Whitestone REIT Q3 FY2020 Earnings Call

Good day, and welcome to Whitestone REIT's Third Quarter 2020 Earnings Conference Call. Today's conference is being recorded and at this time, I would like to turn the conference over to Kevin Reed, Director of Investor Relations. Please go ahead.

Thank you, operator. Good morning, and thank you for joining Whitestone REIT's third quarter 2020 earnings conference call. Joining me on today's call are 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 forward-looking statements due to a number of risks, uncertainties and other factors. Please refer to the company's earnings press release and filings with the SEC, including Whitestone's most recent Form 10-Q and Form 10-K for a detailed discussion of these factors. Acknowledging the fact that this call may be webcast for a period of time, it is also important to note that this call includes time-sensitive information that may be accurate only as of today's date, October 27, 2020. The company undertakes no obligation to update this information. Whitestone's third quarter earnings press release and supplemental operating and financial data package have been filed with the SEC and are available on our website, www.whitestonereit.com, in the Investor Relations section. During this presentation, we may reference certain non-GAAP financial measures which we believe allow investors to better understand the financial position and performance of the company. Included in the earnings press release and supplemental data package are the reconciliations of non-GAAP measures to GAAP financial measures. With that, let me pass the call to Jim Mastandrea.

Thank you, Kevin, and thank you for joining us on our third quarter investor call. We continue to hope and pray that all of you, your families and your businesses remain healthy and are doing well as we navigate these most unusual times. I am pleased to share with you our strong operating and financial results that have sustained the economic downturn caused by the COVID-19 pandemic. Our business has recovered quickly and in doing so, produced shopping centers sector-leading results. Dave Holeman, our Chief Financial Officer, will provide a more detailed look at the drivers of our operating and financial performance. We attribute these results to owning properties located in high household income neighborhoods, in the fastest-growing MSAs in business-friendly states, while operating a consumer-driven business model based on consumer demographics and psychographics to design a tenant mix that drives customer visits and experiences. Our strategic customer focus differentiates Whitestone from other real estate owners that leaned to traditional hard and soft goods retailers. We're enhancing our intrinsic value through redeveloping and developing which adds value as we physically expand our real estate footprint and grow rents, and by balancing a capital management structure to drive revenues, net operating income and funds from operations. With this background, I would like to provide some color as to where we are today, where we plan to go in the coming months and quarters to drive long-term shareholder value, the key building blocks to Whitestone's success and our progress towards the long-term goals we announced in February of 2018. First, where we are today. Since the onset of COVID-19, which injected considerable economic uncertainty, particularly in the real estate industry, we have had shopping center sector-leading rental collections throughout the pandemic and most recently announced 90% cash collections for the third quarter of 2020. These results are in line with our expectations and are trending upward since the first half of the year. Rental collections, solid leasing spreads, and execution of our business model are deeply rooted in Whitestone's team culture. Since the end of the first quarter, we focused on improving our dividend payout ratio, increasing our cash on hand, paying down our debt and strengthening our balance sheet. These actions have prepared us for the next level of growth and provided greater financial flexibility. Our judicious and disciplined allocation of capital has produced positive third quarter operating results, including occupancy of 88.9% at the end of the quarter, revenue that approached $30 million for the quarter, up 8% from the second quarter, property net operating income of $21.3 million, up 6% from the second quarter, leasing spreads that were strong and resulted in a positive 11% increase for the quarter, cash collections of 90% for the quarter, up from 81% in the second quarter, and funds from operations core that were solid at $0.23 per share, up $0.01 or 5% from the second quarter. Dave in his remarks will go into greater detail on these results and comparisons to prior years. Overall, I am very pleased with the way our management team is navigating the economic crisis caused by the Coronavirus, stabilizing our business quickly and enabling us to refocus on extracting the embedded intrinsic value in our properties, while targeting acquisitions that are accretive and further scale our platform. Second, what we will plan on doing in the coming months. We intend to maintain our disciplined capital allocation philosophy going forward, as we have over the past. Our track record of growth from 2010 to 2019 speaks to our plan. Our long-term plan is to grow our strategically chosen markets in Houston, Dallas-Fort Worth, Austin, San Antonio and Phoenix through redevelopment and development opportunities within our portfolio and externally grow by making targeted acquisitions in our existing markets and beyond. The key building blocks of Whitestone's success are building a portfolio of choice properties in great markets that we need to manage with a team of well-trained professionals who continue to do what has worked for us in the past. We view Whitestone as a highly differentiated and somewhat specialty REIT, specializing in e-commerce resistant entrepreneurial tenants and crafting the right mix of those tenants who ultimately meet the neighborhood consumers’ needs by offering a diversified mix of tenants that provide central services that cannot easily be acquired online, if at all. As a result, all our open-air centers provide community experiences that cater to adjacent neighborhoods as an extension of their lifestyle. While we recognize that we are in the retail real estate business, our differentiated approach and contrarian business model has allowed us to profitably grow an asset base over the years despite significant overall industry challenges. Our growth since our IPO in 2010 has been steady and disciplined, and we intend to continue this disciplined approach. Finally, we continue to make progress towards our long-term goals of improving debt leverage and scaling our G&A costs that we set in 2018. During the third quarter, we paid off $9.5 million of real estate debt from cash, lowering our net real estate debt by $11 million from a year ago and improving our ratio of debt-to-gross book value real estate assets to 55% from 58% a year ago. We also are making progress on scaling our G&A. Each cost since the beginning of the year has been reduced, including a reduction of headcount from 105 to 85, or 21%, and further automation, improvements and processes in all of our teams working smarter and harder. Our total G&A costs for 2020 are approximately $900,000 or 6% lower than the same time last year. With that background, I would now like to turn the call over to Dave Holeman, our Chief Financial Officer. Dave?

