**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

**FORM 10-Q**

**(Mark One)**

**x****                             ****QUARTERLY****REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended June 30, 2006**

**o****                                ****TRANSITION REPORT UNDER SECTION13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from                            to                            **

Commission filenumber: ** 01-32386**

**SPIRIT FINANCE CORPORATION**(Exact name of registrant as specified in its charter)

** **

| **Maryland**                             |   | **20-0175773**      |
|------------------------------------------|--------|---------------------|
|  (State or other jurisdiction of    |   | (I.R.S. Employer    |
| incorporation or organization)           |   | Identification No.) |
|                                     |   |                |
| **14631 N. Scottsdale Road, Suite 200**  |   | ** **          |
| **Scottsdale, Arizona**                  |   | **85254**           |
| (Address of principal executive offices) |   | (Zip Code)          |

 

Registrant’s telephonenumber, including area code:**(480) 606-0820**

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.     Yes  x   No  o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.
| Large accelerated  filer x | Accelerated filer o | Non-accelerated filer o |
|--------------------------------------|--------------------------|------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). Yes  o    No  x

Asof July 31, 2006, 99,090,866****sharesof the registrant’s Common Stock, par value $0.01 per share, were outstanding.

 

 

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**PARTI — FINANCIAL INFORMATION**

### **Item1.  Financial Statements**

**SpiritFinance Corporation****CONSOLIDATED BALANCE SHEETS**

(dollars inthousands, except per share data)

 
| ** **                                                                                                                                      | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                      | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                      |       |                    |       |                        |       |
| Investments, at cost:                                                                                                                           |       |                    |       |                        |       |
| Real estate  investments:                                                                                                                       |       |                    |       |                        |       |
| Land and  improvements                                                                                                                          |       | $                       | 943,400    |                        | $          | 524,196 |   |
| Buildings and  improvements                                                                                                                     |       | 1,456,824               |       | 881,386                     |       |
| Total real  estate investments                                                                                                                  |       | 2,400,224               |       | 1,405,582                   |       |
| Less:  Accumulated depreciation                                                                                                                 |       | (39,486                 | )          | (22,729                     | )          |
|                                                                                                                                            |       | 2,360,738               |       | 1,382,853                   |       |
| Loans receivable                                                                                                                                |       | 66,851                  |       | 59,008                      |       |
| Net investments                                                                                                                                 |       | 2,427,589               |       | 1,441,861                   |       |
| Cash and cash  equivalents                                                                                                                      |       | 87,547                  |       | 30,536                      |       |
| Lease intangibles, net                                                                                                                          |       | 20,792                  |       | 21,395                      |       |
| Deferred costs and  other assets, net                                                                                                           |       | 25,423                  |       | 19,633                      |       |
| Total assets                                                                                                                                    |       | $                       | 2,561,351  |                        | $          | 1,513,425 |   |
|                                                                                                                                            |       |                    |       |                        |       |
| **Liabilities and stockholders’  equity**                                                                                                  |       |                    |       |                        |       |
| Liabilities:                                                                                                                                    |       |                    |       |                        |       |
| Secured credit  facilities                                                                                                                      |       | $                       | —     |                        | $          | 229,855 |   |
| Mortgages and  notes payable                                                                                                                    |       | 1,613,694               |       | 664,929                     |       |
| Accounts  payable, accrued expenses and other liabilities                                                                                       |       | 15,742                  |       | 11,639                      |       |
| Dividends payable                                                                                                                               |       | 20,810                  |       | 14,209                      |       |
| Total liabilities                                                                                                                               |       | 1,650,246               |       | 920,632                     |       |
| Commitments and  contingencies (Note 7)                                                                                                         |       |                    |       |                        |       |
| Stockholders’ equity:                                                                                                                      |       |                    |       |                        |       |
| Preferred stock,  $0.01 par value per share, 125,000,000 shares authorized, no shares issued  and outstanding                                   |       | —                  |       | —                      |       |
| Common stock,  $0.01 par value per share, 375,000,000 shares authorized, 99,094,866 (2006)  and 67,663,071 (2005) shares issued and outstanding |       | 991                     |       | 677                         |       |
| Capital in  excess of par value                                                                                                                 |       | 970,431                 |       | 640,289                     |       |
| Accumulated  distributions in excess of net income                                                                                              |       | (52,331                 | )          | (33,607                     | )          |
| Accumulated  other comprehensive loss                                                                                                           |       | (7,986                  | )          | (14,566                     | )          |
| Total stockholders’  equity                                                                                                                |       | 911,105                 |       | 592,793                     |       |
| Total liabilities and stockholders’ equity                                                                                                 |       | $                       | 2,561,351  |                        | $          | 1,513,425 |   |

 

*See accompanying notes.*

2

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**SpiritFinance Corporation****CONSOLIDATED STATEMENTS OF OPERATIONS**(Unaudited)

(dollars inthousands, except per share data)

 
| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                   | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues:                                    |       |                             |       |                           |       |   |   |   |   |
| Rentals                                      |       | $                                | 40,162     |                           | $          | 16,008 |   | $ | 72,061 |   | $ | 29,073 |   |
| Interest income on loans receivable          |       | 1,655                            |       | 958                            |       | 3,154 |   | 1,888 |   |
| Other interest income                        |       | 1,287                            |       | 274                            |       | 1,925 |   | 629 |   |
| Total revenues                               |       | 43,104                           |       | 17,240                         |       | 77,140 |   | 31,590 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Expenses:                                    |       |                             |       |                           |       |   |   |   |   |
| General and administrative                   |       | 4,046                            |       | 3,240                          |       | 8,324 |   | 5,825 |   |
| Depreciation and amortization                |       | 9,827                            |       | 3,999                          |       | 17,995 |   | 7,090 |   |
| Interest                                     |       | 19,569                           |       | 3,341                          |       | 33,265 |   | 5,877 |   |
| Total expenses                               |       | 33,442                           |       | 10,580                         |       | 59,584 |   | 18,792 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Income from  continuing operations           |       | 9,662                            |       | 6,660                          |       | 17,556 |   | 12,798 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Discontinued  operations:                    |       |                             |       |                           |       |   |   |   |   |
| Income from discontinued operations          |       | 160                              |       | 534                            |       | 534 |   | 1,272 |   |
| Net gains on sales of real estate            |       | 1,400                            |       | 284                            |       | 1,267 |   | 227 |   |
| Total  discontinued operations               |       | 1,560                            |       | 818                            |       | 1,801 |   | 1,499 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Net income                                   |       | $                                | 11,222     |                           | $          | 7,478 |   | $ | 19,357 |   | $ | 14,297 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Income per  common share:                    |       |                             |       |                           |       |   |   |   |   |
| Basic:                                       |       |                             |       |                           |       |   |   |   |   |
| Continuing operations                        |       | $                                | 0.12       |                           | $          | 0.10 |   | $ | 0.22 |   | $ | 0.19 |   |
| Discontinued operations                      |       | 0.02                             |       | 0.01                           |       | 0.02 |   | 0.02 |   |
| Net income                                   |       | $                                | 0.14       |                           | $          | 0.11 |   | $ | 0.24 |   | $ | 0.21 |   |
| Diluted:                                     |       |                             |       |                           |       |   |   |   |   |
| Continuing operations                        |       | $                                | 0.12       |                           | $          | 0.10 |   | $ | 0.22 |   | $ | 0.19 |   |
| Discontinued operations                      |       | 0.02                             |       | 0.01                           |       | 0.02 |   | 0.02 |   |
| Net income                                   |       | $                                | 0.14       |                           | $          | 0.11 |   | $ | 0.24 |   | $ | 0.21 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Weighted average  outstanding common shares: |       |                             |       |                           |       |   |   |   |   |
| Basic                                        |       | 81,944,688                       |       | 67,305,458                     |       | 79,194,207 |   | 67,168,949 |   |
| Diluted                                      |       | 82,183,382                       |       | 67,461,430                     |       | 79,478,452 |   | 67,371,783 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Cash dividends  declared per common share    |       | $                                | 0.21       |                           | $          | 0.19 |   | $ | 0.42 |   | $ | 0.38 |   |

* *

*See accompanying notes.*

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**SpiritFinance Corporation****CONSOLIDATED STATEMENTS OF CASH FLOWS**(Unaudited)

(dollars inthousands)

 
| ** **                                                | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| **Cash  flows from operating activities**                 |       |                                              |       |   |   |
| Net income                                                |       | $                                                 | 19,357     |   | $ | 14,297 |   |
| Adjustments to  net income:                               |       |                                              |       |   |   |
| Depreciation and amortization                             |       | 18,116                                            |       | 7,595 |   |
| Stock-based compensation                                  |       | 897                                               |       | 440 |   |
| Amortization of deferred financing costs                  |       | 1,527                                             |       | 1,247 |   |
| Amortization of net interest rate swap hedge losses       |       | 347                                               |       | — |   |
| Net gains on sales of real estate                         |       | (1,267                                            | )          | (227 | ) |
| Other noncash items                                       |       | 185                                               |       | 104 |   |
| Changes in operating assets and liabilities:              |       |                                              |       |   |   |
| Deferred costs and other assets                           |       | (1,515                                            | )          | (1,968 | ) |
| Accounts payable, accrued expenses and other  liabilities |       | 4,366                                             |       | 2,637 |   |
| Net cash  provided by operating activities                |       | 42,013                                            |       | 24,125 |   |
|                                                      |       |                                              |       |   |   |
| **Cash  flows from investing activities**                 |       |                                              |       |   |   |
| Acquisitions of  real estate                              |       | (1,018,679                                        | )          | (310,268 | ) |
| Investments in  loans receivable                          |       | (11,401                                           | )          | — |   |
| Proceeds from  sales of real estate                       |       | 22,505                                            |       | 40,532 |   |
| Collections of  principal on loans receivable             |       | 6,200                                             |       | 193 |   |
| Net cash used in  investing activities                    |       | (1,001,375                                        | )          | (269,543 | ) |
|                                                      |       |                                              |       |   |   |
| **Cash  flows from financing activities**                 |       |                                              |       |   |   |
| Borrowings under  secured credit facilities               |       | 157,289                                           |       | 329,776 |   |
| Repayments under  secured credit facilities               |       | (387,144                                          | )          | (101,500 | ) |
| Borrowings under  mortgage notes payable                  |       | 956,071                                           |       | 67,000 |   |
| Repayments under  mortgages and notes payable             |       | (7,028                                            | )          | (140,441 | ) |
| Deferred  financing costs paid                            |       | (6,377                                            | )          | (3,666 | ) |
| Payments  received (made) on interest rate swaps          |       | 5,825                                             |       | (810 | ) |
| Proceeds from  issuances of common stock, net             |       | 329,555                                           |       | 40,067 |   |
| Dividends paid  on common stock                           |       | (31,480                                           | )          | (19,959 | ) |
| Other                                                     |       | (338                                              | )          | (93 | ) |
| Net cash  provided by financing activities                |       | 1,016,373                                         |       | 170,374 |   |
|                                                      |       |                                              |       |   |   |
| Net increase  (decrease) in cash and cash equivalents     |       | 57,011                                            |       | (75,044 | ) |
|                                                      |       |                                              |       |   |   |
| Cash and cash  equivalents, beginning of period           |       | 30,536                                            |       | 113,225 |   |
| Cash and cash equivalents,  end of period                 |       | $                                                 | 87,547     |   | $ | 38,181 |   |

