Good day, ladies and gentlemen, and welcome to the National Retail Properties Second Quarter 2021 Operating Results Call. At this time, it's my pleasure to turn the floor over to Mr. Jay Whitehurst, CEO. Sir, the floor is yours.

Thank you, Tom. Good morning, and welcome to the National Retail Properties Second Quarter 2021 Earnings Call. Joining me on this call is Chief Financial Officer, Kevin Habicht; and Chief Operating Officer, Steve Horn.

Thanks, Jay. And as usual, I'll start with the cautionary statement that we will make certain statements that may be considered to be forward-looking statements under federal securities laws. The company's actual future results may differ significantly from the matters discussed in these forward-looking statements, and we may not release revisions to these forward-looking statements to reflect changes after the statements were made. Factors and risks that could cause actual results to differ materially from expectations are disclosed from time to time in greater detail in the company's filings with the SEC and in this morning's press release.

This is Parker Decraene, actually on for Katy. Jay, I just noticed that you guys bought a theater asset during the quarter. And I was just wondering if you guys, given the improved rent collections, on a more long-term basis, how you think about the industry and sort of the changing dynamics there.

Right. And let me clarify something there. We did not buy that theater. AMC had been a guarantor of another theater; they spun off some theaters but remained a guarantor of the lease. And so AMC took over that theater as part of a restructuring, a workout with the other tenant that was struggling. So we did not buy another theater; it just became an AMC in our portfolio. That is the line of trade that we've certainly still continue to have the most concern about coming out of the pandemic. We're comfortable with the theater exposure that we have. We acquired our theaters a number of years ago at lower price per property and more reasonable rents than some of the theater transactions that have traded in the last few years that we passed on. That said, that business has been challenged for quite a period of time. And so we have not been looking to expand our theater exposure for a number of years now. We are going to continue to be very thoughtful about any theater transactions that are out there in the world that we might be considering. It's unlikely you'd see us buy any movie theaters anytime soon.

Got it. Yes, that's what I figured. And then just my second question is just on rent collections for full-service restaurants. I think they lagged a bit. Is that just tied to specific tenants or what’s the sort of color there?

Kevin, you may have a little bit of color. But I think for full-service tenants and for movie theaters, they're both below kind of where everybody else is running 98% or higher. And for those two categories, it's both continuing rent deferrals for tenants where the second quarter rents were deferred to be repaid later as opposed to rent forgiveness or disputes with the tenants. It's just rent that we expect to get later down the road.

Can you share an update on your acquisition pipeline? I know you commented on the call, having an opportunity to exceed that. How is it looking today? And what's the likelihood that you will exceed the high end of your range?

Yes. Elvis, welcome to the call. Nice to talk to you. I'll let Steve Horn talk about the pipeline a little bit. But just at the macro level, let me remind folks about the way we look at this. Our strategic goal is to generate consistent mid-single-digit per share growth on a multi-year basis. There are a lot of inputs that go into achieving that goal, acquisitions being certainly the most impactful. Our strategy regarding acquisitions is to do repeat programmatic business with a portfolio of large regional and national operators with whom we can build these relationships and do this repeat business. If we do that, we get slightly better real estate because the retailer doesn't sell us a property that they are worried about. We get a lease document that is tailored to our needs. And we get a long-duration, 15- to 20-year lease. Those are all advantages to us over going out into the open market and acquiring properties on a one-off basis. We get a slightly better cap rate with our relationship tenants than you would in the open market. So that's the strategy that drives our acquisition efforts. And so, Steve, with that kind of macro intro, do you want to talk about the pipeline and how that all stands?

Yes. What a difference a year makes as far as the pipeline. I sat here last year at this time, and we didn't have a pipeline. But our relationship tenants have started growing and they're continuing to grow through 2021. Our pipeline is pretty solid right now. Year-to-date, we've closed a little bit over $200 million. Our guidance, to your question, was $400 million to $500 million. So as I sit here today, I'm very comfortable with that guidance. Our pipeline is very robust. Keep in mind, we could always hit the number and just go buy whatever we wanted if we just threw out the window lease duration and cap rate. But we're still looking for that low to 6% cap rate with a long lease term; we're relying on our relationships. As far as the industry statistics, it would be what you would expect - convenience stores, auto service, and QSR restaurants. There's a significant amount of volume in those industries currently. So yes, feeling good about the pipeline as we sit here today.

