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Edited Transcript of FCPT earnings conference call or presentation 31-Jul-19 3:00pm GMT

Q2 2019 Four Corners Property Trust Inc Earnings Call

MILL VALLEY Aug 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Four Corners Property Trust Inc earnings conference call or presentation Wednesday, July 31, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gerald R. Morgan

Four Corners Property Trust, Inc. - CFO

* William Howard Lenehan

Four Corners Property Trust, Inc. - President, CEO & Director

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Conference Call Participants

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* Collin Philip Mings

Raymond James & Associates, Inc., Research Division - Analyst

* John James Massocca

Ladenburg Thalmann & Co. Inc., Research Division - Associate

* Linda Tsai

Barclays Bank PLC, Research Division - VP & Research Analyst of Retail REITs

* Nathan Daniel Crossett

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Robert Chapman Stevenson

Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the FCPT Second Quarter 2019 Earnings Conference Call and Webcast. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference call over to Mr. Gerry Morgan, Chief Financial Officer. Mr. Morgan, the floor is yours, sir.

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Gerald R. Morgan, Four Corners Property Trust, Inc. - CFO [2]

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Thank you, Mike. Joining me on the call today is Bill Lenehan.

During the course of this call, we will make forward-looking statements, which are based on beliefs and assumptions made by us and information currently available to us. Our actual results will be affected by known and unknown factors that are beyond our control or ability to predict. Our assumptions are not a guarantee of future performance, and some will prove to be incorrect. For a more detailed description of some potential risks, please refer to our SEC filings, which can be found on the IR section of our website at fcpt.com. All of the information presented on this call is current as of today, July 31, 2019. And in addition, reconciliation to non-GAAP financial measures presented on this call such as FFO and AFFO can be found in the company's supplemental report also available on our website.

And with that, I'll turn the call over to Bill.

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [3]

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Thank you, Gerry. Good morning. Thank you, everyone, for joining us to discuss our second quarter results.

FCPT's acquisitions volume reached $43 million for the second quarter, with 18 of the 21 properties leased to large corporate tenants offering strong brands, including Wendy's, Arby's, Texas Roadhouse, Olive Garden, LongHorn and Red Lobster. The average price point for our acquisitions was $2 million, representing a low-basis entry point, reflecting low rents. Average EBITDA rent coverage was 3.8x for properties that reported financial results. The focus on tenant operator credit, store-level performance and low in-place rents remains paramount at FCPT.

We also announced last week the signing of an agreement to purchase 20 additional outparcel properties from Washington Prime Group for approximately $38 million. WPG has been an excellent partner for us, and we look forward to closing these properties and the 11 remaining properties from the first transaction. Closings will occur in rolling tranches as the properties become available to be conveyed.

I want to note a couple of important characteristics of this transaction. The per property purchase price averaged $1.9 million, which reflects low in-place primarily ground lease rents. The transaction represents a group of high-quality and nationally recognized brands, and 19 of the 20 leases are with the brands' corporate entities. In addition, the properties in this transaction represent strong population and traffic demographics that compare favorably to the original spin portfolio.

The transaction includes 8 non-restaurant retail properties, marking our first investments outside of restaurant net lease. We've mentioned over the past year that we will branch out into adjacent retail sectors, especially if by doing so, the facilitator are acquiring restaurants in great locations. These 8 non-restaurant properties share similar qualities as our restaurant locations with comparable building sizes and net lease structures, and 6 of the 8 properties are with investment-grade tenants. We look forward to leveraging our deal sourcing and closing infrastructure to grow in both restaurant and non-restaurant net lease sectors.

The existing portfolio has continued to perform well, as evidenced by the 4.8x EBITDAR coverage in the quarter, and the restaurant industry as a whole looks to be reporting solid Q2 results. This includes Darden, which was led by its Olive Garden and LongHorn brands' same-store sales growth of 3.9% and 3.3%, respectively, in the most recent fiscal year closed in May. We also note the positive operating trends at our second-largest tenant, Brinker International, the parent company of Chili's, which reported same-store sales expanding 2.9% at company-owned locations in the most recent quarter, which represents the fourth straight quarter of positive same-store growth at the brand.

Overall, the restaurant industry continues to largely perform well, but we do note some operators have highlighted headwinds from a slowing economy and rising labor costs, while others are being impacted by technological initiatives such as delivery and royalty and an increase -- and increased competition. FCPT will keep an eye on these trends and continue to align ourselves with best-in-class operators and brands focused on addressing these challenges.

We've received investor questions on whether we have any exposure to NPC International, a large Pizza Hut franchisee and the second-largest domestic franchisee overall, which has recently been downgraded by the rating agencies. We have none of their properties. Also, there had been rumors about the financial situation at Perkins. We don't own any of those either.

