**UNITEDSTATESSECURITIES 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 1934** |
| ** **                                             | ** ** | ** ** |
| **For the  quarterly period ended September 30, 2006** |
|                                                   |   |   |
| o                                                      |   | **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition period from                         to**

 

**Commission file number:**  **01-32386**

 

**SPIRIT FINANCE CORPORATION**

(Exact name of registrantas 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 telephone number, including areacode: **(480) 606-0820**

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.    Yes  x    No  o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated 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 |
|---------------------------------|--------|---------------------------|--------|-------------------------------|

 

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

 

As of October 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 CorporationCONSOLIDATED BALANCE SHEETS**

(dollars inthousands, except per share data)
| ** **                                                                                                                                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                      | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                      | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                      |       |                   |       |                  |       |
| Investments, at cost:                                                                                                                           |       |                   |       |                  |       |
| Real estate  investments:                                                                                                                       |       |                   |       |                  |       |
| Land and  improvements                                                                                                                          |       | $                      | 954,886    |                  | $          | 524,196 |   |
| Buildings and  improvements                                                                                                                     |       | 1,489,217              |       | 881,386               |       |
| Total real  estate investments                                                                                                                  |       | 2,444,103              |       | 1,405,582             |       |
| Less:  Accumulated depreciation                                                                                                                 |       | (51,420                | )          | (22,729               | )          |
|                                                                                                                                            |       | 2,392,683              |       | 1,382,853             |       |
| Loans receivable                                                                                                                                |       | 64,638                 |       | 59,008                |       |
| Net investments                                                                                                                                 |       | 2,457,321              |       | 1,441,861             |       |
| Cash and cash  equivalents                                                                                                                      |       | 61,779                 |       | 30,536                |       |
| Lease intangibles, net                                                                                                                          |       | 21,500                 |       | 21,395                |       |
| Deferred costs and  other assets, net                                                                                                           |       | 26,306                 |       | 19,633                |       |
| Total assets                                                                                                                                    |       | $                      | 2,566,906  |                  | $          | 1,513,425 |   |
|                                                                                                                                            |       |                   |       |                  |       |
| **Liabilities and stockholders’  equity**                                                                                                  |       |                   |       |                  |       |
| Liabilities:                                                                                                                                    |       |                   |       |                  |       |
| Secured credit  facilities                                                                                                                      |       | $                      | 3,062      |                  | $          | 229,855 |   |
| Mortgages and  notes payable                                                                                                                    |       | 1,611,000              |       | 664,929               |       |
| Accounts  payable, accrued expenses and other liabilities                                                                                       |       | 29,581                 |       | 11,639                |       |
| Dividends  payable                                                                                                                              |       | 20,809                 |       | 14,209                |       |
| Total liabilities                                                                                                                               |       | 1,664,452              |       | 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, 99,090,866 (2006)  and 67,663,071 (2005) shares issued and outstanding |       | 991                    |       | 677                   |       |
| Capital in  excess of par value                                                                                                                 |       | 970,738                |       | 640,289               |       |
| Accumulated  distributions in excess of net income                                                                                              |       | (56,088                | )          | (33,607               | )          |
| Accumulated  other comprehensive loss                                                                                                           |       | (13,187                | )          | (14,566               | )          |
| Total stockholders’  equity                                                                                                                |       | 902,454                |       | 592,793               |       |
| Total liabilities and stockholders’ equity                                                                                                 |       | $                      | 2,566,906  |                  | $          | 1,513,425 |   |

 

*See accompanying notes.*

2

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**SpiritFinance CorporationCONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited)(dollars in thousands, except per share data)
| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                   | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues:                                    |       |                             |       |                            |       |   |   |   |   |
| Rentals                                      |       | $                                | 53,272     |                            | $          | 20,938 |   | $ | 124,048 |   | $ | 49,927 |   |
| Interest income on loans receivable          |       | 1,488                            |       | 1,028                           |       | 4,642 |   | 2,916 |   |
| Other interest income                        |       | 1,045                            |       | 1,163                           |       | 2,970 |   | 1,792 |   |
| Total revenues                               |       | 55,805                           |       | 23,129                          |       | 131,660 |   | 54,635 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Expenses:                                    |       |                             |       |                            |       |   |   |   |   |
| General and administrative                   |       | 4,209                            |       | 3,174                           |       | 12,523 |   | 8,998 |   |
| Depreciation and amortization                |       | 12,702                           |       | 5,583                           |       | 30,559 |   | 12,649 |   |
| Interest                                     |       | 25,770                           |       | 8,401                           |       | 59,036 |   | 14,265 |   |
| Total expenses                               |       | 42,681                           |       | 17,158                          |       | 102,118 |   | 35,912 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Income from  continuing operations           |       | 13,124                           |       | 5,971                           |       | 29,542 |   | 18,723 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Discontinued  operations:                    |       |                             |       |                            |       |   |   |   |   |
| Income from discontinued operations          |       | 353                              |       | 239                             |       | 2,025 |   | 1,557 |   |
| Net gains on sales of real estate            |       | 3,572                            |       | 442                             |       | 4,839 |   | 669 |   |
| Total  discontinued operations               |       | 3,925                            |       | 681                             |       | 6,864 |   | 2,226 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Net income                                   |       | $                                | 17,049     |                            | $          | 6,652 |   | $ | 36,406 |   | $ | 20,949 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Income per  common share:                    |       |                             |       |                            |       |   |   |   |   |
| Basic:                                       |       |                             |       |                            |       |   |   |   |   |
| Continuing operations                        |       | $                                | 0.13       |                            | $          | 0.09 |   | $ | 0.34 |   | $ | 0.28 |   |
| Discontinued operations                      |       | 0.04                             |       | 0.01                            |       | 0.08 |   | 0.03 |   |
| Net income                                   |       | $                                | 0.17       |                            | $          | 0.10 |   | $ | 0.42 |   | $ | 0.31 |   |
| Diluted:                                     |       |                             |       |                            |       |   |   |   |   |
| Continuing operations                        |       | $                                | 0.13       |                            | $          | 0.09 |   | $ | 0.34 |   | $ | 0.28 |   |
| Discontinued operations                      |       | 0.04                             |       | 0.01                            |       | 0.08 |   | 0.03 |   |
| Net income                                   |       | $                                | 0.17       |                            | $          | 0.10 |   | $ | 0.42 |   | $ | 0.31 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Weighted average  outstanding common shares: |       |                             |       |                            |       |   |   |   |   |
| Basic                                        |       | 98,442,914                       |       | 67,310,586                      |       | 85,680,951 |   | 67,216,680 |   |
| Diluted                                      |       | 98,668,627                       |       | 67,543,650                      |       | 85,945,685 |   | 67,429,591 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Cash dividends  declared per common share    |       | $                                | 0.21       |                            | $          | 0.19 |   | $ | 0.63 |   | $ | 0.57 |   |

 

