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Pennsylvania Real Estate Investment Trust (NYSE:PEI)

Q3 2012 Earnings Call

October 24, 2012, 11:00 am ET

Executives

Heather Crowell - Investor Relations

Joe Coradino - CEO

Bob McCadden - EVP & CFO

Analysts

Craig Schmidt - Bank of America

Michael Mueller - JPMorgan

Ben Yang - Evercore Partners

Quentin Velleley - Citigroup

Operator

Good day, ladies and gentlemen and thank you for standing by. Welcome to the Pennsylvania Real Estate Investment Trust Third Quarter 2012 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions) The conference is also being recorded today, Wednesday, October 24, 2012.

I would now like to turn the conference over to our host for today, Ms. Heather Crowell. Please go ahead ma’am.

Heather Crowell

Good morning and welcome to PREIT’s third quarter 2012 conference call. During this call, PREIT will make certain forward-looking statements within the meeting of the 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 24, 2012 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.

It is now my pleasure to turn the call over to Joe Coradino, CEO of PREIT.

Joe Coradino

Thanks Heather. Welcome to the Pennsylvania Real Estate Investment Trust third quarter 2012 earnings call. Joining me on the call today is our CFO, Bob McCadden.

We have established a clear plan with stated objectives and measurable goals, setting a determined path for moving forward that requires us to improve our balance sheet and achieve operational excellence in the interest of growing the company's platform in the future.

As discussed with you previously, our near-term goals are to achieve bank leverage below 60%, comp store sales above $400 per square foot, non-anchor occupancy over 90%, gross renewal spreads greater than 3% and growth in same-store NOI in excess of 2%.

In pursuit of balance sheet improvement, we have reduced leverage and average interest rates and have extended the average length of our debt maturities. In addition, we have increased our liquidity and have released two malls from our credit facility collateral pool.

As Bob will discuss in greater detail, during the quarter we completed financings from a diverse group of properties; Cherry Hill Mall, Cumberland Mall and Christiana Center. As a result of the success of the Cherry Hill Mall redevelopment and a substantial value creation, we were able to secure a $300 million, 3.9% mortgage on this property.

After the close of the quarter, we executed a second preferred share offering for the year lending our proforma bank leverage as of September 30th to just under 62%. It’s a significant progress from a nearly 67% where we began the year and toward our previously stated near-term goal of below 60%.

As another step towards de-leveling, we are negotiating the sale of two wholly-owned power centers, Paxton Towne Center and Christiana Center. The bidding process was robust yielding competitive market pricing. Upon closing, we expect that these transactions will result in a meaningful reduction of debt. The marketing of the Commons at Magnolia continues.

On the operations side, we are making progress toward our previously stated goals of driving increases in sales, NOI and occupancy and improving the quality of our portfolio. We had another consecutive quarter of sales growth, improvement in overall occupancy to 92.9% and a noteworthy improvement in our gross renewal spreads to 4.3%. We are taking a multi-pronged approach to improving the metrics of our core portfolio.

First, as you all know, we are looking to dispose some of our non-core mall properties which will improve our overall portfolio of operating metrics and unleashing leverage with national tenants. We are under contract to sell Orlando Fashion Square. The buyer has posted a non-refundable deposit is currently underway with efforts to secure financing and we are working toward the closing prior to year-end. We are also in discussion with several perspective buyers for Phillipsburg, North Hanover and Chambersburg malls.

Second, we are underway with remerchandising efforts of core group of assets that we believe have the greatest potential for near-term growth, guided by a prudent approach to capital allocation and investment returns.

During the quarter, we signed our first restaurant lease for Moorestown Mall with Iron Chef Marc Vetri to open Osteria, named one of the 101 Best Places in the World by Newsweek.

Mercy Health System opened 20,000 square foot Ambulatory Facility at Plymouth Meeting Mall, representing our first major tenant and is part of our strategic healthcare leasing initiative.

After the close of the quarter, new J.C. Penney stores opened at Willow Grove Mart and North Hanover Mall and Forever 21 opened a large format store in the former Border’s books location at Pacific Avenue Mall.

We also executed a lease for American Eagle Outfitters return to Plymouth Meeting Mall which we believe will be a catalyst to re-tenant the mall interior. In addition, to our attention on near-term goals, we are also focused on the company’s growth; along these lines, we are pursuing a number of organic growth opportunities. You may have read that we are in discussions to acquire a property and growth to the gallery of Market Eastern downtown Philadelphia. We have an opportunity to expand our interest in the property what we believe that a measured approach with a measured approach we can create value. The overall gallery project is in the formative stages and requires cooperation from any different end use, including the City of Philadelphia and others in the public financing arena.

