The RMR Group Inc. (RMR) Q1 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the RMR Group's First Quarter 2018 Financial Results Conference Call. [Operator Instructions] Please note today's event is being recorded. I would now like to turn the conference over to Tim Bonang, Senior Vice President. Please go ahead, sir.

Thank you, Rocco, and good morning, everyone. Thank you for joining us today. With me on the call are President and CEO Adam Portnoy; and Chief Financial Officer, Matt Jordan. In just a moment, they will provide details about our business and our performance for the first quarter of 2018. They will then take questions. I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on RMR's beliefs and expectations as of today, February 8, 2018, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning any factors that could cause differences is contained in our filings with Securities and Exchange Commission, or SEC, which can be accessed from our website, rmrgroup.com, or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP numbers during this call, including adjusted EBITDA, adjusted EBITDA margin, and the per share impact of significant items impacting our results this quarter, including the Tax Cuts and Jobs Act or the Tax Act and the incentive business management fees. A reconciliation of net income determined in accordance with U.S. Generally Accepted Accounting Principles or GAAP to adjusted EBITDA can be found in the news release we issued this morning. The news release also includes calculations of adjusted EBITDA margin and the earnings per share impact of the incentive business management fees earned and adjustments related to Tax Act. And now, I'd like to turn the call over to Adam Portnoy to begin our quarterly review. Adam?

Thanks, Tim, and thank you to everyone for joining us this morning. For the first quarter of fiscal 2018, which ended on December 31, we reported net income attributable to RMR of $71.1 million or $4.39 per share, which represents $2.93 per share or 200% increase in earnings per share compared to last year. This quarter's earnings per share include a couple of onetime items. First, RMR earned $155.9 million or $3.49 per share of incentive business management fees from HPT, SIR and SNH for the calendar year 2017. These managed equity REITs outperformed their respective industry benchmarks during the last three years by 15% in HPT, 10% in SIR and 9% in SNH. This quarter also includes the transitional impact of the Tax Act on our operations with a onetime net gain of $4.9 million for the re-measurement of our tax assets and liabilities at lower tax rates. Without these onetime items, our net income was $27.1 million or $0.60 per share. These results represent significant growth when compared to net income excluding onetime items of $0.45 per share for the same period last year and $0.44 per share of net income last quarter. The increase in recurring earnings per share is largely attributable to the realization of the growth discussed in our last earnings call from GOV's acquisition of First Potomac Realty Trust, or FPO, and the launch of our mortgage REIT, Tremont Mortgage Trust. On a combined basis, these two transactions generated almost $3.7 million of incremental revenues this quarter. In addition, our recurring earnings this quarter reflect a lower corporate income tax rates implemented as part of the Tax Act. Matt will discuss our expectations on tax rates in more detail on a moment. At the end of the first quarter, our assets under management were approximately $30 billion, compared to $27.2 billion for the same period a year ago, which represents a 10% increase. At this point of the call, I usually talk about our managed REIT's operating results in some detail. However, because RMR has a September 30th yearend and our managed REITs have December 31 yearends, we are reporting RMR's quarterly results in advance of our client companies this quarter. That said, I can talk about some overarching themes across our client companies, as well as leasing results and activities that have been publically announced. In January, RMR coordinated the launch of our fifth equity REIT, Industrial Logistics Properties Trust or ILPT, with an initial public offering of 20 million common shares at $24 per share. ILPT owns almost all of SIR's industrial properties located in Hawaii, as well as 40 industrial and logistics properties, located in 24 other states. We believe this transaction helped unlock the value of these industrial assets at SIR. With ILPT being priced at a value for approximately 15 times FFO, as compared to SIR's implied in-place multiple of less than 10 times FFO. ILPT intends to expand its core business by focusing on properties that may benefit from the growth of e-commerce. ILPT has a balance sheet positioned for growth with low leverage and significant capacity for low cost debt funded growth. In December, SNH announced the sale of four senior living communities managed by Sunrise Senior Living for $368 million, and realized a gain of over $300 million from the sale. These proceeds will help strengthening SNH's balance sheet and provide a capital for potential accretive acquisition opportunities in the future. On a combined basis, RMR arranged almost 1.5 million square feet of leases during the quarter on behalf of our managed equity REITs. These leases resulted in average rental rates of approximately 7.5% higher than prior rents for the same space based on GAAP and average terms for these leases with 5.9 years based on square feet. From a capital markets perspective, during the quarter, HPT issued $400 million of 3.95% 10-year unsecured senior notes and redeemed $350 million of 6.7% senior notes that were due in 2018. In addition, on January 30, HPT announced that it priced an additional $400 million of 4.375% unsecured senior notes that are due in the year 2030. As it relates to RMR's operations, we remain focused on growing our existing client companies, as well as seeking opportunities to grow and diversify our revenue sources. We ended the quarter with almost $126 million in cash and no debt. In January, we collected the incentive business management fees, providing us additional capacity to pursue possible growth opportunities. Further as outlined earlier, we announced subject to a lower corporate income tax rate that will provide additional free cash flows in the future. Well, I can't speak to specific opportunities at this time consistent with what I've communicated in the past. Our current focus areas for possible growth beyond the managed REITs continues to be seeking opportunities and the private capital space for growing our real estate securities management platform. With the launch of ILPT behind us, I hope that more information about possible new growth opportunities over the coming few months. I'll now turn the call over to Matt Jordan, our Chief Financial Officer, who will review our financial results for the quarter.

