Gladstone Commercial Corp (GOOD) 2009 Q1 法說會逐字稿

Greetings, and welcome to the Gladstone Commercial first-quarter 2009 conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. David Gladstone, Chairman for Gladstone Commercial. Thank you, Mr. Gladstone. You may begin.

Thank you, Claudia, for that nice introduction, and thank you all for calling in. We always enjoy these times that we share with you shareholders, and wish we had more time to talk with you. But it's four times a year. So please come and visit us if you are ever in the Washington, D.C. area. We are located in a suburb called McLean, Virginia. And I want you to know that you have an open invitation to stop by and see us if you're in the area. You will see a great team here.

Now let me read the forward-looking statement. This report that I am about to give may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, including statements with regard to the future performance of the Company. These forward-looking statements involve certain risks and uncertainties that are based on our current plan, and we believe that plan to be reasonable.

There are many factors that may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including those factors listed under the caption Risk Factors in the Company's 10-K and 10-Q filings that are filed with the Securities and Exchange Commission, and those 10-Ks and 10-Qs can be found on our website at www.gladstonecommercial.com, and they are also on the SEC website.

The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

In our talks today, we plan to talk about funds from operation, or FFO as it's called. And since FFO is a non-GAAP accounting term, I need to define FFO, and that is the net income, excluding the gains or losses from sales on real estate, plus depreciation and amortization of the real estate assets. The National Association of Real Estate Investment Trust, or NAREIT, has endorsed FFO as one of those non-accounting standards that we can use in discussions of our REIT. Please see our 10-Q, filed yesterday with the SEC, and our financial statements for a detailed description of the meaning of FFO.

We will begin the call today by hearing from our President, Chip Stelljes. Chip is also the Chief Investment Officer of all of the Gladstone companies. Chip, take it away.

Thanks, David. Our March 2009 quarter-end results reflect continuing positive movement, as we reported last time and again this quarter, despite the difficult economic environment, all of our tenants are current with their rent payments. Because we maintained a conservative acquisition pace in past years and stuck with our thorough due diligence process, we remain optimistic that the portfolio will continue to perform going forward.

As we stated last quarter, the disruptions in the credit markets and the decline in the equity markets have made it extremely difficult to obtain new debt or equity capital on favorable terms, and we are hopeful that our stock price will continue to rise so we can raise new equity.

On the debt side, the current credit market is virtually frozen and the long-term mortgage markets, including the CMBS, or conduit markets, where we traditionally sourced our long-term mortgage financing, are probably just unavailable and we don't know when they will reopen.

When the long-term mortgage market becomes more readily available, we intend to continue building our portfolio by using our line of credit. As you recall, our model calls for us to initially borrow from the line of credit to buy properties. We then seek to obtain long-term fixed-rate mortgages as soon as we can, and strive to have a decent spread between the rent coming in and the mortgage payments going out. And by doing this, we lock in the profit for five to 10 years, or in some cases longer. The proceeds from the mortgages paid down our line of credit, thus making the line available for the purchase of our next property.

With all the turmoil in the credit and equity markets, we expect 2009 will be a difficult year to build the assets of the Company. Thus, our near-term strategy will be to retain capital and build the value of our existing portfolio of properties by reviewing and renegotiating existing leases and performing improvements at our properties.

That being said, we do continue to selectively review potential acquisitions which are consistent with our conservative investment approach and properties that are likely to, one, produce attractive long-term returns for our shareholders; two, have existing assumable financing; and three, where the tenants are weathering the current recession well.

On the funding side, we have about $30 million outstanding on our $95 million line of credit, funded by a group of banks. The line of credit matures in December of this year, but we can and intend to extend the line of credit on the same terms to December 2010. We repaid our $20 million term loan during the quarter with borrowings from the line of credit.

Compared to many REITs, we are in very good shape with our short-term credit. At quarter-end, we had approximately $255 million in long-term mortgages borrowed against the properties we own, with a weighted average fixed interest rate of 6%. The first of these mortgages, in the amount of $48 million, does not mature until 2010. However, the mortgage has three annual extension options that we intend to exercise as we need them. So we are not under the level of financing pressure that some other REITs are experiencing.