Our results during the quarter were consistent with our expectations. Recent separation course and the balance sheet improvements are impacting our earnings which Bob will talk a little bit more about. We view many of these items as temporary, but necessary in the name of progress.

So in summary, we are focused and determined to execute our plan and have made progress in our balance sheet to refinance it, preferred offerings and power center dispositions. On the operational front, we are growing occupancy, sales and renewal rents and are also making progress on the sale of our non-core properties and we remain myopically focused on the execution of our strategic objectives. We anticipate healthy holiday sales growth consistent with NRF and ICSC projection.

And with that, I will turn the call over to Bob McCadden.

Bob McCadden

Thanks Joe. FFO as adjusted to exclude the provision for employee separation expenses was $25.1 million or $0.43 per diluted share for the quarter ended September 30, 2012, reflected a diluted impact of the Series A preferred share dividends. This compares to $29 million or $0.51 per diluted share for last year’s quarter which included a $1.5 million bankruptcy settlement and higher margins from redistributed utilities based on then higher tariffs.

Same store NOI excluding lease termination revenue for the quarter ended September 30, 2012 was $67.7 million, compared to $68.4 million for last year’s quarter. Lease termination revenue for the quarters ended September 30, 2012 and 2011 was $3,00,000 and $2,00,000, respectively.

Results for the quarter were impacted by, lower margins and redistributing utilities which accounted for approximately $400,000 of the difference from last year. We were impacted by a 3% decrease in electric usage by our tenants; while our costs of procuring electricity, was down by 3% per kilowatt hour. The redistribution rates were committed to charge our tenants lower on average by almost 17% in the 2012 period as compared to the 2011 period.

We are experiencing a temporary reduction in occupancy and revenues at Moorestown Mall which is being impacted by the store closings, construction of a new theater and other factors related to the redevelopment in the coming quarter which accounted for an additional $400,000 of the change in NOI.

We also had $300,000 decline in operating margins at the non-core mall properties being offered for sale, principally Phillipsburg Mall. Same-store NOI for the core-mall properties including Moorestown was up by three-tenths of 1% for the quarter on higher occupancy.

Interest expense for the quarter was $33.9 million or 2.3% over than last year’s quarter. This improvement reflects lower average borrowings and slightly higher average rates reflecting a one year step up swap on $200 million of floating rate debt that went into effect in April of 2012. This step up swap entered into in 2010 expires in March of ’13. The negative impact of the swap was partially mitigated by lower interest rates from the 2012 financings.

Average borrowings were $111 million lower than last year’s quarter, and the effective interest rate on all of our borrowings during the quarter increased by 8 basis points to 6.06%. Total occupancy at the end of the quarter was 92.9%, an increase of 100 basis points over the same period last year. Non-anchor occupancy increased 130 basis points from 87.8% to 89.1%.

On the leasing front, we executed 195,000 square feet of new transactions and 461,000 square feet of renewal transactions. For these renewals, we generated an increase in base rents of 3.9% compared to expiring rents and 4.3% on a gross rent basis. Year-to-date, we have generated increase in base rates by renewal of 3.9%, which compares favorably to the 1% spread for the same period last year and we have completed 48% for non-anchor renewal transactions.

In addition we have executed leases for 710,000 square feet at an average base rent of $25.77 per square foot in the first nine months of the year, compared to 684,000 square feet at an average base rent of $18.24 per square foot in the same period in 2011. Comp store sales continue to improve and with $379 per square foot at the end of the quarter, we now have six properties reporting sales of $400 per square foot and are particularly pleased with the continued growth at our Cherry Hill Mall, which now boasts sales of over $639 per square foot.

If we exclude the non-operating or the non-core mall properties sales per square foot average $389. Outstanding debt at the end of the third quarter including our share partnership debt was $2.28 billion, a decrease of $102 million from September 30 of 2011. As Joe mentioned, we have been very active on the capital market front. During the quarter, we refinanced three mortgage loans for $402 million at an average interest rate of 4.06%, generating assets proceeds of approximately $85 million before closing costs and lowering the average interest rate by 124 basis points.

Year-to-date we have completed $496 million of property level financings, generating net proceeds of approximately $103 million and a reduction in average interest rates of 129 basis points to 4.25%. Following these financings, the company's weighted average maturity for its mortgage loans increased to 5.4 years from 3.4 years as of December 31, 2011. We have no remaining mortgage debt maturities until June of next year.

