Pennsylvania Real Estate Investment Trust (PEI) 2015 Q3 法說會逐字稿

Good morning, and welcome to the PREIT third-quarter 2015 earnings conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Heather Crowell, Vice President of Investor Relations and Corporate Communications. Please go ahead.

Good morning, and thank you all for joining us for PREIT's third quarter 2015 earnings conference call. During this quarter, 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, October 28, 2015, 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 CEO, and Bob McCadden, our CFO. It is now my pleasure to turn the call over to Joe Coradino.

Thank you, Heather. Good morning and thank you all for being on the call. We have a nice turnout this morning. That's exciting. We think the renewed interest in PREIT is a result of the fact that we're not the same company we were when I became CEO, and it's apparent in every aspect of our business. We spend a lot of time talking about portfolio quality, but it's much more than that. We've built a quality organization focused on unlocking value through execution and performance. We have improved the quality of our properties, the tenant base, our anchor mix, and our people through transformation of our portfolio, and you're seeing the results. The fundamentals of our business are strong and the metrics, many of which are leading indicators, are evidence of this.

In 2012, we had 14 properties generating sales under $300 per square foot compared with only two today, following the sale of Voorhees Town Center. The comparisons to 2012 continues. In 2012, we generated same-store NOI growth of 1.8% compared to 2.7% in 2014 and 3.4% year-to-date in 2015; sales per square foot were $3.72 compared to $4.28 today, an impressive 15% improvement; 2012 renewal rent spreads of 1.8% compared to 5.3% year-to-date, and 9.1% for the quarter; leverage in 2012 was 62.4% and is now just over 50%.

A common concern raised by investors is portfolio exposure to Sears and JCPenney stores. It's noteworthy that we have reduced our exposure to Sears from 29 stores to 16 today, almost in hand. JCPenney from 29 stores to 23 today, and Bon-Ton from 12 to 6 today. These improvements have differentiated us from our peers and have altered our dialogue with retailers as we are presenting a compelling platform and generating increased retailer demand.

The pace of change is accelerating. On the re-merchandising and re-tenanting front we've also made tremendous progress. Over the past year, we have executed first of portfolio transactions with Field & Stream, Toomey, Lululemon, Vera Bradley, Topshop, Windsor, Guard House, Adidas, Century 21, and Lego: quite an impressive roster of tenants. Similarly, when looking at the expanded presence of sought-after tenants since 2012, we've increased the number of Dick's Sporting Goods in our portfolio by 50% to 12, have grown from one to three Michael Kors stores, have doubled the number of Ulta stores to eight, have added one Apple store, have nine new Francesca stores, and have recently announced our second Whole Foods transaction. Since the beginning of the year, we've executed five new leases with H & M, two more in the pipeline. So in 2012, we had four H & M stores in our portfolio. We'll have 13 by the end of 2016.

In addition to our re-merchandising and repositioning initiatives, we've had continued success disposing of lower productivity and lower growth assets. Last night, we announced the sale of Voorhees Town Center, a transaction we hadn't previously discussed but are pleased to have completed. Voorhees Town Center had the lowest sales in our portfolio, $261 per square foot. We were unofficially informed that one of the anchors plans to close their store and believe it was an opportune time to respond to an unsolicited offer and execute on the sale.

We continue to make progress on the balance of our dispositions. The three mall practice transaction we announced last quarter continues to progress. Our buyer is in discussions for financing and the due diligent period expires in November. [Lycoming] has fallen out of contract. We are in advanced discussions with other buyers and are optimistic we will be able to put it under contract in the near future. Both Washington, Crown, and Palmer are actively being marketed with interested buyers for both.

Our portfolio sales growth continues to outperform, driven primarily by re-merchandising. We included in our earnings release a reconciliation of the growth we've generated to highlight that this is more from organic growth than from disposing of lower productivity malls or closing bankrupt tenants. We fundamentally changed the tenancy in our shopping centers and it's producing results in the form of increased sales.