 

*See accompanying notes.*

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**Spirit Finance Corporation****CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**Six Months Ended June 30, 2006

(Unaudited)(dollars in thousands)

* *
| ** **                                           | ** ** | **Common  Shares** | ** ** | **Common  Stock  Par Value** | ** ** | **Capital in  Excess of Par  Value** | ** ** | **Accumulated  Distributions in  Excess of Net  Income** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|------------------------------------------------------|------------|--------------------|------------|-----------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------|------------|
|                                                 |       |               |       |                              |       |                                                |       |                                                                    |       |                                        |       |                                  |       |
| Balances at  December 31, 2005                       |       | 67,663,071         |       | $                                 | 677        |                                                | $          | 640,289                                                                 |       | $                                           | (33,607    | )                                     | $          | (14,566 | ) | $ | 592,793 |   |
| Net income                                           |       |               |       |                              |       |                                                |       | 19,357                                                                  |       |                                        |       | 19,357                                |       |
| Change in net  unrealized losses on cash flow hedges |       |               |       |                              |       |                                                |       |                                                                    |       | 6,233                                       |       | 6,233                                 |       |
| Net cash flow  hedge losses reclassified to earnings |       |               |       |                              |       |                                                |       |                                                                    |       | 347                                         |       | 347                                   |       |
| Issuances of  common stock, net                      |       | 31,050,000         |       | 310                               |       | 329,245                                             |       |                                                                    |       |                                        |       | 329,555                               |       |
| Dividends  declared on common stock                  |       |               |       |                              |       |                                                |       | (38,081                                                                 | )          |                                        |       | (38,081                               | )          |
| Restricted stock  activity, net                      |       | 381,795            |       | 4                                 |       | 897                                                 |       |                                                                    |       |                                        |       | 901                                   |       |
| Balances at June 30,  2006                           |       | 99,094,866         |       | $                                 | 991        |                                                | $          | 970,431                                                                 |       | $                                           | (52,331    | )                                     | $          | (7,986 | ) | $ | 911,105 |   |

 

*See accompanying notes.*

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**Spirit Finance Corporation****Notes to Consolidated Financial Statements****(Unaudited)**

**1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

**TheCompany**

Spirit FinanceCorporation (“Spirit Finance” or the “Company”) is a Maryland corporationformed on August 14, 2003 as a self-managed and self-advised real estateinvestment trust (“REIT”) under the Internal Revenue Code.   The common stock of Spirit Finance is listedon the New York Stock Exchange under the symbol “SFC.”

**Basis ofAccounting and Principles of Consolidation**

Theaccompanying unaudited consolidated financial statements are prepared on theaccrual basis of accounting in accordance with U.S. generally acceptedaccounting principles for interim financial information.  Accordingly, they do not include all of theinformation and footnotes required for complete financial statements.  In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for a fairpresentation have been recorded. Operating results for the three and six monthsended June 30, 2006 are not necessarily indicative of the results that may beexpected for the year ending December 31, 2006.  The accompanying financial statements andnotes should be read in conjunction with the audited financial statementsincluded in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005.

Theconsolidated financial statements of Spirit Finance include the accounts of theCompany and its wholly-owned subsidiaries, Spirit Management Company, Spirit FinanceAcquisitions, LLC and numerous wholly-owned special purpose entities. SpiritFinance formed several special purpose entities to acquire and hold real estatesubject to mortgage notes payable and to facilitate borrowings under theCompany’s secured credit facilities (see Note 4). As a result, substantialamounts of the Company’s consolidated assets are held in these wholly-ownedspecial purpose entities and are subject to debt. Each special purpose entityis a separate legal entity and is the sole owner of its assets and liabilities.The assets of the special purpose entities are not available to pay, orotherwise satisfy obligations to, the creditors of any owner or affiliate ofthe special purpose entity. At June 30, 2006 and December 31, 2005, assetstotaling $2.4 billion and $1.4 billion, respectively, were held and liabilitiestotaling $1.6 billion and $668.6 million, respectively, were owed by thesespecial purpose entities and are included in the accompanying consolidatedbalance sheets.  All intercompany accountbalances and transactions have been eliminated in consolidation.

For acomplete listing of the Company’s significant accounting policies, please referto Note 1 in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005.

6

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**Reclassifications**

Certain reclassifications have been made to priorperiod balances to conform to the current period presentation.

**Use ofEstimates**

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Although management believes its estimates are reasonable,actual results could differ from those estimates.

**Restricted Cash and EscrowDeposits**

The Company classifiedrestricted cash and deposits in escrow totaling $1.9 million and $1.5 millionat June 30, 2006 and December 31, 2005, respectively, in deferred costs andother assets in the accompanying consolidated balance sheets.  The restricted cash balances representedamounts required to be maintained under certain of the Company’s debtagreements.

**NewAccounting Standard**

Effective January 1,2006, the Company adopted Statement of Financial Accounting Standards No. 123(revised 2004), “Share Based Payment” (SFAS No. 123(R)), using the modifiedprospective application.  SFAS No. 123(R) requires entities to measure andrecognize the cost of employee services received in exchange for an award ofequity instruments based on the grant-date fair value of the award and appliesto (i) new awards, (ii) awards modified, repurchased or cancelled after theadoption date, and (iii) any outstanding awards accounted for under AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees”(APB No. 25), for which all requisite service has not yet been rendered. The adoption of SFAS No. 123(R) did not have a material impact on the Company’sfinancial statements since the Company elected to adopt, effective January 1,2005, the fair value recognition provisions of SFAS No. 123, “Accounting forStock-Based Compensation,” for all unvested stock-based awards outstanding atJanuary 1, 2005 and for all new grants made in 2005.  Prior to January 1,2005, the Company used the intrinsic-value method prescribed by APB No. 25 andrelated interpretations in accounting for its stock-based compensation. Under this method, no compensation expense was recorded with respect to stockoptions as the options were granted at an exercise price equal to the estimatedfair value of the underlying common shares on the date of grant.  The fairvalue of the options was estimated on the grant dates using the minimum-valuemethod, which omits the assumption of any volatility, because the Company wasnot a public entity on the respective grant dates.  Using theminimum-value method, the fair value of the stock options was zero on the dateof grant.  Compensation expense for the unvested stock options outstandingon January 1, 2005 continues to be recognized using the minimum-value method.

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**2. INVESTMENTS**

At June 30, 2006, SpiritFinance had investments in 897 real estate properties, including 800 ownedproperties with a gross acquisition cost of $2.4 billion and mortgage and otherloans receivable representing 97 properties with a carrying amount of $58.5million.  At June 30, 2006, the Companyalso held five equipment loans with an aggregate outstanding balance of $8.3million secured by equipment used in the operation of certain real estateproperties owned by the Company.  Asubstantial portion of the Company’s investments are pledged as collateralunder debt obligations (see Note 4).

The Company’s investmentsare geographically dispersed throughout 42 states.  Only two states, Wisconsin (13%) and Texas(11%), accounted for 10% or more of the total dollar amount of Spirit Finance’sinvestment portfolio at June 30, 2006.

During the six monthsended June 30, 2006, the Company had the following gross real estateacquisition and loan origination activity (dollars in thousands):

|                                              | ** ** | **Number of  Properties Owned or  Financed** | ** ** | **Dollar Amount of  Investments (a)** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Balance,  December 31, 2005                  |       | 684                                                         |       | $                                                    | 1,487,460  |   |
| Acquisitions and  loan originations          |       | 236                                                         |       | 1,032,690                                            |       |
| Sales (see Note  10)                         |       | (23                                                         | )          | (23,718                                              | )          |
| Principal  payments and premium amortization |       | —                                                      |       | (6,168                                               | )          |
| Balance, June 30, 2006                       |       | 897                                                         |       | $                                                    | 2,490,264  |   |

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(a)          The dollar amount ofinvestments includes the gross cost of land, buildings and lease intangiblesrelated to properties owned and the carrying amount of loans receivable.

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The following table showsinformation regarding the diversification of the Company’s total investmentportfolio among the different industries in which our customers operate as ofJune 30, 2006 (dollars in thousands):

 
| ** **                                        | ** ** | **Number of  Properties  Owned or  Financed** | ** ** | **Dollar Amount of  Investments (a)** | ** ** | **Percentage of  Dollar Amount of  Total Real Estate  Investments** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| General and  discount retailer properties         |       | 178                                                     |       | $                                                    | 822,265    |                                                                                         | 33         | % |
| Restaurants                                       |       | 463                                                     |       | 489,917                                              |       | 20                                                                                           |       |
| Specialty  retailer properties                    |       | 30                                                      |       | 223,738                                              |       | 9                                                                                            |       |
| Movie theaters                                    |       | 24                                                      |       | 202,435                                              |       | 8                                                                                            |       |
| Educational  facilities                           |       | 20                                                      |       | 154,510                                              |       | 6                                                                                            |       |
| Automotive  dealers, parts and service facilities |       | 55                                                      |       | 128,352                                              |       | 5                                                                                            |       |
| Recreational  facilities                          |       | 8                                                       |       | 102,100                                              |       | 4                                                                                            |       |
| Industrial  properties                            |       | 12                                                      |       | 70,005                                               |       | 3                                                                                            |       |
| Supermarkets                                      |       | 19                                                      |       | 62,785                                               |       | 3                                                                                            |       |
| Convenience  stores/car washes                    |       | 24                                                      |       | 50,262                                               |       | 2                                                                                            |       |
| Distribution  facilities                          |       | 43                                                      |       | 50,020                                               |       | 2                                                                                            |       |
| Interstate  travel plazas                         |       | 4                                                       |       | 37,535                                               |       | 1                                                                                            |       |
| Call centers                                      |       | 2                                                       |       | 33,988                                               |       | 1                                                                                            |       |
| Health  clubs/gyms                                |       | 5                                                       |       | 23,022                                               |       | 1                                                                                            |       |
| Medical offices                                   |       | 1                                                       |       | 21,020                                               |       | 1                                                                                            |       |
| Drugstores                                        |       | 9                                                       |       | 18,310                                               |       | 1                                                                                            |       |
| Total real estate  investments                    |       | 897                                                     |       | $                                                    | 2,490,264  |                                                                                         | 100        | % |

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(a)          The dollar amount ofinvestments includes the gross cost of land, buildings and lease intangiblesrelated to properties owned and the carrying amount of loans receivable.

The Company’s propertiesare leased to customers under long-term operating leases that typically includeone or more renewal options.  Theweighted average remaining noncancelable lease term at June 30, 2006 isapproximately 16 years. The leases are generally triple-net, which providesthat the lessee is responsible for the payment of all property operatingexpenses, including property taxes, maintenance and insurance; therefore,Spirit Finance is generally not responsible for repairs or other capitalexpenditures related to the properties.

