on a site may give rise to a lien on the site for clean‑up costs.  In several states, such a lien has priority over all existing liens, including those of existing mortgages.  In these states, a lien of a mortgage may lose its priority to such a “superlien.”  If any of the properties on which we have a mortgage are or become contaminated and subject to a superlien, we may not be able to recover the full value of our investment and may be materially and adversely affected.

Certain federal, state and local laws, regulations and ordinances govern the use, removal and/or replacement of underground storage tanks in the event of a release on, or an upgrade or redevelopment of, certain properties.  Such laws, as well as common‑law standards, may impose liability for any releases of hazardous substances associated with the underground storage tanks and may provide for third parties to seek recovery from owners or operators of such properties for damages associated with such releases.  If hazardous substances are released from any underground storage tanks on any of our properties, we may be materially and adversely affected.

In a few states, transfers of some types of sites are conditioned upon cleanup of contamination prior to transfer, including in cases where a lender has become the owner of the site through a foreclosure, deed in lieu of foreclosure or otherwise.  If any of our properties are subject to such contamination, we may be subject to substantial clean‑up costs before we are able to sell or otherwise transfer the property.

Certain federal, state and local laws, regulations and ordinances govern the removal, encapsulation or disturbance of asbestos‑containing materials, or ACMs, in the event of the remodeling, renovation or demolition of a building. Such laws, as well as common‑law standards, may impose liability for releases of ACMs and may impose fines and penalties against us or our tenants for failure to comply with these requirements or provide for third parties to seek recovery from us or our tenants.

If we or our tenants or borrowers become subject to any of the above‑ mentioned environmental risks, we may be materially and adversely affected.

Our properties may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediation.    When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time.  Some molds may produce airborne toxins or irritants.  Exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions.  If our tenants or their employees or customers are exposed to mold at any of our properties, we could be required to undertake a costly remediation program to contain or remove the mold from the affected property.  In addition, exposure to mold by our tenants or others could subject us to liability if property damage or health concerns arise.  If we were to become subject to significant mold‑related liabilities, we could be materially and adversely affected, which could harm our business.

---

 

Our proprietary IT platform may not capture all of the necessary information to allow us to properly monitor and analyze our tenants’ and borrowers’ credit risk, which may materially and adversely affect us.    We have a proprietary information technology, or IT, platform, which we developed to proactively manage our investment portfolio. Our IT platform offers customer relationship management and general ledger and servicing system integration.  Another component of our IT platform is the STORE Universal Database System, or SUDS, which provides our management with access to lease abstracts, tenant information, document scans, property data and servicing information.  Our IT platform and SUDS may not capture all the information needed to mitigate the risk of tenant or borrower default.

Our revenues and expenses are not directly correlated and, because a large percentage of our costs and expenses are fixed, we may not be able to adapt our cost structure to offset declines in our revenue.    Most of the expenses associated with our business, such as our office rent, certain acquisition costs, insurance, employee wages and benefits and other general corporate expenses, are relatively inflexible and will not necessarily decrease with a reduction in revenue from our business.  Our expenses also will be affected by inflationary increases, and certain of our cost increases may exceed the rate of inflation in any given period.  By contrast, our revenue is affected by many factors beyond our control, such as the economic conditions of the markets where we own properties.  As a result, we may not be able to fully offset rising costs by increasing our rents, which could have a material and adverse effect on us.

We may become subject to litigation, which could materially and adversely affect us.    In the future we may become subject to litigation, including claims relating to our operations, debt and equity offerings and otherwise in the ordinary course of business.  Some of these claims may result in significant defense costs and potentially significant judgments against us, some of which are not, or cannot be, insured against.  We generally intend to defend ourselves, but we cannot be certain of the ultimate outcomes of any claims that may arise.  Resolution of these types of matters against us may result in our having to pay significant fines, judgments or settlements, which, if uninsured, or if the fines, judgments and settlements exceed insured levels, could adversely impact our earnings and cash flows, thereby materially and adversely affecting us. Certain litigation or the resolution of certain litigation may affect the availability or cost of some of our insurance coverage, which could materially and adversely impact us, expose us to increased risks that would be uninsured and materially and adversely impact our ability to attract directors and officers.

Our portfolio of tenants and borrowers may be riskier than portfolios comprised of rated investment‑grade companies.    Most of our customers have not been assigned a credit rating by any nationally recognized rating agency.    Our method of determining creditworthiness of potential customers may be less comprehensive and detailed than the process by which nationally recognized rating agencies assign company credit ratings.  As a result, our investment portfolio of tenants and borrowers may be riskier than a portfolio comprised of rated investment‑grade companies.

We may not acquire the properties that we evaluate in our pipeline.    We actively maintain a multi-billion dollar pipeline of investment opportunities.  However, we typically close only a small percentage (approximately 5%) of all transactions we evaluate.   Transactions may fail to close for a variety of reasons, including the discovery of previously unknown liabilities or other items uncovered during our diligence process.  Similarly, we may never execute binding purchase agreements with respect to properties that are currently subject to non‑binding letters of intent, and properties with respect to which we are negotiating may never lead to the execution of any letter of intent.  For many other reasons, we may not ultimately acquire the remaining properties currently in our pipeline. Accordingly, you should not place undue reliance on the concept of a pipeline as we have referred to in this Annual Report.

Risks Related to Our Organization and Structure

Our controlling stockholder has substantial influence over our business, and its interests, and the interests of certain members of our management, may differ from our interests or those of our other stockholders.    Our controlling stockholder beneficially owns approximately 72% of our outstanding common stock.  As a result, our controlling stockholder has the power to elect a majority of our directors and, consequently, appoint our executive officers, set our management policies and exercise overall control over us and our subsidiaries.

The interests of our controlling stockholder may differ from the interests of our other stockholders, and the concentration of control in our controlling stockholder will limit other stockholders’ ability to influence corporate matters.  In addition, certain members of our management have certain ownership interests in the holding company through which our controlling stockholder owns our securities, which may cause them to have interests that differ from

---

 

our other stockholders.  The concentration of ownership and voting power of our controlling stockholder may also delay, defer or even prevent an acquisition by a third party or other change of control of our company and may make some transactions more difficult or impossible without the support of our controlling stockholder, even if such events are in the best interests of our other stockholders.  The concentration of voting power that our controlling stockholder has may have an adverse effect on the price of our common stock.  As a result of our being controlled by a controlling stockholder, we may take actions that our other stockholders do not view as beneficial, which may adversely affect our results of operations and financial condition and cause the value of your investment in us to decline.  

We are a “controlled company” within the meaning of the NYSE’s rules, and, as a result, qualify for, and intend to rely on, exemptions from certain corporate governance requirements.  You will not have the same protections afforded to stockholders of companies that are subject to such requirements.  Our controlling stockholder controls a majority of the combined voting power of all classes of our stock entitled to vote generally in the election of directors.  As a result, we are a “controlled company” within the meaning of the corporate‑governance standards of the NYSE.  Under these rules, a company of which more than 50% of the voting power in the election of directors is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain corporate‑governance requirements, including but not limited to the following:

We  currently use, and intend to continue to use, all of these exemptions.  As a result, a majority of the directors on our board of directors are not independent.  In addition, although we have a fully independent audit committee, our compensation and nominating and corporate governance committees do not consist entirely of independent directors.  Accordingly, you do not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the NYSE.

Our board of directors may change our investment strategy, financing strategy or leverage policies without stockholder consent.    Our board of directors, which our controlling stockholder has the right to elect for the foreseeable future, may change any of our strategies, policies or procedures with respect to property acquisitions and divestitures, asset allocation, growth, operations, indebtedness, financing and distributions at any time without the consent of our stockholders, which could result in our acquiring properties that are different from, and possibly riskier than, the types of single‑tenant real estate and related investments described in this Annual Report.    These changes could materially and adversely affect us.

Our board’s power to increase the number of authorized shares of our stock without stockholder approval may negatively impact our existing stockholders.    Our charter authorizes our board of directors, with the approval of a majority of the board of directors and without stockholder approval, to amend our charter to increase or decrease the aggregate number of shares of stock or the number of shares of any class or series of stock that we are authorized to issue.  Accordingly, our board could authorize the issuance of shares of common stock or another class or series of stock, including a class or series of preferred stock, that could have the effect of delaying, deferring or preventing a change in control of us that our existing stockholders may view as favorable.  In addition, our board may increase our authorized stock in order to issue additional shares in connection with future financings and other transactions.  These additional issuances could dilute the ownership interests of our existing stockholders.

If we fail to implement and maintain an effective system of integrated internal controls, we may not be able to accurately report our financial results.  As a publicly traded company, we are required to comply with the applicable provisions of the Sarbanes‑Oxley Act, which requires, among other things, that we establish and maintain effective internal controls and procedures for financial reporting and effective disclosure controls and procedures for making required filings with the SEC.  Effective internal and disclosure controls are necessary for us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. If we cannot provide

---

 

reliable financial reports or prevent fraud, our reputation and operating results would be harmed, which could depress the trading price of our common stock.

Designing and implementing an effective system of integrated internal controls is a continuous effort that requires significant resources and devotion of time.  As part of the ongoing monitoring of internal controls required of publicly traded companies, we may discover significant deficiencies or material weaknesses in our internal controls.  As a result of deficiencies or weaknesses that may be identified in our internal controls, we may also identify certain deficiencies in some of our disclosure controls and procedures that we believe require remediation. If we discover deficiencies or weaknesses, we will make efforts to improve our internal and disclosure controls.  However, we may not be successful.  In addition, as an “emerging growth company,” our independent registered public accounting firm will not be required to formally attest to the effectiveness of our internal control over financial reporting until the date we are no longer an “emerging growth company.” 

