Whitestone REIT (WSR) 2013 Q2 法說會逐字稿

Good day and welcome to the Whitestone REIT second-quarter 2013 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Suzy Taylor, Director of Investor Relations. You may begin.

Thank you, Melanie. Good morning and thank all of you for joining our conference call this morning. Joining me on today's call will be Jim Mastandrea, our Chairman and Chief Executive Officer, and Dave Holeman, our Chief Financial Officer.

Please note that some statements made during this call are not historical and may be deemed forward-looking statements. Actual results may differ materially from those indicated by the forward-looking statements due to a variety of risk and uncertainties. Please refer to the Company's filings with the Securities and Exchange Commission, including the Company's Form 10-K and Forms 10-Q for a detailed discussion of these risks.

Acknowledging the fact that this call may be webcast for a period of time, it's important to note that today's call includes time-sensitive information that may be accurate only as of today's date, August 6, 2013. Whitestone's second-quarter earnings release and supplemental data package have been filed with the SEC, and the Form 10-Q will be filed shortly. All will be available on our website, WhitestoneREIT.com, in the Investor Relations section. Also included in the supplemental data package are the reconciliations from GAAP financial measures.

And with that, let me pass this over to Jim Mastandrea. Jim?

Thank you, Suzy, and thank you all for joining us on our call today. Today we're going to review our second-quarter results and update you on the recent progress of our initiatives. Dave's portion of our call will focus on our financial results, the overall strong position, trends, and Whitestone's financial position.

As we have stated previously, we are focused on increasing long-term FFO value per share. We do this by extracting the intrinsic value from the assets we own; leasing, redevelopment, and helping our tenants grow their business; by acquiring accretive assets in high-growth target markets; by lowering our overall cost of capital through debt (technical difficulty) refinancings; by initiating our first development project on land we own; and by strengthening our management team as we increase the economies of scale and continue our growth.

Now I would like to review the progress we have made and highlight some of our accomplishments. FFO Core increased to $0.26 per share in the second quarter, up 8.3% from the first quarter, and up over 13% or $1.8 million from the same period last year.

The book value of our real estate portfolio increased to $482 million, up 58% or $177 million since June 30, 2012. We now own 55 Community Centered Properties located in Houston, Dallas, San Antonio, Phoenix, and Chicago totaling approximately 4.6 million square feet. And we have 1,200 tenants, 70% of which are small businesses whose services target their surrounding local communities.

We focus our attention on transforming properties to lease to tenants that meet the community ethnic and demographic profile and need. And we continue to add programs and processes that will provide increasing returns in the coming quarters and years by lowering overall cost of operations and increasing profit margins.

These initiatives sharpen our competitive edge at each and every Community Center where we own real estate, driving traffic to our centers, which in turn draw new tenants. As an example, during the second quarter the improvements we have made to Fountain Square in North Phoenix increased occupancy to 71%, up from 63% as of year-end 2012.

We also initiated redevelopment work at four other centers which should be completed in the third quarter. This work includes improving traffic circulation in the parking lot so our tenants can better serve their customers; using paint, landscaping, and lighting to lighten up liven up properties; giving us a competitive advantage in synergy; showing that we care about our tenants' businesses and the ability to increase rents in our Community Centered Properties.

During the quarter, we continued our property repositioning work at Pinnacle of Scottsdale, in Scottsdale; Lion Square, Woodlake, Torrey Square, all in Houston. This work included new paint and landscaping, improved signage, and preparation for a pad site development. We find that tenants have less resistance to our raising rents, and as a result our occupancies are increased.

In less than three years we have added over $270 million in 20 additional, high-quality, value-add Community Centers consisting of 1.6 million square feet and four future development land parcels. In doing so, Whitestone has emerged as a proven acquirer and operator of properties with an average per square foot investment cost of approximately $168, significantly below replacement cost.

All of the centers we have purchased were one-off transactions and under some level of financial stress, ranging from bank-owned foreclosures to overleveraged sellers. As a result, most of the centers have been undermanaged and undercapitalized. They range from 20% occupancy high-value centers to 100% occupied more stabilized properties.

