Gladstone Commercial Corporation (GOOD) Q1 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Gladstone Commercial Corporation First Quarter ended March 31, 2012, Shareholders' Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. David Gladstone, Chairman. Please go ahead, sir.

Well, thank you, Denise, for that nice introduction, and thanks to all of you for calling in. As I mention each time, we enjoy these times that we have with you on the phone. And I wish we had a lot more of these times, it'd be a lot more fun. Please come by and visit us if you're ever in the Washington, D.C. area. We are in a suburb called, McLean, Virginia. You have an open invitation for us -- from us to stop by and see us if you're here. You'll see a great team at work. There are 55 members now in the team and we're no longer a little, tiny company, and we have a couple of puppy dogs here every day. We're very dog-friendly. Also I'd like to tell you we're having our Annual Shareholders Meeting on Thursday, this Thursday, May 3, beginning at 11 a.m. We are at the McLean Hilton. It's located at 7920 Jones Branch Drive in McLean, Virginia. You're all welcome to join, and I'm hopeful that all of you have mailed in your proxies and voted. And now let's say a word about forward-looking statements. This report that I'm 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. In our call today, we plan to talk about funds from operation or FFO. And since FFO is a non-GAAP accounting term, I need to define FFO as income, excluding gains or losses from the sale of real estate, plus depreciation and amortization of real estate assets. The National Association of REITs or NAREIT has endorsed FFO as one of those non-accounting standards that we can use in discussion of REITs. Please see our 10-Q filed yesterday with the SEC and our financial statement. And 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 of those listed under the caption "Risk Factors" in the 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 at the SEC website. Just to remind you, the company undertakes no obligation to publicly update or revise any of the forward-looking statements, whether it's future results, new information, or otherwise. And now, I'd like to begin the call today by hearing from our President, Chip Stelljes. Chip is also the Chief Investment Officer of all the Gladstone companies. Chip, take it away.

Good morning, everyone. During the quarter, we acquired one additional property raised for equity and expanded our line of credit. Our pipeline is robust and we hope to announce additional acquisitions in the near future. As of today, all but 2 of our buildings are occupied and all of the buildings that remain occupied continue to pay as agreed. The 2 empty buildings constitute about 2.1% of our gross portfolio income and about 1.3% of the total square footage of space we own. We continue to take appropriate actions to re-tenant these properties as quickly as possible. We acquired one new property with 52,000 square feet for $10.8 million. This property is an office building located in suburban Washington, D.C. And the average cap rate over the term of the lease is 9.2%. This asset is currently pledged to the borrowing base on our line of credit. The market for long-term mortgages has been limited for some time. However, we have recently seen 2 longer-term, 5 to 10 year mortgages become more obtainable. The collateralized mortgage backed securities or CMBS market has made a comeback in recent months, but it's more conservative than it was prior to the recession. The pricing in the market remained somewhat volatile. Consequently, we continue to look primarily to regional banks, insurance companies and other non-bank lenders to finance most of our real estate activities. We did issue one new 10-year mortgage through the CMBS market in April for $19 million of proceeds at an interest rate of 6.1%, and that note collateralized by 4 properties. On the equity side, we issued $38.5 million of our Series C preferred stock, which is trading on the NASDAQ under the ticker symbol GOODN. We used the proceeds to pay down the remaining outstanding balance on our line of credit, and we'd hope to invest the remaining funds over the next few months in the new properties. Other than through our senior common stock offering, we do not anticipate a need to raise any additional capital through share issuances until later in 2012. Despite the challenges in the marketplace, we were successful in raising cost-effective equity in issuing additional term-mortgage debt to grow our portfolio of properties. While we're seeing signs of improvement in both the equity and debt capital markets, we believe these markets will remain somewhat challenging during 2012 as we all adjust to the new terms available in these markets. But we continue to use our line of credit to make acquisitions that we believe can be financed with longer-term mortgage debt. As you recall, our customary business model calls for us to initially to borrow from the line of credit to buy properties. We then obtain longer-term fixed-rate mortgages as soon as we can. And by doing this, we are able to secure a spread between the rent coming in and the mortgage payments going out, thus locking in profit for 5 to 10 years or in some cases, longer. From a liquidity perspective, the proceeds from the mortgages then pay down our line of credit, thus making the line available for purchase of our next property. As mentioned earlier, we expanded our line of credit from $50 million to $75 million in January, to give us more room to acquire additional properties. We have one additional bank joining the bank syndication group. With the turmoil in the credit and equity markets over the past few years, our business model adjusted so that we're matching as closely as possible, long-term leases with longer-term credit. If we don't believe we will be able to source attractive debt on new acquisitions, then we'll only buy properties that already have long-term mortgages on them. Our current availability into the line of credit after paying the balance to 0 from proceeds from our preferred offering is $22.1 million. In addition, we have approximately $26 million of cash on hand. So assuming we can obtain 65% loan-to-value on new acquisitions, we have enough liquidity to acquire as much as $130 million of new properties. We also continue to improve the value of our existing portfolio of properties by reviewing and renegotiating existing leases and performing improvements at those properties, and selling a certain of our assets. To this end, we're actively working with our existing tenants who have leases expiring in 2012 and 2013 to renegotiate the terms of their leases and extend the terms. We are relatively confident that the tenant for the one remaining lease that expires in 2012 will renew their lease and we are in negotiations with this tenant now. At quarter end, all of our existing tenants have paid as agreed and our portfolio is 98% leased. So we have 2 buildings without tenants and are working hard to find new tenants for each. Signing new leases will require some capital outlay for leasing commissions and tenant allowances. Our pipeline 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, thank you. That's a good presentation. Now let's turn it over to our Chief Financial Officer, Danielle Jones, who will report on the financial results. Danielle?

