Gladstone Commercial Corp (GOOD) 2011 Q4 法說會逐字稿

Good morning, and welcome to the Gladstone Commercial Corporation fourth-quarter and year-ended 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. Please note this event is being recorded.

I would now like to turn the conference over to David Gladstone. Please go ahead, sir.

All right, thank you, Maureen. That was a nice introduction. And thank all of you for calling in. We enjoy this time we have with you, and wish there were a lot more of these. It's fun to talk with people and get questions.

And again, the invitation is open, if you are ever in the Washington DC area, we're located in a suburb called McLean, Virginia. And if you have a time to come buy you have an open invitation to stop by and say hello and see some great team members working for you.

Now, let me read the standard statement. This report that we are about to give may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Securities and Exchange act of 1934, including statements with regard to the future performance of the Company. These forward-looking statements may involve certain risks and uncertainties, and based on our current plans, we believe those plans 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, of our 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 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 operations, or as we call it, FFO. And since FFO is a non-GAAP accounting term, I'll define it here as net income, excluding the gains or losses from the sale of real estate, plus depreciation and amortization of the real estate assets. The National Association of Real Estate Investment Trusts, or NAREIT, has endorsed FFO is one of that non-accounting standards that we can use to discuss our REIT. Please see our 10-K, filed yesterday with the SEC, and our financial statements for a detailed description of FFO.

As always, we begin the calls that we do every quarter by hearing from our President, Chip Stelljes. Chip is also the Chief Investment Officer of all the Gladstone companies. Chip, go ahead.

Well, good morning. We had a lot of activity since we spoke last quarter. And we acquired six properties, issued long-term debt, raised preferred equity, and expanded our line of credit. As of today, all but two of our buildings are occupied, and all the buildings that remain occupied are paying as agreed.

The two empty buildings constitute about 2.3% of our gross portfolio income, and about 1.3% of the total square footage space that we own. We continue to take appropriate action to re-tenant these properties as quickly as possible. We acquired six new properties, a total of 194,000 square feet, for $38.9 million. The properties are a mixture of office and retail, and the average cap rate over the term of the six leases is 9.0%.

Of note, two of these properties are freestanding Walgreens drug stores that have lower average cap rates, in the 7s. However, because Walgreens is a credit tenant, we were able to issue long-term debt at 4.5% on one of these properties, and are working to issue debt on the second Walgreens at a similar rate.

The market for long-term mortgages as been limited for some time; however, we have recently seen five- to 10-year mortgages become more obtainable. The collateralized, mortgage-backed securities, or CMBS market, where we had traditionally secured mortgages, have been attempting to make a comeback in recent months, but is much more conservative than it was prior to the recession. And the pricing in the market remains volatile. Consequently, we are looking to regional banks, insurance companies, and other non-bank lenders, and, to a lesser extent, the CMBS market to issue mortgages to finance our real estate activities.

We issued three new mortgage notes in the fourth quarter for $20 million at a weighted average interest rate of 5.7%. These three notes were issued from regional banks in close proximity to the properties financed. In addition, we are working on a CMBS mortgage pool that will finance four of our properties that are currently pledged to our line of credit, and we're hopeful this can close soon.

On the equity side, we issued $38.5 million of our Series C Preferred Stock, which is traded on the NASDAQ under the ticker symbol GOODN. We used the proceeds to initially pay down our line of credit, and will invest the remaining funds over the next few months into new properties. But we don't anticipate needing additional equity until sometime later in 2012, or in 2013.

Despite the challenges in the marketplace, we were successful in raising cost-effective equity and issuing additional term debt to grow our portfolio of properties. While we are seeing signs of improvement in both the equity and the debt capital markets, we believe these markets will remain somewhat challenging during 2012.

We continue to only use their line of credit to make acquisitions that we think can be financed with longer-term mortgage debt. As you recall, our customary model was -- called first to initially borrow from the line of credit to buy properties. And we then obtain longer-term fixed-rate mortgages as soon as we can. We are then able to secure a spread between the rent coming in and the mortgage payments going out. And by doing this, we are able to lock in profit for five to 10 years or, in some cases, longer. The proceeds from the mortgages will then pay down our line of credit, thus making the line available to the next purchase of properties. As noted, we did expand our line of credit from $50 million to $75 million in January to give us more capacity to acquire additional properties.