Any failure to maintain effective controls or timely effect any necessary improvement of our internal and disclosure controls could harm operating results or cause us to fail to meet our reporting obligations, which could affect our ability to remain listed with the NYSE.  Ineffective internal and disclosure controls could also cause investors to lose confidence in our reported financial information, which would likely materially and adversely affect us.

We will continue to incur significant expenses as a result of being a public company, which will negatively impact our financial performance.    We incur, and will continue to incur, significant legal, accounting, insurance and other expenses as a result of being a public company.  The Dodd‑Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd‑Frank Act, and the Sarbanes‑Oxley Act, as well as related rules implemented by the SEC and the NYSE, have required changes in corporate governance practices of public companies.  Although the JOBS Act may for a limited period of time lessen the cost of complying with some of these additional regulatory and other requirements, we nonetheless have experienced a substantial increase in legal, accounting, insurance and certain other expenses, which will negatively impact our results of operations and financial condition.  In addition, rules that the SEC is implementing or is required to implement pursuant to the Dodd‑Frank Act are expected to require additional changes.  We expect that compliance with these and other similar laws, rules and regulations, including compliance with Section 404 of the Sarbanes‑Oxley Act, will substantially increase our expenses, including our legal and accounting costs, and make some activities more time‑consuming and costly.  We also expect these laws, rules and regulations to make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage, which may make it more difficult for us to attract and retain qualified persons to serve on our board of directors or as officers.

We are an emerging growth company, and the reduced reporting requirements applicable to emerging growth companies may make our common stock less attractive to investors.    We are an “emerging growth company” as defined in the JOBS Act.  We will remain an “emerging growth company” until the earliest to occur of:

We may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes‑Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy or information statements and exemptions from the

---

 

requirements of holding a non‑binding advisory vote on executive compensation and seeking stockholder approval of any golden parachute payments not previously approved, except we have irrevocably elected not to take advantage of the extension of time to comply with new or revised financial accounting standards available under Section 102(b) of the JOBS Act.  We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions.  If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our per share trading price may be adversely affected and more volatile.

Risks Related to Our Tax Status and Other Tax Related Matters

We would incur adverse tax consequences if we fail to qualify as a REIT.    We have elected to be taxed as a REIT under the Code.  Our qualification as a REIT requires us to satisfy numerous requirements, some on an annual and quarterly basis, established under highly technical and complex Code provisions for which there are only limited judicial or administrative interpretations, and which involves the determination of various factual matters and circumstances not entirely within our control.  We expect that our current organization and methods of operation will enable us to continue to qualify as a REIT, but we may not so qualify or we may not be able to remain so qualified in the future.  In addition, U.S. federal income tax laws governing REITs and other corporations and the administrative interpretations of those laws may be amended at any time, potentially with retroactive effect.  Future legislation, new regulations, administrative interpretations or court decisions could adversely affect our ability to qualify as a REIT or adversely affect our stockholders.

If we fail to qualify as a REIT in any taxable year, we would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates, and would not be allowed to deduct dividends paid to our stockholders in computing our taxable income.  Also, unless the Internal Revenue Service granted us relief under certain statutory provisions, we could not re‑elect REIT status until the fifth calendar year after the year in which we first failed to qualify as a REIT.  The additional tax liability from the failure to qualify as a REIT would reduce or eliminate the amount of cash available for investment or distribution to our stockholders.  This would likely have a significant adverse effect on the value of our securities and our ability to raise additional capital. In addition, we would no longer be required to make distributions to our stockholders.  Even if we continue to qualify as a REIT, we will continue to be subject to certain federal, state and local taxes on our income and property.

Dividends paid by REITs generally do not qualify for reduced tax rates.    In general, the maximum U.S. federal income tax rate for dividends that constitute “qualified dividend income” paid to individuals, trusts and estates is 20%.  Unlike dividends received from a corporation that is not a REIT, our distributions generally are not eligible for the reduced rates.  Although these rules do not adversely affect the taxation of REITs or dividends payable by REITs, investors who are individuals, trusts and estates may perceive investments in REITs to be relatively less attractive than investments in the stocks of non‑REIT corporations that pay dividends, which could materially and adversely affect the value of the shares of REITs, including the per share trading price of our common stock.

We may conduct a portion of our business through taxable REIT subsidiaries, which are subject to certain tax risks.    We have established a taxable REIT subsidiary and may establish others in the future.  Despite our qualification as a REIT, our taxable REIT subsidiaries must pay income tax on their taxable income.  In addition, we must comply with various tests to continue to qualify as a REIT for federal income tax purposes, and our income from and investments in our taxable REIT subsidiaries generally do not constitute permissible income and investments for these tests.  Our dealings with our taxable REIT subsidiaries may adversely affect our REIT qualification.  Furthermore, we may be subject to a 100% penalty tax, we may jeopardize our ability to retain future gains on real property sales, or our taxable REIT subsidiaries may be denied deductions, to the extent our dealings with our taxable REIT subsidiaries are not deemed to be arm’s length in nature or are otherwise not permitted under the Code.

The Internal Revenue Service may treat sale‑leaseback transactions as loans, which could jeopardize our REIT status or require us to make an unexpected distribution.    The Internal Revenue Service may take the position that specific sale‑leaseback transactions that we treat as leases are not true leases for federal income tax purposes but are, instead, financing arrangements or loans.  If a sale‑leaseback transaction were so re‑characterized, we might fail to satisfy the REIT asset tests, the income tests or distribution requirements and consequently lose our REIT status effective with the year of re‑characterization unless we elect to make an additional distribution to maintain our REIT status.

---

 

REIT distribution requirements limit our available cash.  As a REIT, we are subject to annual distribution requirements, which limit the amount of cash we retain for other business purposes, including amounts to fund our growth.  We generally must distribute annually at least 90% of our net REIT taxable income, excluding any net capital gain, in order for our distributed earnings to not be subject to corporate income tax.  We intend to make distributions to our stockholders to comply with the requirements of the Code.  However, differences in timing between the recognition of taxable income and the actual receipt of cash could require us to sell assets or borrow funds on a short‑term or long‑term basis to meet the 90% distribution requirement of the Code, even if the prevailing market conditions are not favorable for these borrowings.

Certain property transfers may generate prohibited transaction income, resulting in a penalty tax on gain attributable to the transaction.    From time to time, we may transfer or otherwise dispose of some of our properties.  Under the Code, any gain resulting from transfers of properties that we hold as inventory or primarily for sale to customers in the ordinary course of business would be treated as income from a prohibited transaction and subject to a 100% penalty tax.  Since we acquire properties for investment purposes, we do not believe that our occasional transfers or disposals of property are prohibited transactions.  However, whether property is held for investment purposes is a question of fact that depends on all the facts and circumstances surrounding the particular transaction.  The Internal Revenue Service may contend that certain transfers or disposals of properties by us are prohibited transactions.  If the Internal Revenue Service were to argue successfully that a transfer or disposition of property constituted a prohibited transaction, then we would be required to pay a 100% penalty tax on any gain allocable to us from the prohibited transaction and we may jeopardize our ability to retain future gains on real property sales.  In addition, income from a prohibited transaction might adversely affect our ability to satisfy the income tests for qualification as a REIT for federal income tax purposes.

We could face possible state and local tax audits and adverse changes in state and local tax laws.    As discussed in the risk factors above, because we are organized and qualify as a REIT, we are generally not subject to federal income taxes, but we are subject to certain state and local taxes.  From time to time, changes in state and local tax laws or regulations are enacted, which may result in an increase in our tax liability.  A shortfall in tax revenues for states and municipalities in which we own properties may lead to an increase in the frequency and size of such changes.  If such changes occur, we may be required to pay additional state and local taxes.  These increased tax costs could adversely affect our financial condition and the amount of cash available for the payment of distributions to our stockholders.  In the normal course of business, entities through which we own real estate may also become subject to tax audits.    If such entities become subject to state or local tax audits, the ultimate result of such audits could have an adverse effect on our financial condition.

Qualifying as a REIT involves highly technical and complex provisions of the Code. Our qualification as a REIT involves the application of highly technical and complex Code provisions for which only limited judicial and administrative authorities exist.  Even a technical or inadvertent violation could jeopardize our REIT qualification.  Moreover, new legislation, court decisions or administrative guidance, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT.  Our qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis.  Our ability to satisfy the REIT income and asset tests depends upon our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination and for which we will not obtain independent appraisals, and upon our ability to successfully manage the composition of our income and assets on an ongoing basis.  In addition, our ability to satisfy the requirements to qualify as a REIT depends in part on the actions of third parties over which we have no control or only limited influence, including in cases where we own an equity interest in an entity that is classified as a partnership for U.S. federal income tax purposes.

---

 

Risks Related to Ownership of Our Common Stock

Changes in market conditions and volatility of stock prices could adversely affect the market price of our common stock.    The stock markets, including the NYSE, on which we list our common stock, have experienced significant price and volume fluctuations.  As a result, the market price of our common stock could be similarly volatile, and investors in our common stock may experience a decrease in the value of their shares, including decreases unrelated to our operating performance or prospects.  In addition to the risks listed in this “Risk Factors” section, a number of factors could negatively affect the price per share of our common stock, including:

Many of the factors listed above are beyond our control.  These factors may cause the market price of shares of our common stock to decline, regardless of our financial condition, results of operations, business or our prospects.