Thanks, Jim. First, I would like to take this opportunity to thank all of our associates who continue to produce the best results possible, given very difficult times. We have a highly dedicated team that works every day to create local connections and communities that thrive. And we feel strongly that we are positioned to withstand the current headwinds and thrive into the future. Given the severe economic pressures caused by the Coronavirus during the quarter, our portfolio has performed quite well. Despite having a significant amount of our tenant businesses impacted, we only had a handful of tenants closed for good, such that the portfolio occupancy rate held up well, ending the quarter at 88.9%, down just 0.3% or 13,000 leased square feet from the second quarter. Also, our annualized base rent per square foot at the end of the quarter was $19.43 on a cash basis and $19.38 on a straight-line basis. This represents a 0.5% increase on a cash basis and a 1.3% decrease on a straight-line basis from a year ago. The decrease on a straight-line basis is largely related to the conversion of 84 tenants to cash-basis accounting and the associated write-off of accrued straight-line rents. Our square-foot leasing activity was up 43% from the second quarter of 2020 and 46% from the third quarter of 2019. We are pleased with positive blended leasing spreads on new and renewal leases of 3.3% on a cash basis and 11% on a GAAP basis for the quarter. As Jim mentioned, for the quarter, we collected 90% of our rents. This includes base rent and triple-net charges billed monthly. We've also entered into rent deferral agreements on 3% of our third quarter rents. As part of the deferral agreements, we have negotiated beneficial items such as entry into our online payment portal, further reporting of tenant sales, suspension of co-tenancy requirements, loosening of exclusives or restrictions that allow further development and stronger guarantees. While we are encouraged by how things are progressing, the pandemic has continued to impact our business in terms of our financial results. Funds from operations core for the third quarter was $10.1 million or $0.23 per share, compared to $10.9 million or $0.26 per share for the same quarter of the prior year, and our same-store net operating income for the quarter decreased by 4.5%. These decreases are primarily due to the impact of the pandemic, which resulted in a charge of $1.3 million to bad debt expense and $100,000 in write-off of straight-line receivables in the third quarter. This charge was incremental to the bad debt expense and straight-line revenue recorded in the prior year by $900,000, or $0.02 per share. Let me add some color on our collectability analysis related to the pandemic and the related receivable balances. At the end of the quarter, we had $23.6 million in accrued rents and accounts receivable. This consists of $21.1 million of billed receivables, $1.9 million of deferred receivables, $16.1 million of accrued rents and other receivables and a bad debt reserve of $15.5 million. Since the beginning of the year, our billed receivable balances have increased $4.4 million and our deferred receivables have increased $1.9 million for a total billed and deferred receivable balance increase of $6.3 million. Against this increase of $6.3 million, we have recorded an uncollectible reserve in 2020 of $4.5 million or 71%. Our accrued rents and other receivables have decreased by $1.1 million, largely the result of the write-off of accrued straight-line rent receivables on tenants converted to cash-basis accounting, and our bad debt reserve has increased by $4.3 million. In accordance with generally accepted accounting principles, if the company determines that the collection of a tenant’s future lease payments is not probable, the company must change the revenue recognition for that tenant to cash basis from accrual basis. In light of the financial pressures that COVID-19 has been placing on many of our tenants, we reevaluated all of those tenants in the second and third quarters and as a result have switched 84 tenants in our portfolio to cash-basis accounting. These 84 tenants represent 3.6% of our annualized base rent and 3.4% of our leasable square footage. As a result of this conversion to cash-basis accounting, we have written off $1.1 million of accrued straight-line rents for the year, but the company intends to collect all unpaid rents from its tenants to the extent possible. Our tenants on cash-basis accounting paid 63% of contractual rents in the third quarter, up from 41% in the second quarter. We have provided additional details of our collection that can be found on Page 27 of the supplemental. Turning to our balance sheet. Since March, we have implemented various measures to conserve cash, including further reductions in headcount. Today, we have approximately $39 million in cash, representing a 6% increase since March 31. Additionally, we paid off $9.5 million of real estate debt in the third quarter, and have no debt maturities in 2021. We have reduced our total net real estate debt by $11 million since the third quarter of 2019. Currently, we have $111 million of undrawn capacity, and $13 million of borrowing availability under our credit facility. We are in full compliance with our debt covenants, and expect to remain so in the future. Looking ahead, one particular trend we are seeing as COVID-19 persists is that Whitestone's best-in-class geography is benefiting from net migration of businesses coming out of regulation-heavy gateway markets. Our markets continue to attract both large and small businesses, as evidenced by Charles Schwab's recent announcement of its move of its headquarters to Dallas from San Francisco. Whitestone's properties are seeing this migration also. Recently, we added a successful restaurant that relocated from California to our Mercato property in Arizona. Examples like these prove the resilience of our markets and give us further assurance that our business model is thriving. We have seen pent-up demand in our markets as consumers are leaving their homes and returning quickly and in force. Parking lots are filling, and stores and restaurants are becoming more active. Whitestone is well positioned to capture this pent-up demand and intends to do so. Our team has worked together through this ongoing crisis. Our shareholders will reap significant future benefits from greater collaboration, a more robust exchange of ideas, better and more effective communication, and improved systems and processes that provide new actionable data and allow us to more efficiently scale our infrastructure. Whitestone is continuing to perform and deliver on our strategic plan. We operate in many of the most highly desirable growth markets and high population growth states and expect these markets to lead the country in economic recovery from the pandemic. We look forward to providing further updates as we progress. And with that, we will now take questions. Operator, please open the lines.

