Gladstone Commercial Corp (GOOD) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Gladstone Commercial Corporation's third quarter ended September 30, 2014, earnings call. (Operator Instructions). As a reminder, this conference is being recorded. And I'd now like to introduce your host for today's conference, David Gladstone, Chairman, you may begin.

All right. Thank you, Sam. It was a nice introduction and thank all of you for calling in. We really enjoy this time on the phone and we wish there was more time to talk, but just do this once a quarter. If you're ever in the Washington DC area, we're located in a suburb called McLean, Virginia; and you have an open invitation to stop by and see us here, you'll see some of the people, many of them on the road. We have about 60 people now, so we're no longer small and some of the folks do bring their dogs to work, we are a dog-friendly environment. So now, let's start with Michael LiCalsi, he's our General Counsel, he is our Secretary, also serves as the President of Administration. Michael?

Good morning, everyone. The report that you're about to hear may include 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; and these forward-looking statements involve certain risks and uncertainties that are based on our current plans, 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 of our Forms 10-K and 10-Q that we filed with the Securities Exchange Commission. They 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 forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. And in our report today, we plan to talk about funds from operations or FFO; and since FFO, which is a non-GAAP accounting term, defined as net income excluding the gains or losses from the sale of real estate and any impairment losses from property, plus depreciation and amortization of real estate assets. And the National Association of REITs, or NAREIT, has endorsed FFO as one of the non-accounting standards that we can use in discussion of REITs. And please see our Form 10-Q filed yesterday with the SEC and our financial statements for this detailed description of FFO.

We also plan to discuss core FFO today, which is FFO adjusted for property acquisition costs. We believe that this is a better indication of our operating results of our portfolio and allows comparability of period-over-period performance. To stay up-to-date, you can sign up on our website to get updates by e-mail on the latest news involving Gladstone Commercial and our other publicly traded funds.

And you can follow us on Twitter of user name GladstoneComps; and on Facebook, keyword, The Gladstone Companies. And you can go to our general website to see more information at www.gladstone.com.

The presentation today is an overview, and we ask that you read our press release issued yesterday and also review our Form 10-Q for the quarter ended September 30, 2014. You can find both on our website and on the SEC's website. And now, we will begin with the presentation today by hearing from our President, Bob Cutlip.

Thanks, Michael. Good morning, everyone. During the third quarter, we acquired two properties. We issued new debt on one and we funded the other property with equity. We funded a loan for a build-to-suit project that is pre-leased upon construction completion to a tenant with a 15-year lease. Entered into a new $100 million ATM program with Cantor and issued additional common equity through this program. Placed the impaired Roseville, Minnesota, property in receivership and agreed to its deed in lieu (technical difficulty) with our lender that should finalize in the next few weeks and extended the lease of a property that was set to expire in 2015.

Subsequent to the end of the quarter, we also extended another one of our leases that was set to expire in 2015 and leased one of our vacant properties in Richmond, Virginia, to a new tenant with a three-year lease and completed the expansion of our property in Canton, North Carolina, an industrial property, and extended that lease until 2034. We had a great quarter as we continue to increase our asset base by acquiring new properties. For the year, we've invested nearly $104 million in 11 properties at an average cap rate of 9.2%. This is our 12th consecutive quarter of closing new acquisitions. We're extremely pleased with our activity and the consistency over the last several months and we continue to have a strong pipeline of acquisitions and expect to close several more prior to the end of the year.

Now, for some details. During the quarter ended September 30, we acquired two properties. The first property is a 125,000 square foot industrial building located in a suburb of Denver, Colorado; the price was $8.3 million and has an average cap rate of 9.3% over the life of the 15-year lease. We funded this acquisition with cash on hand. The tenant in this sale leaseback transaction is Barton Supply which specializes in fabricating steel reinforcement, structural and miscellaneous steel, and concrete construction accessories for both the commercial and the residential markets.