---

 

Limitations on share ownership and limitations on the ability of our stockholders to effect a change in control of us restrict the transferability of our stock and may prevent takeovers that are beneficial to our stockholders.  One of the requirements for maintenance of our qualification as a REIT for U.S. federal income tax purposes is that no more than 50% in value of our outstanding capital stock may be owned by five or fewer individuals, including entities specified in the Code, during the last half of any taxable year.  Our charter contains ownership and transfer restrictions relating to our stock to assist us in complying with this and other REIT ownership requirements, among other purposes.  However, the restrictions may have the effect of preventing a change of control that does not threaten REIT status.  These restrictions include a provision in our charter that generally limits ownership by any person of more than 9.8% of the value of our outstanding stock or 9.8% (in value or by number of shares, whichever is more restrictive) of our outstanding common stock, unless our board of directors exempts the person from such ownership limitation.  Absent such an exemption from our board of directors, the transfer of our stock to any person in excess of the applicable ownership limit, or any transfer of shares of such stock in violation of the ownership requirements of the Code for REITs, may be void under certain circumstances, and the intended transferee of such stock will acquire no rights in such shares.  These provisions of our charter may have the effect of delaying, deferring or preventing someone from taking control of us, even though a change of control might involve a premium price for our stockholders or might otherwise be in our stockholders’ best interests.

A substantial portion of our total outstanding common stock may be sold into the market at any time.  This could cause the market price of our common stock to drop significantly, even if our business is doing well, and make it difficult for us to sell equity securities in the future.    The market price of our common stock could decline as a result of sales of a large number of shares of our common stock or the perception that such sales could occur.  These sales, or the possibility that these sales may occur, also might make it difficult for us to sell equity securities in the future at times or prices that we deem appropriate.    

If we raise additional capital through the issuance of new equity securities, your interest in us will be diluted.    We may, and will likely, have to issue additional equity securities periodically to finance our growth.  If we raise additional capital through the issuance of new equity securities, your interest in us will be diluted, which could cause you to lose all or a portion of your investment.  If we are unable to access the public markets in the future, or if our performance or prospects decrease, we may need to consummate a private placement or public offering of our common stock or preferred stock.  In addition, any new securities we may issue, such as preferred stock, may have rights, preferences or privileges senior to those securities held by you.

If securities analysts do not publish research or reports about our company, or if they issue unfavorable commentary about us or our industry or downgrade the outlook of our common stock, the price of our common stock could decline.    The trading market for our common stock depends in part on the research and reports that third‑party securities analysts publish about our company and our industry.  One or more analysts could downgrade the outlook of our common stock or issue other negative commentary about our company or our industry.  In addition, we may be unable or slow to attract additional research coverage.  Furthermore, if one or more of these analysts cease coverage of our company, we could lose visibility in the market. As a result of one or more of these factors, the trading price of our common stock could decline and cause you to lose all or a portion of your investment.

We may change the dividend policy for our common stock in the future.    The decision to declare and pay dividends on our common stock, as well as the form, timing and amount of any such future dividends, is at the sole discretion of our board of directors and will depend on our earnings, cash flows, liquidity, financial condition, capital requirements, contractual prohibitions or other limitations under our indebtedness, the annual distribution requirements under the REIT provisions of the Code, state law and such other factors as our board of directors considers relevant.  Any change in our dividend policy could have a material adverse effect on the market price of our common stock.

Legislative or regulatory action could adversely affect purchasers of our common stock.  In recent years, numerous legislative, judicial and administrative changes have been made in the provisions of the federal income tax laws applicable to investments similar to an investment in our common stock.  Changes are likely to continue to occur in the future, and these changes could adversely affect our stockholders’ investment in our common stock.  These changes include but are not limited to the reduction or elimination of the corporate income tax under the Code.  Any of these changes could have an adverse effect on an investment in our common stock or on the market value or resale potential of our common stock.  Stockholders are urged to consult with their own tax advisor with respect to the impact

---

 

that recent legislation may have on their investment and the status of legislative, regulatory or administrative developments and proposals and their potential effect on their investment in our stock.

Item 1B.  UNRESOLVED STAFF COMMENTS

None.

Item 2.  PROPERTIES

As of December 31, 2014, our total investment in real estate and loans approximated $2.8 billion, representing investments in 947 property locations,  substantially all of which are profit centers for our customers.  These investments generate our cash flows from more than 350 contracts predominantly structured as net leases, mortgage loans and combinations of leases and mortgage loans, or hybrid leases.  All of our owned single‑tenant properties are subject to leases; the weighted average non‑cancellable remaining term of our leases at December 31, 2014 was 15 years.

Our real estate portfolio is highly diversified.  As of December 31, 2014, our 947 property locations are operated by 226 customers across 46 states.  None of our customers represented more than 4% of our portfolio at December 31, 2014, and our top ten largest customers represented less than 21% of annualized base rent and interest.  Our customers operate their businesses across 208 brand names or business concepts in more than 65 industries.  Our top five concepts as of December 31, 2014 were Gander Mountain, Ashley Furniture HomeStore, Applebee’s, Popeyes Louisiana Kitchen and Starplex Cinemas; combined, these concepts represented 15% of annualized base rent and interest.  Our top five industries as of December 31, 2014 are restaurants, early childhood education centers, health clubs, movie theaters and sporting goods stores.  Combined, these industries represented 55% of annualized base rent and interest.  

Diversification by Customer

As of December 31, 2014, our 947 property locations were operated by our 226 customers.  The following table identifies our ten largest customers as of December 31, 2014:

 

 

---

---

 

Diversification by Concept

As of December 31, 2014, our customers operated their businesses across 208 concepts.  The following table identifies those concepts as of December 31, 2014:

 

 

---

---

 

Diversification by Industry

As of December 31, 2014, our customers’ business concepts were diversified across more than 65 industries within the service, retail and industrial sectors of the U.S. economy.   The following table summarizes those industries as of December 31, 2014:

 

 

---

---

 

Diversification by Geography

Our portfolio is also highly diversified by geography, as our 947 property locations can be found in 46 of the 50 states (excluding Alaska, Delaware, Hawaii and Rhode Island).  The following table details the top ten geographical locations of the properties as of December 31, 2014:

 

 

---

---

 

Contract Expirations

The following table sets forth the schedule of our lease, loan and direct financing receivable expirations as of December 31, 2014:

 

 

---

 

Item 3.  LEGAL PROCEEDINGS

From time to time, we become party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of our business and the business of our tenants.   Since our organization in May 2011, we have not been a party, as plaintiff or defendant, to any legal proceedings that we believe to be material or which, individually or in the aggregate, would be expected to have a material effect on our business, financial condition or results of operations if determined adversely to us.

Item 4.  MINE SAFETY DISCLOSURES

Not Applicable.

---

 

PART II

Item 5.  MARKET FOR REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s common stock is listed on the NYSE under the symbol “STOR”.  The following table sets forth, for the quarters indicated, the range of high and low sales prices for the Company’s common stock on the NYSE during fiscal 2014 and distributions declared per share of common stock. The historical stock prices reflected in the following table are not necessarily indicative of future stock price performance.

 

 

---

During 2013, we declared quarterly dividends aggregating $0.8743 per share of common stock as follows: quarter ended March 31, $0.2096; quarter ended June 30, $0.2156; quarter ended September 30, $0.2216; and quarter ended December 31, $0.2275.

On March 6, 2015, the closing sale price of our common stock was $21.29 per share on the NYSE, and there were 24 holders of record of the 115,210,809 outstanding shares of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.  We have determined that, for federal income tax purposes, approximately 88.72% of the distributions paid in 2014 represented ordinary income and 6.41% represented long-term capital gain.

Distributions

The Company pays regular quarterly distributions to holders of its common stock.  Future distributions will be at the discretion of our Board of Directors and will depend on our actual funds from operations, financial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Code and other factors.

Issuer Purchases of Equity Securities

With proceeds from the IPO, on November 21, 2014 the Company redeemed all of the outstanding shares of its 12.5% Series A Cumulative Non-Voting Preferred Stock at a redemption price of $1,000.00 per share plus accrued and unpaid dividends.  The Company did not repurchase any other equity securities during the year ended December 31, 2014.

Stock Performance Graph

The following performance chart compares, for the period from November 18, 2014 (our first trading day on the NYSE) through December 31, 2014, the cumulative total stockholder return on our common stock with that of the Standard & Poor’s 500 Composite Stock Index (the “S&P 500”) and the MSCI US REIT Index.   The chart assumes $100.00 was invested on November 18, 2014 and assumes the reinvestment of any dividends.  The historical stock price performance reflected in the following graph is not necessarily indicative of future stock price performance.

---

 

 

 

 

The performance graph and the related chart and text are being furnished solely to accompany this Annual Report on Form 10-K pursuant to Item 201(c) of Regulation S-K, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be incorporated by reference into any filing of ours, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

Use of Proceeds from the Sale of Registered Securities

Our registration statement on Form S-11, as amended (Registration No. 333-198486), with respect to our IPO was declared effective on November 17, 2014.  On November 21, 2014, the Company completed the IPO through the registration and sale of 31,625,000 shares of common stock, including 4,125,000 shares of common stock sold in connection with the full exercise of the underwriters’ over-allotment option to purchase additional shares, raising gross proceeds of approximately $585 million.

As of the date of this Annual Report, our IPO has terminated and all of the securities registered for sale by us pursuant to our registration statement on Form S-11 have been sold. The joint book-running managers of the IPO were Goldman, Sachs & Co., Credit Suisse Securities (USA) LLC and Morgan Stanley & Co. LLC. The joint lead managers of the IPO were Citigroup Global Markets Inc., Deutsche Bank Securities Inc., KeyBanc Capital Markets Inc. and Wells Fargo Securities, LLC. BMO Capital Markets Corp., Raymond James & Associates, Inc., Robert W. Baird & Co. Incorporated, Stifel, Nicolaus & Company, Incorporated, SunTrust Robinson Humphrey, Inc. and Comerica Securities, Inc. acted as co-managers for the IPO.

The expenses of the IPO included approximately $35 million for underwriting discounts and commissions and approximately $4 million of other expenses, for total offering expenses of approximately $39 million. All of the foregoing underwriting discounts and expenses were direct or indirect payments to persons other than: (i) our directors, officers or any of their associates; (ii) persons owning ten percent (10%) or more of our shares of common stock; or (iii) our affiliates.