We have good news on our efforts to continue building out our team. In the coming weeks, we have a new acquisition associate and a new corporate finance associate. These additions, along with the continued professional development of our current team, will set us up well to continue executing our investment and funding strategies.

Finally, with respect to the overall investment environment, we did observe some tightening of cap rates on several transactions recently. This is potentially a reaction to the drop in interest rates over the last 90 days. And also, we've seen a lot of equity capital raised in the first half of 2019 by our net REIT peers.

Now Gerry will take you through our financial results. Gerry?

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Gerald R. Morgan, Four Corners Property Trust, Inc. - CFO [4]

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Thanks, Bill. We generated $32.2 million of cash rental income in the second quarter after excluding noncash straight-line rental adjustments. And on a run rate basis, the current annual cash base rent for leases in place as of June 30, 2019 is just under $130 million. Our weighted average 10-year annual cash rent escalator remains at approximately 1.5%. And as Bill mentioned, but worthy of repeat, our EBITDAR coverage was 4.8x for the portfolio.

We reported flat AFFO per share quarter-over-quarter results as we were impacted in the quarter by approximately $0.01 per share due to the short-term dilutive effect of not-yet-invested balance sheet cash. Our results were also impacted by average interest rate -- by a higher average interest rate on our debt due to a greater mix of longer-duration bonds and the rolling of interest rate hedges on our term loans and higher cash G&A as we build and invest in our team.

In the quarter, we reported $2.7 million of cash, general and administrative expenses after excluding stock-based compensation, and our guidance for 2019 remains of an annual cash G&A rate of approximately $11 million.

Turning to the balance sheet. We start the second quarter well-capitalized to support 2019's second half investment activity. We ended the second quarter with net debt-to-EBITDA of 4.9x, over $20 million of available balance sheet cash and full availability on our $250 million revolver.

In addition, as discussed on last quarter's call, in April, we entered into a forward sell agreement through our ATM program at an initial average sales price of $29.30 per share, for gross proceeds of approximately $47 million. We have not yet settled any portion of the forward but continue to expect to do so on one or more dates prior to the end of 2019 to meet acquisition funding needs.

With that, we'll turn it back over to Mike for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question we have will come from Collin Mings of Raymond James.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [2]

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Just as you noted in the prepared remarks, you've communicated for a while now that you're open to potentially investing in properties associated with non-restaurant tenants. Clearly, the WPG deal marks the formal move in this direction. As we think about moving forward, can you just discuss how you plan to approach additional non-restaurant opportunities? Do you expect to pursue them on a one-off basis as well? Or will these brands be brought into the portfolio only as part of, call it, a larger transaction in a similar way to the WPG deal?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [3]

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So Collin, we've been studying non-restaurant properties for well over a year, as you've heard, and this is our first announcement. I think you will see more announcements like this over the next few months as non-restaurant outparcels are included in larger outparcel transactions, and we remain opportunistic in looking at other properties that we feel fit our portfolio. So I think you'll see a mix, but this was an organic way to start off the non-restaurant properties. And I think you'll continue to see us do it that way for the near term.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [4]

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Got it. Okay. That's helpful. And then just as you think of this move into non-restaurant properties, are there any specific sectors, box sizes that you want to particularly focus on or ones that you want to stay away from?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [5]

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Yes, I think we've historically focused on category-killer concepts, bank branches with premium investment-grade tenants and just other properties that naturally exist adjacent to our restaurant properties. I think generic retail is something we would likely stay away from. But if we can find good real estate with long-term leases and good credit behind it with low rents, we want to be opportunistic.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [6]

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Got you. Just maybe just to clarify on that point. Would you be open to outparcel if it's maybe associated with an office building or things like that? Or you really want to stick just specific to retail?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [7]

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I think mostly retail, Collin.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [8]

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Fair enough. And then again, in the prepared remarks, you alluded to the fact that there was a fair number of ground leases associated with the second WPG deal. Can you maybe quantify that mix at all?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [9]

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Yes. I would say that, historically, when we're looking at outparcels, and I'm not specifically referring to WPG since we haven't provided that breakout, historically, when we looked at the outparcel deals, roughly 60% to 70% of the properties that we look at are both corporately operated and ground-leased. And in this case, I think it's relatively similar on the ground lease percentage but higher on the corporate tenant basis.

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Collin Philip Mings, Raymond James & Associates, Inc., Research Division - Analyst [10]

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All right. And then just last one here. Just as -- again, recognize that you guys have put into place a pretty comprehensive due diligence process and underwriting process, again, historically focused on restaurants. What things are you changing on the margin from an underwriting standpoint as you think about some of these non-restaurant rented properties?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [11]

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Great question, Collin. I think, fundamentally, as you look at the properties that we're buying and you run them through our underwriting process, there's a lot of overlap: location, reuse, guarantor, credit, is it a net lease, what's the rent growth, et cetera. And what we're finding is that the variables that we're swapping out, let's say, rent to sales for deposits in the case of a bank branch, they're really minor tweaks on the margin of our underwriting.

