##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934FOR THE QUARTER ENDED MARCH 31, 2004
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 COMMISSION FILE NUMBER: 0-50363 GLADSTONE COMMERCIAL CORPORATION  MARYLAND
(State or other jurisdiction of
incorporation or organization)
    
    02-0681276
(I.R.S. Employer Identification No.)
 1616 ANDERSON ROAD, SUITE 208
MCLEAN, VIRGINIA 22102
(Address of principal executive office) (703) 286-7000
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. x o
 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). x o
 Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date. The number of shares of the
issuers Common Stock, $0.001 par value, outstanding as of May 7, 2004 was
7,642,000.




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GLADSTONE COMMERCIAL CORPORATION
TABLE OF CONTENTS PART I FINANCIAL INFORMATIONItem 1 Consolidated Financial Statements (Unaudited)Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003Consolidated Statement of Operations for the three months ended March 31, 2004 and for the period from February 14, 2003 (inception) through March 31, 2003Consolidated Statement of Cash Flows for the three months ended March 31,2004 and for the period from February 14, 2003 (inception) through March 31, 2003Notes to Financial StatementsItem 2 Managements Discussion and Analysis of Financial Condition and Results of OperationsOverviewResults of OperationsLiquidity and Capital ResourcesItem 3 Quantitative and Qualitative Disclosure About Market RiskItem 4 Controls and ProceduresPART II OTHER INFORMATIONItem 1 Legal ProceedingsItem 2 Changes in Securities and Use of ProceedsItem 3 Defaults Upon Senior SecuritiesItem 4 Submission of Matters to a Vote of Security HoldersItem 5 Other InformationItem 6 Exhibits and Reports on Form 8-KSignatures




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PART I  FINANCIAL INFORMATION Gladstone Commercial Corporation 
 Item 1  Consolidated Financial Statements (Unaudited) March 31, 2004 CONTENTS Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statement of Cash Flows Notes to Financial Statements




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GLADSTONE COMMERCIAL CORPORATION 
 CONSOLIDATED BALANCE SHEETS (Unaudited) March 31,
    
    December 31,2004
    
    2003ASSETSReal estate, net
    
    $
    9,020,410
    
    
    $
    5,436,153Mortgage note receivable
    
    
    11,170,000
    
    
    
    Cash and cash equivalents
    
    
    84,667,117
    
    
    
    99,075,765Restricted deposit
    
    
    205,508
    
    
    
    Interest receivable  mortgage note
    
    
    68,261
    
    
    
    Deferred rent receivable
    
    
    13,764
    
    
    
    Prepaid expenses
    
    
    150,812
    
    
    
    191,432Other assets
    
    
    18,266
    
    
    
    Lease intangibles, net of accumulated amortization of
$14,795 and $1,208, respectively
    
    
    344,433
    
    
    
    358,020Total Assets
    
    
    105,658,571
    
    
    
    105,061,370LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIESDue to Adviser
    
    $
    590,410
    
    
    
    234,295Accounts payable
    
    
    24,161
    
    
    
    Dividends payable
    
    
    917,040
    
    
    
    76,420Accrued expenses
    
    
    78,105
    
    
    
    Restricted deposits
    
    
    205,508
    
    
    
    Rent received in advance and security deposits
    
    
    210,767
    
    
    
    Total Liabilities
    
    
    2,025,991
    
    
    
    310,715Commitments and contingenciesSTOCKHOLDERS EQUITYCommon stock, $0.001 par value, 20,000,000 shares
authorized, 7,642,000 shares issued and outstanding
    
    
    7,642
    
    
    
    7,642Additional paid in capital
    
    
    105,052,574
    
    
    
    105,060,304Distributions in excess of accumulated earnings
    
    
    (1,427,636
    )
    
    
    (317,291
    )Total Stockholders Equity
    
    
    103,632,580
    
    
    
    104,750,655Total Liabilities and Stockholders Equity
    
    $
    105,658,571
    
    
    $
    105,061,370
 The accompanying notes are an integral part of these consolidated financial
statements. 1




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GLADSTONE COMMERCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) For the periodFebruary 14, 2003For the three
    
    (inception)months ended
    
    throughMarch 31, 2004
    
    March 31, 2003OPERATING REVENUES:Rental income
    
    $
    197,773
    
    
    $
    Interest income  mortgage
    
    
    133,419
    
    
    
    Total operating revenues
    
    
    331,192
    
    
    
    OPERATING EXPENSES:Management advisory fee
    
    
    229,416
    
    
    
    Depreciation and amortization
    
    
    79,330
    
    
    
    General and administrative
    
    
    388,213
    
    
    
    10,549Total operating expenses
    
    
    696,959
    
    
    
    10,549Net loss from operations
    
    
    (365,767
    )
    
    
    (10,549
    )INTEREST INCOME  temporary investments
    
    
    172,462
    
    
    
    NET LOSS
    
    $
    (193,305
    )
    
    $
    (10,549
    )Basic loss per weighted average common share
    
    $
    (0.03
    )
    
    $
    (0.20
    )Diluted loss per weighted average common share
    
    $
    (0.03
    )
    
    $
    (0.20
    )Basic  weighted average shares outstanding
    
    
    7,642,000
    
    
    
    52,000Diluted  weighted average shares outstanding
    
    
    7,642,000
    
    
    
    52,000
 The accompanying notes are an integral part of these consolidated financial
statements. 2




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GLADSTONE COMMERCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the periodFebruary 14, 2003For the Three
    
    (inception)Months Ended
    
    throughMarch 31,
    
    March 31,2004
    
    2003Cash flows from operating activities:Net loss
    
    $
    (193,305
    )
    
    $
    (10,549
    )Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:Depreciation and amortization
    
    
    79,330
    
    
    
    Changes in assets and liabilities:Increase in mortgage interest receivable
    
    
    (68,261
    )
    
    
    Decrease in prepaid expenses
    
    
    40,620
    
    
    
    Increase in other assets
    
    
    (18,266
    )
    
    
    Increase in
deferred rent receivable
    
    
    (13,764
    )
    
    
    Increase in accounts payable
    
    
    24,161
    
    
    
    10,549Increase in due to Adviser
    
    
    356,115
    
    
    
    Increase in accrued expenses
    
    
    78,105
    
    
    
    Increase in rent received in advance and security deposits
    
    
    210,767
    
    
    
    Net cash provided by (used in) operating activities
    
    
    495,502
    
    
    
    Cash flows from investing activities:Real estate investment
    
    
    (3,650,000
    )
    
    
    Mortgage loan
    
    
    (11,170,000
    )
    
    
    Net cash used in investing activities
    
    
    (14,820,000
    )
    
    
    Cash flows from financing activities:Proceeds from share issuance
    
    
    
    
    
    
    10,000Offering costs
    
    
    (7,730
    )
    
    
    Dividends paid
    
    
    (76,420
    )
    
    
    Net cash (used in) provided by financing activities
    
    
    (84,150
    )
    
    
    10,000Net (decrease) increase in cash and cash equivalents
    
    
    (14,408,648
    )
    
