Hello, and welcome to Broadstone Net Lease's Second Quarter 2022 Earnings Conference Call. My name is Sarah, and I will be your operator today. Please note that today's call is being recorded. I will now turn the call over to Mike Caruso, Senior Vice President of Corporate Finance and Investor Relations at Broadstone. Please go ahead.

Thank you, operator, and thank you, everyone, for joining us today for Broadstone Net Lease's second quarter 2022 earnings call. On today's call, you will hear from our Chief Executive Officer, Chris Czarnecki; our Chief Financial Officer, Ryan Albano; and our Chief Operating Officer, John Moragne, who will be available for Q&A. Before we begin, I would like to remind everyone that the following presentation contains forward-looking statements, which are subject to risks and uncertainties that can cause actual results to differ materially due to a variety of factors. We caution you not to place undue reliance on these forward-looking statements and refer you to our SEC filings, including our Form 10-K for the year ended December 31, 2021, for a more detailed discussion of the risk factors that may cause such differences. Any forward-looking statements provided during this conference call are only made as of the date of this call. I will now turn the call over to our Chief Executive Officer, Chris Czarnecki.

Thank you, Mike, and good morning, everyone. As we make our way into the second half of 2022, we continue to rely on our diversified net lease strategy to generate consistent and predictable results for our shareholders. Despite a heightened level of macroeconomic uncertainty and persistent volatility in both the equity and debt markets, I'm pleased to report another strong quarter of results across all facets of our business. Before I dive into Q2 operating results, I'd like to take a moment to reiterate how our diversified net lease strategy defensively positions us in today's dynamic market environment. As I've stated on previous calls, our diversified strategy uniquely positions BNL relative to many of our net lease peers to perform across all market cycles and economic backdrops. Relative to other REIT sectors, net lease has proven to be both defensive and resilient during periods of economic stress, and we feel that our differentiated strategy, well-constructed and highly diversified portfolio, along with a fortified balance sheet, provides us the flexibility to navigate periods of dislocation or changes in cap rates by changes in cost of capital. Diversification provides both defensive and offensive advantages during challenging economic times. Our strategy continues to offer unique benefits during the current rising rate and inflationary environment. We are confident that our strategy positions us to achieve both defensive internal growth as well as consistent and accretive external growth in the face of current economic pressures. From a defensive perspective, our portfolio of 764 properties is comprised of 213 tenants to diversify it across 57 industries, with no single tenant accounting for more than 2% of annualized base rent. Granular diversification, coupled with strong weighted average annual rent escalations of 2% translates into consistent and reliable same-store growth. Our portfolio has been deliberately constructed to withstand…

Thank you, Chris, and good morning, everyone. During the second quarter, we generated AFFO of $62.8 million or $0.35 per share, which represents approximately 6.1% growth over per share results from the same period last year. AFFO per share was flat quarter-over-quarter when compared to Q1 2022, which is largely driven by the revenue generated from late Q1 acquisitions, offset by accelerated equity raise that has derisked our capital markets execution in the back half of the year. Acquisitions completed during Q2 were predominantly closed in June and are expected to serve as a tailwind to our Q3 earnings. During the quarter, we incurred $9.3 million of total general and administrative expenses, which includes $7.9 million of cash expenses consistent quarter-over-quarter. Turning now to our balance sheet activity during the second quarter. We are currently experiencing an environment where investors are concerned about inflation, rising rates and the potential for a recession, and we remain focused on navigating this dynamic market backdrop through proactive capital markets activity to maintain balance sheet strength and flexibility. During Q2, we sold 3.2 million shares of common stock under our ATM program at a weighted average sale price of $21.42 per share for net proceeds of $68.3 million. As of quarter end, there was approximately $166 million of capacity remaining on our ATM program. We ended the quarter with leverage of 5.3 times on a net debt to annualized adjusted EBITDAre basis and remain committed to our conservative leverage profile of less than six times. Equity issuance in the first half of the year has provided the leverage capacity and liquidity to fuel additional selective accretive growth opportunities in the second half of the year. We intend to continue to opportunistically utilize our ATM to effectively manage our leverage profile via the match funding…