Our acquisition strategy has positioned us to grow our asset base of occupancies, thus increasing revenue, net operating income, and net asset value. Our total occupancy increased in the quarter, 86%, up from 84%. When -- not if -- inflation occurs, our properties are well located in strong markets and positioned to ride the tailwind.

Acquisitions ramped up in the second quarter as we purchased two new Community Centers and invested $45 million in capital in our Phoenix portfolio. Both acquisitions are Class A properties purchased below replacement cost, and fit within our operating business model, and are immediately accretive and significant value upside.

The Mercado at Scottsdale Ranch is a Class A stabilized Community Center located in a densely populated master-planned affluent community. The 11 acres, 119,000 square foot center has a broad, diverse tenant mix, 80% of which are small shop and service businesses, as well as an AJ's grocery anchor and Walgreens. The center was purchased below replacement cost at $179 per square foot and has in-place annual net operating income of approximately $1.7 million or 8% of the purchase price, with room to increase rents.

The second acquisition was Anthem Marketplace, a 113,000 square foot Class A Community Center with a broad tenant mix of dining establishments, personal care services, and retailers as well as a Safeway grocery anchor.

It was also purchased at a price well below replacement cost and includes a buildable pad with the potential to add another 15,000 square feet of leasable space. Anthem Marketplace has in-place annual operating income of approximately $1.8 million or 8% of the purchase price.

Our pipeline of off-market opportunities remains very attractive and still in excess of $500 million. We have completed over $70 million in acquisition so far in 2013, and have one property currently under contract and several others under negotiation.

With that, I would like to turn things over to Dave Holeman, our Chief Financial Officer. Dave?

Thank you, Jim. I will start by reviewing our balance sheet, our financial position, then turn to a review of our key operating results, and conclude with a few comments regarding our outlook.

During the quarter, as Jim stated, we continued to strengthen our balance sheet by adding high-quality acquisitions, resulting in growth of our book real estate assets by 18% or $72 million from year-end, and by 58% or $177 million from one year ago. The acquisitions for the quarter were funded through the assumption of a 3% fixed-rate loan with 3 years of remaining term and from our corporate-level unsecured revolving credit facility, which had an effective rate of 2.2% as of quarter end.

During the quarter, we continued to improve our overall weighted average cost of capital through the addition of low-cost debt. The addition of $49 million in debt in the second quarter brings our debt leverage as a percentage of total market capitalization to a modest 48%, up slightly from 45% as of the end of the first quarter. Our weighted average interest cost was 3.8% as of quarter end, down 600 basis points from 4.4% at the end of the first quarter.

Our total market capitalization is now in excess of $500 million, up $225 million from a year ago. We have continued to move toward a more unsecured balance sheet, with our pool of unencumbered properties -- that is, properties without secured mortgages -- increasing to 27, with an underappreciated cost basis of $256 million.

Let me touch briefly on our 2013 debt refinancing efforts. In the second quarter we refinanced the mortgage loan on our Pinnacle of Scottsdale property with a $20 million CMBS loan. The new 10-year loan is nonrecourse and has a fixed interest rate of 4.3%. Proceeds from this refinancing were used to pay off a promissory note with a fixed interest rate of 5.7% which matured in June of 2013.

Also in the second quarter, we put in place a $50 million at-the-market equity program led by Wells Fargo Securities. This program provides another source of cost-effective capital.

As we have always done, we will continue to evaluate all sources of capital including this newest tool, the ATM program, and determine how best to fund our growth. There were no sales under the ATM program in the second quarter.

Now let me turn to our operating statement. FFO Core, which adjusts NAREIT's definition of FFO by excluding acquisition expenses, was $4.6 million for the second quarter, a $1.8 million or 62% increase from the second quarter of 2012. On a per-share basis, FFO Core was $0.26 per share in the second quarter, up from $0.24 a year ago.

FFO Core this quarter included only 11 days of our Mercado acquisition and three days of our Anthem acquisition. We expect these two acquisitions to contribute fully in the third quarter.

