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Edited Transcript of PEI earnings conference call or presentation 3-May-19 3:00pm GMT

Q1 2019 Pennsylvania Real Estate Investment Trust Earnings Call

Philadelphia May 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Pennsylvania Real Estate Investment Trust earnings conference call or presentation Friday, May 3, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Heather Crowell

Pennsylvania Real Estate Investment Trust - Executive VP of Strategy & Communications

* Joseph F. Coradino

Pennsylvania Real Estate Investment Trust - Chairman & CEO

* Robert F. McCadden

Pennsylvania Real Estate Investment Trust - Executive VP & CFO

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Conference Call Participants

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* Caitlin Burrows

Goldman Sachs Group Inc., Research Division - Research Analyst

* Christine Mary McElroy Tulloch

Citigroup Inc, Research Division - Director

* Michael William Mueller

JP Morgan Chase & Co, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Good morning. My name is Christine, and I'll be your conference operator today. At this time, I would like to welcome everyone to the PREIT 1Q '19 Earnings Call. (Operator Instructions) Thank you.

Heather Crowell, EVP, Strategy and Communications, you may begin your conference.

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Heather Crowell, Pennsylvania Real Estate Investment Trust - Executive VP of Strategy & Communications [2]

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Thanks, Christine. Good morning, and thank you all for joining us for PREIT's First Quarter 2019 Earnings Call.

During this call, we will make certain forward-looking statements within the meaning of federal securities laws. These statements relate to expectations, beliefs, projections, trends and other matters that are not historical facts and are subject to risks and uncertainties that might affect future events or results. Descriptions of these risks are set forth in the company's SEC filings. Statements that PREIT makes today might be accurate only as of today, May 3, 2019, and PREIT makes no undertaking to update any such statements. Also, certain non-GAAP measures will be discussed. PREIT has included reconciliations of such measures to the comparable GAAP measures in its earnings release and other documents filed with the SEC. Members of management on the call today are Joe Coradino, PREIT's Chairman and CEO; and Bob McCadden, our CFO.

It is now my pleasure to turn the call over to Joe.

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Joseph F. Coradino, Pennsylvania Real Estate Investment Trust - Chairman & CEO [3]

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Thanks, Heather, and good morning, everyone. We are enthusiastic that our results endorse our strategy. We grew same-store NOI, excluding termination fees, by 2.2% this quarter and are maintaining our guidance on both FFO and same-store NOI.

We've created a quality platform through proactive portfolio management, including asset sales, strategic remerchandising and redevelopment investments. And while we have made short-term concessions with challenged retailers, our strategy has put us in a position that we are able to cover 87% of the space impacted by bankruptcies this year. The quality of the portfolio has driven our ability to commit at the top end of our peer group on same-store NOI results and to maintain our full year guidance.

Since we began our remerchandising and disposition efforts, sales have increased approximately $150 per square foot, over a 40% improvement to $517 per square foot. Sales at our top 6 properties, which account for over 50% of our core mall NOI, rang in at $621 per square foot, registering robust growth of 4.2%.

It's worth noting that following our extensive remerchandise -- remerchandising, as we predicted, sales and traffic at Mall of Prince Georges have delivered the largest increases in our portfolio, eclipsing $550 per square foot and joining the ranks of our premier properties.

Total occupancy grew by a robust 100 basis points over last year's quarter and as our anchor redevelopments and pipeline of leases come online. We're very pleased to report traffic at our comparable properties for the Easter season was up 6.5%. Particularly noteworthy is that at our properties where we have recently completed remerchandising efforts, traffic was up 7.2%, more evidence that our strategy is hitting the bull's eye.

Excluding Fashion District, we have 613,000 square feet of leases signed for future openings. 494,000 square feet of space is expected to open in 2019, contributing annual gross rent of $10.4 million. And 119,000 square feet will be opening in 2020, contributing annual gross rent of 2.3%. 88% of this revenue is incremental for space not currently occupied, and 48% of the pipeline revenue is from leases with tenants opening in our premier properties. This will create significant incremental portfolio value by virtue of the low cap rates the market ascribes to these assets.

All anchors in our core portfolio are leased and we have over a dozen new stores opening this year in former department stores. Now of the anchor replacements remaining, on an average, these tenants will pay 9x the rent the space originally delivered. Also noteworthy, we had 3 JCPenney options exercised this quarter, and we have no remaining 2019 anchor expirations in our core mall portfolio.

2019 is a breakthrough year for PREIT as we further our mission to redefine the mall experience and position the portfolio for sustainable growth. Catalyst projects, Woodland Mall, Plymouth Meeting and Fashion District, were all open this fall. Construction at Woodland Mall will be completed this year with REI opening next week; Black Rock Bar & Grill opening this summer; and Von Maur, Urban Outfitters and the expansion wing opening in October.

