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Edited Transcript of PHLD.PK^A19 earnings conference call or presentation 9-May-19 6:00pm GMT

Q1 2019 Phillips Edison Grocery Center REIT I Inc Earnings Call

CINCINNATI May 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Phillips Edison Grocery Center REIT I Inc earnings conference call or presentation Thursday, May 9, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Devin Ignatius Murphy

Phillips Edison & Company - CFO & Treasurer

* Jeffrey S. Edison

Phillips Edison & Company - Chairman, President & CEO

* Michael Koehler

Phillips Edison & Company - Director, IR

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Phillips Edison & Company's First Quarter 2019 Earnings Call. My name is Andrea, and I will be your conference operator today.

Before we begin today's call, I would like to remind our listeners that this live conference call is being recorded and simultaneously broadcast via webcast. The webcast and a copy of the slide presentation can both be accessed on the Investors section of the Phillips Edison website at www.phillipsedison.com. A webcast replay will be available starting later this afternoon and will also be on the Investors section of the Phillips Edison website at www.phillipsedison.com, under the Events and Presentations tab.

I would now like to turn the call over to Michael Koehler with Phillips Edison & Company. Sir, please proceed.

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Michael Koehler, Phillips Edison & Company - Director, IR [2]

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Thank you, operator. Good afternoon, and thank you for joining us. I'm Michael Koehler, the Director of Investor Relations with Phillips Edison & Company. Joining us on today's call is our Chairman and Chief Executive Officer, Jeff Edison; our Chief Financial Officer, Devin Murphy; and our Executive Vice President, Mark Addy.

During today's presentation, Jeff will touch on our highlights for the quarter, speak to the updated estimated value per share of our common stock and provide an update on our portfolio. Following Jeff's comments, Devin will go through our financials for the quarter, discuss our balance sheet and then speak to the share repurchase program. Jeff will then return to talk about our key initiatives for 2019. Upon the conclusion of our prepared remarks, we will address your questions. (Operator Instructions)

Before we begin, I'd like to remind our audience that statements made during our prepared remarks and the Q&A session may contain forward-looking statements, which are subject to various risks and uncertainties. Please refer to Slide 3 for additional disclosure and direction on where you can find information regarding potential risks. In addition, we will also refer to certain non-GAAP financial measures. Information regarding our use of these measures and reconciliations of these measures to our GAAP results are available in our earnings release issued this morning as well as in the slide presentation for this webinar, which is available for download on our website at phillipsedison.com/investors.

I would now like to turn the call over to Jeff Edison, our Chief Executive Officer. Jeff?

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Jeffrey S. Edison, Phillips Edison & Company - Chairman, President & CEO [3]

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Thank you, Michael. Good afternoon, everyone, and thanks for being on the call today.

Slide 4 outlines our highlights for the first quarter. The first quarter of 2019 was the first full quarter since the transformational merger with Phillips Edison Grocery Center REIT II, which closed on November 16, 2018. The $1.9 billion merger added 86 grocery-anchored shopping centers totaling approximately 10.3 million square feet to our portfolio. Our results for the quarter illustrate the successful integration of the REIT II portfolio as well as healthy performance at the property level, highlighting the continued strength and resiliency of grocery-anchored shopping centers.

FFO per diluted share increased 5.6% to $0.19 per share, which represented 111.3% of total distributions made during the quarter. This marks an improvement from 105.4% coverage for the first quarter of 2018. Pro forma same-center NOI increased 2.5% to $87.3 million driven by our best-in-class, fully integrated operating platform. Further, we recognized comparable leasing spreads of 17.2% for new leases and comparable REIT spreads of 12.3% for renewals, for combined leasing spreads of 13.5%. These strong operating results continue the momentum we have seen over the past 3 years and reflects sustained healthy tenant demand for well located, grocery-anchored real estate.

Now turning to Slide 5. During the quarter, we engaged Duff & Phelps, an independent, third-party valuation firm, to provide a calculation of the range and estimated value per share of our common stock as of March 31, 2019. Duff & Phelps prepared a valuation report based substantially on their estimate of a range of the as-is market values of our portfolio and of the in-place contracts of our investment management business. Based on their valuation, Duff calculated a range of estimated per share values based upon the number of outstanding shares of common stock at the end of the quarter. These calculations produce an estimated value per share in the range of $10.07 to $11.48.