    
    10,000Cash and cash equivalents, beginning of period
    
    
    99,075,765
    
    
    
    Cash and cash equivalents, end of period
    
    $
    84,667,117
    
    
    $
    10,000
 The accompanying notes are an integral part of these consolidated financial
statements 3




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GLADSTONE COMMERCIAL CORPORATION 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. Organization Gladstone Commercial Corporation, a Maryland corporation, (the Company)
was incorporated on February 14, 2003 under the General Corporation Law of
Maryland for the purpose of engaging in the business of investing in and owning
property net leased to creditworthy entities and mortgage loans to creditworthy
entities. Subject to certain restrictions and limitations, the business of the
Company is managed by Gladstone Management Corporation (the Adviser). On February 15, 2003, the Companys initial stockholder purchased 52,000
shares of common stock (the Shares) for $52,000 and was admitted as the
initial stockholder of the Company. On August 18, 2003, the Company closed its initial public offering (the
Offering) and sold 6,600,000 shares of its common stock and on September 17,
2003, the underwriters purchased an additional 990,000 shares of common stock,
both sales at $15.00 per share less an underwriting discount of $1.05 per
share, offering costs were $699,352 for total net proceeds to the Company of
$105,015,946. 2. Summary of Significant Accounting Policies On May 28, 2003, the Company completed the formation of a subsidiary,
Gladstone Commercial Limited Partnership (the Operating Partnership). The
Company conducts substantially all of its operations through the Operating
Partnership. As the Company currently owns all of the general and limited
partnership interests of the Operating Partnership, the financial position and
results of operations of the Operating Partnership are consolidated with those
of the Company. Interim financial information Interim financial statements of the Company are prepared in accordance
with generally accepted accounting principles (GAAP) for interim financial
information and pursuant to the requirements for reporting on Form 10-Q and
Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying
annual financial statements prepared in accordance with GAAP are omitted. All
adjustments, consisting solely of normal recurring accruals, necessary for the
fair statement of financial statements for the interim period have been
included. Investments in real estate The Company records investments in real estate at cost and capitalizes
improvements and replacements when they extend the useful life or improve the
efficiency of the asset. The Company expenses costs of repairs and maintenance
as incurred. The Company computes depreciation using the straight-line method
over the estimated useful life of 39 years for buildings and improvements, five
to seven years for equipment and fixtures and the shorter of the useful life or
the remaining lease term for tenant improvements and leasehold interests.
Total real estate depreciation expense was $65,743 for the three months ended
March 31, 2004. The Company accounts for its acquisitions of investments in real estate in
accordance with Statement of Financial Accounting Standards No. 141, Business
Combinations, which requires the fair value of the real estate acquired to be
allocated to the acquired tangible assets, consisting of land, building and
tenant improvements, and identified intangible assets and liabilities,
consisting of the value of above-market and below-market leases, other value of
in-place leases and value of tenant relationships, based in each case on their
fair values. 4




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The Company allocates purchase price to the fair value of the tangible
assets of an acquired property (which includes the land, building, and tenant
improvements) to be determined by valuing the property as if it were vacant.
The as-if-vacant value is allocated to land, building, and tenant
improvements based on managements determination of the relative fair values of
these assets. Above-market and below-market in-place lease values for owned properties
are recorded based on the present value (using an interest rate which reflects
the risks associated with the leases acquired) of the difference between (i)
the contractual amounts to be paid pursuant to the in-place leases and (ii)
managements estimate of fair market lease rates for the corresponding in-place
leases, measured over a period equal to the remaining non-cancelable term of
the lease. The capitalized above-market lease values will be amortized as a
reduction of rental income over the remaining non-cancelable terms of the
respective leases. The capitalized below-market lease values (presented in the
accompanying balance sheet as value of assumed lease obligations) are amortized
as an increase to rental income over the initial term and any fixed-rate
renewal periods in the respective leases. Since the Companys strategy to a
large degree involves sale-leaseback transactions with newly originated leases
at market rates, the above-market and below-market in-place lease values are
not significant for many of the transactions the Company will ultimately enter
into. The aggregate value of other intangible assets acquired are measured based
on the difference between (i) the property valued with existing in-place leases
adjusted to market rental rates and (ii) the property valued as if vacant.
Managements estimates of value made using methods similar to those used by
independent appraisers (e.g., discounted cash flow analysis). Factors
considered by management in its analysis include an estimate of carrying costs
during hypothetical expected lease-up periods considering current market
conditions, and costs to execute similar leases. The Company also considers
information obtained about each property as a result of its pre-acquisition due
diligence, marketing and leasing activities in estimating the fair value of the
tangible and intangible assets acquired. In estimating carrying costs,
management also includes real estate taxes, insurance and other operating
expenses and estimates of lost rentals at market rates during the expected
lease-up periods, which primarily range from six to 18 months, depending on
specific local market conditions. Management also estimates costs to execute
similar leases including leasing commissions, legal and other related expenses
to the extent that such costs are not already incurred in connection with a new
lease origination as part of the transaction. The total amount of other intangible assets acquired is further allocated
to in-place lease values and customer relationship intangible values based on
managements evaluation of the specific characteristics of each tenants lease
and the Companys overall relationship with that respective tenant.
Characteristics considered by management in allocating these values include the
nature and extent of the Companys existing business relationships with the
tenant, growth prospects for developing new business with the tenant, the
tenants credit quality and expectations of lease renewals (including those
existing under the terms of the lease agreement), among other factors. The value of in-place leases is amortized to expense over the initial term
of the respective leases, which range from six to 20 years. The value of
customer relationship intangibles are amortized to expense over the initial
term and any renewal periods in the respective leases, but in no event does the
amortization period for intangible assets exceed the remaining depreciable life
of the building. Should a tenant terminate its lease, the unamortized portion
of the in-place lease value and customer relationship intangibles will be
charged to expense. Total amortization expense was $13,587 for the three
months ended March 31, 2004. Impairment The Company periodically reviews the carrying value of each property to
determine if circumstances that indicate impairment in the carrying value of
the investment exist or that depreciation periods should be modified. If
circumstances support the possibility of impairment, the Company will prepare a
projection of the undiscounted future cash flows, without interest charges, of
the specific property and determine if the investment in such property is
recoverable. If impairment is indicated, the carrying value of the property is
written down to its estimated fair value based on the Companys best estimate
of the propertys discounted future cash flows. There have been no impairments
recognized on the Companys real estate assets at March 31, 2004. 5