*See accompanying notes.*

3

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**SpiritFinance CorporationCONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited)(dollars inthousands)
| ** **                                                | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| **Cash flows from operating  activities**                 |       |                                                    |       |   |   |
| Net income                                                |       | $                                                       | 36,406     |   | $ | 20,949 |   |
| Adjustments to net  income:                               |       |                                                    |       |   |   |
| Depreciation and  amortization                            |       | 30,862                                                  |       | 13,289 |   |
| Stock-based  compensation                                 |       | 1,144                                                   |       | 666 |   |
| Amortization of  deferred financing costs                 |       | 2,306                                                   |       | 1,782 |   |
| Amortization of  net interest rate swap hedge losses      |       | 470                                                     |       | — |   |
| Net gains on  sales of real estate                        |       | (4,839                                                  | )          | (669 | ) |
| Other noncash  items                                      |       | 336                                                     |       | 182 |   |
| Changes in  operating assets and liabilities:             |       |                                                    |       |   |   |
| Deferred costs  and other assets                          |       | (2,547                                                  | )          | (1,398 | ) |
| Accounts  payable, accrued expenses and other liabilities |       | 11,950                                                  |       | 3,827 |   |
| Net cash provided by  operating activities                |       | 76,088                                                  |       | 38,628 |   |
|                                                      |       |                                                    |       |   |   |
| **Cash flows from investing  activities**                 |       |                                                    |       |   |   |
| Acquisitions of real  estate                              |       | (1,092,950                                              | )          | (567,282 | ) |
| Investments in loans  receivable                          |       | (11,401                                                 | )          | (18,645 | ) |
| Proceeds from sales of  real estate                       |       | 56,223                                                  |       | 54,148 |   |
| Collections of  principal on loans receivable             |       | 8,468                                                   |       | 298 |   |
| Net cash used in  investing activities                    |       | (1,039,660                                              | )          | (531,481 | ) |
|                                                      |       |                                                    |       |   |   |
| **Cash flows from financing  activities**                 |       |                                                    |       |   |   |
| Borrowings under  secured credit facilities               |       | 160,351                                                 |       | 386,383 |   |
| Repayments under  secured credit facilities               |       | (387,144                                                | )          | (349,906 | ) |
| Borrowings under  mortgage notes payable                  |       | 959,191                                                 |       | 551,300 |   |
| Repayments under  mortgages and notes payable             |       | (12,698                                                 | )          | (142,191 | ) |
| Deferred financing  costs paid                            |       | (6,245                                                  | )          | (10,396 | ) |
| Payments received  (made) on interest rate swaps          |       | 5,825                                                   |       | (14,758 | ) |
| Proceeds from issuances  of common stock, net             |       | 329,555                                                 |       | 40,067 |   |
| Dividends paid on  common stock                           |       | (52,287                                                 | )          | (32,819 | ) |
| Other                                                     |       | (1,733                                                  | )          | (146 | ) |
| Net cash provided by  financing activities                |       | 994,815                                                 |       | 427,534 |   |
|                                                      |       |                                                    |       |   |   |
| Net increase (decrease)  in cash and cash equivalents     |       | 31,243                                                  |       | (65,319 | ) |
|                                                      |       |                                                    |       |   |   |
| Cash and cash  equivalents, beginning of period           |       | 30,536                                                  |       | 113,225 |   |
| Cash and cash equivalents, end of period                  |       | $                                                       | 61,779     |   | $ | 47,906 |   |

 

*See accompanying notes.*

4

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**Spirit Finance CorporationCONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**

Nine Months Ended September 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                                           |       |               |       |                              |       |                                                |       | 36,406                                                                  |       |                                        |       | 36,406                                |       |
| Change in net  unrealized losses on cash flow hedges |       |               |       |                              |       |                                                |       |                                                                    |       | 909                                         |       | 909                                   |       |
| Net cash flow  hedge losses reclassified to earnings |       |               |       |                              |       |                                                |       |                                                                    |       | 470                                         |       | 470                                   |       |
| Issuances of  common stock, net                      |       | 31,050,000         |       | 310                               |       | 329,245                                             |       |                                                                    |       |                                        |       | 329,555                               |       |
| Dividends  declared on common stock                  |       |               |       |                              |       |                                                |       | (58,887                                                                 | )          |                                        |       | (58,887                               | )          |
| Exercise of  stock options                           |       | 6,000              |       | —                            |       | 60                                                  |       |                                                                    |       |                                        |       | 60                                    |       |
| Restricted stock  activity, net                      |       | 371,795            |       | 4                                 |       | 1,144                                               |       |                                                                    |       |                                        |       | 1,148                                 |       |
| Balances at September 30, 2006             |       | 99,090,866         |       | $                                 | 991        |                                                | $          | 970,738                                                                 |       | $                                           | (56,088    | )                                     | $          | (13,187 | ) | $ | 902,454 |   |

 

*See accompanying notes.*

5

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**Spirit Finance CorporationNotes 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 ninemonths ended September 30, 2006 are not necessarily indicative of the resultsthat may be expected 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, SpiritFinance Acquisitions, LLC and numerous wholly-owned special purpose entities.Spirit Finance formed several special purpose entities to acquire and hold realestate subject 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 September 30, 2006 and December 31, 2005,assets totaling $2.5 billion and $1.4 billion, respectively, were held andliabilities totaling $1.6 billion and $668.6 million, respectively, were owedby these special purpose entities and are included in the accompanyingconsolidated balance sheets.  Allintercompany account balances and transactions have been eliminated inconsolidation.

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 ended December31, 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**

TheCompany classified restricted cash and deposits in escrow totaling $3.3 millionand $1.5 million at September 30, 2006 and December 31, 2005, respectively, indeferred costs and other assets in the accompanying consolidated balancesheets.  The restricted cash balances primarilyrepresented amounts required to be maintained under certain of the Company’sdebt agreements.

**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 the adoptiondate, 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 publicly traded 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 September 30, 2006,Spirit Finance had investments in 914 real estate properties, including 818owned properties with a gross acquisition cost of approximately $2.5 billionand mortgage and other loans receivable representing 96 properties with acarrying amount of $56.3 million.  AtSeptember 30, 2006, the Company also held five equipment loans with anaggregate outstanding balance of $8.3 million secured by equipment used in theoperation of certain real estate properties owned by the Company.  A substantial portion of the Company’sinvestments are pledged as collateral under debt obligations (see Note 4).

The Company’s investmentsare geographically dispersed throughout 43 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 September 30, 2006.

During the nine monthsended September 30, 2006, the Company had the following gross real estateacquisition and loan origination activity (dollars in thousands):
| ** **                                   | ** ** | **Number of **          | ** ** | ** **                           | ** ** |
|----------------------------------------------|------------|-----------------------------------|------------|--------------------------------------|------------|
| ** **                                   | ** ** | **Properties Owned or** | ** ** | **Dollar Amount of ** | ** ** |
| ** **                                   | ** ** | **Financed**                      | ** ** | **Investments (a)**             | ** ** |
| Balance,  December 31, 2005                  |       | 684                               |       | $                                    | 1,487,460  |   |
| Acquisitions and  loan originations          |       | 270                               |       | 1,107,031                            |       |
| Sales (see Note  10)                         |       | (38                               | )          | (52,923                              | )          |
| Principal  payments and premium amortization |       | (2                                | )          | (8,450                               | )          |
| Balance, September 30,  2006                 |       | 914                               |       | $                                    | 2,533,118  |   |

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(a)             Thedollar amount of investments includes the gross cost of land, buildings andlease intangibles related to properties owned and the carrying amount of loansreceivable.