---

 

The net proceeds to us from the IPO totaled approximately $546 million, after deducting the underwriting discounts and commissions and other offering expenses.  Since the completion of the IPO, we used approximately $223 million of the net offering proceeds to repay the outstanding balance under our credit facility, $125,000 to redeem all outstanding shares of our Series A Preferred Stock and approximately $243 million to make property acquisitions from the closing date of the IPO through December 31, 2014.  In 2015, we deployed the remainder of the proceeds for property acquisitions.

Item 6.  SELECTED FINANCIAL DATA

The following tables set forth selected consolidated financial and other information of the Company as of and for each of the years ended December 31, 2014, 2013 and 2012 and for the period from inception (May 17, 2011) through December 31, 2011. The table should be read in conjunction with the Company’s consolidated financial statements and the notes thereto and Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Annual Report on Form 10-K.

 

 

 

---

---

 

Item 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read together with the “Selected Consolidated Financial Data” and “Business” sections, as well as the consolidated financial statements and related notes in Part II, Item 8 in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including information with respect to our plans and strategy for our business, includes forward‑looking statements that involve risks and uncertainties. You should read “Item 1A. Risk Factors” and the “Forward‑Looking Statements” sections of this Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by these forward‑looking statements.

Overview

We were formed in 2011 to invest in and manage Single Tenant Operational Real Estate, or STORE Properties, which is our target market and the inspiration for our name.  A STORE Property is a property location at which a company operates its business and generates sales and profits, which makes the location a profit center and, therefore, fundamentally important to that business. Examples of operational real estate include restaurants, early childhood education centers, health clubs, movie theaters, sporting goods stores, furniture stores and colleges and professional schools.  By acquiring the real estate from the operators and then leasing the real estate back to them, they become our long‑term tenants, and we refer to them as our customers. We provide a source of long‑term capital to our customers by enabling them to avoid the need to incur debt and employ equity in order to finance the real estate that is essential to their business.

We are a Maryland corporation organized as an internally managed real estate investment trust, or REIT.  As a REIT, we will generally not be subject to federal income tax to the extent that we distribute all of our taxable income to our stockholders and meet other requirements.    

The growth of our Company from inception in May 2011 until November 2014 was funded by STORE Holding Company, LLC, or STORE Holding, a Delaware limited liability company, substantially all of which is owned, directly or indirectly, by certain investment funds managed by Oaktree Capital Management, L.P.  In November 2014, we took the Company public on the New York Stock Exchange and now our common stock trades under the ticker symbol “STOR”.  STORE Holding is still our primary stockholder, owning approximately 72% of our outstanding common stock as of December 31, 2014. In November 2014, prior to our initial public offering, or IPO, our board of directors declared a stock split effected through the distribution of 1.67 shares for each share of common stock then outstanding; accordingly, all share and per share information included in this report has been retroactively restated to take into account the effect of the stock split.

Since our inception in 2011, we have selectively originated a real estate investment portfolio totaling $2.8 billion, consisting of investments in 947 property locations across 46 states. All of the real estate we acquire is held by our wholly-owned subsidiaries, many of which are special purpose bankruptcy remote entities formed to facilitate the financing of our real estate. We predominantly acquire our single‑tenant properties directly from our customers in sale‑leaseback transactions where our customers sell us their operating properties and then simultaneously enter into a long‑term triple‑net lease with us to lease the property back. Accordingly, our properties are fully occupied and under lease from the moment we acquire them. Since inception, our portfolio has remained at 100% occupancy, as all of our properties are subject to leases.   We generate our cash from operations primarily through the monthly lease payments, or “base rent”, we receive from our customers under their long‑term leases with us. We also receive interest payments on loans receivable, which are a small part of our portfolio. We refer to the monthly scheduled lease and interest payments due from our customers as “base rent and interest”. Most of our leases contain lease escalations every year or every several years that are based on the lesser of the increase in the Consumer Price Index, or CPI, or a stated percentage (if expressed on an annual basis, currently averaging approximately 1.7%), which allows the monthly lease payments we receive to rise somewhat in an inflationary economic environment. As of December 31, 2014, approximately 97% of our leases (based on annualized base rent) are referred to as “triple net”, which means that our customer is responsible for all of the maintenance, insurance and property taxes associated with the properties they lease from us, including any increases in those costs that may occur as a result of inflation. The remaining leases have some landlord responsibilities,

---

 

generally related to maintenance and structural component replacement that may be required on such properties in the future. Also, we will occasionally incur nominal property‑level expenses that are not paid by our customers, such as the costs of periodically making site inspections of our properties. We do not currently anticipate incurring significant capital expenditures or property costs. Since our properties are single‑tenant properties, all of which are under long‑term leases, it is not necessary for us to perform any significant ongoing leasing activities on our properties. As of December 31, 2014, the weighted average remaining term of our leases (calculated based on annualized base rent) was approximately 15 years, excluding renewal options, which are exercisable at the option of our tenants upon expiration of their base lease term. Leases approximating 98% of our base rent as of that date provide for tenant renewal options (generally two to four five‑year options) and leases approximating 4% of our base rent provide our tenant the option, at their election, to purchase the property from us at a specified time or times (generally at the greater of the then‑fair market value or our cost).

Liquidity and Capital Resources

At the beginning of 2014, our real estate investment portfolio totaled $1.7 billion, consisting of investments in 622 property locations with base rent and interest due from our customers aggregating approximately $12 million per month, excluding future rent payment escalations. By December 31, 2014, our investment portfolio had grown to $2.8 billion, consisting of investments in 947 property locations with base rent and interest aggregating approximately $19.8 million per month. Substantially all of our cash from operations is generated by our real estate portfolio.

Our primary cash expenditures are the monthly principal and interest payments we make on the debt we use to finance our real estate investment portfolio and the general and administrative expenses of servicing the portfolio and operating our business. Since substantially all of our leases are triple net, our tenants are generally responsible for the maintenance, insurance and property taxes associated with the properties they lease from us.  When a property becomes vacant through a tenant default or expiration of the lease term with no tenant renewal, we would incur these property costs during the time it would take to locate a substitute tenant.  As of December 31, 2014, our portfolio was 100% occupied and leases on only five properties are scheduled to expire during 2015, representing less than one-half of one percent of our annualized base rent and interest.  Accordingly, we do not currently anticipate making significant capital expenditures or incurring other significant property costs.

We intend to continue to grow through additional real estate investments. To accomplish this objective, we must continue to identify real estate acquisitions which are consistent with our underwriting guidelines and raise future additional capital. We acquire real estate with a combination of debt and equity capital and with cash from operations that is not otherwise distributed to our stockholders. Prior to our IPO, our equity capital was provided to us as needed for our real estate acquisition activity by investors in STORE Holding, which is our holding company parent.  In our IPO, which closed on November 21, 2014, we raised $585 million in gross offering proceeds through the sale of 31,625,000 shares of our common stock, including the underwriters’ overallotment.  The proceeds of the offering were used to pay offering expenses totaling $39 million, including the underwriters’ discount, leaving net proceeds of $546 million.  The net proceeds were used to pay off amounts outstanding on our unsecured credit facility totaling $223 million, redeem all of our outstanding preferred stock ($125,000) and, through December 31, 2014, approximately $243 million was deployed to continue to selectively acquire real estate properties.

Our debt capital is provided on a temporary basis through our variable‑rate unsecured revolving credit facility with a group of banks, until our short-term, variable-rate borrowings are sufficiently large to enable the economic issuance of term notes from our Master Funding program. We also, from time to time, obtain non‑recourse mortgage financing from banks and insurance companies secured by specific property we pledge as collateral. By matching the expected cash inflows from our long‑term real estate leases with the expected cash outflows of our long‑term fixed‑rate debt, we “lock in”, for as long as is economically feasible, the expected positive difference between our scheduled cash inflows on the leases and the cash outflows on our debt payments. By “locking in” this difference, or “spread”, we seek to reduce the risk that increases in interest rates would adversely impact our profitability. In addition, we may use various financial instruments designed to mitigate the impact of interest rate fluctuations on our cash flows and earnings, including hedging strategies such as interest rate caps, depending on our analysis of the interest rate environment and the costs and risks of such strategies. We target a level of debt within a range of six to seven times our earnings before interest, taxes, depreciation and amortization.

---

 

The availability of debt to finance commercial real estate in the United States can, at times, be impacted by economic and other factors that are beyond our control. An example of this is the period during the recession of 2007 to 2009 when availability of debt capital for commercial real estate was significantly curtailed. We seek to reduce the risk that long‑term debt capital may be unavailable to us by limiting the period between the time we acquire our real estate and the time we finance our real estate with long‑term debt. In addition, we have arranged our short‑term debt facility (described below) to have a multi‑year term in order to reduce the risk that short‑term real estate financing would not be available to us. As we grow our real estate portfolio, we also intend to manage our debt maturities to reduce the risk that a significant amount of our debt will mature in any single year in the future. As of December 31, 2014, we had no significant near-term debt maturities, with balloon payments due during 2015 representing just $19 million, or 1.5%, of our total long-term debt, and our weighted average debt maturity is approximately seven years. As our outstanding debt matures, we may refinance this maturing debt as it comes due or choose to repay it using cash and cash equivalents or our revolving credit facility. Because our long-term debt generally requires monthly payments of principal, in addition to the monthly interest payments, the resulting principal amortization reduces our refinancing risk upon maturity of the debt. The long-term debt we have issued as of December 31, 2014 is comprised, almost exclusively, of secured nonrecourse borrowings with a weighted average loan-to-value ratio of 69% and approximately 66% of our portfolio serves as collateral for this long-term debt.  The remaining portfolio properties, aggregating $952 million, are unencumbered and this unencumbered pool of properties provides us flexibility for future borrowings or as substitute collateral for existing indebtedness. 

