Good day, ladies and gentlemen, and welcome to the Gladstone Commercial Corporation's First Quarter 2019 Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. David Gladstone. Sir, you may begin.

All right. Thank you, Lauren. That was a nice introduction. Thank you all for tuning in and listening to us. I was with a group of brokers yesterday and it's so nice to talk to people and get questions back. Hope we have a lot of good questions today. We really do enjoy this time we have with you on the phone and wish there were more times to talk. Please come and visit us if you're ever in the Washington, D.C. area, we're in a suburb called McLean, Virginia, and you have an open invitation to stop by and see us here at the office. Now, going to hear from Michael LiCalsi, General Counsel and Secretary, he is also the President of Gladstone Administration, which serves as an administrator to all of the Gladstone public funds, will make a brief announcement regarding some of the legal and regulatory matters concerning this report. Michael?

Thanks, David, and good morning. Today's report may include forward-looking statements under the Securities Act of 1933, the Securities Exchange Act of 1934, including those regarding our future performance. And these forward-looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable. And many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements, including all risk factors in our Forms 10-Q, 10-K and other documents that we file with the SEC. You can find all these on our Web site, www.gladstonecommercial.com. Specifically the Investor Relations page or on the SEC's Web site, which is www.sec.gov, and we undertake no obligation to publicly update or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. And today we will discuss FFO, which is, funds from operations. FFO is a non-GAAP accounting term defined as net income excluding the gains or losses from the sale of real estate and any impairment losses on property, plus depreciation and amortization of real estate assets. We'll also discuss core FFO, which is generally FFO adjusted for certain other non-recurring revenues and expenses. We believe this is a better indication of our operating results and allows better comparability of our period-over-period performance. We ask that you take the opportunity to visit our Web site, once again, gladstonecommercial.com, and sign up for email notification service. It can also be found on Facebook, keyword there is the Gladstone Companies, and on Twitter and our handle there is @gladstonecomps. Today's call is simply an overview of our results, so we ask that you review our press release and Form 10-K, both issued yesterday for more detailed information. Those can be found on the Investor Relations page of our Web site. Now, I'll turn the presentation back over to Bob Cutlip, Gladstone Commercial's President. Bob?

Thanks, Michael. Good morning everyone. During the first quarter, we acquired a 26,000 square foot property in a Philadelphia sub market, acquired a 34,800 square foot freezer-cooler industrial property in Indianapolis, renewed a 72,000 square foot tenant whose lease was scheduled to expire in 2020, renewed a 58,000 square foot tenant whose lease was also scheduled to expire in 2020, sold a non-core office property in Maitland, Florida, conduced a non-deal roadshow in Chicago and Milwaukee, and lowered our book leverage to 45.3%. Subsequent to the end of the quarter, we acquired a two-building 383,000 square foot industrial portfolio in Ocala, Florida, acquired a 54,430 square foot industrial property in Columbus, Ohio, and entered due diligence for the acquisition of an industrial property in Tifton, Georgia. As noted in our year-end call, we're beginning to enjoy the benefits of our team's focused efforts to improve operating results. We invested significant equity and personnel resources from 2013 to 2018 to renew tenants and re-lease vacant space, to fund operating deficits on vacant space, to improve our balance sheet, and to acquire accretive assets. The good news is that our occupancy remained high throughout this period. We significantly lowered our book leverage from 63% in 2013, we maintained FFO per share of $1.50 to $1.54, and are now in a path of earnings growth that commenced in 2018. We also improved our cash payout ratio year-over-year. We were able to consistently improve our financial metrics because we acquired accretive assets each and every year in our target growth markets. The combination of the positive characteristics of those investments and the capital structure enhancements validate the strength of our growth trajectory and balance sheet security, and I think are worthy of some note. From 2012 to 2018, the average annual acquisition volume was…