8

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The followingtable shows information regarding the diversification of the Company’s totalinvestment portfolio among the different industries in which our customersoperate as of September 30, 2006 (dollars in thousands):
| ** **                                        | ** ** | **Number of** | ** ** | ** **                     | ** ** | **Percentage of**          | ** ** |
|---------------------------------------------------|------------|--------------------|------------|--------------------------------|------------|---------------------------------|------------|
| ** **                                        | ** ** | **Properties**     | ** ** | ** **                     | ** ** | **Dollar Amount of**  | ** ** |
| ** **                                        | ** ** | **Owned or**  | ** ** | **Dollar Amount of** | ** ** | **Total Real Estate** | ** ** |
| ** **                                        | ** ** | **Financed**       | ** ** | **Investments (a)**       | ** ** | **Investments**                 | ** ** |
| General and  discount retailer properties         |       | 178                |       | $                              | 827,040    |                            | 33         | % |
| Restaurants                                       |       | 488                |       | 519,476                        |       | 21                              |       |
| Specialty  retailer properties                    |       | 34                 |       | 248,983                        |       | 10                              |       |
| Movie theaters                                    |       | 24                 |       | 207,767                        |       | 8                               |       |
| Educational facilities                            |       | 20                 |       | 157,089                        |       | 6                               |       |
| Automotive  dealers, parts and service facilities |       | 51                 |       | 123,119                        |       | 5                               |       |
| Recreational  facilities                          |       | 7                  |       | 100,333                        |       | 4                               |       |
| Industrial  properties                            |       | 12                 |       | 70,005                         |       | 3                               |       |
| Supermarkets                                      |       | 19                 |       | 62,785                         |       | 2                               |       |
| Distribution  facilities                          |       | 44                 |       | 53,502                         |       | 2                               |       |
| Interstate  travel plazas                         |       | 4                  |       | 37,535                         |       | 1                               |       |
| Call centers                                      |       | 2                  |       | 33,988                         |       | 1                               |       |
| Convenience  stores/car washes                    |       | 16                 |       | 29,144                         |       | 1                               |       |
| Health  clubs/gyms                                |       | 5                  |       | 23,022                         |       | 1                               |       |
| Medical office                                    |       | 1                  |       | 21,020                         |       | 1                               |       |
| Drugstores                                        |       | 9                  |       | 18,310                         |       | 1                               |       |
| Total real estate  investments                    |       | 914                |       | $                              | 2,533,118  |                            | 100        | % |

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(a)             Thedollar amount of investments includes the gross cost of land, buildings andlease intangibles related to properties owned and the carrying amount of loansreceivable.

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 September 30, 2006was approximately 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 September 30, 2006 are as follows (dollars in thousands):

| 2006                          |   | $         | 53,690    |   |
|-------------------------------|--------|-----------|-----------|--------|
| 2007                          |   | 214,276   |      |
| 2008                          |   | 214,613   |      |
| 2009                          |   | 215,064   |      |
| 2010                          |   | 215,194   |      |
| 2011                          |   | 213,250   |      |
| Thereafter                    |   | 2,273,750 |      |
| Total future minimum  rentals |   | $         | 3,399,837 |   |

 

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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$2.9 million at September 30, 2006 and $1.5 million at December 31, 2005.

**4. DEBT**

**Secured Credit Facilities**

Short-term creditfacilities are used to partially fund real estate acquisitions pending theissuance of long-term, fixed-rate debt. At September 30, 2006, the Company had outstanding borrowings of $3.1million under the Company’s secured credit facilities.  Real estate properties and loans receivablewith an aggregate investment amount of $107.6 million were pledged ascollateral for future borrowings under the facilities.

The Company’s $300million revolving secured credit facility expired in October 2006 and wasreplaced with a new $400 million revolving secured credit facility with thesame bank.  The facility matures inOctober 2007, with the ability to extend the facility with the consent of thebank.  Borrowings under the new facilityrequire monthly payments of interest indexed to the one-month London InterbankOffered Rate (LIBOR) plus an additional amount ranging from 1.25% to 3.25%,depending on the amount of outstanding borrowings.  The interest rates on borrowings are subjectto increase in the event the Company exceeds a specified leverage amount.  The new facility also provides for a non-usefee which may be incurred under certain circumstances.  Borrowings under the facility are secured bythe underlying real estate properties and may also be secured by the Company’sequity ownership interests in certain of the Company’s consolidated specialpurpose subsidiaries.

The Company is subject tovarious financial and nonfinancial covenants under the new secured creditfacility, including maintaining a minimum tangible net worth of $500 million, amaximum total debt to tangible net worth ratio of 4:1 and a minimum liquidityrequirement of $15 million.  As ofSeptember 30, 2006, Spirit Finance was in compliance with its covenants.  The Company did not renew the $200 millionrevolving secured credit facility when it expired in November 2006.

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**Mortgages and Notes Payable**

The Company’s mortgages and notes payable aresummarized below (dollars in thousands): 
| ** **                                                             | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                             | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Net-lease  mortgage notes payable:                                     |       |                   |       |                  |       |
| Series 2005-1, Class A-1 mortgage note, 5.05%, due  2020               |       | $                      | 173,783    |                  | $          | 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         |       | 299,174                |       | —                |       |
| Secured  fixed-rate mortgage notes payable:                            |       |                   |       |                  |       |
| 8.44% - 9.02% Notes, effective rates 6.19% - 6.62%,  balloons due 2010 |       | 32,323                 |       | 32,668                |       |
| 5.78% Note, balloon due 2010                                           |       | 15,362                 |       | 15,500                |       |
| 5.90% - 6.50% Notes, balloons due 2012                                 |       | 22,450                 |       | 22,728                |       |
| 5.40% Notes, balloons due 2014                                         |       | 34,840                 |       | 35,202                |       |
| 5.26% - 5.62% Notes, balloons due 2015                                 |       | 114,582                |       | 115,747               |       |
| 5.88% Note, balloon due 2016                                           |       | 42,455                 |       | —                |       |
| 6.59% Notes, balloons due 2016                                         |       | 613,206                |       | —                |       |
| Unsecured  fixed-rate promissory note, 7.00%, due 2021                 |       | 2,198                  |       | 2,257                 |       |
|                                                                   |       | 1,608,673              |       | 662,180               |       |
| Unamortized debt  premium                                              |       | 2,327                  |       | 2,749                 |       |
| Total mortgages and  notes payable                                     |       | $                      | 1,611,000  |                  | $          | 664,929 |   |

 

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 September 30, 2006, Spirit Finance was in compliance withthese covenants.  The net-lease mortgagenotes are secured by real estate properties and mortgage notes receivable withan aggregate investment value of $1.1 billion at September 30, 2006.  At September 30, 2006, the fixed-ratemortgage notes payable were secured by real estate properties with an aggregateinvestment value of $1.2 billion.

The mortgages and notes payable requiremonthly principal and interest payments and also require balloon paymentstotaling $44.8 million due in 2010, $19.5 million due in 2012, $29.8 milliondue in 2014, $96.6 million due in 2015, $567.3 million due in 2016, $258.3million 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       |   | $         | 5,917     |   |
|------------|--------|-----------|-----------|--------|
| 2007       |   | 24,459    |      |
| 2008       |   | 25,858    |      |
| 2009       |   | 27,670    |      |
| 2010       |   | 73,761    |      |
| 2011       |   | 30,343    |      |
| Thereafter |   | 1,420,665 |      |
|       |   | $         | 1,608,673 |   |

 

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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 $16.9 million and $12.9 million at September 30, 2006 andDecember 31, 2005, respectively, and are included in deferred costs and otherassets in the accompanying consolidated balance sheets.