Great. And just to follow up on that. Some of your peers have mentioned an increase in the sale leaseback activity. I'm assuming you're seeing the same, but just you're not chasing the lower quality sale leaseback opportunities. Is that the right way to categorize it?

No. I mean, in 2021, just based on our peers and the volume that's being done, there has been definitely an increase in the sale-leaseback market. But keep in mind, a lot of our peers buy just assets in the open market and don't focus completely on the sale leaseback. But yes, there has been an increase in the sale leaseback market.

Yes. Elvis, our relationship tenants kind of took a pause in the middle of last year while they got their own businesses sorted out and figured out how to navigate through the pandemic, and they figured that out. You can see how that's all been reflected in both our occupancy rate and our collections rate. They've all bounced back across every sector. The conversations that we're having with them now indicate they are in growth mode and looking to expand their businesses. I think for many of the lines of trade, there are good M&A opportunities for our tenants to pick up some of the smaller companies that struggled more during the pandemic. So the pipeline feels good for the longer future; the wide end of the pipeline and the more distant future feels good to us as well.

I don't think you guys touched on this yet, but can you just provide a little color on the industry mix overall for your acquisitions made in the quarter?

Spenser, can you say that one more time? We didn't quite hear it.

Yes. Can you provide a little color on the industry mix for the acquisitions made in the quarter?

Yes, it's Steve. The industry mix kind of looks like our current portfolio. But for the most part, it was a little bit heavier in the auto services sector. Kind of your typical QSRs, we did have the general retailer Best Buy in there and some equipment rental. But for the most part, it was heavier in auto service than usual.

Yes. Spenser, the second quarter was kind of the quarter of the car wash.

Okay. And then just as the transaction market has opened up more and you guys have become a little more active again, has anything either surprisingly positive to surprise to the upside or the downside in terms of cap rate movements? Or has anything really shocked you in terms of transaction activity?

I'll take the first step. I'd say nothing's really shocked us. Cap rates remain very low, but that's driven, in our minds, to a large degree by just a lot of capital out there chasing transactions. Throughout the years, we found that cap rates tend not to move up even in situations when one might think they should. Going into the pandemic, we felt our retailers were experienced and had their businesses in good shape, and we expected they would get through it, and they have. We also felt that our real estate was well-located and high-demand prior to the pandemic, and we expected it would be high-demand after the pandemic. Our numbers indicate that has validated itself. So to a large degree, what we've seen has felt like is that this pandemic, just like the great financial crisis of '08 and '09, has validated our strategy of dealing with larger operators and focusing on good locations at reasonable prices and low rents.

Okay. Great. And then maybe just one more, if I may. On the disposition front, how many of these assets sold in the quarter were vacant? And were any of the divestment cash basis tenants?

Yes. I think the split in any one quarter is a little bit of a small sample size. I think in general, our dispositions are going to be kind of 50% leased and 50% vacant, give or take 5% or 10%. Kevin, would you add anything?

The proceeds are running in that kind of ballpark, too. Year-to-date, it's about 50-50 on vacant versus occupied. I don't have the exact note or the data in front of me at the moment to respond to it. Regarding occupiers, I don't think there are very many cash basis tenants involved. That's not a driving factor. It might even be 0. That's not a driver of our decision-making process, to be honest.

I just had a question on the sale leaseback activity. Do you think we'll get back to 2019 levels for the industry and with your tenants? And do you expect to maintain your share with the existing relationships?

Wes, I think the short answer to that question is yes and yes. I do think that as our tenants continue to get back into growth mode, we'll have the same level or additional volume opportunities from each of them. The acquisitions group that works for Steve is out building new relationships every day. We will continue to grow the overall pool of tenants with whom we do repeat programmatic business. Overall, in the marketplace, I think it's going to be equal or greater volume than what we were looking at pre-pandemic.