Good morning, I will start by reviewing our operating results for the first quarter of 2019. Our per share numbers I referenced are based on fully diluted weighted average common shares, FFO and core FFO available to common stockholders were both $0.39 per share for the first quarter, this performance demonstrates the accretive yet prudent growth of the company has completed in recent years as well as the performance of the in place portfolio inclusive of maintaining 99% occupancy. In addition to these accretive deals, our same-store cash rent growth was 2% for the first quarter of 2019 as compared to first quarter of 2018. As Bob mentioned, prior to 2018 core FFO hovered in the $1.50 to $1.54 range for the past number of years as we de-levered the balance sheet and addressed lease rollover. 2018 results demonstrated our highest core FFO per share in the company's history. And we intend to continue to grow profitability for our shareholders in 2019 and beyond. With no near-term meaningful lease expirations, no fractional de-leveraging to do, we are excited about the prospects of continuing to increase earnings going forward. Our first quarter results reflected the increase in total operating revenues to $28.1 million as compared to total operating expenses of $19.3 million for the period. Let's now take a look at our debt activity and capital structure. We continue to enhance our strong balance sheet as we grow our assets and focus on decreasing over leverage. We have reduced our debt to gross assets by nearly 15% to 45.3% over the past 5 years through refinancing maturing debt and financing new acquisitions at lower leverage levels. We believe that we are 1% to 2% away from our target leverage level which means that nearly all raised equity going forward will be…

All right, thank you. I think that was a good report, and it's good report from Bob and Michael LiCalsi as well. This is very nice quarter, very straight forward. And main news here is the report that quarter end through April, company's very good positioned to keep paying consistent dividends and to grow those dividends. The company also continues to grow its assets to the point that we will soon reach a billion dollars in assets. And it will be a millstone for us. We continue to have a promising list of potential quality properties that we are interested in acquiring during the remainder of 2019 with the increase of the portfolio the property comes a great diversification. We believe that protects the earnings of the company and also your dividend. The middle market of businesses, like many of our tenants, is doing very fine today. Our tenants are paying their rents, and that's what counts for us, while I'm optimistic that our company will be in good hands in the future, Bob and his team will continue to be cautious in their acquisitions as they've done in the past. In April, the board voted to maintain the monthly distribution of $0.125 per common share per month for April, May, and June, and it's an annual run rate of $1.50 a year. This is an attractive rate for a well-managed REIT like ours, which we believe is an excellent investment for individuals that want monthly income. I know you all know that we will increase the distribution amount at some point in time. All I can say is we're not quite there yet, but hopefully at this next meeting and the board to -- Bob and board will get together and talk that one through. If you want to…

Yes, sir, thank you. [Operator Instructions] And our first question comes from Rob Stevenson with Janney. Your line is open.

Good morning guys. Bob, you talked earlier about targeting industrial assets. I mean how are you guys thinking about office acquisitions these days? Does it have -- are you still willing to do them, and it just has to meet a higher return that it historically had relative to industrial. You guys are still sort of 65% office, where you guys expect that to trend down to over the next year or two?

Good questions. I think from the standpoint of the office themselves, the teams really are looking to be sure that wherever we acquire we're close to amenities, ala like the Morgan Stanley acquisition that was in Easton Commons, in Columbus and in Salt Lake City, and Central Square, which is in Lake Mary, which is a nice mixed use community in North Orlando. We are not going to walk away from office. I mean, if it's sticky real estate and it's really mission critical we will do office, but I really believe going forward we'll be at a 60-40, 70-30 split industrial versus office from an acquisition standpoint. But I think it's going to take us probably two to three years to get to a point where Mike and I and David think we're comfortable at maybe let's say a 55-45 or a 60-40 split between industrial and office. I just think that long-term when we look at free cash flow raising the dividend, tenant improvement cost, capital improvements industrial plays really well into that because of the lesser cost you pay, and plus, you look at the market conditions, e-commerce is not going away, home delivery is going to continue to grow as you read in almost every research report. And I think we play extremely well in these developed sub-markets, where it is last mile or it is a manufacturer. I think -- and David hit the nail on the head, our ability to underwrite credit is better than, I believe, anyone else out there, and therefore, we can attack these middle market tenants who are manufacturers or who are, let's say, the last mile deliverers.