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Operator [12]

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The next question we have will come from Rob Stevenson of Janney.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [13]

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Collin asked a couple of my questions, but the one that I wanted to talk in greater detail, what do you guys like about bank branches at this point, especially with millennials starting to use the phone for deposits, et cetera, and it's seeming like, maybe not today, maybe not tomorrow, but within the next 10 years, you're going to need less bank branches out there. Obviously, it's a box on a great piece of land that could be repurposed, but that's generally not anybody's first choice. So what -- when you've been doing the underwriting, what has you excited about bank branches in particular?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [14]

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Sure. I don't think there's anything in particular about bank branches that have us focused on them in any sort of specific way. These were properties that were intermingled with the restaurant properties we purchased. But I would call out that bank branch closure rates are actually far less than people expect. Second, they're primarily very large investment-grade tenants who've got good lease term, and then the boxes are more repurpose-able than restaurants. And with the bases that we'd have in these buildings, we'll be in a very attractive economic proposition to repurpose them. So I think it's -- we're not solely focused on bank branches by any means. We're looking at a lot of different things. It just so happens that the first couple in this announcement with Washington Prime happen to be bank branches. But large investment-grade tenants, in this case, very low rents and repurpose-able buildings.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [15]

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Okay. And where's the EBITDAR coverage on the non-restaurant assets versus where you guys are on the restaurant portfolio today?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [16]

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I don't think we disclosed that. The EBITDAR coverage for a bank branch is a little bit difficult to measure. Typically, they use deposits as the key metrics. But it's such a small number of properties. We don't own them yet, so I don't think we've made any disclosures like that.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [17]

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Okay. But there's no material difference in the sort of coverage quality of like the Jareds versus a typical restaurant asset, or something like that, that you're aware of?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [18]

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As I mentioned, we don't yet own those assets, so I don't feel comfortable talking about the financial performance. But obviously, as we were underwriting them, we took a very careful look at how these stores perform and compared them to relevant benchmarks in the industries that they operate in.

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Operator [19]

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And next, we have Nate Crossett of Berenberg.

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Nathan Daniel Crossett, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [20]

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Certainly, there's been a lot of acquisitions sort of come from Washington Prime. And so I was just wondering if you could give us a sense of how much remaining opportunity is left with them? And are there other REITs that you're in active discussions with where you could do similar-type transactions? And do these new property types open the door to more REITs that you could potentially do deals with?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [21]

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Sure. I think we've done quite a bit with Washington Prime. We have a great relationship with their management team. We will continue to look to do additional (inaudible). But frankly, I think we're sort of well on our way to buying the outparcels from them that they are willing to sell and we're willing to buy. We are in conversation with a number of other -- of their peers we are looking to purchase outparcels from. So I think you should expect that to be -- there to be a number of announcements through the remainder of the year along that theme. And yes, obviously, as we've increased our aperture for what kind of properties we can buy, it does lead to the opportunity to make more acquisitions. And given our cost of capital, we find that very attractive.

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Operator [22]

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Mr. Crossett, any further questions, sir?

We'll go ahead and proceed to the next question, and that will come from John Massocca of Ladenburg Thalmann.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [23]

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So touching more maybe on the restaurant side of things, are you seeing any -- placing any greater emphasis today on the value of corporate credit versus franchisees versus, say, like 12 months ago? And what percentage of the portfolio today is corporate versus franchisee credit, roughly?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [24]

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The vast majority is corporate because Darden, Brinker, and most of these outparcel transactions have been corporate credit. I don't have the exact percentage at my fingertips, but it's very, very high. I don't think we would say that our emphasis has changed. We still think large franchise credit is attractive. But clearly, publicly traded large corporations, especially if they're highly rated, is sort of in a different league. So we do obviously feel like corporate credit is an advantage, and it's one of the primary things we like about this outparcel strategy.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [25]

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Okay. And then from a balance sheet perspective, leverage crept up a little bit, which we'd obviously expect given it's kind of well below your target range. But do you think the fact that you have -- or maybe if you even put more of kind of the forward offering out there, that, that gives you some flexibility because you have kind of the forward in your back pocket to maybe move leverage up towards your target levels quicker?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [26]

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I don't think we are in any rush to increase our leverage towards the target. That will happen naturally. But to your point, we have a tremendous amount of financial flexibility, not just with a low overall leverage balance sheet, but with the forward capacity. So we feel like our balance sheet's in a terrific place. And what I found over a long period of time is conservatively levered REITs have a real advantage over the long haul. Obviously, being over capitalized quarter by quarter lowers earnings growth, but we feel like we're in a really good place to be able to enhance our business model and create earnings growth going forward.

