Gladstone Commercial Corporation — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. The company is a REIT focused primarily on net-leased commercial, industrial and retail property.
Business context
At quarter-end, Gladstone owned 78 properties totaling 7.7 million square feet. It reported gross and net carrying values, including lease intangibles, of $569.1 million and $480.5 million, respectively. Six properties were acquired in the first nine months of 2012; the portfolio’s weighted-average yield was 9.3%, or 9.5% assuming full occupancy. These yield figures exclude interest expense.
Financial performance and liquidity
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Operating revenue | $12.970 | $11.173 | $37.478 | $32.508 |
| Net income | $0.992 | $1.748 | $3.147 | $4.598 |
| Net income available to common stockholders | $(0.061) | $0.709 | $0.006 | $1.482 |
| Diluted EPS for common stock | $(0.01) | $0.07 | $0.00 | $0.15 |
| FFO available to common stockholders | $4.215 | $4.338 | $12.178 | $11.955 |
| Diluted FFO per common share | $0.38 | $0.39 | $1.10 | $1.19 |
- Revenue and expenses: Revenue increased 16% in Q3 and 15% for the nine-month period, mainly reflecting acquisitions. Operating expenses after Adviser credits were $6.1 million in Q3 and $17.9 million for nine months. Revenue less these expenses was $6.9 million and $19.6 million, respectively; the filing does not present this as a named margin measure.
- Cash flow: Nine-month operating cash flow was $18.6 million, versus $14.4 million in 2011. Investing used $55.6 million, principally for property investment; financing provided $48.4 million. Cash rose to $14.8 million from $3.3 million at year-end 2011.
- Debt and liquidity: At September 30, mortgage notes were $337.9 million and line-of-credit borrowings were $5.5 million. Mortgage debt carried a weighted-average rate of 5.65%; the line rate was about 3.0%. The company also had $38.5 million of mandatorily redeemable Series C preferred stock recorded as a liability. Reported total liabilities were $401.6 million and stockholders’ equity was $124.0 million. Quarter-end liquidity was reported as $23.1 million, including $14.8 million cash and $8.3 million available on the line; $6.1 million of letters of credit were outstanding.
- Distributions: Common distributions remained $0.375 per share for the quarter. The filing reports $15.4 million of distributions paid across common, senior common and preferred securities during the first nine months.
Material changes versus prior period
- Despite higher rental revenue, Q3 net income declined 43% and common stockholders’ results moved to a $61,000 loss from $709,000 income. For nine months, net income declined 32%, while income available to common stockholders fell to $6,000 from $1.482 million.
- Management attributed the earnings pressure mainly to higher interest expense and distributions on the newly issued Series C term preferred stock, partly offset by rental income from acquisitions. Interest expense increased 23% in Q3 and 16% for nine months.
- Nine-month FFO available to common stockholders increased 2%, but diluted FFO per share declined 8%, to $1.10, reflecting a higher weighted-average share count and other per-share effects. FFO is a non-GAAP supplemental measure, not a substitute for GAAP earnings or operating cash flow.
- Real estate investments were $52.8 million in the first nine months, versus $16.3 million in the prior-year period. The company acquired six properties versus two in 2011 and issued or assumed $57.2 million of mortgages.
Outlook, risks and unusual items
- No quantified earnings or acquisition guidance was provided. Management said available liquidity and expected operating cash flow and financing were sufficient for near-term obligations and anticipated financing access for longer-term needs. These are forward-looking statements and depend on capital-market access and operating performance.
- Management cited economic uncertainty and tenant credit risk. Two properties were vacant, representing 1.9% of annualized rental income; the company was seeking tenants. It reported that the remaining properties were occupied and tenants were paying under their leases.
- A $45.2 million mortgage due October 1, 2012 was repaid that day using a new $34.0 million, 4.86% fixed-rate, ten-year loan and existing cash. The company reported no exit fees. The transaction reduced the near-term maturity but used cash; confirm its post-quarter liquidity effects.
- The $38.5 million Series C preferred offering bears a 7.125% rate, is generally not redeemable before January 31, 2016, and is mandatorily redeemable January 31, 2017. Its distributions are treated as interest expense.
- The Adviser waived part of its incentive fee to support distributions; the waivers were voluntary and not recoupable, but the Adviser was not obligated to continue them. The line-of-credit agreement also limits distributions to 95% of FFO, subject to specified adjustments.
- The company recorded no property impairment. It disclosed an aggregate undiscounted asset-retirement obligation of $9.2 million, primarily relating to potential asbestos disposal, and said it did not expect payments on these obligations in the next five years. No material legal proceedings were reported.
- Management reported effective disclosure controls as of September 30, 2012 and no material change in internal control over financial reporting during the quarter.
Key investor verification points
- Reconcile reported line availability: the quarter-end figure is $8.3 million, while MD&A later states $25.8 million “as of today.” Confirm the applicable date, collateral and effect of the October refinancing.
- Review the October mortgage refinancing, including the cash used, new loan terms, and resulting maturity schedule and liquidity.
- Assess whether rental growth and FFO can support distributions after interest costs, preferred distributions and ongoing financing needs, particularly if Adviser incentive-fee waivers end.
- Evaluate tenant and re-leasing exposure at the two vacant properties, lease renewals, and tenant credit concentration. The largest identified tenant/property contributed 6.7% of nine-month base rent.
- Check future refinancing requirements and covenants: mortgage principal payments were scheduled to rise materially in 2015–2017, and the line matures in December 2013.