Gladstone Commercial Corp (GOOD) 2009 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Gladstone Commercial second-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; we appreciate that nice introduction and thank you all for calling in. We enjoy this time we have with you and wish there were more times that we could talk to you on the phone. If you're ever in this area, the Washington, DC area, we're located in McLean, Virginia, it's a suburb of Washington, DC and you have an open invitation to stop by and see us here, come by and say hello. You'll meet a great team at work.

If you come by I'll be able to say hello. Some people come by and want to spend a couple hours with me; I don't have that much time, but we would enjoy having you come by and say hello. And now let me read the statement about forward-looking statements.

This report that we're 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 do 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 the forward-looking statements including those 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. Both of those, the 10-K and 10-Q, can be found on our website at www.GladstoneCommercial.com, and it's 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 talk today we plan to talk about funds from operation, or FFO, and since FFO is a non-GAAP accounting term I need to define FFO as net income excluding the gains or losses from the sale of real estate plus depreciation and amortization of real estate assets. The National Association of Real Estate Investment Trusts, or NAREIT, has endorsed FFO as one of the non-accounting standards that we can use in the discussion of our REIT. And please see our 10-Q filed yesterday with the SEC and our financial statements for a detailed description of FFO.

Now let's begin. We'll begin the call today from hearing from our President, Chip Stelljes. Chip is also our Chief Investment Officer of all the Gladstone companies. Chip, take it away.

Thanks, David. Our June 2009 quarter end results reflect continued positive movement. As we reported last time, as well as again this quarter, despite the difficult economic environment as of June 30, all tenants are current with their rent payments. We maintained a conservative acquisition pace in past years and executed thorough due diligence processes. And as a result we believe we're benefiting today from the steady performance of our properties and tenants. We're hopeful that the portfolio will continue to perform well in the future.

While the equity and debt markets may have some signs of life the overall disruption in these markets has made it difficult to obtain new debt for equity capital on the terms that we believe are attractive. We've seen improvement in our stock price and we're hopeful that this trend will continue so we can raise new equity.

On the debt side the current credit market is still very difficult and the long-term mortgage markets, including the CMBS or conduit markets where we traditionally sourced our long-term mortgage financing, are presently unavailable. We don't know when they'll reopen. We're now seeing banks willing to issue medium-term mortgages between two and five years, albeit on less favorable terms. As a result we intend to focus on using these medium-term mortgages to finance our real estate until the market for long-term mortgages returns.

We're not currently willing to use our line of credit to any great degree to make acquisitions that we don't believe can be refinanced with longer-term debt. As you remember, our model called for us initially to borrow from the line of credit to buy properties. We then obtained long-term fixed-rate mortgages as soon as we could.

We were able to build in a decent spread between the rent coming in and the mortgage payments going out. And by doing this we were able to lock in a profit for the five to 10 years or in some cases longer. The proceeds from the mortgages would then pay down our line of credit, thus making the line of credit available for the purchase of our next property.

With the turmoil in the credit and equity markets the model has to adjust to shorter-term mortgages. So we are not financing long-term leases with our short-term line of credit. Thus we expect 2009 will be a difficult year to build the assets of the business. Thus our near-term strategy will be to build the value of the existing portfolio of properties by renewing existing leases, performing improvements at our properties and selling certain of our assets.

That being said, we do continue to selectively look at potential acquisitions which are consistent with our investment or our conservative investment approach and in properties that are likely to -- one, produce attractive long-term returns for our stockholders; two, have existing assimilable financing or where attractive bank financing is available; and three, where the tenants are weathering the current recession well.

On May 5, 2009 we extended the lease with one of our tenants in our property located in Akron, Ohio for a period of six months. The lease was originally set to expire in August of 2009 and will now expire in February of 2010. The lease was extended under the same terms that were in place at the time of extension with rent remaining flat. We're in negotiations with this tenant to extend the lease for an additional 10 to 15 years and are hopeful this will close.