**5.DERIVATIVE AND HEDGING ACTIVITIES**

The Company uses interestrate derivative contracts (forward-starting interest rate swaps) to manage itsexposure to changes in interest rates on forecasted debt transactions. SpiritFinance does not enter into derivative contracts for speculative or tradingpurposes.

As of September 30, 2006,Spirit Finance was a party to two outstanding forward-starting interest rateswaps with a notional amount of $140.4 million. These instruments were designed to hedge the variability of cashoutflows related to forecasted interest payments over a term of 15 years onlong-term debt with an initial principal balance of at least $147.4 millionexpected to be issued in early 2007.  Asthe hedging relationships are expected to be highly effective at achievingoffsetting changes in future cash outflows, these interest rate swaps areaccounted for as cash flow hedges.  Forinterest rate swaps entered into prior to August 1, 2006, hedge effectivenessis assessed and measured using the hypothetical derivative method.  For interest rate swaps entered into afterAugust 1, 2006, hedge effectiveness is assessed using a regression analysis andmeasured using the hypothetical derivative method.  No hedge ineffectiveness was recognizedduring 2006 or 2005.  The fair value ofthe interest rate swaps in place at September 30, 2006 was a liability of $5.0million which is included in accounts payable, accrued expenses and otherliabilities with a corresponding unrealized loss recorded in accumulated othercomprehensive income.

In conjunction with theissuance of Series 2006-1 net-lease mortgage notes in March 2006 (see Note 4),the Company settled three forward-starting interest rate swap agreements for anaggregate cash receipt from the swap counterparties in the amount of $5.8million because long-term rates had risen since the inception of thehedges.  This amount is being amortized to earnings, using the effectiveinterest method, as a decrease in interest expense over a period of 15years.  During the nine months endedSeptember 30, 2006, net amortization expense totaled $470,000.

**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 371,795shares (net of forfeitures) of restricted stock to officers, employees anddirectors under its stock-based compensation plan.

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**7.COMMITMENTS AND CONTINGENCIES**

At September 30, 2006,Spirit Finance had contractual commitments totaling $26.4 million primarilyrelated to future improvements on properties the Company currently owns. Theseimprovements include costs to be incurred on facilities during which the tenant’sbusiness continues to operate without interruption and advances for theconstruction of new facilities for which operations have not yetcommenced.  In accordance with theunderlying lease agreements, theseimprovements, the majority of which are anticipated to be completed during2006, will result in increases in related contractual rent.  Spirit Finance is contingently liable for$5.7 million of debt of one of its tenants and is indemnified by that tenantfor any payments the Company may be required to make on the debt.

OnOctober 16, 2006, the Company amended and restated employment agreements withits six senior officers. The employment agreements are for three year termsthat automatically extend for one additional year on each anniversary of theeffective date of the agreement unless either party terminates the agreement.The agreements provide for annual base salaries and maximum bonuses which aresubject to increase as determined at the discretion of the compensationcommittee of the Company’s board of directors. Currently, the maximum aggregate annual cash compensation payable by theCompany under these six agreements totals approximately $4.3 million.  Under these agreements, if an executiveofficer were to be terminated without cause or if the executive officerterminated employment for good reason as defined in the agreement, SpiritFinance would be liable for a lump-sum severance payment at rates ranging fromtwo to three times the sum of the officer’s base salary plus average actualbonus, including the fair market value of equity based awards, and othertermination benefits.

TheCompany may be subject to claims or litigation in the ordinary course ofbusiness.  At September 30, 2006, there were no outstanding claimsagainst the Company that are expected to have a material adverse effect on theCompany’s financial position or results of operations.

**8. SIGNIFICANT CREDIT AND REVENUE CONCENTRATION**

Total revenues in 2006include rental revenues from two tenants under common control totaling $18.8million, or 33%, for the third quarter and $25.3 million, or 19%, for thenine-month period.  The underlying realestate properties were acquired by Spirit Finance on May 31, 2006 from SKOGroup Holding Corp. (“SKO”) and leased to these two tenants, each awholly-owned subsidiary of SKO, under long-term, triple-net master leaseagreements.  These tenants operateapproximately 345 general merchandise retail locations under the ShopKo and Pamida names in both mid-sized to larger citiesand small, rural communities across the Midwest, North Central, Rocky Mountainand Pacific Northwest states.  Thereal estate properties leased to these tenants represented approximatelyone-third of Spirit Finance’s total assets at September 30, 2006.

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**9. STOCK-BASED COMPENSATION**

The following tablesummarizes stock option and nonvested restricted stock award activity for thenine months ended September 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                                     |       | (6,000                 | )          | $                                                          | 10.00      |   |   |   | (78,024 | ) | $ | 10.62 |   |
| Forfeited                                            |       | (24,000                | )          | $                                                          | 11.13      |   |   |   | (57,139 | ) | $ | 11.53 |   |
| Outstanding at  September 30, 2006         |       | 1,260,000              |       | $                                                          | 10.00      |   | 7.2 |   | 646,256 |   | $ | 11.46 |   |
| Options  exercisable at September 30, 2006 |       | 584,000                |       | $                                                          | 10.00      |   | 7.2 |   |   |   |   |   |

 

All stock optionsoutstanding at September 30, 2006 were granted prior to the Company becoming apublic entity.  Each stock option has anexercise price equal to the estimated fair value of the Company’s common stockon the date of grant.  Stock options vestratably each year over a three- or five-year period, subject to continuedemployment, and will expire ten years after the date of the grant.  The aggregate intrinsic value of the stockoptions outstanding and exercisable as of September 30, 2006 was approximately$2.0 million and $940,000, respectively.

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 2003 through 2005, 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 over time.  Compensation expense related to restrictedstock awards granted in 2006 and 2005 is recognized on a straight-line basisover the vesting period. Compensation expense related to restricted stockawards granted prior to 2005 is recognized on a graded (accelerated) scheduleover the vesting period.  The weighted averagegrant date fair value of restricted stock granted during the nine months endedSeptember 30, 2006 and 2005 was $11.51 and $11.71 per share, respectively.  The total fair value of restricted sharesvested during the nine months ended September 30, 2006 and 2005 was $829,000and $530,000, respectively.  As ofSeptember 30, 2006, there was $5.6 million of unrecognized compensation costrelated to restricted stock awards which is expected to be recognized over aweighted-average period of approximately four years.

Stock-based compensationis included in general and administrative expenses in the consolidatedstatements of operations. The Company’s aggregate stock-based, non-cashcompensation expense, net of forfeitures, during the nine months ended September30, 2006 and 2005 was $1.1 million and $666,000, respectively.

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**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 adiversified real estate investment portfolio; consequently, proceeds from thesales of real estate properties are expected to be reinvested in additionalreal estate properties such that cash flows from ongoing operations are notnegatively affected by sales of individual properties.  SFAS No. 144, “Accounting for the Impairmentor Disposal of Long-Lived Assets,” requires that gains and losses from any suchdispositions of properties and all operations from these properties bereclassified as “discontinued operations” in the consolidated statements ofoperations.  As a result of thisreporting requirement, each time a property is sold, the operations of suchproperty previously reported as part of “income from continuing operations” arereclassified into discontinued operations. This presentation has no impact on net income or cash flow.

During the nine monthsended September 30, 2006, the Company sold 38 properties for $56.2 million innet sales proceeds.  During the yearended December 31, 2005, the Company sold 43 properties, including 39properties sold in the first nine months of 2005, for $54.1 million in netsales proceeds.  All of the current andprior period operations and net gains realized from these real estatedispositions have been reclassified into discontinued operations in theaccompanying financial statements.