Scheduled minimum futurerentals to be received under the remaining noncancelable term of the operatingleases at June 30, 2006 are as follows (dollars in thousands):

 

| 2006                          |   | $         | 105,073   |   |
|-------------------------------|--------|-----------|-----------|--------|
| 2007                          |   | 210,050   |      |
| 2008                          |   | 210,448   |      |
| 2009                          |   | 210,851   |      |
| 2010                          |   | 210,967   |      |
| 2011                          |   | 209,016   |      |
| Thereafter                    |   | 2,246,391 |      |
| Total future minimum  rentals |   | $         | 3,402,796 |   |

 

9

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**3. LEASEINTANGIBLES, NET**

Intangible assetsrepresent the value of in-place leases associated with those properties thatthe Company acquired subject to existing leases.  Total intangible assets are shown in theaccompanying consolidated balance sheets net of accumulated amortization of$2.4 million at June 30, 2006 and $1.5 million at December 31, 2005.

**4. DEBT**

**Secured Credit Facilities**

At June 30, 2006, therewere no amounts outstanding under the Company’s secured credit facilities.  These short-term credit facilities are usedto partially fund real estate acquisitions pending the issuance of long-term,fixed-rate debt.  The $300 millionrevolving secured credit facility with Citigroup Global Markets Realty Corp.matures in September 2006 and the $200 million revolving secured creditfacility with Credit Suisse matures in November 2006.

The Company is subject tovarious financial and nonfinancial covenants under the secured creditfacilities, including maintaining a minimum tangible net worth of $647 million,a maximum total debt to tangible net worth ratio of 4:1 and a minimum liquidityrequirement of $15 million.  As of June30, 2006, Spirit Finance was in compliance with these covenants.  At June 30, 2006, real estate properties andloans receivable with an aggregate investment of $100.6 million were pledged ascollateral for future borrowings under the secured credit facilities.Additionally, the member interest of one of the Company’s consolidated specialpurpose entities is pledged as collateral under one of the secured creditfacilities.

**Mortgages and Notes Payable**

The Company’s mortgages and notes payable aresummarized below (dollars in thousands): 
| ** **                                                             | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Net-lease  mortgage notes payable:                                     |       |                    |       |                        |       |
| Series 2005-1, Class A-1 mortgage note, 5.05%, due  2020               |       | $                       | 175,812    |                        | $          | 179,778 |   |
| Series 2005-1, Class A-2 interest-only mortgage  note, 5.37%, due 2020 |       | 258,300                 |       | 258,300                     |       |
| Series 2006-1, Class A mortgage note, 5.76%, balloon  due 2021         |       | 300,507                 |       | —                      |       |
| Secured  fixed-rate mortgage notes payable:                            |       |                    |       |                        |       |
| 8.44% - 9.02% Notes, effective rates 6.19% - 6.62%,  balloons due 2010 |       | 32,436                  |       | 32,668                      |       |
| 5.78% Note, balloon due 2010                                           |       | 15,407                  |       | 15,500                      |       |
| 5.90% - 6.50% Notes, balloons due 2012                                 |       | 22,544                  |       | 22,728                      |       |
| 5.40% Notes, balloons due 2014                                         |       | 34,959                  |       | 35,202                      |       |
| 5.26% - 5.62% Notes, balloons due 2015                                 |       | 114,964                 |       | 115,747                     |       |
| 5.88% Note, balloon due 2016                                           |       | 42,575                  |       | —                      |       |
| 6.59% Notes, balloons due 2016                                         |       | 611,501                 |       | —                      |       |
| Unsecured  fixed-rate promissory note, 7.00%, due 2021                 |       | 2,218                   |       | 2,257                       |       |
|                                                                   |       | 1,611,223               |       | 662,180                     |       |
| Unamortized debt  premium                                              |       | 2,471                   |       | 2,749                       |       |
| Total mortgages and  notes payable                                     |       | $                       | 1,613,694  |                        | $          | 664,929 |   |

 

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The Company’s securedfixed-rate mortgage notes payable, which are obligations of its consolidatedspecial purpose subsidiaries as described in Note 1, contain various covenantscustomarily found in mortgage notes, including a limitation on Spirit Finance’sability to incur additional indebtedness on the underlying real estatecollateral. As of June 30, 2006, Spirit Finance was in compliance with thesecovenants.  The net-lease mortgage notes aresecured by real estate properties and mortgage notes receivable with anaggregate investment value of $1.1 billion at June 30, 2006.  At June 30, 2006, the fixed-rate mortgagenotes payable were secured by real estate properties with an aggregate investmentvalue of $1.2 billion.

The mortgages and notes payable requiremonthly principal and interest payments; the notes payable also require balloonpayments totaling $44.8 million due in 2010, $19.5 million due in 2012, $29.8million due in 2014, $96.6 million due in 2015, $564.6 million due in 2016,$258.3 million due in 2020 and $176.2 million due in 2021.  The debt premium is amortized to interestexpense using the effective interest method over the terms of the relatednotes. Scheduled debt maturities, including balloon payments, for the remainderof 2006 and the next five years are as follows (dollars in thousands):

 

| 2006       |   | $         | 11,582    |   |
|------------|--------|-----------|-----------|--------|
| 2007       |   | 24,426    |      |
| 2008       |   | 25,823    |      |
| 2009       |   | 27,632    |      |
| 2010       |   | 73,721    |      |
| 2011       |   | 30,300    |      |
| Thereafter |   | 1,417,739 |      |
|       |   | $         | 1,611,223 |   |

 

The financing costsrelated to the establishment of the secured credit facilities and mortgages andnotes payable are deferred and amortized to interest expense using either theeffective interest or straight-line method over the initial term of the relateddebt instrument.  Unamortized financingcosts totaled $17.8 million and $12.9 million at June 30, 2006 and December 31,2005, respectively, and are included in deferred costs and other assets in theaccompanying consolidated balance sheets.

**5.DERIVATIVE AND HEDGING ACTIVITIES**

The Company uses interestrate derivative contracts (interest rate swaps) to manage its exposure tochanges in interest rates on forecasted debt transactions. Spirit Finance doesnot enter into derivative contracts for speculative or trading purposes.

As of June 30, 2006,Spirit Finance had one outstanding forward-starting interest rate swapagreement with a notional amount of $41.5 million.  This derivative instrument was designed tohedge the variability of cash flows related to forecasted interest paymentsover a term of 15 years on long-term debt with an initial principal balance ofat least $43.5 million expected to be issued in early 2007.  As the hedging relationship is expected to behighly effective at achieving offsetting changes in future cash flows, thisinterest rate swap is accounted for as a cash flow hedge.  Hedge effectiveness is assessed using thehypothetical derivative method.  No hedgeineffectiveness was recognized during 2006 or

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2005.  The fair value of the interest rate swap inplace at June 30, 2006 was an asset of $356,000 which is included in deferredcosts and other assets with a corresponding amount recorded in accumulatedother comprehensive income.

In conjunction with theissuance of net-lease mortgage notes in March 2006 (see Note 4), the Companysettled three forward-starting interest rate swap agreements for an aggregatecash receipt from the swap counterparties in the amount of $5.8 million becauselong-term rates had risen since the inception of the hedges.  This amountis being amortized to earnings, using the effective interest method, as adecrease in interest expense over a period of 15 years.

In conjunction with theissuance of net-lease mortgage notes payable in July 2005, the Company settledtwo forward-starting interest rate swap agreements.  The fair value of theinterest rate swaps at the time of settlement was a loss totaling $15.0 millionwhich is being amortized to earnings, using the effective interest method, asan increase to interest expense over a period of 25 years.

During the six monthsended June 30, 2006, net amortization expense totaled $347,000.  The netunamortized loss related to interest rate swaps included in accumulated othercomprehensive loss in the accompanying consolidated balance sheets was $8.0million and $14.6 million at June 30, 2006 and December 31, 2005, respectively.

**6.STOCKHOLDERS’ EQUITY**

During 2006, the Companyissued 31,050,000 shares of common stock, receiving proceeds of $329.6 million,after deducting underwriters’ discounts and offering expenses.  During 2006, the Company granted 381,795shares (net of forfeitures) of restricted stock to officers, employees anddirectors under its stock-based compensation plan.

**7.COMMITMENTS AND CONTINGENCIES**

At June 30, 2006, SpiritFinance had contractual commitments totaling $38.2 million for futureimprovements on properties the Company currently owns. These improvementsinclude costs to be incurred on facilities during which the tenant’s businesscontinues to operate without interruption and advances for the construction ofnew facilities for which operations have not yet commenced.  In accordance with the underlying leaseagreements, these improvements, themajority of which are anticipated to be completed during 2006, will result inincreases in related contractual rent. Spirit Finance is contingently liable for $5.7 million of debt of one ofits tenants and is indemnified by that tenant for any payments the Company maybe required to make on the debt.

TheCompany may be subject to claims or litigation in the ordinary course ofbusiness.  At June 30, 2006, there wereno outstanding claims against the Company that are expected to have a materialadverse effect on the Company’s financial position or results of operations.

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**8. SIGNIFICANT CREDIT AND REVENUE CONCENTRATION**

Rental revenues from twotenants under common control totaled $6.4 million, or 15% and 8% of SpiritFinance’s total revenues for the three and six months ended June 30, 2006,respectively.  The underlying real estateproperties were acquired by Spirit Finance on May 31, 2006, from SKO GroupHolding Corp. (“SKO”) and leased to these two tenants, each a wholly-ownedsubsidiary of SKO, under long-term, triple-net master lease agreements.  These tenants operate over 350 generalmerchandise retail locations under theShopKo and Pamida names in both mid-sized to larger cities and small, ruralcommunities across the Midwest, North Central, Rocky Mountain and PacificNorthwest states.  The real estateproperties leased to these tenants represented approximately one-third ofSpirit Finance’s total assets at June 30, 2006, and, based on Spirit Finance’sportfolio at June 30, 2006, the full impact of rental revenue from thesetenants is expected to approximate one-third of Spirit Finance’s ongoingquarterly total revenues.