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Cash and cash equivalents The Company considers all short-term, highly liquid investments that are
both readily convertible to cash and have a maturity of generally three months
or less at the time of purchase to be cash equivalents; except that any such
investments purchased with funds on deposit in escrow or similar accounts are
classified as restricted deposits. Items classified as cash equivalents include
commercial paper and money-market funds. All of the Companys cash and cash
equivalents at March 31, 2004 were held in the custody of one financial
institution, and which balance at times may exceed federally insurable limits.
The Company mitigates this risk by depositing funds with major financial
institutions. Organizational costs The Company expenses organizational costs (primarily filing fees and legal
expenses) as incurred. Stock based compensation In December 2002, the Financial Accounting Standards Board (FASB)
approved the issuance of Statement of Financial Accounting Standards (SFAS)
No. 148 Accounting for Stock-Based Compensation  Transition and Disclosure.
The statement amended SFAS No. 123 Accounting for Stock-Based Compensation to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock based employee compensation.
Furthermore, SFAS No. 148 amended the disclosure requirements of SFAS No. 123
to require more prominent disclosures in both annual and interim financial
statements about the method and related effect on results of accounting for
stock-based employee compensation, effective for fiscal year and interim
periods beginning after December 15, 2002. The Company accounts for the issuance of stock options under its 2003
Equity Incentive plan in accordance with APB Opinion No. 25, Accounting for
Stock Issued to Employees. In this regard, these options have been granted to
individuals who are the Companys officers, and who would qualify as leased
employees under FIN 44, Accounting for Certain Transactions Involving Stock
Compensation, an Interpretation of APB Opinion No. 25. Income taxes The Company has and will operate in a manner that will allow it to qualify
as a real estate investment trust under the Internal Revenue Code of 1986, and
accordingly will not be subject to Federal income taxes on amounts distributed
to stockholders (except income from foreclosure property), provided it
distributes at least 90% of its real estate investment trust taxable income to
its stockholders and meets certain other conditions. Revenue recognition Rental revenues include rents that each tenant pays in accordance with the
terms of its respective lease reported on a straight-line basis over the
non-cancelable term of the lease. Since one of the Companys leases currently
contains rental increases at specified intervals, straight-line basis
accounting requires the Company to record an asset, and include in revenues,
deferred rent receivable that will be received if the tenant makes all rent
payments required through the expiration of the initial term of the lease.
Deferred rent receivable in the accompanying balance sheet represents the
cumulative difference between rental revenue as recorded on a straight line
basis and rents received from the tenants in accordance with the lease terms.
Accordingly, the Company determines, in its judgment, to what extent the
deferred rent receivable applicable to each specific tenant is collectible. The
Company reviews deferred rent receivable on a quarterly basis and takes into
consideration the tenants payment history, the financial condition of the
tenant, business conditions in the industry in which the tenant operates and
economic conditions in the area in which the property is located. In the event
that the collectability of deferred rent with respect to any given tenant is in
doubt, the Company records an increase in the allowance for uncollectible
accounts or 6




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records a direct write-off of the specific rent receivable, which would have an
adverse effect on the net income for the year in which the reserve is increased
or the direct write-off is recorded and would decrease total assets and
stockholders equity. Management considers its loans and other lending investments to be
held-for-investment. The Company reflects held-for-investment investments at
amortized cost less allowance for loan losses, acquisition premiums or
discounts, deferred loan fees and undisbursed loan funds. On occasion, the
Company may acquire loans at small premiums or discounts based on the credit
characteristics of such loans. These premiums or discounts are recognized as
yield adjustments over the lives of the related loans. Loan origination or
exit fees, as well as direct loan origination costs, are also deferred and
recognized over the lives of the related loans as yield adjustment. If loans
with premiums, discounts, loan origination or exit fees are prepaid, the
Company immediately recognizes the unamortized portion as a decrease or
increase in the prepayment gain or loss. Interest income is recognized using
the effective interest method applied on a loan-by-loan basis. Prepayment
penalties or yield maintenance payments from borrowers are recognized as
additional income when received. Use of estimates The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates. Segment information SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information provides standards for public companies relating to the reporting
of financial and descriptive information about their operating segments in
financial statements. Operating segments are defined as components of an
enterprise for which separate financial information is available and is
evaluated regularly by the chief operating decision maker or decision making
group in determining how to allocate resources and in assessing performance.
Company management is the chief decision making group. As of March 31, 2004, the Companys operations are derived from two
operating segments. One segment purchases real estate (land, buildings and
other improvements) which are simultaneously leased to existing users and the
other segment extends mortgage loans and collects principal and interest
payments. Three Months Ended March 31, 2004Real Estate
    
    Real EstateLeasing
    
    Lending
    
    Other
    
    TotalRevenue
    
    $
    197,773
    
    
    $
    133,419
    
    
    $
    
    
    
    $
    331,192Expenses
    
    
    79,330
    
    
    
    
    
    
    
    617,629
    
    
    
    696,959Income (loss) from
operations
    
    
    118,443
    
    
    
    133,419
    
    
    
    (617,629
    )
    
    
    (365,767
    )Other income
    
    
    
    
    
    
    
    
    
    
    172,462
    
    
    
    172,462Net income (loss)
    
    
    118,443
    
    
    
    133,419
    
    
    
    (445,167
    )
    
    
    (193,305
    )Assets
    
    $
    9,378,607
    
    
    $
    11,443,769
    
    
    $
    84,836,195
    
    
    $
    105,658,571
 3. Management Advisory Fee The Company has entered into an agreement with the Companys Adviser in
which the Adviser will be responsible for managing the Company on a day-to-day
basis and for identifying, evaluating, negotiating and consummating investment
transactions consistent with the Companys criteria. In exchange for such
services, the Company will reimburse the Adviser for certain expenses. The
Company will reimburse the Adviser for its pro-rata share of the payroll and
related benefit expenses on an employee-by-employee basis, based on the
percentage of each employees time devoted to Company matters. The Company
will also reimburse the Adviser for general overhead expenses multiplied by the
ratio of hours worked by 7




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Adviser employees on Company matters to the total hours worked by Adviser
employees. For the three months ended March 31, 2004, the Company has incurred
approximately $229,000 in management advisory fees. Approximately $464,000
(which includes prior fiscal year accruals) was unpaid at March 31, 2004. 4. Stock Options In December 2002, the FASB approved the issuance of SFAS No. 148
Accounting for Stock-Based Compensation  Transition and Disclosure. The
statement amended SFAS No. 123 Accounting for Stock-Based Compensation to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock based employee compensation.
Furthermore, SFAS No. 148 amended the disclosure requirements of SFAS No. 123
to require more prominent disclosures in both annual and interim financial
statements about the method and related effect on results of accounting for
stock-based employee compensation, effective for fiscal year and interim
periods beginning after December 15, 2002. The following tables summarizes the Companys operating results as if the
Company elected to account for its stock-based compensation under the fair
value provisions of SFAS No. 123, Accounting for Stock-Based Compensation,
for the three months ended March 31, 2004: Three monthsendedMarch 31,2004Net Loss, as reported
    
    $
    (193,305
    )Less: Stock-based compensation expense
determined under the fair value based method
    
    $
    (111,433
    )Net Loss, pro-forma
    
    $
    (304,738
    )Basic, as reported
    
    $
    (0.03
    )Basic, pro-forma
    
    $
    (0.04
    )Diluted, as reported
    
    $
    (0.03
    )Diluted, pro-forma
    
    $
    (0.04
    )
 The stock-based compensation expense under the fair value method, as reported
in the above table, was computed using an estimated weighted average fair value
of $4.89 using the Black-Scholes option-pricing model and the following
assumptions: dividend yield of five percent, risk-free interest rate of 1.94%,
expected volatility factor of 18.39%, and expected lives of three years. There were no stock options outstanding during the period February 14, 2003
(inception) through March 31, 2003. At March 31, 2004, 679,000 options were outstanding with exercise prices ranging
from $15 to $16.85 with terms of ten years. 8