The following table setsforth the components of discontinued operations related to properties soldsubsequent to January 1, 2005 (dollars in thousands):
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                           | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Rental revenues                      |       | $                                | 402        |                            | $          | 384 |   | $ | 2,398 |   | $ | 2,580 |   |
|                                 |       |                             |       |                            |       |   |   |   |   |
| Expenses:                            |       |                             |       |                            |       |   |   |   |   |
| General and  administrative          |       | 5                                |       | 3                               |       | 69 |   | 19 |   |
| Depreciation and  amortization       |       | 44                               |       | 111                             |       | 303 |   | 640 |   |
| Interest                             |       | —                           |       | 31                              |       | 1 |   | 364 |   |
| Total expenses                       |       | 49                               |       | 145                             |       | 373 |   | 1,023 |   |
|                                 |       |                             |       |                            |       |   |   |   |   |
| Income from  discontinued operations |       | 353                              |       | 239                             |       | 2,025 |   | 1,557 |   |
| Net gains on sales of  real estate   |       | 3,572                            |       | 442                             |       | 4,839 |   | 669 |   |
| Total discontinued operations        |       | $                                | 3,925      |                            | $          | 681 |   | $ | 6,864 |   | $ | 2,226 |   |

 

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**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** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                              | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                                              | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted average  shares:                                                                               |       |                             |       |                            |       |   |   |   |   |
| Weighted average  outstanding common shares used in the calculation of basic income per common  share   |       | 98,442,914                       |       | 67,310,586                      |       | 85,680,951 |   | 67,216,680 |   |
| Effect of  unvested restricted stock                                                                    |       | 92,546                           |       | 96,762                          |       | 97,137 |   | 75,039 |   |
| Effect of stock  options (a)                                                                            |       | 133,167                          |       | 136,302                         |       | 167,597 |   | 137,872 |   |
| Weighted average  outstanding common shares used in the calculation of diluted income per  common share |       | 98,668,627                       |       | 67,543,650                      |       | 85,945,685 |   | 67,429,591 |   |

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(a)             Optionsto purchase 30,000 shares of common stock were included in total stock optionsoutstanding at September 30, 2005 but were not included in the computations ofdiluted net income per common share because the effect was not dilutive.

**12. COMPREHENSIVE INCOME**

The reconciliationof net income to comprehensive income is as follows (dollars inthousands):  
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                           | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                           | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                 |       |                             |       |                            |       |   |   |   |   |
| Net income as  reported                              |       | $                                | 17,049     |                            | $          | 6,652 |   | $ | 36,406 |   | $ | 20,949 |   |
| Change in net  unrealized losses on cash flow hedges |       | (5,324                           | )          | 9,540                           |       | 909 |   | (10,844 | ) |
| Net cash flow  hedge losses reclassified to earnings |       | 123                              |       | 226                             |       | 470 |   | 226 |   |
| Comprehensive income                                 |       | $                                | 11,848     |                            | $          | 16,418 |   | $ | 37,785 |   | $ | 10,331 |   |

 

**13.SUPPLEMENTAL CASH FLOW INFORMATION**

In conjunction with theacquisition of certain real estate investments during the first nine 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 99.1to this 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 as of September30, 2006 and our audited financial statements included in our Annual Report onForm 10-K for the year ended December 31, 2005. Undue reliance should not beplaced upon historical financial statements since they are not indicative ofexpected results of operations or financial condition for any future 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$2.7 billion in real estate acquisitions and mortgage loan investments.

As of September 30, 2006,our investment portfolio of real estate and loans totaled $2.5 billion andrepresented 914 owned or financed properties geographically diversified across43 states.  Only two states, Wisconsin(13%) and Texas (11%), accounted for 10% or more of the total dollar value of ourreal estate and loan portfolio.  Of ourtotal investment portfolio as of September 30, 2006, approximately $2.5billion, or 97%, represented the gross cost of real estate and related leaseintangibles that we own and $64.6 million, or 3%, represented mortgage,equipment and other loans receivable. Our properties are leased or financed to 117 customers operating invarious industries.  The three largestindustries in which our customers operated at September 30, 2006, as apercentage of the total dollar amount of our investment portfolio, were generaland discount retailers (33%), restaurants (21%) and specialty retailers (10%).As of September 30, 2006, our ten largest customers as a percentage of thetotal investment portfolio were: ShopKo Stores Operating Co., LLC; PamidaStores Operating Co., LLC; Carmike Cinemas, Inc. (NASDAQ: CKEC); Casual MaleRetail 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 University ofPhoenix (NASDAQ: APOL).  Together, thesecustomers accounted for 51% of our total investment portfolio at September 30,2006.  ShopKo Stores Operating Co., LLCis the largest individual credit exposure at 29% with no other individualcredit exposure greater than 4% of the total investment portfolio.

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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 loans receivable. Ourability to generate positive cash flow will depend heavily on the differencebetween the income earned on our assets and the interest expense incurred onour borrowings.  The cash we generatefrom our long-term leases is expected to increase over the term of the leasesbecause the leases generally contain rent escalation provisions.  We finance our real estate properties withlong-term, fixed-rate debt which provide for a fixed monthly debt payment.  As a result, we expect to realize a growingstream of net cash flows over the term of the leases.

We expect to grow throughcontinuing our business strategy of acquiring single tenant, operationallyessential real estate principally through sale-leaseback transactions.  Our ability to achieve our plan of continuedgrowth is dependent on achieving a substantial volume of acquisitions atattractive yields without compromising our underwriting criteria and ourability to effectively finance those acquisitions to meet our targetedyields.  The current environment for netlease real estate acquisitions continues to be highly competitive, and thiscompetitive environment could limit both the dollar volume of properties weacquire and the yield on those acquisitions. We may delay or decline opportunities if we feel the financial returnsdo not warrant the capital risk.  Thetiming of completing property acquisitions may vary significantly from quarterto quarter. In response to these challenges, we are committed to seekingnumerous potential investment opportunities through our full-time acquisitionsstaff and through our other sourcing relationships.  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 initially with borrowings on oursecured credit facility and then implement our long-term financing strategiesby raising funds through the issuance of debt and additional 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. During the firstnine months of 2006, we acquired or financed 270 single tenant commercial realestate properties through various transactions totaling over $1.1 billionusing a combination of proceeds from new borrowings and equity offerings.  Year-to-date acquisitions include 178 realestate properties acquired from SKO Group Holding Corp. for $815.3 million,excluding transaction expenses.  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 also used net cash proceeds from the salesof 38 real estate properties, totaling $56.2 million for the nine monthsended September 30, 2006, to acquire new properties.  At September 30, 2006, we hadcontractual commitments totaling $26.4 million primarily related to futureimprovements on properties we currently own. In accordance with the underlying lease agreements, these improvements,the majority of which are anticipatedto be completed during 2006, will result in increases in related contractualrent.  In addition, as of October23, 2006, we had identified for review potential investment opportunities ofmore than $2.7 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 of 

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completing any suchtransactions, which is dependent on the completion of due diligence and otherfactors that may not be under our control, may vary significantly from quarterto quarter.  After further due diligence,we may decide not to pursue any or all of these transactions, we may not be thesuccessful bidder on all of the transactions we pursue, and there is noassurance that we will ultimately complete any of the real estate acquisitions.

