Gladstone Commercial Corp (GOOD) 2010 Q4 法說會逐字稿

Good morning and welcome to the Gladstone Commercial Corporation fourth quarter and year ended December 31, 2010 shareholders conference call. All participants will be in listen only mode. (Operator Instructions) After today's presentation there will be an opportunity to ask questions. (Operator Instructions) Please note, this is being recorded. I would now like to turn the conference over to Mr. David Gladstone. Sir please go ahead.

All right, thank you, Amy, for that nice introduction and thank you all for calling in. We always enjoy this time we have with you on the phone and wish we had more of these, but we do this once a quarter. Please come visit us if you are ever in the Washington, DC area. We are located in a suburb of Washington, DC. It is our home town called McLean, Virginia, and you have an open invitation to stop by and see us here. You'll see some of the greatest team members in the business. Now let me read th is statement about Forward-looking statements. 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 those plans to be valid. There are many factors that may cause our actual results to be materially different from any future results expressed or implied in the Forward-looking statements, including those risk factors listed under the caption risk factors in our Company's 10-K and 10-Q filings that are filed with the Securities and Exchange Commission. Those 10-K's and 10-Q's can be found on our website at www.GladstoneCommercial.com. And they can also be found 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 and that is the net income excluding gains and losses from the sale of real estate plus depreciation and amortization of the real estate. The National Association of Real Estate Investment Trust has endorsed FFO as one of those non-accounting standards that we can use in discussing the performance of our real estate Company. Please see our 10-K filed yesterday with the SEC and our other financial statements for a detailed description 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 our Gladstone companies. Chip, why don't you start for us.

Thanks, David. Our December 2010 quarter was positive, as we completed our first acquisition since the recession began. We were able to extend some of our upcoming expiring leases, rates, common stock and closed on a new line of credit. As of December 31 all but two of our buildings were occupied and all of the buildings that remain occupied were paid as agreed. The two empty buildings constituted about 2.6% of our gross portfolio income. In addition, one of our tenants, Workflow Management, declared bankruptcy last quarter. However, they have continued to pay our rent. They have now rejected our lease in the bankruptcy proceeding and will cease paying rent after April. So we are taking the appropriate action to re-tenant the property as quickly as possible.

Rental income from this tenant is less than 1% of our total NOI's rental income. We believe that the rest of the portfolio will continue to perform well in the future. As we previously announced, we closed an acquisition in December. This acquisition was a 487,000 square foot Office Industrial building in Orange City, Iowa. We purchased the property for approximately $12.3 million including related acquisition expenses and funded it through a combination of borrowings from our line of credit and the assumption of approximately $10.8 million of mortgage debt on the property. The property is leased to a large division of Staples, Inc on a long-term lease.

Equity and debt markets continue to improve. However, the overall disruption in these markets is still making it somewhat difficult to obtain new mortgage debt for our purchases on terms that we believe are attractive. However, our common stock price continues to rebound and as a result we were able to issue and sell 2.4 million of common stock under our At-the-market program during the quarter at an average price per share above $18. In addition we were able to sell 14.3 million of common stock in an underwritten public offering after the close of the fiscal year December 31, 2010.

On the debt side the current credit market is still difficult and the long-term mortgage markets, including the CMBS market where we traditionally sourced our long-term mortgage financing, remain limited. We are seeing some lenders willing to issue mortgages up to ten years, albeit on less favorable terms than we could get in the past, but it is improving, so we are focusing on these mortgages until the CMBS market returns.

In December, we closed on a new line of credit with Capital One, which matures in December 2013. The new line of credit replaced our prior $50 million senior secured revolving credit facility. The new line provides for a senior secured facility of up to $50 million and can be expanded with additional lenders if needed. As we have done in the past, we continue to only use our line of credit to make acquisitions that we believe can be re-financed with longer term mortgage debt.

