Good day ladies and gentlemen and welcome to the Gladstone Commercial’s First Quarter Earnings Call. At this time all participant lines are in a listen-only mode to reduce background noise but later we will be holding a question-and-answer session after the prepared remarks and instructions will follow at that time. [Operator Instructions] As a reminder, today’s conference call is being recorded. I would now like to introduce your first speaker for today, David Gladstone. You have the floor, sir.

All right. Thank you very much for that nice introduction. And we thank all of you for calling in. We have a great deal of fun with these calls and enjoyed doing them. You’re ever in this area we’re in a suburb called McLean Virginia, stop mine say hello, you’ll see some of the people that here they’re over 60 members of the team now. And we’re over $2 billion in assets under management. Now we’ll hear from Michael LiCalsi, he’s General Counsel & Secretary and Michael is also President of Administration, Gladstone’s Administration. And it’s the administrator for all the public funds that we manage. He’ll make a brief announcement regarding some of the legal regulatory matters. Michael?

Good morning everyone. The report that you were about to hear may include forward-looking statements within the meaning of the Securities Act of 1993 and the Securities Exchange Act of 1934 including statements with regard to the Company’s future performance. And 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 the risk factors included in our Forms 10-K and 10-Q that we filed with the SEC. And those can be found at our website, gladstonecommercial.com, and on the SEC’s website, which is www.sec.gov. And 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 also plan to talk about funds from operations, or FFO. FFO 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 the property plus depreciation and amortization of real estate assets. The National Association of REITs has endorsed FFO as one of the non-GAAP accounting standards that we can use in discussion of REIT. Now, please see our Form 10-Q, filed yesterday with the SEC, for a detailed description of FFO. And we also plan to discuss core FFO today, which is generally FFO adjusted for certain non-recurring revenues and expenses. And we believe this is a better indication of the operating results of our portfolio and allows better comparability of period-over-period performance. And to stay up-to-date on our fund, and the other Gladstone publicly traded funds, you can sign up on our website to receive email updates and the latest news plus you can follow us on Twitter, the username there is GladstoneComps and on Facebook, the keyword is The Gladstone Companies. And finally, you can visit our general website to see more information at www.gladstone.com. In today’s presentation is an overview, so we ask that you read our press release issued yesterday, and also our Form 10-Q for the quarter ended March 31, 2017, as well as the financial supplement that we prepared. And all these provide further detail on our portfolio and results of operations; these can all be accessed on our website, gladstonecommercial.com. And now we will begin the presentation today by hearing from Gladstone Commercial’s President, Bob Cutlip.

Thanks Mike. Good morning everyone. During the first quarter, we completed the lease up of both our Chicago industrial property and our Minneapolis office property sold a non-core property in Franklin, New Jersey for a nice capital gain of $5.9 million, issued $4.6 million of common and preferred equity through our aftermarket programs, we paid $35.4 million of maturing mortgages, continued our investor and investment bank outreach program by visiting with four registered investment advisors in three investment banks and conducting conference calls with fund managers to discuss operating results and strategy. Subsequent to the end of the quarter, we sold a non-core property in Hazelwood, Missouri completed the construction of the 75,000 square foot expansion of our industrial property adjacent to the Mercedes-Benz assembly plant in Vance, Alabama. We’re selected to acquire a 60,000 square foot multi-story office property in Philadelphia commenced activities to expand an existing tenant by 200,000 square feet on adjacent property in Big Flats, New York under a long-term lease and issued an additional $5.9 million of common and preferred stock under our ATM programs. As you can see from this overview we had another excellent quarter as we continue to re-lease a vacant property and maintain our exceptionally high occupancy. We are 97.9% occupied at March 31. We continue to be pleased with our activity and have a healthy pipeline of acquisition candidates. As noted during our last quarterly call, overall investment sales volume during 2016 was about 10% below 2015 as reported by national research firms. This slower pace continued through the first quarter. Entering the 9th year of the current cycle noted researchers have forecasted that the market cycle maybe peaking. And discussions with brokers at conferences reflect that listings are up but closings are down. Whether this leads to some cap…