In October, we executed our second preferred share offering this year, closing on an issuance of 3.4 million shares at 7.38%, generating net proceeds of approximately $83 million. We used $15 million of the proceeds to repay the full amount outstanding under revolving facility and $58 million to permanently reduce borrowings under the 2010 term loan. In connection with this repayment we released wire graphs and cross roads malls on a credit facility collateral tool.

In the fourth quarter, we will accelerate the amortization of $700,000 of non-cash deferred financing costs related to the permanent pay down of the term loan. And immediately after repayment there was no balance outstanding under the revolving facility and $182 million outstanding under the 2010 term loan. Following this in the April offering, we now have a total of $201 million of preferred equity outstanding at a blended rate of 7 and [7.8].

Turning to guidance, we're adjusting our estimate of net loss per diluted share and FFO per diluted share of 2012 to give [effect] to the October 2012 issuance of seriously preferred shares, related accelerated amortization of non-cash deferred financing cost resulting from the permanent reduction, the 2000 term loan and other factors. Our estimated net loss per diluted share ranges from a loss of $0.70 per share, an FFO of adjusted is now estimated to be $1.82 to a $1.87 per diluted share.

Our fourth quarter performance will obviously be impacted by the strength of holiday sales, weather related expenses and pending credit worthiness. At last years fourth quarter, our bad debt expenses was de minimus and we benefited from a lower than average weather related (inaudible) expenses. With that, we will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Craig Schmidt with Bank of America. Please go ahead.

Craig Schmidt - Bank of America

I wanted to focus a little on the Plymouth Meeting mall. It seems like in the last couple of years, you’ve been able to grow the sales per square foot, but the average rents continue to turn down. Looks like in 3Q ‘09, you had average around 34.52, then it dropped to 31.75, 29.04 and then this year 28.17 what do you think the future kind of those average rents are going to be and what kind of driving these average rents down?

Joe Coradino

Well I think well first off I think it’s good news that American Eagle is coming back to Plymouth Meeting mall, which is they left in I believe it was ’08. In any event, and our overall strategy around Plymouth Meeting mall was to populate the exterior of the mall with the restaurants, whole food etcetera in the hopes of growing interior space. The property is in a highly competitive environment, 10 miles from (inaudible) mall not too far from Willow Grove.

We have had to put a number of 10 inch in the interior of the mall on I would say deals that were not as favorable as we would have liked. However, I think the future and the transactions that we have in the pipeline are more favorable and we are beginning to take the mall in a direction that we anticipate it taking it to. It used to be a property used to keep us up nights; it’s not keeping us up nights as much any more. There is a healthy pipeline of transactions.

Craig Schmidt - Bank of America

Whatever you are targeting say in the next couple of years in the interiors space to be leased to occupy that?

Joe Coradino

You mean in terms of a percentage of occupancy.

Craig Schmidt - Bank of America

Yeah.

Joe Coradino

Clearly we think we’ve been in the Plymouth Meeting mall into the mid 90s, and we think in the near term we could achieve some thing approximately 90% that's our goal.

Craig Schmidt - Bank of America

What you think the occupancy cost would be as a percent of sale?

Joe Coradino

I don't have that number in my finger tips, right now.

Bob McCadden

Craig I think we expect to drive our occupancy cost to at least the portfolio average.

Craig Schmidt - Bank of America

Okay, right now we are not show the 8%?

Bob McCadden

Right, we expect to get into the 11 and 12 range.

Operator

Thank you. And our next question comes from the line of Michael Mueller with JPMorgan. Please go ahead.

Michael Mueller - JPMorgan

First of all Joe coming back to the leverage where you talk about of having leverage below at 60%, are you including preferred as equity in that calculations or are you including that in leverage?

Joe Coradino

When I talk about leverage, I am talking about bank leverage and so the preferred equity is not in that number.

Michael Mueller - JPMorgan

So you just touched that, that’s below 60%, okay. And then can kind of going to the assets sales, you went through and you talk about a lot of properties, is it possible to as best as you can at this point maybe put some sort of a rough timeframe there. I think you said [Orlando Fashion] square maybe before year end negotiation on (inaudible), could those be 2012 for events as well, does it fell like the 2013, the other stuff for this discussion. Just anything you can do for like a rough timeframe, a little bit more will be great. And then is there a way to bigger picture if you [rumbled] all the stuff together, what's the potential magnitude dollars, if everything hit, I mean what’s the rough dollar amount this could be given a wide range and then thinking enough proceeds?