Sales have organically grown by 6.8% in the last year. Cherry Hill Mall is inching closer to $700 per square foot mark, Willow Grove is in shouting distance of $600 per square foot, and every single one of our properties experienced growth in sales over the prior year. Non-anchor renewal spreads were 9.3% for the quarter. If we exclude direct pass-through expenses and average the rents, these spreads would be over 19%, likely a more comparable calculation to those of our peers.

To provide a little color on our future growth, Springfield Town Center continues to exceed our expectations. We have over 50,000 square feet of space under construction with 46,000 set to open in Q4, including Dave & Busters. Additionally, we're negotiating leases with tenants for 53,000 square feet of space and look forward to announcing some of the exciting tenants with whom we're working. We're pleased that sales are trending above $500 a square foot for the first year of operation. We expect NOI delivered from this property to nearly double in 2016.

Regarding an update on the fashion outlets of Philadelphia, we've completed the majority of work with the city with the remaining public financing request pending with the state. We're under way with an aggressive leasing program. Macerich just attended the value retail conference where the project was well received and one of the most sought after being marketed at the convention. Our priority right now is solidifying the anchor mix.

During the quarter, we announced that we executed a lease with Whole Foods at Exton Square. We're on track to start work when the space next year for spring 2017 opens. We are pleased with the portfolio we have crafted and are enthusiastic about the work to be done. It's been a busy quarter touring investors and analysts through our properties. Without fail, when people see our assets, they exceed their expectations.

We've carved out a new niche with a portfolio comprised largely of major market assets with superior demographics primarily in the densely populated northeast corridor, which will allow us to deliver NOI growth reflective of our uniquely positioned portfolio. To repeat a line from the earnings release for emphasis, we have claimed the unique position within the mall REIT universe. And while we have a distance to go, our path is clear and there is a bright light in our future.

Now, I'll turn it over to Bob McCadden.

Thanks, Joe.

Strategically, operationally, and financially we're in much better shape today than we were just a few short years ago. With a smaller, higher-quality portfolio, we are laser-focused on creating value in our assets in closing the NAV gaps. We've made tremendous progress in all areas of the business, but still see opportunities to improve. I'm going to briefly touch on operating results, give you our capital plan, and cover changes to our earnings guidance for the balance of the year.

Concerning operations, same-store NOI of $64.5 million was up $2.5 million, or 4% when compared to the prior period. The results included $1.4 million of lease termination fees from four RGA concepts and one large format store at Wyoming Valley that was terminated in order to provide swing space for re-merchandising plan that we have under way. Tenant bankruptcies from earlier this year continue to impact the results for the third quarter. The NOI contribution from spaces previously occupied by these tenants was $1.5 million, or $0.02 per share lower in the third quarter of this year compared to last year's quarter. These bankruptcies also impacted our same-store non-anchor mall occupancy by 141,000 square feet, or 126 basis points.

Regarding replacement tenants, we presently have permanent tenants in 20% of the space, as specialty leasing tenants occupy another 30%; 22% is in the deal pipeline and prospects have been identified for another 14%. Same-store non-anchor mall occupancy was down about 20 basis points from last year, reflecting the impact of store closings from tenant bankruptcies. However, we have a robust pipeline of new deals.

Excluding Springfield Town Center, Gloucester and Fashion Outlets of Philadelphia, we currently have about 371,000 square feet of executed leases for future occupancies. These leases are expected to generate annualized revenues of over $11 million when they open in the fourth quarter of this year, and during 2016 and 2017. Approximately $5 million will come online in Q4, another $5 million in 2016, and the balance in 2017. We believe that the improved sales performance environment will continue to allow us to deliver strong renewal spreads and attract new retailers to the portfolio.

I wanted to clarify a point raised regarding five large format tenants leases that are included in our leasing activity report in the supplemental. We reflect that large format leases with rents that don't appear at the surface to offset capital investments. These leases are structured as a percentage rent transactions with the floor to provide us with downside protection. For disclosure purposes, we only included the floor rent. Based on sales projections for these tenants and how they perform elsewhere in the portfolio, the payback of these transactions will be substantially shorter.