We raise debt capital through several different markets, including the asset‑backed and commercial mortgage‑backed securities markets, as well as the market for term debt financing. Each of these is described in more detail below. We believe that having access to multiple debt markets increases our financing flexibility because different debt markets may attract different debt investors, thus increasing our access to a potentially larger pool of debt investors. Also, a particular debt market may be more competitive than another at any particular point in time. In addition to these sources of debt capital, our senior leadership team has prior experience with senior secured lines of credit and senior unsecured term debt, which may be deployed as we continue to grow the business and implement our asset‑liability management strategies.

Typically, we use our short‑term unsecured credit facility to acquire our real estate properties, until those borrowings are sufficiently large to warrant the economic issuance of term notes under our Master Funding conduit, the proceeds from which we use to repay the amounts outstanding under our credit facility. In September 2014, we entered into a new $300 million unsecured revolving credit facility with a group of lenders, which replaced our two previous secured credit facilities that aggregated $300 million. This new facility, which includes an accordion feature that allows the size of the facility to be increased up to $500 million, is for an initial term of three years and includes a one‑year extension option subject to certain conditions and the payment of a 20 basis point extension fee. The facility bears interest at a rate selected by us equal to either one‑month LIBOR plus a leverage‑based credit spread ranging from 1.75% to 2.50%, or a Base Rate, as defined in the debt agreement, plus a leverage‑based credit spread ranging from 0.75% to 1.50%, and also includes a fee of 0.25% assessed on the average unused portion of the facility. Availability under the facility is limited to 50% of the value of our eligible unencumbered assets at any point in time. At December 31, 2014, we had no borrowings outstanding on this new credit facility and we had a pool of unencumbered assets aggregating $952 million, substantially all of which were eligible under the credit facility. Covenants under this new facility include: maximum leverage of 65%, minimum fixed charge coverage of 1.5x, minimum net worth of $600 million plus 75% of new net equity proceeds, and a maximum dividend payout ratio limited to 95% of Funds from Operations, all as defined in the agreement. The facility is recourse to us and includes a guaranty from STORE Capital Acquisitions, LLC, one of our direct wholly‑owned subsidiaries. We remain in compliance with these covenants. Prior to entering into the new $300 million unsecured credit facility, we had two bank credit facilities that were secured by real estate properties we pledged as collateral, as well as our equity interests in certain of our consolidated special purpose subsidiaries and our holdings of the Class B notes issued under our STORE Master Funding debt program described below.

As of December 31, 2014, essentially all of our long‑term debt was fixed‑rate debt, or was effectively converted to a fixed‑rate for the term of the debt. Our primary long‑term debt funding option is STORE Master Funding, which we began to use in 2012. As summarized below, a large portion of our real estate investment portfolio serves as collateral for outstanding borrowings under this debt program. Through this debt program, we arrange for bankruptcy remote, special purpose entity subsidiaries to issue multiple series of investment‑grade asset‑backed net‑lease mortgage notes, or

---

 

ABS notes, from time to time as additional collateral is added to the collateral pool. The ABS notes are generally issued to institutional investors through the asset‑backed securities market. These ABS notes are issued in two classes, Class A and Class B. The Class A notes, which represent approximately 70% of the appraised value of the underlying real estate collateral, are currently rated A+ by Standard & Poor’s Ratings Services. The Class A notes generally require monthly payments of principal and interest with balloon payments due at their respective maturity dates, either seven or 10 years from the date of issuance. We have historically retained the Class B notes, which are subordinated to the Class A notes as to principal repayment. The Class B notes, currently rated BBB by Standard & Poor’s Rating Services, aggregate $78.0 million in principal amount outstanding at December 31, 2014 and are held by one of our bankruptcy remote, special purpose entity subsidiaries. The Class B notes are not reflected in our financial statements because they eliminate in consolidation. Since these Class B notes are issued and outstanding, they provide us with additional financial flexibility in that we may sell them to a third party in the future or use them as collateral for short‑term borrowings as we have done from time to time in the past.

Members of our senior leadership team pioneered the concept of serial issuances of rated debt backed by a growing collateral pool of net‑leased commercial real estate in 2005. When we wish to issue additional long‑term debt under the STORE Master Funding debt program, our special purpose entity subsidiaries acquire real estate assets to increase the size of the existing collateral pool sufficiently to support the additional debt. Upon issuance of a new series of debt under this program, the entire collateral pool (including the newly added real estate) will be pledged to secure all of the notes, both the existing and the new series, on a pro rata basis. This has the effect of increasing the diversity of the collateral pool for all of the note holders, including those that invested in prior series. For example, the first Master Funding note series issued in 2012 totaled $214.5 million in Class A principal amount, which was supported by a collateral pool valued at $305.9 million representing 132 property locations operated by 30 customers; those same note holders now hold notes secured by a significantly more diverse pool than when they purchased their investment, with the Master Funding notes outstanding at December 31, 2014 totaling $1.1 billion in Class A principal amount supported by a collateral pool valued at $1.6 billion (on a gross book value of $1.5 billion) representing 608 property locations operated by 147 customers. The amount of debt that can be issued in any new series is determined by the structure of the transaction and the amount of collateral that has been added to the pool. In addition, the issuance of each new series of notes is subject to the satisfaction of several conditions, including that there is no event of default on the existing note series and that the issuance will not result in an event of default on, or the credit rating downgrade of, the existing note series.

Absent a plan to issue additional long‑term debt through the Master Funding program, we are not required to add assets to, or substitute collateral in, the existing collateral pool. We can voluntarily elect to substitute assets in the collateral pool, subject to meeting prescribed conditions that are designed to protect the collateral pool by requiring the substitute assets to be of equal or greater measure in attributes such as: the asset’s fair value, monthly rent payments, remaining lease term and weighted average FCCR. In addition, we can sell underperforming assets and reinvest the proceeds in better performing properties. Any substitutions and sales are subject to an overall limitation of 35% of the collateral pool unless the substitution or sale is credit‑ or risk‑based, in which case there are no limitations. Since our Master Funding program began in 2012, we sold eight properties in the collateral pool, representing less than 1.2% of the collateral pool value, and have since reinvested the proceeds in newly-acquired properties.  

The A+ rating currently assigned to the Class A notes issued under our Master Funding program reflects the rating agency’s opinion of the level of credit enhancement available for the benefit of the note holders. As structured, the Master Funding notes have several layers of credit enhancement—subordination (because the Class B notes are subordinate in payment of principal to the right of the more senior Class A notes); overcollateralization (since our Class A notes have an advance rate of 70%, the other 30% is the “overcollateralization” provided by the equity and the BBB‑rated Class B notes held by STORE Capital); and the last layer of credit enhancement is the excess monthly cash flow generated by the collateral pool after debt service obligations and servicing and trustee expenses have been paid. A significant portion of our cash flows are generated by the special purpose entities comprising our Master Funding program. For the year ended December 31, 2014, excess cash flow, after payment of debt service and servicing and trustee expenses, totaled $51 million on cash collections of $120 million, which represents an overall ratio of cash collections to debt service of approximately 1.7 to 1 on the Master Funding program. If at any time the debt service coverage ratio (as defined in the program documents) generated by the collateral pool is less than 1.3 to 1, excess cash flow from the Master Funding entities will be deposited into a reserve account to be used for payments to be made on the

---

 

net‑lease mortgage notes, to the extent there is a shortfall. We anticipate that the debt service coverage ratio for the Master Funding program will remain well above program minimums.

We believe our STORE Master Funding program provides us with several advantages, including the ability to:

To complement STORE Master Funding, we also obtain debt in discrete transactions through other bankruptcy remote, special purpose entity subsidiaries, which debt is solely secured by specific real estate assets and is generally non‑recourse to us (subject to certain customary limited exceptions). These discrete borrowings are generally in the form of traditional mortgage notes payable, with principal and interest payments due monthly and balloon payments due at their respective maturity dates, which typically range from seven to 10 years from the date of issuance. We generally obtain discrete secured borrowings from institutional commercial mortgage lenders, who subsequently securitize (that is, sell) the loans within the commercial mortgage‑backed securities, or CMBS, market. We have also occasionally used similar types of financing from insurance companies and commercial banks. Our secured borrowings contain various covenants customarily found in mortgage notes, including a limitation on the issuing entity’s ability to incur additional indebtedness on the underlying real estate. Certain of the notes also require the posting of cash reserves with the lender or trustee if specified coverage ratios are not maintained by the special purpose entity or the tenant. As of December 31, 2014, the long‑term, non‑recourse debt of our consolidated special purpose entities had an aggregate outstanding principal balance of approximately $1.3 billion, a weighted average maturity of 6.9 years and a weighted average interest rate of 4.89%; these amounts include the impact of the 2014 issuance of $260 million in STORE Master Funding seven-year and ten-year notes at a weighted average interest rate of 4.64%.

As previously noted, a large portion of our real estate investment portfolio serves as collateral for our consolidated outstanding debt.  The following is a summary of the outstanding balance of our borrowings as well as a summary of the portion of our real estate investment portfolio that is either pledged as collateral for these borrowings or is unencumbered as of December 31, 2014:

 

 

Our decision to use STORE Master Funding or non‑recourse traditional mortgage loan borrowings depends on borrowing costs, debt terms, debt flexibility and the tenant and industry diversification levels of the collateral pool. As we continue to acquire real estate, we expect to balance the overall degree of leverage on our portfolio by growing a pool of portfolio assets that are unencumbered. A growing pool of unencumbered assets will increase our financial flexibility in the future by providing us with assets that could support unsecured short‑term financing or that could serve as substitute collateral. As of December 31, 2014, our unencumbered assets aggregated $952 million.  Should market factors, which are beyond our control, adversely impact our access to these debt sources at economically feasible rates,

---

 

our ability to grow through additional real estate acquisitions will be limited to any undistributed amounts available from our operations and any additional equity capital raises.

