The RMR Group Inc. (RMR) Q4 2018 Earnings Report, Transcript and Summary

Good day, and welcome to The RMR Group Fourth Quarter 2018 and Year-end Results Conference Call. All participants will be in listen-only mode [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Tim Bonang, Senior Vice President. Please go ahead.

Our CEO, Adam Portnoy and Chief Financial Officer, Matt Jordan. In just a moment, they will provide details about our business and performance for the fourth quarter and fiscal year-end 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, December 03, 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 factors that could cause any differences is contained in our filings with Securities and Exchange Commission or SEC, which can be accessed from our Web site, rmrgroup.com, or the SEC's Web site. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we may be discussing non-GAAP numbers during this call, including adjusted net income, adjusted EBITDA, and adjusted EBITDA margin. A reconciliation of net income determined in accordance with U.S. Generally Accepted Accounting Principles, or GAAP, to adjusted net income, adjusted EBITDA, and the calculation of adjusted EBITDA margin can be found in the news release we issued this morning. And now, I would 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 afternoon. For the fourth quarter of fiscal 2018, which ended on September 30th, we reported adjusted net income of $9.9 million or $0.61 per share, which represents an increase of $0.17 per share, or 39%, compared to the same period last year. This year-over-year growth in adjusted net income is largely attributable to increases in revenues and lower operating costs. In addition, adjusted EBITDA of $31.2 million and adjusted EBITDA margin of 59.7% are both at their highest levels since we became a public company in 2015. From an operations perspective this quarter, we arranged over 1 million square feet of leasing activity on behalf of our client companies with a weighted average lease term of eight and a half years and weighted average roll-up in rent of 6.3%. We also supervised approximately $22 million in capital improvements at our client companies during the quarter. Some of the more noteworthy highlights across our client companies during the quarter include the following. In September, SIR and GOV announced plans for a stock-for-stock merger, which would create the leading national office REIT that will be renamed Office Properties Income Trust or OPI. In connection with this transaction, the cross-ownership between GOV, SIR, and ILPT will be eliminated. GOV has already disposed of its 27.8% ownership in SIR and SIR plans to distribute its 69.2% ownership in ILPT prior to closing. As part of the merger announcement, management has stated that OPI will be both selling up to an additional $750 million in assets by mid-year 2019 and reducing its dividend to ensure leverage and operating metrics are more in line with its peer group. The asset sales and dividend cut will have short-term adverse implications to RMR's fee revenues. However, we believe the merger provides for a stronger combined entity with significant long-term growth potential. We currently expect this transaction will be approved by SIR and GOV shareholders later this month and currently plan to close around year-end. In the meantime, SIR continued to execute on its operating business plan, which included 72,000 square feet of early lease renewals resulting in an increase rental rate of approximately 40% and same-property cash basis NOI growth of 4.8% on a year-over-year basis. GOV saw same property cash basis NOI growth of 2% and executed over 182,000 square feet of new and renewal leases. GOV also entered agreements during the quarter to sell properties totaling 3.3 million square feet located in the Mid-Atlantic Region for approximately $439 million. ILPT acquired two properties during the quarter for $49.3 million and entered into an agreement to acquire an additional property for $27.7 million. ILPT also executed new and renewal leases for more than 320,000 square feet that resulted in weighted average rental rates that were approximately 12% higher than prior rental rates for the same space. Travel Centers of America recently announced an agreement to sell all 225 of their convenience stores for approximately $330 million as part of their strategy to be a more focused leader in the travel center industry. The sale of the convenient stores is expected to close this month and we expect the impact on RMR's service revenues to be less than $2 million annually, a portion of which may be mitigated by the continued growth in TA's non-fuel revenues associated with its truck service business. Recently, Five Star announced potential doubts regarding its ability to continue as a going concern given challenges facing the senior living industry. RMR is currently spending a significant amount of time assisting Five Star to achieve financial stability and position it to respond to changing demographics and consumer preferences in the senior living industry. While we remain confident regarding Five Star's long-term outlook, we would highlight that RMR's service revenues from Five Star represent less than $2.5 million per quarter. Despite the headwinds facing the senior living industry, SNH continued to produce steady operating results this quarter. Consolidated same property cash basis NOI increased 30 basis points over the same period last year and management continues to be focused on finding acquisition opportunities that will grow its medical office and life science segment. Turning to our growth initiatives and the approximately $250 million in cash we had