Greetings and welcome to the Gladstone Commercial Corporation Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. David Gladstone, Chief Executive Officer. Thank you. You may begin, sir.

All right. Thank you very much. Very nice introduction. And thanks to all of you for calling in. We really do enjoy this time we have with you on the phone and wish we had more time to talk with you. But first, before we get started, Michael LiCalsi, our General Counsel and Secretary is to give a little legal and regulatory matters overview. Michael?

Thanks, David. Good morning, everybody. Today's report may include forward-looking statements under the Securities Act of 1933 and the Securities Exchange Act of 1934, including those regarding our future performance. 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 we filed with the SEC. If you go to the Investors page of our website, you can find them there. You can also find them on the SEC's website at www.sec.gov. Now, 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. 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 are generally FFO adjusted for certain other non-recurring revenues and expenses. And we believe these metrics are a better indication of our operating results and allow better comparability of our period-over-period performance. Please take the opportunity to visit our website, once again, that’s gladstonecommercial.com to sign up for our email notification service. On Facebook, you can find us at The Gladstone Companies, and on Twitter, the handle is @gladstonecomps. Now, today's call is simply an overview of our results, so we ask that you review our press release and Form 10-Q, both issued yesterday for more detailed information. Again, that's on the Investors page of our website. With that, I'll turn it over to Gladstone Commercial's President, Buzz Cooper. Buzz?