Thanks, Ryan. I want to close today by reiterating how this quarter shows some of the key principles in North Stars of how BNL has operated and how John and Ryan and I think about running this business for the long term. First and foremost, we will always maintain a very diversified defensive portfolio that supports our base of operations and allows us to grow. Second, committed to maintaining a strong balance sheet and thinking long term as evidenced by the seven-year term loan that we completed just a few days ago and the pull forward of equity. The short-term trade-off that comes from this is something that we will make over and over again as we think on a long-term basis of what's best for the company and our shareholders. And finally, you see very clearly our ability to pivot and the value that comes from our flexible acquisition strategy. But Q1 versus Q2 difference and are going into initial cash cap rates of 70 basis points is the strongest in the space. And that is reflective of our ability to move as market conditions change and ultimately drive the best possible risk-adjusted returns for our shareholders. These three factors to me are cornerstones of how we run the business, and then support an exciting and interesting back half of the year, along with a very robust pipeline. And so I want to reiterate those factors as to why we think Broadstone is the right net lease company for today's environment. With that, operator, you can open the line for questions.

[Operator Instructions] Your first question comes from the line of Ki Kim with Truist. Please go ahead.

Thanks and good morning. Can you just describe the acquisition environment? What's serving change in -- pricing and how you might progress for the remainder of the year?

Ki, would you mind repeating that? It got a little choppy on our end. I think you were asking about the acquisition environment, but if you just repeat it, so I make sure we hear your question, that would be great.

Yes, sure. If you can talk about the acquisition environment -- or pool or pricing? And how you think about this progressing throughout the remainder of the year?.

Sure. Absolutely. Maybe I'll start off, and I'll give it to John to talk a little bit more as well. I think from a very high level, a very strong positive that we feel great about is that transaction volume and things that fit our buy box have remained very robust. And we talked about it on previous calls for the past year or so that the transaction opportunity set has been very strong. To put a little bit of math around that, we've underwritten through the second quarter something north of more than $4 billion than we did last year. So that's a significant increase for our size of our company. And so that has been a net positive that allows us to both be very selective as we're working through this uncertain environment, but also still keep an active pipeline that's very exciting. And then relative to where our cap rates came in at 6.4% for this quarter and what's been driving that I'd say that there's three factors that are ultimately impacting it. Obviously, market dynamics and the competitive set is different than it was a few months ago. We've clearly seen the levered buyers, the PE-backed buyer, the secured financing buyer all generally exit the market, which has created a little bit of cap rate relief for us and ultimately, allowed certain asset classes, excuse me, to look more attractive. So you saw that very clearly with the non-investment-grade industrial space and manufacturing food store -- food processing, things like that. You also see the cost of capital for those who are still active being different and that is changing return expectations and ultimately, how transactions are being bid. And those two dynamics have created some interesting backdrops of the market in certain transactions. We are…

Yes. So to carry forward from where Chris was, we are currently on pace to evaluate about $30 billion in opportunities this year, which is a significant increase over us from even a historical high from last year. The market remains very competitive, but we think that, that placed our strengths with a diversified and differentiated investment strategy. Our ability to pivot between these asset types, industrial, retail, restaurant, health care, we think is unique in the space. And as Chris said in his remarks, you can see that play out in that 70 basis point increase in cap rate from Q1 to Q2. We continue to see great opportunities for us with our investment strategy as well as the disciplined execution and underwriting standards that we employ in that mid-six range up to the high 7s. So we expect to continue to play in that space. Industrial, in particular, is an area where there's a lot of activity, some great opportunities in the pipeline. And we hope to see some additional in the health care. That's always been something we've talked about this year has been a little bit light. Retail and restaurant continue to have some good opportunities as well. But with our strategy, we think the second half of the year is going to be really interesting, and we hope to be able to opportunistically execute on some additional growth on the back half of this year from where we stand today.

