Gladstone Commercial Corp (GOOD) 2013 Q4 法說會逐字稿

Good morning and welcome to the Gladstone Commercial Corporation fourth quarter and year ended December 31, 2013 shareholders conference call. All participants will be in listen-only mode. (Operator Instructions). Please know that this event is being recorded.

Now I would like to turn the conference over to David Gladstone. Mr. Gladstone, please go ahead.

All right. Thank you, Keith, for that nice introduction. This is David Gladstone, Chairman, and thanks to all of you for calling in. We always enjoy the time we have with you on these phone calls and wish there was more time to talk about the Company. If you are ever in the Washington DC area, we are located in a suburb called McLean, Virginia, and you have an open invitation to stop by and see us when you are in this area. You will see a great team at work, and there's about 60 members of the team now. We are no longer a small business. And by the way, some of the people even bring their dogs to work. So you can see them when you come by here, too.

To start off, we will introduce Michael LiCalsi. He is our current lawyer, does a lot of the legal work here. He's also President of the Administrator that runs a lot of the services that we provide to the different funds, and he will present our statement regarding forward-looking statements.

Good morning, everyone. This report that is about to be given may include statements that may constitute forward-looking statements within the meaning of the Securities Act of 1933 or 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, which we believe 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 all those factors listed under the caption Risk Factors in our Company's Form 10-K and Form 10-Q filings that we file with the Securities and Exchange Commission. Those Form 10-Q and 10-K filings can be found on our website at www.gladstonecommercial.com and on the SEC's website at www.sec.gov.

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, except as required by law.

In our talk today, we plan to talk about funds from operations or FFO. And since FFO is a non-GAAP accounting term, I need to define FFO as net income excluding the gains and losses from the sale of real estate and any impairment losses from property plus depreciation and amortization of real estate assets. The National Association of REITs, or NAREIT, has embraced FFO as one of the non-accounting standards that we and other REITs can use in our discussion of REITs. Please see our Form 10-K filed yesterday with the SEC and our financial statements for a detailed description of FFO.

We will begin the presentation today by hearing from our President, Bob Cutlip.

Thanks, Michael. Good morning, everyone. During the fourth quarter, we acquired two properties and closed long-term financing on both of these transactions, refinanced a mortgage on an existing property where the mortgage was maturing, commenced construction to expand one of our properties and simultaneously extended the lease through 2034 and issued additional common equity in an overnight raise. We had a very good year in 2013. We deployed a total of $134 million in new acquisitions or expansions at our existing properties, exceeding our 2012 annual performance by about $27 million. We also acquired our first operative in the West as we seek to expand our presence there.

The fourth quarter marked our ninth consecutive quarter of closing acquisitions, consistent with our objective of increasing our total asset base. In the last few years, we have increased our total real estate assets by about 50%. The list of properties in our acquisition pipeline remains robust, and we hope to announce additional acquisitions in the near future.

Now let's describe some details. During the quarter ended December 31, we acquired two additional properties. The first property acquired was a 99,800-square-foot office building located in Inglewood, Colorado, a Southern submarket of Denver. The property is a Class A lead gold multistory office building that is leased to Viasat, an innovator in satellite and other wireless networking system. The purchase price is $18.3 million, which equates to an average cap rate of 8.2% over the life of the lease. We funded this acquisition with proceeds received from our common raise in November and the issuance of $11.3 million of mortgage debt on the property. Viasat has close to eight years remaining on the lease and has several renewal options.

The second property acquired was a 156,200-square-foot industrial building purchased for $7.3 million with an average cap rate of 9.4% over the life of the lease. The property is leased for 10 years to Eberspaecher, a global German manufacturer of exhaust systems, heating and air-conditioning systems for automotive and commercial vehicles, and this property is located in Novi, Michigan, which is the Western suburb of Detroit. We purchased this property with cash proceeds from our November 2013 common offering, as well as the issuance of $4.4 million of mortgage debt on the property.

Shifting to our overall portfolio, as of today, all three of our buildings continue to be fully occupied, and all of the occupied buildings' tenants continue to pay as agreed. Two of these properties are vacant, and one is partially vacant. The leases on these two vacant buildings comprise less than 1% of our total square footage as of December 31, 2013. One of the vacant properties is located in Richmond, Virginia, and we have three active prospects for this property, each requiring the entire building. Two are call centers, and one is a retail user.