Thank you, Michael, and thank you all for calling in. Today, we will discuss economic and portfolio topics that are top of mind. The country is going through a transitional period economically, which has affected the commercial property markets. Although remote work and lingering effects of the pandemic have weakened the office property market, the industrial property markets remain strong. As we continue to pivot to a higher percentage of industrial assets by divesting non-core office assets, we are lowering our exposure to the office market and de-risking our portfolio. I would like to highlight several positive developments. Our overall portfolio remains stable and strong, and we continue to see attractive acquisition candidates. Further, we continue to have success with re-tenanting and capital recycling into industrial assets. With these facts in mind, let me move on to a discussion covering the results of the last quarter, provide some comments on the state of the portfolio and market outlook before turning the call over to Gary Gerson, our CFO, to review financial results for the period and our capital and liquidity positions. During the second quarter of 2023, we continued our focus on industrial acquisitions and improving operations. We acquired a 76,000 square foot industrial manufacturing facility in Riverdale, Illinois at a GAAP capitalization rate of 9.7%, fully leased our 119,224 square foot office building in Fort Lauderdale, Florida for 11.1 years, executed a lease with a sub-tenant of our 125,682 square foot industrial property in Milwaukee, Wisconsin for 10 years through 2038. We extended the lease of our 220,500 square foot Monroe, Michigan industrial facility for an additional five years, extended lease at our 13,919 square foot Cumming, Georgia medical office building for an additional five years, extended the 22,031 square foot lease at our Burnsville, Minnesota industrial property by an additional 5.4 years and we sold a 12,070 square foot office property in Baytown, Texas outside Houston. We also sold a 30,850 square foot office property in Birmingham, Alabama. Subsequent to the end of the quarter, we acquired a 7,714 square foot medical property in Burleson, Texas with a 10-year lease in place. We acquired a 100,000 square foot industrial manufacturing distribution facility in Cedar Hill, Texas for $9.1 million in a 20-year sale leaseback transaction at a GAAP cap rate of 10.1%. We sold a 26,080 square foot office building in Pittsburgh for $6.75 million, resulting in a gain on sale of $3.6 million. We extended the lease on our Wilmington, North Carolina industrial property until June 30, 2037. And we extended the lease of 51,940 square feet at our new Albany, Ohio office property by an additional five years. These investments, dispositions, and re-leasing activity further reinforce our strategy to increase our portfolio's industrial allocation and improve property operations. Our acquisition volumes since 2019 have exceeded $487 million and 99% of the acquisitions have been industrial in nature. Our industrial allocation based on straight-line rent has increased from 32% to 59% during this period, while pure office allocation has been reduced to 37%. The team's near-term objective is to reach an industrial allocation of at least 60% within the next six to 12 months. And we continue to have success with acquisitions in the 50,000 to 300,000 square foot range with the predominance of sale leasebacks, and we expect to continue this focus. Now I'd like to comment on the portfolio. Our asset management team continues to deliver on improving our same-store operations. Q2 2023 over Q2 2022 same-store lease revenues increased by 9.5%. We are also continuing our capital recycling efforts in order to redeploy sale proceeds into industrial assets. Our rent collections continue to be strong. 100% of cash rents were collected through July and we are very pleased with our portfolio and with our tenants’ performance during these challenging times for all industries. It is appropriate to mention that the average GAAP cap rate on our three acquisitions year-to-date was 9.56%, which is very accretive to our shareholders. The potential acquisitions currently in our pipeline are above 8.5%. Uncertainty and volatility continued in the second quarter of 2023 within the economy and financial markets. As a result of higher interest rates and tightened credit standards, transaction volumes are down by over 60% year-over-year and the disconnect between buyers and sellers, as it relates to pricing expectations, continued throughout the second quarter. The industrial sector normalized in the second quarter of 2023 relative to the last two record-setting years in '21 and '22. However, overall fundamentals remain sound and the sector continues to outperform other asset classes. The increase in the cost of high-yield debt and leveraged loans has made sale leasebacks an attractive source of capital for private equity-backed businesses, and an increasing number of firms are exploring it as a financing alternative. The Fed rate continued on its path of raising interest rates by 0.25% in the July meeting, signaling that the Fed will look for lower levels of inflation before determining peak rate levels. With inflation moderating to its lowest year-over-year increase since March of '21, the economy is showing the effects of rapid rate hikes and tightening credit standards over the past 18 months. Companies continued to push return-to-work policies in the second quarter. Meta, formerly Facebook, and Lyft announced office mandates in the second quarter, which now means that the top 10 US technology tenants all have some form of hybrid attendance policies. Additionally, federal agencies continue to implement policies for their employees to return to the office. Approximately 1.5 million office-based employees have had new attendance policies take effect in 2023, and another 1 million will face return-to-office mandates that will take effect through the end of the year. New office development activity has decreased significantly due to high material costs, decreased demand, and increased cost of capital. Just 5 million square feet of office has broken ground year-to-date, potentially providing much-needed supply constraints in high-quality office for years to come. The US is seeing a high record of office properties removed from the market for demolition, redevelopment, or conversion to other property types. Our firm continues to successfully execute on the disposition of non-core office buildings. As it relates to our acquisition opportunities, we continue to see a reduction in sales listing activity, primarily from third-party leases. And investment sales brokers are indicating that the number of acquisition candidates on a per-property basis has been reduced. We have seen cap rate expansion in the market due to the continued rise in interest rates and cost of debt, and new sponsors exploring sale leaseback transactions. Our current pipeline of acquisition candidates is approximately $408 million in volume, representing 25 properties. Of those, two have LOIs out for consideration and the balance are under review. Our team is staying actively engaged in our markets, and we believe acquisition opportunities will continue to arise that we can and will pursue. So, in summary, our second-quarter activities reflected continued strong leasing and rental collection success, continued active engagements to identify industrial acquisition opportunities, and have collectively positioned us well to pursue growth opportunities. Now, let me turn it over to Gary, our CFO, for a report on the financial results, including our capital market activities.