As you recall, our customary business model called for us initially to borrow from the line of credit to buy properties. We then obtained longer term fixed rate mortgages as soon as we could. We were able to secure a spread between the rent coming in and the mortgage payments going out. By doing this we were able to lock in profit for 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 available for purchase of our next property. With the turmoil in the credit and equity markets over the past few years our model adjusted, so, we are matching as closely as possible long-term leases with longer term credit and if we are not able to source attractive debt we only plan to buy properties that already have long-term mortgages on them, as we did in the most recent purchase.

In addition to making acquisitions selectively, we will continue to improve the value of our existing portfolio properties by reviewing and renegotiating existing leases, performing improvements at our properties and selling certain of our assets. To this end we extended two leases during the quarter and one subsequent to the end of the quarter. We extended the lease on our property located in Toledo, Ohio, for 10 years and the tenant has two options to extend the lease for additional periods of 10 years each. The lease was originally set to expire in December 2010 and it will now expire in December 2020.

We also extended the lease on our property in Fridley, Minnesota for 10 years and that tenant has one option to extend the lease for additional period of five years. The lease was originally set to expire in January 2013. It will now expire in June of 2020. The master lease on five of our properties located in Georgia was extend for an additional period of five years. Their lease was originally set to expire in 2026 will now expire in 2031.

We had one mortgage loan on the liability side of the balance sheet for $48 million which matured in October of this year. However, this mortgage had three annual extension options and we exercised one of those options during the quarter to extend the term to October 2011, expect to exercise the other extension options as we need them. Along with the extension the interest rate reset for the next year, which will reduce the cost of that facility by about $1 million over the next year. We have no other mortgages that mature until 2013, thus we are not under any near-term refinancing pressure.

Quality of the assets remains very good. All but two of our properties are leased and all of our existing tenants are current in their rent payments today. We are working to locate new tenants for the two vacant properties and the one bankrupt tenant property I mentioned earlier. For one of those properties we are considering a plan to reposition that property to a much higher value operation. These transitions will all require some level of capital outlay, so more to come on those. Now let's turn it back to David.

Thank you, Chip, that was a great presentation. Now let's turn to our Chief Financial Officer, Danielle Jones, for a report on the financial results. Danielle, please give us your report.

Thanks, David. We are pleased with our quarterly and year-end results. At the end of the quarter our total assets increased to $411 million, $384 million of which is our net investment in real estate. We had $111 million in both common and preferred equity and approximately $261 million in long-term mortgages borrowed against the properties we own. We had $27 million outstanding under our line of credit end of the quarter at a weighted average interest rate of approximately 3.3%, for a total of $288 million in mortgages and short-term borrowing.

With the subsequent sale of common stock in February, the proceeds of which were used to pay down our line of credit, our current balance has been reduced to approximately $10 million. With the reduction in our line of credit balance, coupled with the increase in our equity balance and common stock sales during the quarter, our current debt to equity ratio decreased approximately 2.1. This is more in line with our target range.

We currently have approximately $23 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 properties pledged as collateral to the line, plus both the amount outstanding under the line and our outstanding letters of credit, our borrowed credit. Our borrowing capacity has increased significantly because of the proceeds from common stock sales during the quarter and subsequent to the end of the year. With the remaining capacity under our line and our current cash flows from operations, we have ample liquidity to fund operations, service our debt, perform capital improvement to our property and maintain our distributions to shareholders.

Now I will discuss the operating 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 stockholder, or FFO for the quarter, were approximately $3 million or $0.35 per share, which was a 10% decrease over the prior year's quarter and FFO for the year was $14.1 million or $1.64 per share, a 4.1% increase over the full year 2009. The decrease in FFO for the quarter was primarily a result of the $386,000 of due diligence cost we were required to expense related to the acquisition during the quarter. Under new accounting guidance we are required to expense these costs rather than capitalize them as we had in years past. If this expense had been capitalized, our FFO for the quarter would have been approximately $3.4 million or $0.40 per share, which would have been a 1% increase over the same quarter last year.