Thanks, Adam. Good morning, everyone. Adjusted EBITDA for the quarter was $30.5 million representing a year-over-year increase of $4.4 million and a sequential quarter increase of $3.4 million. Our adjusted EBITDA margin of 58.4% was an increase of 180 basis points on a year-over-year basis and 160 basis points on a sequential quarter basis. All of these increases were primarily the result of growth in revenues from our client companies and our related ability to maximize our shared-services platform to realize the economies of scale as growth at our client companies occurred. Management services revenues excluding incentive fees were $48.6 million this quarter, which represents of $5.8 million increase on a year-over-year basis driven primarily by incremental business and property management revenue from GOV's acquisition of FPO, as well as share price improvements with the managed equity REITs, most notably HPT. On a sequential quarter basis, management services revenues increased $4.3 million, primarily due to GOV's acquisition of FPO. Advisory revenues on a sequential quarter and year-over-year basis increased more than $300,000, primarily from Tremeont's initial public offering and risk REITs offering both of which closed in September of 2017. Turning to expenses for the quarter. Total compensation and benefits expense was $28.9 million, which includes cash compensation of $26.2 million and $2.7 million in non-cash share-based payments. Cash compensation of $26.2 million is an increase of $4.2 million on a year-over-year basis and $2.3 million on a sequential quarter basis. Both increases are primarily due to headcount additions and supportive growth of the managed REITs, most notably the onboarding of property management employees to support GOV's recently acquired FPO properties. Looking ahead to the remainder of fiscal 2018, there remain operational roles to be filled as part of taking on the FPO properties in the mid-Atlantic region, all of which will be fully reimbursable. As these positions are filled, we would expect normalized cash compensation to be $27 million to $27.5 million per quarter. Total reimbursed payroll and other costs of $12.7 million represents of 44% reimbursement rate, which is up from 42% last quarter. The improved reimbursement rate is being driven by headcount increases in our property operations group all of which are fully recoverable as well as the fact that we are now earning a shared-service fee of $375,000 per quarter from Tremont. G&A expense of $6.7 million represents an increase of approximately $500,000 sequentially due to modest inflation and professional fees, and other ancillary costs to support headcount growth. As it relates to our income tax rate, the Tax Act significantly decreased the U.S. corporate income tax rate from 35% to 21% starting January 1, 2018. Since we have a September 30 fiscal year end, the lower corporate income tax rate will be phased in resulting in a blended federal statutory rate of approximately 24.5% for all periods and this fiscal year were 30% when state taxes are included. Beginning at fiscal 2019, our federal statutory rate will decline to 21% for the full year or 26.8% with state taxes included. As Adam highlighted earlier, the Tax Act also resulted in a one-time net gain of $4.9 million this quarter due to the re-measurement of our tax assets and liabilities at the lower tax rates provided for by the Tax Act. This net gain is the result of our deferred tax assets being written down by $19.8 million and our tax receivable agreement liability being reduced, which in turn generated $24.7 million in income this quarter. That concludes our formal remarks. Operator, would you please open the line to questions?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Bryan Maher of B. Riley. Please go ahead.

Good morning, guys. Couple of questions, and, Adam, you touched upon this a little bit, the building position that you have and not really wanting to get into specifics and I can understand that. But how do measure the thought process behind what you've done so far with your cash, which has been kind of on the small side, relative to how big your cash is now and the ability to drive the dividend higher?

