Americold Realty Trust, Inc. (COLD) Q2 2019 Earnings Report, Transcript and Summary

Greetings, and welcome to the Americold Realty Trust second-quarter 2019 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Scott Henderson, senior vice president of capital markets and investor relations. Please go ahead, sir.

Good afternoon. We would like to thank you for joining us today for Americold Realty Trust Second Quarter 2019 Earnings Conference Call. In addition to the press release distributed this afternoon, we have filed a supplemental package with additional details on our results, which is available in the Investor section on our website at www.americold.com. On today’s call, management’s prepared remarks and answers to your questions may contain forward-looking statements. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. A number of factors could cause actual results to differ materially from those anticipated. Forward-looking statements are based on current expectations, assumptions and beliefs, as well as information available to us at this time and speak only as of the date they are made. And management undertakes no obligation to update publicly any of them in light of new information or future events. During this call, we will discuss certain non-GAAP financial measures. More information about these non-GAAP financial measures and reconciliations to the comparable GAAP financial measures is contained in the supplemental information package available on the company’s website. We would also like to note that numbers presented in today’s prepared remarks have been rounded to the nearest million with the exception of per share amounts. This afternoon’s conference call is hosted by Americold’s chief executive officer, Fred Boehler, and Executive Vice President and Chief Financial Officer Marc Smernoff. Management will make some prepared comments, after which we will open up the call to your questions. Now I will turn the call over to Fred.

Thank you, and welcome to our second quarter 2019 earnings conference call. This afternoon, I will provide highlights for the second quarter and discuss macro trends driving our business. I will then update you on our development pipeline and recent acquisition and integration activity. Marc will follow with a review of our second quarter results and then discuss our balance sheet, capital markets activity and outlook. After our prepared remarks, we’ll open up the call for your questions. The second quarter was a strong quarter for Americold. We reported revenue growth in our Global Warehouse segment of 17.6% and NOI growth of 25.3%, which includes two months of results from our recent acquisitions. On the margin side, as our platform and scale have grown, we continue to benefit from the operating efficiency gains driven by labor productivity and the leveraging of fixed expenses. For the second quarter, our Global Warehouse segment NOI margin expanded by 208 basis points over the same quarter of the prior year to 33.7%. Finally, we are pleased with the performance of our core portfolio. On a constant currency basis, our Global Warehouse segment same-store revenue grew by 3.4%, and our same-store segment NOI grew by 6.2%. Now I’d like to take a moment to discuss the underlying fundamentals within the temperature-controlled warehouse industry. We continue to see attractive supply and demand dynamics that are most favorable to owners of large, fully integrated networks of temperature-controlled warehouse space. We continue to support our more than 2,600 customers, including large global accounts and our mid-sized and emerging customers. We also continue to work with our retail customers as they navigate the evolving competitive landscape by enhancing and integrating their e-commerce offerings. While we believe that the growth of e-commerce does create opportunities for Americold, for the most part, e-commerce does not add overall demand. It simply shifts the end distribution point and customer fulfillment means. Accordingly, as we have previously stated, we expect that demand will rise steadily with population and corresponding consumption growth. In addition, the ongoing shift in consumer preferences toward healthy, perishable food increases the demand for temperature-controlled infrastructure. We believe these fundamentals are sustainable over the long term. Diving deeper into the trends impacting grocery retail, we know that retailers carefully select their restore locations, typically within three to five miles of targeted populations. As a result, the best place for retailers to service last-mile logistics, including click-and-pick shopping or home delivery, is the store itself. This is because transportation costs are typically the most expensive part of the supply chain, so utilizing space that is closest to the end user for the full availability of their inventory is the most advantageous. As a result, we continue to see retailers invest in readily available automation and technology