We have seen activity increased dramatically over the past month at this property as a completed retail development that is anchored by a Kroger megastore was completed nearby. The other vacant property is located in a Houston, Texas submarket and is a 12,000-square-foot medical facility in close proximity to a hospital. We also have three active prospects at this building, and one of them is for the entire building. We submitted a proposal to them recently for that facility.

Our building located in Roseville, Minnesota remains partially vacant, and we continue to aggressively pursue new tenants for this building. To this end, we have three prospects for this building ranging from 30,000 to 50,000 square feet, two call centers and one state agency. We think the state agency has much more interest than the two call centers at this time, but we will see as we are going forward. The loan on this property matures in June of this year, and we have begun discussions with the existing lender.

Turning to our tenants, we continue to improve the value of our existing portfolio of properties, our reviewing and renegotiating existing leases and performing improvements at the properties. We continue to work diligently on the remainder of our leases that come due in 2014 and 2015, and to this end have already renewed five of the six leases that were originally set to expire in 2014. The remaining 2014 lease expires in December, and this building is located in an industrial submarket of Chicago. We are actively marketing this property now and have two prospects, one of which could occupy the entire building. The existing tenant in this property has already vacated. They came to us the middle of last year and said we need to expand, we need to double in size. And, of course, we did not have any adjacent land to where we could expand them, so they did have to move on. However, they have paid their rent through the end of the term in December 2014.

We have 11 leases expiring in 2015, one of which is a building with two tenants in it, and we are in negotiations with tenants in nine of these buildings at this time. Locating new tenants and signing leases with existing tenants for these buildings usually requires some capital outlays for tenant improvements and leasing commissions.

Switching to mortgages, debt financing is available from multiple sources. We have seen an increase in interest rates over the past several months as the yields on U.S. Treasury securities and interest rate swaps increased and spreads widened once demand for higher rates in the CMBS marketplace took hold.

Now, recently spreads have narrowed somewhat. But regardless, we still believe interest rates remain historically low and, as you are aware, we continue to actively try to match found our acquisitions with cost-effective mortgages. Depending upon several factors, including the tenant credit rating, the location of building, the configuration and the terms of the lease, we are seeing fixed interest rates in the marketplace today ranging from the upper 4% to the lower 5% levels.

To this end, we issued about $24 million and three new mortgage loans this quarter, two of which were fixed-rate loans placed on new acquisitions with interest rates ranging from 4.7% to 5.3%.

The third mortgage was a refinance of an existing loan and replaced the variable-rate mortgage on this property with a rate of one-month LIBOR plus 2.15%. We also placed an interest rate cap on this mortgage to cap LIBOR at 3%.

In summary, at year end, all of our existing tenants are paying as agreed, and our portfolio is 96.8% leased. As noted, we acquired two additional properties during the quarter. We have consistently increased our acquisition bible the past three years, and we currently have approximately $22 million of potential acquisitions in due diligence. All of these properties may not close, but this number reflects our continued efforts always to have properties in the final stage of the transaction process. Our current pipeline also includes four properties totaling $63 million that are in the letter of intent stage and about $235 million under initial review. All-in-all, 23 properties in that pipeline, 40% of them industrial and 60% office, so a pretty good split for us.

Our objective is to have, as we've noted in the past, at least $250 million to $300 million in the pipeline of new investments with properties in each phase, including the initial review period, communication of interest, letters of intent and due diligence. At this point, we are exceeding that target, and our team is very active. We hope to close on additional properties in the upcoming months.

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

Good morning. As Bob mentioned, we continue to grow our asset and equity base in the fourth quarter. Our total assets increased to $690 million from our two new acquisitions during the quarter, which was a 4% increase from last quarter and a 23% increase in assets during 2013. The amounts outstanding under long-term mortgages and our line of credit increased about $447 million as a result of the funding of our new acquisition.

Reviewing our upcoming long-term debt maturities, we had mortgage debt in the aggregate principal amount of $24.8 million payable during the remainder of 2014 and $42.4 million payable during 2015. The 2014 and 2015 principal amounts payable includes balloon principal payments due in June of 2014 and three mortgages that mature in the second half of 2015. We are working on the mortgage for 2014 and anticipate being able to refinance the mortgages that come due in 2015 with new mortgage debt.

We do not intend to increase the leverage on the net lease refinancing in order to continue our strategy of reducing our overall leverage. We intend to pay the additional debt amortization payments from operating cash flow and borrowings under our line of credit. The weighted average interest rate on the new debt issued during 2013 was 4.5%. Plus, the weighted average interest rate on all of our existing mortgages dropped 25 basis points during 2013 to 5.4% from the lower rates we were able to achieve on new mortgages during 2013.