on hand at the end of the fiscal year. Last quarter, we announced the formation of The RMR Office Property Fund. Our first real estate investment vehicle targeting private investors. The Fund is focused on identifying multi-tenant suburban and urban office building assets across the country and we've already seen a number of attractive acquisition opportunities. As was previously announced, RMR has committed $100 million to the Fund and the expectation is that this commitment will be utilized in calendar year 2019. As it relates to our dividend, we were pleased to recently announce a 40% increase in our dividend to $0.35 per quarter. We expect to assess our dividend rate on an annual basis, with any future dividend increases predicated on continued growth and our recurring cash flows. In closing, we continue to work toward finding additional strategic growth initiatives. We are regularly evaluating possible acquisition opportunities, though it remains important that any potential deal be complementary to our existing operations and generate accretive returns. 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, and good afternoon, everyone. As Adam highlighted earlier, we reported adjusted net income attributable to RMR of $9.9 million or $0.61 per share this quarter. In addition to adjustments for separation and transaction costs, adjusted earnings per share includes an add-back of $0.10 per share due to an impairment of our investment in Tremont Mortgage Trust and a $0.04 per share reduction due to bonus payments coming in lower than originally projected. Management services revenue was $49.1 million this quarter, which represents a $4.9 million increase on a year-over-year basis, primarily due to growth of the managed equity REITs, most notably, GOV's acquisition of FPO. Management services revenue increased $1.8 million on a sequential-quarter basis, primarily due to the appreciation of HPT and SNH's share prices over the course of the fiscal fourth quarter. As a reminder, we are only able to record GAAP revenues for incentive fees at December 31st of each year. If September 30th had been the end of a measurement period, we would have earned $89.2 million in incentive fees as it relates to the measurement period that ends December 31, 2018, or $118.9 million on a full-year basis. Based on the recent declines in the share prices of certain of our managed equity REITs, these amounts are subject to significant variability and could materially change by December 31st. Turning to expenses for the quarter, total compensation and benefits expense was $31.9 million, comprised of $25.9 million in cash compensation, $4.6 million in non-cash, share-based payments, and $1.4 million in separation costs. Cash compensation of $25.9 million represents an increase of $2 million on a year-over-year basis and a decrease of $2.7 million on a sequential-quarter basis. The year-over-year increase in cash compensation is primarily driven by headcount addition, most notably from GOV's acquisition of FPO, and standard merit and benefit increases, while the sequential decrease in cash compensation is primarily due to the favorable bonus accrual adjustment highlighted earlier. Looking ahead to fiscal 2019, with the recent GOV share price declines, GOV, and ultimately OPI, will begin paying business management fees on a market capitalization basis as of October 2018. While we cannot predict what future share price activity will be, at today's share prices, quarterly business management fees earned from GOV would be down approximately $1 million from fiscal fourth quarter levels. If GOV continues to trade at these current level, when approved, we expect the OPI transaction to result in reductions to RMR's quarterly fees of an additional $1.5 million. As it relates to the combined $1.2 billion in potential asset dispositions outlined by Adam earlier at GOV and OPI, we do not expect an impact to our results in the earlier than the second quarter of fiscal 2019. After the sale of these assets, our quarterly property management revenues are expected to decrease by approximately $600,000. It is our expectation that, as the OPI transaction is completed and the combined entity executes on its long-term strategy, OPI will ultimately begin growing again. In addition, beyond GOV and SIR, we expect that some of our other client companies will see net growth via acquisitions, which should offset a portion of the declines discussed earlier. In terms of the impact to The RMR Office Property Fund, based on current expectations for capital raising and acquisition activity, including the expectation that RMR's $100 million commitment will not be called until the latter portion of fiscal 2019, we are estimating approximately $2.3 million of incremental service revenues for fiscal 2019, with approximately $500,000.00 impacting the first quarter. As it relates to compensation costs for fiscal 2019, in the first quarter, we will recognize approximately $6 million in separation costs associated with the recent announcement of two retiring officers of RMR. We are also projecting quarterly recurring cash compensation, after considering merit increases and changes to our executive leadership, to be approximately $28 million, with 48% of it being recoverable from our client companies. Finally, as it relates to our tax rate, I want to remind everyone that we will benefit from the reduced federal income tax rate of 21% for all four quarters of fiscal 2019, which results in an effective tax rate of approximately 14% after adding state taxes and applying the non-controlling interest. That concludes our formal remarks for this quarter. Operator, would you please open the line to questions?

