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Whitestone REIT (NYSE:WSR)

Q4 2013 Earnings Call

February 27, 2014 11:30 am ET

Executives

Suzy Taylor

James C. Mastandrea - Chairman, Chief Executive Officer and President

David K. Holeman - Chief Financial Officer and Principal Accounting Officer

Analysts

Jonathan Pong - Robert W. Baird & Co. Incorporated, Research Division

Mitchell B. Germain - JMP Securities LLC, Research Division

Carol L. Kemple - Hilliard Lyons, Research Division

Operator

Good day, and welcome to the Whitestone REIT Fourth 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. Ma'am, you may begin.

Suzy Taylor

Thank you, Jamie. Good morning, and thank all of you for joining Whitestone REIT's Fourth Quarter 2013 Earnings Conference Call. 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 the 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 risks and uncertainties. Please refer to the company's filings with the Securities and Exchange Commission, including the company's Form 10-K and Form 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 also important to note that today's call includes time-sensitive information that may be accurate only as of today's date, February 27, 2014. Whitestone's earnings press release and fourth quarter supplemental operating and financial data package have been filed with the SEC, and the Form 10-K will be filed shortly. All are or 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 the call to Jim Mastandrea.

James C. Mastandrea

Thank you, Suzy, and thank you all for joining us on our call today. Today, we're going to review our fourth quarter and full year results, and update you on the recent progress of our initiatives. Dave's portion of our call will focus on our financial results, strong positive trends in Whitestone's operating results, financial position and our financial guidance for 2014.

We remain focused on increasing long-term shareholder value by share -- per share. We do this by extracting the intrinsic value from the assets that we own by leasing, redeveloping and selectively developing adjacent land parcels while helping our tenants grow their businesses, by acquiring accretive assets in high-growth target markets, by leveraging our infrastructure over a larger base of assets and finally, by lowering our overall cost of capital.

Now let me review some the progress we've made and highlight our accomplishments. Whitestone wrapped up 2013 with an excellent fourth quarter, resulting in another year of significant growth and progress towards our financial and operational objectives.

In the fourth quarter, we grew our asset base with value-add acquisitions. We increased our occupancy through the addition of high-quality tenants, we lowered our overall cost of capital and strengthened our capital base through debt refinancing, and we produced both strong top line and bottom line cash flow results.

I'd like to briefly touch on each of these. Growing our asset base in the fourth quarter with over $60 million in acquisitions at 2 value-add Community Centers in Phoenix, and 1 fully developed land parcel, adjacent to a current property owned in the high growth area of the Woodland submarket in Houston. We increased our total occupancy to 86.8%, up 2% from a year ago through the addition of high-quality tenants. Our overall occupancy was a result of same-store growth of 1.4% and the positive effects from our 2013 acquisitions.

Our Phoenix market led the way and delivered a 7.4% increase in occupancy for properties that were owned for the entire year of 2013.

Also during the year, we successfully leased 2 of our large -- larger spaces, 1 in Phoenix to a Walmart neighborhood center, a 44,000 square foot box that was vacant when we acquired the property and 1 in San Antonio to Burke’s Outlet Store, a 22,000 square foot store. The addition of these new tenants will contribute significantly to our 2014 revenues and result in additional revenues from adjacent tenant in both locations by returning to full market contract rents due to both being on lower alternative rent from when we acquired the real estate. This was accomplished through satisfying the co-tenancy requirements.

We lowered our overall cost of capital and strengthened our capital base through the debt refinancing and accretive capital raises. During 2013, we refinanced $106 million of property level debt at a weighted fixed average of 4.2% and a weighted average term of 8.1 years, with maturities laddered over the next 10 years. Also in 2013, we raised approximately $64 million from the sale of 4.9 million common shares in an overnight offering and through utilization of our ATM program. The weighted average issue price was $13.66 per share

We produced strong top line and bottom line results, by growing our annual revenue by 33% from the prior year and our annual FFO-Core by 51% from the prior year. FFO-Core on a per share basis was $0.28 in the fourth quarter, our second quarter in a row to achieve $0.28, and $1.10 for the year, up from $0.95 in 2012. Fourth quarter FFO per share annualized is equal to our annual dividend of $1.14 per share per year.

