The RMR Group Inc. (RMR) Q2 2019 Earnings Report, Transcript and Summary

Good day and welcome to the RMR Group Second Quarter 2019 Financial 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 [Operator Instructions] 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.

Good afternoon, and 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 performance for the second quarter of fiscal 2019. They will then take questions from analysts. 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 belief and expectations as of today, May 10th, 2019 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 revisions 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 the 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 may discuss non-GAAP numbers during this call, including adjusted earnings per share, adjusted EBITDA and adjusted EBITDA margin. A reconciliation of net income determined in accordance with US Generally Accepted Accounting Principles to adjusted earnings per share, adjusted EBITDA and a calculations 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 second quarter of fiscal year 2019, which ended on March 31st, we reported adjusted net income of $8.2 million or $0.50 per share. This quarter's operating results reflect the repositioning efforts we have helped facilitate at certain of our client companies over the last several months to strengthen their balance sheets and improve their operating results and future prospects. We believe these efforts will have positive long-term benefits for both our client companies and RMR, but in the near-term, these efforts have created headwinds for our operating results. Even though some of our client companies' stock prices were negatively affected during the quarter as a result of some of our repositioning efforts, our client company operating fundamentals remained positive this quarter. For example, RMR ranged over 1.7 million square feet of leases on behalf of our client companies this past quarter. These leases resulted in average rental rates of approximately 8% higher than prior rents for the same space, and have an average term of eight years. RMR also supervised approximately $20 million in capital improvements at our client companies during the quarter. Some of the more noteworthy highlights across our client companies include the following; Industrial Logistics Properties Trust was especially busy this quarter, as it recently closed on over $900 million in acquisitions and reported significant leasing activity. ILPT's $900 million in acquisitions were the result of two portfolio deals that were more than 70% funded by recently entered into mortgage financing in Hawaii that we discussed during our last earnings call. As it relates to leasing, ILPT announced 271,000 square feet of leasing activity this quarter, which resulted in weighted average rental rates that were 15.8% higher than prior rental rates for the same space and weighted average lease terms of over nine years. ILPT completed rent resets for 483,000 square feet of Hawaiian ground leases, which resulted in weighted average rental rates that were 28% higher than prior rental rates. These positive developments in ILPT continued to reinforce our belief that the ILPT story is one investors continue to underestimate. Office Properties Income Trust continued moving forward on the strategic initiatives of de-leveraging through asset sales and active property management this quarter. Since January 1, OPI has closed on $268.5 million of property sales and entered into sales agreements representing over $28 million for another three properties. In addition, OPI announced leasing activity of more than 825,000 square feet and weighted average rental rates that were 12.8% higher than prior rental rates for the same space, and weighted average lease terms of 7.5 years. These de-leveraging activities and leasing momentum should position OPI well for future growth and the latter part of calendar year 2019. For the eighth year in a row, Hospitality Properties Trust raised its quarterly cash dividend by $0.01 to $0.54 per common share. During the quarter, HPT also acquired the 335-room Hotel Palomar in Washington D.C. for approximately $142 million. In April, Senior Housing Properties Trust and Five Star Senior Living restructured their business arrangements to both maximize the value of SNH senior living portfolio and stabilize Five Star, SNH's largest tenant. As part of this restructuring, SNH agreed to convert its leased senior living portfolio into managed portfolio with Five Star and Five Star will issue about 85% ownership to SNH shareholders. As a result, SNH reduced its quarterly dividend and announced strategic dispositions of up to $900 million to reduce leverage. When completed, this new arrangement will ensure the long-term financial health of SNH and Five Star, as well as allow SNH and its shareholders to participate in Five Star's performance in the future. Completion of this transaction requires approval by Five Star shareowners, the related parties and insiders currently own more than 50% of Five Star's outstanding shares. At this time, Tremont Mortgage Trust has fully deployed its OPI -- IPO proceeds and recently announced that their quarterly cash dividend would be raised by $0.11 to $0.22 per common share. To ensure loan origination momentum, RMR has recently increased our commitments to Tremont's credit facility from $25 million to $50 million. This credit facility is intended to be a bridge until additional equity capital can be raised. This facility provides Tremont with almost $200 million of investing capacity on a leverage basis and we'll provide Tremont greater flexibility to execute their business strategy and keep its