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 Consumer PriceIndex (“CPI”) and/or contingent rent based on a percentage of the lessee’sgross sales.  At September 30, 2006, ourweighted average noncancelable remaining lease term was approximately 16 years,and our leases generally 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.  Since our tenants generallypay the property operating and maintenance costs, we do not believe we willincur significant capital or operating expenditures on our properties.

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.  Noncashexpenses include depreciation expense on the buildings and improvements in ourreal estate portfolio, stock-based compensation (included in general andadministrative expenses) and deferred financing costs and the amortization ofthe net losses on our settled interest rate swaps (included in interestexpense).  After payment of expenses, ourcash flow from operating activities totaled $76.1 million for the ninemonths ended September 30, 2006 as compared to $38.6 million for the sameperiod in 2005, primarily due to the increases in net income and the non-cashadjustment for depreciation and amortization expense, which are reflective ofthe growth in our investment portfolio.

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.  The distributions we pay may include a returnof capital.  Cash for futuredistributions is expected to be generated from operations, although we may alsoborrow funds to make distributions.  Ourability to pay distributions will depend on, among other things, our actualresults of operations, which are dependent primarily on our receipt of paymentsfrom our leases and loans with respect to our real estate investments. Duringthe nine months ended September 30, 2006, we declared dividends of $0.63 pershare, totaling $58.9 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 two public offerings under our existing shelf registrationon file with the Securities and Exchange Commission (“SEC”) aggregatingapproximately 31.1 million shares of common stock which raised aggregateproceeds of approximately $330 million, after deducting the underwriters’ discountsand offering expenses, of which $228 million was used to pay down borrowingsoutstanding under our secured credit facilities.

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We generally use ourrevolving secured credit facilities to partially fund the initial purchase ofreal estate pending the issuance of long-term, fixed-rate debt.  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.

As of September 30, 2006,we had two secured credit facilities with a maximum aggregate borrowingcapacity totaling $500 million, and $3.1 million was outstanding under thefacilities.   Our $300 million revolvingsecured credit facility with Citigroup Global Markets Realty Corp. (“Citi”)expired in October 2006 and was replaced with a $400 million facility withCiti.  The new facility is structured asa master loan repurchase agreement and our borrowings under the facility aresecured by the underlying real estate properties and may also be secured by ourequity ownership interests in certain of our consolidated special purposesubsidiaries.  Borrowings under the newfacility require monthly payments of interest indexed to the one-month LondonInterbank Offered Rate (LIBOR) plus an additional amount ranging from 1.25% to3.25%, depending on the amount of outstanding borrowings.  The interest rates on borrowings are subjectto increase in the event we exceed a specified leverage amount.   The new facility also provides for a non-usefee which may be incurred under certain circumstances.  We allowed our $200 million revolving securedcredit facility to expire in November 2006.

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 July 2005.  At September 30, 2006, the aggregate balanceof the net-lease mortgage notes totaled $731.3 million and was secured by acollateral pool in excess of $1 billion in real estate assets.  The notes may be prepaid at any time, subjectto a yield maintenance prepayment premium. The notes also permit the substitution of real estate collateral fromtime to time subject to certain conditions and limits. In addition, the notestructure allows for the contribution of additional properties to thecollateral pool and the issuance of additional series of notes secured by theincreased collateral pool.

During the first ninemonths of 2006, we entered into new long-term financing arrangements totaling$657.4 million in conjunction with two real estate acquisitiontransactions. At September 30, 2006, the total carrying amount of ourfixed-rate debt, including the net-lease mortgage notes described in thepreceding paragraph, was $1.6 billion. Real estate investments with an aggregate investment value of$2.3 billion were pledged as collateral for our 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 rates on future borrowings rise faster than lease rates onour existing portfolio of real estate investments, which may reduce our cashflow.  Therefore, in order to limit theeffects of changes in interest rates on our operations, we seek to match-fundour long-term, fixed-rate assets with long-term, fixed-rate liabilities.  At September 30, 2006, 90% of ourinvestment portfolio was match-funded with long-term debt.

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We are subject to variouscustomary operating and financial covenants under our mortgage notes payableand our secured credit facility. The mortgage notes payable and our securedcredit facility include a limitation on our ability to incur additionalindebtedness on the underlying secured real estate. Our secured credit facilityalso includes, among other requirements, a minimum liquidity requirement of$15 million, a maximum total debt to tangible net worth ratio of 4:1 and aminimum tangible net worth requirement of $500 million.  As of September 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 facility 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 September 30, 2006,our leverage ratio was 63%. We intend to obtain additional unsecured and/orsecured financing through various sources including banks, institutionalinvestors and other lenders. We may also obtain lines of credit, bridge loans,warehouse facilities and other debt arrangements or may incur debt in the formof publicly or privately placed debt instruments.  We intend to use substantially all of ourproperties to secure our borrowings under our various debt financings.  Our ability to achieve continuous real estateinvestment growth will also depend on our ability to raise additional equitycapital.

**Resultsof Operations**

Since we beganpurchasing real estate assets in December 2003, we have completed nearly$2.7 billion in real estate acquisitions and mortgage loan investments, ofwhich over $1.1 billion was completed during the first nine months of2006.  The increase in net income, assummarized in the following table, is reflective of the growth in our rentalrevenues as a result of the increase in the size of our investment portfolioand increased gains on the sales of real estate as discussed below.
| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                               | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                               | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Net income (in  thousands)                                               |       | $                                | 17,049     |                            | $          | 6,652 |   | $ | 36,406 |   | $ | 20,949 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Net income per  diluted common share                                     |       | $                                | 0.17       |                            | $          | 0.10 |   | $ | 0.42 |   | $ | 0.31 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Weighted average  outstanding common shares — diluted (in millions) |       | 98.7                             |       | 67.5                            |       | 85.9 |   | 67.4 |   |

 

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 

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principles require thatgains and losses from any such dispositions and all operations from theproperties previously reported as part of “income from continuing operations”be reclassified to “discontinued operations.” This reclassification has no impact on net income or cash flows.

We sold 15 and 38properties during the three and nine months ended September 30, 2006,respectively.  For the same periods in2005, we sold 16 and 39 properties, respectively.  Since the beginning of 2005, we have sold atotal of 81 properties or approximately 4% of the nearly $2.7 billion intotal real estate acquisitions we have made since our first acquisition inDecember 2003.  Income from continuingoperations and discontinued operations and the related per share amounts associatedwith all properties sold subsequent to January 1, 2005 are presented in thetable below (dollars in thousands, except per share data):
| ** **                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                          | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                |       |                             |       |                            |       |   |   |   |   |
| Income from  continuing operations  |       | $                                | 13,124     |                            | $          | 5,971 |   | $ | 29,542 |   | $ | 18,723 |   |
|                                |       |                             |       |                            |       |   |   |   |   |
| Discontinued  operations:           |       |                             |       |                            |       |   |   |   |   |
| Income from discontinued operations |       | 353                              |       | 239                             |       | 2,025 |   | 1,557 |   |
| Net gains on sales of real estate   |       | 3,572                            |       | 442                             |       | 4,839 |   | 669 |   |
| Total  discontinued operations      |       | 3,925                            |       | 681                             |       | 6,864 |   | 2,226 |   |
|                                |       |                             |       |                            |       |   |   |   |   |
| Net income                          |       | $                                | 17,049     |                            | $          | 6,652 |   | $ | 36,406 |   | $ | 20,949 |   |
|                                |       |                             |       |                            |       |   |   |   |   |
| Income per  diluted common share:   |       |                             |       |                            |       |   |   |   |   |
| Continuing operations               |       | $                                | 0.13       |                            | $          | 0.09 |   | $ | 0.34 |   | $ | 0.28 |   |
| Discontinued operations             |       | 0.04                             |       | 0.01                            |       | 0.08 |   | 0.03 |   |
| Net income                          |       | $                                | 0.17       |                            | $          | 0.10 |   | $ | 0.42 |   | $ | 0.31 |   |