We also continued our strategy during 2013 of lowering our overall leverage by reducing our weighted average loan to value of newly issued debt to 60% from 68% in 2012.

Now turning to equity, as Bob mentioned, we concluded an overnight offering of common equity during the quarter. We issued 1.2 million shares of our common stock, which closed in November at a public offering price of $18.15 per share, and that includes the deducting offering expenses or [24.2].

We used the equity raised in the fourth quarter to fund our fourth-quarter acquisitions. In total, we received $80.8 million in net proceeds from common equity offering during 2013, in order to increase our total market cap to shares outstanding.

Because we raised equity in overnight offering, we did not utilize our aftermarket program or ATM program during the fourth quarter. We will look to utilize the ATM in 2014 as it continues to be a great way for us to raise additional equity in a cost-effective manner.

Turning to our line of credit, as we discussed the last time we spoke, we closed on a new unsecured line with KeyBank in August. The is a $60 million line with a capacity to expand the line to $75 million. It's a three-year term and has a one-year extension option. We are excited about this new unsecured line as it gives us more flexibility and ease-of-use since we are no longer required to pledge assets to the line, which has already saved money in the cost we have been incurring to add our new properties to the borrowing days under our old line of credit.

We had $24.4 million outstanding under the line at the end of the quarter at a weighted average interest rate of approximately 3.4%. We continue to only use our line of credit to make acquisitions that we believe can be financed as longer-term mortgage debt or that we believe are good additions to our unsecured property probe acquired under our new line of credit.

As you may recall, our customary business model calls for us initially to borrow from the line of credit to buy properties. We then obtain longer-term fixed-rate mortgages as soon as we can. By doing this, we are able to secure the difference or spread between the rent coming in and the mortgage payments going out, thus locking in a profit for 5 to 10 years or, in some cases, longer.

From a liquidity perspective, the proceeds from the mortgages on our line of credit, thus taking the line available for the purchase of our next property. With the current aggressive credit and equity markets, our business model adjusted so that we were matching as closely as possible long-term leases with long-term mortgages. 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 or are well-suited to be funded on our lines.

Currently we have enough availability to fund our current operations, deals in our pipeline and any upcoming improvements at certain of our properties. Our debt to equity ratio at the end of the year, excluding our term preferred stock, was approximately 2.4 to 1. We will focus on decreasing our debt to equity ratio over the next couple of years as we continue to issue more common stock to both overnight offerings and under our ATM program and reducing our loan to value on the new and refinanced mortgages. As of today, our available liquidity is approximately $24.6 million, comprised of about $4.5 million in cash and an available borrowing capacity of $20 million in our line of credit.

The borrowing capacity on our line is limited to a percentage of the asset value of our unencumbered properties with both the amount outstanding under the line and our expanding letters of credit. With the capacity under our line and our current cash flows from operations, we have sufficient liquidity to fund our operations, service our debt this year, perform capital improvements to our properties and maintain our distributions to our common shareholders.

In addition, we have the ability to raise additional equity in preferred or common equity through the sale of securities that are registered under our shelf registration statement in one or more future public offerings.

And now I will discuss the operating results. Please note that per share numbers referenced are fully diluted and weighted average common shares. FFO available to common stockholders for the quarter was approximately $5.7 million or $0.38 per share, which was about a 3.8% increase when compared to the third quarter and was approximately $20 million or $1.49 per share year to date. FFO per share increased in 2012, primarily because of the additional revenue we achieved from new acquisitions. This was partially offset by vacancies in our portfolio, coupled with additional shares issued during the year.

During 2013 we also managed our lost revenue and additional property operating expenses to our vacancies of close to $3 million. We did this while still maintaining our dividend during the year. This is a good opportunity for us to increase our FFO during 2014 by releasing certain of these properties without significant capital investments.

Total FFO increased this quarter primarily because of the 2% increase in rental income derived from the two properties we acquired this quarter, which was partially offset by an increase in the base management and administrative fees due to the increase in our total assets and equity. We were not able to pay out a large portion of our incentive fee this quarter because of the dilution from the equity offering. However, we believe our payout ratio will increase next quarter since we deployed these proceeds in the fourth quarter. We also believe 2014 will allow us to continue to grow our FFO as we continue to increase our asset base and work diligently to lease our vacant buildings and manage our property operating expenses.