Our bottom-line was also affected by a decrease in our rental and interest income during the quarter, coupled with an increase in our professional fees, partially offset by reduced interest expense and a credit to our base management fee we received from our advisor. Interest expense decreased because of the reduced rate in our $48 million mortgage loan we extended in September. The interest rate decreased to 4.58% from 6.85% resulting in an interest rate reduction of approximately $300,000 during the quarter. In addition, our advisor issued a $225,000 credit to our base management fee during the quarter. Rental income decreased because of the two tenants who vacated their respective properties during the third quarter and we did not collect any interest income during the quarter because their only mortgage lender receivable was repaid in July.

Professional fees also increased because of the write-off of an additional $100,000 of fees associated with the termination of our private offering of unregistered senior common stock. We do not anticipate any further significant expenses related to the termination of the senior common offering in 2011. FFO increased for the year because of the $3.3 million of additional income and prepayment fees and received in connection with the early repayment of our mortgage lender receivable. We paid out 86% of the incentive fee for the quarter and 95% of the incentive fee for the year. We believe that 2011 will be an active year for us. As we build our portfolio and our income grows, we believe we will be able to consistently payout 100% of the incentive fee earned, so we'll be able to grow our FFO.And now I will turn the program back over to David.

All right, thank you, Danielle. That was a great report. We really encourage all the listeners to read the Press Release and the quarterly and annual report that was filed yesterday with the SEC. That's called a Form 10-K, there is a lot of good material in there. The folks here at the office do a lot of work to make sure you get a lot of information there. You can find them on our website at www.GladstoneCommercial.com and also on the SEC's website.

As mentioned, the main news this quarter ending December 2010 was the addition of a new line of credit and the purchase of another property. I think this Company, this REIT is in great position to increase its assets and thereby increase the income from those assets. These are very strong positives for the Company. We are working hard this quarter ending March 31, 2011 to have another great quarter for you when we call you -- next time we call sometime in May.

To begin the March 2011 quarter we raised about $14 million in new capital and that was to fund the new deals that we have coming down the pike. We are probably going to use up all $14 million of that if two of the deals close. And I am hopeful that we can find some very attractive long-term mortgages to go with those new properties. The market is getting much better and I think 2011 will be a really great year for this REIT.

Now that we have more equity, I'm in a positive position to buy more properties. We're also looking to buy more properties where the properties ready have mortgages on them. We were able to do that during the quarter ending December 2010 and I think we can do some of that in this year as well. And if the mortgage market comes back, as we believe it will, it will open up a whole new list of properties for us to buy. So, I am looking for this to be a really good year for our REIT.

Just to rehash some things, the market for Real Estate properties is divided, as we see the world into three big categories. That is tenants that have a AAA or BBB rating and have well located real estate and high quality of real estate. These are sought out by the large real Estate Investment trust and Insurance companies. The cap rates or the amount of money you can make on one of these and the leases continues to move around. I don't know where it will stop, but it is still much to low for us to consider this category in our Company. There are others in this category with -- other properties in this category with lower tenant ratings, maybe a BB or B. And we have purchased some of these properties and have them in our portfolio today.

There is a second category that we call small Real estate properties, like fast food locations or pharmacy chains. Those are being purchased today by individual investors at cap rates that yield 7.5% and higher. They do this for income. This area too is in flux. We see some of this market coming our way and certainly we would like to add some of that Retail properties to our portfolio, we just haven't found the right ones yet.

And then the third place that we talk about and really the investment space is in the middle market where we see non-rated tenants and small and medium size businesses in the Commercial office and Industrial properties area. We like this area and we also like the Medical properties in that area. We just don't have much in that part of the world, that is the Medical properties world. Our competitive advantage in this area is the expertise we have in underwriting the non-rated Business tenants in conjunction with the real estate. We are in a very good position to see a lot of opportunities here. Cap rates in this group are in the 8% and 9% range, so we are looking forward to some exciting times over the next year.