Whitestone strategy to increase long term shareholder and enterprise value per share remains focused on increasing the value of the Community Centers we own. We do this through tenant mix, which is focused on leasing and selective development and redevelopment, disciplined growth through opportunistic, accretive acquisitions in high-growth markets and further leveraging our strong infrastructure of talented people, efficient and effective customer focus processes and systems over a larger base of assets.

Our portfolio management approach remains focused on improving the quality of our Community Centered Properties. And to this end, we strive to assemble a complementary tenant mix and have initiated selective development projects to help tenants grow their businesses and better serve the surrounding communities. This approach allows us to drive traffic to our centers, resulting in increased occupancy, increased rental rates and strong financial revenues.

Let me touch on 2 final points: our dividend philosophy and our 2014 objectives. First, our dividend philosophy. At our recent board meeting, our trustees voted to continue paying the quarterly dividend at $0.285 per share. It is our expectation through our value-add growth strategy to continue to drive cash flow higher each year, resulting in a well-funded dividend over time. We believe the positive impact from this strategy is evident in our 2013 results.

Lastly, our objectives. We will remain focused on our value-add growth strategy, continue our geographic diversification in the business-friendly markets where we can obtain, scale and apply our unique acquisition and operating model; we will continue to recycle capital through divesting of our properties that do not meet our core business parameters or do not have significant value creation potential. We plan to continue to mine our pipeline of off-market acquisition opportunities, which remains robust, fashionable and financially attractive. We plan to develop land parcels that we acquire and are adjacent to our existing Community Centers, adding low cost square footage. And we plan to focus on achieving high returns on a property-by-property basis on invested capital.

We expect to maintain a balance sheet with judicious leverage and financial flexibility, and continue to lower our overall cost of capital as we grow.

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

Dave?

David K. Holeman

Thank you, Jim. I will start by reviewing our balance sheet or financial position, then turn to a review of our key operating results and conclude with the discussion of our initial 2014 financial guidance.

Throughout my comments, I will discuss both our fourth quarter results and our annual results. During the fourth quarter and throughout 2013, we strengthened our financial position through acquisitions of high-quality Community Centers in the Phoenix and Dallas markets through long term, fixed-rate debt financing at attractive rates, through movement toward a more unsecured debt structure, through strengthened relationships with capital sources and through improved overall financial operating results and metrics.

In the fourth quarter, we added over $60 million in high-quality Community Centers to our portfolio of properties, bringing us to $131 million in acquisitions for the full year. $131 million in acquisitions represents a 21% increase in our acquisition volume over 2012. As of year end, we have 54 Community Centers and 6 future development land parcels with a cost basis of $546 million. We now have 5 million square feet of gross leasable area, including nearly 2 million we have added in the Phoenix market over the last 3 years.

Throughout 2013, we have capitalized on the favorable interest rate environment and further strengthened our balance sheet by refinancing $106 million of our property level debt, with $60 million refinanced in the fourth quarter. The weighted average fixed interest rate of our fourth quarter refinancings was 4.1%, with a weighted term of 7.6 years. The weighted fixed interest rate of all of our 2013 refinancings was 4.2%, with a weighted term of 8.1 years.

In 2013, we also continued to move toward a more unsecured balance sheet with secured debt as a percentage of the cost basis of our real estate, decreasing 7% to 23% from 30% in the prior year. Our unencumbered asset pool, that is properties without secured mortgages, is now 41, with an undepreciated cost basis of $357 million at year end.

Our debt leverage as a percent of total market capitalization of $560 million was 46% as of year end, and our ratio of interest expense to EBITDA was 3.3x for the most recent quarter.

As of year end, 68% of our debt was at fixed rates, with a weighted average interest rate of 3.9%. The weighted average interest rate on all of our debt as of year end was 3.4%. We expect to replace approximately $40 million of our variable rate debt with fixed-rate debt over the coming quarters, resulting in over 80% of our debt being at fixed rates.

During 2013, we continued to strengthen our relationships with capital sources through the addition of Bank of America to our credit facility and the addition of Wells Fargo as the lead bank for our ATM program. We expect to begin to recycle capital over the next few quarters through the selective sale of lower growth properties. We expect that additional source of capital to be redeployed in the higher growth Community Centers.