And now I will turn the program back to David.

All right. Thank you, Danielle. That was a good report and certainly a good report from Bob, too.

For those of you who want to keep up with everything, we encourage you all to listen to and read our press releases and annual report that was filed yesterday with the SEC called Form 10-K. There's just an abundance of information. This is just a summary when we give you these reports every quarter, but there's a lot of good material in those documents, and you can find them all on our website at www.gladstonecommercial.com. And to stay up to date on the latest news, you can follow us on Twitter, as well as on Facebook under Twitter. It's gladstonecomps.com, and the Facebook -- well, it is actually egladstonecomps, and also on Facebook, the keyword is Gladstone Company. And you can go to our general website and see more information about all the Gladstone companies. That is at www.gladstone.com.

The main news report for this quarter is obviously the acquisition of the two new properties and the closing on the long-term financing on these properties. We refinanced a mortgage that was coming due, and we raised additional common equity. All of these are very positive news for our shareholders as we have added quality real estate to our portfolio, we have shored up the existing investments, and we have grown our asset base in excess of $130 million during 2013.

And as we continue to grow and our market capitalization increases, we hope to see higher trading volume in our stock and hope to see a corresponding uptick in the stock rise. We continue to have a nice list of potential properties that we are interested in acquiring. And because of that list of properties, we hope to be able to grow the asset portfolio even more during 2014. And with the increase in the portfolio of properties comes greater diversification, and certainly that is better for earnings, to have more diversification.

On another note, we have been able to find some attractive long-term mortgages to finance our newly acquired properties. The mortgage marketplace from banks is much better now than it was even a year ago. We continue to look at properties with mortgages already on them, but we can assume we will keep doing that as well. And secure financing for these acquisitions -- there's just much more opportunity out there for us to find that kind of thing.

When we don't close debt simultaneously, we have been successful in obtaining the debt on the property a few months later or selecting those properties that remain unencumbered and give necessary availability under the line of credit. We are focusing our efforts on finding good properties with long-term financing to match our long-term leases. Being able to lock in the spread between the long-term financing and the rent that's coming in is what we pay out to you as dividends. We are much more optimistic now that things are going to be positive for the next year, feeling pretty good about the economic outlook. Much of the industrial base that rents industrial and commercial properties like the properties that we are buying remain steady, and most of them are paying their rents. There are still some businesses that are having problems, and the economy is still not in great shape. However, we expect the growth for 2014 for this REIT to be very good and strong.

While I'm optimistic that our Company will be fine in the future, we 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. And I think if there's another recession working on the horizon, that our portfolio will continue to stand up against any kind of downturn.

We were successful in raising common equity this year, and we put the new equity to work pretty quickly. And we have been able to find some new acquisitions that we can close on, hopefully, this quarter. We may seek to utilize the ATM program that -- as we didn't use it much in 2014, but we will probably use it this first quarter and the next couple of months.

In January this year, the board voted to maintain a monthly distribution of $0.125 per common share for January, February and March. It's an annual run rate of $1.50 per share. This is a very attract rate for a well-managed REIT like ours. We have now paid 115 consecutive common stock dividends. We went through the recession, as I mentioned before, not cutting our dividend, and here's a great reason to hold this stock in your personal accounts. Because the real estate can be depreciated, we are able to partially shelter the income. The distribution in 2013, for example, was 82% return of capital. That portion is tax-free. This is a tax-friendly stock that in my opinion is a great one for personal accounts, the ones that are seeking income.

The return on capital is due to the depreciation of the real estate assets and other items that has caused earnings to remain low after depreciation, and that's why we talk about the FFO. That's funds from operations because this FFO number is adding back the real estate depreciation. Depreciation of a building is a bit of a fiction, anyway, since at the end of the depreciation period, the building is usually still standing and in pretty good shape. So if you own the stock in a non-retirement account as opposed to having it as IRA or retirement funding, you don't pay any taxes on that part of the dividend that's sheltered by the depreciation that is considered a return of capital. However, as you all know, the return of capital does reduce your cost based on the stock, which may result in the larger capital gains tax when the stock is sold.

Now, with a stock price now about $17.74, distribution yield on the stock is about 8.5%. Many of the REITs are trading at much lower yields. I just read a REIT report. The REIT universe as a whole is trading at 4.3% yield. Certainly, if we were doing that, we would be almost up to $35 a share. And triple-net REITs, which are similar to us in some ways, is trading at about a 6%, and that would mean that if we traded at 6%, that would be $25 per share. So there's plenty of room for yield expansion, and we believe we should be in that range as well.