Our capital allocation strategy has been to sell lower quality assets and recycle the proceeds from asset sales and to reducing our leverage or to make investments in properties with significant value creation opportunities, such as Fashion Outlets of Philadelphia, Target anchor replaces such as Whole Foods at Exton square, and selected other redevelopment opportunities. Since January of 2013, we have sold eight malls, four power centers, half interest in the gallery, and a number of out parcels generating total proceeds of $484 million. Including the proceeds from the sale of Voorhees Town Center, the other six non-core malls being marketed for sale and a land parcel in Gainesville that we have under contract, we anticipate gross sale proceeds in excess of $200 million with net proceeds reduced by $61 million of mortgage debt on two of these malls.

At the end of September, we had over $368 million of liquidity, including undrawn amounts outstanding under our revolving credit facility. Our current estimate of capital expenditures for our share of fashion outlets, the addition of Whole Foods to replace Kmart at Exton square, and other large format retailers are anchor replacements is approximately $200 million to $225 million. We believe we have ample liquidity to fund these expenditures by recycling proceeds from asset sales supplemented by credit facility borrowings.

At the end of September, our leverage is 50.2%. Our effective interest rate was 4.27%, 74-basis point reduction from a year ago, and our debt balances are well matured. I'm sorry -- our debt maturities are well laddered. In light of our current discount to NAV, we will consider the sale of our joint center power interest for joint venture properties in our core categories to raise additional capital if necessary to create additional liquidity or reduce leverage.

Concerning earnings guidance, earlier this month, we completed a reduction force with most of the reduction occurring in the corporate office. We expect to record a charge for employee separation expenses during the fourth quarter of approximately $1.8 million to $2 million, or about $0.025 per share. We also decided not to fill a number of recently vacated positions as part of a corporate reorganization aimed at creating efficiencies within the new portfolio and reducing our G&A costs to below 7% of revenues in 2016, the lowest in our recent history. As a result, we adjusted our forecast of GAAP net income and FFO earnings guidance for this charge. We anticipate adding this expense back to arrive at FFO as adjusted. The sale of Voorhees Town Center yesterday will result in approximately $0.005 of dilution for the balance of the year.

Regarding our outlook for 2015, we have revised our previous estimates of FFO as adjusted to be in the range of $1.83 to $1.88 per share after getting effect the dilution from the sale of Voorhees Town Center. We are tightening of our range for same-store NOI growth to 2% to 2.7%. We now expect that GAAP earnings per diluted share will be a net loss between $1.17 and $1.23, reflecting the additional dilution from asset sales, the impact of the quarter's impairment charges, and anticipated employee separation expenses.

Finally, I want to call your attention to a new presentation of our mall portfolio in the supplemental. In addition to our existing premier group, we reorganized malls formerly in our core growth category into two new categories to provide better clarity into the characteristics of these properties. Malls located in major markets generally defined as top 50 MSAs, and market-dominant malls generally located in other MSAs.

We moved Beaver Valley Mall into our core growth category, as economic activity in the Marcellus shale region creates a new opportunity for that property. We have moved Wire Grass Mall from core growth to non-core based on our plans to divest that asset. Finally, we eliminated the opportunistic category, based on our determination that malls in that grouping have either moved up or are moving out. With that, we'll open it up for questions.

(Operator Instructions)

Our first question comes from DJ Busch with Green Street Advisors. Please go ahead with your question.

Thank you. Bob, I just wanted to follow up on your last comments there regarding the re-categorizing of the malls. What is the criteria now, because it looks like there's a little bit of overlap in sales per square foot. It's certainly not the only criteria to qualify as premier in your view. What is the criteria or growth profile you're looking for when you put something in the premier mall category versus the core growth category?

The premier group would be looking to lead our NOI growth. So we would expect to see NOI growth in the 3% to 4% range coming from that group of assets.

Okay. And then just as it relates to the two different core growth categories, major markets, top 50 MSA, how do you look at the growth profile for those a little bit higher occupancy cost ratio than the market dominant? How do you view those different growth trajectories within those, because it seems like the market-dominant malls may be a little bit -- have a lower risk profile than the major markets, or is that not necessarily accurate?