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##### 



5. Earnings Per Common Share The following table sets forth the computation of basic and diluted
earnings (loss) per share for the three months ended March 31, 2004: For the periodFebruary 14,Three months ended
    
    2003 (inception)March 31,
    
    through2004
    
    March 31, 2003Net Loss
    
    $
    (193,305
    )
    
    $
    (10,549
    )Denominator for basic weighted average shares
    
    
    7,642,000
    
    
    
    52,000Dilutive effect of stock options
    
    
    
    
    
    
    Denominator for diluted weighted average
shares
    
    
    7,642,000
    
    
    
    52,000Basic loss per common share
    
    $
    (0.03
    )
    
    $
    (0.20
    )Diluted loss per common share
    
    $
    (0.03
    )
    
    $
    (0.20
    )
 Due to the Companys net loss, the incremental shares, related to stock
options, have an anti-dilutive effect for the three months ended March 31, 2004
and as a result diluted loss per average common share is equal to the basic
loss per average common share. 6. Real Estate The following table sets forth the Companys real estate holdings at March
31, 2004: Real estate:Land
    
    $
    1,385,000Building
    
    
    6,965,996Tenant improvements
    
    
    739,776Accumulated depreciation
    
    
    (70,362
    )Real estate, net
    
    $
    9,020,410
 On December 23, 2003 the Company acquired a 58,926 square foot commercial
office building in Raleigh, North Carolina. The property was acquired for $5.8
million including transaction costs and was funded using a portion of the net
proceeds from the Companys initial public offering. The property is leased to
a single tenant. The lease has a remaining term of six years. In connection
with this acquisition, the Company recorded lease intangibles in the amount of
$359,228 related to the avoided costs to lease the property and obtain the
current lease. These intangibles will be amortized over the remaining lease
term. On January 30, 2004, the Company acquired a 54,018 square foot commercial
office and warehouse space building in Canton, Ohio for $3.65 million including
transaction costs and was funded using a portion of the net proceeds from the
Companys initial public offering. The Company, upon acquisition of the
property, extended a ten year triple net lease with the sole tenant. The
monthly lease payments are the greater of LIBOR based plus 600 basis points or
9.25% multiplied by the purchase price. 9




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##### 



Future operating lease payments under non-cancelable leases, excluding
customer reimbursement of expenses, in effect at March 31, 2004 are as follows: Year
    
    Rental Payments2004
    
    
    598,9212005
    
    
    866,5492006
    
    
    882,4172007
    
    
    898,7612008
    
    
    915,595Thereafter
    
    
    2,666,746
 In accordance with the lease terms, substantially all tenant expenses are
required to be paid by the tenant, however the Company would be required to pay
property taxes on the respective property in the event the tenant fails to pay
them. 7. Mortgage Note Receivable On February 18, 2004, the Company extended a promissory mortgage note in
the amount of $11,170,000 collateralized by property in Sterling Heights,
Michigan. The note was issued from a portion of the net proceeds of the
Companys initial public offering. The note accrues interest at the greater of
10% per annum or the one month LIBOR rate plus 400 basis points per annum, and
is for a period of 10 years maturing on February 18, 2014. 8. Dividends Declared per Share During the three months ended March 31, 2004, the Company declared a $0.12
per common share dividend to stockholders of record on March 31, 2004 which is
payable on April 15, 2004. 9. Subsequent Event On April 29, 2004, the Company purchased an 83,891 square foot commercial
office and laboratory space in Akron, Ohio for $9.3 million. The purchase was
funded using a portion of the proceeds of the Companys initial public
offering. The property is currently leased to two tenants under separate
triple net leases, one of which occupies 79% of the property and has a
remaining term of twelve years and the other of which occupies 21% of the
property and has a remaining term of five years.
The leases will provide approximately $649,000 of base rents during fiscal
year 2004 with prescribed escalations thereafter. 10




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations. Forward-Looking Statements Some of the statements in this Annual Report onForm 10-Kconstitute
forward-looking statements under Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
including statements made with respect to possible or assumed future results of
our business, financial condition, liquidity, results of operations, plans and
objectives. When we use the words believe, expect, anticipate, estimate
or similar expressions, we intend to identify forward-looking statements. You
should not place undue reliance on these forward-looking statements. Statements
regarding the following subjects are forward-looking by their nature:  
    
    our business strategy;
    
    pending transactions;
    
    our projected operating results;
    
    our ability to obtain future financing arrangements;
    
    estimates relating to our future distributions;
    
    our understanding of our competition;
    
    market trends;
    
    projected capital expenditures; and
    
    use of the proceeds of our initial public offering. These statements involve known and unknown risks, uncertainties and other
factors that may cause results, levels of activity, growth, performance, tax
consequences or achievements to be materially different from any future
results, levels of activity, growth, performance, tax consequences or
achievements expressed or implied by such forward-looking statements. Such
factors include, among other things, those listed below, as well as those
further set forth under the heading Risk Factors included elsewhere in this
report. The forward-looking statements are based on our beliefs, assumptions and
expectations of our future performance, taking into account all information
currently available to us. Although we believe that these beliefs, assumptions
and expectations are reasonable, we cannot guarantee future results, levels of
activity, performance, growth or achievements. These beliefs, assumptions and
expectations can change as a result of many possible events or factors, not all
of which are known to us. If a change occurs, our business, financial
condition, liquidity and results of operations may vary materially from those
expressed in our forward-looking statements. You should carefully consider
these risks before you make an investment decision with respect to our common
stock, along with the following factors that could cause actual results to vary
from our forward-looking statements:  
    
    the loss of any of our key employees, such as Mr. Gladstone, Mr.
Brubaker or Mr. Stelljes;
    
    general volatility of the capital markets and the market price of our
common stock;
    
    risks associated with negotiation of consummation of pending and future
transactions;
    
    changes in our business strategy;
    
    availability, terms and deployment of capital;
    
    availability of qualified personnel;
    
    changes in our industry, interest rates or the general economy; and
    
    the degree and nature of our competition. We are under no duty to update any of the forward-looking statements after
the date of this report to conform such statements to actual results. 
 Overview We were incorporated under the General Corporation Law of the State of
Maryland on February 14, 2003 primarily for the purpose of investing in and
owning net leased industrial and commercial real property and selectively
making long-term industrial and commercial mortgage loans. We 11




