Good morning, ladies and gentlemen, and welcome to Essential Properties Realty Trust Third Quarter 2020 Earnings Conference Call. [Operator Instructions] This call is recorded, and a replay will be available 2 hours after the completion for the -- of the call for the next 2 weeks. The dial-in details for the replay can be found in today's press release. Additionally, there will be an audio webcast available on Essential Properties webcast at www.essentialproperties.com. An archive of which will be available for 90 days. It is now my pleasure to turn the call over to Dan Donlan, Senior Vice President and Head of Capital Markets at Essential Properties. Thank you. You may begin.

Thank you, operator, and good morning, everyone. We appreciate you joining us today for Essential Properties' third quarter conference call. Here with me today to discuss our third quarter and full year results are Pete Mavoides, our President and CEO; Gregg Seibert, our COO; and Mark Patten, our CFO. During this call, we will make certain statements that may be considered forward-looking statements under federal securities law. 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 yesterday's earnings press release. With that, Pete, please go ahead.

Thank you, Dan, and thank you to everyone who is joining us today for your interest in Essential Properties. During the third quarter, we experienced a market improvement in rent collections as our tenants reopened their properties for business. In addition to this positive operating trend, we saw a stabilization in our cost of capital, and a constructive capital markets environment that was conducive towards maintaining a conservative balance sheet. As we stated on prior calls, we wanted to see these circumstances occur before deciding to resume our external growth plans. As such, we began looking for attractive investment opportunities early in the third quarter, which allowed us to invest $149 million this quarter and another $73 million to date in the fourth quarter. Looking at our third quarter investments, 92% were direct sale-leasebacks and 98% were transactions that involved an existing relationship. We believe these direct opportunities were a tangible output of the accommodative and relationship-based approach that we use to navigate the pandemic with our tenant base. While our short-term collections may have been higher, had we taken a more aggressive posture, our deliberate actions have strengthened our tenant relationships, which should benefit the company over the longer term. In order to maintain financial flexibility and appropriately fund our pipeline of opportunities, we raised $210 million of net equity in the quarter, including our overnight offering that raised $184 million of net proceeds in mid-September. We would like to thank those existing and new investors that demonstrated continued confidence in our company for supporting us. In terms of portfolio stabilization, approximately 99% of our portfolio as a percent of ABR is opened and operating today, which compares to 93% back in early August and just 66% in mid-April. In terms of rent collections, we collected approximately 90% of…

Thanks, Pete. Before I get into my prepared remarks, I'd like to say thank you to Pete and the Board for the opportunity to be a part of EPRT. It's a privilege to be a part of the terrific team Pete and Greg have assembled and to participate in the opportunity of helping to maximize value for our shareholders. As we reported in our earnings release last night, we're pleased with our third quarter results, particularly given the significant challenges presented by the ongoing pandemic. Our operating results for the third quarter of 2020 compared to the same period of 2019 included total revenue for Q3 2020 increased by approximately $6.6 million or 18.2%, totaling $42.9 million. We also saw our recurring Q3 G&A, as a percentage of total revenue, trend down sequentially to approximately 13.5%. This has improved from both Q2 2020 and Q3 of 2019. We recognized approximately $3.2 million in impairment charges in Q3, which was not associated with any impact from the pandemic but was related to our ongoing efforts to selectively recycle capital, including adjusting the basis of 8 investments we expect to monetize in the near term. Net income, as you can see from the release, was $12.3 million in the quarter. Our FFO was up $7.3 million, a 35% increase, totaling over $28 million, with our FFO per share reaching $0.30, up from $0.27 per share in the same period in 2019. Our core FFO was up $4.7 million. That's an increase of nearly 20%, totaling $28.6 million, which equates to $0.30 per share, a decrease of $0.01 per share compared to 2019. Our AFFO was up $3.6 million. That's a 16% increase, totaling approximately $26.3 million. With our AFFO per share equaling $0.28 per share, that's also down $0.01 per share compared…