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Bryan Maher of B. Riley FBR. Please go ahead.

Yes. Good afternoon, guys. A couple of quick questions. Can you give us a little bit more color I think, Adam, you said that you guys are spending a lot of time working with Five Star and can be of assistance with making that entity a bit more stable in this challenging market. What type of forms of assistance might we see there?

When I think about assistance, I'm talking about my time and senior folks in the RMR organization spending time helping them work through their business plan and how they're going to fix their business and no longer have a going concern issue. And so it's really spending time on their business plan, making sure and assisting them in thinking through what it is they should be doing and need to be doing to right that company.

So, as it stands at the moment, we're not talking about any type of financial assistance or investment into Five Star on a dollar basis?

From RMR, no, there's nothing like that that's currently being contemplated.

And then moving on to Tremont, can you kind of walk through what you're seeing in that business, the challenges there, and how those might be overcome over the next year or two?

With regards to Tremont, I think that business is progressing largely as it talked about. When it did its quarterly call and announced its results for the third quarter, it said, it publicly announced that it believed it would have all of its money invested by the end of the year and be in a position to hopefully announce a partial dividend in January for the fourth calendar quarter of 2018. There's no change in that view. And our hope is that, once the money is all invested and that we've got a full dividend up and going, we'll then turn our attention with that company on growing it. Obviously, it's sub-scale in size at the moment and we'd like to add assets under management in that business. I'm optimistic that we'll be able to do so, add assets under management in that business in 2019. I think we got off to a very slow start and a disappointing start with that business for the first half of '18 but I think we've largely turned it around in the last few months and I'm optimistic that we'll be able to grow it in 2019.

Thanks. And then just one more from me. On The RMR Office Property Fund, now that it's kind of been officially announced and people know that it's the real deal, have you changed your view at all since you made that announcement last quarter as to how quickly that business could ramp?

There's no real change in our view from what we said last quarter, which, I believe, was somewhere -- we may not have our first investment for 1 to 2 years. And the sales lead takes time there. I'm largely saying that there's no change in our view because we intend to kick off marketing in earnest January 1. We have had very limited marketing efforts over the last couple of months and we have a very big roll-out planned for January 1. So, I haven't gotten enough feedback from investors to change our view if there was going to be a change in the view. I hope to be able to report maybe better on that question as we get into 2019.

The next question comes from Owen Lau of Oppenheimer & Co. Please go ahead.

Yeah. Thank you for taking my question. Could you please just follow up the last question? Could you please add more color on the private fund and also the real estate securities management platform? And in specific, for the private fund, do you still maintain the $0.15 incremental EPS guidance in 2019? And also, for the real estate securities management platform, you mentioned it a little bit over the past few quarters, are you still interested in this area? What is the progress there? Any more color would be very helpful. Thank you.

Hey, Owen, it's Matt. I'll take the first part. I think the $0.15 has probably come down and that's largely due to the expectation being pushed out, in terms of when RMR's $100 million commitment will be pulled. I think we initially expected maybe a mid-fiscal year utilization, which would then translate into dividends on that utilization. I think we're looking at a late summer, trailing part of fiscal 2019, which defers when we'd start earning some of those dividends. So, I think we talked about $2.5 million or so of revenue for the year and that probably translates to $0.05 to $0.07 of earnings.