I am pleased to share that our Board of Directors has increased the estimated value per share of our common stock to $11.10 as of March 31, 2019. This is a $0.05 increase from our previous estimated value per share of $11.05 and an 11% increase from the original offering price of $10. Our estimated value per share of $11.10 is a reflection of the growth in the value of our real estate coupled with the future growth opportunity within our portfolio and the growth potential of our investment management business.

More information including full description of the assumptions and methodologies used to determine the estimated value per share will be available in our 10-Q filing for the quarter ended March 31, 2019, which we -- can be accessed at www.sec.gov as well as on our website later today.

Slide 6 outlines the history of our common stock. From 2010 to 2014, we raised capital at $10 per share. We established our first estimated value per share of $10.20 in August of 2015. Later, it was increased to $11 per share after our acquisition of Phillips Edison Limited Partnership, or PELP, in November of 2017. And subsequently, it was increased for the third time to $11.05 in May of 2018. Today, we're pleased to establish the estimated value of $11.10.

From the inception of our offering to February 2013, we faced annualized distributions of $0.65 per share. And from that date to present, we have paid $0.67 per share per year. Together, with REIT II, we have made distributions of over $1 billion to our shareholders. In fact, their distribution on May 1, 2019 marked our 101st consecutive month of distributions. Throughout our history, our focus on operations and real estate fundamentals has created continued growth in FFO and MFFO, which were both greater than our total distributions for this quarter. These results represent a long history of delivering stockholder value, of which we are very proud. Further, our Board has maintained our distribution rate of $0.67 on an annualized basis.

We are committed to driving stockholder value, and that is illustrated by the strong performance of our common stock. Based on your initial value -- your initial investment of $10 per share, you have received between $5.70 and $8.50 of regular distributions and you retain your shares valued at $11.10. This is a total value of $16.80 -- between $16.80 and $19.60.

Now turning to our portfolio on Slide 7. As of March 31, 2019, our portfolio consisted of 300 wholly owned properties anchored by 37 leading grocers representing multiple banners located in 32 states totaling 34.1 million square feet of gross leasable area. This compares to 237 properties on March 31, 2018, located in 32 states with 34 leading grocers totally 26.4 million square feet of GLA, which was before our merger with REIT II. As of March 31, 2019, our leased portfolio occupancy was 93%, and our in-line occupancy was 85.7%. Of our total rents, 77% came from grocers and national and regional tenants. And our average remaining lease term for our portfolio is 4.9 years.

Our overall annualized base rent was $12.14 per square foot, which was an increase of 6.5% from just a year ago. Our in-line tenant ABR was $19.22 per square foot, which was an increase of 8% from a year ago.

We also have 2 joint ventures: One joint venture with Northwestern Mutual Life Insurance company, which owns 17 properties; and one with TPG Real Estate, which owns 13 properties. These joint ventures with institutional investors like Northwestern Mutual and TPG Real Estate are a meaningful and positive affirmation of the PECO brand and the quality of our asset management platform.

Slide 8 shows a breakdown of our ABR by tenant type and tenant industry as well as our top 5 grocers by ABR and their different banners. As we look at tenant type, 36.3% of our total ABR came from our grocery anchors and 40.7% came from other national and regional tenants. We focus on these classifications because it gives us a sense of the credit quality and stability of our tenant base.

Looking at our tenant industries. 76.5% of our ABR came from grocery, restaurants and service tenants such as hair salons, barbershops, dentists and nail salons. We believe that these types of tenants offer good services and experiences that are Internet-resistant and continue to drive recurring foot traffic to our centers on a regular basis.

Our top 5 grocers by ABR represent a diverse mix of the leading grocers and our largest tenants, Kroger and Publix, contributed 6.9% and 5.6% of our ABR, respectively.

Our portfolio enjoys excellent anchor diversification. As we look at our leading grocers, we continue to see brick-and-mortar as a cornerstone of their future growth strategy, and we remain positive about the future prospects of grocery-anchored retail.

With that, I would now like to turn the call over to our Chief Financial Officer, Devin Murphy, who will go over our results for the first quarter of 2019. Devin?