Good morning. Our quarterly results are positive and reflect our growth from our recent acquisitions. At quarter end, our total assets increased to $468 million, up 12.4% from one year ago. The amount outstanding under long-term mortgages in our line of credit increased slightly to $282.1 million from last year. In addition, our stockholders' equity increased by 6.6% to $131.7 million from our common equity offerings during 2011. Our balance sheet remains strong. During the quarter, we completed a public offering of 1.54 million shares of our 7.125% Series D Term Preferred Stock at a price of $25 per share, resulting in gross proceeds of $38.5 million. We used the proceeds in the offering to repay the remaining outstanding balance on our line of credit. Due to its mandatory redemption future, the preferred stock is classified as a liability on our balance sheet and the costs incurred related to this offering are recorded in deferred offering costs and will amortize over the redemption period ending in January 2017. We have mortgage debt in the aggregate principal amount of $3 million payable during the remainder of 2012, and $58.1 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 cash or borrowing capacity under our line of credit to pay these amounts. Of the $58.5 million of principal payable in 2013, $53.9 million are balloon principal payments not due until the fourth quarter of 2013. We are currently in discussions with these lenders and anticipate being able to extend the maturity dates or alternatively refinance the mortgages with new lenders. The weighted average interest rate in our existing mortgages remains at 5.7%. Because of the proceeds from the preferred equity raise, we had nothing outstanding under our line at the end of the quarter. Our debt-to-equity ratio at the end of the quarter, including our new tranche preferred stock was approximately 2.4:1. Our sources of liquidity include cash flows generated from our operations, existing cash on hand, availability under our line of credit and obtaining mortgages on our unencumbered properties, and issuing additional equity securities. Our current available liquidity is approximately $48.1 million, comprised of $26 million in cash and an available borrowing capacity of $22.1 million under our line of credit. The borrowing capacity on our line of credit is limited to a percentage of the value of properties pledged as collateral to the line with the amount outstanding under the line in our outstanding letters of credit. With the capacity underlying in our current cash flow from operations, we have sufficient liquidity to acquire additional properties in our pipeline, fund our operations, service our debt this year, perform capital improvement to our properties and maintain our distribution to our common shareholders. In addition, we continue to have the ability to raise $218 million of additional preferred or common stock equity through the sale securities that are registered under our shelf registration statement in one or more future public offerings. Of the approximately $218 million of available capacity under our shelf, approximately $22 million of common stock is reserved for additional sales under our open market sales agreement. And now we will review the operating results for the quarter. 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, which was a 9.2% increase in total FFO from the same period last year. The increase in FFO for the quarter was primarily a result of the 15% increase in our rental income, compared to the first quarter of 2011, because of income generated from the 8 properties acquired over the past 12 months. This was partially offset by an increase in our interest expense from the long-term financings from the mortgage debt issued and assumed during 2011, an increase in our preferred dividends from issuance of our series D Term Preferred Stock, and an increase in due diligence expense from acquisitions during the quarter, combined with costs incurred on deals in our pipeline. Also the first quarter of 2011, we had a credit to due diligence expense from the adjustments to due diligence costs that were expense related to the acquisitions during the fourth quarter of 2010. This caused a large increase in the expense quarter-over-quarter. We paid out 34.9% of the incentive fee during the quarter. This amount was limited because we have additional preferred equity raised in January, which has yet to be fully deployed. With our strong pipeline, we are hopeful that we'll be able to pay at a larger percentage of the incentive fee for the remainder of 2012, and as we continue to build our portfolio, we will be able to consistently pay out 100% of the incentive we earned. Through that, we will be able to grow our FFO. And now, I'll turn the program back over to David.