The second property was an 86,500 square foot office building located in Indianapolis, Indiana. This property is anchored by a regional healthcare system which occupied 71% of the space and has 11.5 years remaining on the lease. This tenant has two options to renew the lease for an additional five years each. The remaining tenants in the building are occupying between 1,400 and 7,600 square feet in their respective suites, with lease terms expiring from December of next year through October of 2018. The purchase price for the property was $10.5 million which equates to an average cap rate of 8.6% over the life of the lease. We funded this acquisition with cash on hand and the issuance of $6.1 million of mortgage debt.

We also issued a $5.6 million loan for a build-to-suit project in Phoenix, Arizona, that will be occupied by Kindred Healthcare under a 15-year absolute triple net lease. We received 9% interest on a current basis during construction with no construction liability and have an option to purchase the facility upon construction completion. If the developer prefers to sell the facility upon completion, then, we will receive a success fee equal to a 22% return on our invested capital during that whole period prior to any proceeds received by the developer. That project is currently under construction.

Shifting to our overall portfolio, as of today, all but one of our buildings continue to be fully occupied and all of the occupied buildings' tenants continue to pay as agreed. The vacant property is one that's located in Houston, Texas, and is a 12,000 square foot medical facility in close proximity to a hospital. At this time, we have two active prospects at this building. One is for the entire facility and one is for a little bit less than 50% of that building.

As I've mentioned earlier, we were able to lease one of our previously vacant properties located in Richmond, Virginia. The lease commenced in September and is for three years. We are excited we were able to re-lease this property and reflects our commitment and our focus on our portfolio and maintaining high occupancy.

Our building, located in Roseville, Minnesota, was put in receivership during the quarter and the lender of this property has agreed to a deed in lieu and we anticipate this happening before the end of the fourth quarter. This is the first property we've ever returned to a lender. However, on a positive note, this decision will favorably impact FFO on a going-forward basis; and therefore, we believe is going to benefit our shareholders.

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 at our properties. We continue to work diligently on the remainder of our leases that come due in 2014 and 2015. And to this end, we renewed five of the six leases that originally set to expire in 2014. The loan lease not renewed expires in December and is located in an industrial submarket of Chicago.

The existing tenant had come to us, needed to expand, we couldn't accommodate them, and so they vacated. However, they have prepaid their rent through the end of the term which is December of this year. We're actively marketing this property now with an agent and are very close to signing a lease with a tenant for nearly 40% of the space. There are two other prospects for the property, one which may lease the balance of the building and the other for about a third of the building. Those of you who know Chicago, it's very strong right now; industrial absorption is very good and we're encouraged about the future of this property.

We have 11 leases expiring in 2015 and we have successfully extended the leases for four of these tenants already and are in negotiations with three of the remaining tenants. We have, however, been notified by three tenants that they will leave and we have hired marketing agents to begin actively marketing those properties right now.

For the final property, that tenant is also going to be vacating, but we are right now in negotiations with the subtenant in that property to sell the building to them next year. While we do have 11 leases rolling in 2015, we only have three leases expiring in 2016, four in 2017, and three in 2018. So after next year, our lease rollovers slow down dramatically and our existing portfolio will have stable and growing rental income. Locating new tenants and signing leases with the existing tenants as we all know for these buildings usually require some capital outlays for tenant improvements and leasing commissions.

So in summary, at quarter end, all of our existing tenants are paying as agreed and our portfolio was over 99% leased. We acquired two properties during the quarter, funded a mortgage loan and have a very active pipeline. And our asset management team was also very busy renewing tenants, leasing our properties and completing the expansion of one of our buildings for one of our tenants. We have consistently increased our acquisition volume over the past three years, and we currently have a $10 million property in due diligence, which is scheduled to close in fact tomorrow. Our current list of possible acquisitions also includes four properties totaling $65 million that are in the letter of intent stage and $265 million under initial review.

As I've indicated in the past, for our current side, our objective is to have at least $250 million to $300 million in the pipeline of possible acquisitions with properties in each phase, including under initial review, providing indication of interests, letters of intent and the due diligence process. Our team really continues to exceed its objective and has prospects in each phase of the acquisition process which we hope of course will lead to continuing and consistent closings in the months ahead.