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Devin Ignatius Murphy, Phillips Edison & Company - CFO & Treasurer [4]

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Thanks, Jeff, and good afternoon, everyone. Slide 9 reviews our first quarter 2019 pro forma same-center NOI. For the purposes of evaluating same-center NOI on a comparative basis and in light of a merger with REIT II in late 2018, we are presenting pro forma same-center NOI as if the merger with REIT II had occurred on January 1, 2018. As such, our pro forma same-center NOI includes 294 properties that were owned and operational since January of 2018.

During the first quarter of 2019, pro forma same-center NOI increased by 2.5% when compared to the first quarter of 2018. This improvement was driven by a $0.21 or 1.8% increase in average minimum rent per square foot. Total pro forma same-center revenue and operating expenses decreased year-over-year, almost entirely as a result of the change in the presentation of real estate taxes directly paid by tenants and bad debt expense from the implementation of new lease accounting standards that we were required to adopt and which we will discuss further on the next slide.

If you'll turn to Slide 10, this slide outlines our financial results for the 3 months ended March 31, 2019. For the quarter, the company reported a net loss of $5.8 million, which compares to a net loss of $1.8 million for the same period in 2018. This result is generated by the earnings from owning additional properties from the merger with REIT II, gains of $7.1 million related to the sale of 3 properties in the quarter and $7.5 million of income from a reduction in the liability for the earnout provision of the 2017 contribution agreement related to the acquisition of PELP. These were offset by $13.7 million of impairment charges related to 4 assets, higher depreciation and higher general and administrative expenses as a result of the merger with REIT II.

This quarter, the company adopted FASB Accounting Standards Topic 842. As a result, the company recognized an increase of $1.1 million in net expense for the 3 months ended March 31, 2019 compared to a year ago, primarily related to less capitalization of our leasing costs. More details regarding this are available in our Form 10-Q, which will be filed with the SEC later today.

For the quarter ended March 31, 2019, the company generated FFO of $61 million, which was a $20.7 million increase from the $40.4 million during the same period in 2018. On a per share basis, FFO totaled $0.19 per diluted share, which was a 5.6% increase from $0.18 per diluted share during the first quarter of 2018. This increase in FFO is attributed to income from the merger with REIT II, including NOI from its properties, year-over-year property level NOI growth and the reduction in the PELP earnout liability. This quarter, the company paid gross distributions of $54.8 million, including $17.7 million reinvested through the dividend reinvestment plan and paid net cash distributions of $37.1 million. Our FFO totaled 111.3% of our gross quarterly distributions.

For the 3 months ended March 31, 2019, the company generated MFFO of $55 million, which was a 30.3% increase from MFFO of $42.2 million for the same period in 2018. MFFO fully covered our distributions for the quarter totaling 100.3% of total gross distributions made. On a per share basis, MFFO totaled $0.17 per diluted share, which was a 5.6% decrease from $0.18 per diluted share during the first quarter of 2018.

The increase in total MFFO was driven by the additional properties owned as a result of the merger with REIT II. While the decrease in MFFO per share was the result of asset recycling, higher expenses from the accounting change in lease capitalization and a decrease in leverage through net disposition activity of wholly owned properties over the past year. As we continue to monitor the public markets for a potential liquidity event, we observe that our public peers are targeting lower leverage levels and continued to delever. We expect to continue to delever our balance sheet through asset dispositions and continued portfolio growth.

If you'll turn now to Slide 11, this slide outlines the company's debt profile as of March 31, 2019. The company's debt-to-enterprise value was 40.8% as of March 31, 2019. Our debt had a weighted average interest rate of 3.5% and a weighted average maturity of 4.8 years. Approximately 86.8% of our debt was fixed rate. As we look at our liquidity, we had $439.7 million of borrowing capacity available on our $500 million revolving credit facility.

Turning to Slide 12. This slide provides an update on our share repurchase program, or SRP. During the 3 months ended March 31, 2019, we repurchased approximately 605,000 shares of common stock valued at $6.7 million for debt, disability and incompetence in accordance with the SRP. Our next standard repurchase is expected to be executed on July 31, 2019. At that time, we expect standard repurchase requests will be fulfilled on a pro rata basis. If you have any questions regarding the SRP, please contact our transfer agent, DST, at 1 (888) 518-8073.

I would now like to turn the call back over to Jeff for commentary on our 2019 goals and initiatives and closing comments. Jeff?