All right. Thank you, Danielle, for that good report. We encourage all of the listeners to read the press release and the quarterly reports that were filed yesterday with the SEC, called Form 10-Q. There's a lot of good information and material in those documents, and you can find them on our website at www.gladstonecommercial.com and on the SEC website. To stay up-to-date in the latest news involving the Gladstone Commercial and our other public companies, please follow us on Twitter, using the name, "GladstoneComps," and also on Facebook, keyword, "The Gladstone Companies," and you can go to our general website to see more information about our fund. That's www.gladstone.com. The main news report for the quarter is that we were able to acquire additional property and raise preferred equity and expand our line of credit. All of these are very positive news for shareholders. We've built a nice pipeline of properties that we intend to acquire during the next quarter, the quarter that we're in, and because of that pipeline, we hope to be able to grow the assets even more during 2012. And with the increase in the portfolio and the properties come greater diversification and we believe better earnings for our shareholders. We're still selling some senior common stock and have sold over $1 million to date. Momentum is building, albeit slowly on that program. And I think this company is in a great position today to increase the assets and to increase the income from those assets. I just believe 2012 is going to be a great year for us. On another note, we've been able to find some attractive long-term mortgages to finance our unencumbered properties. And after the March 31 quarter, we put $19 million mortgage debt on the 4 properties. That's a very positive sign that the marketplace is beginning to come back for long-term mortgages on property. The mortgage marketplace from banks is getting much better. But it's still not as robust as it was 4 or 5 years ago. And we continue to work to place some long-term financing on our remaining properties that are unencumbered. We also continue to look at properties with mortgages on them so we can assume the secure financing and close simultaneously on the acquisition, as we did with 3 of the properties acquired in 2011. I think we can do some more of those in 2012 as well. The market for real estate properties is divided into those 3 big categories that I talk about each time, one where the tenant is maybe a AAA or BBB rating and located in a high quality area. These are being sought after by some of the very large real estate investment trusts, insurance companies, pension funds, all of those buy those properties. The cap rates are continuing to move around. They're very low. They've been going down over the last year. But they are still much too low for us to consider in this category because our cost of capital is higher. Then there's another category called small real estate properties like fast food locations, pharmacy-chain locations. We've purchased a couple of the pharmacy chains, and those are very nice. We didn't pay the normal cap rate of 6.5% to 7%. We do that for income and so does everybody else. We were able to get ours at about an 8% to 8.25%. These 2 properties that we purchased last year are probably things that we won't be doing much in this year. They just become too expensive for us to buy right now. The area we most like to invest in is the middle market, where we see non-rated tenants, and small and medium-sized businesses, and commercial office and industrial properties, as well as the medical properties. I think about 40% of all our properties now have rated tenants in them and the other 60% are ones that we rate ourselves. And here's where our competitive advantage comes in. We have an expertise to underwrite the non-rated business tenants in conjunction with the acquisition of the real estate. As most of you know, we operate 2 other funds that are in the business development area, which underwrite small businesses, and we use those folks to underwrite these businesses. So we have a good position. I think we'll see a lot more opportunity here. Cap rates in this group are in the 8% and 9% range, and when they're leveraged, we're in the 11% to 15% range. So this