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

Thanks, Bob; and good morning, everybody. We continued our goal of consistently growing our asset and equity base in the third quarter. Our total assets increased to $759 million this quarter, which was a 3.2% increase from total assets last quarter. We are also focused on decreasing our leverage; and to this end, we implemented a new $100 million ATM program during the quarter with Cantor Fitzgerald to help achieve this goal. We continue to be in a growth mode and expect to continue growing through the remainder of this year and into 2015.

The amounts outstanding under long-term mortgages in our line of credit increased to $506 million, as a result of the funding of both of our new acquisitions in the mortgage loan during the quarter. To date, we have raised over $20 million in common equity under our new ATM program at Cantor and have used these funds to reduce the outstanding balance under our line of credit.

Reviewing our upcoming long-term debt maturities, we have mortgage debt in the aggregate amount of $18.9 million payable during the remainder of this year and $42.7 million payable during 2015. The 2014 principal amounts include both amortizing principal payments and the balloon principal payment that we due in June of this year of $17.5 million on the property that we impaired earlier this year. As Bob mentioned, we are in process of returning this property via deed in lieu transaction, which will happen this quarter. We intend to pay the remaining 2014 debt amortization payments from available cash on hand.

The 2015 principal amounts payable include balloon principal payments due on three mortgages that mature in the second half of 2015. And we anticipate being able to refinance these mortgages with new mortgage debt. We intend to decrease the leverage on these refinancings in order to continue our strategy of reducing our overall leverage. We intend to pay the additional debt amortization payments from operating cash flows and borrowings under our line.

Turning to debt financing, it continues to be available from multiple sources. At the end of the third quarter, interest rates are approximately 50 basis points lower than they were at the beginning of the year. The upward pressure on interest rates associated with the ending of the Federal Reserve's quantitative easing program has been offset by the Federal Reserve's guidance that it will continue to work to keep interest rates low. Weakness in the European and Chinese economy is an international attention.

Lenders are competing with one another to meet their projection goals which is resulting in tightening interest rate spreads and more flexible terms. Interest rates may remain historically low and we continue to actively try to match our acquisitions with cost-effective mortgages. Depending on several factors including the tenant credit rating, property type and location, the terms of the lease, leverage and the term of the loan, we are seeing fixed interest rates ranging from the low-to-mid 4% to 5% levels.

To this end, we issued new debt this quarter of $6.1 million on one of our new acquisitions at an interest rate of 4.4%. As I mentioned, we are continuing our strategy of lowering our leverage by reducing our weighted average loan to value on newly issued or assumed debt and are also issuing additional common equity. Again, we've raised over $20 million net proceeds under the ATM program over the past several months and issued about 1.2 million new shares of common stock.

Turning to our line of credit, we currently have $27.6 million outstanding at a weighted average interest rate of approximately 3%. We continue to only use our line to make acquisitions that we believe can be financed with longer-term mortgage debt or that we believe are good additions to our unsecured property pool acquired under our new line of credit. We continue to finance a majority of our properties with long-term fixed-rate mortgages. By doing this, we are able to secure the spread between the rent coming in and the mortgage payments going out, thus locking in the profit for the length of the lease.

Currently, we have enough availability to fund our current operations, our deals in our pipeline, and any known upcoming improvements at certain of our properties. As of today, our available liquidity is approximately $30 million comprised of about $5.5 million in cash and available borrowing capacity of $24.5 million under our line of credit. The borrowing capacity on our line of credit is limited to a percentage of the asset value of unencumbered properties, less the amount outstanding underlying in our outstanding letters of credit. In addition, we have the ability to raise additional equity through the sale of securities that are registered under our shelf registration statement.

And now, I'll discuss the operating results. In our press release filed yesterday, we reported a core FFO number. We believe core FFO which adjusts for property acquisition expenses allows our investors to better compare period-over-period results as the property acquisition expenses can be very lumpy from quarter-to-quarter. Please note that per-share numbers referenced are fully diluted weighted average common shares.

