Gladstone Commercial Corporation — Q3 2017 Form 10-Q
Business context and period: Unaudited results for the quarter and nine months ended September 30, 2017, compared with the corresponding 2016 periods. Gladstone Commercial is an externally managed REIT focused primarily on office and industrial properties. As of October 31, 2017, it owned 97 properties totaling 11.2 million square feet; occupancy was 97.9%, and the portfolio’s average remaining lease term was 7.7 years.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total operating revenue | $24.4 million | $21.6 million | $69.5 million | $64.4 million |
| Net income (loss) | $2.4 million | $(0.1) million | $7.4 million | $1.7 million |
| Net loss attributable to common stockholders | $(0.4) million | $(2.3) million | $(0.7) million | $(3.4) million |
| Common loss per share | $(0.01) | $(0.10) | $(0.03) | $(0.15) |
| FFO available to common stockholders | $10.4 million | $8.9 million | $30.0 million | $26.5 million |
| FFO per common share | $0.38 | $0.38 | $1.16 | $1.15 |
| Operating cash flow | Not reported by quarter | Not reported by quarter | $34.8 million | $29.8 million |
For the nine months, cash used in investing was $63.4 million and cash provided by financing was $28.2 million; cash and cash equivalents ended at $4.3 million, down from $4.7 million at year-end 2016. The filing does not provide a clear reported operating margin.
At September 30, total assets were $904.9 million, mortgage notes payable net were $450.0 million, and net borrowings under the revolver and term loan were $43.9 million and $24.9 million, respectively. Total debt carrying value was approximately $518.9 million. Mortgage debt’s weighted average rate was 4.52%; all debt averaged 4.34%. Reported liquidity was $38.3 million, comprising $4.3 million cash and $34.0 million of available revolver capacity. The company was in compliance with credit-facility covenants.
Material changes versus prior periods
- Q3 revenue rose 12.9%; nine-month revenue rose 8.1%. Growth principally reflected acquisitions, while same-store rental revenue was essentially flat.
- Nine-month net income increased to $7.4 million from $1.7 million, while common-stockholder losses narrowed. The improvement included a $4.0 million net gain on real estate sales and lower interest expense; preferred and senior common distributions remain deducted in arriving at common results.
- Nine-month FFO available to common stockholders increased 13.4%, but FFO per share rose only to $1.16 from $1.15. Common distributions remained $0.375 per share for Q3 and $1.125 for nine months.
- The company acquired five properties for $94.4 million and sold four non-core properties for $30.3 million during the nine months. Acquisitions added 666,451 square feet with a 10.7-year weighted-average lease term.
- Common and preferred equity issuance generated $69.9 million of proceeds in financing activities. Common shares outstanding increased to 27.7 million from 24.9 million at year-end 2016.
- Mortgage interest expense fell year over year despite higher mortgage balances, reflecting refinancing and repayment activity; the mortgage weighted-average rate declined from 4.71% at September 2016 to 4.52% at September 2017.
Outlook, risks and unusual items
- No numerical earnings or FFO guidance was provided. Management said near-term liquidity was sufficient for distributions, debt service and operating costs, and expected to refinance debt maturing in the remainder of 2017 and 2018 using new mortgage debt and equity issuance.
- After quarter-end, the October 27 credit-facility amendment increased the term loan commitment from $25 million to $75 million, retained the $85 million revolver, reduced rate spreads by 25 basis points at each leverage tier, and extended maturities to October 2022 and October 2021, respectively. The company incurred approximately $0.9 million in fees. Available revolver capacity was reported as $29.4 million at October 31.
- Management cited potential risks from higher interest rates and borrowing costs, tighter or changing lender terms, economic and real-estate-market uncertainty, tenant creditworthiness, vacancy and re-leasing, and the ability to refinance debt. A 1% increase in LIBOR was estimated to reduce annual net income by $1.4 million, based on September 30 exposures.
- Nine-month impairment charges were $4.0 million, primarily associated with properties later sold; the filing reports an additional aggregate net loss of $1.8 million on two impaired-property sales. No impairment was recorded in Q3 2017.
- The quarterly common distribution was $0.375 per share versus Q3 common FFO of $0.38 per share. FFO is a non-GAAP measure and is not cash flow; common GAAP earnings were negative after preferred and senior common distributions.
- The company is externally managed by affiliates controlled by its chairman and CEO. Q3 base and incentive management fees were $1.3 million and $0.6 million; the advisory agreement was renewed through August 31, 2018.
- Management reported no material legal proceedings, no material changes to previously disclosed risk factors, and effective disclosure controls. Four ground leases carry $6.5 million of future minimum payments.
Important facts for investors to verify
- Whether property acquisitions, lease renewals and occupancy improvements sustain rental growth, especially given nearly flat same-store rents and vacant-space carrying costs of about $0.6 million annually.
- Debt maturities and refinancing execution, including the $10.4 million due in the remainder of 2017 and $47.8 million due in 2018, as well as utilization and terms of the amended credit facility.
- Distribution coverage and funding: compare cash available after debt service and capital needs with common, senior common and preferred distributions; do not treat FFO as operating cash flow.
- How much future equity issuance may be needed and its dilution implications, alongside preferred-stock obligations and related-party management fees.
- Potential further impairments, tenant credit deterioration, and sensitivity to interest-rate and property-market changes.