Thanks, Bryan for that question. I think the things that we are currently contemplating in terms of new initiatives at the company will be larger than we've been, than we talked about or used the cash for in the past. Again, as I said in my prepared remarks, the two areas that we're very focused on and we've been focused on for some time, is really trying to access the private capital market, as well as trying to grow our securities management platform. If we're successful with those endeavors and I think we'll have some pretty good indications whether we're going to be successful in the short-term here. And when I say short-term, certainly I think the first half of the year. We'll probably - we're talking about using - it could be upwards of the majority of the cash that we have built up, meaning the $126 million plus the incentive fees net of tax. It could be up to that amount of money. So I mean, all along I've been very clear that, I have a pretty strong bias, I think the board has a pretty strong bias towards trying to find ways to accretively put the cash to work to generate additional recurring fee revenues for the company on a long-term. And so, that's been our primary focus for some time. It continues to be our focus right now. With regards to the dividends, because of our focus, trying to generate recurring fee - recurring fee generating businesses, I don't think the board has - we're very oriented towards a onetime cash dividend at the moment that could change in the future, but at the moment I don't think that's where everyone's head is at. I do think, over the coming months, the board - I think it is fair for the board to think about whether the recurring dividend is something that needs to be adjusted. Not only do we have - we built up a large cash balance. But our recurring cash flow has increased over last year. And so, there could be an argument made that perhaps we should think about - in adjusting our recurring dividend. So that I think as we think about the dividend, I think it's more oriented towards do we adjust the recurring dividend? I think we have less interest at the moment in a onetime dividend. I think we're more focused over the next few months on trying to put upwards to a majority of the cash to work in some growth initiatives that are oriented towards the private capital side of the business and securities management business. Hopefully, that answers your question.

Yeah, thanks for that. And then, my second question is, on the last two equity offerings that have been done now, when it was GOV raising money for First Potomac, and then just last month with the ILPT IPO, I think many of us were surprised with where these offerings are priced. Can you give us a little color on what you saw, which resulted in those coming in, I think pretty far below what people were expecting beforehand?

Yeah, I think with regards to the - specifically GOV and ILPT, I think you have different dynamics going on in each one of those deals. I think GOV - I think I'll focus on ILPT, because it's probably more relevant and more recent. I'll tell you that the thing that was interesting to me in the ILPT deal was the heavy level of institutional support for the company. I was a little surprised at the level of institutional demand, the quality of the institutional orders that came into the book, and frankly, the small amount of retail that was allocated in the offering. I've been frustrated. I think management has been quite frustrated with the price performance of ILPT. Since the pricing, I think we were all somewhat frustrated with where it ultimately priced compared to the offering range. I am optimistic though that all the fundamentals that we discussed during the road show for ILPT are still very much intact in terms of the core business, the internal growth, as well as the external growth, and the opportunity there. So I'm optimistic over time that that stock price will improve. And that's basically what we're hopeful for. We were - we are disappointed with, one, where they priced relative to where the range was and also how it's performed since the IPO. But it's early days, it hasn't even been, I think today is one month exactly since we priced it. So hopefully over the coming months the stock will perform better.

Thanks. And just one last one, I don't mean to monopolize the call, but when you look at your externally managed REITs and where they trade on a multiple basis, relative to what I think most people will classify as comp set or peers. They traded an abnormally big discount, and I suspect that some of that's due to the external management, some people don't like that, and some may be related to the termination fee. But how do you think about that and what would you tell investors as it relates to the quality of your assets versus these peers?

Well, I think, we are working very hard to try to close any discount in our REIT compared to our peers. And I think, it was - I think it's a little bit of a testament that we are doing something right in sense of the incentive fees we've collected, because obviously over the last three years on a total return basis, we've outperformed our peers quite candidly, and at least three of the four equity REITs that we managed during that time. And So I think, that's a testament that we're doing something right with managing the businesses. But I think, it's a fair statement to say that many of our companies we traded sometimes a discount to our peers and I think, we are working very hard to try to close that discount. As much as we're disappointed with where ILPT priced and how it's traded. It is still - it is trading much better than where service has been trading, and those assets as you know Bryan, are coming right out of the service. So there has been some uplift, I think, it's a long process to educate the market on the quality of the assets that we own in our companies. I think the quality is exceptionally high, I could go through each one of the companies. I can't explain you why necessarily in each case, why the market may have us trading, may have a lower multiple and some of our companies than our peers. But I certainly believe the quality of our real estate across the board is as good if not better than many of the peers that trade better than where we are. And so it's what we do every day and will become - that's a big part of our job and our motto, we manage these REITs is to tell the story and we are working and telling that story very hard.

Thanks, Adam.