Core FFO available to common stockholders for the quarter was approximately $7.1 million or $0.39 per share, which is about an 8% increase when compared to the second quarter. Core FFO increased because of the additional revenue we achieved from new acquisitions made this quarter coupled with lower property operating expenses at certain of our vacant properties and a lower administration fee. This was partially offset by a slight increase in G&A expenses and an increase in our base management fee from the cost of the additional shares issued during the quarter.

We were able to pay out a larger portion of our incentive fee this quarter because of the increased volume of acquisitions even though we had dilution from the equity issued while continuing to manage our property operating expenses from our vacant portfolio. We expect over the next few quarters as we invest the equity from our continuous stock offering and our operating expenses decrease that we will grow our FFO.

We believe with our repositioning and growth activities that the remainder of this year and into 2015, we will be successful as we continue to increase our asset and equity base, decrease our leverage, and work diligently to re-lease our vacant buildings and manage our property operating expenses.

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

Alright. That was a good report, thank you, Danielle; and a good one from Bob Cutlip and Michael LiCalsi, too. I think the main report for this quarter is the two properties we purchased for $18.8 million and the mortgage on one of the properties of $6.1 million, extending the lease on the one property that was originally scheduled to expire in 2015. That was nice. And then, of course, finally leasing the property down in Richmond, Virginia; we only had the one vacant property down there in Richmond and that puts us up to 99% occupied.

We have continued to add great new properties to the portfolio and that has shored up the existing investments with more assets on the books and more cash flow coming in as we continue to grow the market capitalization increases and we hope that that will indicate higher trading volumes in our stock as we become a larger company.

As many of you know, this Company didn't cut its dividend during the recession, that was quite a success story. I mentioned last time, I like to mention again, that one of the companies here in town in 2008 had a dividend of $1.36 per share. It's now $0.60 per share, 56% decrease. And then, there's another one in New York; in 2008, the dividend was $1.17 per share; dividend is now $0.68 per share, a 42% decrease. Another one in New York; 2008, $1.25; dividend is now $0.14 for an 89% decrease. And then, one of the companies that Bob used to work for, dividend in 2008 was $2.88 per share; dividend is now $0.41 per share, [186%] decrease; and then, another trust; and all of these are companies that are touted by a lot of the folks out there that write on these and that company's dividend in 2008 was $1.43; it's now $1.10 for a 23% decrease; and nobody writes about Gladstone Commercial.

Dividend in 2008 was $1.50 and it's still $1.50, even though you've gone through a terrible recession and also an increase in the economy that's been [length at city is] the best way of saying it. So I'm really saddened that many of the analysts don't pick this up and compare us to some of these companies that they are touting and I wish our shareholders would look at this point a little stronger. I know all of us want the dividend to increase, I do too. But please give us some credit for building up the Company, issuing new shares and never cutting the dividend. [My pride right there] of not cutting the dividend should stack up extremely well against all these others that cut their dividend and then didn't build it back up over the last six years.

So from an outlook perspective, we continue to see a promising list of potential quality properties that we're interested in acquiring. [To cover] that list of properties, I hope to be able to grow the asset base more during 2014 and into 2015. And with an increase in the portfolio of properties, of course, comes greater diversification and we believe that's better for all of the shareholders and certainly it should increase our earnings as we go forward. We are focusing our efforts on finding the good properties with long-term financing that matches up. So we'll be able to lock in those financial spreads, so that we can pay those out as dividends to shareholders.

Much of the industrial base that rents industrial commercial properties like the ones we (technical difficulty) now, they're paying their rents, we don't see a lot of defaults going on out there. There are still some businesses that are having problems in the economy, but we expect really 2015 to be a pretty good growth [era] for this REIT. While I'm optimistic that the Company will find the future and will continue to be cautious on our acquisitions as we always have and in past years, we'll do that going forward as well. And as we mentioned over and over again, because we match up our long-term leases with long-term debt, it helps us go through recessions. So, [many] of our portfolio will stand up against anything that the Fed might decide to do to us all in the future. Interest rates may go up, but having locked in these with long-term debt and long-term leases, we should be okay.