On May 19, 2009, we extended the lease on our property located in Eatontown, New Jersey for a period of 15 years and the tenet has two options to extend the lease for additional periods of five years each. The lease was originally set to expire in August, 2011 and will now expire in April, 2024. The lease provides for prescribed rent escalations over the life of the lease with annualized straight-line rents of approximately $540,000.

On the funding side we have about $30 million outstanding on our $50 million line of credit funded by a group of banks. We amended our credit agreement during the quarter and reduced the total line from $95 million to $50 million. In exchange for the reduction in the line we received relief from FAS 141(R), which requires us to expense acquisition costs rather than capitalize them.

Under the new credit agreement the definition of FFO was amended to exclude these costs from the calculation of FFO. 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 unless we're able to secure a more favorable financing.

Compared to many REITs we're in very good shape with our short-term credit. At quarter end we had approximately $254 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, this mortgage has three annual extension options that we intend to exercise as we need them. So we are not under the level of refinancing pressure 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're reviewing shorter-term options averaging closer to five years. Rates on these shorter-term mortgages are approximately 7%. All the terms are tighter than in the past 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'll just have to wait and see what mortgage lenders can offer us.

At quarter end we had approximately $286 million in mortgages and short-term borrowings. This means we have about $2.3 in debt to every $1 in equity. We still have a conservative balance sheet with relatively low leverage today. Over the longer term we plan to increase our borrowings to $2.5 of debt for every $1 of equity and we think this is a reasonable debt to equity target for us.

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 June 30, 2009. We're currently working with our tenants to renegotiate lease terms for those leases that are expiring in 2010. For 2010 we have four leases that have to be renegotiated which have a total annualized rent revenue of approximately $1.6 million or 3.8% of our total rental income. This is rather insignificant when we compare to other REITs.

We feel pretty good about the portfolio and remain pleased that so many of our tenants seem to be weathering the poor economy. Finally, we recently signed an agreement to be repaid on the one loan we have in the portfolio, because the building securing the loan is under contract to be sold. We don't know if it will be sold, especially in this difficult market, but if it is sold we will be repaid our principal in interest and since we have a part ownership in the building we could reap over $3 million in additional income. So, stay tuned to see if that happens in the next three to four months and with that we'll turn it back over to David.

Okay. Thank you, Chip. That was a good presentation. I hope that building sells. And now let's turn it over to our Chief Financial Officer, Danielle Jones, for a report on the financial results. Danielle?

Thanks, David. Let's start with our balance sheet. Our balance sheet remains strong. We have a total of $124 million in both common and preferred equity and a total of $286 million in mortgages and short-term borrowings, so our debt to equity ratio is approximately 2.3 to 1. As Chip stated earlier, this is a very conservative balance sheet.

At the end of the quarter we had approximately $15.4 million of remaining borrowing capacity under our line of credit. The borrowing capacity in our line of credit is limited to a percentage of the value of property pledged as collateral to the line, both the amount outstanding under the line and our outstanding letters of credit.

As Chip stated earlier, we reduced the availability under our line during the quarter from $95 million to $50 million and with the current assets pledged to the borrowing base we have access to the full $50 million line. 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.

In addition, subsequent to the end of the quarter we sold our property located in Norfolk, Virginia for approximately $1.15 million for a gain on the sale of approximately $160,000. The proceeds from the sale were used to partially pay down our line of credit. Our current borrowing capacity after the sale of the property in Norfolk, Virginia under the line of credit is now $17.5 million. 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. FFO for the six months ended June 30 was $6.8 million or $0.79 per share. These results remain flat from the same periods last year.

These results were affected by the increase in our portfolio of investments during 2008 which were held for the full period in 2009 and the corresponding 4.4% increase in revenues over the same quarter last year and the 8.2% increase in revenues for the six months over the same period last year. Partially offset by the fact that we financed all of our 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 was also partially offset by an increase in the amount of the net incentive fee paid during the second quarter of '09. We paid approximately 84% of the incentive fee during the second quarter of '09 as compared to approximately 78% from the same period last year. In addition, we paid approximately 77% of the incentive fee during the six months ended June 30 as compared to approximately 51% for the same period 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'll turn the program back over to David.