Bob McCadden

So you asked a couple of questions there, with respect to the timing when we as I said on the call we are anticipating a closing on Orlando prior to year end. I think the power center is probably either fourth quarter or first quarter of next year. We obviously can't guarantee that. We are in negotiations. With respect to a magnitude that's something but we are in a pretty sensitive stages of negotiations at this point and any information I gave you wouldn't be constructive to getting the deals done. So I prefer you guys will be the first to know when we have the money in hand. It’s not over until the (inaudible) try and have the money.

Michael Mueller - JPMorgan

Okay.

Bob McCadden

But understand I mean this is a primary focus of ours right now. We've got an internal team who is working on nothing else other than disposing of the power centers and the non-core mall assets. They are making progress, they are in discussions and we talk about it everyday.

Operator

And our next question comes from the line of Ben Yang with Evercore Partners. Please go ahead.

Ben Yang - Evercore Partners

Just going back to the earlier question on rents, maybe more broadly I probably understand the lag between sales and rents but it’s a little surprising to see this kind of for three years and your average rents overall continuing to fall and is there something going on in your market maybe stronger competition, changing demographics that would suggest that maybe there's little embedded rent process in the portfolio despite the higher sales that you guys have achieved?

Bob McCadden

There's a couple of things going on I think, we've been, as we've converted, I will call it a number of different factors. First of all, as you would imagine that as we move the occupancy up at any level as we increase occupancy your leasing on average less desirables for the shopping center. So by definition you are, the space that your leasing is going to be less valuable than the portfolio average. Likewise, when you see decreases in occupancy typically the spaces that are based and those that are on the side carters and up against the (inaudible) so there's a natural average dilution that takes place as occupancy increases.

Secondly, as you know we've talked about this during the 2004 to 2010 period as we were undergoing redevelopments we were doing a lot of gross deals percentage of sales deals and as we convert some of those back to net rent payers, the base rent is actually flatter declining because now we are able to charge some extras along with that. So one of the things we will likely do is begin reporting our rents on a gross basis either at the end of this year or the first quarter of next year believing that's a more meaningful metric than base rents which sometimes (inaudible) which is actually happening in the portfolio.

Joe Coradino

And I would add to that. This is Joe. I would add to that, that there our occupancy of course its now at about 11.4%. We see that as an area of opportunity to respond further to your question, we brought in a new leasing person, a 17 year veteran from (Simon), who brought in a former VP from Vornado and a new Head of Partnership and Marketing from West Field. I mean so we've got some fresh new talent in here and we think we can see that as an opportunity for us and move in it in a positive direction.

Ben Yang - Evercore Partners

I mean, I guess it's still surprising to see some of your malls. The average rent in the entire mall got parked down so quickly, down 15%. I mean is that fully attributable to when you talk about the last set of occupancies that lower or is there something else kind of unusual going on. I mean it just seems so large and so fast that rent could decline so by that amount?

Bob McCadden

No, we did have a focus in the last few years during the economic downturn of pushing occupancy at the expense of rents and clearly I think that focus has changed because there is little leverage that you have when you are at a 75% occupancy level and you start to move that pass through 80%, 85% closer to 90% it gives us a little more leeway to push rents. But while you are sitting there with the quote of your mall based in some cases, it's roughly hard to attract that next tenant without making some economic concessions.

Ben Yang - Evercore Partners

But would you say that the environment is getting better, where you are getting a little more [quote] as you are negotiating the leases in some of these malls?

Bob McCadden

I think it's reflected in our renewal spreads, the expenses over the last six or eight quarters you will see. We are probably generating renewal spreads double-digit negatives and now we're in the positive territory. We've been there for some period of time.

Ben Yang - Evercore Partners

Okay, fair enough. Did you give an average for Orlando Fashion, the one that you are going to sell for or you still negotiating that one?

Bob McCadden

Really not in a position to talk about a cap rate at this point.

Ben Yang - Evercore Partners

Okay, but you guys will tell us when that gets sold?

Bob McCadden

Yes we will.

Operator

Thank you. (Operator Instructions) And the next question comes from the line of Quentin Velleley with Citigroup. Please go ahead.