Rates on long-term mortgages going forward, if they are available, will be higher and the actual mortgage maturities will be shorter. With the collapse of the CMBS market, we are reviewing shorter-term options averaging closer to five years. Rates on these shorter-term mortgages are approximately 6.5% today. And all of the terms are tighter as well, including lower loan-to-value advances and some recourse to our Company, where in the past, there was only recourse to the properties themselves. As it now stands, all of our mortgages are recourse only to the properties. The market is very volatile today, so we will just have to wait and see what mortgage lenders can offer us.

At quarter-end, we have approximately $285 million in mortgages and short-term borrowings. This means we have about $2.2 in debt to every $1 of equity. We still have a conservative balance sheet, with relatively low leverage. Over the longer-term, we plan to increase our borrowings to $2.5 of debt for every dollar of equity, and we think this is a reasonable debt-to-equity target.

The quality of our assets remains very good. All of our properties are leased and all of our tenants are current in their rent payments as of March 31, 2009. We are currently working with our tenants to renegotiate lease terms for those leases that are expiring in 2009 and 2010. In 2009, we have one least that we are in the process of renegotiating which has a total annualized revenue of approximately $200,000, or less than 1% of our total rental income. In 2010, we have three leases that have to be renegotiated, which have total annualized rent revenue of approximately $1.4 million, or 3.4% of our total rental income. This is rather insignificant when compared to other REITs in the market.

We feel good about the portfolio, and remain pleased that so many of our tenants seem to be weathering the poor economy. And now, I will turn it back to David.

Thank you, Jim. That was a good presentation. Now let's turn it over to our Chief Financial Officer, Danielle Jones, for a report on the financial results. Danielle, go ahead.

Thanks, David. Let's start with our balance sheet. Our balance sheet remains strong. As Chip discussed earlier, we have a total of $127 million in both common and preferred equity and a total of $285 million in mortgages and short-term borrowings. So our debt-to-equity ratio is approximately 2.2-to-1. This is a very conservative balance sheet from that perspective.

We also currently have approximately $18.6 million of remaining borrowing capacity under our line of credit. The borrowing capacity on our line of credit is limited to a percentage of the value of properties pledged as collateral to the line, plus both the amount outstanding under the line and our outstanding letters of credit. With the remaining capacity under our line of credit and our current cash flows from operations, we are confident we have ample liquidity to fund operations, service our debt, perform necessary capital improvements to our properties and maintain our distributions to shareholders.

And now I will turn to the results. As I talk about per-share numbers, please know that I am talking about fully-diluted weighted average common shares. Funds from operations available to common stockholders, or FFO, for the quarter was approximately $3.4 million, or $0.39 per share, which remains flat from the same period last year. These results were affected by the increase in our portfolio of investments during 2008, which were held for the full period of 2009, and the corresponding 12.3% increase in revenues over the same quarter last year, partially offset by the fact that we financed all of the acquisitions during 2008 using fixed-rate long-term debt, which resulted in increased interest expense, as rates on our long-term debt were higher than on our short-term debt.

This increase in revenues allowed us to increase the [net] amount of the incentive fee paid during the first quarter of 2009 by approximately $400,000 over the same quarter last year. Once we are in a position where we can pay out 100% of the incentive fee earned, we will be able to continue to grow our FFO. We are hopeful that we will be able to achieve this by the end of 2009.

And now I will turn the program back over to David.

Thank you, Danielle. That was a great report, and we're certainly glad you are on board as our CFO. The team has maintained our FFO and allowed us to sustain our distribution to shareholders. Please know that they are working hard to achieve the same results during this difficult time, and we are optimistic about the future of the Company.

The real estate marketplace has changed, as you all know, and that is because the mortgage marketplace has changed. This will cause more of the sellers to be realistic in their sale price, or the property just won't sell. If we have mortgages, if we can generate some mortgages for our properties, or equity financing is available to us, then we can make a good number of acquisitions. But without that, we are going to be sort of stuck for a while.

The marketplace, as we explain every time, is really divided into three giant segments. First, there are tenants that have AAA -- well, I guess there are not many AAAs anymore, but certainly the rated tenants that are well-located high-quality real estate being sought after by really the large REITs were the major buyers, but also insurance companies and pension funds have been buying these to hold for 20 to 50 years. The cap rates continue to rise on those, but they are never going to be in our range. That's not an area that we look at and consider in terms of our purchases.

