GLADSTONE COMMERCIAL CORP annual report, FY2014

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Gladstone Commercial Corporation — FY2014 Form 10-K

Business context and reporting period

Annual report for the fiscal year ended December 31, 2014; filed February 18, 2015. Gladstone Commercial is an externally managed REIT focused primarily on owning net-leased industrial, commercial and retail real estate, with limited commercial mortgage lending. At year-end it owned 96 properties totaling about 10.6 million square feet, leased to 91 tenants, and held one $5.6 million mortgage loan.

Financial and operating performance

  • Total operating revenue was $73.8 million, up 20% from $61.3 million in 2013. Rental revenue rose 19% to $71.2 million.
  • Net loss was $5.9 million, versus net income of $1.5 million in 2013. Net loss attributable to common stockholders was $10.5 million, or $0.61 per diluted share, compared with a $2.9 million loss, or $0.22 per share.
  • FFO available to common stockholders, a non-GAAP REIT measure, was $31.3 million, up 57%; diluted FFO per share was $1.77 versus $1.49.
  • Operating expenses rose 75% to $57.4 million, including a $14.2 million impairment charge, higher depreciation and acquisition costs. Interest expense increased 8% to $26.2 million.
  • Net cash provided by operating activities was $28.2 million, compared with $19.9 million in 2013. Investing activities used $130.4 million; financing activities provided $102.3 million. Year-end cash and cash equivalents were $8.6 million.
  • Common distributions remained $1.50 per share for the year, paid monthly. Management reported no prior reduction or missed scheduled common distribution; future payments remain subject to board discretion and financing restrictions.

Debt, liquidity and capital

  • At December 31, mortgage notes payable totaled $459.3 million and line-of-credit borrowings were $43.3 million. The weighted-average mortgage rate was 5.3%; line-of-credit borrowings carried an approximately 3.17% rate. The company also reported $38.5 million of Series C term preferred stock classified as a liability.
  • The $75 million revolving credit facility matures in August 2017, with a conditional one-year extension option and potential capacity to increase to $100 million. The company was in covenant compliance at year-end. Availability was $9.3 million at year-end and $28.3 million as of February 18, 2015.
  • Management reported available liquidity of $17.9 million at year-end, including cash and line-of-credit availability. Mortgage principal due was $42.4 million in 2015 and $99.0 million in 2016; management identified $34.6 million of 2015 balloon payments and expected to refinance maturities using new mortgage debt and equity.
  • 2014 equity fundraising included $26.0 million net from a public common-stock offering, $39.6 million net from ATM programs, and $5.6 million net from Senior Common Stock. Common shares outstanding increased to 19.6 million from 15.7 million.

Changes, outlook and significant items

  • The company acquired 11 properties in 2014 for approximately $140.0 million, including a large Pennsylvania distribution warehouse and two Michigan industrial buildings; it also completed an expansion at a North Carolina property. Rental revenue growth reflected these acquisitions.
  • It sold its Sterling Heights, Michigan property for $11.4 million, recognizing a $1.2 million gain. It transferred its Roseville, Minnesota property to its lender in a deed-in-lieu transaction, recording a $14.2 million impairment and a $5.3 million gain on debt extinguishment.
  • Management described the economic recovery as uncertain and remained cautious. It cited improved leasing conditions in many markets but strong acquisition competition amid low interest rates, and dependence on external financing to fund growth.
  • Lease rollover and tenant credit remain important risks. Seven leases representing $4.1 million of 2014 rental revenue were scheduled to expire in 2015; management had extended seven of the originally identified 12 leases, was negotiating on one, and reported three tenants planned to leave. Year-end vacant space was reported at less than 1% of total square footage.
  • Concentration risks include the five largest tenants contributing about 18% of rental income; telecommunications, healthcare and automobile tenants contributed 17.7%, 12.2% and 12.1%, respectively. Only 34% of tenants were rated by a national credit agency.
  • No specific earnings or FFO guidance was provided. Management said liquidity was sufficient for near-term operating costs, debt service and distributions, while noting that continued financing access, covenant compliance and refinancing are not assured. The Series C preferred stock has a mandatory redemption date of January 31, 2017.
  • The adviser waived $3.0 million of incentive fees in 2014 to support distributions; future waivers are voluntary, not guaranteed. The company is externally managed by affiliates, creating potential conflicts of interest. No material legal proceedings or off-balance-sheet arrangements were reported.

Investor verification priorities

  1. Review the 2015 and 2016 debt maturity schedule, including the 2015 balloon amount, and assess refinancing plans, borrowing capacity and covenant headroom.
  2. Assess whether FFO and operating cash flow can support distributions, debt service and planned tenant improvements without continued fee waivers or equity issuance.
  3. Verify leasing progress on 2015 expirations and vacant space, particularly the Newburyport property and the planned tenant departures.
  4. Examine the Roseville impairment and debt-extinguishment accounting, and the collectability of deferred rent, including the $0.8 million write-off related to the Concord Township lease amendment.
  5. Evaluate tenant and industry concentration, property re-leasing prospects, and exposure to interest-rate changes and external financing conditions.