Gladstone Commercial Corp (GOOD) 2012 Q4 法說會逐字稿

Good morning and welcome to the Gladstone Commercial fourth-quarter and year ended December 31, 2012, conference call. All participants will be in a listen-only mode. (Operator Instructions) Please note this event is being recorded.

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

All right. Thank you, Emily, and thanks to all of you for calling in. We always enjoy these times that we have with you on the phone, and we certainly wish we had more time to talk to you.

Please come and visit us if you are ever in the Washington, DC, area. We are located in a suburb called McLean, Virginia. You have an open invitation to stop by and see us if you are in this area.

You will see a great team at work. There is now about 57 members of the team, so we are no longer a small Company. We are sort of midsized and -- oh, we have a few puppy dogs out here as well that come into the office on a regular routine basis.

Now I will just read the forward-looking statements that we read each time. 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 Exchange Act of 1934, including statements with regard to the future performance of the Company. These forward-looking statements involve certain risk and uncertainties that are based on our current plans, and we believe those plans to be accurate. There are many factors that may cause our actual results to be materially different from any future results expressed or implied in these forward-looking statements, including all those factors listed under the caption Risk Factors of our Company's 10-Ks and 10-Q filings that we file with the Securities and Exchange Commission.

All those 10-Ks, 10-Qs, and other documents 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 of the 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 FFO as we abbreviate it. Since FFO is a non-GAAP accounting term I need to define FFO as net income, excluding 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 has endorsed FFO as one of those non-accounting standards that we can use in discussing our REIT. Please see our 10-K filed yesterday with the SEC and all of our financial statements for a detailed definition of FFO.

Now we will begin the call today by hearing from our President, Bob Cutlip. Bob is out in California looking at real estate. So, Bob, why don't you come on the line and tell us about your section?

Thank you, David. Good morning, everyone. Since we last spoke the Company has acquired two additional properties; issued or assumed long-term debt on both of these properties; refinanced our largest mortgage; issued common equity under our ATM program; and extended the term on three of our upcoming expiring leases. Our pipeline remains robust, and we hope to announce additional acquisitions in the near future.

Now for some details. At December 31, 2012, all but two of our buildings continue to be occupied, and all of the occupied buildings' tenants continue to pay as agreed. The two empty buildings constitute about 1.9% of our stabilized gross portfolio income and about 1.2% of the total square feet of space we own. We continue to take the appropriate action to re-tenant these properties.

We acquired two additional properties this quarter. The first property we acquired is an industrial facility with approximately 208,000 square feet, which was purchased for $20 million and is located in a large, industrial business park in Fort Worth, Texas. We funded this acquisition through a combination of borrowings from our line of credit and the assumption of $14.2 million of mortgage debt on the property.

This property serves as the federal records center for the National Archives and Records Administration Southwest Region and provides storage for records created or received by over 100 federal agencies located in Arkansas, Louisiana, Oklahoma, and Texas, Including US District and Bankruptcy Courts and the Internal Revenue Service. The National Archives has leased the property for 14 years and the lease is fully guaranteed by the US government.

The second property we acquired this quarter is an office building with approximately 147,000 square feet, which was purchased for $29.2 million and is located in Columbia, South Carolina. We funded this acquisition through a combination of borrowings from our line of credit and the issuance of $19 million of mortgage debt on the property. This property serves as an operations center for Verizon Wireless, and they have leased the property for 10 years with three 5-year renewal options.

These two acquisitions, combined with earlier purchases, result in a total investment volume of $107.2 million for 2012, our second-largest annual volume since the REIT was established in 2003.

Switching to mortgages, the market for long-term mortgages has improved. Mid- to long-term -- that is, 5- to 10-year -- mortgages are becoming much more attainable.

The collateralized mortgage-backed securities or CMBS market has made a comeback in recent months, but it is still more conservative than it was prior to the credit crisis and the market remains somewhat volatile. Consequently, we also look to regional banks, insurance companies, and other non-bank lenders as an alternative to finance our real estate activities.

During the quarter, we issued or assumed two new mortgages on both of our new acquisitions for $33.2 million. We also borrowed $34 million collateralized by seven of our properties in order to repay our $45.2 million mortgage which, with extension options, would have been due October 1, 2013. We repaid the mortgage in full in October 2012 without incurring any exit fees.