Thank you. We will take our first from Michael Diana with Maxim Group. Please go ahead.

Jim, Dave, can you hear me?

Hey, Michael. Can you hear me?

Yep. Okay. So, I’d like to ask first about leasing, which looked very strong. I noticed your new leases, you had 32 new leases. Where were those coming from? I mean, I know your general strategy. Could you give us a little more detail on what sort of tenants you're tracking to your new leases?

Hey Michael, thanks for your question. We're very pleased with the rebound in our leasing activity. As we mentioned, we've seen leasing activity in the third quarter come back to kind of the first quarter pre-pandemic levels. We've had activity in goods and service tenants as well. In our markets, we see resilience across the board; the Dallas market in particular is doing very well. From a tenant perspective, we continue to see demand from service-based tenants. We've seen a lot of activity at the tenant level, and restaurants and operators continue to look for opportunities. So, I think we're seeing demand across our unique and differentiated tenant mix, and in our markets they all appear to be recovering very nicely.

Right. And the one restaurant you mentioned from California, was that in Arizona or in Texas that they came to?

The one I mentioned in my remarks was actually in Arizona. With the proximity of our Phoenix market to California, we've seen significant migration over the years and continue to see that. We're also seeing a fair amount move into Texas from some of the coastal cities where people are looking for places where they can run their businesses a little easier.

Right. Okay. And then the second area I want to talk about is your bad debt or uncollectible revenue. As you said, you reviewed all your tenants—very bottoms up. What's the tenor of the tenants you talk to when you go through that process? What is their outlook? Are they optimistic about what's going on? How long do they think things are going to remain challenging?