With the turmoil in the credit and equity markets over the last few years, our business model adjusted so that we're trying to match as closely as possible long-term leases with longer-term credit. So if we don't believe we can source and attract a debt on new acquisitions, then we will only buy properties that already have long-term mortgages on them. We're able to simultaneously close long-term debt on two of our recent acquisitions, and are in talks with various lenders to place term debt on the remaining four properties.

In the meantime, these four properties have been financed by our line of credit. Our current availability under the line, after paying the balance to $0 from the proceeds of our preferred offering, is $39 million. In addition, we have approximately $8 million of cash on hand. So, assuming we can obtain 65% loaned value on new acquisitions, we've got enough equity available to acquire about $100 million in new properties.

We also continue to improve the value of our existing portfolio of properties by reviewing and renewing existing leases and performing improvements at our properties, and then selling certain of our assets. To this end, we are actively working with our existing tenants who have leases expiring in 2012 and 2013, to renegotiate the terms of their leases and extend those terms.

We're relatively confident that the tenant for their one remaining lease that expires in 2012 will renew their lease, and we are in negotiations with this tenant now.

We continue to focus on maintaining our portfolio and working with our existing tenants to extend these leases that we've discussed. At year end, all of our existing tenants have paid as agreed, and our portfolio is 98% leased.

We have two buildings without tenants. And, again, we're working hard on finding new tenants for each of these. Signing new leases is going to require some capital outlay for leasing conditions, tenant allowances, et cetera. And the pipeline on new deals of possible acquisitions is strong today, and we hope to close on a few more properties in the upcoming months. So, stay tuned.

And with that, I'll turn it back to David.

All right. Good presentation. And now let's turn it over to our Chief Financial Officer, Danielle Jones, for a report on the financial results. Danielle?

Good morning. Our quarterly and year-end results were positive, and reflect our growth during 2011. At year end, our total assets increased to $453 million, up 10.4% from 2010. The amounts outstanding under long-term mortgages in our line of credit increased to $304 million, which were up 6.1%. And our stockholders' equity increased by 21.5% to $135.3 million. Our balance sheet remains strong.

We have mortgage debt in the aggregate principal amount of $4.4 billion payable during 2012, and $58.5 million payable during 2013. We have no mortgage maturities in 2012. The mortgage payments due in 2012 are only principal amortization payments, and we have sufficient liquidity to pay these amounts.

Of the $58.5 million of principal payable in 2013, $53.9 million of the loan principal payments are not due until the fourth quarter of 2013. We are currently in discussions with those lenders, and anticipate being able to extend the maturity dates or, alternatively, refinance the mortgages with new lenders.

The weighted average interest rate on our existing mortgages is 5.7%. We had $18.7 million outstanding under our line of credit at the end of the year at a weighted average interest rate of approximately 3%, or a total of $304 million in mortgages and short-term borrowings resulting in a debt-to-equity ratio of approximately 2.2 to 1.

In addition, during the first quarter of 2012, we completed a public offering of 1.54 million shares of our 7.125% Series C Term Preferred Stock at a price of $25 per share, resulting in gross proceeds of $38.5 million. We used the proceeds from the offerings to repay the outstanding balance on our lines. Due to its mandatory redemption feature, the preferred stock will be classified as a liability on our balance sheet. And the costs incurred related to this offering will be recorded in deferred offering costs during the first quarter, which we will record as an asset on our balance sheet and will amortize over the redemption period ending January 31, 2017.

Our sources of liquidity continue to include cash flows generated from our operations, existing cash on hand, availability under our line of credit, obtaining mortgages on our unencumbered properties, and issuing additional equity securities. Our current available liquidity is approximately $47 million, comprised of $8 million of cash on hand and an available borrowing capacity of $39 million under our line of credit.

The borrowing capacity on our line is limited to a percentage of the value of properties pledged as collateral to the line, less both the amount on standing on the line and outstanding letters of credit. With the capacity under our line and our current cash flow from operations, we have sufficient liquidity to acquire additional properties, fund our operations (technical difficulty) preferred debt this year, perform capital improvements to our properties, and maintain our distributions to our common shareholders.

In addition, we continue to have the ability to raise $218 million of additional either preferred or common stock equity through the sales of securities that are registered under our existing shelf registration statement and one or more future public offerings. Of the approximately $218 million of available capacity, approximately $22 million of common stock is reserved for additional sales under our open market sales agreement.

And now we will discuss the operating results. Please note that per-share numbers referenced are fully diluted weighted average common shares. FFO available to common stockholders for the quarter was approximately $3.8 million or $0.34 per share, which was a 24% increase in total FFO from the same period last year. The increase in FFO for the quarter was primarily a result of the 12% increase in our rental income compared to the fourth quarter of 2010, because of income generated from the seven properties acquired during 2011.