Okay. And then when we look at the back half of the year, you did kind of call out M&A activity. Will that be a big part of the second half story? And would you guide us to or maybe not guide us, but I guess, how should we think about the split between 3Q and 4Q?

I wouldn't want to guess at that at this point. We know that our tenants are looking at growing their businesses, and there will be opportunities out there, but it never makes a lot of sense to us to try to predict timing too precisely. Our guidance is generally kind of back-end loaded. So we feel good where we are right now, just in case it turns out that this year it's not back-end loaded. But I wouldn't want to get too granular on predicting when transactions might occur. A lot of things might cause things to speed up or slow down. Steve, did you have anything about the folks you're talking to?

No, I think as we say internally a lot, we're a couple of phone calls away from the pipeline not being as strong. So we don't try to focus on the timing; we kind of focus on getting the deals done as fast as we can. As far as our outlook, as you can imagine, our industry 3 months out, 4 months out usually doesn't have a pipeline for December quite yet. The pipeline when we talk about it is a little bit more shortsighted; third quarter, some will slide into the fourth quarter.

Congrats on the good quarter. Just two quick ones for me. One on the cash basis tenants' collection, the 92%. Is it fair to say that the 8% that's lagging is still just movie theaters and so forth? Or is there any other sort of notable bucket to call out?

Not really. I mean, we had four big lines of trade that had some impact from the pandemic. Our primary cash basis tenants are AMC, Frisch's, Chuck E. Cheese, and Ruby Tuesday. Those four probably make up 90% of our cash basis tenant bucket. So it's a mix in that arena. But clearly, we've talked about the theaters being the most challenged and pressed. You can see that in our collection numbers to some degree, but I would call theaters and casual dining primarily.

Got it. That's helpful. And then I think this was asked earlier, I was just making sure I understand. So on the disposition side, was any of the assets cash basis tenants? Sorry, I don't think I missed the answer to that.

Yes. No. I think we concluded that we really didn't sell any cash basis tenants in the second quarter. That's not a particular driving factor or important factor for us in making our buy or sell decisions, to be honest.

Got it. And then, sorry, last question, if I may. When you're thinking about the industry mix and so forth, I think you talked about this quarter being big for car washes. Is there any other subsector or subsegment that over the last 3 to 6 months you've gotten more constructive on or found more attractive? And is there any that you'd probably want to sort of get away from?

What we try to do is build relationships with retailers in all the different lines of trade where you find retail-type properties located along high-traffic roads. What history has taught us is that transaction volume among industries will kind of ebb and flow for various reasons. So we don't spend too much time trying to project ahead about what particular lines of trade will be active. It's very bottoms-up for us. It's what real estate they are acquiring, and do they want to do a sale leaseback, and if so, what are the right terms for that. If you look at what we've done recently, Steve's group has done a great job of building relationships with different tire store operators. We've done some car wash deals with a number of different operators, and equipment rental is doing well. We have deep relationships across all the fast-food concepts. The portfolio down the road will resemble a lot like the portfolio that it is right now. We will continue to be careful and prudent about doing bigger and special-purpose boxes. I think every REIT is cautious about those types of properties for the time being. Those were the ones that caused the most heartburn during the pandemic.

So I think I asked about this on the last earnings call, but with the kind of collections moving up to 92%, has your outlook changed at all for moving some of these cash basis tenants to accrual accounting again? And if so or if not, how many months or quarters of consistent payment do you want to see before making those changes?

We're consistent with our deliberate and sometimes slow-moving thought process. I don't view it as a big issue having a tenant labeled as cash basis. I don't think it's bad accounting, meaning you report what you collect. We're not in a particular hurry to get folks back to accrual basis. We said really at the time we moved to a cash basis, it wouldn't be 1 year; it would be more than a year before we might evaluate moving them back to accrual. We're going to want to see some quarters of performance from those tenants before we get too interested in making that change. So it will probably be next year sometime before we start to consider drifting some of those tenants from cash basis to accrual basis.