These mortgages were issued at a weighted average interest rate of 4.8%, and the weighted average loan-to-value obtained was 67%. Depending on several factors including the tenant credit rating, the location of the facility, and the terms of the loan, today we are seeing interest rates in the range from 4% to 5% -- historically low rates.

Now let's address equity. We utilized our At the Market or ATM program during the fourth quarter and issued additional shares of common stock for gross proceeds of $2.5 million. We used this additional liquidity for working capital needs and to reduce the balance under our line of credit.

Our stock price has been higher over the past several months, so this was a great opportunity for us to issue a small amount of equity, to reduce our leverage without impacting our stock price. We continued the sales in January, and we issued a small amount of common stock. We anticipate utilizing this program throughout 2013 as needed, in order to continue our long-term goal of slowly reducing our leverage.

We continue to only use our line of credit to make acquisitions that we believe can be financed with longer-term mortgage debt. As you may recall, our customary business model calls for us initially to borrow from the line to buy properties. We then obtain longer-term fixed-rate mortgages as soon as we can.

By doing this, we are then able to secure the difference, or the spread, between the rent coming in and the mortgage payments going out, thus locking in the profit for 5 to 10 years or in some cases even longer. From a liquidity perspective, the proceeds from the mortgages then pay down our line of credit, thus making the line available for the purchase of our next property.

We expanded our line from $50 million to $75 million this past January to give us more room to acquire additional properties. We also had one additional bank joined the bank syndication group.

Our line of credit matures in December 2013. We are currently in discussions with both our existing lenders and various other lenders to either renew our existing line or to implement a new line of credit. We anticipate being able to extend or issue a new line well in advance of the maturity of our existing line.

With the turmoil in the credit and equity markets over the past few years, our business model adjusted so that we are matching as closely as possible long-term leases with longer-term credit. If we do not believe we will be able to source attractive debt on new acquisitions, then we will only buy properties that already have long-term mortgages on them.

Currently, we have enough availability to fund our current operations and any upcoming improvements at certain of our properties. However, we will need to raise equity if we have a lot of deals closing.

Turning to our tenants, we continue to improve the value of our existing portfolio of properties by reviewing and renegotiating existing leases and performing improvements in our properties. To this end, we extended the term on three of our leases, two of which were expiring in 2013.

However, the remaining existing tenant with a lease expiring in 2013 recently notified us of their intent not to renew. This lease represents less than 1% of our rent. The property is a 12,000 square foot medical facility and is favorably located next to a major hospital in Houston, Texas.

We have initiated re-leasing efforts. Locating new tenants and signing leases with existing tenants for these buildings may require some capital outlays for tenant improvements and leasing commissions.

In summary, at year end, all of our existing tenants are paying as agreed and our portfolio was 98% leased. At December 31, 2012, we had two buildings without tenants. We have subsequently signed a lease, pending lender approval, for the entirety of one of these buildings and are aggressively pursuing tenant prospects for the other.

We also are aggressively pursuing new tenant prospects for our partially leased building in Roseville, Minnesota, in the Minneapolis market. The existing tenant renewed the lease but only took one-third of the building, and we are looking to re-lease the remaining space.

Our pipeline of possible acquisitions is strong today, and we hope to close on more properties in the upcoming months. Please stay tuned. Now let's turn it back to David.

All right. Thank you very much. Good presentation.

Now let's turn to our Chief Financial Officer and Treasurer, Danielle Jones, for a report on the financial results.

Thanks, David. Good morning, everybody. Our quarterly and year-end results were strong and reflect our growth from our recent acquisitions. This is evidenced by our total assets increasing to $565 million, which is up 25% from one year ago.

The amounts outstanding under long-term mortgages and our line of credit also increased to $384.2 million, which was a 26.3% increase from last year. In addition, our stockholders' equity including our term preferred stock increased by 18.9% to $160.9 million from our preferred equity offering in January of 2012 and the issuance of common stock under our ATM program during the fourth quarter.

Reviewing our upcoming long-term debt maturities, we have mortgage debt in the aggregate principal amount of $15.6 million payable during 2013 and $24.4 million payable during 2014. The 2013 and 2014 principal amounts payable includes balloon principal payments due in December of 2013 and June of 2014. However, we are initiating conversations with these lenders in advance of these maturities and anticipate being able to extend the maturity dates or refinance with new lenders.