We are focusing our efforts on finding good properties and long-term financing to match that long-term lease that we find on the properties, thereby locking in the long-term financing. And that should be good for us in the future, as we take the difference between those two and pay it out in dividends and distributions to our shareholders. We are much more optimistic than we were last quarter. We think this is going to be a great 2011 and while we will proceed cautiously, we are expecting some good transactions in the near-term.

Just as a background, much of the economic base and the industrial base in the United States, they seem to be doing fine. The industrial and commercial properties in the US remain steady and most of them are paying their rents. There are some that are having problems, of course. And to my way of thinking though, things are much better now than they were last year and we expect significant growth in this Real Estate Investment Trust.

Also, I just want to mention again, we like Medical properties and have a few in our portfolio and we will hopefully add some more to our list of owned properties during the year. And while we don't have any Retail properties, like freestanding drugstores or fast food restaurants, we are going to be looking at those as well. At this point I just mention again, we are very optimistic about the Company being in fine shape for the future, but we will continue to be very cautious as we always are.

We are looking at a number of ways to continue the growth of this business and grow the -- and the growth is really limited to the lack of Commercial mortgages that are in the marketplace today. We continue to talk to some the local banks that provide mortgages on properties and these are local banks located near our properties. They may be able to offer us some mortgage money for our existing properties. We have about $80 million of properties that do not have a mortgage on them and we are working on getting mortgages on these. We have had a few term sheets and banks seem to have changed and we have had to move on to differ mortgage providers. We have a few term sheets outstanding now. We discussing those with the lenders and we'll just have to see where that comes out. But if we can find good mortgages on these and other properties than the new mortgages will free up some of the money that we have used to purchase the properties and we can use that money to buy additional good real estate.

We were successful in raising common equity over the past few months and it is likely that we will raise additional equity during 2011 once we use the new equity that we just raised to buy some properties. So look forward to that. Also, we continue to look at various forms of Preferred stock that we may be able to issue at a reasonable rate. I just want to note here that our Preferred stock is now trading at about par and I'm hopeful that we can find some way to raise additional funds while use Preferred stock or some variation thereof. We are looking at a lot of other ways of raising money, but right now it's really hard to tell you how we will do that at this point. We are going to need to raise equity unless the mortgage market comes back very strong.

From a distribution standpoint, in January 2011, the board declared the monthly distribution of $0.125 per common share for January, February and March. That is a run rate of $1.50 per year. And this is a great rate for this REIT today. Because the Real Estate can be depreciated, we are able to shelter the income of the Company, the distribution in 2010 was about 84% of return of capital and that is tax-free. And that means that this stock is a good one to hold in your regular account because it's so tax friendly, but it is also good for IRAs and any small Retirement Account. This return of capital that you see is due to the depreciation of the real estate assets and other items and has caused earnings to remain low after you factor in depreciation and that's why we always talk to you about FFO because that means we are adding back the real estate depreciation to give you a number that is more accurate in terms of what is actually happening in terms of cash flow in the Company.

Depreciation of the building is a bit of a fiction, as you all know, since at the end of the depreciation period, say 20 or 30 years, the building is still standing. On our books it would be valued at zero at that point in time. The great thing is that if you own the stock personally you don't pay any taxes on that part of the sheltered by the depreciation as it is considered a return of the capital. However, as we all know, the return of capital does reduce the cost basis of the stock, which may result in a large capital gain when the stock is sold. But if you are like me, you are holding the stock for ever and a day and don't really worry about that.

With the stock price now around $18.70 a share, the yield on our stock is right at 8%. Many REITs are trading at much lower yields. I just read a report that says the entire REIT universe is trading at about a 4.3% yield, and the net-net-net REITs that are like us, the triple net REITs, are at 5.7%. We should be trading at that level too and if we were, of course, the stock would be in the mid-20s. We did in 2006 the stock was trading as high as $22 a share and I just expect this Company to go back to that number over a period of time. We did have some institutions come in. One large institution bought some stock in our offering and I'm hopeful that once that information comes out it will encourage other institutions to look at the stock as well.

