Broadstone Net Lease, Inc. quarterly report, Q2 FY2020

Broadstone Net Lease, Inc. — Q2 2020 Form 10-Q

Reporting period: Three and six months ended June 30, 2020. The filing was signed August 4, 2020. Broadstone is a net-lease REIT; at quarter-end it owned 632 commercial properties across 41 U.S. states and British Columbia, with approximately $4.0 billion of gross asset value.

Financial and operating performance

Metric	Q2 2020	Q2 2019	Six months 2020	Six months 2019
Lease revenue, net	$80.4 million	$69.1 million	$158.6 million	$137.5 million
Net income	$17.1 million	$17.3 million	$28.9 million	$32.4 million
Net income attributable to Broadstone	$15.4 million	$16.1 million	$26.2 million	$30.1 million
Basic and diluted earnings per share	$0.57	$0.70	$0.98	$1.32
FFO per diluted share	$1.89	$1.60	$3.19	$3.22
AFFO per diluted share	$1.54	$1.39	$2.96	$2.81

• Quarterly revenue grew 16.4%; management attributed growth mainly to the larger portfolio following 2019 acquisitions and rent escalations. No rental-property acquisitions closed in the first half of 2020.
• Quarterly net income was down 1.4%, while diluted EPS fell 18.6%; higher depreciation, interest expense and a lower gain on property sales offset revenue growth and a $6.3 million noncash gain from remeasuring the earnout liability. For the first half, net income declined 10.6%.
• FFO and AFFO are non-GAAP measures. Q2 FFO per diluted share increased 18.1% and AFFO per diluted share increased 10.8%; the first-half figures were down 0.9% and up 5.3%, respectively. Management cited portfolio growth and lower external management fees, partly offset by higher G&A and interest expense.
• Operating cash flow was $79.5 million in the first half, versus $64.7 million a year earlier. Investing activities provided $10.7 million, compared with $120.9 million used in 2019, reflecting lower acquisitions, property-sale proceeds and internalization costs. Financing activities used $100.7 million; cash and restricted cash declined $10.5 million to $9.8 million.

Balance sheet, debt and liquidity

• At June 30, 2020, total assets were $4.14 billion and total liabilities were $2.27 billion. Debt carrying value, including mortgages, notes and revolving borrowings, was approximately $2.04 billion; estimated fair value was $2.17 billion.
• Cash and cash equivalents were $9.2 million, plus $0.6 million of restricted cash. The $600 million revolving facility had $248.3 million outstanding and $351.7 million of nominal availability; borrowing capacity under covenant limits was $148.8 million.
• Weighted-average interest on outstanding borrowings was 2.45%, excluding swaps. The company extended its $240 million term loan maturity from August 2020 to February 2, 2021, using its first six-month extension option. Approximately $859.8 million of variable-rate debt was hedged with swaps; swap liabilities were $85.7 million.
• Leverage was reported as 45.4% of approximate asset market value. The company said it was in compliance with its debt covenants; its covenant leverage ratio was 0.52 against a maximum of 0.60. Management cautioned that pandemic-related tenant deterioration could affect future compliance.
• Management believed available cash, credit capacity and distribution management were sufficient to meet obligations and maintain REIT status for at least the next four quarters, subject to uncertainty from COVID-19.

Material changes and unusual items

• Internalization: Completed February 7, 2020, ending external management agreements. Consideration included approximately $31.0 million cash, $66.4 million of common stock and $112.2 million of OP units, plus $90.5 million of assumed debt. The preliminary purchase accounting recorded $339.8 million of goodwill, which the company did not expect to be tax deductible.
• The internalization produced a $38.0 million earnout liability at June 30, initially valued at $40.1 million. Up to $75 million of additional consideration may become payable if specified share-price or AFFO-per-share milestones are met. Management estimated internalization-related G&A and interest costs of $8.2 million for the first half, while reporting approximately $5.1 million of first-half savings versus the former management-fee structure.
• Operating expenses included $71.1 million of depreciation and amortization and $2.7 million of property impairment in the first half. The company recorded a $323,000 opening retained-earnings adjustment upon adopting the credit-loss standard.
• The balance sheet included $178.5 million of mezzanine equity associated with internalization securities carrying contingent redemption rights. If an IPO did not occur by December 31, 2020, specified holders could have repurchase rights, subject to the agreement’s terms. The filing says named executive officers later irrevocably waived their repurchase rights.

COVID-19, outlook and risks

• Broadstone received rent-relief requests from 59 tenants relating to 295 properties, representing 33.7% of June annualized base rent; it granted relief to 15 tenants relating to 93 properties, representing 9.7%. Relief primarily consisted of short-term deferrals; one tenant received a partial abatement in exchange for a three-year lease extension and percentage rent provision.
• Q2 base-rent collection was 93.0%; deferred and abated amounts represented 3.0% and 1.1% of base rent due, respectively, and 2.9% was attributed to bankruptcy. As of the filing, July base-rent collections were 96.5%, and all July repayments due under deferral agreements had been collected. One tenant in bankruptcy represented less than 0.5% of June ABR.
• Management said the pandemic’s effect through June was principally rent relief, but warned that further tenant distress, bankruptcies, weakened collections, asset impairments and reduced disposition activity could adversely affect results, liquidity, covenant compliance and distributions. It recorded $0.5 million of Q2 impairment associated with a lease modification.
• The company had approximately 99.5% occupancy by rentable square footage and an 11.0-year weighted-average remaining lease term. Approximately 98.2% of leases had contractual escalations, averaging a 2.1% minimum increase. The filing also reports 99.6% leased in its overview.
• The company suspended monthly distributions in May to preserve cash. On August 4, the board reinstated distributions on a quarterly basis, announcing $0.54 per share and OP unit for Q3, payable on or before October 15, 2020. The share redemption program and distribution reinvestment plan had been terminated effective February 10.
• Management anticipated pursuing an IPO when market conditions allowed; its June 30 weighted-average expected IPO date was October 21, 2020, with a September 2020–February 2021 range. The filing gives no assurance that an IPO would occur. The private offering had been suspended, and the board set a private-company determined share value of $82 through October 31, 2020.
• Potential tax-protection indemnities across four agreements were estimated at approximately $22.3 million if specified taxable dispositions occurred; management said it did not believe the triggering events were likely in the foreseeable future. Management reported no material pending litigation and no material off-balance-sheet arrangements.

Important facts for investors to verify

• Subsequent rent collections, repayment of deferred rents and tenant credit developments, especially in restaurant and retail exposures.
• IPO timing and terms, the related earnout milestones and any remaining redemption rights or liquidity obligations.
• Available borrowing capacity after covenant restrictions, the February 2021 term-loan maturity and ongoing covenant headroom.
• Coverage of the reinstated quarterly distribution by recurring cash flow and REIT distribution requirements; Q2 distribution suspension and later reinstatement occurred after different reporting dates.
• Assumptions underlying property valuations, goodwill and earnout fair value, including sensitivity to capitalization rates and pandemic-related market conditions.