They could, but to the extent that the major markets, I think we really wanted to highlight the fact that we have the concentration of assets both in Philadelphia and Washington, DC, top -- two top 10 MSAs. Clearly, there's going to be growth characteristics that may not be able to generalize for each of those two categories. There's certainly going to be some assets in the market-dominant category that may outperform growth rates for the major markets, but I think the major markets really is intended to really characterize the concentration that we have in the top MSAs.

And then just as it relates to the assets under contract, you said the buyer's seeking financing. What does the financing market look like for that quality of asset? Who are the lenders? Is it available? Can you add any color to that?

Hi, DJ. It's Joe.

Obviously, from a CMBS perspective, probably for a $300 a square foot and less property that doesn't exist. So much of our buyers, many of our buyers if not all, are dealing with traditional banks. They usually come bank-in-hand, if you will. And there's a couple of -- clearly, the loan to values have gone in the wrong direction from the buyer's point of view, as well as increased points in fees. But having said that, we closed a deal yesterday and we think we have a continued pipeline of buyers who can secure financing and can close. Look, selling lower quality malls has never been a walk in the park.

You have certainly made progress. Thank you.

You're welcome. Next question?

Mike Mueller with JPMorgan has our next question.

Hi. Couple of things. One, on the comments relating to G&A, what -- I know you're going to give guidance later on, but what's a rough ballpark number we should be thinking about for a more normalized go-forward G&A run rate?

I think, Mike, we're not prepared to give a number yet, but the target is to get at 7% of our real estate revenues -- under 7% of our real estate revenues.

Okay. Then as it relates to severance, can you give a little more color on where exactly you made the changes organizationally and just --?

Sure. Just to further comment on that under 7%, it would be again, in recent memory, historic low for us. And we think one of the -- we want to do that because we are confident that we can scale down this company, create a gem of a company, and operate it with a down sized G&A efficiently. In terms of what we did, we essentially, we did a number of things. We consolidated several departments from an administrative and IT perspective, but one of the key things we did was to go from three regions to two, given the reduction in our inventory, our properties. We down-sized from three regions to two, which provided us with some opportunities for reduction in force.

Got it, okay. Then one last one.

What exactly -- I heard the asset sale commentary about financing and everything else. What exactly is left to be sold over the near term? How many assets?

Well, we have, remaining on the market three assets with what I would characterize as an institutional buyer. In addition to that, we have both -- so that would be, by the way, Wire Grass, New River, and Gadsden. We also have on the market like [Coming], Palmer, and Washington Crown, total of six assets. Again, the three with the institutional buyer are under agreement and they are in due diligence right now and have secured a financing source. I think as it relates to the other three, I would say that we are in various stages of moving towards an agreement of sale with various buyers for those three.

Okay. And if everything lines up, do you think those are -- you would be finished with those six say in the first half of next year?

That's certainly the goal. I live in anxiety, so that's way too late.

Okay. And then once these six are finished, does that pretty much wrap up all the near-term stuff?

I think for the time being that will -- we'll take a breath at that point. That means we will have sold 14 non-core malls, if you will. And when I think about it from the remaining portfolio, sales at that point should be north of $450 a foot and should really put us in a position from a retailer perspective to have a very compelling portfolio. Over about 50% of our assets will be in either the Philadelphia or DC Metro.

Got it. And -- sorry.

No, go ahead.

I was going to say just one actually one other question. I think in your comments you were talking about the leasing spreads and I think you said on an expense pass-through basis, I'm assuming -- were you saying on a gross basis the spreads were about 20%, and was that year-to-date number? Is that a quarter number? Just a little more color on that.

Mike, the number that Joe cited was a number for the quarter. Essentially what we did was the fact that pass-throughs are reimburse. Whether our expenses go up or down, we really want to highlight the elements of the fixed rent, which would include your min-ren and to the extent we have any fixed cam.

So it's really an average rent compared to the ending rent for the expiring lease. I think that's the way most of our peers are reporting. So, historically, our reported numbers appear to be a lot lower than the peer group, but I think we were reporting on a different basis. This is really our attempt to begin to get it back into the main stream.

So you're not -- is this a GAAP number or cash number then?

That is a GAAP number.

It's a GAAP number, got it. Okay. Thank you.

Our next question comes from Ki Bin Kim with SunTrust. Please go ahead with your question.