We will have our next board meeting in early April for a discussion about distributions for the month of April, May and June, so look forward to that Press Release as well. Now I am going to stop and have Amy come onboard and we will have some questions from our loyal shareholders and some of the analysts who follow our REIT.

(Operator Instructions) Our first question comes from Tom Roberts with Hilliard Lyons. Please go ahead.

Hello, David.

Good morning, Tom.

First, the cap rate rent on that fourth quarter acquisition you made?

Where did we put that? Did we put that in the financial statement some place? We will work on that, do you have another question?

Yes. How much rent was recognized in the fourth quarter?

Very little. That was closed in December, wasn't it?

December 15.

December 15.

Okay. Got that.

Virtually nothing.

All right, great. What type of property is the bankrupt tenant?

It's industrial. Again, it's office and industrial and it's located right near the airport in St. Louis. We had been trying to rent it, but when they are in bankruptcy you can't do anything and we had to be on hold. We are now preparing, now that they have declared the lease non, well, I guess it is void. They only had about nine months more to go on it. So, we have selected a real estate agent and we've prepared brochures, we've got signs going up. So, it's in a great location, we just have to see what that brings in the next six months.

Great. What's your property pipeline looking like, David? You mentioned two properties you expect to close on. Any discussion on what you're looking at?

It's all of the same things we have in the portfolio with the exception that we are making a push trying to get some more medical office building type things in the portfolio that may or may not be on the campus of the hospital. So, just to backup, the cap rate on that deal was about 9.5%. On the deal that (multiple speakers).

That's what I thought. Is that a GAAP or a cash?

That's GAAP. Yes. Everything is quoted in GAAP.

Okay. And the 8% to 9% cap rate that you are looking at, at properties, that's GAAP too, I take it?

Oh, yes.

Yes, okay. You mentioned medical office properties, is it all MOBs or are you looking at laboratories or things like that or just looking at MOBs?

So far it's all medical office buildings, MOBs now.

Okay. And finally, I think Chip mentioned $2.4 million under the ATM program, I think that's $2.4 million worth and not 2.4 million shares right?

That's correct.

Yes, that's correct, dollars not shares.

All right. Yes. I was wondering if you could do 2.4 million shares? All right, great. Thanks David.

Okay, next caller please. Amy, do we have another caller? Hello? I don't know, we can't hear anybody so, we've got the phone on, but it seems to have gone dead. Amy, do you know what's happened?

This is the operator. I believe there was a problem on her computer. Have you completed the question for Tom Roberts?

Yes we have. Go to Chris Lucas, he's up next.

Thank you. Mr. Lucas, please go ahead with your question.

Sure, just following up on John's questions about the ATM. David, was that the first time you guys accessed the ATM program?

We had accessed a small amount in the quarter ending September. It was a tiny amount, we got started a little late, but it is the first time we used pretty much a full quarter.

Okay. And then on the lease activity, both in the fourth quarter and in the first quarter, can you go through the metrics on that. It appears that the stuff that was either renewed or re-tenanted in the fourth quarter was negative, but that the first quarter was a positive and I guess I'm just trying to understand what those, to what degree those were, what drove those decisions, particularly on the first quarter extension given that the lease was already a 2026 expiration? What was the value or opportunity there to extend them? And then what was the cash difference in the lease rate?

Yes. Let me talk to you about that. They were trying to do -- sell off one piece of the property, because it is multiple locations, as well as they are doing some acquisitions. So, in order to accommodate them we had to do an enormous amount of analysis to make sure that we were doing the right thing and they paid a fee for that, work as well as not redoing the lease that much. So, that was the first part of it. And then in the first quarter we have another transaction in which they are doing a much larger deal in which we had to amend the lease significantly and that generated a lease fee of about $750,000 that will be amortized over the life of the lease. So, we got an extension both times and made it a much stronger lease.

So --

On that particular one that David's discussing, the lease was extended and added about $150,000 additional rent to the per year to the lease that's coming into the Company.