And second question. How do you guys think of the balance between raising equity to fund your acquisitions versus additional assets? Obviously, the sector -- spot prices have been a little bit -- but if you just raise equity to buy assets, the spread is smaller. Just curious how you think about handling those different avenues.

Sure. We'll get Ryan into that.

Sure. Look, as we think about the portfolio, we have certainly thought about dispositions before and maybe a little bit of a different light today, but not too different. Frankly, we're always pruning assets that are lower performers. That's our main disposition strategy. As we think about assets that exist in the portfolio that we could sell and positively recycle capital, you take that, you think about the frictional costs associated with it and the fact that we really like these assets and want to hold them for the long term. We don't see a very meaningful way to recycle capital through dispositions versus our ability to raise equity today at various pricing levels and put it to work in an accretive manner. So when we weigh those two things out, we certainly look at it, evaluate it like anybody should from a capital allocation perspective. But feel very comfortable with funding acquisitions through equity rather than shrinking the portfolio and incurring a bunch of frictional costs related to assets that we want to own for the long term.

Your next question comes from the line of Michael Gorman with BTIG. Please go ahead.

Yes, thanks, good morning. I was wondering if you could just talk for a minute about how you're approaching your underwriting. And as you look at this portfolio of deals that you have out there in this pipeline, a lot of discussions in the REIT sector, obviously, about the change in cost of capital for buyers in the market. But I'm wondering how that change in cost of capital is having an impact on the tenants and maybe how you're thinking about underwriting different financial strengths and different financial structures of your tenants given the volatility in the capital markets.

Yes, absolutely. I think that where we sit today relative to history, probably isn't dramatically different. I think we've been always very downside oriented in thinking about our tenants' financial health and picture. Probably the difference and the biggest change of where we sit today is obviously putting a closer lens on retail or restaurant sectors where you clearly could see some incremental pressure on the consumer and making sure that we're acquiring the highest quality, highest performing sites possible in portfolio and perhaps doing a little bit more up-tiering in that regard. But in terms of just underwriting through regular way, industrial or health care, the philosophy is very much the same. Our credit risk team spends a lot of thoughtful and diligent time in conjunction with our acquisition team, stress testing each tenant or underwriting. So one of the most common bullet points in an acquisition memo is that they've gone out and stress tested rates, rising across that stack of a tenant by 400, 500 basis points, and what does that do to their fixed charge coverage and their ability to meet their obligations. And then also looking more carefully at downside margin compression that could occur and the same sort of math of margin compression being 10% or 20%. And what does that ultimately do to the tenant's overall set of obligations. And so I think a lot of that, which is embedded in who we are and how we've been able to collect and have such a strong portfolio in a non-investment-grade basis for the last 15 years, is just a heightened focus on those type of metrics today more than ever. And then obviously, thinking about tenants refinancing risk in the same way that we spent a bunch of time talking about our refinancings today, and trying to make sure that we push out our debt maturities as long as possible looking at the capital stack and understanding where a tenant might have future refinancing risk in the next two, three, four years. Most of our tenants have a pretty good handle on that and are pushed out a number of years, but that's always a discussion topic as well. So I think both factors are all what we're focused on today more than ever.

Great. That's helpful. And then maybe even specifically on the industrial side, as you started to see this wider bid range and as you've seen some of the transactions increasingly coming back to market, are you starting to see sellers accepting not the top bid for the certainty of close? So when you entered some of these, are you winning transactions where maybe you're not the top bid just because of your reputation as being able to close and close on time?

