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EX-31.2 - EXHIBIT 31.2 - Phillips Edison & Company, Inc.pentr_20160331-ex312.htm
EX-32.2 - EXHIBIT 32.2 - Phillips Edison & Company, Inc.pentr_20160331-ex322.htm
EX-31.1 - EXHIBIT 31.1 - Phillips Edison & Company, Inc.pentr_20160331-ex311.htm
EX-32.1 - EXHIBIT 32.1 - Phillips Edison & Company, Inc.pentr_20160331-ex321.htm


 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2016
OR
¨     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to              
Commission file number 000-54691
 
PHILLIPS EDISON GROCERY CENTER REIT I, INC.  
 
(Exact Name of Registrant as Specified in Its Charter)
 
Maryland
27-1106076
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
11501 Northlake Drive
 Cincinnati, Ohio
45249
(Address of Principal Executive Offices)
(Zip Code)
(513) 554-1110
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   ¨ 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer
¨
Accelerated Filer
¨
 
 
 
 
Non-Accelerated Filer
x (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of April 30, 2016, there were 183.1 million outstanding shares of common stock of Phillips Edison Grocery Center REIT I, Inc.





INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


1



PART I.        FINANCIAL INFORMATION
 
Item 1.          Financial Statements

PHILLIPS EDISON GROCERY CENTER REIT I, INC.
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2016 AND DECEMBER 31, 2015
(Unaudited)
(In thousands, except per share amounts)
  
March 31, 2016
 
December 31, 2015
ASSETS
  
 
  
Investment in real estate:
  
 
  
Land and improvements
$
719,781

 
$
719,430

Building and improvements
1,399,392

 
1,397,050

Acquired above-market lease assets
39,311

 
39,311

Acquired in-place lease assets
194,242

 
194,242

Total investment in real estate assets
2,352,726

 
2,350,033

Accumulated depreciation and amortization
(258,378
)
 
(232,102
)
Total investment in real estate assets, net
2,094,348

 
2,117,931

Cash and cash equivalents
10,858

 
40,680

Restricted cash
6,762

 
6,833

Other assets, net
60,297

 
60,804

Total assets
$
2,172,265

 
$
2,226,248

 
 
 
 
LIABILITIES AND EQUITY
  

 
  

Liabilities:
  

 
  

Mortgages and loans payable, net
$
811,498

 
$
845,515

Acquired below-market lease intangibles, net of accumulated amortization of $15,865 and $14,259, respectively
38,176

 
39,782

Accounts payable – affiliates
4,150

 
5,278

Accounts payable and other liabilities
49,508

 
43,881

Total liabilities
903,332

 
934,456

Commitments and contingencies (Note 6)

 

Equity:
  

 
  

Preferred stock, $0.01 par value per share, 10,000 shares authorized, zero shares issued and outstanding at March 31, 2016
  
 
  
and December 31, 2015, respectively

 

Common stock, $0.01 par value per share, 1,000,000 shares authorized, 182,592 and 181,308 shares issued and
  
 
  
outstanding at March 31, 2016 and December 31, 2015, respectively
1,826

 
1,813

Additional paid-in capital
1,601,622

 
1,588,541

Accumulated other comprehensive (loss) income
(7,339
)
 
22

Accumulated deficit
(351,919
)
 
(323,761
)
Total stockholders’ equity
1,244,190

 
1,266,615

Noncontrolling interests
24,743

 
25,177

Total equity
1,268,933

 
1,291,792

Total liabilities and equity
$
2,172,265

 
$
2,226,248


See notes to consolidated financial statements.

2



PHILLIPS EDISON GROCERY CENTER REIT I, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2016 AND 2015
(Unaudited)
(In thousands, except per share amounts)
  
Three Months Ended March 31,
  
2016
 
2015
Revenues:
  
 
  
Rental income
$
46,939

 
$
44,500

Tenant recovery income
15,944

 
14,104

Other property income
199

 
343

Total revenues
63,082

 
58,947

Expenses:
  

 
  

Property operating
10,291

 
9,986

Real estate taxes
9,411

 
8,179

General and administrative
7,553


2,362

Acquisition expenses
20


1,735

Depreciation and amortization
25,706


24,730

Total expenses
52,981


46,992

Other expense:
  

 
  

Interest expense, net
(7,732
)

(6,794
)
Other expense, net
(116
)

(122
)
Net income
2,253


5,039

Net income attributable to noncontrolling interests
(34
)
 
(68
)
Net income attributable to stockholders
$
2,219


$
4,971

Earnings per common share:
  

 
  

Net income per share - basic and diluted
$
0.01


$
0.03

Weighted-average common shares outstanding:
 
 
 
Basic
182,246

 
182,988

Diluted
185,031

 
185,495

 
 
 
 
Comprehensive (loss) income:
  

 
  

Net income
$
2,253

 
$
5,039

Other comprehensive loss:
  

 
  

Change in unrealized loss on interest rate swaps, net
(7,361
)
 

Comprehensive (loss) income
(5,108
)
 
5,039

Comprehensive income attributable to noncontrolling interests
(34
)
 
(68
)
Comprehensive (loss) income attributable to stockholders
$
(5,142
)
 
$
4,971


See notes to consolidated financial statements.

3



PHILLIPS EDISON GROCERY CENTER REIT I, INC.
CONSOLIDATED STATEMENTS OF EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2016 AND 2015
(Unaudited)
(In thousands, except per share amounts)
  
Common Stock
 
Additional Paid-In Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Accumulated Deficit
 
Total Stockholders’ Equity
 
Noncontrolling Interest
 
Total Equity
  
Shares
 
Amount
 
 
 
 
 
 
Balance at January 1, 2015
182,131

 
$
1,820

 
$
1,567,653

 
$

 
$
(213,975
)
 
$
1,355,498

 
$
22,764

 
$
1,378,262

Share repurchases
(514
)
 
(3
)
 
(3,338
)
 

 

 
(3,341
)
 

 
(3,341
)
Change in redeemable common stock

 

 
(54,509
)
 

 

 
(54,509
)
 

 
(54,509
)
Dividend reinvestment plan (DRIP)
1,662

 
16

 
15,782

 

 

 
15,798

 

 
15,798

Common distributions declared, $0.17 per share

 

 

 

 
(30,236
)
 
(30,236
)
 

 
(30,236
)
Issuance of partnership units

 

 

 

 

 

 
4,047

 
4,047

Distributions to noncontrolling interests

 

 

 

 

 

 
(428
)
 
(428
)
Net income

 

 

 

 
4,971

 
4,971

 
68

 
5,039

Balance at March 31, 2015
183,279

 
$
1,833

 
$
1,525,588

 
$

 
$
(239,240
)
 
$
1,288,181

 
$
26,451

 
$
1,314,632

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2016
181,308

 
$
1,813

 
$
1,588,541

 
$
22

 
$
(323,761
)
 
$
1,266,615

 
$
25,177

 
$
1,291,792

Share repurchases
(212
)
 
(2
)
 
(2,160
)
 

 

 
(2,162
)
 

 
(2,162
)
DRIP
1,496

 
15

 
15,241

 

 

 
15,256

 

 
15,256

Change in unrealized loss on interest rate swaps

 

 

 
(7,361
)
 

 
(7,361
)
 

 
(7,361
)
Common distributions declared, $0.17 per share

 

 

 

 
(30,377
)
 
(30,377
)
 

 
(30,377
)
Distributions to noncontrolling interests

 

 

 

 

 

 
(468
)
 
(468
)
Net income

 

 

 

 
2,219

 
2,219

 
34

 
2,253

Balance at March 31, 2016
182,592

 
$
1,826

 
$
1,601,622

 
$
(7,339
)
 
$
(351,919
)
 
$
1,244,190

 
$
24,743

 
$
1,268,933


See notes to consolidated financial statements.

4




PHILLIPS EDISON GROCERY CENTER REIT I, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2016 AND 2015
(Unaudited)
(In thousands)
  
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
  
 
  
Net income
$
2,253

 
$
5,039

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

 
  

Depreciation and amortization
24,933

 
23,958

Net amortization of above- and below-market leases
(272
)
 
(178
)
Amortization of deferred financing expense
1,063

 
1,258

Loss on disposal of real estate assets
104

 
100

Loss on write-off of unamortized capitalized leasing commissions and deferred financing expense
52

 
81

Change in fair value of derivative
53

 
47

Straight-line rental income
(899
)
 
(1,244
)
Other
18

 

Changes in operating assets and liabilities:
  

 
  

Other assets
424

 
(2,063
)
Accounts payable and other liabilities
(1,484
)
 
469

Accounts payable – affiliates
(1,286
)
 
1,204

Net cash provided by operating activities
24,959


28,671

CASH FLOWS FROM INVESTING ACTIVITIES:
  

 
  

Real estate acquisitions

 
(61,839
)
Capital expenditures
(4,274
)
 
(2,995
)
Change in restricted cash
71

 
(506
)
Net cash used in investing activities
(4,203
)
 
(65,340
)
CASH FLOWS FROM FINANCING ACTIVITIES:
  

 
  

Net change in credit facility
(9,000
)
 
66,800

Payments on mortgages and loans payable
(25,026
)
 
(11,654
)
Payments of deferred financing expenses

 
(557
)
Distributions paid, net of DRIP
(15,064
)
 
(14,366
)
Distributions to noncontrolling interests
(306
)
 
(134
)
Repurchases of common stock
(1,182
)
 
(4,908
)
Net cash (used in) provided by financing activities
(50,578
)
 
35,181

NET DECREASE IN CASH AND CASH EQUIVALENTS
(29,822
)
 
(1,488
)
CASH AND CASH EQUIVALENTS:
  

 
  

Beginning of period
40,680

 
15,649

End of period
$
10,858

 
$
14,161

 
 
 
 
SUPPLEMENTAL CASH FLOW DISCLOSURE, INCLUDING NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Cash paid for interest
$
7,478

 
$
6,021

Fair value of assumed debt

 
24,982

Accrued capital expenditures and deferred financing expenses
1,018

 
853

Change in distributions payable
57

 
72

Change in distributions payable - noncontrolling interests
162

 
294

Change in accrued share repurchase obligation
980

 
(1,567
)
Distributions reinvested
15,256

 
15,798


See notes to consolidated financial statements.

