Broadstone Net Lease, Inc. quarterly report, Q2 FY2018

Broadstone Net Lease, Inc. — Q2 2018 Form 10-Q

Reporting period: Three and six months ended June 30, 2018. Amounts are in U.S. dollars; financial statement figures are in thousands unless stated otherwise. The company is an externally managed REIT focused on long-term net-leased commercial properties. At quarter-end it owned 558 properties in 42 states; all were subject to leases, and reported occupancy was 99.4%.

Financial results and liquidity

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Total revenue	$57.0 million	$43.7 million	$112.6 million	$85.9 million
Operating income	$26.4 million	$21.6 million	$52.9 million	$42.3 million
Net income, including non-controlling interests	$18.4 million	$16.0 million	$37.4 million	$29.7 million
Net earnings per diluted share	$0.86	$0.89	$1.77	$1.70
FFO per diluted share	$1.60	$1.40	$3.28	$3.01
AFFO per diluted share	$1.39	$1.33	$2.85	$2.75

Q2 revenue grew 30.6% year over year, primarily from portfolio expansion. Operating expenses rose 39.1%; operating income grew 22.0%. Operating margin was approximately 46.3%, versus 49.6% a year earlier.
Q2 net income increased 15.0%, but diluted EPS declined 3.4% as diluted weighted-average shares rose 19.0%. For the first half, net income rose 25.7% and diluted EPS rose 4.1%.
Interest expense increased 58.4% in Q2 and 49.5% for the first half, principally reflecting higher borrowings. First-half depreciation and amortization rose 34.5% with portfolio growth.
First-half operating cash flow was $58.7 million, versus $45.3 million; investing cash outflow was $187.7 million and financing cash inflow was $139.8 million. Cash and restricted cash totaled $20.8 million at June 30.
Total debt carrying value was $1.289 billion, versus $1.181 billion at December 31, 2017. The company reported a 41.4% debt-to-approximate-market-value leverage ratio and a 3.62% weighted-average borrowing rate. It had $152.5 million available under its $425 million revolver and stated it was in compliance with debt covenants.
Total assets were $2.815 billion and total equity was $1.413 billion. First-half acquisitions totaled $254.8 million across 41 properties; 11 dispositions generated $7.6 million in gains.

Material changes, outlook and other items

Management attributed revenue and operating growth mainly to acquisitions, including $683.6 million of property acquired during 2017. Acquisition activity was funded with equity, debt and operating cash flow.
The company reported collecting more than 99% of rent due and maintained a fully leased portfolio. The weighted-average remaining lease term was approximately 12.9 years; no tenant represented more than 4% of annual rental stream.
No numerical full-year earnings or acquisition guidance was provided. Management said current operating cash flow, equity offering proceeds, cash, revolver capacity and access to long-term debt were expected to fund operations and planned growth for the foreseeable future.
On July 2, 2018, the company agreed to issue $325 million of fixed-rate senior notes: $225 million at 5.09% due 2028 and $100 million at 5.19% due 2030. $150 million was issued initially, with the balance expected September 13; proceeds were intended for general corporate purposes, including possible refinancing and acquisitions. The 2015 unsecured term loan of $325 million was scheduled to mature in February 2019, with extension options.
Subsequent to quarter-end, the board approved monthly distributions of $0.43 per share/unit through October 2018. First-half declared distributions were $53.3 million, equal to reported first-half operating cash flow; $24.8 million was reinvested through the DRIP. The company cautioned future distributions could also be funded from asset sales, borrowings or securities proceeds.
Interest-rate exposure is partly hedged: 30 swaps had aggregate notional value of approximately $820.1 million. First-half comprehensive income included a $24.0 million gain from swap fair-value changes, recorded in other comprehensive income rather than net income.
Key risks include tenant financial health, real-estate and capital-market conditions, acquisition execution and financing availability, rising rates, and potential refinancing needs. Management warned that severe adverse markets could constrain borrowing or require property sales. The company disclosed up to approximately $12.3 million of potential tax-protection agreement damages, which it did not believe likely to arise in the foreseeable future.
Related-party arrangements are material: asset and property management fees totaled $11.6 million in the first half. The company also disclosed potential termination fees of $49.2 million under the asset-management agreement and $17.1 million under the property-management agreement, subject to contract terms. On July 31, it sold a $10.0 million carrying-value investment in the Manager to a related party for $18.5 million.
The company’s estimated NAV was $84.63 per diluted share at June 30; the subsequent offering/share value was set at $85.00. Management estimated a 0.25 percentage-point increase in the portfolio capitalization rate would reduce NAV per share to $79.58. These are estimates, not market quotations.

Important facts for investors to verify

Whether acquisition-driven revenue and FFO/AFFO growth translate into sustainable per-share growth after dilution and higher interest expense.
Debt refinancing and maturity plans, particularly the 2019 term loan, and the final funding and use of proceeds for the 2018 senior notes.
Whether operating cash flow can support distributions and investment plans, given first-half distributions equaled operating cash flow and significant acquisition spending.
Tenant credit quality, rent collections, lease concentration and occupancy, including the distinction between properties under lease and reported 99.4% occupancy.
Assumptions behind estimated NAV and capitalization rates, as well as the related-party governance, fee and transaction disclosures.