Property revenues for the quarter were $14.8 million, an increase of $3.8 million or 35% from the same period of 2012. The increase in property revenues for the quarter was primarily the result of new acquisitions.

Leasing spreads for the rolling 12 months have increased approximately 2% on a straight-line basis over the last rolling 12 months. Property net operating income also increased $2.7 million or 40% to $9.4 million in the second quarter. The increase in property NOI was also driven primarily by new acquisitions.

Interest expense for the quarter was $2.5 million, with an effective interest rate on our average debt for the quarter of 3.9%. The increase of $500,000 in interest expense from the prior year is a result of additional debt used for acquisitions, offset by a 150 basis point decrease in our average interest cost from the prior year.

The effects of scaling our general and administrative expenses across a larger base of assets and revenue were very significant in the quarter. Our headcount has only increased by 12 people from a year ago, while quarterly revenue has increased $3.8 million.

Included in the second quarter's G&A expense was approximately $243,000 of non-cash expense related to the vesting of restricted performance shares granted in 2009, and $344,000 of acquisition expenses. As of quarter-end, there was approximately $2 million of unrecognized non-cash share-based compensation expense which we expect to recognize over a weighted average period of 14 months.

Our G&A expense for the quarter, excluding non-cash share-based compensation and acquisition expenses, was 13% of revenue. We remain focused on our cost-saving efforts and expect our G&A cost as a percentage of revenue to continue to decrease as we grow over time.

Now let me turn to some of our key operating measures. Our total occupancy rate, which represents physical occupancy and does not include tenants under lease which have not yet moved into our properties, was 86% as of the end of the quarter. This was an increase of 2% from the first quarter.

Our total operating portfolio occupancy, which excludes new acquisitions to the earlier of attainment of 90% occupancy for 18 months and also properties that are undergoing significant redevelopment or retenanting, was 87% as of the end of the quarter, up 1% from the first quarter. We have grown our tenant base to nearly 1,200 tenants, up from 963 tenants a year ago.

And during the second quarter we side 87 new and renewal leases representing $13.3 million in total lease value, with an average term of 4.1 years and an average size of 2,386 square feet. Our unique leasing strategy continues to be effective, producing increases in occupancy and positive rental rate spreads.

During the second quarter we added another $45 million in acquisitions, which contributed only minimally to the quarter. As with any growing Company, the current financials reflect only a partial amount from any of these acquisitions and thus do not fully reflect the impact from this growth.

As a result we thought it would be helpful to provide some additional perspective and discuss the key drivers of our near-term financial results and value-creation efforts. First, regarding our second-quarter acquisitions, which were only owned a small portion of the quarter, we expect our two second-quarter acquisitions, Mercado and Anthem, to contribute an additional $800,000 in NOI to the third quarter from what is included in Q2, and an additional $400,000 to $5000 in FFO to the third quarter from what is included in quarter two.

Next let me provide a few more details on the lowering of our overall debt cost. We have $65 million in debt maturing in the balance of 2013. $41 million of this is fixed-rate debt with a weighted average effective interest rate of 6.5%. The remaining $23 million is variable-rate debt with a current rate of approximately 3%.

Given the current interest rate environment, which is fairly volatile, we expect to refinance the fixed-rate debt in the 4% to 5% range and expect to refinance the variable-rate debt at approximately the same rate. We expect to this decrease in interest rates will contribute annually $0.05 to $0.07 per share to FFO, given our current share count.

Additionally, we have another $30 million of fixed-rate debt maturing in 2014 and '15 with a 6.3% weighted average interest rate. Given the expected refinancing rate of 4% to 5%, we expect this refinancing effort also to be positive on a per-share basis.

Most of this 2014 at 2015 debt allows for early repayment, so we are working to refinance at favorable rates as soon as possible. Due to the timing of the debt renewals we will receive only a partial year of savings in 2013, yet almost a full year of savings in 2014.