Okay. And then, what are you guys thinking about in terms of dispositions currently? I mean, is there anything that's on your radar screen where you want to get rid of it sooner rather than later or it doesn't really fit the portfolio or maybe you've had attractive offer type of thing? I mean, how should we be thinking about depositions over the remainder of the year?

Well, it's like the disposition we did in January. We had such an attractive offer from a user, and as the team knows, I am not a proponent of single storey office, because of the re-leasing cost involved there. And so, when we bought that three building portfolio, although we weren't thinking of exiting the property, one of the tenants who was going to elect to leave was 225,000 square foot tenants and that 50,000 square foot building. And then a user who has a campus nearby offered to acquire the property at a very, very nice price, and so, we exited that property, and we were able to redeploy the capital. Going forward, I think Mike and I believe, we'll probably be somewhere between maybe $10 to $15 million a year, and once again, these will be in what I think are like, single property, non-core markets that –- the good tenants are not in a big rush to exit, but if we can sell coincidentally with acquiring in our target markets, I think that's how the team's going to emphasize identifying dispositions, getting them on the list and then as we're acquiring we'll exit, but it won't be a high number from a volume standpoint per year.

Okay. And then one for Mike, we've seen a bounce back here in the preferred market, how are you guys thinking about the balance sheet mix going here, going forward here? I mean, you're about 11% preferred equity, you know, where some of these deals are priced recently, have you guys thinking about opening up the Series D via the ATM, or marketed offering, and issuing there rather than comment at this point?

Fair question, Rob, I mean, as I stated in the past and to your point, with it being 11% to 12% of the total balance sheet, it is still a bit, a couple of points overweighed as compared to peer set. I saw the print last week it's six and three quarters. There has been some wider deals in the low to mid sevens. I would say, strictly on our Series D as of this morning, 692. If there is a sub-seven execution that may work for us, but as we've stated throughout, I mean, our only real interest here to do a preferred trade. We don't want to go above that 11 to 12 points of preferred that we have. So, with the series A being seven and three quarters and the series B at seven and a half, we did a traditional math as our peers would, where we roughly need to save up 75 basis points. So, I'm cautiously optimistic, we're seeing execution in that marketplace and we saw the sub-seven print last week. It's just close right now.

And just remind me, are the A and the B redeemable at this point?

They are.

Okay. Thanks, guys, appreciate it.

Thanks, Rob.

Thank you.

Our next question comes from Barry Oxford from D.A. Davidson. Your line is open.

Great, thanks guys. Just building up to some of Rob's questions, when we look at your ATM and your need for equity and given the fact that you're target leverage matrix, if your stock price were to retreat back and you couldn't go to the ATM or you just didn't want to because of where the stock price is, can you continue to act on your 2019 plan without raising leverage again going forward?

I'll start with it Barry.

Yes.

Trading at 21.75, I mean, over the last couple of years, we've been active in the ATM market and able to source deals at minimum north of $19 a share. So, I mean, there is a good bit of cushion there, obviously, if macro bands or otherwise, there's a massive REIT slice in the tenure that causes REITs to trade off. I mean, that will impact our underwritten cost of capital and would impact what deals that we chase, but in a normalized environment, we feel pretty good about our way to efficiently access the ATM market and raise their requisite equity capital to complete the 2019 business plan.

Great, great, great. And then just one last question, when you guys are in the marketplace, you talk about that pipeline, are there small -- for lack of a better word, small industrial portfolios out there for sale. Are there a lot of them or not so much?

We're chasing one right now that is a five-property industrial portfolio which is going to trade and I'll just give you the average, because who knows where it's going to end up. It's somewhere between $28 million and $32 million. We're starting to see a few more of these that are in, let's say, within our window of opportunity at this point. Most of the deals that we're seeing, Barry, are anywhere from $7 million to $15-$18 million in these developed sub-markets, because they're ranging anywhere from 50,000 to close to 200,000 square feet. And I really like that size based on where I think the market is, because I think there's really upside in the rents.