Okay, thank you Danielle, that was a very good report. Our team has maintained our FFO and allowed us to sustain our distributions to shareholders, that we're always pleased to do in these difficult times. Please know that we're all working hard here to achieve similar results during the challenging times that we have ahead of us, but we are optimistic about the future of this company.

The real estate marketplace has changed because the market for mortgages has changed so much and this has really caused the sellers, all of these sellers out there who were hoping to get very high prices on the real estate, to be much more realistic or really they won't sell the property. We have mortgages or equity financing available to us and when we have that available we can make good numbers of acquisitions, but right now the mortgage marketplace is very difficult today and so we're being very careful of what we're doing.

The market we're buying properties in is divided into three parts. As you know, we don't participate in that part of the marketplace where the tenants are AAA to BBB kind of rating. These are well located buildings, high-quality real estate, those are being sought after by the large asset buyers like the insurance companies and the cap rates on this kind of property, or the yield as we call it -- when we call it a cap rate it's really the yield -- continues to rise. I don't know where it is today but it's gone up substantially over the last year.

The second part of the real estate market place, we call that the small real estate properties like fast food locations and pharmacy chains, these are being purchased by individual investors. These are people who want current income and some of them are a 1031 buyer, that is they're swapping real estate they sold for new real estate.

The yields here have gone up dramatically over the period of time, they're as high as 7.5%, 8% now, and all of these people are doing this for income purposes. These are income producing properties that they buy and hold. This market too is in flux, we'll see some of this market come our way I think. Some of the out-of-the-way locations for this kind of property are 9% cap rates, so they're continuing to move up.

Our part of the marketplace is really a space in the middle market where we see non-rated tenants, these are small- and medium-size businesses in commercial or office buildings, sometimes industrial properties. We like the medical and retail areas well but we're not seeing that much in the way of opportunities in that area.

Our competitive advantage in this area is the expertise that we have in underwriting the small business tenant in conjunction with the real estate. We're in a good position to see a lot of opportunities here and I think the cap rates are continuing to go up. We're seeing them in the 9% to 13% range now. Now we just need to find the debt to go along with it and we can start making some acquisitions.

We also buy business real estate that is leased by some medium and large companies. We've done that on a not direct basis, but that's something that's part of our portfolio as well. We are doing our best to find good properties and long-term financing to match our long-term leases. We have locked in in the past this financing and that should be good for the future, but it's really difficult today to find the right kind of building and real estate and mortgage to go along with it.

When the economy will -- we just don't know when the economy is going to stabilize and when the mortgage marketplace is going to come back to something normal. So we're going slow, we're watching what's going on and what's happening in the marketplace. And I am hopeful that the mortgages will be more plentiful in the future.

As was mentioned before, we don't have any of our mortgages coming due for quite a period out; I think the first one is in 2013 and our line of credit doesn't come due until 2010. So we're really in a pretty good shape today. Much of the industrial base that rents industrial and commercial properties remains steady. Most of them are paying their rents, there are some of course that are having problems. But usually even if they go into bankruptcy they want to keep paying the rent on their property and stay in the building so they get confirmed in the bankruptcy.

We really don't expect significant growth in the base during 2009, it's really hard to guess where the economy is going. But we're very hopeful that the downturn is approaching the bottom and will begin to climb back up over the next two to three years. Certainly commercial real estate has been okay, I say that, it's outside the housing industry obviously and the auto industry and retail has been rather difficult too. But generally speaking commercial real estate has been okay.

At this point I'm optimistic that our company will find will be fine in the future. But we have to worry about what the future is and so we'll be cautious on acquisitions as well as any kind of transactions that we do. The stimulus package and the funds invested in banks by the government will help, but I really don't see this making any kind of difference in 2009. All the spending and the announced tax increases will have a major change in the fabric of our country.