Our G&A costs also decreased, because of a decrease in professional fees. We incurred professional fees in 2010 from fees associated with the termination of our private offering of the unregistered senior common stock. And we also had higher legal costs in 2010 from transactional work at certain of our properties. This was coupled with a decrease in our net incentive fee, due to an increase in our common stockholders' equity from issuance of 2.2 million common shares during 2011, resulting in a higher hurdle rate to overcome, which is the main component of the calculation. This was partially offset by an increase in due diligence expense during 2011 from acquisitions during the year, combined with an increase in the base management fee during 2011.

FFO for the year was $15.7 million, or a $1.53 per share, an 11.6% increase over the prior year's total FFO. The increase in FFO for the year was a result of what I just discussed, coupled with an out-of-period adjustment recorded during the three months ended March 31, 2011, for $250,000, which related to due diligence costs in the Company's acquisitions during the quarter ended December 31, 2010, which were inadvertently expensed rather than capitalized into the cost of the property. These expenses were costs-born by the seller of the property and should not have been expensed by us. This was partially offset by $3.3 million of additional income and pre-payment fees we received in July 2010 in connection with the early repayment of our only mortgage loan.

FFO per share was down from 2010 because of issuance of the common shares during 2011. We were not able to pay out a large percentage of the incentive fee because of additional equity raised in June, which was not put to work until the fourth quarter. We are hopeful that we will be able to pay out a larger percentage of the incentive fee during 2012. And as we continue to build our portfolio, we will be able to consistently pay out 100% of the incentive fee earned, so that we will be able to grow our FFO.

And now, I'll turn the program back over to David.

All right. Good report, Danielle. We encourage all the listeners to read the press release and the annual report that was filed yesterday with the SEC, called Form 10-K. You know, there's a lot of good material in there. And I think sometimes we don't have time to read it, and it's awfully good stuff in there. You can find all of those on our website at www.gladstonecommercial.com, and it's on the SEC website. And if you call here, will actually print one out and mail it to you.

To stay up-to-date on the latest news involving Gladstone's commercial and all of our public companies for that reason, you can follow us on Twitter, named GladstoneComps; and also on Facebook, under the keyword TheGladstoneCompanies. And you can go to our general website and see more information at www.gladstone.com.

The main news to report, since we last spoke with you we were able to acquire the six properties, issue additional mortgage term debt, raise some preferred equity, and expand our line of credit. All of this is very positive news to our stockholders. And we are happy to report it, and hopeful that 2012 will be that way as well.

They do have a nice pipeline built up of properties to buy. And because the pipeline is so good, we hope to be able to grow the assets even more during 2012.

We're still selling our senior common stock, and have sold over $1 million worth to date. Momentum is building on the program. It is the lowest cost of the equity offerings that we have today. And I'm hopeful the stock price will come up. But in the interim, we'll keep selling senior common stock.

I just think this Company, now, is in a great position to increase the assets and to increase the income on those assets, so that 2011 was a great year, but I think 2012 will be stronger than 2011.

On another note, I'm hopeful that we can find some attractive long-term mortgages to finance our unencumbered properties. The mortgage marketplace that some of the banks is getting much better, but it's still not as robust as it was before the recession. And I hope we can announce additional financing for some of our non-mortgage properties in the near future. We've been working on them for quite a while, and this will move the properties off our line of credit and finance them long-term.

We continue to look at properties with mortgages already on them, so we can assume them. And that way, we know we have a secure financing in place. Also, we work on properties that we think we can close simultaneously with mortgages on them. And we've been able to do two of the properties in the fourth quarter that way. And I think we'll do some more of those in 2012.

As I mention each time, the marketplace for real estate properties is divided up into three big groups. There are the AAA rated tenants that are located out there in high-quality real estate. And those are taken up by the big, large REITs at much lower rates than we can assume. There are a lot of insurance companies buying those, in pension funds. The cap rates continue to move around there. I don't know whether they will ever get close to what we need in order to make money.

There's also small real estate properties, like fast food locations, that we don't do; and pharmacy chains that have been purchased by individual investors over the years -- those are going for 6.5 to 7 cap rates now. They do this -- people buy this in place of the bonds for those companies. And we actually purchased two of those last year that were somewhat out of the marketplace. For example, one has a ground lease on it. And a lot of people don't like ground leases, but this is in commercial and office and industrial properties, as well as some medical properties. Those are the sweet spots for us.