Lastly, let me touch on capturing the potential cash flow from the intrinsic value that is embedded in our Community Centered Properties. The first way is the lease-up of our portfolio of assets. While it is difficult to predict the timing, we are very confident in our ability to lease our portfolio centers into an aggregate, stabilized, 93% to 95% occupancy range that should result in an incremental annual FFO of approximately $4 million to $7 million in the coming years.

We also expect to capture additional cash flows from the value embedded in our portfolio that can be created from the development on our land parcels and outparcels. We estimate that we can develop an additional 300,000 square feet of gross leasable area that will produce at least $3 million in annual funds from operations.

We also have ample financial capacity to support our potential development and growth as we harvest from an outstanding pipeline of actionable off-market acquisitions. With that, let me turn the call back to Jim.

Thank you, Dave. As we look to the future, Whitestone's prospects are very exciting. Our core strength is our people. We seek and retain only those who have demonstrated a passion and the desire to continue to hone their skills for the real estate business within the Whitestone culture.

We train, educate and provide the necessary tools for our associates to be successful. Specifically, our in-house training and development program of people allows us to meet our growing needs and effectively service our tenants.

Our strong results and progress this quarter are a result of our working together towards a common goal of increasing shareholder value. We remain committed to advancing on our strategy and unique business model and capturing the embedded cash flow or intrinsic value in our portfolio.

In closing I would like to thank you for your continued confidence and support, and the privilege that I have to lead Whitestone. With that, I would like to conclude the review of our results and open it up for questions. Operator, I will turn it back to you.

(Operator Instructions) Paul Adornato, BMO Capital Markets.

Hi, good morning. You guys mentioned a couple of times starting some ground-up development, developments of outparcels. Was wondering if you could describe what's in the near-term pipeline, and also what types of risks you are willing to accept in your ground-up development.

Great. Good question. The first parcel we are looking to start is called Pinnacle II. It is adjacent to our Pinnacle Center where we have a Safeway and a Starbucks. Starbucks wants to expand and they want to have a drive-through, so we are going to start the development of the property next to them.

We are going through the architectural plans. We have had the approval with the city of Scottsdale to build an additional 55,000 square feet. We will probably keep that under 55,000, and it will be led by the lease we have with Starbucks.

The way we will be doing this, Paul, is taking our plans out to market the space and try to pre-lease as much of it as we can. We don't expect to have too much risk, other than some interest carry on the debt while we are financing the development. That is one piece.

A second piece we are looking at, which is in the early stages, is the property we call I-10, which is an industrial property flex space. Has very low overall rents on it -- and when I say overall I am saying in the $2 to $4 a square foot.

It is a great piece of land along the energy corridor on I-10 here, and what we have is apartments sprouting up all around it. We are going through a process of looking at some combination of apartments and retail, which gives us a full range of the Community Center services to meet the community, and we think that is one that we could be looking at.

A third one is our headquarters office here in Houston, which we think there is some -- the market is here, a demand for more retail space, and possibly some residential next to our office building here. So we have got those three that we are queuing up early.

My guess is that no ground will be broken this year with the exception of Pinnacle Scottsdale. We'd like to start that this year, but we are just in the early stages right now.

I was wondering if you could quantify how much you will be expecting to spend on these projects and also what types of returns we should expect.

Well, it is too early to tell on what we expect to return -- what we expect to spend. But when you do ground-up development, particularly when I have done it in the past, I have always targeted in the double-digit range, meaning somewhere from around 10% to about 22%, 23%. And depending on how well we control it, and how well we execute, and the timing of moving tenants in to get our cash flow going, you can usually expect that in development work.

We are right at that point in the cycle right now where you don't have as much of a supply in the value-added or the foreclosed or the off-market transactions. There is still plenty of it, but the prices are increasing a little bit. So we're getting close to the point where development makes a lot of sense, and we have always positioned our strategy to pick up a parcel here and there to feed into that part of the cycle.

Okay, great. You have already started to answer my next question, and that is on the acquisition front. Could you maybe tell us what type of cap rate compression you have seen and where you see cap rates today on the type of stuff that you are looking at?