Thank you, Buzz. I'll start my remarks regarding our financial results this morning by reviewing our operating results for the second quarter of 2023. All per share numbers referenced are based on fully diluted weighted average common shares. FFO and core FFO per share available to common stockholders were both $0.41 per share for the quarter. FFO and core FFO available to common stockholders during the second quarter of 2022 were both $0.39 per share, respectively. FFO and core FFO for the six months ended June 30, 2023 were $0.77 and $0.78, respectively. FFO and core FFO for the same period in 2022 were both $0.78 per share. Our same-store cash rent in the first two quarters of 2023 increased by 9.5% over the same period in 2022. This was primarily due to one-time accelerated rental payment from a lease termination. Our second-quarter results reflected total operating revenues of $38.7 million with operating expenses of $33.7 million as compared to operating revenues of $36.4 million and operating expenses of $27.8 million for the same period in 2022. Operating expenses were higher in this period in 2023 mainly due to impairment charges of $6.8 million taken against three office properties, all of which are currently held for sale. In connection with the preparation of our financial statements for the second quarter of 2023, we identified errors in the calculation of depreciation of tenant-funded improvement assets at several of our properties. We had depreciated these assets through a term that was different than their useful lives. Their correction resulted in changes to depreciation expense, a non-cash amount, and net income. The correction of these errors had an immaterial impact on the incentive fee and no impact on any other advisory fee. The identified errors were included in our previously issued 2021 quarterly and annual financial statements, the 2022 quarterly and annual financial statements, and the quarterly financial statements for the three months ended March 31, 2023. We evaluated the errors and determined that the related impact was not material to the consolidated statements of operations and comprehensive income, consolidated balance sheets, consolidated statements of cash flows, or consolidated statements of equity for any period impacted. We have revised the previously issued financial statements as of and for the three and six months ended June 30, 2022 to correct for these errors. These revisions are reflected in our 10-Q filed yesterday. A summary of the corrections to the impacted financial statement line items to our previously issued financial statements for each aforementioned affected period is presented in Note 9 to the 10-Q. Please note that these corrections had no effect on FFO. Looking at our debt profile, 46.2% is fixed rate, 48.7% is hedged floating rate, and 5.1% is floating rate, which is the amount drawn on our revolving credit facility. As of June 30, our effective average SOFR rate was 5.09%. Our outstanding bank term loans are hedged with $200 million of interest rate swaps and the remainder with interest rate caps. In addition, we have $100 million of forward starting swaps to replace the maturing caps in Q3 2023. We have continued to monitor interest rates closely and update our hedging strategy as needed. As of today, our 2023 and 2024 loan maturities are manageable with $9 million due in 2023 and $19.7 million coming due in 2024. As of the end of the quarter, we had $38.5 million of revolver borrowings outstanding. We had no activity this quarter in issuing equity through our at-the-market or ATM program. During the quarter, we repurchased $1 million of our common stock. We also received net proceeds of $3.8 million from sales of our Series F preferred stock. We continue to manage our equity activity to ensure that we have sufficient liquidity for upcoming capital requirements and new acquisitions. Presently, we have six office properties held for sale, one is scheduled to close in August. As of today, we have approximately $6.9 million in cash and $44.1 million of availability under our line of credit. We encourage you to also review our quarterly financial supplement posted on our website which provides more detailed financial and portfolio information for the quarter. Our common stock dividend is $0.30 per quarter or $1.20 per year. Our common stock closed yesterday at $13.36. The distribution yield on our stock is at 9.02%. And now I'll turn the program back to David.

Well, thank you very much, Gary. That was a good report, good one from Buzz as well, and Michael. The team has produced very well this quarter and reacted admirably to the various challenges presented by the lasting impact of the pandemic and our economy that seems to be in a bit of turmoil. Overall, we have a nice quarter. You've heard a lot today. Summary, during the quarter we had a 76,000 square foot industrial building and we collected 100% of cash rents. We also reviewed and leased 502,000 square feet of remaining lease terms from 5.4 to 14 years and six of our properties. So we're going right along in our renewals. Subsequent to the end of the quarter, we acquired two additional properties, including a 100,000 square foot industrial facility. We also renewed 397,000 square feet of remaining lease ranging from 13.9 to 18.7 years at two of our properties. So again, everything is filling out as we'd like to see it. The commercial team is growing the real estate own at a good pace and the team is doing a great job of managing the properties we own, especially during these times that are a little bit challenged by all the interest rates. The company outlook, again, the team is strong, professionals continue to pursue potential quality properties on the list of acquisitions they are reviewing. Our acquisition team is seeking strong credit tenants. They know that the quality of the tenants is what makes the real estate an excellent investment. Our asset managers are actively managing the properties that the company owns in order to maximize their value. It is a different environment that we're in, and the team is doing a good job of doing that. So I'm going to stop here and let the operator come on and help us listen to some questions that should be asked from some of the listeners.