About 45% of all of the properties we have are tenants with ratings. And then the rest of them are non-rated tenants. And our competitive advantage in that area is the expertise we have in underwriting the non-rated businesses. As most of you know, we have two businesses -- two funds that we manage -- that do nothing but lend and invest in small businesses. So we have the expertise in-house to underwrite those smaller tenants.

So we are in a good position to see a lot more opportunities here. The cap rates for this group are in the 8% and 9%-plus range. And we're hopeful to bring in quite a few more of those during the 2012 period. We are focusing our efforts on good transactions in the near-term. I hope everybody knows we're back in the marketplace, so we're starting to see a lot of stuff.

Much of the industrial base that rents industrial and commercial properties is in pretty steady hands. There's still some businesses obviously that are having problems. We avoid those. But in our way of thinking these days, this last year, 2011, was great. And we think 2012 is going to be very a significant growth period. I am optimistic that the Company will be fine in the future. Nevertheless, we'll continue to be cautious in our acquisitions, as we've done in the past years. As you know, we were able to go through the recession without cutting the dividend or having a lot of problems. And I think if there is another recession in the near-term, we'll come through that one very well -- as well as we did in the last one. We were successful in raising some common equity twice in 2011. And, of course, the preferred that we just raised in 2012 and we'll be using -- we've used the equity that we raised in the common, pretty much used up. And now we've got to put to work on the preferred that we have.

January 2012, the Board maintained a monthly distribution of $0.12 per common share for January, February and March. So the annual run rate is $1.50 a year. And this is nice that we've been able to do that for so many years. We've been able to pay our preferred, our senior common, and our common. We paid 91 consecutive common stock dividends since inception, and we went to the recession without having a hitch in that.

Because the real estate can be depreciated, we are able to shelter the income of the Company. Distribution in 2011 was about 83% of return on capital. And that of course, to individual investors, is tax-free. So this is a very tax-friendly stock. And in my opinion, it's a good one to have in your personal accounts. And we're just seeking income. And for those who are seeking income, we think this is a great fit for their personal statements.

This return of capital is due to the depreciation of the real estate asset and other items that we have on the balance sheet. And it causes earnings to remain low after depreciation. That's why we talk about FFO, because that adds back the real estate depreciation.

You know, folks, the depreciation of a building is a bit of a fiction, since at the end of the depreciation period, the building is still standing. Yes, you have to put a few dollars in it, but you've depreciated it down to $0.

And the great thing is that, if you own stock personally, as opposed to having it in an IRA or retirement plan, you don't pay any taxes on that part that is sheltered. However, the return of capital does reduce the cost basis of the stock, which may result in the larger capital gains when the stock is sold.

Just to mention again, the price of the stock was about $18.31 yesterday. And so the distribution yield is about 8.2%. Many of the REITs are trading at much lower yields. I just read in the entire REIT universe is trading at about 4.1% yield. If we were trading at that today, the price of the stock would be $36. And the triple-net REITs are trading at about 5.7%. And if we were in that range, we'd be in the $26 range. So I think we have a lot of room here for this Company to trade up, as people get comfortable with the portfolio that we have, and learn more about us. The stock was over $20 before the recession, and, I think, will come back up.

The Board will vote early in April, during the quarterly Board meeting, for the monthly distributions in April, May and June. I see no reason we won't meet those dividends as we have thought out.

And now, why don't we just stop at this point in time, and have some questions from the shareholders and analysts who are on the phone.

So, Operator, if you will come back on and tell our listeners how they can ask some questions.

(Operator Instructions). Andrew DiZio, Janney Capital Markets.

Just a couple of property-specific questions. First, do you guys have any updates on the leasing efforts at either the Hazelwood or the Richmond assets?

Richmond is going along very nicely. We do have a tenant that wants to rent it. We signed an LOI, negotiating final terms of the lease now. I don't expect it to get started for quite a few more months, because it's just going to take us a while to get through the negotiations. But we are moving forward on that one. Now, the other one is still sort of in limbo. We keep having people through it, but nobody has signed up yet.

Thanks. And then on the Roseville asset -- in the K, it looks like you guys leased about a third of that with the prior tenant. And the other two-thirds, you're looking to re-lease by the end of this year. Does that have any effect on the mortgage loan that is accompanying that property, if you're not able to re-lease the other two thirds?

Well, we went through that with the lender on that, and they signed off on the new lease. We actually get about half of the rent that we would have gotten before. And we've got plenty of room.