This quarter, we signed The Cheesecake Factory for only their second Michigan location. With the addition of Von Maur, the region's only new Apple Store and The Cheesecake Factory, this property will take its place as a trophy mall and a top performer in our premier portfolio.

At Plymouth Meeting, we have 5 diverse uses opening in the former Macy's that will transform the property and offer more reasons for our customers to visit the mall, expanding our trade area and increasing customer visits. Dick's Sporting Goods, Burlington, Miller's Ale House, Edge Fitness and Michaels would be open this fall. These tenants are expected to deliver over 4x the sales productivities Macy's had and continue to differentiate this property from its competition.

And we are just 139 days from the opening of Fashion District, and the momentum is ramping up on what is sure to become the next great destination in Philadelphia. The high-profile multidimensional project will meet unmet demand for retail, dining and entertainment in Philadelphia. It's more than 85% committed with notable tenants, including Century 21, Burlington, H&M, Nike, ULTA Beauty, Hollister, Columbia Sportswear, GUESS Factory, Forever 21, AMC Theatres, Round 1 and City Winery. The company is getting stronger. Our core portfolio continues to improve, and we're fortifying our balance sheet.

Year-to-date, we've completed asset sales generating cash proceeds of $43 million and improved our liquidity position by over $70 million when including the benefit of moving Capital City Mall into our unencumbered asset pool. We are currently pursuing asset sales opportunities that could generate proceeds sufficient to recapitalize the company, which are being underwritten by various capital sources. As part of this recapitalization initiative, we're making tremendous progress with our densification program, with entitlements either secured or underway at all of our Philadelphia and D.C. properties. We have several institutional investors engaged, and we will continue to pursue this with speed to execution a top priority.

The densification of our properties has a multitude of benefits. First, we create a vibrant community, which is made possible by the amenity-rich environment we offer as a foundation. Having been focused on diversifying our tenant base, we have put ourselves in a position to deliver variety, convenience, dining and entertainment options.

Second, we enhance our balance sheet by monetizing the multifamily platform of 5,000 to 7,000 units that implies a land value of between $150 million and $300 million. In so doing, we're enhancing the value of our assets and the value of the company. We're focused on adding diverse uses throughout our portfolio and continue to drive our team to think about the mall as an interconnected social hub rather than just a place to shop. We have created a portfolio that is benefiting from improving traffic and sales, is well positioned for the future. And we have certainty and excitement around anchors, and we're in the process of adding multifamily units and hotels to our properties.

Now I'll turn it over to Bob.

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Robert F. McCadden, Pennsylvania Real Estate Investment Trust - Executive VP & CFO [4]

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Thanks, Joe. We had a strong quarter with same-store NOI increasing by 2% over last year and 3.2% at our wholly owned properties. Key drivers of the NOI increase include contributions from anchor replacements and other tenants that opened after the first quarter of 2018. This was partially offset by the impact of lost revenue from bankruptcies.

May REIT FFO for the quarter was $0.17 a share and $0.26 a share on an adjusted basis, which was ahead of consensus by $0.01. Before we go into some of the other operating metrics and earnings guidance, let me highlight a few items that impact our quarterly FFO results and financial statement presentation for the quarter.

As expected, we adopted the new lease accounting standard. And because of required changes in the GAAP financial statements, we revised our supplemental to provide additional details in our presentation of wholly owned and joint venture NOI. We're disclosing the detailed components of lease revenue and operating expenses, so you can more easily track the accounting changes and update your models.

We're now required to expense the cost of our internal leasing and legal personnel who work on lease transactions. Our G&A expenses now include approximately $1.5 million of these costs in the quarter.

The national tenants that filed for bankruptcy protection reduced our same-store NOI for the quarter by about $0.5 million. We've been aggressively working to backfill these expected vacancies and anticipate having a significant portion of the space re-let to permanent and temporary leases by the end of the year. These tenants contributed annualized revenue of $8 million in our core portfolio.

The 2019 impact of the anticipated closures on same-store NOI net of replacement rent is expected to be $2.8 million, which is covered by tenant-specific assumptions and our general bankruptcy reserves. We do not anticipate any further impact to our 2019 projected NOI as a result of these bankruptcies experienced to date.

In fact, Sears has assumed all the leases in our portfolio. We incurred debt extinguishment cost of $4.7 million when we defeased the Capital City Mall mortgage. By unencumbering this recently redeveloped property, it will add approximately $40 million in incremental borrowing capacity to our credit facility this year. At our current line rate, we will realize interest savings of approximately $900,000 each year for the next 3 years.

We sold the first of 2 remaining development parcels at Gainesville, Florida, for $5 million. And the remaining parcel is under contract for sale in the third quarter for an additional $10 million. As a result of this transaction, we recorded a $1.5 million impairment. We reorganized some of the revenue functions by eliminating 2 officers and 3 staff positions, which will generate annual savings in excess of $900,000. In conjunction, we took a $700,000 charge for severance costs in the quarter.