An investment-grade tenant at a property where our debt matures in December of this year recently extended their lease for an additional 10 years. Thus we believe we will be able to refinance this mortgage relatively easily. We intend to pay the additional debt amortization payments from operating cash flow and borrowings under our line of credit.

As Bob mentioned, we were able to refinance our largest mortgage, the $45.2 million GE mortgage that originally matured in 2012, with KeyBanc, which closed in October of 2012. The KeyBanc mortgage was a $34 million 10-year mortgage on seven of the nine properties that had been originally financed under the GE mortgage.

We placed the remaining two properties in our borrowing base on our line of credit. We funded the difference between the KeyBanc mortgage and the GE payoff with existing cash on hand.

We were able to reduce the weighted average interest rate in our existing mortgages by 10 basis points this quarter to 5.6% from the drop in interest rates from the new mortgages we've placed on our property.

Turning to our line of credit, we had $25 million outstanding under the line at the end of the year at a weighted average interest rate of approximately 3%. As Bob discussed, our line matures at the end of this year, but we are actively working on extending or replacing the line today.

Our debt-to-equity ratio at the end of the quarter, excluding our new tranche of term preferred, was 3.1-to-1. We are focused on decreasing our debt-to-equity ratio in the next couple of years as we continue to issue common stock under our ATM program.

At February 15, our available liquidity was approximately $13.6 million, which comprised of $3 million of cash and an available borrowing capacity of $10.6 million under our line of credit. The borrowing capacity on our line is limited to a percentage of the value of property pledged as collateral to the line, less both the amount outstanding under the line and our outstanding letters of credit.

With the capacity in our line and our current cash flows from operations, we have sufficient liquidity to continue to fund our operations, service our debt this year, perform any capital improvements we need we need at our properties and maintain our distributions to our common stockholders. In addition, we continue to have the ability to raise $214 million of additional preferred or common stock equity through the sale of securities that are registered under our shelf registration statement and one or more future public offerings.

Now I'll 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 $4.2 million or $0.38 per share, and $16.4 million or $1.50 per share for the year, which was about a 12% and 4% increase, respectively, when compared to the same periods last year for total FFO. Total FFO increased primarily because of the 20% increase in operating revenues derived from the eight properties acquired in 2012, which was partially offset by a 24% increase in interest expense from the mortgage debt that we issued and assumed during 2012, coupled with the dividends paid on our Series C term preferred stock, which was not outstanding in 2011.

There was also an increase in property operating expenses during the quarter. Property operating expenses increased because of ground lease payments we are now responsible for at two of our properties, and overhead expenses and franchise taxes we are responsible for paying at our vacant properties.

Our funds from operations have not grown as we would like because of the additional preferred equity raised in January and the debt issued during 2012, which was not fully deployed until the latter half of the year. This lag between the time we raised the money and when we put it to work reduces funds from operations in the short term. We hope 2013 will be a better year for growth for us, and now I will turn the program back over to David.

All right. That was a good report, Danielle. We encourage all the listeners to read our press releases and our annual report, certainly the one that was filed yesterday with the SEC called Form 10-K. There are a lot of good material in that document. You can find that and all the other documents at our website, www.GladstoneCommercial.com, and also on the SEC website.

To stay up-to-date on the latest news involving Gladstone Commercial and our other public companies, please follow us on Twitter using the name GladstoneComps and on Facebook; the keyword is The Gladstone Companies. And you can go to our general website and see more information about all the Gladstone entities; that is at www.Gladstone.com.

I think the main news today is that we are reporting really good numbers for the quarter, that we were able to acquire $50 million of additional properties, issue long-term debt on both of these acquisitions, refinance our largest mortgage that came due for another 10 years, which just pushes that way out. We issued some common stock under the ATM program and certainly extended three of our leases. So this is all very positive news for all of our shareholders and those who are thinking about buying some stock.

We have built up a nice pipeline of potential properties. Bob came onboard during the summer and he has been instrumental in helping everyone move this along.

We are interested in acquiring because of that pipeline, and we hope to be able to grow the asset portfolio even more during 2013. With the increase in portfolio of properties come greater diversification, and we certainly believe that is better.

We are still selling some of our senior common stock. We sold about $1.8 million of that.

