Gladstone Commercial Corporation — Q2 2016 Form 10-Q
Business context and period: The company is an externally managed REIT focused primarily on owning and managing office and industrial properties. This unaudited report covers the quarter and six months ended June 30, 2016; balance-sheet comparisons are with December 31, 2015. As of July 25, 2016, it reported 99 properties across 24 states, 11.1 million square feet, 98.5% occupancy and an 8.1-year average remaining lease term.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total operating revenue | $21.247 million | $20.688 million | $42.774 million | $40.567 million |
| Net income | $0.883 million | $0.431 million | $1.738 million | $1.125 million |
| Net loss attributable to common stockholders | $0.631 million | $0.853 million | $1.056 million | $1.407 million |
| Common loss per share | $0.03 | $0.04 | $0.05 | $0.07 |
| Basic FFO per common share | $0.39 | $0.39 | $0.77 | $0.77 |
Rental revenue rose 4.4% in Q2 and 5.7% for the first half. GAAP net income improved, but preferred and senior-common distributions left common stockholders with a net loss. FFO is a non-GAAP supplemental measure, not a substitute for cash flow or GAAP earnings. Common distributions were $0.375 per share in Q2 and $0.75 for the first half.
- Cash flow: First-half operating cash flow was $17.832 million, versus $16.475 million. Investing used $11.304 million, versus $63.173 million; financing used $7.687 million, versus providing $41.396 million. Cash and cash equivalents ended at $3.993 million, down from $5.152 million at year-end.
- Assets and equity: Total assets were $818.285 million, down from $827.184 million at year-end. Stockholders’ equity was $226.555 million; Series D preferred was reported separately as $25.532 million of mezzanine equity.
- Debt and liquidity: Carrying amounts were $441.604 million of mortgage notes, $60.229 million under the line of credit and $24.887 million under the term loan. Mortgage principal was $446.3 million, with a 4.77% weighted-average rate and 6.4-year weighted-average remaining maturity. Line and term borrowings totaled $85.8 million at an approximately 2.95% weighted-average rate; $2.5 million of letters of credit was outstanding. Available liquidity at June 30 was $12.6 million ($4.0 million cash and $8.6 million available line capacity); available line capacity was $28.6 million as of July 25. The company reported covenant compliance.
- Margins and costs: Depreciation and amortization was $18.338 million and property operating expenses were $3.045 million in the first half. Total reported operating expenses increased 9.6% year over year, partly because the 2015 comparison included $2.5 million of adviser incentive-fee credits. Interest expense declined 3.3% to $13.310 million.
Material changes versus prior period
- First-half revenue growth primarily reflected acquisitions; same-store rental revenue increased 0.7%, while revenue from acquired and disposed properties increased $2.401 million.
- The company acquired one Salt Lake City property for $17.0 million in May 2016, versus four acquisitions totaling $58.248 million in the first half of 2015. It sold a Dayton property for $0.2 million and classified four other properties as held for sale.
- It refinanced or repaid mortgages, including repayment of $22.510 million of principal in April, and issued new mortgage debt. Interest expense fell year over year, chiefly reflecting lower-rate refinancings and principal amortization.
- It redeemed $25.0 million of Series C term preferred stock in June and issued Series D preferred stock, with $25.3 million net proceeds from a private placement. Common and preferred ATM sales also raised equity. Common shares outstanding increased from 22.486 million at year-end to 22.984 million at June 30.
Outlook, commentary, risks and unusual items
- Outlook: No earnings or revenue guidance is provided. Management said liquidity was sufficient for near-term distributions, debt service and operating costs, and expected operating cash flow and future financing to support longer-term needs. It anticipated refinancing mortgage principal of $25.3 million due in the remainder of 2016 and $70.1 million due in 2017, using new debt and potentially additional equity.
- Operating conditions: Management cited tighter acquisition competition, potentially rising fixed-rate financing costs and economic uncertainty, including global slowdown and geopolitical risks. It reported one fully vacant property and five partially vacant buildings; vacant space represented 1.5% of square footage and carried approximately $0.9 million in annual costs.
- Interest-rate exposure: Management estimated that a 1%, 2% or 3% increase in one-month LIBOR would raise annual interest expense and reduce net income by approximately $1.488 million, $2.976 million or $4.174 million, respectively. Rate caps covered certain variable-rate debt but do not eliminate exposure.
- Unusual items: First-half impairment charges totaled $0.230 million, including impairment of properties held for sale and a Dayton property. A Newburyport tenant settlement produced $0.334 million of other income and a separate $0.9 million reimbursement of repair costs. Management noted the settlement related to deferred capital obligations and repairs.
- Preferred-stock redemption: After quarter-end, the company gave notice to redeem the remaining 540,000 Series C shares on August 19, 2016, at $25 per share plus unpaid dividends. Its July 2016 advisory-agreement amendment added mezzanine equity to the equity base used to calculate management and incentive fees, effective July 1.
- Other: The company stated there were no material legal proceedings, no material changes to previously disclosed risk factors, and no material off-balance-sheet arrangements. It reported effective disclosure controls and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether the four held-for-sale properties were sold as expected in Q3 2016 and at what prices relative to carrying value.
- Completion and funding of the Series C redemption, and the resulting preferred distribution and financing costs.
- Refinancing terms and funding sources for 2016–2017 mortgage maturities, including balloon payments and reliance on equity issuance.
- Whether occupancy, vacant-property carrying costs and lease renewals improve, and whether same-store rent growth strengthens.
- The effect of the July advisory-fee amendment on future fees, and the sustainability of common distributions relative to FFO and cash flow.
- Potential changes in variable-rate borrowing costs, available credit capacity and compliance with debt covenants.