within their existing stores that facilitates more efficient selection of high-volume products to support e-commerce. As these retailers prioritize their investments in the customer experience and maintaining low prices, Americold stands ready to provide advanced supply chain solutions and infrastructure for their temperature-controlled needs. On the supply side, significant barriers to entry remain in place. These include high construction costs, as well as requisite operational expertise and customer relationships. Our processes are backed by many years of research and millions of dollars of technology investment. We leverage this investment, along with the expertise we have developed in-house to create advanced solutions for our customers. This, coupled with the Americold Operating System, drives significant competitive advantages and gives our customers confidence in our ability to maintain their brand integrity. We believe this customer-centric focus, combined with our portfolio that has the right assets and the right locations, will serve us well as we seek to achieve consistent and profitable growth over the long term. Now I’d like to turn to our development activity where we have been making exciting progress. In Chicago, at our state-of-the-art automated expansion project, we have completed construction and have received temporary certificates of occupancy. We are currently commissioning our automation systems and continue to inbound customers. As a reminder, we underwrite to achieve stabilization in one year, and we believe we are well on track. In Australia, we continue our conversation with our customers on our build-to-suit projects. Due to changes in the timeline, we can now update you that our spending will be pushed out by a year to 2020, with the first delivery and associated cash flows now expected in 2022. While we expect the economics and the return profile to remain the same, we would remind you that this is a customer-driven build. And as such, we have to remain flexible to meet their needs. In Atlanta, we continue to make progress on our major market expansion at Tradewater and the redevelopment of our Gateway property to a state-of-the-art automated facility. At completion, we will have significantly increased our capacity in Atlanta where available space is limited due to strong customer demand. Finally, in Savannah, we broke ground at the end of the second quarter on our planned 15 million cubic foot state-of-the-art temperature-controlled facility. On the transaction front, during the second quarter, we completed the acquisition of Cloverleaf Cold Storage, which consisted of 22 facilities comprising 132 million cubic feet, and Lanier Cold Storage, which added two facilities and 14 million cubic feet to our portfolio. These acquisitions meaningfully grew our portfolio and added size, scale, density and diversification of product and customer. Since closing, we have been focused on fully integrating these assets into our portfolio. At Cloverleaf, we have begun to realize synergies and eliminated redundant corporate SG&A. While Marc will discuss the financial impact. I would like to note that we have already successfully integrated their 22 facilities into our U.S.A. operating structure. Further, we have implemented our commercial processes and have begun rolling out the Americold Operating System across all sites. We have also transitioned their core SG&A functions, including HR, finance and engineering, to our headquarters in Atlanta. I’m excited about our progress to date, and I believe we are on track to achieve our synergy goals. With respect to the development pipeline we acquired as a part of the Cloverleaf acquisition, we have reviewed each of the three expansions, which are located in Chesapeake, Virginia, Little Rock, Arkansas and Columbus, Ohio. These projects, which total $51 million to $57 million of investment, have been aligned with our Americold standards and construction continues to be on track. Turning to Lanier. We are far along with the integration of both sites. Our existing local market presence in Gainesville helped us to quickly integrate this acquisition into our operations. We have begun to implement our operating system and move both facilities to our commercial platform and processes. We expect to recognize the benefit of moving to the Americold Operating System and engineered standards over time. Finally, before I turn the call over to Marc, I’d like to note that we’ve recently announced the appointment of three new members to our Board of Trustees, Kelly Barrett, Tony Fernandez and David Neithercut. These three individuals have skill sets that are complementary to our existing Board, and we look forward to benefiting from their fresh perspective and experience. With these additions, our Board remains at nine members, eight of which are independent, which we believe demonstrates our commitment to shareholder-friendly corporate governance. Now I will turn the call over to Marc.