And my own estimation is that inflation is probably on the way, maybe not this year but certainly next year. I think that bodes well for real estate it's a good time to own good real estate because real estate values usually go up in inflationary times. And that's why I'm so bullish on this REIT. It has reasonable business tenants with good outlooks on their business and during an inflationary economy the value of the real estate should go up with inflation. Anyway, that's why we think this company is a big winner.

We are looking at a number of ways to grow the business. First, as we indicated, we're talking to some of the local banks to provide mortgages on the property. The local banks, that is those near the properties, may be able to offer us some mortgage money. We have about $80 million of properties that do not have mortgages on them and we're working hard to get mortgages on these properties so that we can pay down our banks. And obviously once we've gotten these mortgages in place if we get a good mortgage in place then that means it will free up some money for us to purchase an additional piece of real estate.

We are looking for ways to raise some equity capital too. We looked at various forms of preferred stock that may be able to issue some kind of reasonable rate. I'm hopeful that we can find some way to raise some funds with preferred stock or some variation of preferred stock.

We've talked to many different people about some creative ways of trying to raise money. We've discussed selling common stock but the price is not quite high enough for us, we don't want the dilution to go on with our current shareholders so we've been holding back in that area. We have seen an increase in the stock price over the past few months. However, the stock hasn't gone up enough for us really to say it's time to sell some common stock.

We are considering a new type of sale of the common stock, it's called at the market, or ATM as it's abbreviated. In that case we'll register some shares and sit them on a shelf at the brokerage house and from time to time a few shares would be sold into the marketplace. So we're looking at that alternative, we've not made a decision yet on whether to go or not go in that area.

As we say, stay tuned. We're still working hard trying to figure out a way to continue to grow the Company. As you all know, in July the Board declared the monthly distributions of $0.125 per common share for July and August and September. That's run rate of $1.50 a share per year, and that's a very nice rate for a good REIT and I think that's one that stands out, we're certainly trading at a rate that's much higher than most of the REITs in the marketplace.

Because the real estate can be depreciated, and we're able to shelter the income from the real estate depreciation, the distribution in 2008 was about 91% of return of capital, and that is tax-free. It should be similar this year; I think we should be in the 90% or 90 so percent range.

This stock can be a good one for you to hold in your regular account because it's so tax friendly. After all, if you buy the stock at around $14 a share and it has a pretax yield of 10.7, but then if you're in the 40% tax bracket you're getting a tax yield of about 10.3 and how many times can you get a yield of 10.3% after paying taxes to the government. That's a great deal, I think.

This 91% return of capital is due to depreciation on the real estate assets and other items that we have on the balance sheet. It really causes earnings to remain very low after depreciation. And that's why in these conversations we always talk about FFO, or funds from operations, because it adds back the real estate depreciation. After all, as all of you know, depreciation of a building is a bit of a fiction since at the end of the depreciation period the building is still standing and still there and still usable.

It's a great thing if you own the stock personally because you don't pay taxes on that part that's sheltered by the depreciation shield, which is really a return of capital. However, return of capital does reduce the cost basis in your stock which may result in a larger capital gain when the stock is sold down the road.

With the stock price at $13.90 at yesterday's close that means the yield is about 10.8%. With 90% of that sheltered by depreciation and not having a tax on it I think that it's a heck of a buy. Many of the REITs are trading at much lower yields and we should be trading there too. But unfortunately we're a bit too small for the big institutions to wade into our stock and so as a result we suffer from lack of liquidity out there in the marketplace.

The Board will consider and I expect them to declare the next monthly distributions in early October for the months of October, November and December. Now of course we turn it over to our listeners and ask for them for some questions. So if the operator, Claudia, you will come back on we will take some questions from the folks out there in listening land.

(Operator Instructions). John Roberts, Hilliard Lyons.

What was the average yield on the portfolio at the end of Q2?

9.68 according to our CFO.

Good.

The weighted average.

Weighted average, right. What do you see -- do you see any acquisition activity through the end of the year?