The second area is the small real estate properties, like fast food locations or pharmacy chain locations. These are being purchased by individual investors, such as the 1031 buyers, who have sold one piece of real estate and want to buy another in order to avoid taxes on the profit. And the cap rates here are about 7.5% today, and have been higher. They are continuing to move up. We are looking at some of those now to see if we can figure out how to do them.

They -- the buyers of this kind of property do it for the income, and they are rolling over profits from some real estate that they've sold. This area is in flux, and we will see some changes in this marketplace as it continues to come our way, as mortgages are harder to get on this kind of property. Some of these in a little bit out-of-the-way places and locations are at 9%, 9.5% cap rates, so they are continuing to move up.

Our investment space, as I tell you every quarter, is in the middle market, where we see non-rated tenants and small- and medium-sized businesses and commercial office and some industrial properties. We do like the medical and retail area, but don't have much in that part of the world. We would like to have more medical and more retail, but it's just not something that is easy for us to get into.

Our competitive advantage over and over is the expertise we have in underwriting these small business tenants in conjunction with our ability to underwrite the real estate. As you know, in our other businesses, we do lend to and invest in small businesses. So we have a great underwriting team to underwrite the tenants.

We are in a good position to see a lot of opportunities here. Cap rates have risen. They are on the low side at 9%, on the high side at 13%. Should we be able to generate some mortgages and some equity money, we should be able to take advantage of these higher cap rates in our sweet spot.

We are doing our best to find good properties and long-term financing that match our long-term leases, because we like to lock in this kind of financing and have it in place. And it should be good in the future, but it is really difficult right now. We don't know when the economy will begin to stabilize and mortgage marketplace come back to something normal.

So we are going slow. We are watching what's happening in the mortgage marketplace, and I am hopeful that the mortgage marketplace will turn back around and will be able to generate some mortgages.

Much of the industrial base that rents industrial and commercial properties that we like remain steady. Most of them are paying their rents. However, we don't expect significant growth in the base in 2009. It is kind of one that is going to be stable during 2009, and we are hopeful that we can get back into that marketplace.

It is hard to guess where the economy is going, but we hope the downturn is approaching a bottom, and we will begin to climb back out of this over the next two or three years. Those will be great years for us if we are at the bottom and going back up again.

At this point, I am optimistic that our Company will find in the future -- will be fine in the future, but we all have to worry about the future, and we will just be very cautious in our acquisition. The stimulus package from the government and the funds being vested in the banks by the government I think help a little bit, but I don't see it making a big difference in 2009.

All the spending and the announced tax increases will have a major change in the fabric of our country, of course, and it's my guess that inflation is on the way. So it is a good time to own real estate, because real estate goes up in an inflationary environment.

And that is why I like this REIT so much. It has business tenants with reasonably good outlooks in an inflationary environment. Our rents are allowed to go up because we have escalation clauses in the leases, so they bump up every year. And that means the value of the real estate should continue to go up. And I think this structure is just a great winner in this kind of economy that we are in.

We are looking at a number of ways to grow the business. First, we are talking to some local banks that will provide mortgages on local properties that we have. That is, the local banks near our properties may be able to offer us some mortgage money. So we are working the local banks, first of all. We have about $80 million of properties that do not have mortgages on them. So to the extent we can find mortgages there, and will be working on these mortgages all during the summer, and if we can find good mortgages, then these new mortgages will free up some money so that we can purchase some additional good real estate. And I think that you will see that during the summer as we continue to work on that.

We are looking for ways to raise equity, too. We are looking at preferred stock, may be able to issue some of that at reasonable rates this year. Right now, it's very expensive, but I'm hopeful that we can do some fundraising in the preferred stock area during this year.

And we have, of course, discussed selling common stock, but the price has not been reasonable. I think the stock has to go up much more before we can consider the sale of common stock.

So folks, just stay tuned. More is on the way as we go forward, and it should be an interesting summer. As you have heard from the reports, we have balanced our assets and our liabilities, so we are in good shape there. Our short-term line comes due in December of 2010. We have no mortgages coming due for years and years, so we are in great shape there. We only have a few leases coming up, 3% or 4% through 2010. All of our tenants are paying as agreed. So quite frankly, we are in great shape right now.