Thank you, Fred, and good afternoon, everyone. Today, we will provide updates on our actual performance, as well as certain metrics on a constant currency basis. We would also note that our portfolio results this quarter includes the benefit of two months of ownership following the closing of the Cloverleaf and Lanier acquisitions. For the second-quarter 2019, we reported total revenue of $438 million and total NOI of $121 million, which reflects an 11.1% increase and a 23.3% increase over the prior year, respectively. Core EBITDA was $94 million for the second quarter of 2019, an increase of 27.1% year over year. As a result, our core EBITDA margin grew by 269 basis points to 21.4%. We reported net income of $5 million, compared to net income of $29 million for the same quarter of the prior year. Please note, our net income was impacted by several items, including costs associated with our recent acquisition activity and subsequent integration efforts to realize synergies. Also, please note that second- quarter 2018 net income included $8.4 million in gains on the sale of real estate. Our second-quarter core FFO was $56 million or $0.30 per diluted share. This compares to $43 million or $0.29 per diluted share in the second quarter of 2018. Our second-quarter AFFO was $58 million or $0.31 per diluted share, compared to $40 million or $0.27 per diluted share in the second quarter of last year. As a reminder, the full definition and reconciliation of core EBITDA, core FFO and AFFO to reported net income can be found in our supplemental. For the second-quarter 2019, Global Warehouse segment revenues were $338 million, which reflects growth of 17.6% year over year. Segment NOI was $114 million, which reflects growth of 25.3%. Global Warehouse margin was 33.7% for the second quarter, a 208-basis-point improvement over the same quarter of the prior year. We estimate that about 60 basis points of this margin expansion can be attributed to our recent acquisitions. At quarter end, on a dollar volume basis, $232 million of our rent and storage revenues were derived from customers with fixed commitment storage contracts, as compared to $222 million in the first quarter of 2019 and $203 million for the second quarter of 2018. Our recent acquisitions have a lower percentage of fixed commitment contracts as a percent of rent and storage revenue. On a combined pro forma basis, 38.3% of our rent and storage revenues are on fixed commitment contracts. We view this as an opportunity as we bring these acquisitions onto Americold’s commercialization standards. Now I will turn to our same-store results in the Global Warehouse segment. We define same-store as facilities that have at least 24 months of normalized operation. For the second-quarter 2019, 138 of our 166 warehouses were included within our same-store pool. One recently stabilized facility was moved into our same-store pool this quarter, and the total number of warehouses reflects our recent acquisitions, as well as the sale of our last remaining idle assets. Finally, we would note that our same-store results this quarter reflect the timing of the Easter holiday in the second quarter of 2019 as compared to the first quarter of 2018. Please note, the number of business days was the same in the second-quarter 2019 and the second quarter of 2018. In the third quarter of 2019, our results will include one additional business day compared to the prior year. As we have said, given the seasonality of our business, we believe that our annual results are the best way to track our progress. For the second quarter of 2019, our same-store Global Warehouse segment revenues were $288 million, which reflects growth of 1.5% year over year and 3.4% on a constant currency basis. Global same-store NOI was $95 million, up 4.9% over the prior-year results and grew by 6.2% on a constant currency basis. As a reminder, this comparison was impacted by a previously announced $1 million benefit realized in the second quarter of last year for favorable workers’ comp settlements. Adjusting for those prior-year benefit, same-store NOI growth would have been 7.4% on a constant currency basis. Looking ahead to the third and fourth quarters, we did not recognize any one-time favorable benefit last year. I will now discuss our same-store results in a little more detail. For the second quarter, global same-store rent and storage revenues grew by 0.3% year over year or 2% on a constant currency basis. Our same-store economic occupancy was 76.7%, down 148 basis points from the prior year. Our continued transition to fixed commitment contracts partially offset a 249-basis-point decline in physical occupancy.O Our global same-store rent and storage NOI grew by 2.4% year over year or 3.8% on a constant currency basis. This corresponding NOI growth was a result of active portfolio management, combined with our efforts to grow our fixed commitment storage contracts and disciplined cost controls through the Americold Operating System. Global same-store warehouse services revenue for the second quarter increased 2.4% year over year or 4.5% on a constant currency basis. This increase resulted from the volume associated with the Easter holiday combined with a favorable mix, which resulted in a 3.7% growth in our same-store warehouse services revenue per throughput pallet. This more than offset the 1.2% lower throughput pallet volume associated with this mix. Our same-store warehouse services NOI was $13 million, an increase of $3 million or 24.7% for the quarter. Warehouse services NOI margin increased 141 basis points to 7.9% in the quarter due to our favorable customer mix and improvements through the Americold operating system. Please note that adjusting for our workers’ comp benefit realized in the second-quarter 2018, our same-store warehouse services NOI growth would have been 38.7% on a constant currency basis. Using the same-store pool for the first half of the year, which represents 137 facilities and normalizes for the impact of the Easter holiday, our revenue growth was 3.1% and NOI growth was 3.9% on a constant currency basis. Adjusting for the $2 million workers’ comp benefit received in the first half of 2018, our NOI growth would have been 5.1%. This is consistent with our expectations for the year. Within our Global Warehouse segment, we had no material changes to the compositions of our top 25 customers who, on a pro forma basis, account for 60% of our Global