Gladstone Commercial Corporation — Q1 2019 Form 10-Q
Business context and period. Gladstone Commercial is an externally managed REIT focused primarily on office and industrial properties. This filing covers the three months ended March 31, 2019, compared with the same period in 2018. As of April 30, the company reported 105 properties across 24 states, 99.0% occupancy and a 7.2-year average remaining lease term.
Financial performance and position
- Revenue: Lease revenue was $28.1 million, up 6.8% from $26.4 million. Management attributed growth to acquisitions, contractual rent increases and leasing of previously vacant space.
- Earnings: Net income was $4.7 million, up 1.5%. Net income available to common stockholders was $1.8 million, and basic and diluted EPS were $0.06, unchanged year over year. The quarter included a $3.0 million net gain on sale of real estate.
- Expenses and margins: Operating expenses rose 10.7% to $19.3 million, faster than revenue, including 16.4% higher interest expense. Operating income before other items was $8.9 million, approximately 31.5% of revenue; net income margin was approximately 16.6% versus 17.5% a year earlier.
- FFO: Basic FFO available to common stockholders and non-controlling OP unitholders was $11.9 million, up 3.1%; basic FFO per share/unit fell to $0.39 from $0.41. The declared common distribution was $0.375 per share for the quarter. FFO is a non-GAAP measure and is not operating cash flow.
- Cash flow: Operating cash flow was $12.6 million, essentially unchanged. Investing activities used $0.3 million; financing activities used $14.4 million. Cash, cash equivalents and restricted cash ended at $7.0 million.
- Debt and liquidity: Debt principal was approximately $557.5 million: $449.7 million of mortgages, $32.8 million drawn on the revolver and a $75.0 million term loan. The weighted average rate on all debt was 4.60%. March 31 available liquidity was $43.8 million, including $4.3 million cash and $39.5 million revolver capacity; revolver capacity was $32.6 million at April 30. The company reported compliance with credit-facility covenants.
- Balance sheet: Total assets were $935.0 million and total equity, including non-controlling interests, was $258.3 million at March 31. The company recorded approximately $6.0 million each in operating-lease right-of-use assets and liabilities after adopting the new lease standard.
Changes versus Q1 2018
- Revenue growth was driven chiefly by properties acquired since the prior-year period; same-store lease revenue increased 1.2%.
- Depreciation and amortization increased 12.3%, property operating expenses increased 9.9%, and interest expense increased 16.4%. Net income rose only 1.5%.
- The gain on real estate sales increased to $3.0 million from $1.8 million. Excluding property-sale gains, the filing’s results show greater pressure from financing and operating costs.
- The company issued about $14.1 million of common stock through its ATM program and reduced net revolver borrowings during the quarter. Basic FFO per share/unit declined despite higher total FFO.
Outlook, risks and notable items
- Management provided no quantified earnings or FFO guidance. It expects to continue using ATM programs during 2019, acquire properties, recycle non-core assets and refinance upcoming mortgage maturities. Management said available liquidity and future financing should support near-term needs and that it expects to refinance 2019 and 2020 maturities.
- Mortgage principal of $56.8 million was scheduled for payment during the remainder of 2019, including five balloon payments; a further $32.2 million was due in 2020. Refinancing depends on access to debt and equity markets.
- Interest-rate exposure is a key risk. Variable-rate borrowings and the credit facility expose earnings to rate increases, partly mitigated by caps and swaps. Management’s sensitivity analysis estimated a $0.8 million reduction in net income for a 1 percentage-point LIBOR increase, based on March 31 balances and assumptions.
- Management cited uncertainty in the economy, potential increases in borrowing costs, possible office-market vacancy pressure and the risk of tenant defaults or inability to re-lease space. Three partially vacant buildings represented 1.1% of total square footage; annual carrying costs were approximately $0.5 million.
- Subsequent to quarter-end, the company raised $6.8 million net through common-stock ATM sales and acquired two industrial properties for a combined $22.3 million. The acquisitions were fully leased to single tenants, with reported lease terms of 20 years and seven years.
- The Adviser and Administrator are affiliates controlled by the CEO; Q1 base management, incentive and administration fees were approximately $1.3 million, $0.9 million and $0.4 million, respectively. This is a related-party arrangement relevant to governance and expense review.
- No material legal proceedings, material changes to previously disclosed risk factors, or material off-balance-sheet arrangements were reported. Disclosure controls were assessed as effective.
Investor verification priorities
- Review the maturity schedule and confirm refinancing or repayment plans for 2019 balloon maturities and 2020 debt.
- Assess recurring earnings and distribution coverage, including the effect of property-sale gains and the decline in FFO per share/unit.
- Track ATM issuance, dilution, remaining capacity and the funding mix for acquisitions and debt reduction.
- Monitor variable-rate debt, hedge coverage, borrowing costs and available revolver capacity.
- Evaluate vacancy, lease expirations, tenant credit quality and the performance and concentration risks of recently acquired single-tenant properties.
- Review related-party fees and governance terms, including the Adviser’s incentive-fee calculation and advisory-agreement renewal.