Good morning. I’ll start by reviewing our first quarter operating results. All per share numbers I reference are based on fully diluted weighted average common shares. FFO and core FFO available to common stockholders was $9.7 million or $0.38 per share for the quarter, while this is a 4% increase totaling approximately $350,000 over the prior quarter the per share number remains the same. This is a function of increase in common shares outstanding related to our opportunistic $14 million direct placement in December and our continued usage of our ATM program. This dry powder will assist us in funding the acquisition pipeline that was laid out by Bob. Our first quarter results reflects an increase in total operating revenues to $22.3 million, as compared to total operating expenses excluding impairment charges of $14 million for the period. Net operating expenses at the property level declined by approximately $150,000 from the fourth quarter. In addition, we continue to reduce our interest expense by $100,000 from Q4, due to our gradual deleveraging and efficient loan refinancings. As Bob mentioned, we did sell one non-core property during the quarter, the sale resulted in a gain of $5.9 million. Now, let’s look further into our debt activity and capital structure. We continue to have a strong balance sheet as we grow our assets and focus on decreasing our leverage. We’ve reduced our debt to gross assets to 51% from 57% at the beginning of 2016 through refinancing maturing mortgage debt at lower leverage levels and redeeming our Series C preferred stock, which was considered debt due to its mandatory redemption date. We expect to continue to gradually decrease our leverage over the next 18 to 24 months. We continue to use primarily long-term mortgage debt as well as our line of credit to…

That was good report Mike. Thanks so much. And Bob Cutlip and Mike LiCalsi good reports as well. Main news again is very similar raise common and preferred stock for future acquisitions, we have a nice list of potential acquisitions, leased more vacant space that we have and repaid maturing loans or refinance them at lower interest rates and positioned ourselves for growth. The one item that Bob mentioned, which was the Alabama thing explains our success in the marketplace and that we’re willing to step up and help existing tenants, do most anything including expanding plans. Obviously, we have to increase the rent and we build on to it. As many of you know, the Company didn’t cut its monthly cash distributions during the recession that was quite a success story. We watched many very good REITs cut their distributions, most of them are never recovered, bringing the dividend back to the original level and we’re in a great position not to have a problem if the economy hits the skids again. Here is some of the things that we’re doing today. We need to continue to increase the common stock marketplace capitalization in order to increase the trading volumes. This will give the institutions who want to buy the stock, the ability to do this. Institutions always say the same thing; they want to be able to buy $10 million, $20 million, $30 million worth of our stocks. So we need to be big enough to accommodate that, they also want to obviously sell some day and so they want liquidity. We continue to grow the company, but consistently, we’ve built our assets and equity base doubling the size in the past five years with this growth, we hope we will see more buyers come into the stock…

[Operator Instructions] We will be taking our first question from the line of Dan Donlan from Ladenburg Thalmann. Your line is open.

Thank you and good morning. David all the talk on the external management agreement makes you think you must know I was in the queue.

We still love you, Dan. I know you don’t like external managers but still love you.

Well, to be honest with David at this point time given where you’re trading not – doesn’t seem to be an issue for investor itself. Our issue has always been that externally advice, we intended to trade at discount to NAV and clearly that’s not the case now. Just want to move to kind of growth versus the deleveraging. You’ve got a good cost to capital now with your equity. So I’m just curious, how you’re looking to manage that, it’s oftentimes kind of hard to grow when you’re delivering. But given your comments about how far we are out in the recovery. I’m just kind of curious your – how you weighted too?

Dan, as you know I’m highly in favor of leverage. I have been in this business and I think because we don’t have the kind of defaults and problems that others have had. That we’ve had this over 96% rented REIT for so long, that it’s proved that what we’re doing is not the high risk proposition that many REITs get into. And I don’t disagree with what they’re doing. They’re going out trying to make a lot of money by building things and changing things. We’re just sluggers, we’re in there every day, buying companies, buying buildings that have companies that are just solid payers of rent. So we’re building ours one brick at a time and growth for us is dependent on what we see in the marketplace. If we find the right one, we’re going to buy it. We’re under – Mike under a 50% leverage now.

We’re at 51% on a book basis.

51% on a book basis, that’s a nice number for me, Dan. I would like to knock it down any more than that. As you know during the last three or four years, we’ve been every time we were refinance something we borrowed less against the building even though it had probably gone up in value than we had before. So we had to put equity in. I’d like to stop doing that but I’m going to follow Bob on this. And Bob has to live with his leverage and so do I but, I want to grow and we’re going to grow, it just won’t grow as fast as someone would in this position. And I don’t really want to delever beyond this. But Bob will probably delever it down in the 40%s. So that he looks well, when he’s talking with people, he’s out in the marketplace today and one of the things people always say is you’re highly leveraged. Well, we’re not highly leveraged if you look at the track record of the company. We’ve been able to pay our dividends, we’ve been able to do things that others haven’t been able to do and given the strength of the portfolio, I just think deleveraging as a mistake. But Bob, you want to answer how you’re going to deleverage.

Sure. And Mike can add to this. I think Mike and I have spoken with a lot of analysts, investment banks, investors. And we think that if we lower the leverage another 5% to 7% maybe Mike – we think we are where we are. I mean, I think as David said, and what has always and I’ve had this conversation with you, before Dan. What always impressed me when I before I joined this company was our ability to acquire properties with people who are long-term rent payers. And I think our renewal percentage kind of supports that. And so yes, I think we can be a little bit higher leverage but for us to get I think more institutional coverage and to get even better multiples on our income. We’re going to need to lower and lower a bit. So you know 5% to 7% is where I think we’re going to be going Dan.

Okay. I appreciate the comments. And then as we look at this kind of shifting to set future financings, how do you feel about unsecured versus secured debt. A lot of the bigger public REITs IT is unsecured. But it kind of does limit their ability to hand back buildings and in the event something goes wrong. So just kind of curious, how you’re viewing that and if you’re going to continue to use more secured debt in order to protect yourself in the event of default or something like that.

Yes. Thanks, Dan. And I’ll address that. I think by and large you will see predominately continue to use secured debt, candidly we’ve been watching the peers, appreciating how other people do use corporate debt, corporate unsecured debt, I would think it would be reasonable over time as we grow the portfolio and some of those buckets of capital become more viable to a larger company that you would see some gradual shift in terms of contemplation and execution on the unsecured side. But all this is just going to be done on an organic level, we’re not going to wake up one day and have a dramatically different balance sheet. So by and large sticking to the Gladstone strategy, but probably with some trending toward being closer to our peer set from a desirable corporate execution.

Okay, appreciate that. And then maybe Bob for you. As you look at your – at the portfolio you definitely seem to shift to more higher growth markets with your acquisitions since you come on board. Just kind of curious, what percentage of the portfolio you may view as non-core, I mean you’ve been an active seller over the last couple of years. When – does that continue and how do you see that trending.

Well, I think a lot of its market driven there’s a couple of factors that we look at. As David indicates, we want to grow the portfolio or we can’t go into a wholesale capital recycling program and we don’t need to because these tenants are good rent payers. But when we look at long-term operating efficiencies, we know that we need to reduce the number of markets that we’re going to be operating in. Our goal and we stated in our business plan is for us to get down to 30 to 35 markets over time. We’re now just under 50 markets but it’s going to be gradual because we’ve already gone through renewals with a number of these smaller tenants. But as the opportunities present themselves and we can match acquisitions with the dispositions will continue to slowly leave those markets. But it’s going to be gradual, this is a marathon, it’s not a sprint and the team has done a great job of selling assets, when it made sense and we’ll continue to do so. But it’s not going to be aggressive Dan, just because the quality of the cash flow is very good. But long-term to be a better operating company, we do need to be in fewer markets and we will be.

Okay, it makes sense. And then just in terms of asset type. Something that you continue to add to both office and industrial. Is there any type of bent towards one or the other it really just simply depends on the tenant credit and I hate to use the word mission critical, but maybe the importance of the asset to the tenants underlying business?

Well as David said, first and foremost we look at the tenant and we spend a lot of time there. We look at the mission critical nature of the property, I mean as he indicated we’ve only had one BK in the entire history of the company approximately 100 tenants. So that is critical to us. I think from the standpoint of just looking purely real estate, we would like to move more towards industrial and as I indicated in my comments, we are being able to see – we are able to see more industrial now just because our cost to capital is dropped. And I like to move that to more of a higher percentage on the industrial long-term, but we’re not going to be in a big rush to do it. The majority of our pipeline right now is industrial because we can’t operate in that space. But we will continue to be looking at mission critical first and if it’s in office property, we will buy it.

Okay. Thank you, appreciate it.

Okay, next question.

Our next question comes from the line of Larry Raiman from LTR Capital Management. Your line is open.

Thank you. Good morning, everyone. Nice job on the quarter to the team. Two quick questions, first, with regard to any maintenance capital expenditures in the portfolio, I know so many of your properties are net lease than there’s not much lease roll. But in terms of maintenance requirements at the company level regarding parking lots or routes, could you guide folks with regard to how much money you spend in that activity?

Yes. This is Bob. And I can give you a macro right now and Larry, I can give you some more specifics when I have access to it. But this year for both tenant improvements and the capital for the buildings themselves. We’re looking at about $7 million and of that it’s about 50-50 with tenant improvements – and tenant improvements and building improvements. We have probably another $4.5 million of capital we’re going to expand during the first half of the year relating to that expansion of the Lear facility. But you could probably anticipate that with the size of this company our recurring cap improvement for us is probably $3 million to $4 million a year.

So $3 million to $4 million a year for just building, maintaining it not reimbursed by the tenants, is that correct.

That is correct.

$3 million to $4 million.

Yes, it’s about – and it’s probably closer to $3 million because some of our capital requirements on these buildings, we do get amortization of HVAC systems and roofs depending upon how the lease is structured and of course, we inherit the lease that is given to us when we buy the property.

Right, okay. Thank you for that disclosure. And then one final question there was a – I saw on the income statement that there was about a $3.7 million reserve taken for an asset. Could you describe what happened there?

Sure. And Larry, it’s more further expanded within the footnotes of the financial. The impairment charges of $3.7 million were pertaining to the accounting assessment on two non-core properties within the portfolio. Obviously, appreciating as an accounting exercise that goes along with that where you probability weigh. Your sales scenario as well as – cash flows for the remaining lease clearly within the accounting guidance you don’t get upside on any of your properties within your GAAP income statement. You take the down side so these would be two properties that as of today we consider that non-core and it’s just part of really the quarterly assessment of the entire portfolio.

And are those assets that are earmarked for sale at some point in the future.

I wouldn’t say. Bob can expand after I speak to it. I don’t think of that’s a probable scenario, it’s a possible scenario. But they would be ones that potentially at the right price we would certainly consider it.

Okay, thank you.

Next question.

[Operator Instructions] Looks like we have no other questioners in the queue at this time. So I’d like to turn the call back over to Mr. Gladstone for closing comments.

All right. Thank you all for all the support you’ve given us. Just watch, we’re going to keep going, keep growing. Thanks again, that’s the end of this call.

Ladies and gentlemen, thank you again for your participation in today’s conference call. This now concludes the program and you may now disconnect your phones at this time. Everyone have a great day.