As shown in the table below, net cash provided by operating activities rose each year primarily due to the increase in the size of our real estate investment portfolio. Our real estate investing activities have grown in volume as we continue to make headway into our target market by identifying and acquiring real estate, primarily through sale‑leaseback transactions. Our investing activities in the table below are shown net of cash proceeds from the sales of 16 properties in 2014 aggregating $39.4 million, 17 properties in 2013 aggregating $40.7 million and seven properties in 2012 aggregating $5.3 million. Real estate investment activity was funded with a combination of cash from operations, proceeds from the issuance of debt and proceeds from the issuance of common stock. We began making distributions in 2012 and paid dividends to our stockholders totaling $5.7 million in 2012, $51.6 million in 2013 and $64.6 million in 2014.  The 2014 dividends exclude a pro-rated dividend per common share of $0.1139, or $1.00 per share on an annualized basis, for the period since the closing of the IPO through December 31, 2014. This dividend was paid in January 2015 and represents our intended annual cash dividend of $1.00 per share. Cash for the increase in dividends between years resulted primarily from the increase in cash provided by our operations. Cash and cash equivalents totaled $136.3 million, $61.8 million and $64.8 million at December 31, 2014, 2013 and 2012, respectively.

 

 

Management believes that the cash generated by our operations, together with our cash and cash equivalents at December 31, 2014, our current borrowing capacity on our revolving credit facility and our access to long‑term debt capital, will be sufficient to fund our operations for the foreseeable future and allow us to acquire the real estate for which we currently have made commitments. In order to continue to grow our real estate portfolio in the future beyond the excess cash generated by our operations and our ability to borrow, we intend to raise additional equity capital through the sale of our common stock.

Off‑Balance Sheet Arrangements

We have no off‑balance sheet arrangements as of December 31, 2014.

Contractual Obligations

The following table provides information with respect to our contractual commitments as of December 31, 2014, including any guaranteed or minimum commitments under contractual obligations.

 

 

---

---

 

Recently Issued Accounting Pronouncements

See Note 2 to the December 31, 2014 consolidated financial statements.

Critical Accounting Policies and Estimates

Our discussion and analysis of our historical financial condition and results of operations is based upon our consolidated financial statements which are prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Although management believes its estimates are reasonable, actual results could differ materially from those estimates. The accounting policies discussed below are considered critical because changes to certain judgments and assumptions inherent in these policies could affect the financial statements. For more information on our accounting policies, please refer to the notes to our consolidated financial statements.

Accounting for Real Estate Investments

We record the acquisition of real estate properties at cost, including acquisition and closing costs. We allocate the cost of real estate properties to the tangible and intangible assets and liabilities acquired based on their estimated relative fair values. Real estate properties subject to an existing in‑place lease at the date of acquisition are recorded as business combinations, and each tangible and intangible asset and liability acquired is recorded at fair value. Management uses multiple sources to estimate fair value, including independent appraisals and information obtained about each property as a result of its pre‑acquisition due diligence and its marketing and leasing activities. We expense transaction costs associated with real estate acquisitions accounted for as business combinations in the period incurred. Properties classified as held for sale are recorded at the lower of the carrying value or the fair value, less anticipated closing costs.

Lease Intangibles

In‑place lease intangibles are valued based on management’s estimates of lost rent and carrying costs during the time it would take to locate a tenant if the property were vacant, considering current market conditions and costs to execute similar leases. In estimating lost rent and carrying costs, management considers market rents, real estate taxes, insurance, costs to execute similar leases including leasing commissions and other related costs. The value assigned to in‑place leases is amortized on a straight‑line basis as a component of depreciation and amortization expense typically over the remaining term of the related leases.

The fair value of any above‑market and below‑market leases is estimated based on the present value of the difference between the contractual amounts to be paid pursuant to the in‑place lease and management’s estimate of current market lease rates for the property, measured over a period equal to the remaining term of the lease. Capitalized above‑market lease intangibles are amortized over the remaining term of the respective leases as a decrease to rental revenue. Below‑market lease intangibles are amortized as an increase in rental revenue over the remaining term of the respective leases plus the fixed‑rate renewal periods on those leases, if any. Should a lease terminate early, the unamortized portion of any related lease intangible is immediately recognized in operations.

Loans and Direct Financing Receivables

We hold our loans receivable for long‑term investment. Loans receivable are carried at amortized cost, including related unamortized discounts or premiums, if any. Certain of our real estate investment transactions are accounted for as direct financing leases. We record the direct financing receivables at their net investment, determined as the aggregate minimum lease payments and the estimated residual value of the leased property less unearned income.

---

 

The unearned income is recognized over the life of the related contracts so as to produce a constant rate of return on the net investment in the asset.

Impairment

We review our real estate investments and related lease intangibles periodically for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Management considers factors such as expected future undiscounted cash flows, estimated residual value, market trends (such as the effects of leasing demand and competition) and other factors in making this assessment. An asset is considered impaired if the carrying value of the asset exceeds its estimated undiscounted cash flows, and the impairment is calculated as the amount by which the carrying value of the asset exceeds its estimated fair value. Estimating future cash flows is highly subjective and such estimates could differ materially from actual results.

We periodically evaluate the collectibility of our loans receivable, including accrued interest, by analyzing the underlying property‑level economics and trends, collateral value and quality and other relevant factors in determining the adequacy of our allowance for loan losses. A loan is determined to be impaired when, in management’s judgment based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Specific allowances for loan losses are provided for impaired loans on an individual loan basis in the amount by which the carrying value exceeds the estimated fair value of the underlying collateral less disposition costs.

Revenue Recognition

We lease real estate to our tenants under long‑term net leases that are predominantly classified as operating leases. Direct costs associated with lease origination, offset by any lease origination fees received, are deferred and amortized over the related lease term as an adjustment to rental revenue. Substantially all of the leases are triple‑net, which provide that the lessees are responsible for the payment of all property operating expenses, including property taxes, maintenance and insurance.

Our leases generally provide for rent escalations throughout the lease terms. For leases that provide for specific contractual escalations, rental revenue is recognized on a straight‑line basis so as to produce a constant periodic rent over the term of the lease. Accordingly, accrued rental revenue, calculated as the aggregate difference between the rental revenue recognized on a straight‑line basis and scheduled rents, represents unbilled rent receivables that we will receive only if the tenants make all rent payments required through the expiration of the lease. We provide an estimated reserve for uncollectible straight‑line rental revenue based on management’s assessment of the risks inherent in those lease contracts, giving consideration to industry default rates for long‑term receivables. Leases that have contingent rent escalators indexed to future increases in the CPI may adjust over a one‑year period or over multiple‑year periods. Generally, these escalators increase rent at the lesser of (a) 1 to 1.25 times the increase in the CPI over a specified period or (b) a fixed percentage. Because of the volatility and uncertainty with respect to future changes in the CPI, our inability to determine the extent to which any specific future change in the CPI is probable at each rent adjustment date during the entire term of these leases and our view that the multiplier does not represent a significant leverage factor, increases in rental revenue from leases with this type of escalator are recognized only after the changes in the rental rates have actually occurred. For leases that have contingent rentals that are based on a percentage of the tenant’s gross sales, we recognize contingent rental revenue when the threshold upon which the contingent lease payment is based is actually reached.

We suspend revenue recognition if the collectibility of amounts due pursuant to a lease is not reasonably assured or if the tenant’s monthly lease payments become more than 60 days past due, whichever is earlier. In the event that the collectibility of a receivable with respect to any tenant is in doubt, a provision for uncollectible amounts will be established or a direct write‑off of the specific rent receivable will be made.

We recognize interest income on loans receivable using the effective interest method applied on a loan‑by‑loan basis. Direct costs associated with originating loans are offset against any related fees received and the balance, along with any premium or discount, is deferred and amortized as an adjustment to interest income over the term of the related loan receivable using the effective interest method. A loan receivable is placed on nonaccrual status when the loan has

---

 

become 60 days past due, or earlier if management determines that full recovery of the contractually specified payments of principal and interest is doubtful. While on nonaccrual status, interest income is recognized only when received.

Share‑Based Compensation

Certain of our directors, officers and key employees have been granted long‑term incentive awards, including restricted shares of our common stock and profits interests units issued by STORE Holding, which provide them with equity interests as an incentive to remain in our service and align executives’ interests with those of our equity holders. We estimate the fair value of restricted stock at the date of grant and recognize that amount in general and administrative expense ratably over the vesting period at the greater of the amount amortized on a straight‑line basis or the amount vested. The fair value of the restricted stock is based on the per‑share price of the common stock on the date of the grant. Prior to our IPO, the fair value was based on the per-share price of the common stock issued in our private equity offerings.

Depreciation

Our real estate portfolio is depreciated using the straight‑line method over the estimated remaining useful life of the properties, which generally ranges from 30 to 40 years for buildings and is 15 years for land improvements. Any properties classified as held for sale are not depreciated.

Income Taxes

We have made an election to qualify, and believe we are operating in a manner to continue to qualify, as a REIT for federal income tax purposes beginning with our initial taxable year ended December 31, 2011. As a REIT, we will generally not be subject to federal income taxes to the extent that we distribute all of our taxable income to our stockholders and meet other specific requirements; however, we are still subject to certain state and local income taxes and to federal income and excise tax on our undistributed income.

Derivative Instruments and Hedging Activities

We may enter into derivatives contracts as part of our overall financing strategy to manage our exposure to changes in interest rates associated with current and/or future debt issuances. We do not use derivatives for trading or speculative purposes. We record our derivatives on the balance sheet at fair value as either an asset or liability. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the earnings effect of the hedged forecasted transactions in a cash flow hedge.