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expect that a large portion of our tenants and borrowers will be small and medium-sized
businesses that have significant buyout fund ownership and will be well
capitalized, with equity constituting between 20% and 40% of their permanent
capital. We expect that other tenants and borrowers will be family-owned
businesses that have built significant equity from paying down the mortgage
loans securing their real estate or through the appreciation in the value of
their real estate. We will seek to enter into triple net leases having terms of
approximately 15 years, with rent increases built into the leases. Under a
triple net lease, the tenant is required to pay all operating, maintenance and
insurance costs and real estate taxes with respect to the leased property. At
March 31, 2004, we owned two properties and had one mortgage loan. We are
actively communicating with buyout funds, real estate brokers and other third
parties to locate properties for potential acquisition or mortgage financing in
an effort to build our portfolio. We conduct substantially all of our activities through, and all of our
properties are held directly or indirectly by, Gladstone Commercial Limited
Partnership, a Delaware limited partnership formed on May 28, 2003, which we
refer to as our Operating Partnership. We control our Operating Partnership
as its sole general partner, and, through our wholly owned subsidiary Gladstone
Commercial Partners, LLC, we also own all limited partnership units of our
Operating Partnership. We expect our Operating Partnership to issue limited
partnership units from time to time in exchange for industrial and commercial
real property. By structuring our acquisitions in this manner, the sellers of
the real estate will generally be able to defer the realization of gains until
they redeem the limited partnership units. Limited partners who hold limited
partnership units in our Operating Partnership will be entitled to redeem these
units for cash or, at our election, shares of our common stock on a one-for-one
basis at any time after the first anniversary of the completion of our initial
public offering. Whenever we issue common stock for cash, we will be obligated
to contribute any net proceeds we receive from the sale of the stock to our
Operating Partnership and our Operating Partnership will, in turn, be obligated
to issue an equivalent number of limited partnership units to us. Our Operating
Partnership will distribute the income it generates from its operations to us
and its limited partners on a pro rata basis. We will, in turn, distribute the
amounts we receive from our Operating Partnership to our stockholders in the
form of quarterly cash distributions. We intend to qualify as a REIT for
federal tax purposes, thereby generally avoiding federal and state income taxes
on the distributions we make to our stockholders. Gladstone Management Corporation, a registered investment adviser and an
affiliate of ours, serves as our external adviser (our Adviser). Our Adviser
is responsible for managing our business on a day-to-day basis and for
identifying and making acquisitions and dispositions that it believes meet our
investment criteria. Recent Events In August 2003, we completed our initial public offering of 7,590,000
shares of common stock (including 990,000 shares sold in September 2003 upon
the exercise by the underwriters of an over-allotment option granted in
connection with our initial public offering), at a public offering price of $15
per share, resulting in aggregate net proceeds to us after underwriters
discounts and offering expenses of approximately $105 million. On December 23, 2003 we acquired a 58,926 square foot commercial office
building in Raleigh, North Carolina. The $5.8 million acquisition cost for the
building (including transaction costs) was funded using proceeds of our initial
public offering. The building is currently leased to a single tenant under a
triple net lease with a remaining term of six years, and the tenant has an
option to renew the lease for an additional five year term. On January 30, 2004, we acquired a 54,018 square foot commercial office
and warehouse building in Canton, Ohio. The $3.65 million acquisition cost for
the building (including transaction costs) was funded using proceeds of our
initial public offering. This building has been leased to one tenant under a
10 year triple net lease. The monthly lease payments are the greater of LIBOR
based plus 600 basis points or 9.25% multiplied by the purchase price. 12




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On February 18, 2004, we extended a mortgage loan in the amount of $11.17
million for the purchase of a commercial property in Sterling Heights,
Michigan. The loan was funded using proceeds from our initial public offering.
This 10 year mortgage loan, collateralized by the Sterling Heights property,
accrues interest at the greater of 10% per annum or the one month LIBOR rate
plus four percent per annum. On April 29, 2004, we purchased an 83,891 square foot commercial office
and laboratory space in Akron, Ohio for $9.3 million. The purchase was funded
using a portion of the proceeds of our initial public offering. The property
is currently leased to two tenants under separate triple net leases, one of
which occupies 79% of the property and has a remaining term of twelve years,
and the second of which occupies 21% of the property and has a remaining term
of five years. Expenses Our Adviser currently has an expense sharing arrangement with Gladstone
Capital Advisers, a wholly-owned subsidiary of our affiliate Gladstone Capital
Corporation, through which our entire workforce is employed. Under that
relationship, our Adviser reimburses Gladstone Capital Advisers for a portion
of Gladstone Capital Advisers total payroll and benefits expenses (based on
the percentage of total hours worked by Gladstone Capital Advisers employees
on our matters on an employee-by-employee basis) and a portion of Gladstone
Capital Advisers total overhead expense (based on the percentage of total
hours worked by all Gladstone Capital Advisers employees on our matters). In
turn, subject to the terms and conditions of our advisory agreement, Gladstone
Management passes these charges on to us. During the three months ended March 31, 2004, payroll and benefits
expenses were approximately $165,000. The actual amount of payroll and benefits
expenses which we will be required to reimburse our Adviser in the future is
not determinable, but we currently estimate that during the year ending
December 31, 2004 this amount will be approximately $425,000. This estimate is
based on our current expectations regarding our Advisers payroll and benefits
expenses and the proportion of our Advisers time we believe will be spent on
matters relating to our business. To the extent that our Advisers payroll and
benefits expenses are greater than we expect or our Adviser allocates a greater
percentage of its time to our business, our actual reimbursement of our Adviser
for our share of its payroll and benefits expenses could be materially greater
that we currently project. During the three months ended March 31, 2004, the amount of overhead
expenses that we reimbursed our Adviser was approximately $64,000. The actual
amount of overhead expenses for which we will be required to reimburse our
Adviser in the future is not determinable, but we currently estimate that
during the year ending December 31, 2004 this amount will be approximately
$275,000. Under the terms of the advisory agreement, we are responsible for all
expenses incurred for our direct benefit. Examples of these expenses include
expenses incurred in connection with our organization and initial public
offering, legal, accounting, tax preparation, consulting and related fees.
During the three months ended March 31, 2004, the total amount of these
expenses that we incurred was approximately $388,000. In addition, we are also responsible for all fees charged by third parties
that are directly related to our business, which may include real estate
brokerage fees, mortgage placement fees, lease-up fees and transaction
structuring fees (although we may be able to pass some or all of such fees on
to our tenants and borrowers). During the three months ended March 31, 2004,
we passed all such fees along to our tenants, and accordingly we did not incur
any such fees during this time. The actual amount of such fees that we incur
in the future will depend largely upon the aggregate costs of the properties we
acquire, the aggregate amount of mortgage loans we make, and the extent to
which we are able to shift the burden of such fees to our tenants and
borrowers. Accordingly, the amount of these fees that we will pay in the future
is not determinable at this time. 13