Now let me turn to the operating statement. Funds from operations core for the quarter was $6.2 million or $0.28 per share, which is an increase of 48% on an absolute dollar basis and 17% on a per share basis over the prior year fourth quarter. For the full year 2013, FFO-Core was $20.8 million or $1.10 per diluted share, up 51% on an absolute dollar basis and 16% on a per share basis over 2012.

Total revenues for the quarter were $17.2 million, an increase of 27% or $3.7 million from the same period of 2012. For the full year 2013, total revenues were $62.1 million, up 33% or $16 million from the prior year. 2012 and 2013 property acquisitions were the primary drivers of the revenue increase.

For the year, same-store revenues were 70% of the total revenue, and were up 3% from 2012, excluding approximately $800,000 in termination fees received in 2012.

Leasing spreads on new and renewal leases signed during 2013, were up 2.2% on a straight-line basis per square foot.

Total property net operating income for the quarter was $10.7 million, an increase of 28% from the same period last year. Property NOI was up $1.2 million or 13% from the most recent third quarter of 2013. For the full year 2013, total property NOI was $38.6 million, up 34% from 2012.

Same-store property NOI was up approximately 1% from 2001, excluding the termination fees received in 2002. Our interest expense for the quarter was $2.5 million, including $170,000 of early debt extinguishment cost. Excluding this amount, interest expense decreased 4% from the prior year quarter. This decrease was driven by a decrease in our effective interest rate of 1.9% as compared to the prior quarter -- as a result of our 2013 refinancings.

Our interest expense for the year was $10.2 million. And excluding the early debt extinguishment charge, interest expense increased 14% or $1.2 million from the prior year. This increase was the result of increased debt levels used for acquisitions, offset by a decrease of 1.4% in our effective interest rate as a result of our refinancing efforts.

We continue to see the effects of scaling our general and administrative expenses across a larger base of assets and revenue. In 2013, our employee headcount remained flat at 68 people, while our annual revenues increased by 34% or $16 million.

Included in fourth quarter's G&A expense are acquisition expense of $398,000 and $783,000 of expense from the amortization of performance-based restricted stock, granted over the last 5 years. The amortization of share-based compensation relates to the expected vesting period and does not reflect actual payments made.

As of December 31, 2013, there was approximately $1.9 million of unrecognized noncash share-based compensation expense, which we expect to amortize throughout 2014.

Our G&A expense for 2013, excluding acquisition expenses and the amortization of share-based compensation, was 12.3% of total revenue as compared to 13.3% a year ago. We remain focused in our cost savings efforts and expect our G&A cost as a percent of revenue to continue to decrease as we grow over time.

Now let me touch on some of our key operating measures. As Jim mentioned, our total occupancy rate was 86.8% as of the end of the year, up 2% from year end 2012, and up 1.8% from last quarter. I will remind you that our total occupancy represents physical occupancy and does not include tenants under lease, which have not yet moved into our properties. Our tenant base is approximately 1,250 tenants, and our unique leasing strategy continues to be effective, producing increases in occupancy and positive rental rate spreads.

Finally, let me provide more details on the 2014 earnings guidance. Progressing toward enhancing our disclosure and increasing our transparency, we are providing FFO-Core per share guidance for 2014. We expect FFO-Core per diluted share for 2014 to range from $1.09 per share to $1.18 per share, and full year FFO to range from $0.88 to $0.97 per share. We expect full year 2014 EPS to be $0.22 to $0.30 per diluted share.

That range of the company's initial 2014 earnings guidance assumes acquisitions of $40 million to $80 million, and dispositions and development of $10 million to $20 million each. Acquisition and development volume reflect the amount we expect to fund from debt and proceeds from asset dispositions. The impact to our 2014 FFO-Core range from projected 2014 acquisitions and dispositions is approximately $0.03 to $0.05 per diluted share.

The 2014 guidance also reflects same-store NOI growth of 4% to 7%, and same-store ending occupancy in the range of 87% to 89%.

The 2014 guidance assumes our 2013 year end share count plus a 5% increase on our weighted average shares from the dilution of performance-based restricted shares issued under our long-term equity incentive program. If our guidance changes materially, we will provide subsequent updates on our quarterly earnings calls and releases. Our supplemental data package provides additional information on the company's 2014 guidance and includes reconciliations of FFO-Core per share to FFO and net income per share. Also included in the supplemental data package is a reconciliation from 2013 FFO-Core per share to our 2014 guidance range.