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Jeffrey S. Edison, Phillips Edison & Company - Chairman, President & CEO [5]

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Thanks, Devin. Please turn to Slide 13. I'd like to take this opportunity to provide an update on our key initiatives for 2019 that we discussed on the year-and earnings call in March.

As we look to our goal of executing a full cycle liquidity event, one of the possible ways we can do this is through the listing of our shares on a national stock exchange like The New York Stock Exchange or NASDAQ. In preparation for listing, we discussed 3 important strategies that we feel will position the company for a successful liquidity event and long-term growth.

First, we must continue to focus our efforts on driving cash flow at each of our centers. We do this by increasing leasing activity, driving rent increases at renewal and filling vacant shops at our centers with high-quality tenants. During the quarter, we executed on each of these fronts and we have a solid path forward. This is the core of our business and will always be critical to our success.

Secondly, we will continue our disposition program. We sold 3 properties this quarter and anticipate this will continue. This disposition program allows us to do 3 things: First, we are selling assets where we believe the proceeds can be redeployed into other assets with better growth or assets that no longer fit our risk profile because of tenant of market concerns. With sale proceeds, we can acquire higher-quality properties with attractive growth potential. Second, we can use the proceeds to pay down debt and reduce leverage. As we consider liquidity options in the current environment, lower leverage is an important metric. And third, we can use the proceeds to invest in redevelopment projects in our current portfolio, which will yield attractive returns.

Our third 2019 initiative is to continue growing our investment management business, which provides high-margin recurring revenue throughout our market cycles. As I mentioned on last quarter's call, our current CFO, Devin Murphy, has been tasked with expanding our investment management business, raising additional equity and overseeing our current joint ventures. This initiative aligns very well with Devin's extensive previous experience with Morgan Stanley and Deutsche Bank. We are confident Devin and his team will bring new institutional partners and relationships to PECO.

Liquidity for our investors is important to us and something we are working hard to affect. Our 2019 initiatives have us focused on operational areas that will benefit and position PECO for the future regardless of whether liquidity happens in the near term or over the longer term. We continue to be disappointed by the current discounted net asset value, or NAV, that our public shopping center REIT peers trade at in current equity markets. As of May 1, 2019, our public peers were trading at an average discount to NAV of over 20%. This discount is meaningful, and we would like to see the share price of our public peers and the value of our shopping center REIT move closer to NAV, reflecting their true value before we move forward with liquidity events.

A patient approach to liquidity is prudent. We believe executing on our strategic alternatives, our initiatives will position us to achieve a full-cycle liquidity event at a more attractive valuation when public equity valuations for shopping center REITs improve and a meaningful discount to NAV is not required to affect liquidity. In closing, we're pleased with our results for the quarter but know we have to be laser-focused on execution in order to achieve our goals and provide liquidity for our investors.

With that, I would now like to turn the call back to Michael Koehler, our director of Investor Relations. Michael?

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Questions and Answers

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Michael Koehler, Phillips Edison & Company - Director, IR [1]

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Thank you, Jeff. This concludes our prepared remarks, and we will now begin our question-and-answer session.

Our first question, which was asked by many of you as well as [Ron Ritchie], asks, "What market conditions must be present in order for management to list or liquidate this investment vehicle? When do you expect that we will be able to get our money out of the investment?"

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Jeffrey S. Edison, Phillips Edison & Company - Chairman, President & CEO [2]

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I'll take that, Michael. This is Jeff. We continue to monitor the markets, and the current 20% discount to NAV is really one of our key focal points. To issue our stock at 20% discount to what we think is current, we can currently sell it for in the market, is just not something that we are -- we think would be prudent for the company right now. We know that over time and really over the last 10 years, the shopping center REITs have traded at a premium to NAV. So we are -- we certainly want to get back to a much more stabilized valuation before we can take that step. But I can promise you as the largest shareholder in the company, we are laser-focused on it and we'll do it when we -- as quickly as we can when we believe that it's the right timing from a valuation standpoint.

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Michael Koehler, Phillips Edison & Company - Director, IR [3]

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Thanks, Jeff. Next question comes from [James Yarbrough] and [Marshall Rogers] asking, "What is the threat of online shopping to property traffic and then property values?"