Thanks. Could we -- first off, let me start off by giving an update on the leasing activity at Springfield.

I believe in yours supplemental you show physical occupancy not on a leased percentage basis. So maybe an update on where pro forma leasing is at that center, and of course it is always helpful to understand how much NOI is in the third quarter run rate and how much we should expect on maybe next couple quarters going forward. And similar question for [gallery] please.

Well, today the inline at Springfield is approximately 80% -- I'm sorry, is approximately 87% occupied, right -- 87% leased, I might add. It's about 79% occupied, about 87% leased. There are additional prospects, et cetera, to get us into the low 90s in Q1 2016. So from a --

Ki Bin, in the third quarter we had about $3.7 million of NOI from Springfield Town Center, and we would expect that in the fourth quarter to ramp up to about $3.9 million. And as Joe mentioned in his remarks, we would expect -- so on the nine months that we would have owned Springfield for the year, call it about $10.5 million, then we expect the number in 2016 to be about twice that amount. So 20 -- a little over $20 million.

And with respect to FOP, the NOI from -- essentially what is left as office tenants in a few retail, we're running about $1 million a quarter, and we expect that level to be maintained until we start with up to the grand opening date of revised property. So think about it as $1 million a quarter until the Fashion Outlets redevelopment is completed.

And I know you haven't given official numbers on the dollars and the yields, but should we -- how should we think about this? Is it the yield on incremental development costs that you're -- that we are thinking about, or is it yield on commodity development costs plus current yield on the base value of the asset?

I think at this point we're -- let me take a step back and just finish the leasing question on Fashion Outlets of Philadelphia, because I think you mentioned that in your point. Right now, it's a real anchor focus. We have a very robust pipeline of anchors that we are in discussions with. Some are in lease negotiations, letters of intent, et cetera. And that's our first priority is really to solidify the anchor transactions.

In -- and our sense is that's going to get concluded by in the next quarter. So it's -- that's where the leasing effort is for Fashion Outlets of Philadelphia. If you think about the balance of the lease-up, it's really going to occur over the next several years. Grand opening is two years away. I think from a --

How to look at the returns.

I think in terms of the returns, both ourselves and Macerich has talked about a return in the 8% to 10% range and that's incremental.

Okay. Thanks for the opening remarks regarding the new leases for bigger spaces. It looked like it was upside down on the supplemental. So, if I look at your Company and what you've done over the past year, gone through the bankruptcy era and released some of that stuff and improved the quality of the portfolio pretty significantly, but what I get concerned about looking into next year is that maybe we go through not the same level of volatility, but maybe something similar to it and maybe you lose some Gaps and Abercrombie stores. My question is when you look at your watch list of things you're worried about next year, is that a much more manageable smaller pool of things that you're concerned about or is it -- how would you describe that?

Well, we think to an extent we have sold off a good deal of the problems, right? That's step number, that's point number one. And many of the properties where we had problems with tenants like Gap, Abercrombie, Aeropostale, American Eagle, et cetera, we don't own anymore, right? That's one point.

I think as it relates to bankruptcies or store closings going forward, certainly we -- because we've transformed the portfolio, we don't expect a significant level of store closures. We're paying close attention to the children's operators, the juniors categories that I just mentioned, but we don't think that is a difficult-to-manage situation.

If you look back at the bankruptcies that occurred Q4 2014 and Q1 2015, we're about over 70% through the lease up of that. And, again, if you think back they were performing -- those tenants were performing sales at about $168 a square foot in sales, and I think the rent they were paying was probably 50% of our portfolio average. So, again, as the portfolio has improved, the impact of bankruptcies and store closings ends up being a positive one, not a negative one.

Okay. Thanks, Joe.

Thank you.

Our next question comes from Christy McElroy with Citi.

Good morning. Just a followup on the last question regarding the releasing of the bankruptcy space. The table that you have in your press release regarding the impact of sales per square foot is really helpful, but if the store closing favorably impacted by sales per square foot -- if they favorably impacted sales per square foot by $11 and you're about 70% of the way through the releasing, can you quantify the impact that the releasing of that space will have? So what's the average sales of the replacement tenants that you're working with relative to the portfolio average, and will it have sort of a neutral impact on the sales productivity number or will it enhance it?