That has been designed for a specific marketplace. We have a new group in place that is marketing that now, and I think that will pick up during 2013, so we will get some additional equity coming into the Company from that.

On another note, we have been able to find some attractive, long-term mortgages to finance our unencumbered properties. These mortgages are market from banks and getting much better. We are now having long-term mortgages on 64 of our 80 properties that we own, and most of the remaining properties are pledged as collateral on our line of credit and provides us with additional liquidity.

We also continue to look at properties with mortgages on them that we can assume when we buy the properties, and just close or secure financing at the same time and close simultaneously, as we have on the two properties that we acquired in 2012. We don't close on the debt simultaneously, then, we have been able to successfully obtain debt on the properties just a few months later.

So this is the way we operate. Bob explained to that.

As all of you know, the market for real estate properties is divided into what I consider three big categories. There is the one piece of the business that has AAA and BBB rated. These are rated tenants located in high-quality real estate area.

They are sought after by the large real estate investment trusts, insurance companies, and pension funds. The cap rates continue to move around on this; and today they are significantly lower than they were last year this time and are continuing to be out of the reach of companies like ours.

Small real estate properties is another category. These are the fast-food locations or pharmacy chains. These are being purchased by individual investors at cap rates that yield about 6.5%.

We have seen some of those move up a little bit, but we have seen some others move down. They do this -- that is, the buyers do this for income.

We purchased a couple of these in the last few years at somewhat normal market times. I am not sure there is any available for us during this market cycle.

Then a third area is the one that we are in and we like the most. The area we most like to invest in is this middle market that we see.

These are mostly non-rated tenants, although we have a large number of rated tenants. We have unrated small and medium-sized businesses in commercial and office and industrial properties as well as some medical properties.

Our competitive advantage here is the expertise that we have to underwrite non-rated business tenants in conjunction with the acquisition of the real estate. We are in a good position to see a lot of opportunities here. Cap rates for this group are in the 8% and 9% range even today; and with leverage that gives us an 11%, sometimes even as much as a 15% return on equity.

We are focusing our efforts on finding good properties in this category with long-term financing that match our long-term leases. We are much more optimistic that things are going to be positive for us during this 2013 year. So while we proceed cautiously, as we always do, we are expecting some beneficial transactions in the near term.

So one of the things I need to mention here is that we may have to raise equity during the year. As you know, the disconnect between the time that we raise the equity and finally get it invested and our FFO finally moved up from $0.34 to $0.38 a share, so we're up to $1.52. I am hopeful that if we have to raise equity this year, we can use most of it to pay down debt and then come back into the marketplace to replace that.

Much of the industrial base that rents industrial and commercial properties remains steady and most of them are paying their rent, so we have had had good luck there. And we see mostly good properties out there in the business world today.

But there are still some businesses that are having problems, and the economy is still not in good shape. However, we expect this 2013 year to be fine.

While I am optimistic that our Company will be fine in the future, we will continue to be cautious in our acquisitions, as we have done in past years. We made it through the last recession without cutting the dividend or having a lot of problems from the tenants. And if there is another recession lurking on the horizon, I think our portfolio will go through that easily, too.

We were successful in raising common equity twice in 2011 and preferred equity in 2012. We used the new equity to fund our acquisitions over the past couple of years.

We also raised a little common equity with the ATM program in the fourth quarter and continue to use that in 2013. This ATM program during 2013 helps us fund our pipeline of acquisitions. And even with that in place, I think we are likely to raise some common or preferred stock during 2013.

In January 2013 the Board voted to maintain the monthly distributions of $0.125 per common share for the January, February, and March, so an annual run rate of about $1.50 a year. This is still a very attractive rate for such a well-managed REIT like ours. We have now paid 102 consecutive common stock dividends since inception, and we recently went through the recession without cutting that dividend.

Because the real estate can be depreciated -- and I say this each time -- we are able to shelter the income that is coming in from the Company on our rents. The distribution and 2012 was actually a 100% return of capital; and that, of course, is tax-free to those who are holding their stock.

This is a very tax-friendly stock. In my opinion, it is a very good one to put in personal accounts that are seeking income, because of this depreciation shield.

Remember, the return of capital is due to the depreciation of the real estate asset and other items; and that causes the earnings to remain extremely low after you apply the depreciation. That is why we talk about FFO, because that is adding back the real estate depreciation.