Thanks, Mark. I want to start with the ongoing impact of the pandemic on our portfolio, which we have summarized on Pages 15 and 16 of our supplemental. As of late October, 87% of our portfolio ABR was open, 12% was open on a limited operating basis and 1% was closed, which is largely concentrated in our properties leased to entertainment and casual and family dining operators. In terms of rent deferrals, we have granted rent deferral requests to tenants, representing approximately $18 million in rent. As of the third quarter end, we had approximately $3.9 million of deferred rent remaining for future periods, of which we only expect to recognize $1.1 million in future revenues. So the vast majority of deferrals are behind us, and we have begun to collect repayment of these short-term concessions. Moving on to investments. During the third quarter, we invested $149 million into 19 transactions and 50 properties at a weighted average cash cap rate of 7.1%. These investments were made within 7 different industries, with over 85% of our activity coming from 4 industries: auto service at 36%, car washes at 28%, grocery at 10% and quick service restaurants at 10%. The weighted average lease term of our third quarter investments was 17.6 years. The weighted average annual rent escalation was 1.5%. The weighted average unit level coverage was 2.8x, and our average investment per property was $2.9 million. Consistent with our investment strategy, 92% of our third quarter investments were originated through direct sale-leasebacks, which are subject to our lease form with ongoing financial reporting requirements and 79% contained master lease provisions. From an industry perspective, quick service restaurants remain our largest industry at 14.1% of ABR followed by carwashes at 13.3%, early childhood education at 13.3%, medical dental at 10.7% and…

Thanks, Gregg. We're excited that the operating environment and capital markets have allowed us to pivot away from managing through the pandemic with our tenants and properties and move forward with capitalizing on our robust pipeline of accretive investment opportunities in order to drive earnings growth. We look forward to the balance of the year and continuing to put pandemic-related issues behind us as we continue to accretively build our portfolio of granular net lease properties. With that, operator, please open the call for questions.

[Operator Instructions] Our first question comes from the line of Haendel St. Juste with Mizuho.

Yes. Would you please -- so a question on, I guess, the portfolio. About 1/4 of your revenue is tied to travel centers, movies, gyms, entertainment. So curious on perhaps where you'd like to get that over time. In your prepared remarks, I think you mentioned reducing movies and gyms, but not childhood centers. So maybe you could discuss some of these as well as potential portfolio shifts post COVID, post vaccine a bit more?

Sure. And thanks for that. And I think Gregg gave you some stats in the prepared remarks. And we've very deliberately been focusing our investments in industries that we saw as durable and had real estate characteristics that we liked. And you saw that trend really since pre pandemic and taking those 5 industries down from 37% to 17% was material. And quite frankly, we haven't invested in the movie theater since coming public. Our gyms have been growing at a much slower rate as has our casual and family dining. We've been lightening up both through growth as well as disposition. Notably, our kind of generic retail exposure has been coming down dramatically as well, which is largely concentrated in furniture. And so we've had a very deliberate shift in our industry mix. The one outlier to that, that you pointed to is childcare. We like childcare. We think that industry has a good place in our portfolio and has good operating fundamentals. Obviously, it was impacted pretty significantly by the pandemic, but our operators in that space have been recovering nicely and performing well. And so you should expect to see us continue to invest in childcare. We have not been investing in a material way in any of those other industries. And you should expect to see that continue.

That's helpful. And maybe can you discuss a bit more the investments in the quarter. Cap rates here in the low 7s. We've heard some peers discuss higher cap rates and have even seen some investment yields north of 8%. So maybe you could discuss some of the pricing trends you're seeing in the assets that interest you. Is this low 7% -- a rate that we should expect to continue near term? And is the $150 million-ish you acquired in the quarter, a good run rate to think about near term?