In April 2009, the Board declared the monthly distributions of $0.125 per share per month for April, May and June. That is $1.50 per year. A very nice rate for such a good REIT. Because the real estate can be depreciated, we are able to shelter the income of the Company from taxes. The distributions in 2008 were about 91% of return on capital, and that is tax-free to people who are looking at it from the tax perspective.

It should be similar this year. That is, it should be 90 some percent this year. This stock is really a good one to hold in your regular accounts because it is so tax friendly. After all, if you buy the stock, and it has been around 11 a few times in the last month per share, and it has a pretax yield then of about 13.6%. But if you are in a 40% tax bracket, than the yield is about 13.1%. I don't know how many times you can get a yield of 13% after-tax, after paying the government, but it seems to me that is a pretty good opportunity.

And this 91% return of capital is due to the depreciation of the real estate assets and the other items. That causes earnings to remain low after depreciation, and that is why we talk about FFO, because this is adding back the real estate depreciation. Depreciation of the building is a bit of a fiction, as we mention each time, since at the end of the depreciation period, the building is still standing and you have written it off.

The great thing is that if you own this stock personally, you don't pay any taxes on that part that is sheltered by the depreciation, as that is considered a return of capital. However, as you know, the return of capital does reduce the cost basis of the stock, which means that that results in larger capital gains tax when it's sold.

The yield today, with the stock price averaging -- it closed yesterday at $11.78 -- that means the FFO yield on our stock is about 12.7%, and about 90% of that, as I mentioned, we expect to be sheltered by depreciation, so it is not taxable.

Many other REITs, as you all know, are trading at much lower yields. We should be trading at a lower yield because we have such high quality situation, but I guess we are just a bit too small for the big institutions to take part in our REIT.

We will declare the next monthly distribution in early July 2009 for the months of July, August and September. And hopefully, we can over this year book some more assets so that we can look at increasing the dividend.

Now we'll have some questions from our loyal shareholders and the analysts that follow our good REIT. Would the operator please come on and help our listeners so that they can ask some questions?

(Operator Instructions) [Jim Altschul], Aviation Advisory Service.

Two quick questions, if I may, please. First of all, do you have a figure either for the year 2008 or an estimate for this year for the common dividends as a percentage of cash available for distribution or adjusted FFO? Is that something you provide?

It is right now running at about 95% distribution.

Okay. And have you started talking with the tenants whose leases expire next year about renewal?

Yes, of course. We are in constant contact with our tenants. One thing we do is we work with our tenants very close, and we think all of them will extend. We don't have any reason to believe that any of the tenants are going out. We may have one that goes out, but right now, we don't know.

Thank you very much.

John Roberts, Hilliard Lyons.

Good morning, David. First, why the increase in professional fees in the quarter?

Good question. Probably -- the professional fees, what was that from, Danielle? Do you want to look at the Q? You go another question while she's looking up (multiple speakers)?

Sure. Any thoughts on what the fee waiver looks like going forward, for modeling purposes?

We think it is going to get lower over the years in the giveback. We should be through that this year.

What do you think, ending that in the third quarter?

That would be a good guess.

Okay. What are the rent increases looking like?

They run anywhere from 1% to 3%, is the range. And we don't have -- we should do that calculation for you and tell you what it looks like for '09 and also for 2010.

And the final question on the professional fees was, any thoughts on when acquisitions might start this year? I mean, I know in the current environment, it is very tough to really be able to tell when you are going to be in a position to make acquisitions and when they are going to be appropriate. But any thoughts, and what type of cap rates are we looking at?

Well, our best guess right now is that the $80 million we have that doesn't have a mortgage on it, that we are going to get some mortgages on some of those during this summer, and that will free up money that we will then use to buy new properties. Now, no guarantee that we are going to be able to find it, but the bottom line is that is the goal. That is what we are trying to do. So I would hope that this summer something will happen.

And cap rates still around 8.5%, 9%?

No, they are 9% to 13% right now.

9 to 13?

Yes, in the stuff that we look at.

Okay.

In terms of the professional fees, we had a lot more legal stuff that we worked on with a couple of the tenants that renewed. So we ran up a bit of a bill there. One of them was an argument over the parking lot. We seem to spend a lot of money over that stupid parking lot in Texas. But that's the way it goes.

And then we have a little bit of offering costs. We had thought that we might be able to do an offering, and so we redid our shelf, and that cost us $16,000, $17,000 -- no, it is more like $20,000. And that is really the major thing that went on, is lease negotiations and using our lawyers for those kind. Now we did have -- what is this taxing fee?