With that, let me turn the call back to Jim.

James C. Mastandrea

Great. Thank you, Dave. I'd like to conclude by highlighting significant strengths of Whitestone. Our operating cash flow is strong and continues to grow on a per share basis. Our capital improvements are progressing, and we're meeting funding requirements relating to the value-add portion through debt refinancings at our corporate credit facility and from the increase in the value of our properties.

Our properties have significant upside with an overall cost basis on 5 million square feet of space, of slightly over $100 per square foot, which we refer to as the intrinsic value which is being extracted as we redevelop, reposition, lease and move in new tenants.

And last, we believe shareholders who invest in a value-add business, like ours, should be rewarded while they are waiting for the inherent intrinsic value to be harvested, which our stable dividend policy continues to support.

With that, I'd like to thank you all for your time. And operator, I'd like to turn it over for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Jonathan Pong with Robert W. Baird.

Jonathan Pong - Robert W. Baird & Co. Incorporated, Research Division

It looks like you've got a pretty solid mark-to-market opportunity with 23% of your rent turning over in '14. What are you guys baking into guidance for your blended leasing spreads next year? And then maybe on a quarter-to-date basis, can you talk a little bit about what you're seeing out there? Do you expect to see continued positive cash spreads like you saw in Q4?

David K. Holeman

Jonathan, thanks for your question. As far as the role of our square footage, I think it's consistently in that range that we have roll in next year. As you know, we tend to have shorter leases, 3 to 5 years, and with that, have roll and opportunity to increase rental rates. I think you saw in the fourth quarter, we had nice positive results in our leasing spreads. It's probably prudent to look over a little more time than just 1 quarter. But for the year, we've had a positive spread of 2.2%. Built into the same-store growth next year is approximately 3% leasing spreads and then to approximately 2% lease up.

James C. Mastandrea

Jon, let me add to that. Cash is generated from our leasing and filling our properties. And when we started with value-add properties, we're acquiring these, they initially have significant more vacancy than stabilized properties. So our business model works through that by filling the property first. And then as the demand for the property continues to grow because we're filling the space and the supply shrinks, then we're able to keep short term leases and then roll the rents higher as we roll over the tenant. So that's been very effective for us. And that's beginning to start to show some traction now.

Jonathan Pong - Robert W. Baird & Co. Incorporated, Research Division

Great. And then maybe on the $15 million of the midpoint development guidance that you're putting out for 2014, is that more of redevelopment geared? Or is that going to be more of a ground-up on an empty pad-site type of development?

James C. Mastandrea

Yes. As we've been purchasing properties, what we look for is a segment of each property we've acquired, where there's some potential to add square footage. So what we're looking at is those pads. For example, we call the Pinnacle pad we have, which is adjacent to a center that we have on the corner of Scottsdale Road and Pinnacle Peak, we'll be developing and adding about 35,000 or 40,000 square feet there ground up. And then, we have several other pads like that. So what we see in that redevelopment is really to enhance the properties we already own. In some cases, we're looking at properties with -- just the use is no longer income driven and we may look at replacing a property or two in our Houston portfolio, where we have a totally different use closer to the Community Center model, there might be some development there.

Jonathan Pong - Robert W. Baird & Co. Incorporated, Research Division

Great. And last question, just on the G&A side, also for guidance. What's driving the $0.04 to $0.05 impact on core G&A for 2014? It looks like most of the head count you had or you have today was already in place a year ago, so I just wanted to see if there's anything, maybe more onetime in nature.

David K. Holeman

No, it's just -- it's a little bit of -- as we've grown a little bit, there's a little higher legal and public company cost. Our headcount has remained fairly flat. But just a slight increase in heads as we grow, obviously, in scale of our operations. So nothing significant in there, other than just little bit of growth as we get bigger, but obviously, continuing to reduce that as a percent of revenue.

Operator

We'll take the next question from Mitch Germain with JMP Securities.

Mitchell B. Germain - JMP Securities LLC, Research Division

Jim, do you still see the same level of distressed sort of investment activities out there? Or is that really kind of minimized at this point?