Sure. And so in terms of volume and cap rate, generally our discussion around that has been pointing to our trailing quarterly average, which is pretty consistent with this quarter. So I think that's a good indicator of where we're set up to transact. In terms of cap rates, we generally have been telling people to expect us to transact in kind of the low to mid-7s range. And clearly, this quarter at 7.1% is towards the low end of that range. And I think what you see there is we are deliberately focusing in industries that had relatively de minimis impact from the pandemic, notably auto service, QSRs and car washes and really staying away from some of the higher cap industries that were adversely impacted, such as movie theaters and gyms and furniture. And so I think driving that cap rate down a little bit is the industry mix and the selection of the tenants that we did during the quarter. But from a going-forward perspective, you should continue to see us transact in the low to mid-7s range at a pace that's relatively consistent with our past practice.

Our next question comes from the line of Nathan Crossett with Berenberg.

Just wanted to get your thoughts on if we went back into a potential lockdown, how that may affect your pipeline? And also, was there any kind of elevated deal activity from people trying to get things done before the election?

Sure. I would say there's elevated deal activity really from what we saw as kind of a backlog of 6 months' worth of deals. A lot of our relationships and operators put M&A and development and other expansion on hold while they focus on grappling with the pandemic. And as we come out of the backside, I think they've restarted those growth plans, and that has created a backlog of opportunity. We have not seen a lot of election-related sales, and there may be some here in the late -- late in the fourth quarter. But we have not seen that to date. In terms of shutdowns and a potential impact to the pipeline, I would say we're making 20-year investments in industries that we think to be durable and lasting. And so I think temporary shutdowns really aren't going to weigh heavily on that. In my -- in our view, shutdowns would be very localized and temporary and shouldn't have a massive impact on our pipeline. It may have some impact on the portfolio. But we'll monitor that and obviously, continue to work with our tenants as we navigate through this pandemic.

Okay. And then I was just going to ask one on the theater assets. I know you only have 5 AMCs. But for your property specifically, are there any potential other use cases, I guess, in a worst-case scenario for them?

Yes. I think we have 6 theaters, 5 of them with AMC. On average, there are 50,000 square foot boxes with contractual rent of about $14, $15 a square foot. They're generic real estate. And to the extent that there -- I think, the first course of action to the extent that one of our operators were to go out, would be a relet to another theater operator. And they are theaters, and we believe firmly that theaters will survive and have a role and continue to exist. But to the extent that we had to gut them and reposition them into other uses, at the end of the day, there are 50,000 square foot boxes with a very reasonable rent per square foot.

Our next question comes from the line of Sheila McGrath with Evercore.

Pete, I was wondering if you could comment if there's any evidence that your target tenant base may be more prone to seek out raising capital via sale leaseback, given the pressure from COVID that might bode well for more acquisition opportunities as you look ahead into 2021?

We haven't seen that, Sheila, generally, our middle market tenant base -- one of the reasons they're in our tenant base is that they see the benefits of sale-leaseback transactions and view the weighted average cost of capital of our capital as favorable to their own weighted average cost of capital. And at the margin, the pandemic hasn't shifted that mindset. But I think there will be some of that as alternative sources of capital become more expensive, kind of against that is rates are really low and borrowing is really cheap to the people that can get it. I would say the people that -- the universe of people that can access traditional bank financing is probably a bit more limited as a result of the pandemic. So I guess that's a long way of saying we haven't seen it. We would expect to see some of it at the margin. But regardless, we have plenty of opportunities and a robust pipeline.

Okay. Great. One more. Just -- I missed what you said on Town Sports. They rejected the lease, but did you say you already have a tenant?

I did not. But what I've said in the past...

I'm sorry.

No worries. Listen, we saw that bankruptcy coming for a long time, and we've engaged with the market to find tenants and we have robust demand in those properties and those gyms. And we would expect to have them relet in short order, which is kind of what we said on the call that there's good demand, and we have a number of discussions going on, and those sites will be -- hopefully be productive here shortly.

Okay. Great. And one last quick one on Ruby Tuesdays. How many units do you have there? And do you have any visibility on their path forward? Do you expect to get those buildings back vacant? Or what is your expectation?