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Critical Accounting Policies Management believes our most critical accounting policies are revenue
recognition (including straight-line rent), purchase price allocation,
accounting for our investments in real estate, provision for loans losses, the
accounting for our derivative and hedging activities, if any , income taxes,
stock based compensation and our Advisory agreement. Each of these items
involves estimates that require management to make judgments that are
subjective in nature. Management relies on its experience, collects historical
data and current market data, and analyzes these assumptions in order to arrive
at what it believes to be reasonable estimates. Under different conditions or
assumptions, materially different amounts could be reported related to the
accounting policies described below. In addition, application of these
accounting policies involves the exercise of judgments on the use of
assumptions as to future uncertainties and, as a result, actual results could
materially differ from these estimates. Revenue Recognition Rental revenues include rents that each tenant pays in accordance with the
terms of its respective lease reported on a straight-line basis over the
initial term of the lease. Since one of the Companys leases currently contains
rental increases at specified intervals, straight-line basis accounting will
require us to record as an asset, and include in revenues, deferred rent
receivable that we will only receive if the tenant makes all rent payments
required through the expiration of the initial term of the lease. Deferred rent
receivable in the accompanying balance sheet represents the cumulative
difference between rental revenue as recorded on a straight-line basis and
rents received from the tenants in accordance with the lease terms.
Accordingly, our management must determine, in its judgment, to what extent the
deferred rent receivable applicable to each specific tenant is collectible. We
review deferred rent receivable on a quarterly basis and take into
consideration the tenants payment history, the financial condition of the
tenant, business conditions in the industry in which the tenant operates and
economic conditions in the area in which the property is located. In the event
that the collectability of deferred rent with respect to any given tenant is in
doubt, we would be required to record an increase in our allowance for
uncollectible accounts or record a direct write-off of the specific rent
receivable, which would have an adverse effect on our net income for the year
in which the reserve is increased or the direct write-off is recorded and would
decrease our total assets and stockholders equity. Management considers its loans and other lending investments to be
held-for-investment. We reflect held-for-investment investments at amortized cost
less allowance for loan losses, acquisition premiums or discounts, deferred
loan fees and undisbursed loan funds. On occasion, we may acquire loans at
small premiums or discounts based on the credit characteristics of such loans.
These premiums or discounts are recognized as yield adjustments over the lives
of the related loans. Loan origination or exit fees, as well as direct loan
origination costs, are also deferred and recognized over the lives of the
related loans as yield adjustment. If loans with premiums, discounts, loan
origination or exit fees are prepaid, we immediately recognize the unamortized
portion as a decrease or increase in the prepayment gain or loss. Interest
income is recognized using the effective interest method applied on a
loan-by-loan basis. Prepayment penalties or yield maintenance payments from
borrowers are recognized as additional income when received. Purchase Price Allocation We record above-market and below-market in-place lease values for owned
properties based on the present value (using an interest rate which reflects
the risks associated with the leases acquired) of the difference between (i)
the contractual amounts to be paid pursuant to the in-place leases and (ii)
managements estimate of fair market lease rates for the corresponding in-place
leases, measured over a period equal to the remaining non-cancelable term of
the lease. We amortize the capitalized above-market lease values as a reduction
of rental income over the remaining non-cancelable terms of the respective
leases. We amortize the capitalized below-market lease values (presented in the
accompanying balance sheet as value of assumed lease obligations) as an
increase to rental income over the initial term and any fixed-rate renewal
periods in the respective leases. Since our strategy to a large degree involves
sale-leaseback transactions with newly originated leases at market rates, the
above-market and below-market in-place lease values are not significant. 14




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The total amount of other intangible assets acquired are further allocated
to in-place lease values and customer relationship intangible values based on
managements evaluation of the specific characteristics of each tenants lease
and our overall relationship with that respective tenant. Characteristics to be
considered by management in allocating these values include the nature and
extent of our existing business relationships with the tenant, growth prospects
for developing new business with the tenant, the tenants credit quality and
expectations of lease renewals (including those existing under the terms of the
lease agreement), among other factors. Managements estimates of value are expected to be made using methods
similar to those used by independent appraisers (e.g., discounted cash flow
analysis). Factors considered by management in its analysis include an estimate
of carrying costs during hypothetical expected lease-up periods considering
current market conditions, and costs to execute similar leases. We will also
consider information obtained about each property as a result of our
pre-acquisition due diligence, marketing and leasing activities in estimating
the fair value of the tangible and intangible assets acquired. In estimating
carrying costs, management also includes real estate taxes, insurance and other
operating expenses and estimates of lost rentals at market rates during the
expected lease-up periods, which we expect to primarily range from six to
eighteen months, depending on specific local market conditions. Management also
estimates costs to execute similar leases including leasing commissions, legal
and other related expenses to the extent that such costs are not already
incurred in connection with a new lease origination as part of the transaction. We amortize the value of in-place leases to expense over the initial term
of the respective leases, which we primarily expect to range from ten to twenty
years. The value of customer relationship intangibles are amortized to expense
over the initial term and any renewal periods in the respective leases, but in
no event will the amortization period for intangible assets exceed the
remaining depreciable life of the building. Should a tenant terminate its
lease, the unamortized portion of the in-place lease value and customer
relationship intangibles would be charged to expense. Investments in Real Estate We record investments in real estate at cost and we capitalize
improvements and replacements when they extend the useful life or improve the
efficiency of the asset. We expense costs of repairs and maintenance as
incurred. We compute depreciation using the straight-line method over the
estimated useful life of 39 years for buildings and improvements, five to seven
years for equipment and fixtures and the shorter of the useful life or the
remaining lease term for tenant improvements and leasehold interests. We are required to make subjective assessments as to the useful lives of
our properties for purposes of determining the amount of depreciation to record
on an annual basis with respect to our investments in real estate. These
assessments have a direct impact on our net income because, if we were to
shorten the expected useful lives of our investments in real estate, we would
depreciate these investments over fewer years, resulting in more depreciation
expense and lower net income on an annual basis. We have adopted Statement of Financial Accounting Standards (SFAS) No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets, which
establishes a single accounting model for the impairment or disposal of
long-lived assets including discontinued operations. SFAS 144 requires that the
operations related to properties that have been sold or that we intend to sell
be presented as discontinued operations in the statement of operations for all
periods presented, and properties we intend to sell be designated as held for
sale on our balance sheet. When circumstances such as adverse market conditions indicate a possible
impairment of the value of a property, we review the recoverability of the
propertys carrying value. The review of recoverability is based on our
estimate of the future undiscounted cash flows, excluding interest charges,
expected to result from the propertys use and eventual disposition. Our
forecast of these cash flows considers factors such as expected future
operating income, market and other applicable trends and residual value, as
well as the effects of leasing demand, competition and other factors. If
impairment exists due to the inability to recover the carrying value of a
property, an impairment loss is recorded to the extent that the 15