**9. STOCK-BASED COMPENSATION**

The following tablesummarizes stock option and nonvested restricted stock award activity for thesix months ended June 30, 2006: 

 
| ** **                            | ** ** | **Stock Options** | ** ** | **Nonvested Restricted Stock Awards**       | ** ** |
|---------------------------------------|------------|------------------------|------------|------------------------------------------------------------|------------|
| ** **                            | ** ** | **Shares**             | ** ** | **Weighted  Average  Exercise Price  per Share** | ** ** | **Weighted  Average  Remaining  Contractual  Term  (years)** | ** ** | **Shares** | ** ** | **Weighted  Average Grant  Date Fair Value  per Share** | ** ** |
| Outstanding at  December 31, 2005     |       | 1,290,000              |       | $                                                          | 10.02      |   |   |   | 352,485 |   | $ | 11.22 |   |
| Granted                               |       | —                 |       | —                                                     |       |   |   | 428,934 |   | $ | 11.51 |   |
| Exercised/Vested                      |       | —                 |       | —                                                     |       |   |   | (78,024 | ) | $ | 10.62 |   |
| Forfeited                             |       | (21,000                | )          | $                                                          | 11.03      |   |   |   | (47,139 | ) | $ | 11.40 |   |
| Outstanding at  June 30, 2006         |       | 1,269,000              |       | $                                                          | 10.00      |   | 7.5 |   | 656,256 |   | $ | 11.47 |   |
|                                  |       |                   |       |                                                       |       |   |   |   |   |   |   |
| Options  exercisable at June 30, 2006 |       | 593,000                |       | $                                                          | 10.01      |   | 7.5 |   |   |   |   |   |

 

Each stock optionhas an exercise price equal to the market price (or estimated fair value, foroptions granted prior to the Company becoming a public entity) of the Company’scommon stock on the date of grant.  Stockoptions vest ratably each year over a three-year period, subject to continuedemployment, and will expire ten years after the date of the grant.  Compensation expense related to stock optionsgranted in 2005 is recognized on a straight-line basis over the stock optionvesting period.  For options grantedduring the six months ended June 30, 2005, the fair value of each option wasestimated on the date of grant using a Black-Scholes-Merton option-pricingmodel with the following weighted average assumptions: (i) expected life ofstock options of 6.5 years, (ii) expected volatility of 19.5%,(iii) dividend yield of 6.4%, and (iv) risk free rate of return of 4.1%.  The weighed average grant date fair value ofstock options granted during the six months ended June 30, 2005 was $1.09 peroption.  The aggregate intrinsic value ofthe stock options outstanding and exercisable as of June 30, 2006 wasapproximately $1.6 million and $743,000, respectively.

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Restricted stock awards,which are granted and valued based on the fair value of Spirit Finance commonstock on the date of grant, vest ratably over a three- or five-yearperiod.  In general, for restricted stockawards granted in 2005, 2004 and 2003, fifty percent of the restricted sharesgranted to employees vest solely over time and the other fifty percent vestover time based on meeting Company performance criteria. The performancecriteria include meeting total return targets each year (or on a cumulativebasis) over the full three- or five-year period.  Restricted shares granted to non-employeedirectors and restricted stock awards granted in 2006 vest solely overtime.  Compensation expense related torestricted stock awards granted in 2006 and 2005 is recognized on astraight-line basis over the vesting period. Compensation expense related torestricted stock awards granted prior to 2005 is recognized on a graded(accelerated) vesting schedule over the vesting period.  The weighted average grant date fair value ofrestricted stock granted during the six months ended June 30, 2006 and 2005 was$11.51 and $11.74 per share, respectively. The total fair value of restricted shares vested during the six months endedJune 30, 2006 and 2005 was $829,000 and $530,000, respectively.  As of June 30, 2006, there was $6.5 millionof unrecognized compensation cost related to restricted stock awards which isexpected to be recognized over a weighted-average period of approximately 4.1years.

Stock-based compensationis included in general and administrative expenses in the consolidatedstatements of operations. The Company’s aggregate stock-based compensationexpense, net of forfeitures, during the six months ended June 30, 2006 and 2005was $897,000 and $440,000, respectively.

**10. DISCONTINUED OPERATIONS**

Periodically, SpiritFinance may sell real estate properties. The Company considers these occasional sales of real estate propertiesto be a part of its long-term business strategy of acquiring and holding a diversifiedreal estate investment portfolio; consequently, proceeds from the sales of realestate properties are expected to be reinvested in additional real estateproperties such that cash flows from ongoing operations are not negativelyaffected by sales of individual properties. SFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets,” requires that gains and losses from any such dispositions ofproperties and all operations from these properties be reclassified as “discontinuedoperations” in the consolidated statements of operations.  As a result of this reporting requirement,each time a property is sold, previously reported “income from continuingoperations” will be restated to reclassify the operations of such property intodiscontinued operations.  Thispresentation has no impact on net income or cash flow.

During the six monthsended June 30, 2006, the Company sold 23 properties for $22.5 million in netsales proceeds.  During the year endedDecember 31, 2005, the Company sold 43 properties, including 23 properties soldin the first six months of 2005, for $40.5 million in net sales proceeds.  All of the current and prior periodoperations and net gains realized from these real estate dispositions have beenreclassified into discontinued operations.

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The following table setsforth the components of discontinued operations related to properties soldsubsequent to January 1, 2005 (dollars in thousands):

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                           | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Rental revenues                      |       | $                                | 247        |                           | $          | 837 |   | $ | 711 |   | $ | 2,112 |   |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Expenses:                            |       |                             |       |                           |       |   |   |   |   |
| General and administrative           |       | 49                               |       | 6                              |       | 54 |   | 15 |   |
| Depreciation and amortization        |       | 37                               |       | 207                            |       | 121 |   | 505 |   |
| Interest                             |       | 1                                |       | 90                             |       | 2 |   | 320 |   |
| Total expenses                       |       | 87                               |       | 303                            |       | 177 |   | 840 |   |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Income from  discontinued operations |       | 160                              |       | 534                            |       | 534 |   | 1,272 |   |
| Net gains on  sales of real estate   |       | 1,400                            |       | 284                            |       | 1,267 |   | 227 |   |
| Total discontinued  operations       |       | $                                | 1,560      |                           | $          | 818 |   | $ | 1,801 |   | $ | 1,499 |   |

 

**11.INCOME PER COMMON SHARE**

Areconciliation of the denominators used in the computation of basic and dilutedincome per common share is as follows:

 
| ** **                                                                                              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                                              | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted average  shares:                                                                               |       |                             |       |                           |       |   |   |   |   |
| Weighted average outstanding common shares used in  the calculation of basic income per common share    |       | 81,944,688                       |       | 67,305,458                     |       | 79,194,207 |   | 67,168,949 |   |
| Effect of unvested restricted stock                                                                     |       | 78,817                           |       | 62,312                         |       | 99,433 |   | 64,177 |   |
| Effect of stock options (a)                                                                             |       | 159,877                          |       | 93,660                         |       | 184,812 |   | 138,657 |   |
| Weighted average  outstanding common shares used in the calculation of diluted income per  common share |       | 82,183,382                       |       | 67,461,430                     |       | 79,478,452 |   | 67,371,783 |   |

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(a)          Options to purchase 3,000 and 30,000 sharesof common stock were outstanding at June 30, 2006 and 2005, respectively, butwere not included in the computations of diluted net income per common share becausethe effect was not dilutive.

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**12. COMPREHENSIVE INCOME (LOSS)**

The reconciliation of netincome to comprehensive income is as follows (dollars in thousands):  

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                           | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                           | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Net income as  reported                              |       | $                                | 11,222     |                           | $          | 7,478 |   | $ | 19,357 |   | $ | 14,297 |   |
| Change in net  unrealized losses on cash flow hedges |       | 356                              |       | (22,220                        | )          | 6,233 |   | (20,384 | ) |
| Net cash flow  hedge losses reclassified to earnings |       | 124                              |       | —                         |       | 347 |   | — |   |
| Comprehensive income  (loss)                         |       | $                                | 11,702     |                           | $          | (14,742 | ) | $ | 25,937 |   | $ | (6,087 | ) |

 

**13.SUPPLEMENTAL CASH FLOW INFORMATION**

In conjunction with theacquisition of certain real estate investments during the first six months of2005, Spirit Finance assumed existing mortgage notes payable of $49.9 million.

* * * * * * * * **

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**SKO GroupHolding Corp.****Unaudited Consolidated Financial Statements**

The unauditedconsolidated financial statements of SKO Group Holding Corp. required byRegulation S-X to be included in this Item 1 are included in Exhibit 99.1 tothis report and are incorporated by reference herein.

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### **Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

Management’s discussionand analysis of financial condition, liquidity and capital resources andresults of operations are more clearly understood when read in conjunction withthe accompanying unaudited consolidated financial statements and notes theretoas of June 30, 2006 and our audited financial statements included in our AnnualReport on Form 10-K for the year ended December 31, 2005. Undue reliance shouldnot be placed upon historical financial statements since they are notindicative of expected results of operations or financial condition for anyfuture periods.

**Overview**

Spirit FinanceCorporation is a self-managed and self-advised real estate investment trust, orREIT, formed as a Maryland corporation on August 14, 2003. Our objective is toacquire single tenant, operationally essential real estate throughout theUnited States to be leased on a long-term, triple-net basis to retail,distribution and service-oriented companies. Single tenant, operationallyessential real estate consists of properties that are free-standing, commercialreal estate facilities that contain our customers’ retail, distribution orservice activities that are vital to the generation of their sales and profits.A triple-net lease generally requires the tenant to pay all operating andmaintenance costs, insurance premiums and real estate taxes on the property. Wemay also selectively originate or acquire long-term, commercial mortgage loansthat are integral to our strategy of providing a complete solution of financingproducts to our customers.  Since webegan purchasing real estate assets in December 2003, we have completed nearly$2.6 billion in real estate acquisitions and mortgage and other loaninvestments.

As of June 30, 2006, ourinvestment portfolio of real estate and loans totaled $2.5 billion andrepresented 897 owned or financed properties geographically diversified across42 states.  Only two states, Wisconsin(13%) and Texas (11%), accounted for 10% or more of the total dollar value ofour real estate and loan portfolio.  Ofour total investment portfolio as of June 30, 2006, approximately $2.4 billion,or 97%, represented the gross cost of real estate and related lease intangiblesthat we own and $67 million, or 3%, represented mortgage, equipment and otherloans receivable.  Our properties areleased or financed to 113 customers operating in various industries.  Our three largest property types at June 30,2006, as a percentage of the total dollar amount of our investment portfolio,were general and discount retailers (33%), restaurants (20%) and specialtyretailers (9%). As of June 30, 2006, our 10 largest customers as a percentageof the total investment portfolio were: ShopKo Stores Operating Co., LLC;Pamida Stores Operating Co., LLC; Carmike Cinemas, Inc. (NASDAQ: CKEC); CasualMale Retail Group, Inc. (NASDAQ: CMRG); Dickinson Theatres, Inc.; CarMax, Inc.(NYSE: KMX); United Supermarkets, Ltd.; Main Event Entertainment, LP, theoperator of Main Event family entertainment centers; CBH2O, LP, the operator ofCamelback Ski Area and Camelbeach Waterpark in Pennsylvania; and PamCo, Inc., apetroleum distribution, convenience store and car wash operator.  Together, these customers accounted for 51%of our total investment portfolio at June 30, 2006.  ShopKo Stores Operating Co., LLC is thelargest individual credit exposure at 29% with no other individual creditexposure greater than 4% of the total investment portfolio.  At June 30, 2006, all of our properties wereoccupied, and the monthly lease and loan payments were current.

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We generate our revenueand cash flow primarily by leasing our real estate properties to our customersand from interest income on our portfolio of mortgage and equipment loansreceivable. Our ability to generate positive cash flow will depend heavily onthe difference between the income earned on our assets and the interest expenseincurred on our borrowings. We expect to grow through continuing our businessstrategy of acquiring single tenant, operationally essential real estateprincipally through sale-leaseback transactions.