is where we want to focus a lot of our attention during the coming year. We are focusing our efforts on finding good properties with long-term financing that match our long-term leases. Being able to lock in long-term financing to match the long-term leases, and it just makes the money continue to roll in, year in and year out. We are much more optimistic this year than we were even last year. I think 2012 is going to be a wonderful year for us, but we are proceeding cautiously as we always do. Much of the industrial base that rents industrial and commercial properties remained steady. Most of them are -- they're paying their rents as they always seem to do. There are still some businesses that are having problems, but in my way of thinking, we are better off now even than we were last year. And we expect this to be a significant growth period for this real estate investment trust. And while I'm optimistic about our company funding the future, nevertheless, we will continue to be cautious in our acquisitions, as we've done in the past years. As you know, we made it through the last recession without cutting dividend or having a lot of problems from our tenants. And if there's another recession coming, I think this portfolio will continue to stand the test of time for those kinds of problems. Now we were successful in raising common equity twice in 2011. We raised preferred stock in 2012. We'll use the new equity and have used it to even -- and buy more and more business, real estate. And in April 2012, the board maintained the distribution rate of $0.125 for April, May, and June. And the annual rate now is $1.50 per rate and this is a very attractive rate for such a well-run and well-managed -- and we're done -- I always say this every time, we pay 93 consecutive common stock dividends, since inception, and we went through the recession without cutting the dividend or making any changes. So again, I think you have a great real estate investment trust here. And the depreciation is one thing that a lot of people ask me about. The distribution in 2011 was about 83% of return to capital, and that of course is tax-free. And that makes us a very tax-friendly stock and in my opinion a good one for personal accounts. It's also good for IRAs and QoS, but at the same time, personal accounts because it's so tax friendly, it makes it a very good acquisition for your portfolio. This return to capital is due to the depreciation of real estate assets and other items, and that causes earnings to remain low after depreciation. We obviously gross it up to FFO, and that's why we talk about FFO so much because we've added back the real estate depreciation. Depreciation of the building is a bit of a fiction since at the end of the depreciation period, the building is still standing. It's just -- it shelters our income. If you own a stock in a non-retirement account, as opposed to having an IRA or retirement plan, and you don't pay any taxes on that part that's sheltered by the depreciation, as it's considered a return to capital. However, return to capital does reduce your cost basis on the stock, which may result in a larger capital gains tax when your stock is sold. For the stock price now, it's just under $17. The distribution yield on the stock is about 8.8%, and again having so much of that is tax-free. It's a very wonderful stock. Many of the REITS today, trading at much lower yields. I just read that the entire REIT universe is trading at about 4.1% yield. Obviously, if we traded at about 4.1%, we'd be over $36 a share. And the triple net REITs that are very similar to us are trading at about a 5.7%, and if we were trading at a 5.7% yield, we'd be at $26 stocks. So there's plenty of room for expansion of the yields here. We should be trading in those areas. And as we continue to grow and build the company, I'm sure more and more folks will find us attractive. We will be voting in early July during our quarterly board meeting to declare the monthly distribution of July, August and September. And now, let's stop and have Denise come on, and we'll have some questions from our loyal shareholders and a few of the analysts out there who follow this great REIT. Will the operator please come on, and listeners, so they can ask questions?