It was some timing differences at the preparation of some tax (multiple speakers).

So, we redid the tax -- I remember that now. We did research, and then we had to do some research on some tax issues that cost us about $22,000, as well. So just normal things that go on in a business. Hopefully, they won't go on next quarter and be a little bit less.

Okay, good. So I can lower my expectations for professional fees in Q2 and going forward?

Give me a gun and I'll shoot them (multiple speakers). But they are just very expensive, all these professional (multiple speakers).

Tell me about it. I understand that completely. All right, David. Thanks a lot.

Chris Lucas, Robert W. Baird.

Good morning, David. Just a follow-up on John's question about rent growth. Do you have a calculation or a number for what it was for this quarter relative to on a same-store basis over the prior year?

No, we don't. What was the rent increase on the existing stores this quarter versus last quarter? We don't know that off the top of the head.

Why don't we do this? We will do some calculations on that and try to put it on the website under the questions and answers.

We have a number of leases that -- a number of our leases have fixed escalations, and a number of them have variable escalations, so it is not -- it's a little dynamic. So we could put that information together.

But you should know also that if it is fixed, we do a straight line. So it is straight-lined right (technical difficulty). There is no increase. But we have not sat down and done that calculation, and we probably should do that. And we will do that and put it on the questions and answers on the website.

Okay, thanks. Just on the line of credit, you had mentioned that you are likely going to extend that. Have you guys looked at redoing the line completely before exercising extension?

No, it's extremely cheap, and we couldn't possibly get the money that cheap today. So there would be no reason to do it. We've talked with -- there are four banks involved, and we've talked with them about trying to figure out a better way of going.

All of the banks are interested in getting their money back today. There is not a bank -- I mean, you hear these banks talk about making loans. It's very rare that they step up and make new loans. So I would say that if we were trying to redo the line, we probably would lose two of the four banks, and the other two would be with us, but it would be higher interest rates and --. You'd probably get a longer term. You might be able to get a two- or three-year extension on what we are doing.

But Chris, I really want to encourage you to think about us as not using our line of credit to hold long-term properties. It seems to me the way people get in trouble in this business is that you finance a 15-year lease with a two-year piece of paper, and that eventually, one day gets in your way and you have a problem.

So we are trying to right now figure out how we can put mortgages on the $80 million worth of leases that we already have, of properties we already have, free up that money, and then use some of it to buy another property and then mortgage it, buy another property and mortgage it. As opposed to using some mechanism of having a very large line of credit.

The $95 million for us is really not worth keeping in place. $95 million -- I can't imagine having $95 million on a line of credit that expired in two years. Just don't want to go there.

So we are going to be very cautious. We are going to find mortgages for our existing properties. And that will pay down the line of credit. We will put a few more back on the line of credit. But we are going to work matching the book, as they call it, with long-term assets on one side and long-term liabilities on the other.

Then I guess on the tenant credit issue, I just wondered, do you get updated financials from your tenants? I know you underwrite them going in.

Yes, we do. In some cases, we get quarterlies. In other cases, we only get annuals. Most of them are quarterlies. And we are close to our tenants. Unlike some of the situations in which we don't know what is going on with a tenant, I think our visiting them and talking to them on the phone and following them -- we have a model that we use for tracking these tenants, and we track them as frequently as we can.

Some of the properties we bought and didn't underwrite initially -- I say initially -- we underwrote them as a buyer, but we didn't make the deal and use our own leases. We were buying somebody else's property with their lease. They don't usually have much in the way of tracking the tenants as well as we do, and we've had to renegotiate that part of many of the leases as we go in. And sometimes you get what you want and sometimes you don't get as much as you want, but you get something more than most people do.

So we are fairly strong in underwriting our tenants. And some of our tenants are nationally known companies. So we don't have to worry about getting financials there. We can get them off the SEC website. But we do track the tenant as closely as we would if we were lending them money.

Thanks a lot, David. That's all I have for you this morning.

Other questions, please?

We have no other questions at this time, but I would like to remind everyone (Operator Instructions). Mr. Gladstone, it appears there are no further questions --.

All right. Well, this meeting is adjourned. Thank you all for attending. We'll see you next quarter.

This does conclude today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.