5



 Phillips Edison Grocery Center REIT I, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
 
1. ORGANIZATION
Phillips Edison Grocery Center REIT I, Inc., (“we,” the “Company,” “our,” or “us”) was formed as a Maryland corporation in October 2009. Substantially all of our business is conducted through Phillips Edison Grocery Center Operating Partnership I, L.P., (the “Operating Partnership”), a Delaware limited partnership formed in December 2009. We are a limited partner of the Operating Partnership, and our wholly owned subsidiary, Phillips Edison Grocery Center OP GP I LLC, is the sole general partner of the Operating Partnership.
Our advisor is Phillips Edison NTR LLC (“PE-NTR”), which is directly or indirectly owned by Phillips Edison Limited Partnership (the “Phillips Edison sponsor”). Under the terms of the advisory agreement between PE-NTR and us (the “PE-NTR Agreement”), PE-NTR is responsible for the management of our day-to-day activities and the implementation of our investment strategy.
We invest primarily in well-occupied, grocery-anchored neighborhood and community shopping centers having a mix of creditworthy national and regional retailers selling necessity-based goods and services in strong demographic markets throughout the United States. As of March 31, 2016, we owned fee simple interests in 147 real estate properties acquired from third parties unaffiliated with us or PE-NTR.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Set forth below is a summary of the significant accounting estimates and policies that management believes are important to the preparation of our consolidated interim financial statements. Certain of our accounting estimates are particularly important for an understanding of our financial position and results of operations and require the application of significant judgment by management. As a result, these estimates are subject to a degree of uncertainty. There have been no changes to our significant accounting policies during the three months ended March 31, 2016, except for those policies included below. For a full summary of our accounting policies, refer to our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the U.S. Securities and Exchange Commission (“SEC”) on March 3, 2016.
Basis of Presentation and Principles of Consolidation—The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Readers of this Quarterly Report on Form 10-Q should refer to the audited consolidated financial statements of Phillips Edison Grocery Center REIT I, Inc. for the year ended December 31, 2015, which are included in our 2015 Annual Report on Form 10-K. In the opinion of management, all normal and recurring adjustments necessary for the fair presentation of the unaudited consolidated financial statements for the periods presented have been included in this Quarterly Report. Our results of operations for the three months ended March 31, 2016, are not necessarily indicative of the operating results expected for the full year.
The accompanying consolidated financial statements include our accounts and those of our majority-owned subsidiaries. All intercompany balances and transactions are eliminated upon consolidation.
Repurchase of Common Stock—We offer a share repurchase program which may allow certain stockholders to have their shares repurchased subject to approval and certain limitations and restrictions (see Note 8). We account for those financial instruments that represent our mandatory obligation to repurchase shares as liabilities to be reported at settlement value. When shares are presented for repurchase, we will reclassify such obligations from redeemable common stock to a liability based upon their respective settlement values.
Under our share repurchase program, the maximum amount of common stock that we may redeem, at the shareholder’s election, during any calendar year is limited, among other things, to 5% of the weighted-average number of shares outstanding during the prior calendar year. The maximum amount is reduced each reporting period by the current year share redemptions to date. In addition, the cash available for repurchases on any particular date is generally limited to the proceeds from the DRIP during the preceding four fiscal quarters, less amounts already used for repurchases during the same time period.

6



Reclassifications—The following line items on our consolidated balance sheets as of December 31, 2015, were reclassified to conform to the current year presentation:
The acquired intangible lease assets balance was separated into Acquired Above-Market Lease Assets and Acquired In-Place Lease Assets,
Certain unamortized debt issuance costs were reclassified from Deferred Financing Expense, Net to Other Assets, Net.
Newly Adopted and Recently Issued Accounting Pronouncements—In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-03, Interest - Imputation of Interest (Topic 835): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). This update amends existing guidance to require the presentation of certain debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of a deferred charge. In August 2015, the FASB issued ASU 2015-15: Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements (“ASU 2015-15”). This update provides guidance regarding the presentation and subsequent measurement of debt issuance costs related to line-of-credit arrangements. We adopted ASU 2015-03 and ASU 2015-15 on January 1, 2016, and retrospectively applied the guidance for all periods presented. Unamortized debt issuance costs of $7.9 million and $8.6 million are included in Mortgages and Loans Payable, Net as of March 31, 2016 and December 31, 2015, respectively, which were previously included in Deferred Financing Expense, Net in our consolidated balance sheets. The remaining amounts included in Other Assets, Net on our consolidated balance sheets were related to our revolving credit facility. The adoption did not have an impact on our results of operations (see Note 5).
In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis to ASC Topic 810 Consolidation. ASU 2015-02 includes all reporting entities within the scope of Subtopic 810-10 Consolidation - Overall, including limited partnerships and similar legal entities, unless a scope exception applies. Overall the amendments in this update are to simplify the codification and reduce the number of consolidation models and place more emphasis on risk of loss when determining controlling financial interests. ASU 2015-02 is effective for public businesses for interim and annual periods beginning after December 15, 2015. This ASU was effective beginning in the first quarter of our year ending December 31, 2016. We have evaluated the impact of the adoption of ASU 2015-02 on our consolidated financial statements and have determined under ASU 2015-02 the Operating Partnership is considered a variable interest entity (“VIE”). We are the primary beneficiary of the VIE and the our partnership interest is considered a majority voting interest. As such, this standard did not have a material impact on our consolidated financial statements.
The following table provides a brief description of recent accounting pronouncements that could have a material effect on our financial statements:
Standard
 
Description
 
Date of Adoption
 
Effect on the Financial Statements or Other Significant Matters
ASU 2014-09, Revenue from Contracts with Customers
 
This update outlines a comprehensive model for entities to use in accounting for revenue arising from contracts with customers. ASU 2014-09 states that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” While ASU 2014-09 specifically references contracts with customers, it may apply to certain other transactions such as the sale of real estate or equipment. In 2015, the FASB provided for a one-year deferral of the effective date for ASU 2014-09, making it effective for annual reporting periods beginning after December 15, 2017.
 
January 1, 2018
 
We are currently evaluating the impact the adoption of this standard will have on our consolidated financial statements.
ASU 2016-02, Leases (Topic 842)
 
This update amends existing guidance by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. It is effective for annual reporting periods beginning after December 15, 2018, but early adoption is permitted.
 
January 1, 2019
 
We are currently evaluating the impact the adoption of this standard will have on our consolidated financial statements.


7



3. FAIR VALUE MEASUREMENTS
ASC 820, Fair Value Measurement (“ASC 820”) defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. ASC 820 emphasizes that fair value is intended to be a market-based measurement, as opposed to a transaction-specific measurement. Fair value is defined by ASC 820 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, various techniques and assumptions can be used to estimate the fair value. Assets and liabilities are measured using inputs from three levels of the fair value hierarchy, as follows:
Level 1—Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access at the measurement date. An active market is defined as a market in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2—Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active (markets with few transactions), inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data correlation or other means (market corroborated inputs).
Level 3—Unobservable inputs, only used to the extent that observable inputs are not available, reflect our assumptions about the pricing of an asset or liability. 
The following describes the methods we use to estimate the fair value of our financial and non-financial assets and liabilities: 
Cash and Cash Equivalents, Restricted Cash, Accounts Receivable, and Accounts Payable and Other Liabilities—We consider the carrying values of these financial instruments to approximate fair value because of the short period of time between origination of the instruments and their expected realization.
Real Estate Investments—The purchase prices of the investment properties, including related lease intangible assets and liabilities, were allocated at estimated fair value based on Level 3 inputs, such as discount rates, capitalization rates, comparable sales, replacement costs, income and expense growth rates and current market rents and allowances as determined by management. Real estate assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the individual property may not be recoverable, or at least annually. In such an event, a comparison will be made of the projected operating cash flows of each property on an undiscounted basis to the carrying amount of such property. Such carrying amount would be adjusted, if necessary, to estimated fair values to reflect impairment in the value of the asset.
Mortgages and Loans Payable—We estimate the fair value of our debt by discounting the future cash flows of each instrument at rates currently offered for similar debt instruments of comparable maturities by our lenders using Level 3 inputs.  The discount rate used approximates current lending rates for loans or groups of loans with similar maturities and credit quality, assuming the debt is outstanding through maturity and considering the debt’s collateral (if applicable). We have utilized market information, as available, or present value techniques to estimate the amounts required to be disclosed.
The following is a summary of discount rates and borrowings as of March 31, 2016 and December 31, 2015 (dollars in thousands):
 
 
March 31, 2016
 
December 31, 2015
Discount rates:
 
 
 
 
Fixed-rate debt
 
3.14
%
 
2.75
%
Secured variable-rate debt
 
2.69
%
 
2.36
%
Unsecured variable-rate debt
 
1.94
%
 
1.66
%
Borrowings:
 
 
 
 
Fair value
 
$
840,113

 
$
880,854

Recorded value(1)
 
819,379

 
854,079

(1) 
Recorded value does not include deferred financing cost of $7.9 million and $8.6 million as of March 31, 2016 and December 31, 2015, respectively.
Derivative InstrumentsIn April 2015, we entered into three interest rate swap agreements with a notional amount of $387.0 million that are measured at fair value on a recurring basis. These interest rate swap agreements effectively fix the LIBOR portion of the interest rate on $387.0 million of outstanding debt under our existing credit facility. These swaps qualify and have been designated as cash flow hedges.