Okay, but that's the GAAP adjustment, so -- but I'm a little confused, is the fee paid in the first quarter or how exactly is that working?

As a fee that is in now, you can see the credit to the base management fee of $225,000 is a portion of that fee.

Okay.

That occurred, and additionally, we extended the lease which added about $150,000 additional GAAP income coming in. There is a second transaction that David discussed that we closed in this quarter, which is another modification to the deal with the exact same tenant, which will generate about a $750,000 fee that David mentioned will be amortized over the period of that lease.

Okay.

So, two different transactions.

Okay. And then on the second transaction, are the cash rents going up or are they -- is the, essentially, the bump in GAAP just a function of the extension?

No, cash rent went up too.

Okay. Okay. And then, I guess that really covers it for me, David. I guess the only other thing is, is that just in terms of the scale of the pipeline of deals that you are looking at, should we expect, again, a continued slow ramp or is there -- are there larger transactions or large volumes of single one-off deals that you are looking at that would suggest that the activity this year will be significantly ramped up?

Well, if significant means more than last year, of course, the answer is yes. We didn't do much last year. But it is just so hard, Chris. We get these deals in, we work them for a while and then find something is wrong with them, so we end up turning them down.My guess is you will see one or two transactions each quarter. Maybe it might be in some quarters three, but it is not going to be 10 transactions or one big monster transaction. We do see those kind of things, but our DNA here is to proceed cautious.

Okay. And then on the transaction you did complete in the fourth quarter, how much of the quote, due diligence expense, was property transfer related taxes and other fees associated with just transfer taxes as opposed to actual diligence expense?

Good question. It's about $386,000, which was about $0.045 a share. I don't know. We'll see if we can break it out.

Because the percentage on the -- just from a percentage of sales or of purchase cost is relatively high compared to what we see generally. And I was just curious as to what drove that?

Well I don't -- I think the problem that you are going see going forward is if you're trying to adjust historical or going forward numbers so that they say, okay, in the first quarter we did X and in the first quarter of 2009 we did Y, you are going to have to always adjust those for purchase accounting. For example, if you were trying to adjust for this one, you would have to add the $0.045, which would give you $0.395 in comparable earnings, or I'm sorry, FFO for that period ending December 31.

And the worst case is the one that happened in December that is you close it at the end of the quarter and especially at the end of the year in which you get hit with all the expenses and none of the rent. That is the unfortunate circumstance of purchase accounting, that change from 2009 to 2010. Every time you close a deal and have expenses it's going to impact earnings and all we can do is work with you and show you some of the numbers so that you can adjust them and have an adjusted FFO. But, about 63% was commissions paid on the transaction that you are talking about.

Okay. Commissions paid to who?

Let's see, we have a whole list here. Well, it is the partners, the broker in between.

Okay, but not to the adviser or the management Company?

Oh, no, I'm sorry, this is to independent brokers that we use in the marketplace. As you know, most properties are listed by brokers and not by the owners.

Right. No, I understand. I just want to make sure, I was trying to understood the fee structure and how it was flowing, but understand the third-party fee. And then just the last question, as it relates to your relationship with your line of credit facility and the dividend coverage and your FFO number, when you have expenses associated with an acquisition, is there an adjust -- it sounds like there is an adjustment made, for compliance with -- ?

Right. That is exactly right.

Okay.

What they do is they go back and add back purchase accounting numbers so that we come up, in this example, obviously we are close to $0.40 a share so paying out $0.375 is well within the guidelines of our line of credit.

Okay, perfect. Thanks, David.

Next question?

(Operator Instructions)

Are there no more questions?

Mr. Gladstone, I am not showing anyone further in the queue today.

Well we thank you all again. It was a great year, your team did a good job for you, but I am hopeful that this year coming up will be the granddaddy of them all and we will show you some real good numbers. Thank you all, that's the end of this call-in.

Your conference has now concluded. Thank you for attending today's presentation and you may now disconnect.