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Jeffrey S. Edison, Phillips Edison & Company - Chairman, President & CEO [4]

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[James], that's a great question and one that we are laser-focused on. If you look back really 5 to 10 years ago, our -- the biggest risk in our business, we believe, was the online threat. We believe that if you could deliver groceries online and you could eliminate the stores that, that was a huge risk for us. And obviously, Amazon was the leader in that game. When Amazon bought Whole Foods, it really changed the question. And the question is, "How much will grocery take from the bricks-and-mortar grocery business?" Not whether or not they -- bricks-and-mortar will go away because Amazon clearly would have preferred to have done this with just online delivery. They realized they couldn't do it. And it's not just in grocery but grocery, I think, is the most pronounced. It's across the board. The Internet-only retailers are actually stepping back to an omnichannel plan. And clearly, if Amazon can't do it as the best in that business and the dominant market share, we think that we're going to continue to see pieces of our business go to the Internet, but the grocery business is probably going to stay predominantly in a bricks-and-mortar format.

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Michael Koehler, Phillips Edison & Company - Director, IR [5]

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Thanks, Jeff. Next question comes from [Ritchie Hafin], an investment advisor at [Hafin Financial]. He has 2 questions. First one reads, "Which publicly traded REITs are most relevant for tracking a potential good time for a PECO listing?"

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Devin Ignatius Murphy, Phillips Edison & Company - CFO & Treasurer [6]

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[Ritchie], it's Devin Murphy. I'll answer that question. We benchmark our performance against 9 publicly traded REITs. Those include, in alphabetical order: Brixmor, Cedar, Kimco, Kite, Regency, Weingarten, RPT, RPAI and ROIC. I guess not in perfectly alphabetical order but those are the 9 companies that we benchmark ourselves against.

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Michael Koehler, Phillips Edison & Company - Director, IR [7]

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Great. Thanks, Devin. Next question is, "Are rising wages, transportation or commodity costs impacting tenant margins such that it is having an impact on PECO's ability to raise rents or rent escalators or finding satisfactory new tenants?"

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Devin Ignatius Murphy, Phillips Edison & Company - CFO & Treasurer [8]

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Yes, [Ritchie], it's Devin. I'll answer that as well. We are not actually seeing that in our business. As you'll note from the quarter, during the quarter, our overall annualized base rent increased 6.5% from a year ago. Our in-line ABR increased 8% from a year ago and we're seeing very strong comparable leasing spreads. We saw comparable leasing spreads of 17.2% for the new leases we executed and 12.3% for our renewals, which resulted in combined leasing spreads of 13.5%. So we are enjoying the ability to push rents fairly dramatically in this environment. In addition, we enjoyed a retention rate of over 84%. So we are not seeing the rising costs impacting our ability to increase rents. Where we are seeing costs as an issue is in construction costs. Construction costs are rising. And that is obviously having an impact on us because it's increasing our TI costs. But again, we believe that, that is a cost that we're working hard to manage effectively.

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Michael Koehler, Phillips Edison & Company - Director, IR [9]

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Follow-up question here. "What are the anticipated cost impacts and remaining hiring needs for PECO to become a publicly traded company?"

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Devin Ignatius Murphy, Phillips Edison & Company - CFO & Treasurer [10]

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Okay. It's Devin. I'll answer that as well. We are a public company now. We are an SEC registrant, and we do not anticipate any meaningful increases in our operating costs as a result of being a traded company.

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Michael Koehler, Phillips Edison & Company - Director, IR [11]

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Final question from [Ritchie] here. "How much is artificial intelligence changing PECO's business model?"

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Jeffrey S. Edison, Phillips Edison & Company - Chairman, President & CEO [12]

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To date I would say it's not changing our model dramatically. Its biggest impact is done in 2 areas for us today. One is -- I put on the efficiency side and the second, really, the decision process. A good example is we currently are using robots to help us streamline the parts of our accounting business that are -- and we're seeing very, very positive results from that, and that's sort of the efficiency side of AI. The decision process is -- really been more driven on the acquisition side, where we have a -- our own really proprietary algorithm that we use to evaluate product quality for each center that we buy in order to determine valuation and whether or not it's a project that will help to augment our overall portfolio for PECO. So those are our 2 biggest areas. We do -- we are monitoring it very closely because as I think most of us believe, it is going to be a bigger and bigger -- it's got a bigger and bigger impact each year, and you've got to be able to use that advantage where it can best be used over time. And you got to be literate in terms of what it can do for you so that you're ready when it makes its biggest changes, which will likely be over the next 5 years, I think, we'll see pretty dramatic changes in how AI is used in our business.