Yes. I would -- listen, that's an ongoing negotiation with that tenant. What I would say -- we have 7 sites leased to them in a master lease. And I would say just generically, we're confident in the basis in our assets and that they have good reuse potential. And to the extent that we don't come to a favorable outcome with Ruby Tuesdays through this process, much like Town Sports, we're confident that there will be another user that would pay us similar levels of rent in those sites.

Our next question comes from the line of Katy McConnell with Citigroup.

So based on the occupancy fallout that you've already seen to date, can you elaborate on the demand that you're seeing to really set vacant space today? And based on any progress you've made so far, what are your expected spreads?

Yes. Listen, I would argue that we haven't seen a vacancy fall out. At quarter end, we were over 99% leased and we were -- had 7 vacant properties, 3 of which came to us on the last day of the quarter. And so I think -- and we tried to say this in our prepared remarks that there's good demand for our properties, and we have a very robust ability to keep these properties leased and occupied, as evidenced by are very high occupancy. So it's an important part of our underwriting is to have fungible assets that have ready reuses and have the ability to re-tenant sites when they do become vacant. And I think our team has done an excellent job of maintaining a very high occupancy in our properties.

Okay. And then can you provide some more color on your strategic plans for the 15% of tenant exposure where you expect a slower recovery? And for those categories, how much of the uncollected 3Q rent have you deferred at this point versus have left unresolved where we could potentially see fallout down the line?

Sure. So the slower recovery industries, the casual dining, the health and fitness, entertainment, I would say the gyms, they're open, operating and returning to profitability. Our entertainment sector has -- which is largely trampoline parks and bowling alleys, we've seen them rebound very nicely and return to profitability. And our restaurants are doing well in both the casual and dining. Where the slowest recovery at 2.5% of our ABR really is in the movie theaters. And I think everyone can draw their own conclusion on that, our view is the recovery there is not necessarily pandemic related. It's more related to the release of content, and it seems like that is on the horizon, which should bring those sites back open and operating. And so we have very little left to be deferred. We had some commentary on the call. I think it's about $3 million and only $1 million of that -- $1-point-something million is going to be recognized into revenue. The vast majority of the balance of that is largely attributable to our theaters, which is AMC.

[Operator Instructions] Our next question comes from the line of Greg McGinniss with Scotiabank.

Gregg, just to make sure I heard correctly, collections have held consistent 91% for the last few months. It sounds like deferrals are starting to be repaid. So does that mean we could see collections number tick up closer to 94% in November, given those repayments?

Well, the repayments aren't going to really -- that's not ABR. The repayments really is prior period rent that was recognized, not collected. So that's really just a cash flow number. The paid ticking up from 90% to 94% is really going to be the burn-off of the recognized deferrals, and -- which is 3%, and that will happen. I think most of those deferrals probably go through the end of the year. So our return to that 94%, it's going to be slower because those deferrals are in place. That said, we're recognizing the revenue. We think they're money good, and those tenants are going to pay us as contracted. So in our view, there's not a big differential between the 91% and the 94% in those 3% recognized deferrals.

Right. Okay. So it's basically just reflecting different deferral agreements that were maybe in place for Q2, but not Q3 and vice versa? That's why we're seeing that.

Yes, they're the same deferral agreements that were in place, they just span through the end of the year.

Okay. And then, Pete, on the acquisitions front, I have to imagine that kind of weren't up to full speed this quarter given pandemic uncertainty. But obviously, balancing that against your comments on the backlog of opportunities and the return to kind of pre-pandemic level acquisitions, just curious how we should be thinking about kind of that level of acquisitions into 4Q? And obviously, not guidance on 2021, but how you're feeling about it?

Yes. Listen, I think you're right. We got started in the quarter late, largely as a result of kind of working through August, wanting to see sustained collections and stabilization in the cost of capital. But I think if you look at the $149 million in the quarter is kind of right on our trailing-8-quarter run rate, it's pretty indicative of our ability to scale the pipeline. We feel good about the pipeline. If you look in our Q that we filed last night, subsequent to quarter end, we've closed about $75 million. And so -- and we feel good kind of looking at the back half of the year or back quarter, excuse me, almost there.