Okay, understood. And then speaking of tenant health, now that you're collecting close to 100% of rent across the board, broad brush strokes - what are you seeing in terms of coverages? Do you have that data yet? What does it look like historically pre-pandemic? Any color there would be helpful.

The data is still coming in, so there's somewhat of a lag. Some tenants, we get quarterly data, some annually, I mean, it feels to us that the vast majority of our portfolio falls within prior coverage levels that we deem to be very strong. We feel pretty good on that front. The one question always lingers in my mind is how much of it is stimulus-related, and how lasting will it be once we get to a post-stimulus environment? It feels very good right now in terms of coverages. What we’ve seen in a number of our tenants is that their profitability has improved through the pandemic as they've rethought their processes and cost structures. Margins have held up well. They’ve actually done well in terms of profitability and therefore, rent coverage.

Okay. And then one last quick one. What drove the impairment in the quarter? Just thinking specifically about the pretty high rent collection? Any color there would be helpful.

On the impairments for the quarter, there were a number of properties, primarily two or three larger dispositions that ended up getting impaired. Three of the top four were vacant properties that were sold or going to be sold. That was really the driver of that.

It looks like guidance on your real estate expenses net of reimbursements went down a little and then G&A went up. Can you just give some more color on the shifts?

Yes. Fair comment. They didn't move a whole lot, but they did move a little. We generally model property expenses to somewhat mirror vacancy or rent loss, if you will. To the extent rent loss projections improve, then it also tends to improve our property expense projections. At the margin, that is the primary difference there. On G&A, that's largely just a function of incentive compensation that was down notably last year and will hopefully return to more normal levels this year. So just accruals related to that.

And then you talked about some challenges with movie theaters and full-service restaurants. What are your thoughts on fitness as an industry right now? Is this an area you would invest in further?

Yes. At the start of the pandemic, that was one of the lines of trade we were concerned about. Our primary fitness exposure is with LA Fitness and Life Time Fitness, and both of those companies have gotten through the pandemic in pretty good shape. Anecdotally, what we hear and feel is that customers do want to return to working out at the gym. Individuals that used to go to the gym want to get back to fitness facilities. We think that industry will rebound over the long haul. I mentioned in answer to a previous question that we'll be very thoughtful about larger, more special-purpose boxes, and to some degree, fitness center properties fall into that category. We will be thoughtful about that. That being said, if a portfolio of fitness centers were out there, or our relationship tenants had some transactions they wanted to do, those are things that we'd look at with a focus on the cost per property and the rent.

Got it. Just one last one. As you look out over the next 6 to 12 months, what's your preferred source of financing?

That's a tough one for us. I was going to say stock at $60 a share.

Yes, there you go. So we are constantly evaluating what's the best opportunity in the marketplace for us. The good news is we don't need any capital for much of the time period that you laid out there. It will be a variety, the usual mix of our capital structure. We're not looking to change that notably. It will be a blend of debt and equity as usual, both are relatively well priced. We take a very long-term view in this; we don't think about needing more debt or equity today or tomorrow. We know we're thinking about 2 years out and how to position our balance sheet and the liquidity we have. I'm being a little elusive. That's one reason we don't give guidance on capital raises, as we're fairly opportunistic about that front. We'll see what the market presents us.

Two other sources of capital that people forget about are dispositions. We have historically been able to sell around $100 million worth of properties per year at cap rates lower than we are reinvesting at. We’ve consistently recycled capital through our disposition business, and we have hundreds, if not thousands of properties in the portfolio that would sell for very low cap rates. The other is free cash flow after payment of dividends. We have, Kevin, around $120 million? In a normal year, it was $120 million this year due to the rent deferral repayments, notably higher, at closer to $150 million this year. All of which positions us well to not need to seek capital in order to fund our guidance and deal with whatever opportunities arise.

Mr. Whitehurst, there appears to be no further questions at this time. I'd like to turn the call back over to you for any closing remarks.

All right. Thank you, Tom, and thank you all for joining us this morning. We look forward to hopefully seeing many of you in person during the fall conference season. Have a good day.

Ladies and gentlemen, this does conclude today's conference. We appreciate your participation. You may disconnect at this time, and have a great day.