Our ability to achieveour plan of continued growth is dependent on achieving a substantial volume ofacquisitions at attractive yields without compromising our underwritingcriteria and our ability to effectively finance those acquisitions to meet ourtargeted yields.  The current environmentfor net lease real estate acquisitions continues to be highly competitive, andthis competitive environment could limit both the number of properties weacquire and the yield on those acquisitions. We may delay or decline opportunities if we feel the financial returns donot warrant the capital risk.  The timingof completing property acquisitions may vary significantly from quarter toquarter. In response to these challenges, we are committed to seeking numerouspotential investment opportunities through our full-time acquisitions staff.  We continue to seek opportunities to combineour cost of capital and operational structure with efficient leveragestrategies to deliver competitively priced lease products to our customers. Weintend to fund future real estate investments primarily with borrowings on oursecured credit facilities and by raising funds through the issuance of debt andadditional equity securities.

**Liquidityand Capital Resources**

Our real estateinvestments are generally acquired using a combination of cash and borrowingsunder our secured credit facilities or mortgage notes payable. As of June 30,2006, we had two secured credit facilities totaling $500 million and noamounts were outstanding under the facilities.

During the second quarterof 2006, we acquired or financed 195 single tenant commercial real estateproperties through various transactions totaling over $881 million using acombination of proceeds from new borrowings and equity offerings, bringing ouracquisitions for the first six months of 2006 to 236 properties totaling over$1.0 billion.  We also used net cashproceeds from the sales of 23 real estate properties, totaling$22.5 million for the six months ended June 30, 2006, to acquire newproperties.  At June 30, 2006, we hadcontractual commitments totaling $38.2 million for future improvements onproperties we currently own.  Inaccordance with the underlying lease agreements, these improvements, themajority of which are anticipated to becompleted during 2006, will result in increases in related contractualrent.  In addition, as of July 24,2006, we had identified for review potential investment opportunities of morethan $2.5 billion.  We considerinvestments as under review when we have signed a confidentiality agreement, wehave exchanged financial information or we or our advisors are in current andactive negotiations.  Investments underreview are generally subject to significant change, and the timing ofcompleting any such transactions, which is dependent on the completion of due diligenceand other factors that may not be under our control, may vary significantlyfrom quarter to quarter.  After furtherdue diligence, we may decide not to pursue any or all of these transactions, wemay not be the successful bidder on all of the transactions we pursue and thereis no assurance that we will ultimately complete any of the real estateacquisitions.

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On May 31, 2006, weacquired 178 real estate properties from SKO Group Holding Corp. (“SKO”) for$815.3 million, excluding transaction expenses. In conjunction with the acquisition of the properties, we entered intolong-term triple-net master lease agreements with two wholly-owned subsidiariesof SKO.  The SKO subsidiaries operateover 350 general merchandise retail locations under the “ShopKo” and “Pamida” names in both mid-sized to largercities and small, rural communities across the Midwest, North Central, RockyMountain and Pacific Northwest states. The properties we acquired included 112 ShopKo and 66 Pamidalocations.

The ShopKo and Pamidaleases are triple-net master lease agreements with an initial lease term of 20years for the ShopKo properties and 15 years for the Pamida properties.  The initial lease rate is approximately 9.1%and is subject to increases every three years based on changes in the ConsumerPrice Index (“CPI”) with a maximum increase of 6% for each three-yearperiod.  Each tenant may extend itsrespective master lease with respect to any or all of the properties for twoadditional ten-year periods.  Theacquisition was partially funded with $611.5 million in long-term mortgagenotes and the remainder of the purchase price was funded with existing cash andborrowings available under our secured credit facilities.

We generate our revenueand cash flow primarily by leasing our real estate properties to our customers.We generally offer long-term leases that provide for payments of base rent withscheduled increases, increases based on future changes in the CPI and/orcontingent rent based on a percentage of the lessee’s gross sales.  At June 30, 2006, our weighted averagenoncancelable remaining lease term was approximately 16 years, and our leasesgenerally provide for one or more renewal options.  Our leases are generally triple-net, whichprovides that the lessee is responsible for the payment of all propertyoperating expenses, such as insurance, real estate taxes and repairs andmaintenance including any increased operating expenses that may result fromrecent increases in oil prices.  Sinceour tenants generally pay the property operating and maintenance costs, we donot believe we will incur significant capital or operating expenditures on ourproperties.

Our operating expensesinclude interest expense on our debt and the general and administrative costsof acquiring and managing our real estate investment portfolio, such as thecompensation and benefit costs of our employees, professional fees such aslegal and portfolio servicing costs and office expenses such as rent and otheroffice operating expenses.  Noncash expensesinclude depreciation expense on the buildings and improvements in our realestate portfolio, stock-based compensation (included in general andadministrative expenses) and amortization of deferred financing costs (includedin interest expense).  After payment ofexpenses, our cash flow from operating activities totaled $42.0 millionfor the six months ended June 30, 2006 as compared to $24.1 million for thesame period in 2005.

We intend to make regularquarterly distributions to our stockholders so that we distribute each year allor substantially all of our REIT taxable income to avoid paying corporate levelfederal income tax and excise tax on our earnings.  During the initial years of our operations,the distributions we pay may include a return of capital.  Cash for future distributions is expected tobe generated from operations, although we may also borrow funds to makedistributions.  Our ability to paydistributions will depend on, among other things, our actual results ofoperations, which are dependent primarily on our receipt of payments from ourleases and loans with respect

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to our real estateinvestments. During the six months ended June 30, 2006, we declared dividendsof $0.42 per share, totaling $38.1 million. Dividends paid during the sixmonths ended June 30, 2006 totaled $31.5 million.

In order to continue toachieve significant growth in revenues and net income, we will need to makesubstantial real estate acquisitions, which will in turn require that we obtainsignificant additional debt and equity funding beyond our currently committedexternal sources of liquidity.  During2006, we completed public offerings aggregating approximately 31.1 millionshares of common stock which raised aggregate proceeds of approximately $330million, after deducting the underwriters’ discounts and offeringexpenses.  We used $228 million of theoffering proceeds to pay down borrowings outstanding under our secured creditfacilities.

We generally use ourrevolving secured credit facilities to partially fund the purchase of realestate pending the issuance of long-term, fixed-rate debt.  We have established an aggregate$300 million credit facility, which matures in September 2006, withCitigroup Global Markets Realty Corp. and a $200 million credit facility, whichmatures in November 2006, with Credit Suisse. During the third quarter, we expect to renew or replace these maturingshort-term facilities.  The facilitiesrequire monthly payments of interest indexed to one-month LIBOR plus 1.25% to1.50% for borrowings on $400 million of the facilities and one-month LIBOR plus1.50% to 2.75% on the remaining $100 million, depending on amountsborrowed.  Both facilities also providefor a non-use fee which may be incurred under certain circumstances.  The interest rates on these borrowings aresubject to increase in the event we exceed a specified leverage amount.  As described further in the Notes toConsolidated Financial Statements and Quantitative and Qualitative DisclosuresAbout Market Risk, we use interest rate swaps to manage our exposure to changesin interest rates until we can put into place our long-term debt arrangements.

In March 2006, we issued,through a private placement, $301.8 million aggregate principal amount ofnet-lease mortgage notes consisting of amortizing 5.76% notes due in 2021.  We used $160.4 million of the proceedsto repay balances outstanding under our secured credit facilities.  The remaining proceeds were used to providefunds for real estate acquisitions.  Thiswas the second issuance under our master funding structure which was created in2005; the first series of notes totaling $441.3 million was issued in July2005.  At June 30, 2006, the aggregatebalance of the net-lease mortgage notes totaled $734.6 million and was securedby a collateral pool in excess of $1 billion in real estate assets representing578 commercial properties.  The notes maybe prepaid at any time, subject to a yield maintenance prepayment premium, andthe notes permit substitution of real estate collateral from time to timesubject to certain conditions and limits. In addition, the note structureallows for the contribution of additional properties to the collateral pool andthe issuance of additional series of notes secured by the increased collateralpool.

During the first sixmonths of 2006, we entered into new long-term financing arrangements totaling$654.3 million in conjunction with two real estate acquisitions. At June30, 2006, the total carrying amount of our fixed-rate debt was$1.6 billion.  Assets with anaggregate investment value of $2.3 billion were pledged as collateral forour fixed-rate debt.

Over the long term, weexpect lease rates on new leases to fluctuate commensurate with changes inlong-term interest rates. In the near-term, we may experience a period wherelong-term interest

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rates on futureborrowings rise faster than lease rates on our existing portfolio of realestate investments, which may reduce our cash flow.  Therefore, in order to limit the effects ofchanges in interest rates on our operations, we seek to match-fund ourlong-term, fixed-rate assets with long-term, fixed-rate liabilities.  At June 30, 2006, 92% of our investmentportfolio was match-funded with long-term debt.

We are subject to variouscustomary operating and financial covenants under our mortgage notes payableand our secured credit facilities. The mortgage notes payable and securedcredit facilities include a limitation on our ability to incur additionalindebtedness on the underlying secured real estate. Our secured creditfacilities also include, among other requirements, a minimum liquidityrequirement of $15 million, a maximum total debt to tangible net worthratio of 4:1 and a minimum tangible net worth requirement of $647 million.  As of June 30, 2006, we were in compliancewith all of our debt covenants and requirements.

In the short-term, webelieve that cash provided by our operating activities and the liquidityavailable on our secured credit facilities will be sufficient to meet ourliquidity needs for the operating and financing obligations and commitments ofour existing real estate investment portfolio. On a long-term basis, we intend to use a combination of debt and equityfinancing methods to accomplish our goal of acquiring real estate whilemaintaining our borrowings at a targeted leverage ratio, defined as the ratioof our total debt to total assets, of approximately 65%. At June 30, 2006, ourleverage ratio was 63%. We intend to obtain additional unsecured and/or securedfinancing through various sources including banks, institutional investors andother lenders. We may also obtain lines of credit, bridge loans, warehousefacilities and other debt arrangements or may incur debt in the form of publiclyor privately placed debt instruments.  Weintend to use substantially all of our properties to secure our borrowingsunder our various debt financings.  Ourability to achieve continuous real estate investment growth will also depend onour ability to raise additional equity capital.

**Results of Operations**

Net income for the threemonths ended June 30, 2006 was $11.2 million, or $0.14 per diluted share,based on 82.2 million weighted average shares of common stockoutstanding.  Net income for the threemonths ended June 30, 2005 was $7.5 million, or $0.11 per diluted share,based on 67.5 million weighted average shares of common stockoutstanding.  The increase in net incomeis reflective of the growth in our investment portfolio.  Since we began purchasing real estate assetsin December 2003, we have completed nearly $2.6 billion in real estateacquisitions and mortgage and other loan investments, of which $881.3 millionwas completed during the second quarter of 2006; the full impact of the secondquarter acquisitions will begin to be realized in the third quarter.