8



As of March 31, 2016 and December 31, 2015, we were party to an interest rate swap agreement with a notional amount of $11.3 million. The interest rate swap was assumed as part of an acquisition and is measured at fair value on a recurring basis. The interest rate swap agreement, in effect, fixes the variable interest rate of one of our secured variable-rate mortgage notes at an annual interest rate of 5.22% through June 10, 2018.
The fair value of the interest rate swap agreements as of March 31, 2016 and December 31, 2015 was based on the estimated amount we would receive or pay to terminate the contract at the reporting date and was determined using interest rate pricing models and interest rate-related observable inputs. Although we determined that the significant inputs used to value our derivatives fell within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our counterparties and our own credit risk utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties. However, as of March 31, 2016 and December 31, 2015, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative position and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives. As a result, we have determined that our derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Considerable judgment is necessary to develop estimated fair values of financial and non-financial assets and liabilities. Accordingly, the estimates presented herein are not necessarily indicative of the amounts we did or could actually realize upon disposition of the financial assets and liabilities previously sold or currently held.
Our derivative liability is currently recorded in Accounts Payable and Other Liabilities on our consolidated balance sheets. The fair value measurements of our financial liability and asset as of March 31, 2016 and December 31, 2015 are as follows (in thousands):
  
March 31, 2016
 
December 31, 2015
Derivative liability (asset) designated as hedging instruments:
 
 
 
Interest rate swaps - unsecured credit facility
$
7,338

 
$
(22
)
Derivative liability not designated as hedging instrument:
 
 
 
Interest rate swap - mortgage note
496

 
442


4. REAL ESTATE ACQUISITIONS
During the three months ended March 31, 2015, we acquired eight grocery-anchored retail centers for an aggregate purchase price of approximately $86.4 million, including $24.0 million of assumed debt with a fair value of $25.0 million. We did not acquire any properties during the three months ended March 31, 2016. The following tables present certain additional information regarding our acquisitions of properties during the three months ended March 31, 2015, that were deemed individually immaterial when acquired, but were material in the aggregate. 
For the three months ended March 31, 2015, we allocated the purchase price of acquisitions to the fair value of the assets acquired and liabilities assumed as follows (in thousands):
 
 
2015
Land and improvements
 
$
29,516

Building and improvements
 
51,186

Acquired in-place leases
 
8,703

Acquired above-market leases
 
356

Acquired below-market leases
 
(3,319
)
Total assets and lease liabilities acquired
 
86,442

Fair value of assumed debt at acquisition (1)
 
24,982

Net assets acquired
 
$
61,460

(1) 
Debt assumed relates to five properties as well as a strip center adjacent to a previously acquired grocery-anchored retail center.  

9



The weighted-average amortization periods for acquired in-place lease, above-market lease, and below-market lease intangibles acquired during the three months ended March 31, 2015 are as follows (in years):
 
 
2015
Acquired in-place leases
 
16
Acquired above-market leases
 
16
Acquired below-market leases
 
21
The amounts recognized for revenues, acquisition expenses, and net loss recorded during the year of acquisition related to the operating activities of our acquisitions are as follows (in thousands):
 
 
March 31, 2015
Revenues
 
$
752

Acquisition expenses
 
1,458

Net loss
 
1,498

The following unaudited pro forma information summarizes selected financial information from our combined results of operations, as if all of our acquisitions for 2015 had been acquired on January 1, 2015. Acquisition expenses related to each respective acquisition are not expected to have a continuing impact and, therefore, have been excluded from these pro forma results. This pro forma information is presented for informational purposes only and may not be indicative of what actual results of operations would have been had the transactions occurred at the beginning of the period, nor does it purport to represent the results of future operations.
 
Three Months Ended
(in thousands)
March 31, 2015
Pro forma revenues
$
60,970

Pro forma net income attributable to stockholders
6,806


5. MORTGAGES AND LOANS PAYABLE
Our credit agreement provides access to an unsecured revolving credit facility and an unsecured term loan facility (the “Term Loans”). The revolving credit facility has a capacity of $500 million with a current interest rate of LIBOR plus 1.3%. The revolving credit facility matures in December 2017 with additional options to extend the maturity to December 2018. The Term Loans include three term loan tranches with interest rates of LIBOR plus 1.25%. The first tranche of Term Loans has a principal amount of $100 million and matures in February 2019, with two 12-month options to extend the maturity to February 2021. The second tranche of Term Loans has a principal amount of $175 million and matures in February 2020, with one option to extend the maturity to February 2021. The third tranche of Term Loans has a principal amount of $125 million and matures in February 2021. A maturity date extension for the first or second tranche of Term Loans requires the payment of an extension fee of 0.15% of the outstanding principal amount of the corresponding tranche.
As of March 31, 2016 and December 31, 2015, the weighted-average interest rate for all of our mortgages and loans payable was 3.5%.
The following is a summary of our debt obligations as of March 31, 2016 and December 31, 2015 (in thousands):
  
March 31, 2016
 
December 31, 2015
Unsecured Term Loans - fixed-rate(1)
$
387,000

 
$
387,000

Unsecured Term Loans - variable-rate
13,000

 
13,000

Unsecured revolving credit facility - variable-rate(2)
132,000

 
141,000

Fixed-rate mortgages payable(3)(4)
281,409

 
306,435

Deferred financing costs, net(5)
(7,881
)
 
(8,564
)
Assumed below-market debt adjustment, net(6)
5,970

 
6,644

Total
$
811,498

 
$
845,515

(1) 
As of March 31, 2016 and December 31, 2015, the interest rate on $387 million outstanding under our Term Loans was, effectively, fixed at various interest rates by three interest rate swap agreements with maturities ranging from February 2019 to February 2021 (see Notes 3 and 7).

10



(2) 
The gross borrowings under our revolving credit facility were $7.0 million during the three months ended March 31, 2016. The gross payments on our credit facility were $16.0 million during the three months ended March 31, 2016.
(3) 
Due to the non-recourse nature of our fixed-rate mortgages, the assets and liabilities of the related properties are neither available to pay the debts of the consolidated property-holding limited liability companies nor constitute obligations of such consolidated limited liability companies as of March 31, 2016.
(4) 
As of March 31, 2016 and December 31, 2015, the interest rate on one of our variable-rate mortgage notes payable was, in effect, fixed at 5.22% by an interest rate swap agreement (see Notes 3 and 7).
(5) 
Net of accumulated amortization of $3.4 million and $2.8 million as of March 31, 2016 and December 31, 2015, respectively. Accumulated amortization of deferred financing costs included in Other Assets, Net was $4.7 million and $4.8 million as of March 31, 2016 and December 31, 2015, respectively.
(6) 
Net of accumulated amortization of $6.7 million and $6.5 million as of March 31, 2016 and December 31, 2015, respectively.

6. COMMITMENTS AND CONTINGENCIES 
Litigation 
In the ordinary course of business, we may become subject to litigation or claims. There are no material legal proceedings pending, or known to be contemplated, against us. 
Environmental Matters 
In connection with the ownership and operation of real estate, we may be potentially liable for costs and damages related to environmental matters. We record liabilities as they arise related to environmental obligations. We have not been notified by any governmental authority of any material non-compliance, liability or other claim, nor are we aware of any other environmental condition that we believe will have a material impact on our consolidated financial statements.

7. DERIVATIVES AND HEDGING ACTIVITIES
Risk Management Objective of Using Derivatives
We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposure to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments. Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash receipts and our known or expected cash payments principally related to our investments and borrowings.
Cash Flow Hedges of Interest Rate Risk
Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for our making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive (Loss) Income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three months ended March 31, 2016, such derivatives were used to hedge the variable cash flows associated with certain variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. 
As of March 31, 2016, we had three interest rate swaps with a notional amount of $387.0 million that were designated as cash flow hedges of interest rate risk. Amounts reported in Accumulated Other Comprehensive (Loss) Income related to these derivatives will be reclassified to Interest Expense, Net as interest payments are made on the variable-rate debt. During the next 12 months, we estimate that an additional $2.9 million will be reclassified from Other Comprehensive Loss as an increase to Interest Expense, Net.
Derivatives Not Designated as Hedging Instruments
Derivatives not designated as hedges are not speculative and are used to manage our exposure to interest rate movements and other identified risks, but do not meet the strict hedge accounting requirements to be classified as hedging instruments. Changes

11



in the fair value of these derivative instruments, as well as any payments, are recorded directly in Other Expense, Net and resulted in a loss of $119,000 and $121,000 for the three months ended March 31, 2016 and 2015, respectively.
Tabular Disclosure of the Effect of Derivative Instruments on Accumulated Other Comprehensive (Loss) Income (“AOCI”) and the Consolidated Statements of Operations and Comprehensive Income (Loss)
We did not have any changes in AOCI for the three months ended March 31, 2015. The table below presents the changes in AOCI and the effect of our derivative financial instruments on the consolidated statements of operations and comprehensive (loss) income for the three months ended March 31, 2016 (in thousands):
Balance in AOCI as of January 1, 2016
$
22

Amount of loss recognized in other comprehensive income on derivative
(8,307
)
Amount of loss reclassified from accumulated other comprehensive income into interest expense
946

Current-period other comprehensive income
(7,361
)
Balance in AOCI as of March 31, 2016
$
(7,339
)
Credit-risk-related Contingent Features
We have an agreement with our derivative counterparties that contains a provision where, if we either default or are capable of being declared in default on any of our indebtedness, we could also be declared to be in default on our derivative obligations. As of March 31, 2016 and December 31, 2015, the fair value of our derivatives excluded any adjustment for nonperformance risk related to this agreement. As of March 31, 2016 and December 31, 2015, we had not posted any collateral related to this agreement.