Quentin Velleley - Citigroup

Just in terms of, I just want to talk a little bit about NOI growth and obviously you had good retail sales growth and a good increase in occupancy but it hasn’t yet been reflected in same store NOI and I guess that goes to some of the comments you made about the electricity recoveries and also some of the expense increases, how should we be thinking about operating expenses and the recovery right going forward? Should we see an improved recovery right and some improvement in operating expenses that should drive some better NOI growth or is this still a little bit of risk there?

Bob McCadden

A large part of our operating expenses are [permanent] control but non controllable. I think what you are seeing a reflected and the quarterly performance I think we benefited as we talked about last year from the one-time increase in utility rates for some of our Pennsylvania properties to some extent now that we are working irregular environment you may see a little bit about more volatility on some of those line items. So we are buying electricity on the upper market typically buying it ahead on a slower basis but the utility commission of this state basically separates at their [win]. So sometimes we made the advance of that where some other periods like that.

So you are going to see I think again more volatility on the utility leadership income line. Also early part of this year and the end of fourth quarter of last year we had the benefit of relatively mild weather which reduced the amount of some renewal cost and broke down our common area electric usage as well. So again those are not controllable that we are really at the mercy Mother Nature if you will. And with respect to the controllable we have entered into long-term outsourcing contracts with our maintenance and security providers and typically provide for equivalent of their cost of living increase in the annual contract amounts. So those are generally pretty predictable and we know what they are going to be year to an advance, but it’s the non-controllable that create the volatility in our quarterly had aligned quarterly expensive.

Quentin Velleley - Citigroup

Okay, and then just in terms of market. I think you really (inaudible) space could you just talk about what the opportunities with the other space, or is leasing that really contingent on whether or not you buy joining property and what your redevelopment plans might be?

Bob McCadden

Actually yes, we did retain a significant portion of (inaudible) building with suppose to State of Pennsylvania and the Philadelphia newspaper, Philadelphia Inquirer and Daily News. So currently you have concords one and two available, three building available and we are actively in the leasing effort for that, that building can be leased irrespective of whether or not the redevelopment of the balance of the gallery takes place or the acquisition of the 907 market building occur. So we are forward that will be a highlight of our trip to New York, we will focused on leasing that, we have the number of prospects.

Quentin Velleley - Citigroup

Okay, and then just with that asset for whether or not you buy the adjoining property. How should we think about the timing of the deal and could you might be just talk a little bit about, who else has interest in the project and ultimately how much capital you might be spending on it, assuming you do go forward with an acquisition and the redevelopment?

Joe Coradino

Are you talking about interest from a tenant perspective?

Quentin Velleley - Citigroup

Well, it’s kind of like this local government interest and from a…

Joe Coradino

Okay, so if you think about the gallery you think about two things, one is its going to require a significant public financing which is a work in progress, right. And a number of government concessions that need to occur that we are working on. With respect to the timing of it, it would be difficult to predict at this point, given the slowness of the government decision making process, number one. Number two, with respect to the cost same because the scope and scale of the project is going to be driven to a great extent by the amount of public financing that we end up getting. We will design a project based on how much public financing we get. But if you want to get some real color on this between, come to our Investor Day, at (inaudible) commercial. November 8.

Quentin Velleley - Citigroup

We will all look forward to that. And then just a last question for me, we have seen a retail group which I guess is [Justice] a lot of your [Justice] stores. The number of locations under percentage rent deals look like it went up a double by the square footage by the same. I am not sure if it was just a difference in classification of your store panel or something there.

Joe Coradino

I don't think anything happened.

Quentin Velleley - Citigroup

There must just be a difference in the supplemental but that's okay.

Joe Coradino

Yeah, they acquired Dressbarn right. They acquired Dressbarn in the last couple of quarters. So that would be the inclusion of the Dressbarn location into the portfolio.

Quentin Velleley - Citigroup

Right. But the number of locations went up and it looked like the [JLI] didn't but maybe it just a classification issue?

Bob McCadden

Yeah, we will double check that. If there is more color there we will get back to you.

Operator

Thank you and I'm showing no additional questions in the queue at this time. I will now turn the call back over to Joe Coradino for any closing remarks.

Joe Coradino

Well, thank you everyone. And as a reminder we do have an Investor Day coming up on November 8th. We will go into more detail on our strategic objectives and plans for the future. We hope you will all be able to join us for this event. If you need additional information please feel free to contact Heather Crowell in our Investor Relations department. So thank you very much for participating in the call and have a great day.

Operator

Ladies and gentlemen that does conclude our conference for today. Thank you again for your participation and you may now disconnect.

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