As we continue to build our portfolio and increase our income, I think we should all notice more investors being attracted to the stock. The board will vote in early April during our regularly scheduled board meeting to determine and declare the monthly distribution payable (technical difficulty).

I'm going to stop at this point in time and have some questions from our loyal shareholders and some of the analysts who are following this wonderful REIT. Would the operator please come on and help us get those questions?

(Operator Instructions). John Roberts, Hilliard Lyons.

Can you talk a little bit about -- obviously, you have been pretty consistently waving your incentive fees. Can you talk a little bit about the strategy on that and what you anticipate doing going forward, since you are not covering the dividend unless you are waving the fees?

Sure. That's one of the things that we always look at when we are doing a new deal. Unfortunately when we raise capital and try to get it to work quickly, sometimes we are not as good at that as we would like to be. And so as a result, in order to cover those new shares that have been issued, we need to use that by giving back some of our incentive comp.

As time goes on, that will go away. As we get bigger and the new offerings have less dilutive effect on the earnings power, I think all of that will go away. We all understand that, and it's not like people here are giving up. They give up in the short range in order to get long-term benefits for us and our shareholders. And I think it shows something to shareholders that we are willing to give that up in order to make sure that we continue to grow the asset base and the earnings base of the Company. So not excited about giving it up, but at same time, it's just a short term give up. We will eventually get back to normal and be able to pay it all out.

Well, it shows some shareholder friendliness, David.

Yes, we are friendly to shareholder, and sitting around the table, we are all big shareholders. So what we give up on one side, we generally get on the other side.

Right. Any thoughts on -- obviously, you are not going to see any growth in FFO until that goes away. Any timeframe for your expectations on when we might get by that?

Oh, John, you are always asking for projections. It's really hard in this business. Until we get to about $1 billion in assets, I think it's going to take us that time to get there, John. We are about $680 million, $690 million, probably another year before we get past that and start looking at maybe 2015 to start to think about that. So that's where we are. But the good news is, for all the shareholders, the dividend is in very solid position, both certainly in the preferred shares, but in the common shares, very solid coverage ratio because of that ability to give back the incentive comp. So people who are buying it today are buying it with a good deal of certainty that they are going to get their dividend. Nothing is guaranteed, of course, but I think it is pretty well covered.

Okay. Thanks, David.

Dan Donlan, Ladenburg Thalmann.

This is actually [John Masuk] on for Dan Donlan. I notice in the fourth quarter you announced you are doing an expansion at your Canton, North Carolina property. Could you maybe give us a little more color on that deal, and then as a follow-up, was any construction actually completed in the fourth quarter?

Yes, certainly, John. That is a 230,000 square foot industrial facility. We are expanding it by about 150,000 square foot. The expansion is purely infrastructure for additional circulation for their trucking as well as for distribution. The Company is consolidated into this location from I believe it was one other location, and there was really no construction done in the fourth quarter. We did -- the design was completed, and we began moving dirt. But the weather turned bad on us. We are still anticipating that the building will be completed in August. And as this property, as we place money into this transaction, the tenant actually begins paying rent on the in-place capital. And as I indicated earlier, with this transaction, we are extending the lease on the building to 2034.

That's very helpful. Thank you very much. And then also one quick broader question, if you will. Have you seen any kind of change in leasing demand, particularly for suburban office properties? The Company has kind of been improving here. That affected in a positive way your ability to lease and re-lease some of your suburban office properties.

Well, we are seeing more demand out there really across the board. As I indicated, most of the year we were seeing more office opportunities in suburban markets than we were seeing industrial opportunity. And, of course, a lot of that relates to so many of the institutions that chase in industrial properties. But yes, we are seeing -- although the job growth for office is not great, if you look at the macro, everyone is saying that really from a space or employee standpoint that is dropping from, let's say, the 250s down into the 100s to 150s with the millennials. There could be a challenge.

But with us picking facilities that we think really are mission-critical and, therefore, the people around there want to be there, we still feel confident long-term with the movement that we are going into these secondary growth markets.

All right. Thanks very much, everyone.

(Operator Instructions).

Keith, it sounds like we don't have anymore.

No, sir.

All right. Well, again, thank you all for calling in and look forward to talking to you next quarter. That completes the call.

Thank you. That concludes today's teleconference. You may now disconnect your phone lines. Thank you for participating, and have a nice day.