8. EQUITY
On April 14, 2016, our board of directors reaffirmed its estimated value per share of our common stock of $10.20 based substantially on the estimated market value of our portfolio of real estate properties in various geographic locations in the United States as of March 31, 2016. We engaged a third party, Duff & Phelps, LLC, to provide a calculation of the range in estimated value per share of our common stock as of March 31, 2016, which reflected the balance sheet assets and liabilities as of that date.
Dividend Reinvestment Plan—We have adopted a dividend reinvestment plan (the “DRIP”) that allows stockholders to invest distributions in additional shares of our common stock. As of March 31, 2016, shares were issued under the DRIP at a price of $10.20 per share.
Share Repurchase Program—Our share repurchase program provides an opportunity for stockholders to have shares of common stock repurchased, subject to certain restrictions and limitations. The following table presents the activity of the share repurchase program for the three months ended March 31, 2016 and 2015 (in thousands, except per share amounts):
 
 
2016
 
2015
Shares repurchased
 
212

 
514

Cost of repurchases
 
$
2,162

 
$
4,908

Average repurchase price
 
$
10.20

 
$
9.54

During the first quarter of 2016, repurchase requests continued to surpass the funding limits under the share repurchase program. Due to the program’s funding limits, no funds will be available for repurchases during the second quarter of 2016, and the funds available for repurchases during the third quarter of 2016, if any, are expected to be limited. If we are unable to fulfill all repurchase requests in any month, we will attempt to honor requests on a pro rata basis. We continue to fulfill repurchases sought upon a stockholder’s death, determination of incompetence or qualifying disability in accordance with the terms of the share repurchase program.

12



We record a liability representing our obligation to repurchase shares of common stock submitted for repurchase as of period end but not yet repurchased. The liability for a repurchase request recorded as of March 31, 2016, is due to a stockholder’s death, “qualifying disability,” or “determination of incompetence," and is not subject to the funding limitations of the share repurchase program. Below is a summary of our obligation to repurchase shares of common stock recorded as a component of Accounts Payable and Other Liabilities on our consolidated balance sheets as of March 31, 2016 and December 31, 2015 (in thousands):
 
 
March 31, 2016
 
December 31, 2015
Shares submitted for repurchase
 
96

 

Liability recorded
 
$
980

 
$

On April 14, 2016, our board of directors amended and restated the share repurchase program. The amendments provide that the board of directors reserves the right, in its sole discretion, at any time and from time to time, to reject any request for repurchase, and clarifies that the cash available for repurchases on any particular date will generally be limited to the proceeds from the DRIP during the preceding four fiscal quarters, less amounts already used for repurchases since the beginning of that period. The amendments will become effective on May 15, 2016.
Class B and Operating Partnership Units—The Operating Partnership issues limited partnerships units that are designated as Class B units and Operating Partnership units (“OP units”) for asset management services provided by PE-NTR. The vesting of the Class B units is contingent upon a market condition and service condition. OP units may be exchanged at the election of the holder for cash or, at the option of the Operating Partnership, for shares of our common stock, under the terms of exchange rights agreements to be prepared at a future date, provided, however, that the OP units have been outstanding for at least one year. PE-NTR has agreed under the PE-NTR Agreement not to exchange any OP units it may hold until the listing of our common stock or the liquidation of our portfolio occurs. As the form of the redemptions for the OP units is within our control, the OP units issued as of March 31, 2016 are classified as Noncontrolling Interests within permanent equity on our consolidated balance sheets. Additionally, the cumulative distributions that have been paid on these OP units are included in Distributions to Noncontrolling Interests on the consolidated statements of equity.
Below is a summary of our outstanding OP units and unvested Class B units as of March 31, 2016 and December 31, 2015 (shares in thousands):
 
 
March 31, 2016
 
December 31, 2015
OP units
 
2,785

 
2,785

Class B units
 
2,211

 
2,083


9. EARNINGS PER SHARE
We use the two-class method of computing earnings per share (“EPS”), which is an earnings allocation formula that determines EPS for common stock and any participating securities according to dividends declared (whether paid or unpaid). Under the two-class method, basic EPS is computed by dividing the sum of distributed earnings to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from share equivalent activity.
Class B units and OP units held by limited partners other than the Company are considered to be participating securities because they contain non-forfeitable rights to dividends or dividend equivalents and they have the potential to be exchanged for shares of our common stock in accordance with the terms of the Operating Partnership’s Second Amended and Restated Agreement of Limited Partnership, as amended (the “Partnership Agreement”). The impact of these Class B units and OP units on basic and diluted EPS has been calculated using the two-class method whereby earnings are allocated to the Class B units and OP units based on dividends declared and the units’ participation rights in undistributed earnings. The effects of the two-class method on basic and diluted EPS were immaterial to the consolidated financial statements as of March 31, 2016 and 2015.
Since the OP units are fully vested, they were included in the diluted net income per share computations for the three months ended March 31, 2016 and 2015. However, as vesting of the Class B units is contingent upon a market condition and service condition, unvested Class B units were not included in the diluted net income per share computations since the satisfaction of the market or service condition was not probable as of March 31, 2016 and 2015. There were 2.2 million and 0.2 million unvested Class B units outstanding as of March 31, 2016 and 2015, respectively, which had no effect on EPS.

13



The following table provides a reconciliation of the numerator and denominator of the earnings per unit calculations for the three months ended March 31, 2016 and 2015:
 
 
2016
 
2015
Numerator for basic and diluted earnings per share:
 
 
 
 
Net income attributable to stockholders
 
$
2,219

 
$
4,971

Denominator:
 
 
 
 
Denominator for basic earnings per share - weighted-average shares
 
182,246

 
182,988

Effect of dilutive OP Units
 
2,785

 
2,507

Denominator for diluted earnings per share - adjusted weighted-average shares

 
185,031


185,495

Basic earnings per share:
 
 
 
 
Net income attributable to stockholders
 
$
0.01

 
$
0.03

Diluted earnings per share:
 
 
 
 
Net income attributable to stockholders
 
$
0.01

 
$
0.03


10. RELATED PARTY TRANSACTIONS
Economic Dependency—We are dependent on PE-NTR, Phillips Edison & Company Ltd. (the “Property Manager”), and their respective affiliates for certain services that are essential to us, including asset acquisition and disposition decisions, asset management, operating and leasing of our properties, and other general and administrative responsibilities. In the event that PE-NTR, and/or the Property Manager, and their respective affiliates are unable to provide such services, we would be required to find alternative service providers, which could result in higher costs and expenses.
As of March 31, 2016 and December 31, 2015, PE-NTR owned 176,509 shares of our common stock, or approximately 0.10% of our outstanding common stock issued during our initial public offering period, which closed in February 2014. PE-NTR may not sell any of these shares while serving as our advisor. 
Advisory Agreement—Pursuant to the PE-NTR Agreement effective as of December 3, 2014, PE-NTR is entitled to specified fees for certain services, including managing our day-to-day activities and implementing our investment strategy. PE-NTR manages our day-to-day affairs and our portfolio of real estate investments subject to the board’s supervision. Expenses are to be reimbursed to PE-NTR based on amounts incurred on our behalf by PE-NTR.
In October 2015, we entered into amended agreements to revise certain fees that are paid to PE-NTR in consideration for the advisory services that PE-NTR provides to us. Beginning October 1, 2015, we no longer pay a 0.75% financing fee to PE-NTR. The asset management fee remains at 1% of the cost of our assets but is paid 80% in cash and 20% in Class B units of the Operating Partnership. The cash portion is paid on a monthly basis in arrears, in the amount of 0.06667% multiplied by the cost of our assets as of the last day of the preceding monthly period.
Acquisition Fee—We pay PE-NTR an acquisition fee related to services provided in connection with the selection and purchase or origination of real estate and real estate-related investments. The acquisition fee is equal to 1.0% of the cost of investments we acquire or originate, including any debt attributable to such investments.
Acquisition Expenses—We reimburse PE-NTR for direct expenses incurred related to selecting, evaluating, and acquiring assets on our behalf. During the three months ended March 31, 2015, we reimbursed PE-NTR for personnel costs related to due diligence services for assets we acquired during the period. During the three months ended March 31, 2016, there were no acquisition expenses to reimburse as no properties were acquired during the period.
Asset Management Subordinated Participation—Within 60 days after the end of each calendar quarter (subject to the approval of our board of directors), we will pay an asset management subordinated participation by issuing a number of restricted operating partnership units designated as Class B Units to PE-NTR and American Realty Capital II Advisors, LLC (“ARC”), equal to: (i) the product of (x) the cost of our assets multiplied by (y) 0.05% (0.25% prior to October 1, 2015); divided by (ii) the most recent primary offering price for a share of our common stock as of the last day of such calendar quarter less any selling commissions and dealer manager fees that would have been payable in connection with that offering.
PE-NTR and ARC are entitled to receive distributions on the Class B units (and OP units converted from previously issued and vested Class B units) they receive in connection with their asset management subordinated participation at the same rate as distributions are paid to common stockholders. Such distributions are in addition to the incentive fees that PE-NTR, ARC, and their affiliates may receive from us. 