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carrying value exceeds the estimated fair value of the property. We are
required to make subjective assessments as to whether there are impairments in
the values of our investments in real estate. Provision for Loan Losses Our accounting policies require that we reflect in our financial
statements an allowance for estimated credit losses with respect to mortgage
loans we have made based upon our evaluation of known and inherent risks
associated with our private lending assets. We have only recently extended one
mortgage loan and have not experienced any actual losses in connection with our
lending investments. Management will reflect provisions for loan losses on a
portfolio basis based upon our assessment of general market conditions, our
internal risk management policies and credit risk rating system, industry loss
experience, our assessment of the likelihood of delinquencies or defaults, and
the value of the collateral underlying our investments. Actual losses, if any,
could ultimately differ from these estimates. Accounting for Derivative Financial Investments and Hedging Activities We will account for our derivative and hedging activities, if any, using
SFAS 133, Accounting for Derivative Instruments and Hedging Activities, as
amended by SFAS 137 and SFAS 149, which requires all derivative instruments to
be carried at fair value on the balance sheet. Derivative instruments designated in a hedge relationship to mitigate
exposure to variability in expected future cash flows, or other types of
forecasted transactions, will be considered cash flow hedges. We will formally
document all relationships between hedging instruments and hedged items, as
well as our risk-management objective and strategy for undertaking each hedge
transaction. We will periodically review the effectiveness of each hedging
transaction, which involves estimating future cash flows. Cash flow hedges will
be accounted for by recording the fair value of the derivative instrument on
the balance sheet as either an asset or liability, with a corresponding amount
recorded in other comprehensive income within stockholders equity. Amounts
will be reclassified from other comprehensive income to the income statement in
the period or periods the hedged forecasted transaction affects earnings.
Derivative instruments designated in a hedge relationship to mitigate exposure
to changes in the fair value of an asset, liability, or firm commitment
attributable to a particular risk, such as interest rate risk, will be
considered fair value hedges under SFAS 133. As of March 31, 2004, we were not
a party to any separate derivatives contract. Certain of our leases and loans
contain embedded derivatives which do not require separate accounting. Income Taxes Our financial results generally do not reflect provisions for current or
deferred income taxes. Management believes that we have and will operate in a
manner that will allow us to be taxed as a REIT and, as a result, we do not
expect to pay substantial corporate-level income taxes. Many of the
requirements for REIT qualification, however, are highly technical and complex.
If we were to fail to meet these requirements, we would be subject to federal
income tax which could have a material adverse impact on our results of
operations and amounts available for distributions to our stockholders. Stock Based Compensation We apply the intrinsic value method to account for the issuance of stock
options under our 2003 Equity Incentive Plan in accordance with APB Opinion No.
25, Accounting for Stock Issued to Employees, where appropriate. In this
regard, the substantial portion of these options were granted to individuals
who are our officers and who qualify as leased employees under FIN 44,
Accounting for Certain Transactions involving Stock Compensation, an
interpretation of APB Opinion No. 25. Accordingly, because the grants were at
exercise prices equal to the fair value of the stock at date of grant, we did
not record any expense related to the issuance of these options under the
intrinsic value method. 16




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Results of Operations For the three months ended March 31, 2004 Revenues For the three months ended March 31, 2004, we earned $197,773 of rental
revenue, representing three months of rent from our Raleigh, North Carolina
property and two months of rent from our Canton, Ohio property, which was
acquired January 2004. We recorded interest income of $133,149 for the three months ended March
31, 2004, which represents approximately two months of interest income on the
mortgage loan that we extended in February 2004 for the purchase of a Sterling
Heights, Michigan commercial property. Expenses Operating expenses for the three months ended March 31, 2004 were
$696,959. Operating expenses mainly consist of the management advisory fee,
depreciation and amortization, and general and administrative expenses. The
management advisory fee consists of the reimbursement of expenses, including
direct allocation of employee salaries and benefits as well as general overhead
cost to our Adviser in accordance with the terms of the advisory agreement.
For the three months ended March 31, 2004, the aggregate management advisory
fees were $229,416. Depreciation and amortization expenses of $79,330 were recorded for the
three months ended March 31, 2004. General and administrative expenses were
$388,213 for the three months ended March 31, 2004 and consisted mainly of
incurred insurance expense for directors and officers insurance, as well as
general insurance, directors fees, professional fees (consisting of legal and
accounting fees), and also stockholder-related expenses such as the printing of
our 2003 annual report. Because we have only recently begun our operations, we do not believe that
our current level of operating expenses is indicative of our operating expenses
in the future. As we begin to expand our real estate investments, we expect our
revenues and operating expenses to increase and that ultimately our management
advisory fee will be approximately 2% of our invested assets. Interest Income During the three months ended March 31, 2004, we earned interest income on
cash and cash equivalents of $172,462. This interest represents the interest
earned on the investment of the net proceeds from our initial public offering
in short-term investment grade securities, primarily U.S. Treasury Bills. As
we increase our real estate investment portfolio, we anticipate that the
interest earned on cash and cash equivalents will decrease. Net Loss For the three months ended March 31, 2004, we incurred a net loss of
$193,305. Based on the basic and diluted weighted average common shares
outstanding of 7,642,000 for the three months ended March 31, 2004, the basic
and diluted loss per common share was $0.03 for the three months ended March
31, 2004. 
 Liquidity and Capital Resources At March 31, 2004, we had two real estate investments and one mortgage
note outstanding. At March 31, 2004, we had approximately $84.7 million in
cash and cash equivalents available to make investments and fund our continuing
operations. Those funds were predominantly raised though our initial public
offering in 2003. 17




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During the three months ended March 31, 2004, we acquired a 54,018 square
foot commercial office and warehouse building in Canton, Ohio for $3.65 million
in cash (including transaction costs) and also extended one mortgage loan in
the amount of approximately $11.2 million. On April 29, 2004, we purchased an 83,891 square foot commercial office
and laboratory space in Akron, Ohio for $9.3 million. As of May 5, 2004, we have invested approximately $30 million, or 28.5
percent, of the net proceeds from our initial public offering in real
properties and mortgage loans. Investments in three real properties account
for approximately $18.8 million of the currently invested net proceeds, and an
investment in one mortgage loan accounts for approximately $11.2 million of the
currently invested net proceeds. We anticipate that the remaining net proceeds
will be sufficient to fund our real estate investments for the foreseeable
future. However, once the net proceeds of our initial public offering have
been substantially fully invested, we intend to acquire additional properties
by borrowing all or a portion of the purchase price and collateralizing the
loan with a mortgage on some or all of our real property. If we were unable to
make any required debt payments on any borrowings we make in the future, our
lenders could foreclose on the properties collateralizing their loans, which
could cause us to lose part or all of our investments in such properties. We
also may issue additional equity securities in the future to finance future
investment although there can be no assurance that we would be able to do so on
favorable terms if at all. Net cash provided by operating activities during the three months ended
March 31, 2004 was $495,502, consisting primarily of an increase in the amount
due to Adviser, increases in rent received in advance and security deposits and
an increase in accrued expenses and other liabilities. Net cashed used by
operating activities was $42,000 for the period from inception through March
31, 2003 and consisted primarily of costs associated with our formation. Cash used by investing activities during the three months ended March 31,
2004 was $14.8 million, and consisted primarily of our purchase of the Canton,
Ohio commercial office and warehouse property in January 2004 and our extension
of a mortgage loan of approximately $11.2 million in February 2004. Net cash used in financing activities for the three months ended March 31,
2004 was $84,150 for the three months ended March 31, 2004. These amounts
consisted primarily of the dividend payments to our stockholders of $76,420 and
of $7,730 in costs associated with our initial public offering. Net cash
provided by financing activities was $52,000 for the period from inception
through March 31, 2003 and consisted of the proceeds from the initial issuance
of common stock to our founder in connection with our formation. There were no contractual obligations or commitments at March 31, 2004. Funds from Operations The National Association of Real Estate Investment Trusts (NAREIT)
developed Funds from Operations, (FFO), as a relative non-GAAP (Generally
Accepted Accounting Principles in the United States) financial measure of
performance and liquidity of an equity REIT in order to recognize that
income-producing real estate historically has not depreciated on the basis
determined under GAAP. FFO, as defined by NAREIT, is net income (loss)
(computed in accordance with GAAP), excluding gains (or losses) from sales of
property, plus depreciation and amortization of real estate assets, and after
adjustments for unconsolidated partnerships and joint ventures. FFO does not represent cash flows from operating activities in accordance
with GAAP (which, unlike FFO, generally reflects all cash effects of
transactions and other events in the determination of net income (loss)) and
should not be considered an alternative to net income (loss) as an indication
of our performance or to cash flow from operations as a measure of liquidity or
ability to make distributions. Comparison of FFO, using the NAREIT
definition, to similarly titled measures for other REITs may not 18