origination network engaged until additional capital can be raised. Tremont recently filed a Registration Statement with the SEC to raise additional equity capital and any secondary offering remains subject to the SEC's review and ultimately market conditions. Due to SEC rules, we are unable to comment further or take questions about any possible offering by Tremont. Looking forward, possible RMR growth strategies remain focused on three core areas. First, we are always focused on organic growth at our current client companies. Second, we are continuing our efforts to diversify and grow new vehicles that will leverage private capital and third, we hope to leverage our balance sheet to identify strategic acquisitions and seed new client companies. On the private capital front, starting in 2019, we officially launched our marketing effort for the RMR office real estate open-end fund in conjunction with our third-party sales team. As I've highlighted in previous calls, this fundraising process will likely be lengthy, and we don't expect to have any news around capital raising until later this year at the earliest. Nevertheless, we have made contact or met with over 100 potential investors so far this year, and believe we are making progress in our fundraising efforts. Depending on the pace of future acquisition opportunities, we continue to expect RMR's $100 million commitment to the fund to be called in the latter half of calendar year 2019. We ended the quarter with approximately $384 million in cash and no debt. While I cannot speak to specific opportunities, we continue to assess opportunities to possibly further diversify revenues and put our balance sheet to work. Management and our Board of Directors continues to believe that using our balance sheet to grow the organization with a longer-term view remains a higher priority than other options, such as using capital for special dividend or stock buybacks. In terms of possible acquisition opportunities, we continue to focus on growing our real estate securities management platform, and we've recently expanded our search to include real estate private equity firms. I look forward to providing more details on future calls as this process evolves. 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 afternoon, everyone. Management services revenues were $42.6 million this quarter, which represents a $4 million decrease on a year-over-year basis, primarily from lower base business management fees due to declines in the average market capitalization of OPI and SNH, partially offset by acquisition related fee growth at ILPT. On a sequential quarter basis, management services revenues decreased almost $5 billion from lower base business management fees due to declines in the average market capitalization of OPI, declines in construction management fees tied to lower capital spend at the managed equity REITs, and lower TA non-fuel revenues, as a result of the sale of the convenience store business. For the quarter ended March 31, 2019, all our managed equity REIT, except for ILPT, are currently paying monthly base business management fees on a market capitalization basis. The impact of being on this lower measure for calculating our monthly base business management fees results in a lost revenue opportunity, with revenues this quarter being approximately $7 million lower than they otherwise would have been on an invested capital basis. Turning to expenses for the quarter. Total compensation and benefits expense was $30.6 million, which includes cash compensation of $29 million, $1.2 million of non-cash share-based payments, and $400,000 in separation costs. Cash compensation of $29 million is an increase of approximately $1 million, both on a year-over-year and sequential quarter basis. These increases are primarily attributable to overall headcount additions, as well as standard wage and benefit inflation. As it relates to cash compensation and reimbursements from our client companies, our recovery rate remained at 43% this quarter. Looking ahead to the remainder of fiscal 2019, we expect normalized cash compensation to be approximately $29 million for the quarter, and we are projecting $200,000 of severance costs next quarter, related to retiring RMR executives. G&A expense this quarter was $7.1 million, which we believe represents a normalized run rate. So I'd like to highlight our Board of Directors, -- issued the annual share grants in April, all of which vested immediately. Accordingly, our third quarter results will include incremental G&A costs of approximately $750,000. In closing, I'd like to reiterate that RMR and its client companies are now well positioned to benefit from the repositioning and restructuring actions we've facilitated over the last six months. In future periods, we believe potential growth from the capture of lost revenue opportunities at our managed equity REITs, organic growth at our client companies, and RMR's growth strategies should hopefully make this quarter's financial results, a low watermark for RMR. In other words, we think there is more upside potential rather than downside risk to our operating performance going forward. To that end, we are projecting total management and advisory service revenues to be approximately $45 million for each of the next two fiscal quarters, an increase of approximately $2 million from this quarter's results. This projection takes into consideration the current share prices of our managed equity REITs, projections of when strategic disposition activity will occur, projected capital spend at our managed equity REITs, and ILPT's recent acquisitions. That concludes our formal remarks. Operator, would you please open the line for questions?