Well, I do hope we can mortgage out some of these -- this $80 million we've got. If we could mortgage off say a couple of those properties then it would put us in a position ready to buy a couple of properties. But lacking the ability to get a mortgage on the $80 million, some part of that $80 million, I think we're in a hold position unless we can figure out how to raise some equity money.

With that in mind, any divestitures possible, any properties -- I know you sold that one small one this quarter.

Right, and we have the $10 million loan that's coming due probably in the fourth quarter, they'll pay that off and so we'll get $10 million back. At that point in time with that $10 million we may be able to buy the next property.

Okay. And no defaults at this point?

At this point everybody is paying as agreed.

Great. Thanks, David.

Okay, next question.

Jim Altschul, Aviation Advisory Services.

Good morning. Two small questions, please. First of all, I noticed in the financial statements they're saying year-on-year both for the quarter and the first six months there's a small decline in the base management fee. Why was that, please?

Well, it's based on the net worth of the Company. And when you're paying out a return of capital your net worth is going down. So as the net worth goes down our payment to the advisor goes down.

Okay. And the asset retirement obligations, what does that relate to and are the charges to income likely to be steady or are they going -- any possibility they're going to increase in a meaningful way over the next year or so?

Danielle?

Asset retirement obligation is something we're required to accrue for properties that were acquired prior to 1985 related to asbestos. It's just a requirement from the FASB that we recorded, but it shouldn't increase. If we don't acquire any new properties it's going to remain flat throughout the year.

What happens there is they just assume that there's something wrong with an older building and they make you take a percentage of it and amortize it over assuming that somewhere along the way you're going to have to destroy the building and remove whatever bad stuff is in there. They got down to as low as the tiles on the floor might have asbestos in them. It was really a ridiculous thing that the accountants dreamed up. But nonetheless we have to live with it.

So there is not -- this is a non-cash item and you may not actually be required to lay out the cash when the building is sold?

That's right. And the one in workflow that we just sold in Norfolk we got all of that back.

Oh, you did. Okay, good. Thank you both very much.

All right, next question.

Chris Lucas, Robert W. Baird.

Good morning, David. Could you characterize the buyer on the Tysons asset?

Oh, it's been in the newspapers here. We don't really know exactly who they are, it's part of the West Group purchase, I don't know if you've read about it. And so this building is owned by West Group and it's part of that acquisition and we'll get paid off as part of that.

Okay, great. And then just on the New Jersey lease, you had mentioned on the one in Akron that the extension was done on the same basis. On the New Jersey lease that you've got the long-term extension on, how do rents compare?

What was the story on that?

They dropped slightly the extension, but still over the life of lease we have 2% --.

So we lowered it a little bit on the renewal date, but it goes up by 2% or so every year. So we're in very positive territory over the life of the lease.

Okay. And then have you guys calculated the same asset year-over-year performance for the portfolio?

I don't know what that means, Chris. I'm sorry.

The same-store NOI change?

No.

No, we haven't done that. How do you do that?

Take the same -- take the portfolio at the beginning of the time period, accumulate the NOI for that and then compare it to where you are today on that same --.

Oh, well we're ahead of that. We're ahead if you're taking all of the assets. Sure, we haven't had any of our tenants come in and demand relief and reduce the rent, we haven't had any of that happen.

We haven't granted any rent reductions at all. So it's definitely accretive. The question is we don't have the exact number in front of us, but it's going up.

Okay. And then my last question. Just on the portfolio you said everybody is paying as agreed. Are you noticing any trends in terms of payment timing or are you adjusting anything as it relates to your reserves for bad debt at this point?

No, right now everything is going very well. So we're not doing any of that to date.

Okay. That's it, David. Thank you.

Okay, next question.

I'm showing we have no further questions at this time.

All right -- go ahead.

I was just going to turn the floor back over to you, sir.

Any last questions? We're about to hang up if we don't hear another question.

(Operator Instructions).

All right, well we thank you all for coming to the meeting and listening to us and we appreciate all the stuff that you do for us. That's the end of this conference call.

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