14



We continue to issue Class B units to PE-NTR and ARC in connection with the asset management services provided by PE-NTR under our current advisory agreement. Such Class B units will not vest until the economic hurdle is met in conjunction with (i) a termination of the PE-NTR Agreement by our independent directors without cause, (ii) a listing event, or (iii) a liquidity event; provided that PE-NTR serves as our advisor at the time of any of the foregoing events. During the three months ended March 31, 2016 and 2015, the Operating Partnership issued 0.1 million and 0.4 million Class B units, respectively, to PE-NTR and ARC under the PE-NTR Agreement for asset management services performed by PE-NTR.
Disposition Fee—We pay PE-NTR for substantial assistance by PE-NTR or any of its affiliates in connection with the sale of properties or other investments 2.0% of the contract sales price of each property or other investment sold. The conflicts committee of our board of directors determines whether PE-NTR or its affiliates have provided substantial assistance to us in connection with the sale of an asset. Substantial assistance in connection with the sale of a property includes PE-NTR or its affiliates’ preparation of an investment package for the property (including an investment analysis, rent rolls, tenant information regarding credit, a property title report, an environmental report, a structural report and exhibits) or such other substantial services performed by PE-NTR or its affiliates in connection with a sale. However, if we sold an asset to an affiliate, our organizational documents would prohibit us from paying a disposition fee to PE-NTR or its affiliates. 
General and Administrative Expenses—As of March 31, 2016 and December 31, 2015, we owed PE-NTR $138,000 and $124,000, respectively, for general and administrative expenses paid on our behalf.
Summarized below are the fees earned by and the expenses reimbursable to PE-NTR and ARC, except for general and administrative expenses, which we disclose above, for the three months ended March 31, 2016 and 2015 and any related amounts unpaid as of March 31, 2016 and December 31, 2015 (in thousands):
  
Three Months Ended
 
Unpaid Amount as of
  
March 31,
 
March 31,
 
December 31,
  
2016
 
2015
 
2016
 
2015
Acquisition fees(1)
$

 
$
855

 
$

 
$

Acquisition expenses(1)

 
139

 

 

Asset management fees(2)
4,619

 

 
1,539

 
1,538

OP units distribution (3)
464

 

 
158

 
159

Class B units distribution(4)
354

 
440

 
125

 
119

Financing fees(5)

 
180

 

 

Total
$
5,437

 
$
1,614

 
$
1,822

 
$
1,816

(1) 
The acquisition fees and expenses are presented as Acquisition Expenses on the consolidated statements of operations.
(2) 
Asset management fees are presented as General and Administrative on the consolidated statements of operations.
(3) 
The distributions paid to holders of OP units are presented as Distributions to Noncontrolling Interests on the consolidated statements of equity.
(4) 
The distributions paid to holders of unvested Class B units are presented as General and Administrative on the consolidated statements of operations.
(5) 
Financing fees are presented as Other Assets, Net or Mortgages and Loans Payable, Net, on the consolidated balance sheets and amortized over the term of the related loan. As of October 1, 2015, we are no longer required to pay financing fees.
Subordinated Participation in Net Sales Proceeds—The Operating Partnership may pay to Phillips Edison Special Limited Partner LLC (the “Special Limited Partner”) a subordinated participation in the net sales proceeds of the sale of real estate assets equal to 15.0% of remaining net sales proceeds after return of capital contributions to stockholders plus payment to stockholders of a 7.0% cumulative, pre-tax, non-compounded return on the capital contributed by stockholders. ARC has a 15.0% interest and PE-NTR has an 85.0% interest in the Special Limited Partner.
Subordinated Incentive Listing Distribution—The Operating Partnership may pay to the Special Limited Partner a subordinated incentive listing distribution upon the listing of our common stock on a national securities exchange. Such incentive listing distribution is equal to 15.0% of the amount by which the market value of all of our issued and outstanding common stock plus distributions exceeds the aggregate capital contributed by stockholders plus an amount equal to a 7.0% cumulative, pre-tax non-compounded annual return to stockholders. 
Neither the Special Limited Partner nor any of its affiliates can earn both the subordinated participation in net sales proceeds and the subordinated incentive listing distribution. No subordinated incentive listing distribution has been earned to date.
Subordinated Distribution Upon Termination of the Advisor Agreement—Upon termination or non-renewal of the PE-NTR Agreement, the Special Limited Partner shall be entitled to a subordinated termination distribution in the form of a non-interest bearing promissory note equal to 15.0% of the amount by which the value of our assets owned at the time of such termination or non-renewal plus distributions exceeds the aggregate capital contributed by stockholders plus an amount equal to a 7.0% cumulative, pre-tax non-compounded annual return to stockholders. In addition, the Special Limited Partner may elect to defer

15



its right to receive a subordinated distribution upon termination until either a listing on a national securities exchange or a liquidity event occurs. No such termination has occurred to date.
Property Manager—All of our real properties are managed and leased by the Property Manager. The Property Manager is wholly owned by our Phillips Edison sponsor. The Property Manager also manages real properties acquired by the Phillips Edison affiliates or other third parties.
Property Management Fee—We pay to the Property Manager a monthly property management fee of 4.0% of the monthly gross cash receipts from the properties it manages.
Leasing Commissions—In addition to the property management fee, if the Property Manager provides leasing services with respect to a property, we pay the Property Manager leasing fees in an amount equal to the leasing fees charged by unaffiliated persons rendering comparable services based on national market rates. The Property Manager shall be paid a leasing fee in connection with a tenant’s exercise of an option to extend an existing lease, and the leasing fees payable to the Property Manager may be increased by up to 50% in the event that the Property Manager engages a co-broker to lease a particular vacancy.
Construction Management Fee—If we engage the Property Manager to provide construction management services with respect to a particular property, we pay a construction management fee in an amount that is usual and customary for comparable services rendered to similar projects in the geographic market of the property.
Expenses and Reimbursements—The Property Manager hires, directs and establishes policies for employees who have direct responsibility for the operations of each real property it manages, which may include, but is not limited to, on-site managers and building and maintenance personnel. Certain employees of the Property Manager may be employed on a part-time basis and may also be employed by PE-NTR or certain of its affiliates. The Property Manager also directs the purchase of equipment and supplies and will supervise all maintenance activity. We reimburse the costs and expenses incurred by the Property Manager on our behalf, including employee compensation, legal, travel and other out-of-pocket expenses that are directly related to the management of specific properties, as well as fees and expenses of third-party accountants.
Summarized below are the fees earned by and the expenses reimbursable to the Property Manager for the three months ended March 31, 2016 and 2015 and any related amounts unpaid as of March 31, 2016 and December 31, 2015 (in thousands):
  
Three Months Ended
 
Unpaid Amount as of
  
March 31,
 
March 31,
 
December 31,
  
2016
 
2015
 
2016
 
2015
Property management fees(1)
$
2,427

 
$
2,185

 
$
863

 
$
755

Leasing commissions(2)
2,195

 
2,028

 
748

 
729

Construction management fees(2)
159

 
165

 
71

 
155

Other fees and reimbursements(3)
1,170

 
1,003

 
508

 
1,699

Total
$
5,951

 
$
5,381

 
$
2,190

 
$
3,338

(1) 
The property management fees are included in Property Operating on the consolidated statements of operations.
(2) 
Leasing commissions paid for leases with terms less than one year are expensed immediately and included in Depreciation and Amortization on the consolidated statements of operations. Leasing commissions paid for leases with terms greater than one year, and construction management fees are capitalized and amortized over the life of the related leases or assets.
(3) 
Other fees and reimbursements are included in Property Operating and General and Administrative on the consolidated statements of operations based on the nature of the expense.

11. OPERATING LEASES
The terms and expirations of our operating leases with our tenants vary. The lease agreements frequently contain options to extend the terms of leases and other terms and conditions as negotiated. We retain substantially all of the risks and benefits of ownership of the real estate assets leased to tenants.

16



Approximate future rentals to be received under non-cancelable operating leases in effect at March 31, 2016, assuming no new or renegotiated leases or option extensions on lease agreements, are as follows (in thousands):
Year
Amount
April 1 to December 31, 2016
$
179,309

2017
167,446

2018
149,548

2019
126,547

2020
104,496

2021 and thereafter
415,966

Total
$
1,143,312

No single tenant comprised 10% or more of our aggregate annualized effective rent as of March 31, 2016.

12. SUBSEQUENT EVENTS
Distributions to Stockholders
Distributions equal to a daily amount of $0.00183060 per share of common stock outstanding were paid subsequent to March 31, 2016 to the stockholders of record from March 1, 2016 through April 30, 2016 as follows (in thousands):
Distribution Period
 
Date Distribution Paid
 
Gross Amount of Distribution Paid
 
Distribution Reinvested through the DRIP
 
Net Cash Distribution
March 1, 2016 through March 31, 2016
 
4/1/2016
 
$
10,367

 
$
5,076

 
$
5,291

April 1, 2016 through April 30, 2016
 
5/2/2016
 
10,054

 
4,887

 
5,167

In March 2016, our board of directors authorized distributions to the stockholders of record at the close of business each day in the period commencing May 1, 2016 through May 31, 2016. The authorized distributions equal a daily amount of $0.00183060 per share of common stock.
Tender Offer
On April 25, 2016, in order to deter an unsolicited tender offer by a third party and other potential future bidders that may try to exploit the illiquidity of shares of our common stock and acquire them from stockholders at prices substantially below their value, we launched a self-tender offer to purchase up to 9.3 million shares of our common stock.  The tender offer will expire at 5:00 p.m. central time on Tuesday, June 7, 2016, unless extended or withdrawn. Our share repurchase program has been temporarily suspended during this offer as required by SEC rules. No repurchases will be made under the share repurchase program during the tender offer and for ten business days thereafter. Redemption requests that are submitted through the share repurchase program during the offer will not be accepted for consideration.