At Jacksonville Mall in North Carolina, we continued our remediation and construction efforts. Earlier this week, Belk opened its remodeled new prototype store [over the] average comparable day this year. We expect to record insurance recoveries of approximately $4 million to $5 million by the end of the year. These are included in our FFO guidance, but we do exclude them from income for our FFO as adjusted guidance.

At the end of March, we had opened an additional 315,000 square feet of space when compared to March of 2018. Embedded in this net absorption is also a reduction in space leased to temporary tenants by 93,000 square feet, another validation of the strength of our portfolio in the face of industry headwinds.

Now let me provide some updates to our capital plan. At our year-end earnings call, we targeted initiatives to generate an additional $70 million of liquidity in the first half of the year. We've already exceeded that goal, and as Joe mentioned, we have additional efforts underway to improve our liquidity position.

During the quarter, we spent $22 million on redevelopments and department store replacements and ended the quarter with $227 million of available liquidity more than sufficient to fund the cost of our announced redevelopment projects. In our release last night, we reaffirmed our February guidance for FFO as adjusted of between $1.20 and $1.34 per share.

The key following assumptions underlying our guidance remain unchanged. Same-store NOI, excluding lease termination is expected to grow between 1% and 1.9%. Lease termination revenues are assumed to be between $2 million and $4 million. And landfill gains are assumed to be between $5 million and $10 million.

In our non-same-store category, the sale of the Whole Foods parcel at Exton Square Mall closed earlier than anticipated, and we expect Wyoming Valley to exit the portfolio in the third rather than second quarter. These changes did not materially impact our overall view of operating performance for the year.

And with that, we'll open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Mike Mueller from JPMorgan.

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Michael William Mueller, JP Morgan Chase & Co, Research Division - Senior Analyst [2]

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Joe, I just love how you slipped in there casually. We may recapitalize the company right in the middle of the comments. So that was pretty good. I guess the question here is, starting off of that, are you contemplating -- is it several JVs, is it one big JV transaction or something else?

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Joseph F. Coradino, Pennsylvania Real Estate Investment Trust - Chairman & CEO [3]

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Are you speaking with respect to the residential land in terms of the recapitalization?

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Michael William Mueller, JP Morgan Chase & Co, Research Division - Senior Analyst [4]

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I thought you were talking about the company, I think, overall entity-type transaction.

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Joseph F. Coradino, Pennsylvania Real Estate Investment Trust - Chairman & CEO [5]

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Yes. I mean our sense is that we have significant value in 5,000 to 7,000 multifamily units. We think the valuation of that is between $150 million and $300 million. And we're actually working on a number of fronts. We have several institutions that are reviewing the opportunity, and we're also looking at individual sales as well. So we're sort of keeping our optionality open, if you will.

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Michael William Mueller, JP Morgan Chase & Co, Research Division - Senior Analyst [6]

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Okay. So it sounds like it'll all be residential-based as opposed to retail. Is that fair?

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Joseph F. Coradino, Pennsylvania Real Estate Investment Trust - Chairman & CEO [7]

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Well, I think at this point, that is our primary focus, because it really is selling non-income-producing land. It has minimal impact on the company's performance and does give us the ability to recapitalize.

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Michael William Mueller, JP Morgan Chase & Co, Research Division - Senior Analyst [8]

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Got it. Okay. And then just one quick question on Fashion District. You mentioned 29% leased and committed. Where do you think that project is likely to open with occupancy level?

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Joseph F. Coradino, Pennsylvania Real Estate Investment Trust - Chairman & CEO [9]

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I think we're going to open up in plus or minus 70% this year. We'll open up in September. The theater will then follow in -- theater and entertainment will follow in November. And we're expecting that by early to mid-2020, we're around 90%.

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Operator [10]

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Your next question comes from the line of Christy McElroy from Citi.

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Christine Mary McElroy Tulloch, Citigroup Inc, Research Division - Director [11]

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Just wanted to follow up on the opening remarks about the leasing spreads. I'm just wondering if you could provide a little bit of additional color on the portfolio deals that drove the percentage in lieu leasing. Are these rent adjustments just on 2019 expirations? Or should we expect sort of more of these adjustments in future years for these struggling retailers? And I realize you have rent floors, but you also have kick-out rights as well.

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Joseph F. Coradino, Pennsylvania Real Estate Investment Trust - Chairman & CEO [12]

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I think a couple of things. One is, there were a number of leases where we did percentage in lieu of 32 leases, about 120,000 square feet. And we really look upon that as available space, right? If you couple that with the fact that of the closings and bankruptcies we've experienced already this year, we think we're going to cover close to 90% of that. And so we made those deals really to keep the space occupied. The average term was less than 2 years. And so that space is, for all intents and purposes, occupied and available.