---

 

Results of Operations

Year Ended December 31, 2014 Compared to Year Ended December 31, 2013

 

 

Overview

As of December 31, 2014, our real estate investment portfolio had grown to $2.8 billion, consisting of investments in 947 property locations in 46 states, operated by 226 customers in various industries. Approximately 96% of the real estate investment portfolio represents commercial real estate properties subject to long‑term leases, 4% represents mortgage loan and direct financing receivables primarily on commercial real estate buildings (located on land we own and lease to our customers) and a nominal amount represents loans receivable secured by our tenants’ other assets. All of our owned properties were subject to a lease as of December 31, 2014.

Revenues

Revenues rose by 74.9% to $190.4 million for the year ended December 31, 2014 from $108.9 million for the year ended December 31, 2013, driven primarily by the growth in the size of our real estate investment portfolio, which generated additional rental revenues and interest income. Our real estate investment portfolio grew from $1.7 billion in gross investment amount at the end of 2013 to $2.8 billion in gross investment amount at December 31, 2014. Our real estate investments were made throughout the years presented and were not all outstanding for the entire period; accordingly, about half of the increase in revenues between years is related to recognizing a full year of revenue in 2014 on acquisitions that were purchased during 2013 and about half of the increase represents a partial year of revenue on assets that were acquired during 2014. The full revenue impact of 2014 acquisitions will be seen in 2015.  The weighted average real estate investment amounts outstanding during the years were $2.24 billion in 2014 and $1.28 billion in 2013.

The weighted average initial real estate capitalization rate on the properties we acquired during 2014 (calculated as the initial annualized base rent divided by the purchase price of the properties) was 8.3% as compared to 8.5%  for properties acquired during 2013.

The initial rental rates we receive on sale‑leaseback transactions on the various types of properties we target across the United States vary from transaction to transaction based on many factors, such as the terms of the lease, each property’s real estate fundamentals and the market rents in the area. The majority of our transactions are sale‑leaseback transactions where we acquire the property and simultaneously negotiate a lease with the tenant based on their business

---

 

needs, whereas the properties listed in online commercial real estate marketplaces are often subject to existing leases and are offered by third‑party sellers. Since our real estate leases represent an alternative for our customers to other forms of corporate capitalization, lease rates can also be influenced by changes in interest rates and overall capital availability. In general, because we provide tailored customer lease solutions, our lease rates have been historically subject to less variance than the auction marketplace as a whole. We have seen a general decrease of approximately 0.35% between December 2013 and December 2014 in real estate capitalization rates listed in online commercial real estate marketplaces. While we have experienced less downward lease rate pressures with the investments we funded during 2014, we have seen some lease rate compression, particularly during the latter part of the year. The lower long‑term interest rate environment during 2014 contributed to this easing. The impact of the lower lease rates may be wholly or partially offset by opportunities for lower long‑term borrowing costs, although there is no assurance of this.

Interest Expense

Interest expense increased to $68.0 million for the year ended December 31, 2014 from $39.2 million in 2013 due primarily to an increase in long‑term borrowings used to partially fund the acquisition of properties for our growing real estate investment portfolio. We funded the growth in our real estate investment portfolio with added equity and long‑term debt, using our short‑term credit facilities to temporarily finance properties we acquired until we had a sufficiently large and diverse pool of properties to issue long‑term fixed‑rate debt.

The following table summarizes our interest expense for the periods.

 

 

The average amount of long-term debt outstanding was $1.19 billion during 2014, up significantly from $0.63 billion in 2013 which is the primary driver for the increase in interest expense on long-term debt.  This increase was slightly offset by a decrease in the weighted average interest rate of the long-term debt. During 2014, our consolidated special purpose entities issued one series of STORE Master Funding net‑lease mortgage notes payable aggregating $260 million in principal amount with a weighted average interest rate of 4.64%.   In addition, we added $52.7 million of traditional mortgage debt during 2014.  At the end of 2014, we had $1.28 billion of outstanding long term debt with a weighted average interest rate of 4.9%. The average debt outstanding on our credit facilities increased to $79.5 million in 2014 from $77.3 million in 2013. The weighted average interest rate, including non-use fees on undrawn amounts, on our short-term borrowings was 3.9% in 2014, down from 4.3% in 2013.  During these periods, our two main secured credit facilities bore interest at a variable rate based on one‑month LIBOR plus a credit spread of 2.45% to 3.0%.  In September 2014, we replaced these two secured credit facilities with an unsecured credit facility that bears interest based on one‑month LIBOR plus a credit spread ranging from 1.75% to 2.50% using a leverage‑based scale. The LIBOR rate has been fairly stable since the beginning of 2013, with the one‑month LIBOR rate hovering between 0.15% and 0.17% during 2014 and between 0.16% and 0.21% during 2013.   

From time to time, we may have construction activities on one or more of our real estate properties and interest capitalized as a part of those activities represented less than $1 million in 2014.  In addition, interest expense in 2014

---

 

includes the write off of $1.2 million in remaining unamortized deferred financing costs related to the two secured credit facilities that we replaced with our new $300 million unsecured credit facility in September 2014.    

Transaction Costs

Our real estate acquisitions have been predominantly sale‑leaseback transactions in which acquisition and closing costs were capitalized as part of the investment in the property.  We  also occasionally acquire properties subject to an existing lease. Costs incurred on real estate transactions where we acquired properties that are subject to an existing lease were expensed to operations as incurred. Transaction costs expensed during the year ended December 31, 2014 totaled $2.8 million, as compared to $2.6 million incurred during 2013. Whether the real estate we acquire is subject to an existing lease or not determines how we account for the related transaction costs and, accordingly, may cause variability in the level of such costs expensed to operations from year to year.

Property Costs

Approximately 97% of our leases are triple-net, meaning that our tenants are generally responsible for the property-level operating costs such as taxes, insurance and maintenance. Accordingly, we  generally do not expect to incur property-level operating costs or capital expenditures, except during any period where one or more of our properties is no longer under lease. As of December 31, 2014, all of our properties are under lease and we have few near-term scheduled lease maturities, so we do not expect to incur significant property costs in the near term.  Our need to expend capital on our properties is further reduced due to the fact that some of our tenants will periodically refresh the property at their own expense to meet their business needs or in connection with franchisor requirements.

Included in property costs in 2014 and 2013 is approximately $57,000 and $30,000, respectively, related to the amortization of ground lease interest intangibles. Property costs also include the expense of performing site inspections of our properties from time to time, as well as the property management costs of the few properties we own that have specific landlord property-level expense obligations. 

General and Administrative Expenses

General and administrative expenses include compensation and benefits; professional fees such as portfolio servicing, legal and accounting fees; and general office expenses such as insurance, office rent and travel costs. General and administrative costs totaled $19.5 million for the year ended December 31, 2014 as compared to  $14.1 million for 2013 primarily due to the growth of our portfolio and additions to our staff due to the growth in our operations. Expenses, such as property‑related insurance costs and the costs of servicing the properties and loans comprising our real estate portfolio, increase in direct proportion to the increase in the size of the portfolio. Other costs, including the compensation paid to our real estate acquisition personnel, are based on the volume of real estate acquisitions made during the period; these costs were higher during the year ended December 31, 2014 as compared to the year ended December 31, 2013 commensurate with the increase in acquisition volume. Our number of employees grew from 44 employees at the end of 2013 to 50 employees as of December 31, 2014;  the added positions expanded our portfolio management and servicing team and other operations support functions and contributed to the increase in compensation and employee benefits expense. We expect an increase of approximately $2 million per year in ongoing costs related to being a public company, including the costs of public company governance and reporting and meeting other regulatory filing requirements. We also expect that general and administrative expenses will continue to rise in some measure as our real estate investment portfolio grows; however, we expect that such expenses as a percentage of the portfolio will decrease over time due to efficiencies and economies of scale.

Depreciation and Amortization Expense

Depreciation and amortization expense generally rises in proportion to the increase in the size of our real estate portfolio and, accordingly, such expense rose from $30.3 million for the year ended December 31, 2013 to $57.0 million for the year ended December 31, 2014.

---

 

Net Income

Our net income rose to $48.1 million for the year ended December 31, 2014 from the $26.3 million in net income reported in 2013. The increase in net income is primarily due to the growth in the size of our real estate investment portfolio, which generated additional rental revenues and interest income.  A portion of the increase in net income relates to an increase in gains from the sale of properties. We sell properties from time to time in order to enhance the diversity and quality of our real estate portfolio. We reported gains aggregating $5.5 million on the sale of 16 properties during the year ended December 31, 2014. The cost of the properties sold during 2014 represented 2% of our total real estate investment portfolio at the beginning of the year. During the year ended December 31, 2013, we reported gains aggregating $2.2 million (net of tax) on the sale of 17 properties; the cost of these properties represented 4% of our real estate investment portfolio at the beginning of that year.  As discussed in Note 2 to the consolidated financial statements, we adopted Accounting Standards Update No. 2014‑08 effective as of the beginning of 2014. As a result of this new accounting guidance, during 2014, the gains on the sales of the three properties that were considered to be held for sale as of the end of 2013 are reported in income from discontinued operations and the remaining gains are reported separately below income from continuing operations. During the year ended December 31, 2013, all gains on sales of properties were reported, net of tax, in income from discontinued operations.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

 

 

Overview

As of December 31, 2013, our real estate investment portfolio totaled $1.7 billion, consisting of investments in 622 property locations in 42 states, operated by 148 customers in various industries. Approximately 96% of the real estate investment portfolio represented commercial real estate properties subject to long‑term leases, 4% represented mortgage loans receivable on commercial real estate buildings (located on land we owned and leased to our customers) and a nominal amount represented loans receivable secured by our tenants’ inventory or other assets. All of our owned properties were subject to a lease as of December 31, 2013 and 2012.