I'll start and Jim will add some comments as well. It's obviously a fluid and granular process right now. We are seeing a lot of pent-up demand in our markets and people coming back to restaurants and other areas. Schools are open in all of our markets; most school districts are offering in-person and some virtual as well. We're seeing demand and tenant optimism in many cases. Tenants in our markets have been surprised by their activity levels. We have many tenants that have created new forms of revenue during this pandemic. Some restaurants that historically did not do curbside or takeout have developed those channels and will continue to have them in their portfolio going forward.

Yeah, I'll add to that, Michael. We're seeing some second-generation restaurant operators based in both Arizona and Texas that are leasing up very quickly with equipment and tables and are ready to reopen. We're also seeing demand for small office spaces we call CubeX—small enclosed offices, roughly 150 to 200 square feet—and those are leasing up. We also did a new lease with a pilates studio, where we took a 25% equity position. The operator has franchise rights to open in multiple properties. We're seeing strong and perhaps resurgent demand for exercise, including pilates, particularly in Texas and Arizona.

Okay. So given that there's pent-up demand and some optimism, wouldn't your bad debt reserve build this quarter fade fairly quickly?

I think we are seeing improvement. Our collections for the third quarter were 90%, up from 81% in the second quarter. Predicting the ultimate outcome is difficult, but we are pleased with the positive trends. We also reported our October collections, which were 90% through the 25th of the month, which bodes well. We expect over time our collection percentage to go up, and the related reserve flexibility to decline.

Okay, great. That's all I have, sounds good. Thank you.

Thanks, Michael.

And our next question will come from Craig Kucera with B. Riley Securities. Please go ahead.

Thank you. Good morning, guys. Can you give me some additional color on what specifically is within the entertainment bucket on the table on Page 27? Is that mostly movie theaters or any other categories there?

Entertainment makes up about 2% of our leased square footage and about 2% of our annualized base rents. The tenants in that category include one movie theater, a child-focused entertainment venue, a couple of local theaters, and a children’s play area type entertainment facility. The movie theater is the largest single tenant in that category.

Got it. And I just want to double check on the expansion of your line of credit capacity from last quarter. I think it increased about $12 million. Was that sequential improvement because you paid down the $9 million mortgage or something else?

Yes, our credit facility availability improved this quarter by about $12 million. That's a result of two things: our NOI improved with greater collections, and we paid off one mortgage loan which allowed that property to be unencumbered and therefore included in the availability of our properties. That mortgage loan was about $9 million; the credit availability went up about $12 million—$9 million from paying off the debt and the rest from NOI improvement.

Okay, got it. Jim, I feel like early on you worked hard assisting your tenants in garnering government support. I think in late first quarter you said about 30% of your tenant base had reached out. Do you have a sense of how many of those tenants actually were successful in getting into programs such as PPP while working with them?

Yes. In terms of the PPP, we've had very good success—I'd say upwards of 80% at least. It paid off because these are small business people and many needed help with the banking process. We were able to set up banks for them and expedite that process, and it worked out well for them.

Got it. And so with your collections improving—81% in second quarter to 90% in third quarter, with 3% deferred—thinking about the remaining bucket, are those longer-term issues or just temporary? Can you give us thoughts on the folks that aren't paying and their longer-term viability?

It's a fluid process. Our business model has shown resilience and we have greater hands-on depth in our markets and tenants. We've worked with tenants who got their businesses going and paid. Some we've reached agreements allowing relief for a period, with payback over 12 to 24 months. Some we are still working with. The 90% collections, 3% deferred and roughly 7% we're working with reflect that mix. We've been diligent in collecting and doing rent relief agreements. We've also secured benefits such as greater sales reporting, online payment portal entry, and lease cleanups where exclusives inhibited leasing activity. We're seeing good progress and are focused on continued collections and lease enforcement where appropriate.

The overall properties are very strong, and many tenants are replicated from city to city. When a tenant looks like they won't make it, we move quickly to get them out of the space and have been able to collect anywhere from 75% to 90% of contractual amounts and then replace them. We've also opened the doors to community events that drive traffic. For example, in Arizona we host a 'Coffee & Cars' event on the first Saturday of the month, attracting 40 to 100 exotic and high-end cars and providing business for restaurants, which helps stimulate the properties. These types of activities have continued during the pandemic in many locations and help our tenants.

Okay, thanks. That is it for me.

Our next question will come from Aaron Hecht from JMP Securities.