Warehouse revenue and who have been with us on average for over 30 years. Additionally, our churn rate was approximately 4% of total warehouse revenue, a 100-basis-point increase over the same period last year. Our active portfolio management and our continued emphasis on shifting to fixed storage commitment have contributed to the slight increase. Corporate SG&A totaled $33 million for the second quarter of 2019, as compared to $28 million for the comparable prior-year quarter. This increase is primarily a result of the SG&A absorbed with the acquisitions of Cloverleaf and Lanier, increased stock compensation expense and additional investments made to support our expanded development pipeline. Additionally, we incurred total cost of $18 million for the second quarter, as shown on the acquisitions, litigation and other line within our statement of operations, which primarily reflects M&A advisory fees and integration-related severance. Now let me update you on our development and acquisition spending during the second quarter for the projects Fred outlined to you. In aggregate, we spent $77 million year to date on expansion and development capital. In Chicago, our total estimated cost and stabilized returns remain consistent with our prior stated range. As Fred mentioned, we have completed construction, and we are in final commissioning phases of the automation system. We expect to achieve stabilization within the next 12 months. In Atlanta, we began construction during the second quarter, and spending totaled $3 million. In Savannah, we broke ground at the quarter end, and second-quarter spending was not meaningful. And finally, with respect to the three in-process expansion projects we added as part of the Cloverleaf acquisition, we spent $20 million through the end of the second quarter out of an anticipated total spend of $51 million to $57 million. This includes $9 million spent prior to our ownership. Turning now to our balance sheet and capital markets activity. On May 1, we closed the acquisition of Cloverleaf Cold Storage for a purchase price of $1.25 billion. This translates to an approximate 7% NOI entry yield, which is exclusive of SG&A expense. The transaction was accretive day one on a leverage neutral basis, and we are currently working to realize synergies. Of the $10 million in total cost savings that we expect to realize, we have already eliminated approximately $4 million on an annualized basis, mainly consisting of duplicative corporate expenses. Further, we have taken actions to eliminate an additional $5 million of corporate costs and $1 million of operational spend in the warehouse segment, both on an annualized basis. Please keep in mind that of these total synergies, our original expectation was to capture a run rate of $8 million in the first 12 months after closing. We are on track to meet or exceed this target. Additionally, on May 1, we acquired Lanier Cold Storage for $83 million, which translates to an approximate 7.9% NOI entry yield, again, exclusive of SG&A expense. As Fred mentioned, we are making progress on integration as expected. As of June 30, 2019, our total portfolio consisted of 178 mission-critical facilities. Of these, 166 are in the warehouse segment and 12 are managed, and our total portfolio exceeds over one billion cubic feet. With respect to our capital markets activity, in April, we issued 50.31 million shares in a follow-on offering, including the exercise of the underwriters’ option at $29.75 per share. The 50.31 million shares were inclusive of a forward contract for 8.25 million shares to be settled within one year. We utilized the net proceeds, which totaled $1.2 billion prior to the forward offering, to fund our acquisition and development activity. Also in May, we closed on the private placement of $350 million of senior unsecured notes, which bear interest at a rate of 4.1% with an initial duration of 10.7 years. We used the fund as long-term debt financing for the Cloverleaf and Lanier acquisitions. As of June 30, 2019, we had total liquidity of $1.5 billion. This includes $138 million and $236 million of net proceeds from our September 2018 and April 2019 equity forwards, respectively. Our total debt outstanding was $1.9 billion, of which 75% was in an unsecured structure and 80% was at a fixed rate. Our pro forma net debt to core EBITDA was approximately 4.1x. Our real estate debt has a weighted average term of 6.9 years and carries a weighted average contractual interest rate of 4.49%. Subsequent to the quarter end, we extended our forward contract from September 2018 by 12 months with a new settlement date of no later than September 2020. We made this decision in light of our recent capital markets activity, which provides us with adequate liquidity for our near-term funding needs. Before I turn the call back to Fred, we’d like to update you on our outlook for the remainder of 2019. We are reiterating our Global Warehouse segment same-store revenue growth range of between 2% to 4%, and we continue to expect same-store NOI growth to range between 100 to 200 basis points higher than the associated revenue growth, both on a constant currency basis. SG&A expense as a percentage of total revenue is expected to range between 7% and 7.2%. This reflects the timing and integration of our recent acquisitions, as well as increased resources for our development pipeline. We expect to be able to leverage these expenses over time, as our developments and the associated revenues come online and as we realize synergies from our recent acquisitions. Recurring maintenance and IT capital expenditures are expected to be within the range of $56 million to $66 million, which reflects the addition of Cloverleaf and Lanier portfolios. Development capital expenditures are expected to be $220 million to $250 million. This includes spending related to the company’s announced projects in Chicago, Savannah, Atlanta, our land purchase in Sydney, as well as three expansions associated with Cloverleaf. This also reflects the shift of our anticipated spending in Australia being pushed out an additional year to 2020. Anticipated AFFO payout ratio of 65% to 68%, which reflects a full-year weighted average diluted share count of 180 million to 184 million shares. This no longer includes our six million share equity forward issued in September 2018, which has a new settlement date of no later than September 2020. I will now turn the call back to Fred.