 

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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 September 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                           | ** ** | **Continuing  Operations**                               | ** ** | **Discontinued  Operations** | ** ** | **Total  Operations** | ** ** |
| ** **                           | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues                             |       | $                                                        | 55,805     |   | $ | 23,129 |   | $ | 402 |   | $ | 384 |   | $ | 56,207 |   | $ | 23,513 |   |
| Expenses:                            |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| General and  administrative expenses |       | 4,209                                                    |       | 3,174 |   | 5 |   | 3 |   | 4,214 |   | 3,177 |   |
| Depreciation and  amortization       |       | 12,702                                                   |       | 5,583 |   | 44 |   | 111 |   | 12,746 |   | 5,694 |   |
| Interest                             |       | 25,770                                                   |       | 8,401 |   | — |   | 31 |   | 25,770 |   | 8,432 |   |
|                                      |            |                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                           | ** ** | **Continuing  Operations**                              | ** ** | **Discontinued  Operations** | ** ** | **Total  Operations** | ** ** |
| ** **                           | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues                             |       | $                                                       | 131,660    |   | $ | 54,635 |   | $ | 2,398 |   | $ | 2,580 |   | $ | 134,058 |   | $ | 57,215 |   |
| Expenses:                            |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| General and  administrative expenses |       | 12,523                                                  |       | 8,998 |   | 69 |   | 19 |   | 12,592 |   | 9,017 |   |
| Depreciation and  amortization       |       | 30,559                                                  |       | 12,649 |   | 303 |   | 640 |   | 30,862 |   | 13,289 |   |
| Interest                             |       | 59,036                                                  |       | 14,265 |   | 1 |   | 364 |   | 59,037 |   | 14,629 |   |
|                                      |            |                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Revenues***

Total revenues increasedto $56.2 million for the third quarter of 2006 from $23.5 million forthe third quarter of 2005.  Totalrevenues for the first nine months of 2006 rose to $134.1 million from $57.2 millionfor the comparable period in 2005.  Theincrease in revenues is the result of the growth in our investment portfolioprimarily due to property acquisitions made over the past year.  Because the acquisition of properties tendsto occur later in a quarter, the full quarterly earnings impact of acquisitionsmade in the third quarter of 2006 will not be realized until the fourthquarter.

Approximately 94% of therevenues we generated in 2006 were rental revenues from real estate propertieswe own and lease to our customers.  AtSeptember 30, 2006, essentially all of our properties were occupied and currentin their monthly lease and loan payments. Total revenues in 2006 include rental revenues from two tenants undercommon control totaling $18.8 million, or 33%, for the third quarter and $25.3million, or 19%, for the nine-month period. The underlying real estate properties were acquired by Spirit Finance onMay 31, 2006, from SKO Group Holding Corp. (“SKO”) and leased to these twotenants, each a wholly-owned subsidiary of SKO, under long-term, triple-netmaster lease agreements.  These tenantsoperate approximately 345 general merchandise retail locations under the ShopKo and Pamida names in bothmid-sized to larger cities and small, rural communities across the Midwest,North Central, Rocky Mountain and Pacific Northwest states.  The real estate properties leased tothese tenants represented approximately one-third of our total assets atSeptember 30, 2006.  As our investmentportfolio grows, the portion of revenues represented by these tenants isexpected to decrease.  No other 

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individual tenantrepresented more than 5% of total revenues during the three and nine monthsended September 30, 2006.

Our long-term leasesgenerally provide for payments of base rents with scheduled increases, increasesbased 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 revenues haveincreased in relation to the growth in our investment portfolio.  Rental revenues, including rental revenuesreclassified as discontinued operations, and the related weighted average realestate investments are presented in the following table (dollars in thousands):
| ** **                                                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                        | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                        | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Rental revenues,  excluding the adjustment for straight-line rent |       | $                                | 53,267     |                            | $          | 21,023 |   | $ | 125,280 |   | $ | 51,697 |   |
| Straight-line  rent, net                                          |       | 407                              |       | 299                             |       | 1,166 |   | 809 |   |
| Total rental  revenues                                            |       | $                                | 53,674     |                            | $          | 21,322 |   | $ | 126,446 |   | $ | 52,506 |   |
|                                                              |       |                             |       |                            |       |   |   |   |   |
| Weighted average real  estate investments                         |       | $                                | 2,429,578  |                            | $          | 982,129 |   | $ | 1,927,687 |   | $ | 796,701 |   |

 

During the three and ninemonths ended September 30, 2006, interest income on mortgage and other loansreceivable totaled $1.5 million and $4.6 million, respectively, ascompared to $1.0 million and $2.9 million for the same periods in 2005.  The increase in interest income in 2006 over2005 was primarily the result of the origination of approximately $14 millionof new loans since September 30, 2005. Other interest income is generated from temporary investments pendinginvestment in real estate.

***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 36 employees at September 30, 2005 to 39 at September 30, 2006 tosupport our larger real estate investment portfolio. The large increase in thenumber of properties in our portfolio has also resulted in increased portfolioservicing costs and higher general insurance costs.

Depreciation andamortization expense relates primarily to real estate properties and relatedlease intangibles. Depreciation and amortization expense was $12.7 million and$30.9 million for the three and nine months ended September 30, 2006,respectively, as compared to $5.7 million and $13.3 million in the sameperiods in 2005. The increase over the 2005 periods was primarily the result ofthe increase in the real estate investment portfolio.

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The increase in interestexpense during the third quarter and for the first nine months of 2006 isprimarily attributable to higher weighted average outstanding debt resultingfrom new borrowings used to grow our investment portfolio.  The following table summarizes our interestexpense and related borrowings (dollars in thousands):
| ** **                                                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                               | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                               | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                                     |       |                             |       |                            |       |   |   |   |   |
| Interest expense                                                                         |       | $                                | 24,268     |                            | $          | 7,357 |   | $ | 54,669 |   | $ | 12,246 |   |
| Amortization of  deferred financing costs, debt insurer premiums and interest rate swaps |       | 1,502                            |       | 1,075                           |       | 4,368 |   | 2,383 |   |
| Total interest  expense                                                                  |       | $                                | 25,770     |                            | $          | 8,432 |   | $ | 59,037 |   | $ | 14,629 |   |
|                                                                                     |       |                             |       |                            |       |   |   |   |   |
| Weighted average debt  outstanding                                                       |       | $                                | 1,611,473  |                            | $          | 545,404 |   | $ | 1,254,113 |   | $ | 299,673 |   |

 

As our investmentportfolio grows, our general and administrative expenses are expected tocontinue to increase; however, general and administrative expenses calculatedas a percent 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 we continueto make investments in real estate.

**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 operating activities determined in accordance with GAAP as ameasure of liquidity. Spirit Finance’s statements of operations and cash flowsinclude disclosures of interest expense, capital expenditures and itemsexcluded from the calculation of FFO, all of which should be considered whenevaluating our performance.