Yes. We look to buy on a cash-on-cash return because -- it isn't necessarily cap rate because the properties we buy aren't necessarily fully occupied. On a stabilized basis, we are seeing cap rates from the 5% up through the 7%, depending on what type of property it is. If you get in and kick around a little bit you can usually do a little better than that, and then it's how it is negotiated.

We have not seen cap rates based on pro forma income as yet. That is usually the next phase.

So in other words, you will see the cash in-place cap rate coming down; and the next phase of the growth cycle with sellers is usually they start capping the income that is not sort of the phantom income on pro formas. We haven't seen that yet.

Okay, and just one more. I was wondering if you could describe what type of leasing momentum you've had after quarter end. Should we expect some good leasing news throughout the rest of the year?

That is another good question, Paul. I can always count on you for good questions, Paul.

The momentum is about as it was the second quarter and picking up slightly. What we are trying to do is to flush out some of the tenants that we think will not be long-term tenants for us, and there's not too many of those.

We have a truly invigorated leasing team and we have added to it. So we now have in Houston here five leasing agents that are internal to the Company, and we have four in Phoenix. And then -- and we think that that activity is starting to pick up.

We are going through the training process on about half of them right now. So we expect to see more leasing activity towards the end of the year than you have seen in the first half of the year. During the summer it stays about the same as it is the second quarter.

Okay, great. Thank you.

Jonathan Pong, Robert W. Baird.

Hey, good morning, guys. I just wanted to dig in a little bit on the Mercado at Scottsdale. AJ's Fine Foods has, I believe, a 2014 expiration. Any update there on what you guys see on that potential renewal? Or do you think about potentially replacing them with someone else?

Yes, so that story is doing very well, Jonathan. One of the things that I'd like to point out is it has a very low rental rate. So in our underwriting of that asset we have looked at other options and potentially being able to raise that rental rate or have another tenant.

But the AJ's store is doing very well, and we think their business is doing well. So we expect over time to be able to increase the rental rate in that space, in the center.

Jonathan, I would like to add to that. We have met with the owners of AJ and they like the location. It is one of their early locations, so they are interested in remodeling the space.

And we have talked to them about our investing in remodeling the space to change the rent. Rent's in the low single digits now; we think that should be either in the high single digits or low double digits. So it depends on what we invest in the property to redo it.

Great. Then I guess when you think about your acquisition pipeline, are the deals that you are looking at right now, are they more stabilized, fully leased deals, like Mercado Scottsdale? Or are you looking at the deeper turn opportunities like Dana Park?

We are looking at one deal that is very much like Dana Park right now, and it is under contract. We are really excited about it.

It is an opportunity to really demonstrate our strength in taking a property that has some existing cash flow, and having the opportunity to expand it and even redevelop a portion of it. That is one of the deals.

Another deal we had really goes to Paul's question. There was a $2 million spread. We didn't want to get into a bidding war; but when we put an offer in they decided to take it to market, and we took a pass on it.

That was more cash flow, and the upside in that property was to -- in five or six years to start tearing down some buildings and build some high-rises. It was right in a very dense urban center of town.

Another deal we are looking at has -- it is a bank foreclosure. It is well under $200 a square foot, and we are looking to go under a contract on that property in about two weeks. But we are trying to position it so we can pick up some property around it.

So we are still finding the deals. What we have learned and what we have found is that, because of our track record and our way of acquiring and closing deals, we are finding some terrific stuff that is coming to us now. We never retrade a property.

We have only -- there is only two deals we had under contract that we walked away from. And that was once we went through the due diligence period, that facts weren't representing what we understood the facts to be.

So we have got a high credibility in Phoenix even though we have tried to stay off the radar. And we are getting some very good sellers who are coming to us, looking to do business with us.

Great, thanks. Maybe, Jim, on that note, when you think about the interest rate environment, are you seeing a lot of competition fall off now that rates have picked up a little bit? Does that put you guys in a better position negotiating-wise for these deals?

I think we are seeing a fair amount of competition. If you remember our -- primarily the centers we are looking at we tend to compete more against the private investors than the larger REITs. We like to look at a little smaller center; some are anchored and some are not. But we are very comfortable with the small service tenants.