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necessarily be meaningful due to possible differences in the application of the
NAREIT definition used by such REITs. Diluted funds from operations per share (Diluted FFO per share) is FFO
divided by weighted average common shares outstanding on a diluted basis during
a period. We believe that Diluted FFO per share is useful to investors because
it provides investors with a further context for evaluating our FFO results in
the same manner that investors use earnings per share (EPS) in evaluating net
income available to common shareholders. In addition, since most REITs provide
Diluted FFO per share information to the investment community, we believe
Diluted FFO per share is a useful supplemental measure for comparing us to
other REITs. We believe that diluted EPS is the most directly comparable GAAP
measure to Diluted FFO per share. The following table provides a reconciliation of our FFO for the three
months ended March 31, 2004 to the most directly comparable GAAP measure, net
income (loss) and a computation of diluted FFO per weighted average
common share to diluted net income (loss) per weighted average common
share. Three MonthsEndedMarch 31, 2004Net loss
    
    $
    (193,305
    )Real estate depreciation and amortization
    
    
    79,330Funds from operations
    
    $
    (113,975
    )Diluted weighted average shares outstanding
    
    
    7,642,000Diluted net
loss per weighted average common share
    
    $
    (0.03
    )Diluted funds from operations per weighted average common
share
    
    $
    (0.01
    )
 19




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Item 3. Quantitative and Qualitative Disclosure About Market Risk Market risk includes risks that arise from changes in interest rates,
foreign currency exchange rates, commodity prices, equity prices and other
market changes that affect market sensitive instruments. The primary risk that
we believe we will be exposed to is interest rate risk. In the future, we may be exposed to the effects of interest rate changes
primarily as a result of long-term debt used to maintain liquidity and fund
expansion of our real estate investment portfolio and operations. Our interest
rate risk management objectives are to limit the impact of interest rate
changes on earnings and cash flows and to lower overall borrowing costs. To
achieve this objective, we will borrow primarily at fixed rates or variable
rates with the lowest margins available and, in some cases, with the ability to
convert variable rates to fixed rates. We may also enter into derivative
financial instruments such as interest rate swaps and caps in order to mitigate
the interest rate risk on a related financial instrument. We will not enter
into derivative or interest rate transactions for speculative purposes. In addition to changes in interest rates, the value of our real estate is
subject to fluctuations based on changes in local and regional economic
conditions and changes in the creditworthiness of lessees, all of which may
affect our ability to refinance debt if necessary. 
 Item 4. Controls and Procedures As of March 31, 2004, our management, including the chief executive
officer and chief financial officer, evaluated the effectiveness of the design
and operation of our disclosure controls and procedures. Based on that
evaluation, management, including the chief executive officer and chief
financial officer, concluded that the disclosure controls and procedures were
effective in timely alerting management of material information about the
Company required to be included in our periodic Securities and Exchange
Commission filings. However, while evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply judgment in evaluating the cost-benefit relationship of
possible controls and procedures. There were no changes in internal controls for the period ended March 31,
2004 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. 20




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PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings Neither we nor any of our subsidiaries are currently subject to any material
legal proceedings nor, to our knowledge, is any material legal proceeding
threatened against us or our subsidiaries. 
 Item 2. Changes in Securities and Use of Proceeds As of March 31, 2004, we had invested approximately $20.7 million of the net
proceeds from our initial public offering in two real properties and one
mortgage loan. As of March 31, 2004, we have used approximately $688,000 in
our operating activities, of which approximately $83,000 has been paid to our
Adviser (which is an affiliate of ours) in partial payment of amounts owed
under our advisory agreement. As of March 31, 2004, substantially all of the
remaining net proceeds from our initial public offering were invested in
short-term, investment grade, interest-bearing instruments. 
 Item 3. Defaults Upon Senior Securities Not applicable. 
 Item 4. Submission of Matters to a Vote of Security Holders Not applicable. 
 Item 5. Other Information. Not applicable. 
 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits
See Exhibit Index. (b) Reports on Form 8-K: On January 16, 2004, we filed with the Securities and Exchange Commission
(SEC) a report on Form 8-K under Item 2 reporting our acquisition of a
commercial office building located in Raleigh, North Carolina. We filed the
required financial statements and pro forma financial information regarding
this acquisition to the SEC under Item 7 of Form 8-K/A on March 8, 2004. On March 4, 2004, we filed with the SEC a report on Form 8-K under Item 2
reporting our acquisition of a commercial office building located in Canton,
Ohio. On March 8, 2004, we filed with the SEC a report on Form 8-K under Item 2
reporting our extension of a mortgage note on February 18, 2004 to Mayco
Property Holdings LLC. On March 11, 2004, we furnished to the SEC under Item 12 of Form 8-K our press
release, dated March 10, 2004, announcing our results of operations for the
period from February 14,2 003 (inception) through December 31, 2003. In
accordance with the regulations of the SEC, this report was deemed to be
furnished to, rather than filed with, the SEC. 21




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SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. GLADSTONE COMMERCIAL CORPORATIONBy:
    /s/ Harry BrillHarry BrillChief Financial OfficerDate:
    May 10, 2004 22




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Exhibit Index Exhibit
    
    Description of Document3.1
    
    Amended and Restated
Articles of
Incorporation of the
Registrant,
incorporated by
reference to the
Registration Statement
on Form S-11 (File No.
333-106024), file June
11, 20033.2
    
    Bylaws of the
Registrant,
incorporated by
reference to the
Registrant,
incorporated by
reference to the
Registration Statement
on Form S-11 (File No.
333-106024), file June
11, 200311
    
    Computation of earnings
(loss) per common share
(included in the notes
to the unaudited
financial statements
contained in this
report.)31.1
    
    Certification of Chief
Executive Officer
pursuant to Section 302
of The Sarbanes-Oxley
Act of 2002.31.2
    
    Certification of Chief
Financial Officer
pursuant to Section 302
of The Sarbanes-Oxley
Act of 200232.1
    
    Certification of Chief
Executive Officer
pursuant to Section 906
of The Sarbanes-Oxley
Act of 200232.2
    
    Certification of Chief
Financial Officer
pursuant to Section 906
of The Sarbanes-Oxley
Act of 2002
  Previously filed. 23