Thank you. We will now be conducting a question-and-answer session. Our first question is from Rob Stevenson with Janney Montgomery Scott. Please proceed, sir.

Good morning, guys. So you had a little over $63 million of assets held for sale at June 30. Sold one already for just under $7 million. So call it $57 million more or less still held for sale. What's the expected timing on those remaining five dispositions? Are they likely to close in the third quarter? By year-end? Or some of that spill over into ‘24? And where's pricing coming in versus your acquisition cap rates?

Thanks, Rob. I'll take a shot at this. My Chief Investment Officer, EJ Wislar, is here as well. Regarding the number you mentioned, I think one of them might carry over into 2024. Other than that, I don't expect any spillover. The reason is that this is a repositioning within the property marketplace. So while it could close in 2023, I believe it will more likely be in the first quarter of 2024. As for valuations, I don’t have the exact figure related to our impairment, but I can't say for certain because a few of the properties are going through necessary adjustments as we conduct due diligence.

Okay that’s helpful. And then how should we be thinking about the investment-grade tenant base in the portfolio? If I go back pre-COVID, year-end 2019, your portfolio was 63% investment-grade tenants. Now it's 51%. I assume that the vast majority of that is the migration from investment-grade office tenants to industrial. But when you're looking at new acquisitions, how are you guys thinking about the credit quality of industrial tenants in the sort of smaller and mid-range assets versus the sort of underwriting that you did when you were focused on investment-grade office tenants?

Again, I'll let EJ have a statement here as well, but we have not gotten away from our historical and prioritized underwriting as it relates to all of our tenants. We lost some credit tenants as it relates to their going remote, and we're selling buildings. But as it relates to our internal underwriting as well, we have maintained those standards. EJ?

Yeah, it's obviously really important to us on the underwriting side to your point to make sure we're putting good credit tenants into the portfolio. As we've moved more into industrial, to your point, you do see more middle-market type businesses, especially in the manufacturing space. What we do find though is you're able to acquire assets that are a lot more mission-critical to the tenant. So you have a lot higher renewal probabilities than your legacy office assets. So it’s a bit of a balancing act as we look to construct the portfolio. But for us, the key is making sure that the asset you're acquiring is a major revenue and EBITDA driver to the underlying business in order to ensure a high renewal probability mixed in with the overall corporate strength of that tenant.

Okay, that's helpful. And then, Gary, you guys bought back $1 million of stock. What was the average price there or how many shares did you wind up buying? I didn't see that in the release.

We can get back to you on the average price. I believe it was somewhere around $12.

Okay.

But, in around 90,000 shares, something around that neighborhood.

That's helpful. Lastly, you paid down $36 million of debt in the third quarter. Will any proceeds from that be used to pay down additional debt? Are you still considering buying back stock, or will that be focused on funding acquisitions? How are you planning to allocate proceeds from the dispositions and any available free cash flow at this time?

Obviously, we look to redeploy capital into industrial acquisitions, as we've stressed. We'll be talking internally as to whether or not we continue to look to buy back at this point. It is on the table. But at this point in time, what we want to do is redeploy that capital into, for lack of a better word, higher accretive deals.

Okay. That's helpful.

And obviously, move away from non-core assets.

All right, guys, thanks.

Just so you know, Rob, it was 80,000 or so shares at an average price of $12.40.

Okay. Do we have a new question?

Thank you. Our next question is from Craig Kucera with B. Riley Securities. Please proceed sir.

Yeah. Hey, good morning, guys. Could you give us a little bit more color on the lease termination this quarter, where the tenant was located, anything in that regard?

Certainly. I'll let EJ have that. He did a great job with his asset manager on getting that completed for us.

That was specific to the Fort Lauderdale office property where Citrix was the legacy tenant there as part of their take-private a few years ago. They’ve gone remote. And so we've been working with them, putting a sub-tenant in, and we worked then with a sub-tenant to make that a prime lease. It’s a great opportunity for us to effectuate a termination fee and go direct with the tenant that took the entire facility. The cash value of that was approximately $2 million, offset a bit by some deferred rent assets there. So it was a great outcome there, being able to execute it over an 11-year lease to go direct and make that their corporate headquarters for the new tenant.