We are successful on implementing the new ATM program this quarter and raise a small amount of common equity and we do that in very slow amounts simply because it keeps us from diluting our shareholders and we put the money to work quickly, able to cover the new dividends that are needed for the new shares. And our goal is to continue to build the Company out in terms of assets and equity during the next year of 2015.

In October 2014, the Board of course maintained the monthly distribution of $0.125 per common share for October, November, and December. I suppose the run rate is $1.50 per year. Now, this is a very attractive rate for a well-managed REIT like ours. We've now paid 122 consecutive common stock dividend since inception, and we went through the past recession under the sluggish recovery without having any problems at all.

Because the real estate can't be depreciated, I hope you all remember that we are able to shelter the income of the Company. The distributions in 2013 were 82% of return on capital and that portion of course is tax-free. This is an extremely tax-friendly stock [in writing] and a great one to be in personal accounts that are seeking income. Now, the return of capital was due to the depreciation of the real estate assets and the other items that has caused earnings to remain low after depreciation and that's why we talk about FFO; and like all the real estate investment companies, it adds back the depreciation on the real estate. The appreciation of course is a fiction since at the end of the appreciation period, you've depreciated the building down to zero where it's still standing; and if you own the stock in a non-retirement account as opposed to an IRA, you don't pay any taxes on that part of the shelter depreciation and is consistent return of capital. However, as you all know, when you sell the stock, the return of capital does reduce your cost basis and that means you have a larger capital gain when you do that.

Just ending up with a stock price here at $17.84, the distribution yield was about 8.4%. Of all that REIT universe I just looked at again last night is about 3.5%; man, if we were trading at 3.5%, we'd be a $42 stock and even the triple net REITs, which trade at a higher number of about 5.7% if we were trading in that like all of our peers in the triple net area would be at about a $25 stock price. So, as we get bigger and we have more in institutions buying our stock, I think you'll see that the stock price will go up and we call that yield compression, like when people talk about price earnings expansion, this will be a yield compression, meaning the yield will come down from where it is today and the stock price will go up.

So, Board will meet again in January to declare the January, February, March 2015 dividends and we're looking forward to that and we will discuss a lot of things at that meeting about this great Company.

So, Sam, if you will come on now, we'll take some questions from the folks out there and radio lane and see what we can do to answer their questions.

(Operator Instructions) John Roberts, Hilliard Lyons.

Good morning, David.

Morning, John.

Bob mentioned that one of the tenants is vacating next year, the one in Chicago, I think it was, you couldn't accommodate the tenant on an expansion. Why was that?

They vacated really, John, at the end of last year and our facility is 55,000 square feet and they needed to double in size. So they went to another building that's 110,000, 115,000 square feet. But as part of their agreement to relieve them from the lease based on the provisions of the lease, they agreed to escrow the balance of the rent and the operating expenses through the end of the lease term which is December of this year.

Okay. So, really it was you couldn't accommodate, it was a building that couldn't be expanded then?

That is correct, that we couldn't expand and we didn't have any additional land on site.

Right, okay. That clears it up. And also, the property that you placed in receivership, is that going to have a negative impact on FFO?

Why don't you answer that?

No, actually, we're actually expecting a little bit of an uptick in FFO because the property operating expenses we are incurring to run the property were greater than the rental income after we're paying that debt service on the property. So, they actually expect a little bit of an uptick this next quarter.

Okay, but you're going to lose titles at that property, I assume?

That's correct.

Okay. And as far as the deed in lieu property goes, that still is going to have a positive impact on FFO?

That's the same property.

Yes.

That was the same property? Okay.

Yes.

Same property, yes.

That's the same property.

Okay. Right. And so the only vacant property you have now is the one in Houston?

That's correct.

That's right.

Okay. Alright, thanks.

Next question, please.

(Operator Instructions).

Well, it sounds like Sam that nobody is going to ask any more questions and that means there won't be any answers until next quarter.

It does look like we have no more questions at this time.

Well, thank you all for calling in. Hopefully, we answered your questions. If not, you can always email us and we will try to do that over the year. That's the end of this conference.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect.