Welcome to the Gladstone Commercial Corporation second quarter earnings ended June 30, 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, David Gladstone. Please go ahead.

Well, thank you, Charlotte. Nice introduction and we thank all of you for calling in. We always enjoy this time that we have with you on the phone which we have more time to talk to you. Opening invitation, please come by and visit us if you're ever in the Washington, D.C. area. We're located in a suburb called McLean, Virginia and you have an open invitation to stop by and say hello to the people that are here, a lot of people on the road. But we have 60 members on the team now or so and it's usually always someone here to say hello to you if you stop by. We will now hear from Michael LiCalsi, he's our General Counsel and Secretary. Michael is also the President of Gladstone Administration. And he serves as the administrator to all of our public funds and related companies as well. He will make a brief announcement regarding some of the regulatory matters concerning this call. Michael.

Thank you, David. Good morning, everyone. This report 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 company's future performance. And these forward-looking statements involve certain risks and uncertainties that are based on our current plans which we believe to be reasonable. And there are many factors that may cause our actual results to be materially different from any future results expressed or implied by these follows, including all the risk factors, including in our forms 10-K and 10-Q which we filed with the SEC. Those can all be found on our website, gladstonecommercial.com; and on the SEC's website which is 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 also plan to talk about funds from operations or FFO. The 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 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 REITs. Please see our form 10-Q filed yesterday with the SEC for a detailed description of FFO. We also plan to discuss core FFO today which is generally FFO adjusted for certain other nonrecurring revenues and expenses. We believe this is the 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 other Gladstone publicly traded funds, you can sign up on our website to receive e-mail updates on the latest news plus you can also 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 gladstone.com. And today's presentation is an overview. So we ask that you read our press release issued yesterday and also our review our Form 10-Q for the quarter ended June 30, 2017, as well as the financial supplement that we prepared for everyone. And this provides further detail of our portfolio and results of operations. You can find all these documents on our website at gladstonecommercial.com. And now we will begin today's presentation by hearing from Gladstone Commercial's President, Bob Cutlip.

Thanks, Mike. Good morning, everyone. During the second quarter, we acquired a $15.5 million multi-storey office property in Philadelphia completed construction of 75,000 square foot expansion to our industrial property in Vance, Alabama. Extended an 83,000 square foot office lease through 2028 in Allen, Texas. Sold 1 noncore property in Hazelwood, Missouri and 1 in Concord Township, Ohio. Issued $20.2 million of common and preferred equity through our at-the-market programs and continued our outreach program by visiting with registered investment advisers and then meeting with investment banks, analysts, fund managers and lenders to discuss operating results and strategy. Subsequent to the end of the quarter, we acquired a $26.4 million industrial property in Philadelphia, Pennsylvania. Acquired a $51.4 million 3 building office complex in Orlando, Florida. The press release for that acquisition was just issued this morning. Extended the lease on 223,000 square foot industrial facility through 2031 in Northeast Pennsylvania. Commenced activity to expand an existing tenant by 200,000 square feet in big flats New York under a long term lease. Issued $26.1 million of common equity through overnight offering and issued an additional $13.6 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 add high-performing assets to our portfolio, renew and extend leases and issue equity as we anticipate additional growth opportunities. Our portfolio is 97% occupied at June 30th and we continue to be pleased with our activity and have a healthy pipeline of acquisition. Now for some company-specific details. We completed 1 acquisition during the quarter and 2 acquisitions in July. We acquired a $15.5 million office property in Philadelphia in June. Jacobs Engineering, a Fortune 500 company is the tenant. Jacobs has been in the building since construction…

Good morning. I'll start by reviewing our second 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 were $10.3 million and $9.8 million or $0.40 and $0.37 per share for the quarter respectively. While this is a 6% increase in FFO totaling approximately $570,000 over the prior quarter, this substantially associated with the lease termination fee that we received on the disposition of a non-core asset. With the exception of this, core FFO reflects a $23,000 increase from the prior quarter. As Bob mentioned, we have made 2 individual building acquisitions as well as a 3 building portfolio acquisition in the past six weeks. In advance of these acquisitions, we did raise a good amount of equity which I'll discuss further in a minute. Our second quarter results reflect an increase in total operating revenues to $22.9 million as compared to total operating expenses excluding impairment charges of $14 million for the period. We continue to reduce our interest expense by $200,000 from Q1 due to our gradual deleveraging and efficient loan refinancings. As Bob mentioned, we did sell 2 non-core properties during the quarter. These sales resulted in a net loss of $1.9 million. We also did record an impairment charge on 1 asset that is classified as held-for-sale totaling $250,000. Now let's look further into our debt equity 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 growth assets to 50% from nearly 60% 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…

Okay. That was a great report from Mike and Bob and Michael. That quarter ending June 30th was an excellent one and coming out the first month of next quarter of the September 30th quarter that's really exciting with all of those closings. And the main news, of course, for the quarter that ended is we raised common stock and preferred stock. We continued to increase our equity and offering that we did, we leased more vacant space, we paid loans or refinanced them at lower interest rates. We really positioned ourselves for some good growth going forward. We have had some quality real estate to our portfolio and short of the existing properties. And many of your --that our company didn't cut its monthly cash distributions during the recession, I think that was a story that we told over and over again. It was a wonderful story. We want some of our good companies that were out there, we were competing with, that they cut their distributions and most of them never came back or recovered from cutting their dividend during that period of time. So we're in a great position not to have substantial problems if they economy hits the skids again. We also looking at how strong we're today. We don't have many leases coming due for the next 2.5 years. So low risk and low spending on new tenant improvements. We continue to refinance loans that were coming due. And we do have a much lower interest rates than they are currently on the books. So that falls right to the bottom line. We're now building up the asset base with new purchases and we have more of those to come. I just think the balance sheet today of this company is strong, it's battle ready…

[Operator Instructions]. Our first question comes from the line of from Ryan Meliker from Canaccord Genuity. Your line is open.

I just have two quick questions. First of all congratulations on getting all the deals done. You guys have been pretty active. But as we think about some of the deals, especially the equity offerings. I guess which you guys do the overnight offering as opposed to continued issue on the ATM. I mean, it looks like net proceeds on the ATM came out to a similar level to where you were on overnight in the last 4 months. But the pricing on the ATM is much, much more attractive. Do you guys look like net bases about over 7% higher proceeds per share. So I'm wondering why you guys chose to do that. And if we're going to see more of that? Or if you guys be more active on the ATM?

To your point, we were very active in the ATM. Q1 and Q2 we were doing about $25 million and even subsequent to June and July doing roughly $30 million the ATM issuances with a common piece of being that in the mid-to-low $21 range net of fees. But as we think about our pipeline and as you can see, this has been a pretty robust 6-week period. The ATM facility will always fund our traditional asset acquisitions probably predominantly more in the $10 million to $25 million single property range. When we get to the points where we're looking at larger portfolio deals like the ADP portfolio which is great property with great credit, we can't be solely reliant upon the ATM program for the amount of equity that is going to be required for that type of deal when we're doing those acquisitions in the 50% or 55% leverage level. So be mindful of doing $100 million of acquisitions in a 45-day period. We've been looking at the overnight market, feel like as we did a close we did it with a common share price of $21.72. Still a positive for the shareholders to fund that accretive deal. So as we look forward, it's upon timing and size of pipeline. The ATM program will continue to hum along and be active predominantly on the common side a little bit on the Series D throughout 2017 and into the future. But when we hit times where we have bumpier acquisitions we will be potentially looking at those markets that we looked out in the past.

Ryan, do you have a second question?

Yes, secondly, I wanted to ask you about along those the acquisition time line and what's going on. It sounded like you mentioned you had $55 million in assets on letter of intent. How confident are you that those will close? And I'm assuming none of those are the size that would warrant another overnight, is that fair?

That is fair. Those do not warrant an overnight. And I can only talk to you about history. When we look at letter of intent, we're still in a competitive mode with a number of other people and we're going to best and final offer. So our track record has typically been somewhere between 15% to 25%. So since I've been here 5 years that's been pretty indicative of how we score. Sometimes we get a little bit higher, but it's a very competitive market out there now. As you know, cap rates really haven't risen and there is more foreign money chasing deals in the secondary growth market. So I think that's still a pretty good percentage, Ryan.

Okay. That's helpful. And then 1 last question. And Mike this is probably more for you. If I recall correctly your series A and B preferred I think both redeemable at this point in time. Would you guys look to take those out whether with another preferred closer to where the market seems to be on Series D ATM?

Yes, I think it's a fair question, Ryan. They both are freely redeemable at this point in time. All I can say is it is one of many capital markets topics that we kick around, while we continue to watch where the preferred market is .But there is no indication of direction one way or the other by the company at this point.

Our next question comes from the line of John Roberts from Hilliard Lyons Capital.

This is mainly for you. You laid out the pipeline and I'm - sorry, you spoke off a quick. So I didn't get all the numbers 14 properties, I think.

14 properties, right, 14 due diligence. By due diligence that is the property that is going to be an expansion of our tenant in New York. So that is the done deal. We're just finalizing the lease negotiations. So that's only property due diligence at this point. The other properties that are in letter of intent are 2 industrial and 1 office property, pretty much in our sweet spot of size. And as I indicated, Brian, our history has been 15% to 25% kill ratio on those things. And so we will see how they turn out. But at the beginning of the year, as you know, it was very slow. And, in fact, reports from and even and volume was down 20%, Q1 '17 versus Q1 '16. That volume is now increased and, of course, it has led to more listings. So we're cautiously optimistic about the balance of the year. We're still seeing product come cross some and removing it from initial review standpoint. We would like to have somewhere between $150 million and $200 million in the initial review stage all the time because we all know they fall out.

Right. So that's four properties, you were 14 in total. What's the other 10 look like?

Four of them are industrial and 6 of them are office. And they are all in our target markets. They are on the website the 20 target markets. The team has done a great job of staying with growing portfolios in the secondary growth market so that we improve our operating efficiencies. We're staying away from tertiary markets completely.

And those 10 probably $150 million in total so?

It's about $160 million, almost $170 million.

$170 million. Okay. And David you've got a real wide range of cap rates this. The 1 property 6.6 and you've got going as high as 10.5. You want to give us some clue as to sort of the range you're looking at and would you feel more comfortable at this point on a cap rate basis?

Bob is going to answer that one. He is online every day.

John. Here is what transpired across the on those. As we have noted in the past, we're really wishing to move more on the industrial side as many people have. And the property in Philadelphia which is the 6.6% cap rate is with an existing tenant, NARA and we recognize that the margin on that is much, of course, much smaller. But from an industrial standpoint, we feel confident anywhere from the mid really the upper 6s to the low to mid 7s. We will chase those deals on an office product. We really want to start with the 7, if we possibly can. So when I look at that property from an industrial standpoint that fits into or wanting to be into the secondary growth market with really a very stable tenant and existing tenant. And with the ability to expand that property by 40,000 square feet, I feel very confident of continued long term occupancy which I think because the security related to every NARA facility they don't want to leave and I think we have a little bit better negotiating position on the renewal. Moving up the spectrum, the office property that we bought was in the low 7s, cap rate once again in a strong market with an excellent tenant. They are Fortune 500, very strong for us and a place that we wanted to be. The 10.5 is a bit of an outlier and that was the expansion of our existing facility in Alabama. When we bought it as a forward purchase of the build-to-suit in 2013 want to be sure that we did a good job recognizing we may need additional space in future so we bought the land with additional expansion capability. And since Mercedes-Benz doubled their investments, our tenant was able to expand and increase their contract and, of course, they couldn't go anywhere. So that improved the leverage that we had on negotiating of that deal. And then the deal - the deal in Center which is absolutely if you have been down to Florida Center is the first submarket in the north of the CBD. It is completely built out right now. We're buying that property below replacement cost. In my opinion, it's $170. We've structured parking on that. And our parking ratio, I think, is like over [indiscernible]. And with ADP and over 70% of the building, we getting a cap rate at that level is really, really strong, almost 8.5% on.

That's sounded very high to me.

Well, here is thing. We were not - to be honest, we were not selected first on that deal. And had identified some items that had to be done on the property. And so we were not selected. As it turned out, the company or the buyer who was selected identified the same issues that we had afterwards and did not incorporate into their underwriting. And so as it turned out, the items that we said had to be done were in fact done when it came back to us. And I think there was just a question of - it's not a net leased property, it's our anchored multi-tenant program that we felt so strongly about ADP they in fact have just expanded into the current space that they are in now and in one of the buildings they are in, 4 of the 5 floors and the other floor is occupied by 3 tenants which are Florida. So if they move out, I think it's a great opportunity for them to expand. So we look at it from the standpoint as we're taking on more risk. So we're going to take more risk you have got multiple tenants, more management intensive, the cap rate should be higher.

Great. We'll sound like good property.

We're excited about it. The construction is A quality, by excellent developer, owner. So we feel very, very happy by team absolutely, great job and getting this across-the-board line.

Next question comes from Daniel Donlan from Ladenburg Thalmann.

I just wanted to go back over the Orlando building you guys announced and then just recently talked about. I'm just kind of curious as you said you were multi-tenant structure program. Could you maybe expand upon that I heard that in the future?

We call it anchored multi-tenant. And what that means Dan is we will buy a property that has maybe 3 to 4 tenants in it. If the lead tenant, the anchor tenant is leased-in 60%, 60% to 70% of the building and has a minimum of 7 years left on the lease and because of our credit underwriting look, we see them in a growth trajectory. And if, in fact, they need to grow in the future, we know that the balance of the space will accommodate them because they're already in it and then we can work with the other smaller leases to move people out if necessary. I mean, as you know, in the net lease business is binary. 3 things can happen at the end of the tenant's lease period and 2 of them are good, they need to expand or they need to contract. And so with the building now that we see as anchored multi-tenant that we know is flexible and since there are other tenants in that building if, in fact, our prime tenant needs to reduce the space, we know that we can release the balances space. If the tenant needs to expand, then we should be able to accommodate through expansion because of the other tenants in the building. So it's a very small product type for us. It will never be over 10% of our total portfolio. But we think it does a couple of things for us. It initiates the relationship with the company that we think have a great growth trajectory ahead of them. And it also gives us flexibility at the end of the lease term should they either need to expand or contract.

Okay. That makes sense. I'm just kind of curious from a buy perspective. Is this something that because it's over 60% anchored over 60%, is this something that's not as interesting to some of the of multi-tenant office folks and obviously, not attractive to the office folks. Is there kind of a sweet spot for you in that?

We think it is. And the recent is the typical multi-tenant player and I was one in the past. Once we acquire the property that has some vacancy in it. And, therefore, they have - obviously and currently more upside because they're taking on more risk. And so we're trying to carve out a niche play here which has been very successful as we've done it in Columbus, Ohio and in Dallas, Texas to buy a property that has multiple tenants in it. So you do have to have management capability to take care of the tenant. But it is fully occupied. So the typical value add multi-tenant player is not going to have interest in this because the returns are not going to be as great. Net lease returns are not expected to be as great on a levered basis as value-add properties.

Okay. Appreciate. That make sense. Just wanted to lease expansion as well as the lease. Could you maybe talk about concessions there. Did you roll the rents up or down? What percentage that was?

The GAAP rent in the Texas went up. I can't tell you the exact figure, but we can get that to you because they extended the lease. The rent they kept at current rent. We gave the tenant in Texas I think it was 700 - about $700,000 of tenant improvement to be done over the next 12 to 18 months. The lease in the there was no concession at all. And it just stayed - the GAAP stayed the same. So we just gave them a cash concession on the rent and we want to maintain the GAAP rent for the period of time. That's sounds right, Mike?

That is right. And just to follow-up on the Allen, Texas, Bob. With the TI's counterbalancing that and getting the 6-year extension, the GAAP rent went up by 10%.

Okay. And then kind of just speaking. I don't think you guys provide the same store rent number as some of the peers do. But you did mention in your prepared remarks that you thought same store rents would be stable. What does that mean? Is that kind of negative ones or positive one? Or was it just kind of flat? What did you mean by stable in the press release?

By stable, I mean, they are flat. They are flat to maybe as high as the 3% increase. When we include like the property that we did. On that property, we did the expansion. Well, we also extended the existing lease and that rent went up. So we had a positive there. The lease in Boston, the Yankee lease went up about 1% on a GAAP basis, on a cash and GAAP basis 1 year. And then we had a roll-down on the other lease which was a call center with T-Mobile. So overall and I don't have the specific Dan, but I can get those to you and I will get those to you. I think we're going to be somewhere between on a GAAP basis 1% to 3% up this year.

And on a cash basis?

It is going to be a little bit of drop, there is no doubt. These are typically 5-year renewals, as you know. On most of the leases that you get the renewal options are typically five years. So it could be 2% to 3% drop in cash for the first year.

Okay. And for those of you who may be interested in the answer to this question we will put it in our Q&A section on the website just so it's available to everybody.

And then just last question for you Mike. On the ATM issuance just going back to Ryan's question. Did you get any queries on that. I mean, have you done any large blocks with institutions or is it just most of just issuing the stock in the market place?

The answer is yes. Some of it's just traditional flow and then there are reverse inquiries that come in either directly to us or to our bank. And on those candidly depends on our liquidity needs. In some instances, we've said yes and executed them. And some hasn't been the need for liquidity based upon historical issuance as well as the foreseeing pipeline.

Our next question comes from Barry Oxford from D.A. Davidson.

The piggyback on the ATM and capital ways. You were talking about finding a larger portfolio and then needing to do an equity offering. Would you say that the probability in 2018 is probably pretty decent that you're going to do another follow on of similar size that you just did or not necessarily?

It all depends on what we find out there. And I would say the probability is high only because at some point in time you're going to have something that's going to come along that you want to do that's a larger transaction that can't be satisfied with the ATM. But trying to give you an idea when that might happen is just impossible. But I think it's a good idea to keep that in mind. It's not going to hurt the stock because we're going to do it so close to the point where we're closing as we did this time that the money is going to go to the work immediately.

Great. And then another question on the cap rates. You mentioned the continued strong demand for the buildings that you guys around trying to acquire. Is it possible to think about the cap rates actually compressing in the back half of 2017 as your acquire given the strong amount of people that are in the marketplace looking at product?

Barry, I think, it's hard for me to say we have seen in Intel that our leaders are out in the field is that they are pretty much stabilized. I mean, there are a few places in the West where cap rates in fact dropped some. But then in the Midwest, we're seeing some movement up in the cap rates. So I would say that and everything that I've read from a research standpoint, stabilized cash rates is what we're seeing just because we don't know exactly what's the next move on interest rates and when it's going to be. And how it would really impacts long term debt because as you just mentioned there is so much money flowing in from foreign sources that the competition continues and we're safe haven

Our next question comes from the line of Rob Stevenson from Janney.

Bob, how are you balanced thinking about the balance today between continuing to bring down leverage and continuing to also bring down your dividend payout ratio in terms of how you're financing transaction and what type of transactions you guys are looking at?

Rob, what we do as follows. As Mike indicated, we have every year lowered what our leverage would be on new deals. When I came on board, we were at over 60. We're now in the low 50s. The plan for Mike and I is to continue to do that. But do it selectively because if we can still maintain, that's what David and I look at, we can maintain the margin of over 200 to 250 bps, weighted average cost of capital versus our return. We're accretive. And that's what the team really focuses on. But I hear you on the dividend payout ratio. And the bottom line is we have to grow the FFO per share. And that will lead to a number of things, as you know. I mean, ultimately, we will be able to raise the dividend but people will see a growth pattern for us. We've had a deal with I think some many challenges as you and I and Mike have discussed when we met with you in the last 3 to 4 years relating to lowering our leverage, re-leasing space and we see ourselves entering a much more favorable position here, particularly now with the stock trading, logically above NAV right now based on everybody's calculations. I'm encouraged that we're going to be more competitive. I mean, 12 to 18 months ago, I could not do a deal with average cap rate of 7% and say it was accretive. I can do that now. And it is accretive and it makes sense. And we just have to - we have to pick our spots, stay in our secondary growth markets, add to our portfolio in each of those markets so that people see concentration growing which relates to better, I think NAV calculation because fewer markets and with more products in each of those better markets which will I think lead to then lower dividend payout ratio because the stock will slowly rise. But we have to go to the FFO per share growth which Mike and I are committed to and David and I see that ahead of us over the next 12, 24 months.

Okay. And then, I guess, 1 follow-up question there is when you're looking at your final acquisition opportunities today, I mean, how constrained are you from our capital standpoint? I mean, is it a situation where it was due this $50 million deal or do a couple of other ones? Are you basically work now the way that you think about it, able to do whatever comes across your desk that meets your returns threshold? How do you guys sort of look at that these days?.

Well, let me start and then Michael finish out. When we provide guidance to our leaders out in the field, we're saying, Number one, we've always operated under the strategy that we don't want to buy a single asset that is going to create great risk for us. And so that's why as Mike indicated earlier, our sweet spot is $10 million to $25 million. We have since I have been on board only bought 2 what I would consider to be large assets over $50 million. One was the GM and this is with ADP. So I think our focus until we really get above $1 billion to $1.2 billion in assets is going to stay under $30 million on a typical basis and I think we can handle that mostly with our ATM. But when we come across an opportunity like we did with ADP or with GM earlier and we see that it makes sense based on our underwriting, we will pursue that. But as David indicated, we don't know where that is right now, but we're hopeful that we will have over next 12 to 18 months.

From my side Rob, I think based upon what we've done recently where we go forward, I feel comfortable that the traditional acquisitions on an individual basis or even in the 3 property portfolio deals can be funded. We've done almost $40 million in the ATM year-to-date. We did $26 million overnight. We have over $40 million still available on the line after the Orlando acquisition. And our lenders have been appreciative of the deleveraging efforts. So I think to the extent we required incremental capital is out there. We're very cognizant from a diversification perspective that we had a company plus or minus $1 billion of assets. Of our going to go out and on a 10% credit or anything like that. If you're looking at those in the capital requirements to that, that could be challenging. But that's not our playbook and how we're organically growing the company. So as CFO I feel comfortable that they will not be up on the capital market side as we see the good deals that deal team brings to our investment committee and to close.

At this time, I'm not showing any further questions. I would like to turn the call back over to David Gladstone.

All right. Thank you all for calling in. We really appreciate all the effort that goes into asking good questions and giving us a chance to explain things much greater. And we will see you again next quarter. That's the end of this call.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may now disconnect. Everyone, have a great day.