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Michael Koehler, Phillips Edison & Company - Director, IR [13]

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Thanks, Jeff. Next question comes from [Jane Cramer]. She's looking for some color on -- "How can we as shareholders have confidence in the NAV as it relates to liquidity price?" Devin, you want to take that?

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Devin Ignatius Murphy, Phillips Edison & Company - CFO & Treasurer [14]

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Sure, I'll take that. [Jane], we view our declared NAV as the metric to determine the private market value of our real estate assets. An evidence that our NAV is an accurate metric is that as you know in 2018, we sold over $400 million of assets to a sophisticated institutional investor in Northwestern Mutual Life at values that were equivalent to the NAV of those assets. So that transaction gives us confidence that our NAV is an accurate reflection of the value. We believe that our declared NAV is an accurate reflection of the value of our real estate assets. We do not have insight into how other entities have declared NAV. And therefore, the delta between their declared NAV and where a liquidity event ultimately took place is difficult to determine. But our belief is that our declared NAV is an accurate reflection of the value of our real estate assets.

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Michael Koehler, Phillips Edison & Company - Director, IR [15]

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Thanks, Devin. The next question's from [Jay MacLellan]. He asks, "We've gotten a number of questions" -- I'm sorry. The next question comes from Jay MacLellan , "Regarding executive compensation that was disclosed in the proxy, can you provide some commentary on that?"

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Devin Ignatius Murphy, Phillips Edison & Company - CFO & Treasurer [16]

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Sure. I'll take that, Michael. In 2018, our Compensation committee engaged FDL Associates, an independent compensation consultant, to provide guidance to our compensation committee regarding our executive compensation program for 2019. FDL compared the compensation of our executives to 140 REITs that are members of NAREIT that compete with our company for executive talent. Our compensation committee believes that market-based compensation is necessary to motivate and reward our executive officers for their overall performance. The compensation philosophy and approach of our compensation committee is to provide a base salary for each of our executive officers at or near the 50th percentile base salary amount of similarly situated executives. Further, our bonus compensation is primarily based on AFFO and same-center NOI growth, which ultimately drives the value of the company. It's important to note that 80% of our total annual comp is performance-based and at risk based upon the operating results of the company.

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Michael Koehler, Phillips Edison & Company - Director, IR [17]

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Thanks, Devin. Next question comes from Matthew Wright from Wright Financial. He asks, "The NAV range decreased from last year to this year, yet the Board elected a NAV that was higher than last year's. Can you explain the rationale behind this?"

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Jeffrey S. Edison, Phillips Edison & Company - Chairman, President & CEO [18]

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Great. Great question, Matthew. The -- there are 3 pieces than went into the valuation, I think that most strongly -- that had the Board decided the range that -- or the pricing that they did. One was that we had a very solid increase in the value of the real estate. The second is the opportunity for additional NOI growth through redevelopment. And the third was the growth potential of our investment management business. Those were the driving factors in our Board's decision to increase our estimated value per share.

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Michael Koehler, Phillips Edison & Company - Director, IR [19]

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All right. Thank you, Jeff. This now concludes our question-and-answer session. I'd like to turn the call back over to Jeff for some closing comments. Jeff?

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Jeffrey S. Edison, Phillips Edison & Company - Chairman, President & CEO [20]

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Thank you, Michael, and thank you all for being on the call today. On behalf of the entire management team, we appreciate your -- the support that you're -- you've given us. We want -- we -- as I hope you know, we are laser-focused on creating a liquidity event for our investors at a point in time where we can do that at a number that reasonably represents the value of our assets. We are working hard to push through the operating results that we've been able to do so far this year and over the last 2 years, and we believe that, that will, in the long term, give us the most options for the company and be able to meet our long-term goals.

So thank you again for being on the call, and have a great day.

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Michael Koehler, Phillips Edison & Company - Director, IR [21]

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Thank you for joining us, everyone. You may now disconnect.

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Operator [22]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.