I think it's hard to quantify sales for tenants, many of which haven't even opened yet, but our expectation is that the tenants that we're replacing, some of them are large format tenants, so it wouldn't be reflected in our comparative metrics, but we're replacing some of the bankrupt tenants with smaller shop tenants. We're generally improving the quality of the tenancy and we would expect an increase in sales from those replacement tenants, but at this point we haven't quantified that impact.

Okay. And then--

But we have done -- Christy, hi, this is Joe. We have done some sensitivity modeling around that where we've looked at, as a for instance, what H & M moving into a center does to overall sales performance, and I would say that it is positive in a significant way, right, in terms of the result of it. And also, again, to that point, in many cases we experienced store closing our core group of assets, so we're going to be bringing those H & M stores into, if you will, our core assets. And in many cases there's not an H & M for 50, 75 miles within that -- near that property. So we see it as a real opportunity to be an anchor to the property, not just a tenancy.

Okay. And then sorry if I missed this, but did you disclose what the cap rates were on Union Town and Voorhees? And then specifically to Voorhees, what were those credits issued the buyer related to?

Well, first off, we don't disclose cap rates. But my qualifier always when I answer that question is the fact that in a number of these instances we avoided what could be a problem where we needed to make a significant investment in a lower quality asset. In the case of Voorhees Town Center an impending anchor closing. So, we were -- we're probably less cap rate sensitive than some sellers, but we think it's the right decision to make, right?

And then just on those three malls that are under agreement, given that they have secured financing at this point, I think back in July that was still a consideration. What's your confidence level that the deal closes at this point where you stand today?

Depends when you ask me. I would say, look, they are very sophisticated buyer and this is a name you would know. They are a sophisticated buyer and these are always difficult transactions to bring home, but we feel good about them.

So these assets are under agreement, not under contract, right?

I don't -- I'm not sure what the difference is.

Okay.

They are under contract.

Just trying to get a sense for how firm it is.

They are under contract.

Okay. Thank you.

Our next question comes from Linda Tsai with Barclays. Please go ahead with your question.

Yes, hi. For the Philadelphia outlets, what are occupancy cost ratios like for these stores? Do retailers view it more as urban street retail in terms of the branding opportunity and therefore willing to pay more, or are the occupancy costs more comparable to traditional enclosed mall?

Well, it depends on the location within the property. I mean, clearly, the way in which the leasing is intended to occur, we're trying to minimize the street front retail that a store takes by creating either a two-floor store going up. In one case, we had a three-floor store going up or in some cases going down into the concourse level, but clearly frontage on Market Street is quite valuable. Philadelphia has, from a rent per square foot, made some huge strides in the past five years or so. So, street retail is quite valuable, and I would say generally the answer to that question is higher than a typical suburban mall.

Thanks.

And then in light of Whole Foods coming to Exton Square, do you think there's an opportunity to add a grocery component to any of your existing properties, either on out parcel, or maybe there is an opportunity to replace a traditional department store?

Well, this is our second Whole Foods. We did add one at Plymouth Meeting Mall. We like the co-tenancy. I think for us, tenants like Whole Foods or Fresh Markets or some of these more natural organic work a lot better, really, in terms of their size and scale.

Wegman's would probably be very difficult to configure into a mall environment, but we certainly continue to look to bring food, prepared foods, grocery into a mall environment. Working on one other deal right now. Not a Whole Foods; it's a little more unique, but I think it's a win-win.

Thanks.

(Operator Instructions)

There are no additional -- this includes our question and answer session. I would like to turn the conference back over to Joe Coradino for closing remarks.

Thank you for participating on the call. We strongly believe we are well on our way to transforming PREIT and that we will begin to consistently perform in the 3% to 4% same-store NOI range, consistent with our higher quality portfolio. Our post disposition portfolio presents a compelling opportunity for retailers, which will allow us to continue to drive our rent spreads and build our leasing pipeline. And we would like to invite you to join us for a deeper dive into the Company and our future at our planned investor day on January 20 and 21. We're going to be sending details out today. And thank you, again, and have a great day.

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