Right, right. Okay, that's all from me. Thanks so much, guys.

Thanks, Barry.

Our next question comes from Henry Coffey with Wedbush. Your line is open.

Yes, good morning, everyone.

Good morning.

And really just two questions. When you look to buy a property what's the ideal mix that you have in the back of your mind and even though maybe you don't get it the day you closed the property, but are you able to kind of queue up like we termed that going into the deal or is that more of a challenge?

Sure, not a challenge in today's normalized environment, Henry. I would say at book equity -- book debt to gross assets of 45.3% in appreciating we have about $14 million of scheduled amortization on an annual basis, we're underwriting deals plus or minus 50% debt, 50% equity. So your point, I mean, in typical environments we have day one long-term debt, if it's an accelerated closed process, we could in a minimum basis tap into our credit facility and then execute the debt after the fact. And the ATM, we just programmatically issue either prior or accommodation of prior afterwards to get that 50% of equity.

Are your sellers open to up REITs or are there more institutional parties looking for cash?

Henry, a good question, we did our first up REIT transaction last fall, and we're starting to see more interested sellers in the up REIT transaction for state planning purposes. These are primarily private owners, developers that are just thinking long-term. So I think there's going to be an increase in that opportunity, and of course, that's a less costly transaction for us and I think it will just continue to expand over the next several months.

And then it looks like you got a good handle on $35 million-$50 million of additional properties by year end, is that a fair way to read your pipeline or…

No, I think it's going to be higher than that. As I indicated the last six months, we closed about $75 million with a $260 million pipeline. Right now with $55 million in the letter of intent or due diligence stage, I would be very surprised -- our goal has been somewhere around $120 million this year. And I think that is achievable unless the bottom falls out of the market. I mean, as David and I've always said, so long as we've got our margin of a 100 to 150 basis points over our WACC weighted average cost to capital, we're going to buy in those markets with our credit tenants. And I don't see an issue, at least near terms, with the velocity dropping.

Excellent, thank you.

Thanks, Henry.

Our next question…

Are there questions…

Yes. Our next question comes from Craig Kucera with B Riley FBR. Your line is open.

Hi, good morning, guys.

Good morning.

Good morning. I saw you had a lease termination this quarter. Can you give us some color on where that building was and do you anticipate trying to sell it or potentially release that asset?

That was the tenant that was going to leave that single-storey office property which we also sold. So that's the only termination, yes.

Got it, got it. And you mentioned in your commentary that you had the potential to double the space at the Columbus acquisition. Has the tenant indicated that they eventually might need to expand on that kind of order?

Of the three tenants that we have expansion capabilities, one has indicated they may, with the long-term lease, I mean David and I like long-term relationship and having that extra land and really it turns out to be free land because if we expand it we already paid for the land, it gives us an opportunity to extend that relationship, so I am really excited about what the team has done in finding properties that do have expansion land as part of the deal and we are going to continue to look for those. But only one of the three right now has mentioned it right now but they are long-term leases and if they in growth situation, it's good to have the ability to say, "Yup, we can expand that," it happened with our Lear facility in Vance, Alabama at the Mercedes Benz assembly plant, when we bought that back in 2013 Buzz Copper our leader down there said to the developer, I am going to buy this deal, I really like to have some additional land, well as it turned out, they came to us at the end of 2016 saying Mercedes Benz is doubling their dug-on investment in their plant there and we need to expand the building and we expanded by 75,000. So we are going to continue to look at those type of acquisitions.

Got it. And one more for me, appreciate the color on the pipeline but as far as the assets that are currently under LOI or contract what is our composition, I mean are they heavily geared towards industrial and are they in your target markets?

