Gladstone Commercial Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; comparative periods are the same periods in 2017. The company is an externally managed REIT focused primarily on office and industrial properties. As of July 30, 2018, it owned 98 properties totaling 11.4 million square feet in 24 states, with 99.1% occupancy and a 7.1-year average remaining lease term.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total operating revenue | $26.6 million | $22.9 million | $52.9 million | $45.2 million |
| Net income | $2.5 million | $0.7 million | $7.1 million | $5.0 million |
| Income (loss) available to common shareholders | $(0.3) million | $(2.0) million | $1.5 million | $(0.3) million |
| Common EPS, basic and diluted | $(0.01) | $(0.08) | $0.05 | $(0.01) |
| FFO per common share, basic | $0.40 | $0.40 | $0.81 | $0.78 |
| Cash provided by operating activities | Not separately provided | Not separately provided | $26.0 million | $21.4 million |
Q2 revenue increased 16.3%; rental revenue rose 14.3%. Q2 operating expenses increased 22.2%, faster than revenue, including higher depreciation and property costs. Operating income as a share of revenue, calculated as revenue less operating expenses divided by revenue, was approximately 34.0% versus 37.2% in Q2 2017. For the first half, the comparable measure was approximately 34.0% versus 29.0%, reflecting in part the absence of the $4.0 million impairment charge recorded in 2017. FFO is a non-GAAP REIT performance measure, not a measure of cash flow or liquidity.
For the six months, investing activities used $5.6 million and financing activities used $22.2 million; cash, cash equivalents and restricted cash decreased by $1.8 million to $7.3 million. Common distributions were $0.375 per share for Q2, unchanged year over year. Total distributions paid across common, senior common and preferred shares were $27.0 million in the first half.
Balance sheet, debt and liquidity
- At June 30, total assets were $912.0 million and total liabilities were $575.2 million. Net real estate was $742.0 million.
- Debt carrying values were $435.1 million of mortgage notes, $32.8 million under the revolver and $74.6 million under the term loan. Aggregate principal obligations were approximately $548.3 million; weighted average interest rates were 4.63% on mortgage debt and 4.46% on all debt.
- Available liquidity was reported as $50.7 million: $4.6 million cash and $46.1 million available under the revolver at June 30. Revolver and term-loan borrowings totaled $108.4 million; the company reported covenant compliance.
- Mortgage principal payments were $20.7 million for the remainder of 2018 and $48.0 million in 2019. The company extended two mortgage maturities totaling $13.0 million to July 2020; after quarter-end it extended a $4.0 million maturity to September 2019.
Changes, outlook and risks
- First-half revenue growth was driven largely by acquisitions and leasing, while same-store rental revenue increased only 0.4%. The company acquired one Alabama property for $14.3 million, sold two non-core properties for $11.1 million in aggregate, and recorded a $1.8 million net gain on sale.
- Management said it expects near-term liquidity to cover distributions, debt service and operating costs, and expects to refinance mortgages coming due. It anticipates using equity issuance and new debt as funding sources and expects to continue ATM sales through the remainder of 2018. No earnings or FFO guidance was provided.
- Management cited rising borrowing costs, interest-rate volatility, changing lender spreads, potentially softer investment sales, possible office-market vacancy increases, and broader economic and geopolitical uncertainty. A modeled 1-percentage-point LIBOR increase would reduce net income by approximately $1.2 million under the filing’s sensitivity analysis. Interest-rate caps and swaps provide partial protection.
- No impairment was recorded in the first half of 2018; the company cautioned that future property impairment could be significant if market conditions deteriorate or favorable leases cannot be secured. It reported no material off-balance-sheet arrangements, no material legal proceedings, and no material change in previously disclosed risk factors.
- The company is externally managed by affiliates controlled by its chairman and CEO. First-half base and incentive fees were $2.6 million and $1.4 million, respectively; the advisory agreement was renewed through August 31, 2019.
Key investor verification points
- Assess whether acquisition-led revenue growth can translate into sustained same-store growth, given first-half same-store rental growth of 0.4%.
- Verify refinancing progress for upcoming mortgage maturities and available revolver capacity, particularly if interest rates or lender conditions worsen.
- Evaluate distributions against operating cash generation, debt repayments and continued equity issuance; review the potential dilution from ATM programs.
- Review the impact of external-adviser fees, preferred distributions and debt costs on earnings available to common shareholders and FFO.
- Monitor occupancy, the prospective sale of the South Hadley property, and potential impairment exposure.