Thanks, Marc. We are very pleased with our results year to date. It’s never easy to integrate a business, but our team is up for the challenge. We truly appreciate the hard work from each member of our legacy and newly expanded team. We are excited to bring these acquisitions into our platform and the direction we are headed as a company. As we continue through the second half of the year and beyond, we believe Americold is uniquely positioned to drive long-term growth and create shareholder value. We will continue to leverage our portfolio, operations, talent and technology to profitably serve all of our customers and their mission-critical temperature-controlled supply chain needs. Thanks again for joining us today and we will now open the call for your questions. Operator?

Thank you. [Operator instructions] Our first question comes from the line of Manny Korchman with Citigroup. Please proceed with your question.

Hey, everyone. Good afternoon. Fred, I appreciate your remarks on e-commerce sort of maybe not impacting your business very much, but there are certainly business out there that are trying to bring all grocery delivery sort of delivered fresh to you or fresh to the consumer. Are you just saying that you think that those businesses are going to end up relying on the supermarkets? Or you just think – don’t think that they’re big enough at the distribution level to sort of change things in your business very much?

Well, I think when you look at Manny. Sorry about that. When you look at the supply chain overall, really, when you think about e-commerce, e-commerce is another distribution method. So it’s not incremental consumption that’s going to happen in the marketplace. So product is still going to be made by the manufacturers and moved through our production-advantaged facilities. It’s then going to be moved closer to the markets and our major logistics corridors. And then it gets moved on, in this case, going to e-commerce, most of those – some of the smaller e-commerce providers are felt – fed by the local distributors. So they ship it to the distributor and then the distributor would service those local e-commerce providers. So we think that there will be a little bit of a shift as e-commerce continues to penetrate the marketplace, but we don’t think it’s a monumental shift in terms of overall demand and consumption. We also believe that for the broader United States where the density isn’t as massive as it is in, say, Manhattan, for example, that a lot of the real estate that’s already in existence, i.e., the store itself, will become a better platform to be able to service e-commerce. So you hear about micro fulfillment centers, for example, companies like Takeoff and their technology. There’s four major grocers in the United States today that are doing tests with that. And what that is, is it’s automation that’s literally in the back end of a grocery store. So they’re moving the walls out, shrinking the store itself, expanding the backroom and putting efficient automation in the backroom to be able to select its highest SKUs. So they’re only going to handle 10,000 SKUs in the automation, whereas the store has 45,000 SKUs. So the slower-moving product, they’ll still select from the store itself and then marry that off with the automation. So just in aggregate, yes, I believe that there’s a shift. Yes, I believe that e-commerce is going to continue to grow. I’m just a little bit more cautious on the amount of demand that it’s going to bring to new infrastructure and to overall volume.

Thanks, Fred. And for Marc, on guidance, your payout ratio went down. I think you tied that to the lower share count from the delayed forward offering. Wouldn’t that impact both sides of the equation? So how much of that is just math? And how much of it is your AFFO or expected FFO actually just going up?

So a number of things. The revised payout ratio really is driving both of those. So as we said from our initial guidance, we mentioned that we expected the acquisitions to be immediately accretive. And then also the fact that we’re reducing the denominator due to extending the forwards, they’re both having impact to the overall yield target for the year.

Our next question comes from the line of Michael Carroll with RBC Capital Markets. Please proceed with your question.

Yes. Thanks. Fred, the company has been active acquiring assets, obviously, in the second quarter. But since Americold and Lineage own about 55% of the domestic market, should we expect that the company’s going to pursue more tuck-in deals as opposed to the larger portfolios like the Cloverleaf deal going forward?

Well, I think that’s just a function of what’s out there and available, if you will. There’s very few companies that are the size and scale of a Cloverleaf, right? I think Cloverleaf, when we acquired them, was No. 5. So there’s very few companies of that size. If you recall, if you look at the top 10 players in the marketplace here in the U.S., if I just focus on the U.S., I think No. 10 on that list has two or three assets. So it’s just a very, very steep drop off. So you can kind of take with that what you’re going to read out of it. There probably are lesser opportunities of big acquisitions, more tuck-in.

Okay. And how are you thinking about the European market or other international markets? Does it make sense to pursue a larger platform transaction abroad, especially given the recent activity we’ve seen in your cost of capital?

Yes. We continue to explore around what we would call good, stable countries that we believe add benefit to our overall portfolio. We continue to explore those opportunities. And if we find the right situation, we will do that. But one thing that we will continue to remain true to is our acquisition strategy and kind of a deliberate aspect of finding companies that complement our portfolio and that we believe can be fully integrated into our way of doing business.

Okay. And then I guess lastly for me, I know that you guys still have a pretty healthy shadow development pipeline. I mean is it still around $1 billion? And if so, do you expect that you can break ground on more projects in the second half of this year? Or would you prefer to just kind of advance the in-process pipeline to date?

Yes. I mean it’s possible that we could break ground later this year. The pipeline is still healthy. It is still over $1 billion. We do have seven active projects going on right now between expansions and kind of finishing facilities and new shovels that just went into the ground. So we’re pretty busy right now, but things are heating up with some other opportunities, and we’ll see how the timing works.

Your next question comes from the line of Ki Bin Kim with SunTrust Robinson Humphrey. Please proceed with your question.

Good afternoon, guys.

Hey, Ki Bin.

Hey. Let’s go back to the e-commerce topic. Let’s just say e-commerce, grocery e-commerce grows to 10%. And for argument’s sake, let’s assume half of that is fulfilled through micro fulfillment centers at the grocery store, like with Takeoff or CommonSense Robotics, and the half is done through the more warehouse network. So how Amazon does it, or how Ocado and Kroger tend to do it. How does Americold position itself to take advantage of that? Or does it make – or does it not make a big impact to you?