But we are seeing a little bit of increase in competition in the markets, but we continue to -- through our relationships we have built, to be able to see deals early and get a nice off-market look at many of the deals we are looking at.

Jonathan, just along the debt side, what we are seeing is deals that were restructured three to five years ago with CMBS loans, that the process had become very slow in turning -- in respect to getting the CMBS approvals. There is usually two to three levels of rules you have to go through. And that is the only obstacle that we have found so far, is the CMBS process is very slow.

Sellers who have restructured their debt restructure with CMBS loans, they are told to be assumable; and yet it is just a very, very long process. So that is the only obstacle we have come across.

Great. Thanks a lot, guys.

(Operator Instructions) Carol Kemple, Hilliard Lyons.

Good morning. Earlier in the call I think you all said there is $2 million of non-cash expense you all expect to have related to vested shares over the next 14 months. Should we expect that to be evenly spread through the next five quarters?

Yes. That relates to the restricted shares granted back in 2009. That is just the vesting of those shares as we hit the financial targets. We are starting to hit some of this financial targets. But you should see that fairly evenly over those 14 months.

And once that is over, then we won't have that expense anymore?

No, you will still see -- so we have restricted shares that have been granted from our performance-based programs whereby employees, all of our employees participate and have the ability to share in value-add as we grow the Company and add value to the Company. So you will continue to see some vesting of those shares.

I think we reported in our financials the amount of shares that are unvested and the targets. So hopefully we will be continuing to grow and add value, as a result hitting some of those targets over the next several quarters.

Okay. I know on previous calls you all mentioned that you were looking at properties in some new markets besides the ones you are already in. Is anything that's in your pipeline right now outside of the Texas or Phoenix market?

Nothing outside of Texas right now. We are looking to see --

Texas or Phoenix, right.

Phoenix right now. Yes, nothing on Texas or Phoenix right now. But we are looking at the Phoenix market closely, and every time we think we are ready to pull out and look at another market we get more deals offered to us. So the pipeline is still strong in terms of Phoenix.

We have had some deals come to us in Dallas, deals in San Antonio. We think those are excellent markets.

But what we find is that we have taken the efforts to build our infrastructure in Phoenix as well as we have in Houston. So we have far fewer people in Phoenix than we have in Houston but the infrastructure really supports it, because that is necessary for our business model. So we still have the capacity to add another anywhere from four to 10 properties in Phoenix without adding any people there other than one or two leasing people, and one or two property managers.

So we are going to see what capacity we can bring that to and if -- what we do -- what we have to watch is we don't want to choke our people. We don't want to give them too much to handle in one area.

Then -- so when we think it is getting to the point where we are optimizing that or we are at least -- we might just look at one of the other markets for a while. But we do have properties lined up in other markets. We are just able to put them on the back burner right now.

So there are properties in other markets besides Houston and Phoenix, but they are just kind of really far away on the back burner?

Yes, they are on the back burner; and they are in Dallas and in San Antonio. And there is a significant number of them, and it is just a matter of when we want to get aggressive with them.

Okay, thanks.

It appears there are no further questions at this time. I would like to turn the conference back to Mr. Mastandrea for any additional or closing remarks.

Well, I would like to thank you all for not only your interest in this call but your interest in Whitestone. We have been very excited about the opportunity to grow the Company. We think the business model is getting perfected more and more every day, and the emphasis on service-based tenants really has a payoff in terms of profitability for our shareholders.

While we have about 70% of our tenants that are service based, I do want to remind you that we have a number of anchors. We just don't highlight them.

For example, we have several Safeways, we have Albertson's, we have Walgreens, we have AJ's, and multiples in these locations. So we do have -- in the 30% of our properties, in the non-service related we have some anchors as well.

So with that, I would really like to invite you either to come and visit us in Houston at any time, or in Phoenix or Dallas or one of our other markets. And feel free to call myself or Dave at any time, as well as Suzy. With that, I will end the conference call. Thank you all.

This does conclude today's conference. We thank you for your participation.