[Operator Instructions] Today's next question comes from Mitch Germain with JMP. Please go ahead.

Good morning, guys. So Adam, you talked about when you first took this vehicle public, commercial mortgage, we've got that one checked out. You talked about growing your AUM and your securities fund, that's happened. But you've diversified your revenues by taking out the PC [ph] public. It seems like you kind of check the boxes on talking about how you're diversifying those revenues. The one sector, where you're still kind of underpenetrated if you want to include SIR in that is really office, is that kind of where you're thinking the next move is for growth?

Yes. It is an area, and I think we have a lot of built up expertise in our organization and then we can execute a strategy around office very well. We've talked a lot about growing the private side of the business and that's something that we really focused on. If we were to grow the private side of the business, I think, thinking about it in and around the office side is certainly a plausible place for us to think about it.

Got you. Anything else that's on the horizon potentially?

Well, also the securities management business, we've grown that a little bit, but I think there is more to do there and we're focused on it. I would say, in order of - in ordering things and how we're focused on it. I think, we're first focused mainly on the private side of raising capital in and around commercial real estate, we've already hinted it. And office could be an area that we could focus in that area. And I think, after that, the next thing on the block is trying to think about a way to grow the securities management business. We don't - we haven't talked a lot about it, and we haven't been asked many questions about it on this call. But, we do look - we do have a lot of cash. We do look strategic opportunities, could we acquire somebody and fold them into our business. I think that's very hard to predict. I don't see anything in the short to medium term for doing that. We certainly evaluate a lot of things - a lot of different opportunities. And I'm mentioning this in and around the securities management business that we could look at. But that's certainly something that we could do in the future. But I also - I tempered my statements by saying it's not something I see happening in the short to medium term. It's something that I think we've been - we've looked at a lot of opportunities to acquire businesses in and around that business, and could be a way we grow in that business going forward.

Got you. That's helpful. And then, just talking about the integration with GOV and FPO, A, how is that going? And, B, what kind of - in terms of the FPO staffing, how much were retained versus how much turnover there was?

We retained a majority, but not everybody at FPO. And when I talk about those folks, it's a lot of great folks that we hired into the field in and around the Washington D.C. that have actually turned out to be great hires for us. We still have some open positions in and around the D.C. area. We've been doing a very good job of filling those positions. I think the integration is actually going very well. The FPO, what they had in the FPO portfolio, which is not something we're not able to do. It's not something that we're very capable of doing. But they have a lot more, what I'd call, development projects or redevelopment projects in the portfolio in and around the D.C. market. That's actually been pretty exciting for RMR and our staff. We've done a lot of development activities throughout the country. We've run well over a couple of hundred million dollars of capital through our portfolio any one year. But there is some really interesting development opportunities, re-development opportunities really that came with the FPO acquisition that I think the RMR staffs really enjoyed digging our - digging our teeth into. So I think it's been a lot of positives. I think we've hired some great folks out in the field that came from FPO. We've enjoyed having them join our company. And I think there are some pretty interesting specific opportunities for GOV really in terms of redeveloping some pretty interesting assets inside the district.

Great. That's it for me. Thank you.

And our next question comes from Chris Kotowski of Oppenheimer. Please go ahead.

Yeah. Good morning. Just as we go to fine-tune our base management fee earnings model, I assume that since the GOV transaction closed on October 2 that both the revenue and expense side, that is pretty much seen in the fourth quarter results. Is that right?

That's correct.

And then, with IPLT, should we just assume that there is an incremental 50 basis point base management fee on the proceeds from the IPO, and then, secondarily are there any incremental expenses associated with that?

There will be no incremental expenses and there won't be at the outset incremental revenue, because it's essentially a spinout of SIR. And we essentially - the assets were there the day before the IPO and they're there at the day after. As Adam mentioned, ILPT has a lot of dry powder now to go out and grow. So I think there will be incremental benefits to RMR as they go out and buy industrial assets. But day one, there is not incremental gains to RMR.

Okay. But presumably, when we see the first quarter press release there will be an extra line there or it will be split upon 5 rather than 4?

Correct. And it might be at second quarter, March 31 results, yes.

Right. Okay, great. Thank you.

And this concludes our question-and-answer session. I'd like to turn the conference back over Adam for any closing remarks.

Thank you for joining us this morning. We look forward to updating you on our progress during our second quarter conference call. Operator, that concludes our call.

Thank you so much. So today's conference has now concluded. And we thank you all for attending today's presentation. You may now disconnect your lines. And have a wonderful day.