We're a little bit behind the eight ball on that, because we wanted to -- we had several tenants. This property has potential for being a data center, and a lot of it is already data center by this current tenant. And that's why they wanted to stay in the building, at least partially. So we've been working with people who wanted to come in. But we haven't been able to get to them, because we hadn't signed up the lease with Unisys. Now that we have that in place and are finishing up that, it will be possible to move forward. But to your point, the lender did sign off on the lease, and made no changes in the loan. So everything is still in place.

So even if you're not able to release the other two thirds, there's no change with the loan status.

Shouldn't be -- I mean, they've approved it. So we're just going forward the way we are today.

Great, thanks a lot. That's all for me.

Next question, please.

David Miyazaki, Confluence Investment Management.

I was wondering if you could maybe talk about the properties that you acquire that already have existing mortgage on them. Obviously, that saves a lot of G&A expense when you don't have to go out and get the financing for it. But how much, in cap rate, do you usually give up on something that already has an assumable mortgage on it?

Well, there is usually an assumption fee, so it's not exactly a freebie. You usually have a .5 a point to 1 point to assume a loan that is already in place. So we usually -- it's all calculated in. And we haven't really lost any of what you would term an ability to get good leases in place with good mortgages. So the spreads have not contracted on those kind of transactions.

So the cap rates aren't any lower because there's financing that's already attached?

No, well --

If it is, it's just that it's lower, but the mortgage is lower so the spread is still more or less the same, or we wouldn't be doing the transaction. So yes, there may be a lower cap rate, but that's because you got a fairly lower mortgage rate on there. But the spread for us has remained constant. (multiple speakers)

And the opposite is true as well, which is sometimes the loan is not as attractive. And we have to price the purchase of the property in order to assume that loan, and it still makes the spread that we are talking about.

Okay, thank you very much.

Our next question, please.

(Operator Instructions).

You know, one of the things that has come up, just wanted to mention it, is that in sometimes it looks like a lease -- for example, the Unisys lease, where we got to work hard this year and get some more tenants in. Sometimes it looks like we're running against a wall. And no one counts in the fact that we could lease some of the properties that we have that are currently not leased.

And, in addition to that, over the past we've always been willing to give up our incentive fee. We have about $3.3 million, $3.4 million in incentive fees. And over the years we've always given that back to the Company in order to make the numbers. So for those of you who are worried -- and by the way, when you're giving up the incentive fee, it gives us a huge incentive to go out and get transactions done and get places leased up.

So my guess is that during the year, you'll see a lot of activity. And if not, then, obviously, we won't earn the incentive fee that we always like to earn. So just put that in your analysis when you are looking at things.

Do we have any other questions?

Jeff Rudner, UBS.

Congratulations on a very nice finish to the year. A question about the dividend, which you referred to earlier. Obviously you have been paying $0.125 a month for many, many years now. But the FFO this past quarter was about $0.34, $0.35, which did not cover the dividend. Do you anticipate, or when do you anticipate, the FFO to cover the dividend going forward?

The problem was that we raised the equity money and didn't get it to work as fast. So now that it is to work, I think you'll see that. The other thing that impacts that that didn't impact it in the past, is that we have due diligence expenses that have to be expensed now, during the quarter in which they are incurred. It used to be that you amortized them.

So, for example, in the fourth quarter ending December 31, we had over $500,000 worth of due diligence expenses. So it's a bit of a change to the way the world works. And that this point in time, we thought that we could have the people who are selling us the property pay the due diligence expense. But that's not allowed under the accounting rules. So, as a result, we've ended up having to put that in as an expense.

But Jeff, right now, I would say, going forward, we've got the dividends -- obviously, the preferred and the senior common dividends are covered in spades. And I think we do have the current dividend covered, as well, in terms of earnings.

Now, that will change. Let's say, for example, in this quarter and the next quarter, we have a large number -- five, six transactions. That will make the expenses, the due diligence expenses, jump up and pound into that amount that you have available for the dividend. But that's only a one-quarter event. And then, the next quarter, of course, you're back up again.

So, anyway, that is a thumbnail sketch of how we look at the world. And if we just keep putting good deals on the books and growing the assets, I think things will be very, very strong for us this year.

Well, thank you very much, David.

Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to David Gladstone for any closing remarks.

All right. Thank you all for tuning in. And we will talk to you again in next quarter, which will be a little bit quicker, because it will be a 10-Q next time. Thanks, all, for calling in. That's the end.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.