Revenues

Revenues rose by 168% to $108.9 million for the year ended December 31, 2013 from $40.6 million for the year ended December 31, 2012, driven primarily by the growth in the size of our real estate investment portfolio, which generated additional rental revenues and interest income. Our real estate investment portfolio grew from $911.7 million in gross investment amount representing 371 properties at December 31, 2012 to $1.7 billion in gross investment amount representing 622 properties at December 31, 2013. The $837 million we invested in portfolio assets during 2013 represented 268 properties operated by 94 customers in 33 industries in 39 states. Our real estate investments were made throughout the years presented and were not all outstanding for the entire period.  The weighted average real estate investment amounts outstanding during the years were $1.28 billion in 2013 and $486.2 million in 2012. The weighted average initial real estate capitalization rate on the properties we acquired in 2013 (calculated as the initial annualized base rent divided by the purchase price of the properties) was 8.5%  for 2013 as compared to 8.7% for 2012.

---

 

Interest Expense

The following table summarizes our interest expense for the years ended December 31, 2013 and 2012.

 

 

Interest expense increased to $39.2 million for the year ended December 31, 2013 from $11.5 million in 2012 due primarily to an increase in short‑term and long‑term borrowings used to partially fund the acquisition of properties for our growing real estate investment portfolio. We funded the growth in our real estate investment portfolio with added equity and long‑term debt, using our short‑term credit facilities to temporarily finance properties we acquired until we had a sufficiently large and diverse pool of properties to issue long‑term fixed‑rate debt. The average debt outstanding on our secured credit facilities increased from $54.8 million in 2012 to $74.9 million in 2013 at a weighted average interest rate of 3.18% in 2012 as compared to 3.13% in 2013. During these periods, our secured credit facilities bore interest at a variable rate based on one‑month LIBOR plus a credit spread of 2.45% to 3.0%. The LIBOR rate was fairly stable during 2012 and 2013 at less than 0.3%. In addition to the interest, we paid a non‑use fee on undrawn amounts. During 2013, our consolidated special purpose entities issued a total of three series of STORE Master Funding net‑lease mortgage notes payable aggregating $633 million in principal amount. In addition, we added $61.6 million of traditional mortgage debt during the year, bringing our long‑term debt outstanding to $991.4 million at December 31, 2013, up from $306.6 million at December 31, 2012. The interest rates achieved on the debt added during 2013, primarily consisting of the Master Funding notes issued throughout the year, resulted in a decrease in the weighted average cost of our long-term debt.

Transaction Costs

Transaction costs expensed during the year ended December 31, 2013 totaled $2.6 million and were higher than the $0.4 million incurred during the comparable period of 2012, because we had a higher volume of transactions subject to existing leases in 2013. Whether the real estate we acquire is subject to an existing lease or not determines how we account for the related transaction costs and, accordingly, may cause variability in the level of such costs expensed to operations from year to year.

General and Administrative Expenses

General and administrative costs totaled $14.1 million for the year ended December 31, 2013 as compared to $10.4 million for 2012 primarily due to the growth of our portfolio and additions to our staff due to the growth in our operations. Expenses, such as property‑related insurance costs and the costs of servicing the properties and loans comprising our real estate portfolio, increased in direct proportion to the increase in the size of the portfolio. Other costs, including the compensation paid to our real estate acquisition personnel, were based on the volume of real estate acquisitions made during the period; these costs were higher in 2013 than in 2012 because our acquisition volume was

---

 

higher in 2013. We hired eight employees in 2013 to expand our primary internal operating functions, increasing compensation and employee benefits expense.

Depreciation and Amortization Expense

Depreciation and amortization expense increased in proportion to the increase in the size of the real estate portfolio and, accordingly, such expense rose from $11.0 million for the year ended December 31, 2012 to $30.3 million for the year ended December 31, 2013.

Net Income

Our net income rose to $26.3 million for the year ended December 31, 2013 from the $8.2 million in net income reported in 2012. The increase in net income is primarily due to the growth in the size of our real estate investment portfolio, which generated additional rental revenues and interest income. In addition, we reported an aggregate gain of $2.2 million (net of taxes) on the sale of 17 properties during the year ended December 31, 2013 as compared to an aggregate gain of $0.2 million on the sale of seven properties during 2012. During the years ended December 31, 2013 and 2012, gains and losses on the sales of properties were reported, net of tax, in income from discontinued operations.

Non-GAAP Measures

Our reported results are presented in accordance with U.S. generally accepted accounting principles, or GAAP. We also disclose Funds from Operations, or FFO, and Adjusted Funds from Operations, or AFFO, both of which are non‑GAAP measures. We believe these two non‑GAAP financial measures are useful to investors because they are widely accepted industry measures used by analysts and investors to compare the operating performance of REITs. FFO and AFFO do not represent cash generated from operating activities and are not necessarily indicative of cash available to fund cash requirements; accordingly, they should not be considered alternatives to net income as a performance measure or cash flows from operations as reported on our statement of cash flows as a liquidity measure and should be considered in addition to, and not in lieu of, GAAP financial measures.

We compute FFO in accordance with the definition adopted by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT. NAREIT defines FFO as GAAP net income, excluding gains (or losses) from extraordinary items and sales of depreciable property, real estate impairment losses and depreciation and amortization expense from real estate assets, including the pro rata share of such adjustments of unconsolidated subsidiaries. To derive AFFO, we modify the NAREIT computation of FFO to include other adjustments to GAAP net income related to non‑cash revenues and expenses such as straight‑line rents, amortization of deferred financing costs and stock‑based compensation. In addition, in deriving AFFO, we exclude transaction costs associated with acquiring real estate subject to existing leases.

FFO is used by management, investors and analysts to facilitate meaningful comparisons of operating performance between periods and among our peers primarily because it excludes the effect of real estate depreciation and amortization and net gains on sales, which are based on historical costs and implicitly assume that the value of real estate diminishes predictably over time, rather than fluctuating based on existing market conditions. Management believes that AFFO provides more useful information to investors and analysts because it modifies FFO to exclude additional non-cash revenues and expenses such as straight‑line rents, amortization of deferred financing costs and stock‑based compensation as such items may cause short-term fluctuations in net income but have no impact on operating cash flows or long-term operating performance. Additionally, in deriving AFFO, we exclude transaction costs associated with acquiring real estate subject to existing leases. We view transaction costs to be a part of our investment in the real estate we acquire, similar to the treatment of acquisition and closing costs on our sale-leaseback transactions, which are capitalized as a part of the investment in the asset. We believe that transaction costs are not an ongoing cost of the portfolio in place at the end of each reporting period and, for these reasons, we add back the portion expensed when computing AFFO.  As a result, we believe AFFO to be a more meaningful measurement of ongoing performance that allows for greater performance comparability.  Therefore, we disclose both FFO and AFFO and reconcile them to the most appropriate GAAP performance metric, which is net income.  STORE Capital’s FFO and AFFO may not be comparable to similarly titled measures employed by other companies.

---

 

The following is a reconciliation of net income (which we believe is the most comparable GAAP measure) to FFO and AFFO.

 

 

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

Our interest rate risk management objective is to limit the impact of future interest rate changes on our earnings and cash flows. We seek to match the cash inflows from our long‑term leases with the expected cash outflows on our long‑term debt. To achieve this objective, our consolidated subsidiaries primarily borrow on a fixed‑rate basis for longer‑term debt issuances. At December 31, 2014, substantially all of our outstanding long‑term debt carried a fixed interest rate and the weighted average debt maturity was approximately seven years. We are exposed to interest rate risk between the time we enter into a sale‑leaseback transaction and the time we finance the related real estate with long‑term fixed‑rate debt. In addition, when that long‑term debt matures, we may have to refinance the real estate at a higher interest rate. Market interest rates are sensitive to many factors that are beyond our control.  

We address interest rate risk by employing the following strategies to help insulate us from any adverse impact of rising interest rates:

Although the substantial majority of our debt is fixed-rate debt, we utilize credit facilities that are based on a variable rate.  During the year ended December 31, 2014, we had average daily outstanding borrowings of $79.5 million on our variable‑rate credit facilities at a weighted average annual interest rate of one‑month LIBOR plus 2.25% to 3.0%.  We monitor our market interest rate risk exposures using a sensitivity analysis.  Our sensitivity analysis estimates the exposure to market risk sensitive instruments assuming a hypothetical adverse change in interest rates.  Based on the results of a sensitivity analysis, which assumes a 1% adverse change in interest rates, the estimated market risk exposure for all of our variable‑rate debt was approximately $849,000, or less than 1% of net cash provided by operating activities for the year ended December 31, 2014. In addition, we may use various financial instruments designed to mitigate the impact of interest rate fluctuations on our cash flows and earnings, including hedging strategies, depending on our analysis of the interest rate environment and the costs and risks of such strategies.  We do not use derivative instruments for trading or speculative purposes.  See Note 5 to our Consolidated Financial Statements for further information on derivatives.

---

 

Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Board of Directors and Stockholders of

STORE Capital Corporation

We have audited the accompanying consolidated balance sheets of STORE Capital Corporation (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of STORE Capital Corporation at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

As discussed in Note 2 to the consolidated financial statements, the Company changed its method for reporting discontinued operations effective January 1, 2014.

/s/ Ernst & Young LLP

Phoenix, Arizona

March 10, 2015

---

 

STORE Capital Corporation

Consolidated Balance Sheets

(In thousands, except share and per share data)

 

 

See accompanying notes.

---

 

STORE Capital Corporation

Consolidated Statements of Income

(In thousands, except share and per share data)

 

 

See accompanying notes.

---

 

STORE Capital Corporation

Consolidated Statements of Comprehensive Income

(In thousands)

 

 

See accompanying notes.

---

 

STORE Capital Corporation

Consolidated Statements of Stockholders’ Equity

For the Years Ended December 31, 2014, 2013 and 2012

(In thousands, except share data)

 

 

See accompanying notes.

---

 

STORE Capital Corporation

Consolidated Statements of Cash Flows

(In thousands)

 

 

See accompanying notes.