Net income for the sixmonths ended June 30, 2006 was $19.4 million, or $0.24 per diluted share,based on 79.5 million weighted average shares of common stockoutstanding.  Net income for the six monthsended June 30, 2005 was $14.3 million, or $0.21 per diluted share, basedon 67.4 million weighted average shares of common stock outstanding.  The increase in the number of weightedaverage shares outstanding between 2006 and 2005 is primarily the result of ourpublic equity offerings totaling approximately 31.1 million common sharescompleted during 2006.

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Periodically, we may sellreal estate properties.  We considerthese occasional sales of real estate properties to be an integral part of ourlong-term business strategy in acquiring a diversified real estate investmentportfolio; consequently, proceeds from the sales of real estate properties areexpected to be reinvested in additional properties such that cash flows fromongoing operations are not negatively affected by sales of individualproperties. In addition, we consider the combined effect of income fromcontinuing operations and discontinued operations in our evaluation of ourability to pay dividends.  Each timeproperties are sold, current accounting principles require that gains andlosses from any such dispositions and all operations from the propertiespreviously reported as part of “income from continuing operations” to bereclassified to “discontinued operations.” This reclassification has no impact on net income or cash flows.

We sold 17 properties and23 properties during both the three and six months ended June 30, 2006 and2005, respectively; since the beginning of 2005, we have sold 66properties.  Income from continuingoperations and discontinued operations and the related per share amountsassociated with all properties sold subsequent to January 1, 2005 are presentedin the table below (dollars in thousands, except per share data):

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                               | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                               | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                     |       |                             |       |                           |       |   |   |   |   |
| Income from  continuing operations                       |       | $                                | 9,662      |                           | $          | 6,660 |   | $ | 17,556 |   | $ | 12,798 |   |
|                                                     |       |                             |       |                           |       |   |   |   |   |
| Discontinued  operations:                                |       |                             |       |                           |       |   |   |   |   |
| Income from discontinued operations                      |       | 160                              |       | 534                            |       | 534 |   | 1,272 |   |
| Net gains on sales of real estate                        |       | 1,400                            |       | 284                            |       | 1,267 |   | 227 |   |
| Total  discontinued operations                           |       | 1,560                            |       | 818                            |       | 1,801 |   | 1,499 |   |
|                                                     |       |                             |       |                           |       |   |   |   |   |
| Net income                                               |       | $                                | 11,222     |                           | $          | 7,478 |   | $ | 19,357 |   | $ | 14,297 |   |
|                                                     |       |                             |       |                           |       |   |   |   |   |
| Income per  diluted common share:                        |       |                             |       |                           |       |   |   |   |   |
| Continuing operations                                    |       | $                                | 0.12       |                           | $          | 0.10 |   | $ | 0.22 |   | $ | 0.19 |   |
| Discontinued operations                                  |       | 0.02                             |       | 0.01                           |       | 0.02 |   | 0.02 |   |
| Net income                                               |       | $                                | 0.14       |                           | $          | 0.11 |   | $ | 0.24 |   | $ | 0.21 |   |
|                                                     |       |                             |       |                           |       |   |   |   |   |
| Weighted average  outstanding common shares—diluted |       | 82,183,382                       |       | 67,461,430                     |       | 79,478,452 |   | 67,371,783 |   |

 

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The following discussionincludes the results of both continuing and discontinued operations assummarized in the following tables (dollars in thousands):
| ** **                          | ** ** | **Three Months Ended June 30,** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                          | ** ** | **Continuing  Operations**                          | ** ** | **Discontinued  Operations** | ** ** | **Total  Operations** | ** ** |
| ** **                          | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues                            |       | $                                                   | 43,104     |   | $ | 17,240 |   | $ | 247 |   | $ | 837 |   | $ | 43,351 |   | $ | 18,077 |   |
| Expenses:                           |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| General and administrative expenses |       | 4,046                                               |       | 3,240 |   | 49 |   | 6 |   | 4,095 |   | 3,246 |   |
| Depreciation and amortization       |       | 9,827                                               |       | 3,999 |   | 37 |   | 207 |   | 9,864 |   | 4,206 |   |
| Interest                            |       | 19,569                                              |       | 3,341 |   | 1 |   | 90 |   | 19,570 |   | 3,431 |   |
|                                     |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                          | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **Continuing  Operations**                        | ** ** | **Discontinued  Operations** | ** ** | **Total  Operations** | ** ** |
| ** **                          | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues                            |       | $                                                 | 77,140     |   | $ | 31,590 |   | $ | 711 |   | $ | 2,112 |   | $ | 77,851 |   | $ | 33,702 |   |
| Expenses:                           |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| General and administrative expenses |       | 8,324                                             |       | 5,825 |   | 54 |   | 15 |   | 8,378 |   | 5,840 |   |
| Depreciation and amortization       |       | 17,995                                            |       | 7,090 |   | 121 |   | 505 |   | 18,116 |   | 7,595 |   |
| Interest                            |       | 33,265                                            |       | 5,877 |   | 2 |   | 320 |   | 33,267 |   | 6,197 |   |
|                                     |            |                                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Revenues***

Total revenues increasedto $43.4 million for the second quarter of 2006 from $18.1 millionfor the second quarter of 2005.  Totalrevenues for the first six months of 2006 rose to $77.9 million from$33.7 million for the comparable period in 2005.  The increase in revenues is the result of thegrowth in our investment portfolio primarily due to property acquisitions madeover the past year.  Because theacquisition of properties tends to occur later in a quarter, the full quarterlyearnings impact of acquisitions made in the second quarter of 2006 will not berealized until the third quarter.

Approximately 93% of therevenues we generated in 2006 were rental revenues from real estate propertieswe own and lease to our customers. Rental revenues from two tenants under common control totaled $6.4million, or 15% and 8% of Spirit Finance’s total revenues for the three and sixmonths ended June 30, 2006, respectively.  The underlying real estateproperties were acquired by Spirit Finance on May 31, 2006, from SKO GroupHolding Corp. (“SKO”) and leased to these two tenants, each a wholly-ownedsubsidiary of SKO, under long-term, triple-net master lease agreements.  These tenants operate over 350 generalmerchandise retail locations under theShopKo and Pamida names in both mid-sized to larger cities and small, ruralcommunities across the Midwest, North Central, Rocky Mountain and PacificNorthwest states.  The real estateproperties leased to these tenants represented approximately one-third ofSpirit Finance’s total assets at June 30, 2006, and, based on Spirit Finance’sportfolio at June 30, 2006, the full impact of rental revenue from thesetenants is expected to approximate one-third of Spirit Finance’s ongoingquarterly total revenues. As the Company’s investment portfolio grows, the portionof

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revenues represented bythese tenants will decrease.  No otherindividual tenant represented more than 5% of total revenues during the threeand six months ended June 30, 2006.

Our long-term leasesgenerally provide for payments of base rents with scheduled increases,increases based on future changes in the CPI and/or contingent rent based on apercentage of the lessee’s gross sales. For leases with scheduled rent increases, rental revenue is recognizedon a straight-line basis, net of a valuation allowance, to produce a constantperiodic rent over the term of the leases. Rental revenue and the related weighted average real estate investmentsare presented in the following table (dollars in thousands):
| ** **                                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                        | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                        | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Rental revenues,  excluding the adjustment for straight-line rent |       | $                                | 40,009     |                           | $          | 16,582 |   | $ | 72,013 |   | $ | 30,675 |   |
| Straight-line  rent, net                                          |       | 400                              |       | 263                            |       | 759 |   | 510 |   |
| Total rental  revenues                                            |       | $                                | 40,409     |                           | $          | 16,845 |   | $ | 72,772 |   | $ | 31,185 |   |
|                                                              |       |                             |       |                           |       |   |   |   |   |
| Weighted average real  estate investments                         |       | $                                | 1,850,171  |                           | $          | 761,368 |   | $ | 1,672,583 |   | $ | 702,401 |   |

 

The weighted averageyield on our real estate acquisitions was lower for the three and six monthsended June 30, 2006 as compared to the same periods in 2005, reflecting marketlease rate compression and increased investments in properties leased tocompanies having higher credit profiles. Investments in properties leased to companies with higher creditprofiles meet our total target rate of return requirements as we were able toobtain long-term borrowings at lower rates ranging from 5.3% to 5.9%.

During the three and sixmonths ended June 30, 2006, interest income on mortgage, equipment and otherloans receivable totaled $1.7 million and $3.2 million, respectively, ascompared to $1.0 million and $1.9 million for the same periods in2005.  The increase in interest income in2006 over 2005 was primarily the result of the origination of approximately $30million of new loans since June 30, 2005.

Other interest incomerepresents income generated from temporary investments pending investment inreal estate.  Other interest incometotaled $1.3 million and $1.9 million during the three and six months endedJune 30, 2006, respectively, and $274,000 and 629,000, respectively, during thesame periods in 2005.

***Expenses***

General andadministrative expenses include employee-related expenses, professional fees,portfolio servicing costs and office and other expenses.  Employee-related expenses increased primarilyas a result of our real estate investment activity as we increased our workforce from 32 employees at June 30, 2005 to 38 at June 30, 2006 to support ourgrowth. The large increase in the number of properties in our portfolio hasalso resulted in increased portfolio servicing costs and higher insurancecosts; these costs will continue to grow proportionately with the growth in ourinvestment portfolio.

Depreciation andamortization expense relates primarily to real estate properties and relatedlease intangibles. Depreciation and amortization expense was $9.9 million and$18.1 million for the

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three and six monthsended June 30, 2006, respectively, as compared to $4.2 million and$7.6 million in the same periods in 2005. The increase over the 2005periods was primarily the result of the increase in the real estate investmentportfolio.

The increase in interestexpense during the second quarter and for the first six months of 2006 isprimarily attributable to higher weighted average outstanding debt resultingfrom new borrowings used to grow our investment portfolio, partially offset bya decrease in our effective interest rate. The following table summarizes our interest expense and relatedborrowings (dollars in thousands):
| ** **                                                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                               | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                               | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                                     |       |                             |       |                           |       |   |   |   |   |
| Interest expense                                                                         |       | $                                | 18,043     |                           | $          | 2,729 |   | $ | 30,401 |   | $ | 4,889 |   |
| Amortization of  deferred financing costs, debt insurer premiums and interest rate swaps |       | 1,527                            |       | 702                            |       | 2,866 |   | 1,308 |   |
| Total interest  expense                                                                  |       | $                                | 19,570     |                           | $          | 3,431 |   | $ | 33,267 |   | $ | 6,197 |   |
|                                                                                     |       |                             |       |                           |       |   |   |   |   |
| Weighted average debt  outstanding                                                       |       | $                                | 1,246,086  |                           | $          | 199,864 |   | $ | 1,072,472 |   | $ | 174,805 |   |

 

As our investmentportfolio grows, our general and administrative expenses are expected to continueto increase; however, general and administrative expenses calculated as apercent of average total assets are expected to continue to decrease.  Depreciation and amortization as well asinterest expense are also expected to increase in future periods as the fullimpact of our second quarter 2006 real estate acquisitions activity is realizedin our results of operations and as we continue to make investments in realestate.