Yes. I love examples. I'll let John give examples because I'm sure he's got a view from that. And no, I'll just say absolutely. We absolutely are winning deals because of that with a 15-year track record of surety to close and not having financing contingencies, and also having a reputation in the market with brokers and sellers that we make sure that when we have signed up a deal that we have integrity around the terms that we've underwritten that we have done the work that we need to do to ensure that unless there's some real unknown that comes up during the diligence, we are going to close. And that matters in this market, particularly in comparing us with folks that are coming in with financing contingencies or with slightly shorter track record or no track record at all, where sellers are looking at it and saying that this is a key part of their business operational and financing strategy, and they want to make sure that they're going to have that cash in hand at the end of this deal. So that absolutely has played a part in our ability to execute on these transactions. I would also say, I mean, it's about walking the walk or talking the talk. We continue to honor what we've set out for. We closed an industrial transaction in early July that we picked up and shook hands on in March, and it took a while to close. And we honored the spirit of that deal and put it a price differently today, probably. But for a repeat partner that we know really well and a long-standing brokerage relationship, it was far more important for us to be the steady hand during this time than to squabble over an incremental change there. And so I think that's that will continue to serve us well. And as John said, it's happening every day with opportunities that we're going after to today's environment, so.

Okay. Great. And then maybe one for Ryan. Just sticking with the financing side of things. I completely understand, especially in this market, wanting to take care of pending maturities. And I just wonder how you think about it, right, 2024 is certainly probably further out, I think, than a lot of other folks would be thinking, but how you balance out potential interest rate drag in the short term versus how far out you're looking at extending maturities. And should we take this as some type of indication of your thoughts on where rates are going over the next two to three years or where you think access to capital is going over the next two to three years as you think about your capital stack?

Sure. I think maybe if I sort of reference back to previous conversations even last quarter's call, I believe we talked a little bit about the fact that we didn't need to go out to say the bond market or a more permanent financing source until maybe late this year or early next year, and it would really be driven by the pace of acquisitions. Our pace of acquisitions has been very solid, and we're excited about that. We're also very excited about the term loan execution that we just recently had. As always, we're really assessing all forms of our debt capital. And as you pointed out, the bond market itself has been a bit choppy and dislocated and frankly, there hasn't been a redeal executed since, I believe, April at this point. So as we sort of thought through where rates are, where rates may be headed, we are not really taking any long view other than the fact of shoring up our balance sheet, creating liquidity and locking in permanent financing. We saw an opportunity while discussing unsecured term loans with our banking relationships. And due to the strength of our banking relationships, we did identify the fact that we were able to access a seven-year term loan. So what we just did was a $200 million five-year term loan and a $300 million seven-year term loan. At seven -year is -- not all REITs can access that seven-year time frame from a term loan perspective. And from an overall pricing perspective, on an all-in kind of swapped out basis, you're talking, say, high 3s on that seven versus the alternative in the bond market of, call it, mid-5s on a seven or 10 year. So to us, it was a no-brainer, locking in today, locking the cost of capital from a debt perspective, put it out into a more permanent financing source. And if that meant a little bit of interim drag or near-term drag, that was a no-brainer that we decided we would take all day long.

Your next question comes from the line of John Kim with BMO Capital Markets. Please go ahead.

Hi guys, good morning. It's Eric on for John. Just kind of sticking with the theme on capital markets. On your new secured or unsecured facility, is that -- is the reason to keep it variable is just a better sense to give you more flexibility in the market today than versus swapping that facility?

Sure. Maybe I'll just add a little bit of color. So of the $500 million total term debt, we used the $190 million to pay down our 2024 term loan which was already swapped out. So with our balance sheet, we have a pool of swaps that -- a pool of swaps and a pool of unsecured bank debt, which removes the majority of that variability. So 190 is already swapped out. At this point, we're evaluating fixing out the new term loan exposure all to remaining 300 or 310 rather for five- to seven -year tenors. And that's the all-in rate that I was referencing. So we're evaluating that right now and likely look to fix some of it out.

Perfect. And then maybe one on the watch list. How does your view change at all kind of given the current environment today? Is there anything that has been added or removed?