Hey guys. You talked about the strength of Arizona and Texas markets and communities; wondering if you had any metrics that could capture the performance of those properties versus pre-COVID levels, whether it be traffic or revenue—anything to get a sense of that trend?

Good question. One metric is leasing activity—we saw leasing activity back to pre-COVID levels in the quarter, which is positive. We also track traffic levels in our centers with third-party software; I don't have the exact numbers on hand here, but anecdotally we are seeing consumer visits come back to pre-COVID levels in our markets. We operate open-air centers in generally warmer geographies, which is helpful. Our tenant mix is positioned long-term with more experiential tenants and not a lot of big-box exposure, and we feel very good about the activity level we're seeing.

It's interesting—our experience since March has been that across our four offices in Houston, Phoenix, Dallas and San Antonio, with roughly 100 people, we've only had one person contract COVID. That was someone who traveled to Seattle. Our teams are working virtually and carefully and our markets have different reopening dynamics. We've seen some people and businesses move from California, and we currently have about eight interested parties who've moved here from California. We are starting to see more activity as those migrations occur.

On the collection side—and I guess it relates to leasing too—90% is very strong and stable through October. Are there structural impediments given the tenant base or the type of state law that will make that last 10% significantly harder to start collecting anytime soon without a vaccine or therapy—for example, movie theaters? Any insights on structural difficulties in getting from 90% back to 95% to 100%?

We are pleased with the progress from 81% to 90% and expect to continue to improve toward historical levels. There aren't structural impediments per se; our tenant base is largely smaller service-oriented entrepreneurial tenants. We don't have any one tenant that makes up more than 3% of revenue. It's just continued hard work and recovery in consumer demand. Warmer climate markets where we operate should help in the near term. So it's more a function of continued tenant recovery rather than one large structural obstacle.

I would add that Texas and Arizona have business-friendly laws that allow us to lock a tenant out in seven days if they haven't paid rent, which tenants understand and which provides enforcement leverage. In other states, the process is often 90 days and more litigation intensive. When we evaluate expansion, we consider business-friendly jurisdictions like Tennessee, Florida and Colorado. Those legal rights help us manage delinquency and tenancy more effectively.

And the Pillarstone portfolio shows occupancy drops—any comments around that and how you think about performance?

Whitestone still has an ownership interest in eight non-retail properties through a Pillarstone-related portfolio. That represents a small amount—roughly a couple hundred thousand dollars impact to earnings for the quarter. Pillarstone has plans to develop and change the use of those assets, so we are seeing occupancy trend down a bit there, but it's not a material impact to the company overall.

Thank you very much.

Thanks Aaron.

And with no further questions, I'd like to turn the call back to Mr. Mastandrea for any closing remarks.

Well, thank you, operator, and thank you all for joining us. I would like to close by reiterating that the proof is in the pudding. Our management team and our Board, our significant shareholders and we are shoulder-to-shoulder with our shareholders. Our view is we strive to make our existing and our new shareholders aware of our story. We have a great story and we love sharing it. When we're able to accomplish this, we expect to break away from the stigma that has dragged down the retail real estate industry. We believe that our operating strength is evidenced by our track record and will continue to improve as the economy gains traction and guide our Board's decisions regarding our dividend payout ratio. In the meantime, we will continue to pay attractive dividends. Our shareholders will recognize that our share price does not reflect our business operations that have been dramatically impacted by the COVID pandemic. The superiority of our business model and the strength of our management team's experience have really stood the test, and I'm really pleased with that. Over the past six months, and continuing, our team has produced solid financial results. Our responsibility is to continue to perform and make the market aware of our story. We think that's the link we have to really work on as a team. We believe that as the market becomes more knowledgeable about what we're doing, they will see Whitestone as an investment choice. With these dynamics, we expect our share price to more accurately reflect our true value. We thank our shareholders for the confidence they have placed in us and our stewardship. As we move towards the future, we remain excited and optimistic about what we see ahead. We will continue to provide results and work to deliver industry-leading returns. We recognize there will be macro-driven volatility in the near term, but our deep experience and strong performance through dynamic times are reminders that there is a bright long-term future for us. We will continue to hold ourselves accountable and stay true to our core values, execute our strategic business model, and deliver significant long-term sustainable value to our shareholders. We feel guided in our mission and we thank you all for your confidence in us. With that, operator, we close.

And that concludes today's conference. Thank you for your participation and you may now disconnect.