[Operator Instructions] Our first question today will come from Mitch Germain of JMP Securities. Please go ahead.

Thank you. Adam, I appreciate your thoughts about diversifying and growing the revenue stream. I am curious, your in-office, your in-hospitality, healthcare, industrial, are there any other asset classes that you think -- I mean, given the bandwidth of the organization I can understand the hesitancy that maybe from retail, but are there any other asset classes that might make sense for you?

I think, from an asset class, the big one that we're obviously not in is multi-family residential. I mean you could make an argument that our senior living portfolio is related to multi-family because people live there, but it is different than traditional multifamily. That's the obvious missing piece in terms of our assets under management. You mentioned retail. That's an area that we have some exposure to. But I think could be an area for also expansion going forward. You could do that through acquisitions and/or lifting outlets, say a team from another group. So there's many ways we could think about getting into those sort of asset classes, and we are thinking about that as we think about acquisitions and growth initiatives for the company.

What about growing the amount that you managed, property management, obviously maybe looking more toward third-party management for other landlords. Is that something that you've considered.

It is definitely something we have considered and thought a lot about. I'll tell you that the property management business is typically not a very high margin business, and it's large. The people that have been successful with it have largely tied to business to leasing brokerage and sales brokerage business. Oftentimes the property management is a lost leader to get those other parts of the business and I think it continues to be an advantage for our client companies that we say we only do in our property management, facilities management in and around clients of RMR that where our clients own real estate, and I think that provides a tremendous amount of focus on the client companies and so I don't think we have definitely thought about it, but I don't think it's an area that I'm particularly focused on in terms of growth.

Great. Last one from me. I might have missed it. I do apologize, but I was just curious about the fundraising initiatives with the third-party capital initiatives with the office fund and how that's moving along and what about the deal pipeline there?

So, great question. We did talk a little bit about it in our prepared remarks. Since the beginning of the year, we have met with or made contact with over 100 potential investors. Several of those meetings and contacts are ongoing. This is a long sales cycle, and it's our first fund focused on private investors. It's a new market for us. I continue to believe that we will be successful here and I continue to believe it will take us a while, I don't -- certainly till the end of this year, till I would expect us to have any news around meaningful additional investors. But, I think we're tracking towards our expectations that we originally outlined. We originally outlined, it was going to take us time. But, I think we're tracking to that. And I also think we're working very hard in putting all our energy behind it. And I think, we'll be successful ultimately.

And so, that would be tied to any future growth, is that the way to think about it?

Yes. We think accessing private capital is a part of our future growth. Yes.

So not much in terms of deal flow that we should expect from that entity until the third-party capital is committed?

No, I understand your question better now. Okay. Yes. We still believe that there will be -- there's still capacity just based on the commitments and leverage that we can put into the vehicle that -- I would round numbers at least $200 million, maybe more buying power today in that vehicle -- absent any third-party. So yes, I didn't understand the question before.

No, I appreciate it. I didn't ask -- I asked it wrong the first time. Thanks, I appreciate it.

Our next question will come from Bryan Maher of B. Riley FBR. Please go ahead.

Yes. Good afternoon. So, it's a little frustrating, as I am sure, you well know, where the shares are trading relative to what many of us believe is the underlying value. Is there anything that can be done with your increasingly large cash ward to kind of throw down the gauntlet and kind of show investors that you really believe in names like OPI and SNH, and kind of maybe buy shares into RMR. I don't know, if it's 1 million, 2 million, 3 million shares. You're going to earn a great return in the meantime, as if and when the shares recover, and further align yourself with those entities. Have you guys given any thought to that?

Short answer is -- we've given a lot of thought to that. But we have come to the conclusion, certainly, I don't think our thinking has changed. I think our thinking has been consistent on it although we continue to think about it. We continue to believe that the capital that RMR in the balance sheet of RMR is best used to think about diversifying and growing the client base rather than investing in current client base. Your question is a good one. It's something that we think about every day, but today there is no strategic shift, we continue to be focused on using our balance sheet and cash to diversify revenues, grow our client base and that's the focus.

And when you think about the kind of challenging years that OPI and SNH have this year, not so much from operationally challenged, just a lot to do with the asset sales, and in the case of SNH switching kind of the structure and with Five Star, which of those are going to be more time consuming for you a management company and which one do you think is going to be more heavy lifting and why?