17



Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Cautionary Note Regarding Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q of Phillips Edison Grocery Center REIT I, Inc. (“we,” the “Company,” “our,” or “us”) other than historical facts may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We intend for all such forward-looking statements to be covered by the applicable safe harbor provisions for forward-looking statements contained in those acts. Such statements include, in particular, statements about our plans, strategies, and prospects and are subject to certain risks and uncertainties, including known and unknown risks, which could cause actual results to differ materially from those projected or anticipated. Therefore, such statements are not intended to be a guarantee of our performance in future periods. Such forward-looking statements can generally be identified by our use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “anticipate,” “estimate,” “believe,” “continue,” or other similar words. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date this report is filed with the U.S. Securities and Exchange Commission (“SEC”). We make no representations or warranties (express or implied) about the accuracy of any such forward-looking statements contained in this Quarterly Report on Form 10-Q, and we do not intend to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Any such forward-looking statements are subject to risks, uncertainties, and other factors and are based on a number of assumptions involving judgments with respect to, among other things, future economic, competitive, and market conditions, all of which are difficult or impossible to predict accurately. To the extent that our assumptions differ from actual conditions, our ability to accurately anticipate results expressed in such forward-looking statements, including our ability to generate positive cash flow from operations, make distributions to stockholders, and maintain the value of our real estate properties, may be significantly hindered. See Item 1A in Part II of this Form 10-Q and Item 1A in Part I of our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the SEC on March 3, 2016, for a discussion of some of the risks and uncertainties, although not all of the risks and uncertainties, that could cause actual results to differ materially from those presented in our forward-looking statements.
Overview
Organization
The Company was formed as a Maryland corporation in October 2009 and elected to be taxed as a real estate investment trust (“REIT”) commencing with the taxable year ended December 31, 2010. Our advisor is Phillips Edison NTR LLC (“PE-NTR”), which is directly or indirectly owned by Phillips Edison Limited Partnership (the “Phillips Edison sponsor”). Under the terms of the advisory agreement between PE-NTR and us, PE-NTR is responsible for the management of our day-to-day activities and the implementation of our investment strategy.
We invest primarily in well-occupied grocery-anchored neighborhood and community shopping centers having a mix of creditworthy national and regional retailers selling necessity-based goods and services in strong demographic markets throughout the United States.
Portfolio
Below are statistical highlights of our portfolio’s activities from inception through March 31, 2016:
  
 
Cumulative
  
 
Portfolio Through
  
 
March 31, 2016
Number of properties
 
147

Number of states
 
28

Total square feet (in thousands)
 
15,560

Leased % of rentable square feet
 
95.8
%
Average remaining lease term in years(1)
 
5.8

(1) 
As of March 31, 2016. The average remaining lease term in years excludes future options to extend the term of the lease.

18



Lease Expirations
The following table lists, on an aggregate basis, all of the scheduled lease expirations after March 31, 2016, over each of the ten years ending December 31, 2016 and thereafter for our 147 shopping centers. The table shows the approximate rentable square feet and annualized effective rent (“AER”) represented by the applicable lease expirations (dollars and square feet in thousands):
Year
 
Number of Expiring Leases
 
Leased Rentable Square Feet Expiring
 
% of Leased Square Feet Expiring
 
AER(1)
 
% of AER
April 1 to December 31, 2016(2)
 
253

 
605

 
4.1
%
 
$
9,416

 
5.2
%
2017
 
312

 
1,391

 
9.3
%
 
17,336

 
9.5
%
2018
 
320

 
1,619

 
10.9
%
 
20,810

 
11.4
%
2019
 
341

 
1,925

 
12.9
%
 
25,593

 
14.0
%
2020
 
282

 
1,746

 
11.7
%
 
21,734

 
11.9
%
2021
 
180

 
1,589

 
10.7
%
 
16,033

 
8.8
%
2022
 
65

 
879

 
5.9
%
 
9,189

 
5.0
%
2023
 
77

 
1,297

 
8.7
%
 
15,419

 
8.4
%
2024
 
105

 
1,124

 
7.5
%
 
10,878

 
6.0
%
2025
 
98

 
675

 
4.5
%
 
10,513

 
5.8
%
Thereafter
 
123

 
2,060

 
13.8
%
 
25,913

 
14.0
%
 
 
2,156

 
14,910

 
100.0
%
 
$
182,834

 
100.0
%
(1) 
We calculate AER as monthly contractual rent as of March 31, 2016, multiplied by 12 months, less any tenant concessions.
(2) 
Subsequent to March 31, 2016, we renewed 21 of the 253 leases expiring in 2016, which accounts for 46.7 thousand total square feet and total annualized effective rent of $0.9 million.
Portfolio Tenancy
Prior to the acquisition of a property, we assess the suitability of the grocery-anchor tenant and other tenants in light of our investment objectives, namely, preserving capital and providing stable cash flows for distributions. Generally, we assess the strength of the tenant by consideration of company factors, such as its financial strength and market share in the geographic area of the shopping center, as well as location-specific factors, such as the store’s sales, local competition, and demographics. When assessing the tenancy of the non-anchor space at the shopping center, we consider the tenant mix at each shopping center in light of our portfolio, the proportion of national and national franchise tenants, the creditworthiness of specific tenants, and the timing of lease expirations. When evaluating non-national tenancy, we attempt to obtain credit enhancements to leases, which typically come in the form of deposits and/or guarantees from one or more individuals.
The following table presents the composition of our portfolio by tenant type as of March 31, 2016 (dollars and square feet in thousands):
Tenant Type
 
Leased Square Feet
 
% of Leased Square Feet
 
AER(1)
 
% of AER
Grocery anchor
 
8,128

 
54.5
%
 
$
77,335

 
42.3
%
National and regional(2)
 
4,724

 
31.7
%
 
68,853

 
37.7
%
Local
 
2,058

 
13.8
%
 
36,646

 
20.0
%
  
 
14,910

 
100.0
%
 
$
182,834

 
100.0
%
(1) 
We calculate AER as monthly contractual rent as of March 31, 2016, multiplied by 12 months, less any tenant concessions.
(2) 
We define national tenants as those that operate in at least three states. Regional tenants are defined as those that have at least three locations.

19



The following table presents the composition of our portfolio by tenant industry as of March 31, 2016 (dollars and square feet in thousands):
Tenant Industry
 
Leased Square Feet
 
% of Leased Square Feet
 
AER(1)
 
% of AER
Grocery
 
8,128

 
54.5
%
 
$
77,335

 
42.3
%
Retail Stores(2)
 
3,379

 
22.7
%
 
40,993

 
22.4
%
Services(2)
 
2,193

 
14.7
%
 
39,696

 
21.7
%
Restaurant
 
1,210

 
8.1
%
 
24,810

 
13.6
%
  
 
14,910

 
100.0
%
 
$
182,834

 
100.0
%
(1) 
We calculate AER as monthly contractual rent as of March 31, 2016, multiplied by 12 months, less any tenant concessions.
(2) 
We define retail stores as those that primarily sell goods, while services tenants primarily sell non-goods services.
The following table presents our grocery-anchor tenants by the amount of square footage leased by each tenant as of March 31, 2016 (in thousands, except number of locations):
Tenant  
 
Number of Locations(1)
 
Leased Square Feet
 
% of Leased Square Feet
 
AER(2)
 
% of AER
Kroger
 
37

 
2,057

 
13.8
%
 
$
16,192

 
8.9
%
Publix
 
31

 
1,458

 
9.8
%
 
14,804

 
8.0
%
Walmart
 
9

 
1,121

 
7.5
%
 
5,198

 
2.8
%
Albertsons-Safeway
 
13

 
783

 
5.3
%
 
8,177

 
4.5
%
Giant Eagle
 
7

 
560

 
3.8
%
 
5,396

 
3.0
%
Ahold USA
 
6

 
411

 
2.8
%
 
6,411

 
3.5
%
SUPERVALU
 
4

 
273

 
1.8
%
 
2,382

 
1.3
%
Raley’s
 
3

 
193

 
1.3
%
 
3,422

 
1.9
%
Winn-Dixie
 
3

 
147

 
1.0
%
 
1,545

 
0.8
%
Delhaize America
 
4

 
142

 
0.9
%
 
1,855

 
1.0
%
Hy-Vee
 
2

 
127

 
0.9
%
 
527

 
0.3
%
Schnuck’s
 
2

 
121

 
0.8
%
 
1,459

 
0.8
%
Coborn’s
 
2

 
108

 
0.7
%
 
1,388

 
0.8
%
Sprouts Farmers Market
 
3

 
94

 
0.6
%
 
1,146

 
0.6
%
H-E-B
 
1

 
81

 
0.5
%
 
1,210

 
0.7
%
Price Chopper
 
1

 
68

 
0.5
%
 
844

 
0.5
%
Big Y
 
1

 
65

 
0.4
%
 
1,048

 
0.6
%
PAQ, Inc.
 
1

 
59

 
0.4
%
 
1,046

 
0.6
%
Trader Joe’s
 
4

 
55

 
0.4
%
 
921

 
0.5
%
Rosauers Supermarkets, Inc.
 
1

 
51

 
0.3
%
 
537

 
0.3
%
Save Mart
 
1

 
50

 
0.3
%
 
399

 
0.2
%
The Fresh Market
 
2

 
38

 
0.3
%
 
597

 
0.3
%
Marc’s
 
1

 
36

 
0.3
%
 
382

 
0.3
%
Fresh Thyme
 
1

 
30

 
0.1
%
 
450

 
0.1
%
 
 
140

 
8,128

 
54.5
%
 
$
77,336

 
42.3
%
(1) 
Number of locations excludes (a) 28 auxiliary leases with grocery anchors such as fuel stations, pharmacies, and liquor stores, (b) six locations where we do not own the portion of the shopping center that contains the grocery-anchor, and (c) two locations that have non-grocery anchors.
(2) 
We calculate AER as monthly contractual rent as of March 31, 2016, multiplied by 12 months, less any tenant concessions.