**Reconciliation of Non-GAAPFinancial Measures**

We use certain measures of historical or futurefinancial performance that are different from measures calculated and presentedin accordance with U.S. generally accepted accounting principles (“GAAP”).  One such non-GAAP financial measure is fundsfrom operations (“FFO”). We use FFO as a measure of our performance as a REITbecause we believe this measure provides investors with an understanding of ouroperating performance, cash flows and profitability.

We calculate FFOconsistent with the definition used by the National Association of Real EstateInvestment Trusts (“NAREIT”), adopted to promote an industry-wide standardmeasure of REIT operating performance. We use FFO as a measure of performance to adjust for certain non-cashexpenses such as depreciation and amortization because accounting for realestate assets under GAAP implicitly assumes that the value of real estateassets diminishes predictably over time. We disclose FFO to facilitatecomparisons between Spirit Finance and other REITs, although other REITs maynot calculate FFO in accordance with the NAREIT definition and, accordingly,our FFO may not be directly comparable to FFO reported by other REITs.

FFO should not beconsidered an alternative to net income determined in accordance with GAAP as ameasure of profitability, nor should it be considered an equivalent to cashflows provided by

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operating activitiesdetermined in accordance with GAAP as a measure of liquidity. Spirit Finance’sstatements of operations and cash flows include disclosures of interestexpense, capital expenditures and items excluded from the calculation of FFO,all of which should be considered when evaluating our performance.

A reconciliation of netincome calculated in accordance with GAAP to FFO is presented in the followingtable (dollars in thousands):
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                        | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                        | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                        |       | $                                | 11,222     |                           | $          | 7,478 |   | $ | 19,357 |   | $ | 14,297 |   |
| Portfolio  depreciation and amortization expense: |       |                             |       |                           |       |   |   |   |   |
| Continuing operations                             |       | 9,784                            |       | 3,969                          |       | 17,910 |   | 7,029 |   |
| Discontinued operations                           |       | 37                               |       | 207                            |       | 121 |   | 505 |   |
| Less: Net gains  on sales of real estate (a)      |       | (1,264                           | )          | (284                           | )          | (1,131 | ) | (227 | ) |
| FFO (b)                                           |       | $                                | 19,779     |                           | $          | 11,370 |   | $ | 36,257 |   | $ | 21,604 |   |

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(a)          Excludes the gain on sale related to sixdevelopment properties totaling $136,000, net of tax, for both the quarter andsix months ended June 30, 2006.

(b)         FFO includes the adjustment between scheduledrents and rental revenue recognized on a straight-line basis ($400,000 and$263,000 for the three months ended June 30, 2006 and 2005, respectively, and$759,000 and $510,000 for the six months ended June 30, 2006 and 2005,respectively).

**Forward-Looking Statements**

Someof the statements in this report constitute ­forward-looking statements.Forward-looking statements relate to expectations, beliefs, projections,future plans and strategies, anticipated events or trends and similarexpressions concerning matters that are not historical facts. In some cases,forward-looking statements can be identified by terms such as “anticipate,”“believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,”“should,” “will” and “would” or the negative of these terms or other similarterminology.

Theforward-looking statements are based on our beliefs, assumptions andexpectations of our future performance, taking into account all informationcurrently available to us. These beliefs, assumptions and expectations canchange as a result of many possible events or factors, not all of which areknown to us or are within our control. If a change occurs, our business,financial condition, liquidity and results of operations may vary materiallyfrom those expressed in our forward-looking statements. The following aresome of the factors that could cause actual results to vary from our forward-lookingstatements:

·                  changes in our industry,interest rates or general economic conditions;

·                  general volatility of thecapital markets and the market price of our common stock;

·                  changes in our businessstrategy or development plans;

·                  availability and terms ofadditional capital;

·                  failure to maintain ourstatus as a REIT;

·                  availability of suitableproperties to acquire at favorable prices and our ability to rent thoseproperties at favorable rates;

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·                  defaults by tenants on ourleases;

·                  our ability to renewleases with tenants at the expiration of their lease term or otherwise re-leasethose properties to suitable new tenants;

·                  availability of qualifiedpersonnel and our ability to retain our key management personnel;

·                  changes in, or the failureor inability to comply with, government regulation;

·                  the extent and nature ofour competition; and

·                  other factors referenced in our annual reporton Form 10-K, including those set forth under the captions “Risk Factors” and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.”

Theseforward-looking statements speak only as of the date of this report. Weexpressly disclaim any obligation or undertaking to disseminate any updates orrevisions to any forward-looking statement contained in this report toreflect any change in our expectations with regard to the statements or anychange in events, conditions or circumstances on which any such statement isbased.

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

Spirit Finance is exposed to variousfinancial market risks, especially interest rate risk. Interest rates andcredit risk influence our performance more so than does inflation. Changes ininterest rates do not necessarily correlate with inflation rates or changes ininflation rates.  We generally offerleases that provide for payments of base rent with scheduled increases,increases based on changes in the Consumer Price Index and/or contingent rentbased on a percentage of the lessee’s gross sales to help mitigate the effectof inflation.  Because the properties inour portfolio are generally leased to tenants under triple-net leases where thetenant is responsible for property costs and expenses, this tends to reduce ourexposure to rising property expenses due to inflation.

Interestrates are highly sensitive to many factors, including governmental monetarypolicies, domestic and global economic and political conditions, and otherfactors which are beyond our control. Our operating results will depend heavilyon the difference between the income earned on our assets and the interestexpense incurred on our borrowings. Decreases in interest rates may lead toadditional competition for the acquisition of real estate due to a reduction indesirable alternate income-producing investments. Increased competition for theacquisition of real estate may lead to a decrease in the yields on real estatewe have targeted for acquisition. In such circumstances, if we are not able tooffset the decrease in yields by obtaining lower interest costs on ourborrowings, our results of operations will be adversely affected. Significantincreases in interest rates may also have an adverse impact on our earnings ifwe are unable to acquire real estate with rental rates high enough to offsetthe increase in interest rates on our borrowings.

In a rising interest rateenvironment and/or economic downturn, defaults may increase and result incredit losses which may adversely affect our liquidity and operating results;through June 30, 2006, we have not experienced any significant creditlosses.  In a decreasing interest rateenvironment, borrowers are generally more likely to prepay their loans in orderto obtain financing at lower interest rates; however, our investments inmortgage loans receivable are subject to significant restrictions on prepaymentin the form of yield maintenance provisions or 

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other prepaymentpenalties which provide us with a certain level of yield protection in adecreasing interest rate environment.

Our interest rate riskmanagement policy seeks to limit the effects of changes in interest rates onour operations.  One objective of ourinterest rate risk management policy is to match fund fixed-rate assets withfixed-rate liabilities and variable-rate assets with variable-rate liabilities.As part of this strategy, we have used and may continue to use derivativecontracts, such as interest rate swaps, to manage our interest rate risk.  We do not enter into derivative contracts forspeculative or trading purposes. We generally intend to utilize derivativeinstruments to hedge interest rate risk on our liabilities and not usederivatives for other purposes, such as hedging asset-related risk, as suchhedging transactions may generate income which is not qualified income forpurposes of maintaining our REIT status. Our hedging strategy is monitored bythe audit committee of our board of directors.

At June 30, 2006, ourfixed-rate debt totaled $1.6 billion as compared to $664.9 million atDecember 31, 2005.  Using a discountedcash flow analysis based on estimates of the amount and timing of future cashflows, market rates and credit spreads, the estimated fair value of thefixed-rate debt was approximately $44.2 million below its carrying amountat June 30, 2006.  Our mortgage loansreceivable are also fixed-rate instruments. At June 30, 2006 and December 31, 2005, our mortgage loans receivable(excluding equipment loans) totaled $55.3 million and $55.6 million,respectively.  Using a discounted cashflow analysis, the estimated fair value of our fixed-rate mortgage loansreceivable was below the carrying amount by approximately $721,000 at June 30,2006.  It is our intent to hold ourfixed-rate mortgage loans receivable and our fixed-rate mortgages and notespayable to maturity; accordingly, changes in market interest rates impact thefair value of these financial instruments but have no impact on interestrecognized or cash flows.

We use variable-rate debtto fund acquisitions on a short-term basis until our long-term debt strategiescan be implemented.  During the sixmonths ended June 30, 2006, the weighted average outstanding balance of ourvariable-rate debt, which was based on spreads over one-month LIBOR, was$93.9 million.  Excludingamortization of deferred financing costs, this variable rate indebtedness had aweighted average interest rate of 6.3%. During the first six months of 2006,one-month LIBOR increased approximately 94 basis points. Had the weightedaverage interest rate been 100 basis points higher (lower) during the first sixmonths of 2006, our net income for the six months ended June 30, 2006 wouldhave been reduced (increased) by approximately $472,000.  This amount was determined by considering theimpact of a hypothetical interest rate change on our average variable-rateborrowings outstanding during the first six months of 2006 and assumes no otherchanges in our capital structure.

As of December 31,2005, Spirit Finance had three outstanding forward-starting interest rate swapagreements with a total notional amount of $225 million.  In March 2006, the anticipated long-term debtwas issued, and the interest rate swaps were settled for an aggregate cashreceipt from the swap counterparties because long-term rates had risen sincethe inception of the swaps.  The fairvalue of the interest rate swaps at the time of settlement, totaling $5.8million, was recorded in accumulated other comprehensive income and is beingamortized to earnings as a decrease in interest expense over a period of 15years.

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As of June 30,2006, Spirit Finance had one outstanding forward-starting interest rate swapagreement with a notional amount of $41.5 million.  This derivative instrument was designed tohedge the variability of cash flows related to forecasted interest paymentsover a term of 15 years on long-term debt expected to be issued in early2007.  The fair value of the interestrate swap in place at June 30, 2006 was an asset of $356,000 which is includedin deferred costs and other assets with a corresponding amount recorded inaccumulated other comprehensive income. The counterparty for the swap is amajor financial institution that has a credit rating of at least “A-” from anationally recognized rating agency.

As the hedgingrelationship is expected to be highly effective at achieving offsetting changesin future cash flows, this interest rate swap is accounted for as a cash flowhedge.  Hedge effectiveness isperiodically assessed using the hypothetical derivative method.  No hedge ineffectiveness was recognizedduring the six months ended June 30, 2006 or 2005.  The net unamortized loss related to allinterest rate swaps at June 30, 2006 was $8.0 million.  Because the anticipated interest payments areconsidered probable, the hedges continue to be effective.

**Item4.  Controls and Procedures**

We have adopted and maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our reports under the Securities Exchange Act of 1934 (the “ExchangeAct”) is recorded, processed, summarized and reported within the time periodsrequired under the Securities and Exchange Commission’s rules and forms andthat the information is gathered and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate, toallow for timely decisions regarding required disclosure. In designing andevaluating the disclosure controls and procedures, management recognizes thatany controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving the desired control objectives,and management is required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures.