It’s not a huge impact. I mean let me explain kind of the supply chain. So if it’s micro fulfillment centers, it follows the exact same supply chain path that we have in place today, right? So that micro fulfillment center is not treated any different than a store would be, okay. So from a flow standpoint, from an asset utilization standpoint, it’s really no different. What I would say is that we’re working with our retail customers that are doing those tests, and there might be some additional services that we can provide in our DCs to help make the goods more prepared for that automation in advance of sending it to the store, in other words, doing decanting, getting rid all the corrugate so that doesn’t have to flow to store type of thing, right? So those are additional services that we can do in our operations. If it’s a stand-alone type of operation, like an Ocado, it’s yet to be seen exactly how that will work because it can take one of two paths: either number one, it’s coming out of our distribution centers and we’re shipping product directly to Ocado, or we continue the path of shaping to a Kroger DC, and then a Kroger DC in turn, sends product to the Ocado DC. So we see Ocado, that technology, which is fantastic technology, we see it doing more than fulfilling e-commerce, at least in the beginning. There’s a lot of products in the grocery store that is slow moving, that doesn’t need full case replenishment such that it happens today. So what happens is a lot of grocers have extra supply, a lot of working capital tied up into the stores of some of these slow-moving products. So I can see Kroger and others that are getting involved in this technology leveraging that each-pick efficiency and allowing that operation to actually backfill stores in aegis.

Has the idea of being a capital partner for those build-outs, how realistic is that?

Yes. No, that’s potential. I would remind you though that the Ocado, even the micro fulfillment centers still the percentage that’s temperature control is still a minor percentage, right, less than 20%. And it’s still yet to be seen whether or not these technologies are even operating in the frozen, in the deep freeze to support ice cream, for example. So we’ll have to look at those volumes and see how that goes to see whether or not the investment in the technology within the temperature-controlled area makes sense or whether they handle it as a one-off type of pick. So I think it’s still early to be seen.

Okay. And just last question, if I may. Just going back to your underlying business trends. It’s good to see your operating metric go back into higher growth mode. But with that said, the only comp slide alignment is the occupancy continues to be down year over year, rather than be physical pallet positions or economic occupancy. So I just want to understand what’s going on in the underlying business. Is it – how does your customer retention rate look like? And the customers that are there, are they using more services or not? And when should we see the year-over-year declines in occupancy, economic occupancy start to peter out or bottom out?

Yes. So again, it’s this function between physical occupancy and economic occupancy is one of the big contributors. Because remember, we’re not overselling space. So when customers – as our economic occupancy continues to be on the rise, which it is, as a percentage of our overall dollars and storage and rent, as that continues to go up, it’s less space for me to physically sell into. So hence, less opportunity to drive that physical occupancy. The other thing to remember is we continue to guide looking at an annual basis. The ebbs and flows of volume from our manufacturers and from our retailers is not something that we can directly control. Sometimes there’s initiatives associated with cutting back on working capital, which might mitigate the volume going through a facility or the space at any one point in time, the harvest cycles, which have less impact on dollars, as you can see, but have an impact on physical occupancy. We had an operation that used to be leased out, which would account as 100% occupancy, and we’re moving that tenant out, and we’re going to repurpose that facility for a real nice customer that’s coming on board. But those things just tend to ebb and flow.

Yes. Ki Bin, if I can jump in and add. I’d say as the management – through our active portfolio management, what we’re really focused on is how do we drive four-wall cash flow. That’s the highest priority of our business. So while the other metrics, we report them, they’re very important and we do pay attention to them, what we focus on is how do we drive the most cash flows out of our network. And I’m going to prioritize driving cash flow over driving an occupancy metric or a throughput metric, right? So and as you see, I think the portfolio performance is performing consistent with our guidance for the year.

Yes. And I think you asked the question about retention rate. Again, we haven’t lost any material customers. Our churn rate is pretty much consistent, and that’s just under 4% or right around 4% I think for this particular quarter. It kind of hovers around that 3% to 4% type of range, and that’s just what I’ll call normal type of churn. Customers that either are bought or customers that go out of business or customers that report folio manager, there’s a variety of reasons for that churn. But it’s still pretty low churn overall.

Your next question comes from the line of Dave Rodgers with Baird. Please proceed with your question.

Yes. Good afternoon, Fred and Marc. And I guess, notwithstanding your comment, Marc, just about driving four-wall cash flow, I guess, go back to the economic occupancy and physical occupancy. Because we think about it from the first quarter, you had said Easter really drove a lot of that activity, the throughput volume into the second quarter. But in the second quarter, we really didn’t see the year-over-year pick up that would have expected to see with the holiday shift. You mentioned maybe emptying out a facility. Can you quantify some of the impact that you’re seeing in the numbers that might be one-time in nature that are driving the lower occupancy, both economic and physical?

Yes. I want to make sure we’re not overstating the impact of Easter. Easter, the volume push was in the second quarter. And bear in mind, I think – and so if you think about it, Easter I think was April 20 or right around there. The push was to have the product in the stores a week prior, so we’re talking about a two-week push. So that occupancy isn’t going to impact the average on the quarter. Overall, though, if you look at – our same-store revenue grew on a constant currency basis at 3.4%, which for this industry, for overall growth, especially a significant growth. And if you think about that extrapolated over a long term, we’re very consistent with kind of our long-term guidance. And the reason why we also focus, and we say this in our prepared remarks, is to encourage people to look at a full year is because a lot of the things Fred mentioned in his prior comments was seasonality of product and different strategies of different customers or retailers in any given time, that can move the underlying holdings or throughput of volume. Our job is to make sure that we can manage that and turn it into more cash flow, which I think you saw with our performance this quarter, we’re able to show and do.