They are all industrial, the only one that is not one of our original target markets which David has talked with me about is Tifton, Georgia and I will tell you that being an Atlanta boy for a long part of my career, it is south of Atlanta, but I think the positive aspect of Tifton Georgia is long I75 and its equidistant from the port of Brunswick and port of Jacksonville in fact our tenant there. When we closed this deal in probably six weeks is exporting product out of the port of Jacksonville with the port lowering the depth of the channel and so I think we are going to see more opportunities along that 75 quarter in that Tifton area. But every other one was in Chicago, Jacksonville, Columbus Ohio and they are all industrial.

Got it. And what are typical terms for the assets that are under LOI initial cap rate kind of give us some color there?

They are ranging anywhere from the high 6s to the low 7s going in, that's what we are seeing right now. I think Rob brought it up before about the split of cap rates, our split between let's say industrial and office is about 50 basis points to 75 basis points higher so I am at a 675 on the industrial, I am at a 7.25 to 7.50 on the office but the deals that we have now are anywhere from the high 6s to the kind of low to mid 7s going in.

Got it, all right, thank you.

Thanks.

Our next question comes from Merrill Ross with Boenning. Your line is open.

Thank you. I see that the amount of lease expirations in 2020 has declined with some success in renewals, but can you talk about particularly the GM renewals since that's your biggest property?

No, I will talk about all of them. I won't get into specifics because of course we are in negotiations with the number of them already. Right now as you know, as I indicated we had 11 leases scheduled to expire next year in 2020 and quite frankly our team is already talking with people in the 2021 timeframe because we would like to start two years out, right now we have the two done and we have proposals out on five others and we've begun discussions with GM I think when I talk about -- to think about the GM program it was brought to my attention and a lot of question GM is closing a lot of plants, what's going to happen here. Our property is one of their four innovations center and when they began to cut back at the plants interested transparency they actually cut people in our building by 100 in their staff but they have just recently increased their staff by 80 in the building, and then Buzz Copper and his partner EJ who are leading that effort to re-lease that property or renew that property have collected a lot of good market intel and what we are finding Austin is really on fire. The current rental rates compared to our building for let's say nominal TI are at least $4 to $5 higher than what GM is paying now and if you go to the $25 to $30 for TI it's $6 to $7. So we bought that property going in cap rate of 7.4% so our return is extremely good right now since we bought in 2013. So I am pretty encouraged the brokers and even our colleagues Buzz's counter parts there who are owners of property are saying they really have very limited places to go, particularly with that size. So I'm encouraged that we are going to get something done, I am hopeful let's say at least 12 months before their lease expiration and their lease expires in August of 2020.

Great. It sounds very interesting, keep on that one.

Thank you.

[Operator Instructions] our next question comes from John Massocca with Ladenburg Thalmann. Your line is open.

Good morning. This is Brandon Travis on for John, two questions for you. First on the Orlando portfolio can you give any additional color on how the acquisition is sourced and then can you give us some general color what to expect timing wise for acquisitions this year?

You are talking about the two building industrial. It was sourced third party through one of our broker contacts and relationship which is pretty typical, I mean we probably are able to go direct on sale leaseback and 10% to 15% of our product but it's evolved to where even in most of the cases people say listen I need to go to markets because I am going to get a better price. So, this is one with broker relationship with Brandon Flick and [indiscernible] who runs our Southeast region.

And to the second piece of your question having about $30 million of deals in the bond year-to-date and guiding to about $120 million I would say the remaining $90 million would probably be from a modeling perspective Brandon just doing it pro rata for throughout the year.

Yes, I would say pro rata, yes.

Okay, good. Thank you.

Thank you.

Thank you. I am not showing any further questions at this time. I would now like to turn the call back to Mr. Gladstone for any closing remarks.

All right, thank you for calling in, and you had a nice list of questions, we really appreciate it when you ask us questions and get us off track and let us talk about the business. So anyway, we will see in about 90 days. Thank you for calling. That's the end of this call.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone have a wonderful day.