[Operator Instructions] And our first question will come from John Roberts of Hilliard Lyons.

Can you talk a little bit about what your expectations are for the year for acquisitions, and what the existing pipeline looks like at this point?

Sure. Chip, you want to talk about that? I know we have a couple that are coming close to closing, but we all hold our breath, as we get near to closing because sometimes they fall out. But Chip, go ahead.

Yes, with the pipeline still, we've got multiple deals until a letter of intent right now. They are somewhere in the due diligence closing process, and it's often hard to forecast quarter-to-quarter, but we certainly feel like we can make more than one acquisition per quarter on average. And so we're pushing forward. We have a good pipeline. I hate to be too specific because as David said, sometimes -- and deals fall out of the pipeline and sometimes goes the wrong direction and we find a problem with them. But I'm confident that we've got enough of a pipeline to deliver a pretty good acquisition year by the end of the fiscal year, December.

But you've got about -- you said $130 million in existing liquidity which you basically can use for acquisitions. Are you anticipating a level where you will not have to do any additional capital raises for the current year?

That's what we're forecasting right now is that we wouldn't have to raise any additional equity by the end of the year at this point. And the only additional equity we would be raising is our ongoing efforts for senior common.

Just to piggyback on that, the goal here obviously, is to put as many good assets on the books as possible without being crazy and just loading up with anything that comes along. And that would allow us -- the marketplace is very receptive to our preferred stock. I think we could sell common stock if we wanted to. I think the stock is a little too low today to be going out for common stock. But if we had the opportunities out there and the numbers work, that is if we raise money at x, and can do it at x-plus, something in terms of return, we're obviously going to do that as long as it's accretive. So who knows? Maybe we'll get very lucky through the summer, close a lot of deals and need to raise money in the fall, but right now, we're making a very conservative production.

I would also note that while we haven't done one historically, we're occasionally looking at some portfolio opportunities that would be multiple transactions or multiple acquisitions, and so that might change that dynamic, too. And we are reviewing those and sometimes we see one that might make some sense for us.

Our next question will come from Daniel Donlan of Janney Capital Markets.

This is actually Elizabeth Bland with Dan Donlan. We were just wondering if you could provide any additional details on leasing progress at your vacant properties, if there's an update on the LOI you had at Richmond or anything on Hazelwood.

Chip, go ahead.

Yes, we had the 2 vacant properties both continue to have some level of interests from the community of brokers in those 2 areas, but we're not close on something on either one of them right now. With the one that we were fairly close on is not going to occur in our Richmond property and so we're, I wouldn't say, back to the drawing board on that, but we're back to talking with new tenants. The good news is, Richmond absorption is improving, and we are seeing interest in our property in the area of the city where the property is because there's some new construction going on and some new retail going on. So we're positive on that one. The other one is in St. Louis, we continue to work on, but there's nothing definite at this point, or no candidate that we're negotiating directly with. But we've had a number of people through the building and showing interest in it, but nothing that we can concretely talk about today.

[Operator Instructions] And we have a question from Jeff Rudner of UBS.

You referred to the dividend and the longevity of the dividend having never been caught paying the $0.125 per month. What would have to occur with the company in order for you to consider raising the dividend beyond the $0.125 monthly level?

Yes, e look at it obviously every quarter. The board considers whether they should raise it or not. We just need to get the FFO up higher than it is today. And I think if you look at how many deals we've put on the books during the last year, most of those were only on for part of the year. As they strengthen and continue to grow, I think this year might be a good chance for us to raise the dividend. I just -- I do want to make any promises, but I think we're getting very strong right now.

And I'm showing no additional questions in the queue. I'd like to turn the conference back over to Mr. David Gladstone for any closing comments.

All right. Again, thank you, all, very much for attending the meeting. And if you have other questions, you can e-mail them in. We'll do the best we can to answer them. And that's the end of this conference.

Ladies and gentlemen, the conference has concluded. We thank you for attending today's presentation. You may now disconnect.