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John James Massocca, Ladenburg Thalmann & Co. Inc., Research Division - Associate [27]

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Okay. And then on the debt side, what are maybe your thoughts on the long-term plan for the 25% of the outstanding term loans that aren't currently swapped today, especially given kind of the low interest rate environment we're in right now?

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Gerald R. Morgan, Four Corners Property Trust, Inc. - CFO [28]

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Bill, I'll grab that. Our strategy is to have some unfixed debt in the 10% to 15% range, which I think is typical in our sector. So I think we'll monitor that. But we're comfortable with having a portion of our term facility today remain unhedged.

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Operator [29]

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We do have another question, that is from Linda Tsai of Barclays.

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Linda Tsai, Barclays Bank PLC, Research Division - VP & Research Analyst of Retail REITs [30]

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I know your going in cash yields for your acquisitions have been pretty consistent, and the recent Washington Prime transaction is maybe towards the low end of the range. Just in terms of the 8 non-restaurant retail brands, did those components carry a lower cap rate versus restaurant -- the restaurants?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [31]

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No, they're very much in line.

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Linda Tsai, Barclays Bank PLC, Research Division - VP & Research Analyst of Retail REITs [32]

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Okay. And then you alluded to the reuse potential of non-restaurant retail. And the attractiveness is, I guess, a function of more generic build-outs in smaller size boxes. Is there a certain range of box size that you view as a sweet spot for reuse potential?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [33]

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Yes. I think it really depends on how the building would demise because there's some sort of larger buildings that cut up naturally. But we have historically stayed away from the really large boxes, sort of department store-sized boxes that some uses like gyms or others, have gone into. So our preference is to keep it is small, to keep our risks granular. And clearly, with low rents and long lease term, you have a lot of positive optionality. But given the bank branch deposits that we have here and the operating performance of the other tenants, we think they're going to be in these buildings for a very long time.

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Operator [34]

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We do have a follow-up from Nate Crossett of Berenberg.

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Nathan Daniel Crossett, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [35]

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Did you hear my first question? My line dropped. So I wasn't sure if you answered it or not.

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [36]

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Would you mind repeating it? I think we did.

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Nathan Daniel Crossett, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [37]

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Oh, it was about Washington Prime, and if kind of give us a sense of the remaining opportunity left with them.

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [38]

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Yes, we did cover that, Nate.

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Nathan Daniel Crossett, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [39]

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Okay. And then -- okay, that's -- I'll go back and look at the transcript. But maybe you can talk about how you're sourcing new deals outside of these larger transactions. I don't know, can you remind us of the size of the sales team? You mentioned you hired an associate?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [40]

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Right. So our investment team is comprised of myself and 3 others. We're adding a fourth in September. I would say that our sourcing has been very consistent for the last 2 years. It's just that now, we have more experience and more people that have been focused on restaurants. Now that we bought a couple hundred properties, our name is out there perhaps a bit more. But sourcing is very similar. Our investment team is now just a little bit more experienced. And we feel like evidencing our ability to execute on these outparcel transactions is a real differentiator. I think they're not easy. They require a lot of work in parcelization and selection. And kudos to Jim Brat, our General Counsel, especially for becoming really an expert in how to purchase these complicated transactions that are a lot of work upfront, but long term, we're really excited about the percentage of corporate tenants, the brands that we're getting, the demographics, and of course, the variable rents.

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Nathan Daniel Crossett, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [41]

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Okay. That's helpful. And then just maybe one on -- I just wonder what we should think about the dividend and dividend growth. What's the kind of AFFO ratio you guys target? Or how should we think about that?

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [42]

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We've historically addressed the dividend with our Board at the end of every year. We've typically targeted around an 80% AFFO payout ratio. But of course, a lot of factors are considered by our Board. But we typically do it once a year in the November, December time frame.

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Operator [43]

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We do not have any further questions at this time.

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William Howard Lenehan, Four Corners Property Trust, Inc. - President, CEO & Director [44]

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Great. Well, I'll just wrap it up by thanking everyone for joining us on the call today. We're excited about this Washington Prime transaction. We're excited about growing in non-restaurants. And most importantly, we're really excited about the team and how the team is growing.

Thank you, everyone. If you have follow-up questions, please don't hesitate to reach out to Gerry and myself. Thank you.

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Operator [45]

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And we thank you, sir, also for your time today and to the rest of the management team. Again, the conference call has now ended. At this time, you may disconnect your lines. Thank you, take care, and have a great day, everyone.