Asrequired by Rule 13a-15(b) of the Exchange Act, we carried out an evaluation,under the supervision and with the participation of management, including ourChief Executive Officer and Chief Financial Officer, of the effectiveness ofthe design and operation of our disclosure controls and procedures as of theend of the period covered by this report. Based on the foregoing, our Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective atthe reasonable assurance level.

Nochange in our internal control over financial reporting occurred during ourmost recent fiscal quarter that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

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**PART II — OTHER INFORMATION**

**Item1.  Legal Proceedings**

We are not a party to any material litigation or legal proceedings which,in the opinion of management, individually or in the aggregate, would have amaterial adverse effect on our results of operations or financial condition.

**Item1A.  Risk Factors**

Our Annual Report on Form10-K for the fiscal year ended December 31, 2005 includes a discussion offactors that could affect our business and results of operations under thecaption “Item 1A. Risk Factors.”  Thefollowing discussion updates and supplements the discussion contained in ourForm 10-K, and should be read together with the factors set forth in our Form10-K.  These factors, taken together, setforth important information that may cause our actual results of operations infuture periods to differ materially from those currently expected or discussedin forward-looking statements contained in this report relating to ourfinancial results, operations and business prospects.  Except as set forth below, there have been nomaterial changes to the risk factors set forth in our Form 10-K.

***A substantial amount of our investment portfolio consists ofproperties operated by two customers under common control, which may result inincreased risk due to tenant and industry concentrations.***

As of June 30, 2006, ourinvestment portfolio totaled $2.5 billion. Approximately 33% of this portfolio represented real estate assetsoperated by ShopKo Stores Operating Co., LLC and Pamida Stores Operating Co.,LLC, affiliated general retailers operating under the “ShopKo” and “Pamida”names. These properties include 112 ShopKo properties and 66 Pamida propertiesleased under master leases to ShopKo and Pamida, respectively. A default byeither of these tenants will significantly and adversely affect our results ofoperations and the amounts available to pay distributions. Due to this tenantconcentration, our performance will be closely tied to the performance of ourtenants operating the ShopKo and Pamida stores and the retail industry in whichthey operate until we acquire a substantial amount of additional properties.

ShopKo operates as amulti-department store retailer under the “ShopKo” name primarily in mid-sizeand larger communities in the Midwest, Pacific Northwest and Western Mountainstates. Pamida operates as a general merchandise retailer under the “Pamida”name in smaller and more rural communities in the Midwest, North Central andRocky Mountain states. ShopKo and Pamida stores are subject to the followingrisks, as well as other risks that we currently do not know, that couldadversely affect their ability to pay rent to us:

·                  Theretail industry in which ShopKo and Pamida operate is highly competitive, whichcould limit growth opportunities and reduce profitability for ShopKo andPamida. ShopKo and Pamida compete with other discount retail merchants as wellas mass merchants, catalog merchants, internet retailers and other generalmerchandise, apparel

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and household merchandiseretailers. Competition has increased recently with large national discountretailers, such as Wal-Mart, Kmart and Target;

·                  ShopKo and Pamida stores aregeographically located in a limited region, particularly the Midwest, WesternMountain and Pacific Northwest regions. Adverse economic conditions in theseregions may materially and adversely affect ShopKo’s and Pamida’s results ofoperations and retail sales;

·                  Fluctuations in quarterly performanceand seasonality in retail operations may cause ShopKo’s and Pamida’s results ofoperations to vary considerably from quarter to quarter and could adverselyaffect cash flows;

·                  The failure to upgrade the existingShopKo and Pamida stores or to carry out current remodeling plans in acost-effective manner could have a material adverse affect on ShopKo’s andPamida’s results of operations, financial condition, anticipated sales andprofitability;

·                  ShopKo and Pamida stores aredependent on the efficient functioning of their distribution networks. Problemsthat cause delays or interruptions in the distribution networks could have amaterial adverse impact on the results of their operations; and

·                  ShopKoand Pamida stores depend on attracting and retaining quality employees. Manyemployees are entry level or part-time employees with historically high ratesof turnover.

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

Not Applicable.

**Item3.  Defaults Upon Senior Securities**

Not Applicable.

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**Item4.  Submission of Matters to a Vote ofSecurity Holders**

The Annual Meeting of Stockholders of Spirit FinanceCorporation was held on May 19, 2006. The following table sets forth each of the proposals that thestockholders were asked to vote upon and the results of the meeting:

1.     A proposal to elect 10 directors to theBoard of Directors.

 

| Director             | ** ** | **For**    | ** ** | **Withheld  Authority** |
|----------------------|------------|------------|------------|-------------------------|
| Morton H.  Fleischer |       | 75,280,785 |       | 1,421,243               |
| Christopher H.  Volk |       | 76,613,050 |       | 88,978                  |
| Willie R. Barnes     |       | 76,513,720 |       | 188,308                 |
| Linda J.  Blessing   |       | 76,509,363 |       | 192,665                 |
| Dennis E.  Mitchem   |       | 76,614,900 |       | 87,128                  |
| Paul F. Oreffice     |       | 76,513,183 |       | 188,845                 |
| James R. Parish      |       | 76,615,200 |       | 86,828                  |
| Kenneth B. Roath     |       | 76,514,233 |       | 187,795                 |
| Casey J. Sylla       |       | 76,615,200 |       | 86,828                  |
| Shelby Yastrow       |       | 76,613,770 |       | 88,258                  |

 

2.               A proposal to ratify the appointment of Ernst& Young LLP as Spirit Finance’s independent registered public accountingfirm for the fiscal year ending December 31, 2006.

| FOR     | 76,638,428 |   |
|---------|------------|--------|
| AGAINST | 54,095     |   |
| ABSTAIN | 9,505      |   |

** **

**Item5.  Other Information**

None.

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**Item6.  Exhibits**

** **
| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                        |
|--------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                                                                                                                   |
| 2.1          |       | Stock Purchase Agreement by and between Spirit  Finance Acquisitions, LLC and SKO Group Holding Corp. dated May 9, 2006. (1)                                                                                                                           |
|         |       |                                                                                                                                                                                                                                                   |
| 10.1         |       | Master Lease between Spirit SPE Portfolio 2006-1,  LLC and Spirit SPE Portfolio 2006-2, LLC, collectively as landlord, and  ShopKo Stores Operating Co., LLC dated May 31, 2006. (2)                                                                   |
|         |       |                                                                                                                                                                                                                                                   |
| 10.2         |       | Master Lease between Spirit SPE Portfolio 2006-3,  LLC and Pamida Stores Operating Co., LLC dated May 31, 2006. (2)                                                                                                                                    |
|         |       |                                                                                                                                                                                                                                                   |
| 10.3         |       | Loan Agreement among Spirit SPE Portfolio 2006-1,  LLC and Spirit SPE Portfolio 2006-2, LLC, collectively as borrowers, and  Barclays Capital Real Estate Inc. and Citigroup Global Markets Realty Corp.  dated May 31, 2006. (2)                      |
|         |       |                                                                                                                                                                                                                                                   |
| 12.1         |       | Computation of Ratio of Earnings to Fixed Charges.                                                                                                                                                                                                     |
|         |       |                                                                                                                                                                                                                                                   |
| 31.1         |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                   |
|         |       |                                                                                                                                                                                                                                                   |
| 31.2         |       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                   |
|         |       |                                                                                                                                                                                                                                                   |
| 32.1         |       | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                   |
|         |       |                                                                                                                                                                                                                                                   |
| 32.2         |       | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                   |
|         |       |                                                                                                                                                                                                                                                   |
| 99.1         |       | Unaudited quarterly financial statements of SKO  Group Holding Corp. and Subsidiaries as of April 29, 2006 (Successor) and  April 30, 2005 (Predecessor) and for the Thirteen Weeks Ended April 29,2006  (Successor) and April 30, 2005 (Predecessor). |

----

(1)  Incorporated by reference tothe Registrant’s Current Report on Form 8-K dated May 9, 2006, filed on May 10,2006.

(2)  Incorporated by reference to the Registrant’sCurrent Report on Form 8-K dated May 31, 2006, filed on June 6, 2006.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

|                      |   | SPIRIT FINANCE CORPORATION                                                     |
|----------------------|--------|--------------------------------------------------------------------------------|
|                 |   |                                                                           |
| Date: August 8, 2006 | By:    | /s/ Christopher H. Volk                                                        |
|                 |   | Christopher H. Volk

Chief Executive Officer and  President                    |
|                 |   |                                                                           |
|                 | By:    | /s/ Catherine Long                                                             |
|                 |   | Catherine Long

Chief Financial Officer,  Senior Vice

President and Treasurer |

 

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**ExhibitIndex**
| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                        |
|--------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                                                                                                                                                   |
| 2.1          |       | Stock Purchase Agreement by and between Spirit  Finance Acquisitions, LLC and SKO Group Holding Corp. dated May 9, 2006. (1)                                                                                                                           |
|         |       |                                                                                                                                                                                                                                                   |
| 10.1         |       | Master Lease between Spirit SPE Portfolio 2006-1,  LLC and Spirit SPE Portfolio 2006-2, LLC, collectively as landlord, and  ShopKo Stores Operating Co., LLC dated May 31, 2006. (2)                                                                   |
|         |       |                                                                                                                                                                                                                                                   |
| 10.2         |       | Master Lease between Spirit SPE Portfolio 2006-3,  LLC and Pamida Stores Operating Co., LLC dated May 31, 2006. (2)                                                                                                                                    |
|         |       |                                                                                                                                                                                                                                                   |
| 10.3         |       | Loan Agreement among Spirit SPE Portfolio 2006-1,  LLC and Spirit SPE Portfolio 2006-2, LLC, collectively as borrowers, and  Barclays Capital Real Estate Inc. and Citigroup Global Markets Realty Corp.  dated May 31, 2006. (2)                      |
|         |       |                                                                                                                                                                                                                                                   |
| 12.1         |       | Computation of Ratio of Earnings to Fixed Charges.                                                                                                                                                                                                     |
|         |       |                                                                                                                                                                                                                                                   |
| 31.1         |       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                   |
|         |       |                                                                                                                                                                                                                                                   |
| 31.2         |       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                   |
|         |       |                                                                                                                                                                                                                                                   |
| 32.1         |       | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                   |
|         |       |                                                                                                                                                                                                                                                   |
| 32.2         |       | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                   |
|         |       |                                                                                                                                                                                                                                                   |
| 99.1         |       | Unaudited quarterly financial statements of SKO  Group Holding Corp. and Subsidiaries as of April 29, 2006 (Successor) and  April 30, 2005 (Predecessor) and for the Thirteen Weeks Ended April 29,2006  (Successor) and April 30, 2005 (Predecessor). |

----

(1)  Incorporated by reference tothe Registrant’s Current Report on Form 8-K dated May 9, 2006, filed on May 10,2006.

(2)  Incorporated by reference to the Registrant’sCurrent Report on Form 8-K dated May 31, 2006, filed on June 6, 2006.

 

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