Okay. I'll take that. In terms of the watch list, I'd say, there's been no real material change since Q1. Only a handful of tenants on it. Obviously, we continue to monitor them, and they have varying degree of changes in terms of strength or weakness associated with them. But overall, nothing new specifically from a tenant perspective has come on or gone off in any meaningful way from one quarter to the next. I'd say maybe to sort of piggyback off of one of Chris' points from a thematic perspective, where clearly, looking at the market backdrop, the uncertainty, the inflationary pressures, supply chain-related dislocations and trying to understand how that really impacts each of our tenants. So one area that we certainly have focused on is consumer discretionary spending, where does that impact our portfolio? And how do we see that play through. Chris had referenced the restaurant space. We're keeping an eye on that and a few other sort of consumer discretionary focused spaces. But overall, that's more thematic, no actual tenant identified that would make its way to watch list at this point.

Your next question comes from the line of Ronald Kamdem with Morgan Stanley. Please go ahead.

Just a couple of quick ones. Just going back to the question on sort of the bank loans. Asked in a different way, debt-to-EBITDA was 5.3 times at end of the quarter, just how high are you on to let that go as you sort of evaluate opportunities before you have to come back to the equity markets?

Sure. As we think about our leverage, I think I've said that we're comfortable sort of operating in that low to mid-5% zone. So we're certainly comfortable operating in the mid-5s. And I think from one quarter to the next, we were 5.1 to 5.3. We raised some equity off of the ATM subsequent to quarter end. We've also identified deals. So I'd say that mid-five zone still feels very comfortable to us in this environment.

Great. And I missed the opening comments, so apologies if you covered, but sort of the acquisitions in Canada last quarter, maybe can you talk about just what the opportunity set is that market, what it's looking like and so forth?

Sure. Ron, we continue to think about Canada as excluding the portfolio we did last quarter as complementary to what we're doing. I think this quarter, we looked at two industrial portfolios and we're pretty active and neither of them came to fruition, but they were sort of three plus one as our internal joke. It's three U.S. assets and one Canadian asset. And we've -- that seems like that's a good spot for us to continue to differentiate ourselves and add value to a bidding process where a purely domestic buyer would only be focused on the U.S. assets, whereas we can provide a holistic solution through a sale-leaseback transaction. And then we also continue to have some dialogue with tenants who are thinking -- or looking at space in Canada as well. And so that is sort of where we are for the rest of the year. We also continue to explore if there's more opportunities across the retail verticals within Canada, but that's a little bit more preliminary at this point. So generally focused more on those sale leasebacks where we might pick up an incremental asset or two as part of a larger portfolio or a diversified portfolio as a way to differentiate ourselves in the competitive landscape.

Great. And my last one was just on cap rates, just where you're seeing the most order widening and sort of you guys have the opportunity to look at a lot of different buckets, where is sort of the best opportunities right now for the incremental dollar?

Sure. Yes, I think we talked a little bit about it in the early part of the call, but certainly have seen more widening in the non-investment-grade industrial space. So again, taking distribution out of it, but the light manufacturing, food processing has seen some of that widening and then secondarily on the non-investment-grade retail that has also widened up a little bit. Health care for us this year, which is sort of our third vertical, has been a little bit quieter. So we're not ready to call any dramatic pricing movements there and the investment-grade retail space maybe a little bit of widening, but has also hung in there because the 10 31 buy has been pretty strong. So for the incremental dollar and where the pipeline is today, more heavily weighted towards that non-investment-grade industrial space, which is, I think, we were looking at yesterday, something like about half our pipeline right now with the other three verticals being fairly equally weighted after that for the remainder.

And this concludes the question-and-answer session. I will turn the call to Chris Czarnecki.

Sounds good. Thank you so much, everybody, for joining us for our second quarter earnings call. We continue to appreciate the support of all of our investors, and we wish you a great end of the summer. And we look forward to being back in front of you with strong Q3 results in early November. Bye.

This concludes today's conference call. You may now disconnect your line.