And then maybe on the margin expansion for the year. It looked like, and just doing the quick math, I think it was the – if you adjusted for the $1 million of expenses last year, the credit last year, maybe expenses were up 1.3% normalized. Is that something that you can continue to drive? And how much of that risk, which is kind of the labor shortages and things that you’re seeing out there, can you hold that level of expense growth?

Yes. No, we definitely – our overall guidance implies that we will get margin expansion because, obviously, we’re outpacing our NOI growth by roughly 100, 200 basis points relative to the top line revenue growth. So we delivered that through the first half of the year, and we expect to deliver that. And that’s why we reiterated guidance in our prepared remarks.

Lastly, Fred, is there any chance with the Australian development deals from the customers that those don’t happen? And can you go a little bit more into color on kind of what the delay might be there?

Yes. It’s just – they’re complex operations. This is the retailer’s entire supply chain for the temperature-controlled areas. So when you get into detailed design, just different things come up, different criteria come up. You get to the negotiations of commercialization and all the legal work that needs to get done, it just takes time. So we’ve gone through a number of iterations. We still are very, very bullish on this. It’s just a slide in timing. I think we pointed to even a less complex operation, like the facility that we’ve built that came up last October, the Ocean Spray cranberry warehouse in Middleborough, Massachusetts. That facility is pretty straightforward, no level of high sophistication in an un- racked building, dealing with tons of cranberries. That building was pushed an entire year, right? I mean it’s just timing of working with the customer. This is a little bit more complex, but we’re still very bullish and progressing nicely with them. So we do anticipate it’s continuing to happen, and the push out that Marc did was really just to align the capital with the needs.

Got you. Thank you, guys.

Your next question comes from the line of Nate Crossett with Berenberg. Please proceed with your question.

Hi. Thanks, guys. Maybe you can just remind us on your guideposts for leverage. I mean you’re currently below peers. And given the potential for more M&A, I’m just curious how you think about the leverage here. And then on the M&A front, are there are certain markets in the U.S. that you’re not in, that you want to have a bigger presence? Or maybe you can just add a little bit more color on potential M&A.

Yes. Yes, I’ll take the first half, and I’ll hand off to Fred to take the second half. So you know what we tried to be is very thoughtful about managing the balance sheet. As Fred mentioned, we have several large, active development projects going on in addition to the project in Australia ramping up next year. So we’ve been very thoughtful about how we try to manage the balance sheet to make sure that we have adequate liquidity to not only support those projects but also to continue to support the business and other opportunities with other customers and other opportunities for M&A deal. So we’re obviously very comfortable with our leverage position and our liquidity profile. We would expect, as we continue to deploy capital, that that leverage would slightly tick up because we’re going to deploy that capital in advance of the cash flows coming online. But once those cash flows come back online, they’ll help to obviously delever back down.

And I think on the M&A front, it’s really less about going after specific markets. It’s more about how do we complement our business and deepen our penetration with our key customers and being able to fulfill their supply chain needs. So with 155 assets in the U.S., we’re pretty much in all the markets that we need to be. It’s about just continuing to gain market share and penetration with our customers.

Okay. That’s helpful. And then on the same-store labor cost increase year over year, it sounded like most of that was a 2Q ‘18 comp issue. Just curious, are there any other labor costs? Like are labor costs going up in the last three months? Or has it been relatively consistent? I was just trying to understand it.

Yes. The labor environment I think that we’ve been facing has been very consistent quarter to quarter and, well, in the year to year. If you do look at that labor line, you got to look at it in relation also to the warehouse services line because they tend to be highly correlated, right? So the more services, the more labor, right?

Yes.

And it kind of flexes at that.

Yes.

But yes, no issues there in terms of our access to labor and labor costs themselves. We continue to work on initiatives to drive the efficiency and the scale, and that’s why we’re able to outpace our top line growth with NOI.

Yes. And I think you saw that we achieved conversion, especially in the services segment in terms of how we expanded our margin in that segment.

Okay. What about just general build cost, like year to date, have those meaningfully increased? And I mean I think you’ve maintained kind of your yield guidance on developments. But are there any pressures on like build cost?

So I think what we see on build costs, construction costs are high – are higher we’ve seen year over year, both the price of steel and also the cost of automation at a number of our automation projects. There’s high demand for automation, not only from the temperature-control industries, but from broad warehousing industries in general. So we have seen those. Those are – have been reflected into our pricing and our discussions with what we’ve underwritten. So we’re still comfortable that we can deliver what we’ve discussed in terms of return targets for our projects.

Yes. I think that’s – you hit the nail on the head is whatever those costs are, we build that into our pricing. So we’re always capable of maintaining our margin expectations.