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A reconciliation of netincome calculated in accordance with GAAP to FFO is presented in the followingtable (dollars in thousands):
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                        | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                        | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                        |       | $                                | 17,049     |                            | $          | 6,652 |   | $ | 36,406 |   | $ | 20,949 |   |
| Portfolio  depreciation and amortization expense: |       |                             |       |                            |       |   |   |   |   |
| Continuing operations                             |       | 12,657                           |       | 5,550                           |       | 30,429 |   | 12,555 |   |
| Discontinued operations                           |       | 44                               |       | 111                             |       | 303 |   | 640 |   |
| Less: Net gains  on sales of real estate (a)      |       | (3,372                           | )          | (442                            | )          | (4,503 | ) | (669 | ) |
| FFO (b)                                           |       | $                                | 26,378     |                            | $          | 11,871 |   | $ | 62,635 |   | $ | 33,475 |   |

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(a)             Excludesthe gain on sale related to development properties totaling $200,000 and$336,000, net of tax, for the quarter and nine months ended September 30, 2006,respectively.

(b)            FFOincludes the adjustment between scheduled rents and rental revenue recognizedon a straight-line basis ($407,000 and $299,000 for the three months endedSeptember 30, 2006 and 2005, respectively, and $1.2 million and $809,000 forthe nine months ended September 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;

·                  timing of acquisitions

·                  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;

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·                  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 report on Form 10-K, includingthose set forth under the captions “Risk Factors” and “Management’s Discussionand Analysis of Financial Condition and Results of Operations” and otherdocuments and reports we file with the SEC.

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 to additionalcompetition for the acquisition of real estate due to a reduction in desirablealternate 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 September 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 other prepayment penalties whichprovide us with a certain level of yield protection in a decreasing interestrate environment.

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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 forward-starting interest rate swaps, to manage our interestrate risk.  We do not enter intoderivative contracts for speculative or trading purposes. We generally intendto utilize derivative instruments to hedge interest rate risk on our liabilitiesand not use derivatives for other purposes, such as hedging asset-related risk,as such hedging transactions may generate income which is not qualified incomefor purposes of maintaining our REIT status. Our hedging strategy is monitoredby the audit committee of our board of directors.

At September 30, 2006,our fixed-rate debt totaled $1.6 billion. Using a discounted cash flow analysis based on estimates of the amountand timing of future cash flows, market rates and credit spreads, the estimatedfair value of our fixed-rate debt exceeded its carrying amount atSeptember 30, 2006 by approximately $13.6 million.  Our mortgage loans receivable are alsofixed-rate instruments.  At September 30,2006, our mortgage loans receivable (excluding equipment and other loans)totaled $55.2 million.  Using adiscounted cash flow analysis, the estimated fair value of our fixed-ratemortgage loans receivable exceeded its carrying amount by approximately $1.4million at September 30, 2006.  It is ourintent to hold our fixed-rate mortgage loans receivable and our fixed-ratemortgages and notes payable to maturity; accordingly, changes in marketinterest rates impact the fair value of these financial instruments but have noimpact on interest recognized 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 ninemonths ended September 30, 2006, the weighted average outstanding balance ofour variable-rate debt, which was based on spreads over one-month LIBOR, was$62.3 million.  Excludingamortization of deferred financing costs, this variable rate indebtedness had aweighted average interest rate of 6.5%. During the first nine months of 2006,one-month LIBOR increased approximately 93 basis points. Had the weightedaverage interest rate been 100 basis points higher (lower) during the firstnine months of 2006, our net income for the nine months ended September 30,2006 would have been reduced (increased) by approximately $473,000.  This amount was determined by considering theimpact of a hypothetical interest rate change on our average variable-rateborrowings outstanding during the first nine months of 2006 and assumes noother changes 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.

As of September30, 2006, Spirit Finance was a party to two outstanding forward-startinginterest rate swaps with a notional amount of $140.4 million.  These instruments were designed to hedge thevariability of cash outflows related to forecasted interest payments over aterm of 15 years on long-term debt expected to be issued in early 2007.  The fair value of the interest rate 

29

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swaps in place atSeptember 30, 2006 was a liability of $5.0 million which is included inaccounts payable, accrued expenses and other liabilities with a correspondingunrealized loss recorded in accumulated other comprehensive income. Thecounterparty for the swap is a major financial institution that has a credit ratingof at least “A-” from a nationally recognized rating agency.

As the hedgingrelationships are expected to be highly effective at achieving offsettingchanges in future cash outflows, these interest rate swaps are accounted for ascash flow hedges.  Hedge effectiveness isassessed periodically.  No hedgeineffectiveness was recognized during the nine months ended September 30, 2006or 2005.  The net unamortized lossrelated to all interest rate swaps at September 30, 2006 was $13.2million.  Because the anticipatedinterest payments are considered 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**

For a discussion offactors that could affect our business and results of operations, you shouldreview the information included under the caption “Item 1A. Risk Factors” inour Annual Report on Form 10-K for the fiscal year ended December 31, 2005, aswell as the information supplementing that disclosure under the caption “Item1A. Risk Factors” in our Quarterly Report on Form 10-Q for the fiscal quarterended June 30, 2006.  These factors,taken together, set forth important information that may cause our actualresults of operations in future periods to differ materially from thosecurrently expected or discussed in forward-looking statements contained in thisreport relating to our financial results, operations and businessprospects.  There have been no materialchanges to the risk factors set forth in our Form 10-K and Form 10-Q referencedabove.

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

During the quarter ended September 30, 2006, werepurchased the following shares of our common stock:
| **Period**                         | ** ** | **Total Number of  Shares  Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares Purchased  as Part of  Publicly  Announced Plans  or Programs** | ** ** | **Maximum  Number of   Shares that May  Yet Be Purchased  Under the Plans   or Programs** | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------|------------|
| July 1, 2006 to  July 31, 2006     |       | 10,000                                           | (1)        | $                                                | 0.01       |                                                                                                                         | —     |                                                                                                                                        | —     |   |
| August 1, 2006  to August 31, 2006 |       | —                                           |       | —                                           |       | —                                                                                                                       |       | —                                                                                                                                      |       |
| September 1 to  September 30, 2006 |       | —                                           |       | —                                           |       | —                                                                                                                       |       | —                                                                                                                                      |       |
| Total                              |       | 10,000                                           | (1)        | $                                                | 0.01       |                                                                                                                         | —     |                                                                                                                                        | —     |   |

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(1)             Werepurchased 10,000 unvested shares of our restricted stock which were forfeitedby an employee in accordance with the terms of the Spirit Finance Corporation2003 Stock Option and Incentive Plan.

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**Item3.  Defaults Upon Senior Securities**

Not Applicable.

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

None.

**Item5.  Other Information**

None.

**Item6.  Exhibits**
| Exhibit  No. | ** ** | **Description**                                                                                                                                                                                                                                                                    |
|--------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1         |       | Extension Agreement between Spirit Finance Corporation  and Citigroup Global Markets Realty Corp. dated September 11, 2006  (incorporated by reference to the Registrant’s Current Report on Form 8-K  dated September 11, 2006).                                             |
|         |       |                                                                                                                                                                                                                                                                               |
| 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 July 29, 2006 (Successor), January  28, 2006 (Successor) and July 30, 2005 (Predecessor) and for the 13 and 26  Weeks Ended July 29, 2006 (Successor) and July 30, 2005 (Predecessor). |

 

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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: November 7, 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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