And no, we don't think that, that is a condition that will continue. We think it was, again, a very prudent business decision, given the situation in front of us and the opportunity to sort of re-lease the space in a relatively short term. With respect to kick-outs, there are no kick-outs. But again, these are short-term deals, and we're expecting to currently re-lease the bulk of that space.

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Christine Mary McElroy Tulloch, Citigroup Inc, Research Division - Director [13]

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Okay. And then sorry if I missed this point, but just in regard to the NAREIT FFO guidance, you have the good amount of insurance recoveries in there, I think. What is that related to? And maybe you could discuss the timing of when those would hit.

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Robert F. McCadden, Pennsylvania Real Estate Investment Trust - Executive VP & CFO [14]

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So the insurance recoveries related to Hurricane Florence, which impacted Jacksonville Mall last fall, so much of the work has been done. But the way the accounting works is we actually don't recognize the recovery revenue until the insurance companies process the claims. We expect the bulk of that to come in during the second quarter of this year -- second or third, but most of it in second.

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Operator [15]

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Your next question comes from the line of Caitlin Burrows from Goldman Sachs.

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Caitlin Burrows, Goldman Sachs Group Inc., Research Division - Research Analyst [16]

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Maybe just on the topic of same-store NOI growth, so this quarter was up 2.2%. I think this did have some benefit of easier comps on snow removal cost. But I guess, going forward, given that this is ahead of your full year plan, could you just give a sense for the pressures that we should expect over the rest of the year? Is it just occupancy headwinds or is there other pieces?

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Robert F. McCadden, Pennsylvania Real Estate Investment Trust - Executive VP & CFO [17]

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Yes, Caitlin, I think what you expect to see -- I think when we provided our initial guidance, we had guided towards kind of the lower end. So we outperformed in the first quarter. But we'll see the impact of the bankruptcies more so in the second, third quarters. And the backfilling, some of that's already beginning to occur. But you'll see the big pickup toward the fourth quarter. So you'll see a little bit of softness in quarters 2 and 3 just as we absorb the impact of the bankruptcies.

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Caitlin Burrows, Goldman Sachs Group Inc., Research Division - Research Analyst [18]

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Okay. And then maybe just on the topic of CapEx and TIs, so the Page 19 of your supplement shows it was only 1 but 1 over 10,000 square foot lease, where the initial rent appears to be $821 and the TI was $1,701. So A, I was just wondering if I'm reading it right that, that appears to come out to a negative net effective. And if so, I guess, what made you go forward with that deal?

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Joseph F. Coradino, Pennsylvania Real Estate Investment Trust - Chairman & CEO [19]

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Yes, as you said -- Caitlin, this is Joe. As you say, that was really only one transaction. It was a key tenant and it was in the expansion at Plymouth Meeting. And given that we had -- we have 5 tenants opening in the new anchor box in the fall, we believe that was relatively conservative projection of percentage rent. And we have significant upside as a result of that traffic. I mentioned that we're expecting sales in that -- of those 5 tenants to be 4x what we were getting from Macy's and commensurate traffic. So that was a transaction that was done eyes wide open to keep an important tenant in the Plymouth Meeting at a -- for a transaction that was driven -- the rationale was really around anticipated percentage rent.

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Caitlin Burrows, Goldman Sachs Group Inc., Research Division - Research Analyst [20]

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Got it. And then maybe one last one, if I could, back to that, you were talking about the land in the multifamily units could generate a couple of hundred million dollars of value potentially. I guess over how long do you think it would take to realize that based on some of the other land transactions you've done?

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Joseph F. Coradino, Pennsylvania Real Estate Investment Trust - Chairman & CEO [21]

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Well, that's something that we're pretty deep into right now. So I'd rather not comment, negotiate a transaction on the earnings call, so to speak. But as I mentioned in my remarks, it's a high priority and speed to execution is key.

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Operator [22]

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There are no further questions at this time. Mr. Joe Coradino, I turn the call back over to you.

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Joseph F. Coradino, Pennsylvania Real Estate Investment Trust - Chairman & CEO [23]

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Well, thank you all for being on the call. I just have a couple of closing comments that I think are important for me to make.

One, we're real proud of what we created here. We've got a great management team. And we're delivering. We're transforming the portfolio. We're generating improved traffic and sales, NOI growth, fully leased anchors, a plan to strengthen our balance sheet and an exciting densification initiative underway. We were the first to dispose of assets, the first to take back and repurpose anchors, and we're going to continue that trend in terms of our recapitalization strategy. So look forward to good things in the future. Thank you all for being on the call.

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Operator [24]

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This concludes today's conference call. You may now disconnect.