20



Results of Operations
Summary of Operating Activities for the Three Months Ended March 31, 2016 and 2015
(In thousands, except per share amounts)
 
2016
 
2015
 
Change
 
% Change
Operating Data:
 
 
 
 
 
 
 
 
Total revenues
 
$
63,082

 
$
58,947

 
$
4,135

 
7.0
 %
Property operating expenses
 
(10,291
)
 
(9,986
)
 
(305
)
 
3.1
 %
Real estate tax expenses
 
(9,411
)
 
(8,179
)
 
(1,232
)
 
15.1
 %
General and administrative expenses
 
(7,553
)
 
(2,362
)
 
(5,191
)
 
219.8
 %
Acquisition expenses
 
(20
)
 
(1,735
)
 
1,715

 
(98.8
)%
Depreciation and amortization
 
(25,706
)
 
(24,730
)
 
(976
)
 
3.9
 %
Interest expense, net
 
(7,732
)
 
(6,794
)
 
(938
)
 
13.8
 %
Other expense, net
 
(116
)
 
(122
)
 
6

 
(4.9
)%
Net income
 
2,253

 
5,039

 
(2,786
)
 
(55.3
)%
Net income attributable to noncontrolling interests
 
(34
)
 
(68
)
 
34

 
(50.0
)%
Net income attributable to stockholders
 
$
2,219

 
$
4,971

 
$
(2,752
)
 
(55.4
)%
 
 
 
 
 
 

 
 
Net income per share—basic and diluted
 
$
0.01

 
$
0.03

 
$
(0.02
)
 

Below are explanations of the fluctuations in the results of operations for the three months ended March 31, 2016 and 2015.
Total revenues—Of the $4.1 million increase in total revenues, $1.8 million was related to the acquisition of nine properties in 2015. The remaining $2.3 million increase was primarily related to same-center properties, which are the 133 properties that were owned and operational for the entire portion of both comparable reporting periods, except for those properties we classify as redevelopment during either of the periods presented. The increase in same-center revenue was due to a $1.1 million increase in rental income and a $1.4 million increase in tenant recovery income, offset by a $0.2 million decrease in other property income. The increase in same-center rental income was driven by a $0.21 increase in minimum rent per square foot and a 1.0% increase in occupancy since March 31, 2015. The increase in same-center tenant recovery income stemmed from the increase in occupancy and recovery percentages.
Real estate tax expenses—Of the $1.2 million increase in real estate tax expenses, $0.3 million was related to the acquisition of nine properties in 2015. The remaining $0.9 million was primarily the result of changes in assessed property values and increased property tax rates at certain properties following acquisition.
General and administrative expenses—General and administrative expenses include cash asset management fees, legal and professional fees, insurance for directors and officers, transfer agent fees, taxes and other corporate-level expenses. General and administrative expenses increased $5.2 million, which was primarily related to a $4.6 million increase in asset management fees as a result of the change to our advisory fee structure as of October 1, 2015. Previously, the asset management fee had been deferred via the issuance of Class B units of our operating partnership, which did not result in the recognition of expense under GAAP. The asset management fee remains at 1% of the cost of our assets; however, 80% is now paid through cash and therefore recognized as expense under GAAP with the remaining 20% paid in Class B units.
Acquisition expenses—Acquisition expenses decreased $1.7 million as no properties were acquired during the three months ended March 31, 2016, compared to eight property acquisitions during the three months ended March 31, 2015.
Interest expense, net—Interest expense increased $0.9 million primarily due to a higher debt balance as of March 31, 2016 when compared to March 31, 2015.


21



Leasing Activity
Below is a summary of leasing activity for the three months ended March 31, 2016 and 2015:
 
 
Total Deals
 
Inline Deals(1)
 
 
2016
 
2015
 
2016
 
2015
New leases:
 
 
 
 
 
 
 
 
Number of leases
 
49

 
51

 
46

 
49

Square footage (in thousands)
 
212

 
142

 
114

 
99

First-year base rental revenue (in thousands)
 
$
2,731

 
$
1,967

 
$
1,889

 
$
1,652

Average rent per square foot (“PSF”)
 
$
12.85

 
$
13.90

 
$
16.50

 
$
16.69

Average cost PSF of executing new leases(2)
 
$
31.62

 
$
28.93

 
$
38.20

 
$
34.73

Weighted average lease term (in years)
 
8.0

 
7.3

 
7.3

 
7.2

Renewals and Options:
 
 
 
 
 
 
 
 
Number of leases
 
63

 
70

 
58

 
66

Square footage (in thousands)
 
510

 
428

 
118

 
145

Retention rate
 
88.4
%
 
90.5
%
 
79.3
%
 
87.9
%
First-year base rental revenue (in thousands)
 
$
4,261

 
$
4,781

 
$
2,305

 
$
2,955

Average rent PSF 
 
$
8.36

 
$
11.16

 
$
19.61

 
$
20.38

Average rent PSF prior to renewals
 
$
7.59

 
$
10.26

 
$
17.04

 
$
18.18

Percentage increase in average rent PSF
 
10.1
%
 
8.8
%
 
15.1
%
 
12.1
%
Average cost PSF of executing renewals and options(2)
 
$
2.41

 
$
6.21

 
$
4.49

 
$
4.29

Weighted average lease term (in years)
 
5.7

 
6.0

 
5.3

 
5.1

(1) 
We consider an inline deal to be a lease for less than 10,000 square feet of gross leasable area (“GLA”).
(2) 
The cost of executing new leases, renewals, and options includes leasing commissions, tenant improvement costs, and tenant concessions.
Non-GAAP Measures

Same-Center Net Operating Income
We present Same-Center Net Operating Income (“Same-Center NOI”) as a supplemental measure of our performance. We define Net Operating Income (“NOI”) as total operating revenues less property operating expenses, real estate taxes, and non-cash revenue items. Same-Center NOI represents the NOI for the 133 properties that were owned and operational for the entire portion of both comparable reporting periods, except for those properties we classify as redevelopment during either of the periods presented. A property is removed from the same-center pool and classified as redevelopment when it is being repositioned in the market and such repositioning is expected to have a significant impact on property operating income. While there is judgment surrounding changes in designations, once a redevelopment property has stabilized, it is typically moved to the same-center pool the following year. Currently, we have identified five properties that we classify as redevelopment properties.
We believe that NOI and Same-Center NOI provide useful information to our investors about our financial and operating performance because each provides a performance measure of the revenues and expenses directly involved in owning and operating real estate assets and provides a perspective not immediately apparent from net income. Because Same-Center NOI excludes the change in NOI from properties acquired after December 31, 2014 and those considered redevelopment properties, it highlights operating trends such as occupancy levels, rental rates, and operating costs on properties that were operational for both comparable periods. Other REITs may use different methodologies for calculating Same-Center NOI, and accordingly, our Same-Center NOI may not be comparable to other REITs.
Same-Center NOI should not be viewed as an alternative measure of our financial performance since it does not reflect the operations of our entire portfolio, nor does it reflect the impact of general and administrative expenses, acquisition expenses, interest expense, depreciation and amortization, other income, or the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties that could materially impact our results from operations.

22



The table below is a comparison of the Same-Center NOI for the three months ended March 31, 2016 to the three months ended March 31, 2015 (in thousands):
 
 
2016
 
2015
 
$ Change
 
% Change
Revenues:
 
 
 
 
 
 
 
 
Rental income(1)
 
$
42,076


$
40,622

 
$
1,454

 
 
Tenant recovery income
 
14,556


13,173

 
1,383

 
 
Other property income
 
146


298

 
(152
)
 
 
Total revenues
 
56,778

 
54,093

 
2,685

 
5.0
%
Operating expenses:
 
 
 
 
 
 
 
 
Property operating expenses
 
9,277


9,454

 
(177
)
 
 
Real estate taxes
 
8,438


7,540

 
898

 
 
Total operating expenses
 
17,715

 
16,994

 
721

 
4.2
%
Total Same-Center NOI
 
$
39,063

 
$
37,099

 
$
1,964

 
5.3
%
(1) 
Excludes straight-line rental income and the net amortization of above- and below-market leases.
Same-Center NOI increased $2.0 million, or 5.3%, for the three months ended March 31, 2016, as compared to the same period in 2015. This positive growth was primarily due to a $0.21 increase in minimum rent per square foot, an improvement in occupancy of 1.0%, and an increase in tenant recovery income. The $1.4 million increase in tenant recovery income is a result of a combination of an improved tenant recovery percentage and higher recoverable expenses, including the $0.9 million increase in real estate taxes, which is the result of increased assessed property values and property tax rates at certain properties.
Below is a reconciliation of net income to Same-Center NOI for the three months ended March 31, 2016 and 2015 (in thousands):
 
2016
 
2015
Net income
$
2,253


$
5,039

Adjusted to exclude:





Interest expense, net
7,759


6,794

Other expense, net
116


120

General and administrative expenses
7,553


2,362

Acquisition expenses
20


1,735

Depreciation and amortization
25,706


24,730

Net amortization of above- and below-market leases
(272
)

(178
)
Straight-line rental income
(911
)

(1,244
)
NOI
42,224

 
39,358

Less: NOI from centers excluded from Same-Center
(3,161
)