Our next question comes from the line of Bill Crow with Raymond James. Please proceed with your question.

Thanks. Good evening, guys.

Hey, Bill.

One more try on the occupancy issue. As we think about your same-store guidance for the second half of the year, or the revenue guidance and the NOI guidance, is that – is there an implicit gain in same-store year-over-year occupancy in the second half of the year?

Yes. There is a seasonal gain. If you look to the occupancy chart in our supplement, you’ll see there’s a seasonal build that impacts both physical occupancy every – going into the third and fourth quarter. We don’t expect this year to be any different than prior years. With that, as you said, there are different mix, there are different things but I think what we’re showing through our active portfolio management is that the team is doing a good job of converting the business that we do have and the opportunities that we are winning to stronger cash flows and NOI growth.

Okay. So seasonal build but not necessarily same-store year-over-year build.

Well, the same store will experience the seasonal build. And so it’s just as our economic occupancy continues to take hold, during those times when the warehouses are not full, we will have less physical occupancy opportunity, if that makes sense. So I would expect that trend to continue. Again, that allows us to be more efficient in our operations, locks up, guarantees that space for our customers and creates the demand that we can use in our development cycles as well, so yes.

Okay. All right. Two more quick questions. I think I know the answer to this one but you’re not seeing any benefit or detriment from the trade situation, right? That’s not really impacting your business at all?

Yes. We’re not really seeing that on our side.

Yes. Not yet. We’re obviously monitoring and we pay attention, but have not seen any material impact to the business yet.

Yes. And finally for me. Gosh, I don’t know whether it’s a month ago or so. CBRE came out with a study saying that the U.S. I think it was 100 million additional square feet of temperature-controlled storage over the next five years. I’m just curious where that would come from. We aren’t seeing any spec development still, right?

That is correct. We honestly don’t know.

Yes. I think as you saw with Fred’s prepared remarks, we think the bigger drivers overall are going to be population growth and the trend toward healthier products that typically require a level of temperature control. We continue to see many of the large, historically, kind of vertically integrated or in-source retailers kind of outgrow their existing temperature control needs. Often, that infrastructure has been built decades ago. So we continue to see attractive opportunities for us to grow and deploy capital and support our customers. But what we’d say is the bigger driver of the overall macro will continue to be overall population growth.

Yes. And the trend toward healthier food, so we’ll see a little bit of pick up there. I just don’t see a massive ramp in space need. I see a nice, steady increase of space needs over the next several years.

Well, speaking of healthier foods, maybe if you said that Beyond Meat was a big customer, your stock would go up.

Beyond Meat is a big customer.

There you go.

We do 100% of all their temperature control needs today.

All right. Very Good. Thanks for the time guys. Appreciate it.

Your next question comes from the line of Mike Mueller with JP Morgan. Please proceed with your question.

Yes. Hi. Just a quick one on I guess development expansion returns. Looking at the SOP and looking at all the projects that are under way, they all have a generic 10% to 15% target return level on them. And I was just wondering, can you kind of walk through some of the factors that ultimately are going to decide whether a project hits a 10% or a 15% stabilized return?

Yes. I mean, look, we evaluate risk associated with less complex operations that don’t have a lot of labor, for example, might be on the lower end, more complex operations, might be on the higher end. It’s really a function of the customer set that we’re trying to sell for and it just varies.

Got it. And when you kick one of these off, I mean do you have a general sense it’s going to be little bit more toward the 10% or the 15%? I’m just sitting here just trying to figure out if we look at – should we be thinking of a certain facility type is going to generally end up with a higher return or a lower return? Just trying to whittle that 10% to 15% range out a little more.

Yes. You can’t really do a buy facility side. It’s – there’s just so many other factors that get involved in that. And then in a major market, for example, we have a target based on who we expect to bring in there. But who actually shows up and how much volume can mix that out a little bit different. But when we do our underwriting, we have a tighter targeted range, if you will, that we’re executing to.

Yes. And just remember, what we’re quoting here is kind of the year – it’s typically year two, which is our first year stabilized return and it tends to improve from there as we dial in the operation.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to management for closing remarks.

Great. Well, thanks, everyone, for joining us for our call. Again, we continue to be very bullish on this business and how it’s performing, very consistent with what we’ve stated. Hopefully, you’re seeing that in the year-to-date results, and you can look at that for the full year as we continue to execute on our plans, consistency of delivery on our acquisitions. Our integration on our acquisitions is going as planned, so we’re very excited to welcome the three new companies that joined us. That’s going very, very well. Our conversations with our customers, through that integration, as well as some other efforts, continue to be strong and favorable, and the macroeconomic trends continue to be able to support our business model. So we’re very excited about the business model and our ability to remain consistent with what we said we’re going to do. So thank you all for joining us.

This concludes today’s conference, you may disconnect your lines at this time, thank you for your participation.