James C. Mastandrea

They're harder to find, but we are seeing them. And what's interesting, Mitch, we're finding deals that -- where they were renegotiated 5 years ago with the lenders, and they were sort of extend-and-pretend type deals with lenders, and what's happened is the developers because -- the developers didn't really have quite the incentives or still weren't able to turn around the properties. So we're seeing some of those that are coming to us right now. For example, one of our most recent acquisitions in December was a 5-year restructure plan that was in its -- it's almost in its fourth year. And for lack of brevity, we could call that a prepackaged short sale made 5 years ago. So we're starting to see some deals like that. And what's interesting is because of our -- the credibility and reputation we have within the industry, both in Houston and Phoenix, we're having deals come to us where people don't want to publicize that they have a distressed situation, so that we can take and then roll it in -- roll it out then into our portfolio. And we have -- we have right now at this time we have a couple of letters of intent out on properties just like that.

Mitchell B. Germain - JMP Securities LLC, Research Division

And when you look at your deal pipeline, is it still mostly Phoenix or are you kind of shifting now your growth away back into markets like Dallas and Houston?

James C. Mastandrea

We've been -- we've spent some time in San Antonio, we've spent some time in Dallas and we've spent a lot more time in Houston. And I'd say, we're spending some time in Phoenix, properties that come to us. We're not out scouting as much as we were scouting before. So we're starting to look at -- we think that we want to grow the base of assets that we have in Phoenix. And we've got a great staff here to really operate -- I mean, we've got actually a terrific staff here. And as you've seen from our results, we think it's now time to fill in some of the Texas market. Both states are excellent to add new acquisitions in.

Mitchell B. Germain - JMP Securities LLC, Research Division

Great. And I think I might have missed your -- Jonathan's question about your lease expiration schedule. Seems like average size is about 2-point -- 2.5 -- sorry 2,500 square feet, sorry. It seems like that's kind of in your forte of small tenants. Is there anything lumpy in there? And are there any no move outs that we should know about?

David K. Holeman

No. I think if you look at the roll, as I said, it's typical next year to what we tend to see. We like with the ability to manage those tenants. No, no known lumpiness in our move outs, just the normal roll in of our small tenants, which we've been very successful in renewing and being able to increase rates as well.

Operator

[Operator Instructions] And we'll take our next question from Carol Kemple with Hilliard Lyons.

Carol L. Kemple - Hilliard Lyons, Research Division

On your acquisition pipeline, can you quantify the amount, I know you've done that quarters the past.

James C. Mastandrea

We have, any time -- we've always managed to maintain about $0.5 billion worth of deals in and out of that pipeline. And -- so we still stay within that range. One LOI that we just submitted was in the, I want to say, in the mid-70 range. And we're just waiting to see if that's something we want to negotiate, to put it together into a contract. So it doesn't take a lot of deals to add up to that. But we're probably in that $0.5 billion range to $600,000 range.

Carol L. Kemple - Hilliard Lyons, Research Division

Okay. And then on your guidance from your adjustment from FFO to FFO-Core, it's about $0.21. What is that made up of? I figure it's the $1.9 million noncash share-based compensation and acquisition expense. Is there anything else I'm missing?

David K. Holeman

The 3 big differences between FFO and FFO-Core for us, which we exclude for FFO-Core, because we think it gives greater comparability to other REITs, as well as other quarters, are: acquisition expenses, so we -- acquisition expenses came out of FFO-Core; the amortization of the share-based performance, stock-based compensation program; and then we have a small amount of rental support payments from sellers that we also add back to FFO-Core. So in the range, the biggest piece for 2014 range is that the share-based compensation is approximately $4 million of that amount, and then the acquisition cost is approximately $600,000 and the rental support payment is about $200,000, and I'm close on my numbers there, Carol.

Operator

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

James C. Mastandrea

Well, thank you, Jamie. And I'd like to thank you, all, for joining us today. As you can tell, we continue to work very, very hard, and we have really -- appreciate all of your's confidence and support in everything that we're doing.

We would like to invite you at any time to visit us, either in Houston or in Phoenix, and have the opportunity to show you some of the properties that we own or, in fact, you own, and walk you through some of the exciting things that we've been doing and expect to do in 2014.

And with that, I'd like to say thank you, and we'll look forward to our next conference call.

Operator

Thank you for your participation. This does conclude today's call.

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