Our next question comes from the line of Alexander Pernokas with Bank of America.

Sorry if I missed this, but how much quarterly revenue is on a cash basis? And is Towns Sports included in that?

Yes. So Town Sports is on a nonaccrual basis. This is Dan Donlan. So you should look at the disclosure on Page 15. You should assume that everybody and their nonrecognized unresolved lost abated bucket. So it all -- the 6%, give or take, is all on nonaccrual status.

So they're all on cash accounting.

Okay. Great. And then could you just give your outlook for bankruptcies over kind of the next 12 months? And how has your tenant watch list changed over the course of the pandemic?

Yes. I would say, at the onset of the pandemic our tenant watch list was comprised of all of our tenants and really focused on the industries and the sectors that we felt to be most impacted. And I think we gave good disclosure around that on Page 16. As we sit here today, I would say our main focus is on the 6%, that's on cash accrual. Guys that are either not paying us rent that they owe us or there's a deferral that we we're not sure we're going to get down the road. And so I think that really is where our focus is. And that, as you would imagine, is really in the sectors that have been most impacted and are the slowest to recover. But I think we see a path to most of those operators and we'll continue to monitor them and work with them as -- hopefully, we put this pandemic behind us.

You our next question comes from the line of John Macedo (sic) [ John Massocca ] with Ladenburg Thalmann.

Sorry if I missed this earlier, but what drove the big decline in industrial same-store rents?

John, this is Dan. That was a typo. That's my fault. You should just switch around the retail and the industrial, it was updated on the website. So that's really the retail is actually down that amount related to Loves Furniture.

Okay. That makes sense. And then as we think about dispositions, there kind of appears to be a strong bid out there for restaurant properties. Could that drive an acceleration in capital recycling on your end? And assuming you are seeing that kind of same strong bid, are you seeing an extend to kind of family dining and casual dining assets as well as QSR?

Yes. Listen, the QSRs are clearly -- there's a stronger bid for QSRs. Our disposition activity has been focused on kind of derisking the portfolio. And as a result, has been largely focused in the casual and family dining sectors. We feel pretty good about our QSR exposure and our tenants there. And so we don't feel the need to sell to recycle capital. I think we have a great capital position and good access to capital. And so really, our sales of assets is going to be kind of just moving risk out of the portfolio, and that will be in the casual and family dining sectors.

Okay. But those would be, I mean, potentially as kind of a thesis in how you want a portfolio, maybe that over time could be something that comes out of the portfolio via dispositions or partially out of the portfolio via dispositions?

Yes. Yes, I think that's been a thesis since day one. And I think you've seen a kind of regular disposition activity, and we disclose kind of where the industries are we're selling. Gregg gave you the commentary bringing down those 5 industries from 37% to 17%. And a lot of that is through strategic asset disposition. John, as we've discussed, a very important part of our portfolio construction is having asset level liquidity and owning assets that are granular in bite size and where there exists a good bid on an individual asset basis. And so we think, for the most part, the vast majority of our assets have strong bids, and that allows us to sell and manage industry exposures where we think appropriate.

And I guess just generally, I mean, what is kind of the spread in the bid out there? I know it's a little bit generic. So it's kind of tough to know of an asset, but the spread out there between kind of the casual and family dining versus kind of QSR.

Listen, I think QSR new deals, they could be 5.5 to 6.5, casual dining could be 7 to 8 to no bid. Right? And so that's pretty wide range. But there's not a lot of demand for casual diners. And I think a lot of the bankruptcies are focused in the casual dining. On the flip side, the QSR guys are doing great. You saw a -- sorry. So [ Carrols ] was in our top 10 last quarter. We really like them as a QSR operator. They dropped out this quarter and replaced by a Zaxby's franchisee, again, a great QSR operator that you can see them replacing names like Perkins and Ruby Tuesdays. And so that's been underway for a long time now.

There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.

Great. Well, thank you all for your time today. Hopefully, this has been helpful, and we look forward to engaging with you all in the coming NAREIT conference. Thank you. Have a great day.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.