(2,259
)
Total Same-Center NOI
$
39,063

 
$
37,099


Funds from Operations and Modified Funds from Operations
Funds from operations (“FFO”) is a non-GAAP performance financial measure that is widely recognized as a measure of REIT operating performance. We use FFO as defined by the National Association of Real Estate Investment Trusts (“NAREIT”) to be net income, computed in accordance with accounting principles generally accepted in the United States of America (“GAAP”) excluding extraordinary items, as defined by GAAP, and gains (or losses) from sales of depreciable real estate property (including deemed sales and settlements of pre-existing relationships), plus depreciation and amortization on real estate assets and impairment charges, and after related adjustments for unconsolidated partnerships, joint ventures and noncontrolling interests. We believe that FFO is helpful to our investors and our management as a measure of operating performance because, when compared year to year, it reflects the impact on operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses, and interest costs, which are not immediately apparent from net income.
Since the definition of FFO was promulgated by NAREIT, GAAP has expanded to include several new accounting pronouncements, such that management and many investors and analysts have considered the presentation of FFO alone to be insufficient. Accordingly, in addition to FFO, we use modified funds from operations (“MFFO”), which excludes from FFO the following items:

23



acquisition fees and expenses;
straight-line rent amounts, both income and expense;
amortization of above- or below-market intangible lease assets and liabilities;
amortization of discounts and premiums on debt investments;
gains or losses from the early extinguishment of debt;
gains or losses on the extinguishment of derivatives, except where the trading of such instruments is a fundamental attribute of our operations;
gains or losses related to fair-value adjustments for derivatives not qualifying for hedge accounting;
losses related to the vesting of Class B units issued to PE-NTR and our previous advisor, American Realty Capital II Advisors, LLC (“ARC”), in connection with asset management services provided; and
adjustments related to the above items for joint ventures and noncontrolling interests and unconsolidated entities in the application of equity accounting.
We believe that MFFO is helpful in assisting management and investors with the assessment of the sustainability of operating performance in future periods and, in particular, after our acquisition stage is complete, because MFFO excludes acquisition expenses that affect operations only in the period in which the property is acquired. Thus, MFFO provides helpful information relevant to evaluating our operating performance in periods in which there is no acquisition activity.
Many of the adjustments in arriving at MFFO are not applicable to us. Nevertheless, as explained below, management’s evaluation of our operating performance may also exclude items considered in the calculation of MFFO based on the following economic considerations.
Adjustments for straight-line rents and amortization of discounts and premiums on debt investments—GAAP requires rental receipts and discounts and premiums on debt investments to be recognized using various systematic methodologies. This may result in income recognition that could be significantly different than underlying contract terms. By adjusting for these items, MFFO provides useful supplemental information on the realized economic impact of lease terms and debt investments and aligns results with management’s analysis of operating performance. The adjustment to MFFO for straight-line rents, in particular, is made to reflect rent and lease payments from a GAAP accrual basis to a cash basis.
Adjustments for amortization of above- or below-market intangible lease assets—Similar to depreciation and amortization of other real estate-related assets that are excluded from FFO, GAAP implicitly assumes that the value of intangibles diminishes ratably over the lease term and should be recognized in revenue. Since real estate values and market lease rates in the aggregate have historically risen or fallen with market conditions, and the intangible value is not adjusted to reflect these changes, management believes that by excluding these charges, MFFO provides useful supplemental information on the performance of the real estate.
Gains or losses related to fair-value adjustments for derivatives not qualifying for hedge accounting—This item relates to a fair value adjustment, which is based on the impact of current market fluctuations and underlying assessments of general market conditions and specific performance of the holding, which may not be directly attributable to current operating performance. As these gains or losses relate to underlying long-term assets and liabilities, management believes MFFO provides useful supplemental information by focusing on the changes in core operating fundamentals rather than changes that may reflect anticipated, but unknown, gains or losses.
Adjustment for gains or losses related to early extinguishment of derivatives and debt instruments—Similar to extraordinary items excluded from FFO, these adjustments are not related to continuing operations. By excluding gains or losses related to early extinguishment of derivatives and debt instruments and write-offs of unamortized deferred financing fees, management believes that MFFO provides supplemental information related to sustainable operations that will be more comparable between other reporting periods and to other real estate operators.
Neither FFO nor MFFO should be considered as an alternative to net income or income from continuing operations under GAAP, nor as an indication of our liquidity, nor is either of these measures indicative of funds available to fund our cash needs, including our ability to fund distributions. MFFO may not be a useful measure of the impact of long-term operating performance on value if we do not continue to operate our business plan in the manner currently contemplated.

24



Accordingly, FFO and MFFO should be reviewed in connection with other GAAP measurements. FFO and MFFO should not be viewed as more prominent measures of performance than our net income or cash flows from operations prepared in accordance with GAAP. Our FFO and MFFO as presented may not be comparable to amounts calculated by other REITs.
The following section presents our calculation of FFO and MFFO and provides additional information related to our operations. As a result of the timing of the commencement of our initial public offering and our active real estate operations, FFO and MFFO are not relevant to a discussion comparing operations for the periods presented.
FFO AND MFFO
FOR THE PERIODS ENDED MARCH 31, 2016 AND 2015
(Unaudited)
(In thousands, except per share amounts)
 

2016

2015
Calculation of FFO

  

  
Net income attributable to stockholders

$
2,219

 
$
4,971

Adjustments:

 
 
 
Depreciation and amortization of real estate assets

25,706

 
24,730

Noncontrolling interest

(387
)

(334
)
FFO attributable to common stockholders

$
27,538


$
29,367

Calculation of MFFO

  


  

FFO

$
27,538


$
29,367

Adjustments:

  


  

Acquisition expenses
 
20

 
1,735

Net amortization of above- and below-market leases

(272
)

(178
)
Write-off of unamortized deferred financing expense
 
(12
)
 
47

Straight-line rental income

(899
)

(1,244
)
Amortization of market debt adjustment
 
(612
)
 
(607
)
Change in fair value of derivative

53


47

Noncontrolling interest

26


3

MFFO attributable to common stockholders

$
25,842


$
29,170

 
 
 
 
 
Earnings per common share:
 
 
 
 
Weighted-average common shares outstanding - basic
 
182,246

 
182,988

Weighted-average common shares outstanding - diluted
 
185,031

 
185,495

Net income per share - basic and diluted

$
0.01


$
0.03

FFO per share - basic and diluted

$
0.15


$
0.16

MFFO per share - basic and diluted

$
0.14


$
0.16

Liquidity and Capital Resources 
General
Our principal demands for funds are for operating expenses, capital expenditures, distributions to stockholders, share repurchases (including the tender offer announced in April 2016), and principal and interest on our outstanding indebtedness. We intend to use our cash on hand, operating cash flows, proceeds from debt financings, and proceeds from our dividend reinvestment program (the “DRIP”) as our primary sources of immediate and long-term liquidity.
As of March 31, 2016, we had cash and cash equivalents of $10.9 million. During the three months ended March 31, 2016, we had a net cash decrease of $29.8 million, primarily as a result of debt repayments.
Short-term Liquidity and Capital Resources
We expect to meet our short-term liquidity requirements through existing cash on hand, operating cash flows, DRIP proceeds, and proceeds from secured and unsecured debt financings, including borrowings on our unsecured revolving credit facility.
As of March 31, 2016, we had $813.4 million of contractual debt obligations, which excludes $7.9 million of deferred financing costs and below-market debt adjustments of $6.0 million. These contractual debt obligations represent mortgage loans secured by our real estate assets, our unsecured term loan facility (the “Term Loans”), and our unsecured revolving credit facility. As these mature, we intend to refinance our debt obligations, if possible, or pay off the balances at maturity using

25



proceeds from corporate-level debt or cash generated from operations. Of the amount outstanding at March 31, 2016, $76.4 million was for loans which mature in 2016.
We offer a share repurchase program that provides a limited opportunity for stockholders to have shares of common stock repurchased, subject to certain restrictions and limitations. The cash available for repurchases on any particular date is generally limited to the proceeds from the DRIP during the preceding four fiscal quarters, less amounts already used for repurchases during the same period. During the three months ended March 31, 2016, we repurchased $2.2 million of common stock, all of which was repurchased in connection with a stockholder’s death, “qualifying disability,” or determination of incompetence. We have limited repurchase activity because repurchase requests have surpassed the funding limits under the share repurchase program. There will be no funds available for repurchases during the second quarter of 2016, and the funds available for repurchases during the third quarter of 2016, if any, are expected to be limited to requests as a result of the stockholder’s death, “qualifying disability,” or determination of incompetence,” which are not subject to our funding limitations.
Activity related to distributions to our common stockholders for the three months ended March 31, 2016 is as follows (in thousands):
 
2016
Gross distributions paid
$
30,320

Distributions reinvested through DRIP
15,256

Net cash distributions
15,064

Net income attributable to stockholders
2,219

Net cash provided by operating activities
24,959

FFO(1)
27,538

(1) See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Measures - Funds from Operations, Adjusted Funds from Operations and Modified Funds from Operations” for the definition of FFO, information regarding why we present FFO, as well as for a reconciliation of this non-GAAP financial measure to net income on the consolidated statements of operations.  
We expect to pay distributions monthly and continue paying distributions monthly unless our results of operations, our general financial condition, general economic conditions, or other factors make it imprudent to do so. The timing and amount of distributions will be determined by our board and will be influenced in part by our intention to comply with REIT requirements of the Internal Revenue Code. 
To maintain our qualification as a REIT, we must make aggregate annual distributions to our stockholders of at least 90% of our REIT taxable income (which is computed without regard to the dividends paid deduction or net capital gain, and which does not necessarily equal net income as calculated in accordance with GAAP). If we meet the REIT qualification requirements, we generally will not be subject to U.S. federal income tax on the income that we distribute to our stockholders each year. However, we may be subject to certain state and local taxes on our income, property or net worth, respectively, and to federal income and excise taxes