Depreciation of a building is a bit of a fiction, since at the end of the depreciation period, some 20, 25 years, the building is still really standing. If you own stock in a non-retirement account such as an IRA or a Keogh or one of those retirement plans, then you are not paying any tax on part that is sheltered by the depreciation and considered a return of capital. However, as we all know, the return of capital does reduce our cost basis in the stock, which means that when you sell the stock you have a larger capital gain, hopefully, down the road.

With the stock price now, yesterday, close about $19.23, the distribution yield on the stock is about 7.8%. I remind you each time I look at all of these documents out there, many of the REITs are trading at much lower yields.

I just read the -- looked at the entire REIT universe; it is trading at about 3.77% today. And, my goodness, if we were trading at 3.77% our stock would be at $40 a share.

The triple-net marketplace, which we are similar to in many ways, are at 5% cap rate. And certainly if we were trading at a 5% yield we would be at $30 a share.

There is really no reason for us not to be there, other than we are smaller than some of the others and people see that is a bigger risk, although we have certainly fared better than most during the last recession.

Anyway, the Board will vote in early April during our regularly scheduled quarterly Board meeting on the declaration of the monthly distributions for April, May, and June. So stay tuned for that.

And now I am going to stop and have some questions come in from our loyal shareholders and also the analysts who follow this wonderful REIT. Would the operator please come on and help our listeners, so they can ask questions?

(Operator Instructions) John Roberts, Hilliard Lyons.

Morning, David. Two questions, and you have sort of answered one, but let me have you expand on it a bit. First, pipeline. What are your expectations for acquisitions this year?

Second, you mentioned you're likely to raise some common and preferred, which obviously is needed, given the leverage. But what is your touchstone as to which way you're going to go?

Well, I will answer the last one first. We always look at the marketplace for common and preferred and try to make a determination on which is best for shareholders. Obviously, preferreds are usually a little bit different in terms of yield than common, although the common stock has moved up some.

Really hard to say that until the moment in time that we need the common or preferred or additional equity. So I can't give you much of an answer, other than we just sit down and do the math, and the math usually tells you which is the best of the two to go with.

On the pipeline, I will just comment briefly and then I will ask Bob to comment on it. Pipeline looks much stronger than it has in the past, only because I think the marketplace is shifting. A lot of different people have decided to sell their properties now.

We didn't see a big pileup of properties for sale coming at the end of the year, even though the capital gains changed. It didn't change that much, and I think a lot of people are thinking about selling their properties now rather than waiting for capital gains tax to go up again.

But, Bob, why don't you come on and just talk about the pipeline?

Sure. John, the acquisition team -- and we have spent a lot of time with over the last several months just identifying where we are trying to go. But our ongoing strategy for us to achieve the goals that we achieved this year, we believe requires us to have at a minimum about $250 million in the pipeline. And by the pipeline we mean those that come into the categories of under initial review, letter of intent, negotiating the contract, and a due diligence activity.

The emphasis is for all of us who are sourcing these deals to have something in each pot so that we have some consistent deal flow and closings. Today, we really exceed that minimum by about 20% to 25%, and I think we will be able to keep that going, subject to market conditions.

We all know that we are going to be driven by what is going on economically as well as regionally in each of our markets. So we are hopeful that we can repeat the success that we had in 2012, and it looks at least like -- right now at least, our pipeline is strong, as David indicated..

Great answer. Do you think you can close the same amount as you did last year? Is that your hope?

Well, we are going to try. I mean our goal is -- when we set goals at the end of the fourth quarter and the team is pretty pumped about being able to repeat what we did in 2012. And of course, our goal -- David and Danielle's and mine -- is to probably do a little bit better, but we'll see how things unfold over the next several months.

Very good. Thanks a lot, guys.

Okay. Next question, please.

(Operator Instructions) At this time I am not showing any further questions. I would like to turn the conference back over to Mr. Gladstone.

All right. Well, thank you very much. Obviously, I know John Roberts is asking the perennial question of -- how are you going to do next year? And we always love to dodge that question, because it is really hard to answer and we don't like to give forward-looking statements in that much detail.

I do think we are in good position to go forward and be very successful in 2013. Again, thank you all for calling in and that is the end of this conference.

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