Got it. That's helpful. And did you mention with the two dispositions this quarter, what the cap rate was?

I don't think we mentioned it, but on average, I may have to get back to you on that. I'm not sure I have that handy.

One of the properties had some vacancies, so calculating a true cap rate based on the current occupancy wouldn’t be accurate. The office building sold after the quarter was fully leased and exited at just under a 6.5% initial cap rate. We plan to reinvest that at least at a 200 basis point spread, which should yield a favorable outcome.

Got it. You're expecting to see a significant increase in the assets you're planning to sell. Is one of those buildings the former Verizon call center that closed at the end of last year? Can you provide some details on the average occupancy of those buildings?

Verizon is a big one. We are looking forward to that sale in this quarter. We are waiting for a blessing in order for it to close from the municipality and that will get that off our books. That's the primary, if you will, property that I think you're referring to.

Correct. Got it. And I guess what I'm just looking for is just some color on, are these office assets that have meaningful vacancy, or are there any industrial assets in that pool or just any color would be helpful?

There are no industrial assets in that category; in comparison to Verizon's single-story office, we have a two-story building in Richardson, Texas. I should mention that these properties are for sale, and we currently have purchase and sale agreements in negotiation. The total area is 558,000 square feet, and we expect to complete the sale of all but one of these properties by the end of this year.

And to that point, the majority of those have some vacancy or are completely vacant. And so the thought process there as we kind of look at the office market today, there are some office markets where there is still good activity like Fort Lauderdale, but in certain markets where absorption is negative or leasing is very slow, we view it as a more prudent capital allocation strategy to exit those deals, redeploy them versus sinking money into those buildings. So that's kind of the thought process there, and we should hopefully see an uptick in occupancy as we move through those vacant assets.

Okay. That’s helpful. And I apologize, but there was some background noise when you were reading through your comments on your sort of acquisition pipeline and what was under due diligence, et cetera. Can you go through those again just so we have a little clearer listening on that?

What I'll do, just so that it is more clear, is I'll let EJ provide an update on that for you. But the team is actively engaged looking at many opportunities.

Yes, look, the pipeline is about $408 million plus or minus. Two deals. We have LOIs out. We had closed a few deals recently subsequent to quarter-end, so nothing's currently in diligence. We’ve got a few deals we think are very actionable at the moment. We're viewing a lot. And as Buzz mentioned in the prepared remarks, I'm seeing a lot of interesting sale leaseback opportunities.

Got it. And are you at this point comfortable handicapping sort of what your expectations are on the acquisition front for the rest of the year or third quarter or is it still sort of TBD?

I'd say it's more TBD. Obviously, as it relates to what cap rates are doing and the availability of capital and debt.

Got it. And just one more from me. We've seen REITs, I think, in a lot of sectors sort of pick up their activity of stepping in as sort of a temporary lender for merchant builders. I don't know if new product necessarily fits kind of what you've been doing on the industrial front, but is that something you guys are looking at as far as sourcing some additional transaction volume?

I don't know if we're going to be merchant builders, per se. We certainly would look at and have been exploring internally how we can generate more business, whether it's through JV or otherwise. But I'll let EJ have a throw at that.

Yeah, to your point, obviously, with a lot of regional banks and banks sort of on the sideline, the construction lending world, we have seen some groups private and public that are traditionally equity players stepping in to provide construction financing. We see those opportunities. We have some of those discussions. In our view, as we look at our capital allocation strategy, you can still see better returns on the equity side, especially in the sale leaseback space as we look to construct a long-term weighted average lease term for our portfolio. So, we look at those; I don't see us doing any in the near term.

All right. Thanks.

Thank you.

Do we have another question?

Thank you. As there are no further questions at this time, I am turning the call back to Mr. David Gladstone for closing comments. Please proceed, sir.

Well, we thank you very much for a good meeting and wish you all well, and we'll see you next quarter. That's the end of this call.