There's not any change in the view of the business, it's just a timing. The business is going very well, the private fund. We already have -- we have a lot of acquisition opportunities we're looking at. We have a property, actually, under agreement there for over $50 million. It'll be the first follow-on investment we're going to make there and we have several others in the queue that we're looking at very seriously. So, it's not a matter of our change in outlook on the Fund. It's just, as Matt said, the timing's changed. Mid-fiscal year for us is March. March. I think we're thinking more mid-calendar year, which is summer. And so it's just a timing issue. With regards to securities management business, we continue to be interested in growing that business. There is nothing to announce specifically around that business today in terms of growth. But I can tell you that is something that we plan to spend some time focused on, definitely in 2019. It's one of the last pillars that I've articulated for some time now that I'd like to try to grow within the organization and it's something that I think we're going to turn our attention to in more earnest as we get into '19. As I said before, that's the one area, for the areas we've talked about growth, where it's maybe more likely that we could take advantage of what's going on in that sector with regards to consolidation among asset managers in and around securities management platforms. And that's being driven by fee compression. And our view is that there could be some interesting opportunities to require small- to mid-sized securities management platforms and bolt them on to our existing operation going forward. And so I think that's something that we're -- that's how I've been thinking about it. We could also organically grow it, in terms of setting up maybe a new fund and perhaps seeding that fund and perhaps going out to the market with that as well. But I think what's most interesting about the securities management platform is the ability to maybe go off and take advantage of the consolidation in the industry and maybe make some small to medium-sized acquisitions in the space. And so that's how we're thinking about it.

Okay. I think that's very helpful. Switching gears a little bit, the shareholders of GOV and SIR will vote on the merger later this month. Based on the current progress, when would you expect the deal to close if shareholders approve the merger? I think you kind of alluded to the end of the second quarter but I want to make sure I understand it correctly. And also will the pro forma $5.3 billion total depreciated book value of the Office Properties Income Trust be a good estimate of the historical cost of the combined entity going forward before the $436 million property disposition under way and the potential $750 million additional disposition?

Sure. Yes, so the merger is currently scheduled to be voted on by both SIR and GOV shareholders. I believe it's Thursday, December 20, I believe is the date. And if it's approved at that meeting, which our view is and which our expectation is that it would be approved at that date at those meetings, we would be on track to close around year-end is the current timing on that. So, a little -- if the vote goes as we think, I think we'll be closing it maybe modestly earlier than what we announced to the marketplace. And with regards to the unappreciated book value?

Yeah, Owen, at the end of September, the combined invested capital of GOV and SIR was somewhere around $7 billion, pretty much each around $3.5 billion. Unfortunately, GOV has flipped to market cap and once SIR converts and you have the merged OPI entity, the whole thing will be on market cap. And using today's share prices, that enterprise value is somewhere between $5 billion and $5.5 billion. So, they will most likely, barring some material change in the share price, be paying on a market cap basis.

Okay. Got it. And, finally, how would you think about -- would RMR prefer OPI, Office Properties Income Trust, to sell the $750 million of property over the selling of 2.8 million shares of RMR shares to reduce their leverage? Given the recent stock movement of RMR, what are your considerations here right now, in terms of reducing the leverage?

Yeah, I think RMR's largely indifferent. It's really a decision for the board of the new OPI to consider that after the merger is closed. These would be secondary shares that would be sold and so RMR doesn't have a particularly strong view one way or the other. I could come up with arguments pro and con each way from RMR's perspective. And so we're largely, I would say, from RMR's perspective, somewhat indifferent and it's really a decision for the OPI board to make some time in the first half of '19, let's say.

This concludes our question-and-answer session. I would like to turn the conference back over to Adam Portnoy, President and Chief Executive Officer, for any closing remarks.

Thank you for joining us this morning. Operator, that concludes our call.