They are both -- they are all time consuming for the organization. In organizations large enough that I think you can quite easily do it. We're just as good at selling properties as we are buying properties. And to be honest with you, I don't see the sales at OPI and their assets versus let's say the sales that SNH and their type of assets being one being meaningfully different difficult. I will tell you maybe with one exception and it's a small part with maybe within the SNH portfolio and I'm sure the management team at SNH would agree with me. The stand-alone sniffs which we don't have a big portfolio of, anything is heavily reliant on Medicaid. And we don't have a lot of those, those are probably the hardest. But everything else, there is nothing particularly harder or easier about any of the other potential asset sales, and the only thing I'll say about the stand-alone sniffs is it's not a lot of dollars or a lot of communities, it's a relatively small part, but if you push me to say what's the hardest. Those are probably the hardest to sell.

And so, as all of us kind of finish earnings here and we've listen to the calls, particularly with OPI and SNH and we listen to the CEOs and CFOs talk about the prospective cap rates to which these assets are going to be sold. And then when we look at the cap rate and the implied cap rate of where the shares are trading I know the goal is to de-lever those entities, but at what point do you say that the gap between where we're selling assets at 6 or 7 cap and our stock's trading at a double-digit cap rate did not redeploy some of the proceeds to buy back some stock at these ridiculous level.

Yes. It's a tough situation because both the companies that are selling assets are focused on selling assets. SNH and OPI, they need to sell those assets, to delever and maintain their investment-grade rating. I don't think those companies, given where they are could afford to take any of that cash and not delever. If they were to use that cash into -- continue to lever up, in terms of taking out stock, I think that would -- that's not something I think those two companies or the boards of those companies would be particularly favorable upon. I mean, I think the investment-grade rating is incredibly important to both SNH and OPI, and deleveraging those companies is the priority. And so, I don't see in -- I don't think the conversation around stock buybacks is really going to even be seriously debated until leverage is in check. And we've maintained -- and we've got confirmation that the ratings are secure.

And how long do you think that process plays out. Is it a back half, late in 2019 scenario that you get that comfort?

I think our goal is that -- all the disposition and deleveraging happens by the end of this year.

Okay. Thanks, Adam.

[Operator Instructions] Our next question will come from Owen Lau of Oppenheimer. Please go ahead.

Thank you for taking my questions. Could you please provide more color on the real estate private equity funds in your expanded search. What is the strategic rationale of this type of fund? What is the target size of this fund? And any more color at this point would be very helpful. Thank you.

So, it's a good question. What we're looking, why we have expanded our searching in and around private real estate private equity funds, is that we believe we will be successful in growing our own private fund capacity. But there may be an opportunity to leapfrog or really turbocharge it, if we could possibly partner up or acquire a fund shop, to put round numbers around it, I would say would need to be as shop that had meaningful assets under management, I'm not thinking -- this is not, hundreds of millions of dollars, that have to be billions of dollars under management in the space, and it would really have to being something where, let's say the private equity firm, was there a stage in their growth where partnering with us would basically allow them to sort of turbocharge their growth, meaning they might be of certain size. But, if they were to become part of let's say RMR and we're a $30 billion dollar organization, in 35 offices around the country, a large employee base focused on real estate that by partnering with us are working with us, they would be able to sort of turbocharge their own capital raising and from our perspective, it would sort of accelerate the growth of that part of our business for us. So, that would have to be the both parties what they would be getting out of it. And again I think we would be thinking something meaningful if we did there, not -- I don't think we would achieve what I'm trying to articulate if it was a relatively small private equity shop, it would have to be mid-size. What's mid size? It's multi-billion dollars in size. And I think that's the way we're thinking about it and you know, we having conversations with folks, but you never know how these conversations will work out. And of course, there is a lot of social issues involved in those types of conversations. And so, we’re hopeful that we can maybe do something there, but I'm not sure we will be able to.

That's helpful. And just to be clear, you are looking for 100% equity stake, instead of partial equity stake or even joint venture. Right? I just want to make sure.

I would describe to it as our preferred structure is a 100% ownership, I think we would accept a control stake. So, more than 50, we would, if in the right circumstances. But, I do not think we are not interested in a minority position or necessarily just a joint venture. It would be at minimum a control stake.

That's perfect. Finally a modeling question, maybe for Matt, managed operator revenue, it's a little bit light this quarter compared to last quarter and also same quarter last year. What are the key drivers of that and also is this quarter a good run rate going forward?

No. It's a good question. There is seasonality that plays in their Owen. When I talk about the $45 million in projected revenues the next two quarters, a chunk of the $2 million or so in increase, approximately $700,000 of that is the managed operators increased revenues. The TA business tends to tends to pick up the next two quarters. So, in that this has some renovation activity. So, you should definitely not model off solely this quarter's run rate.

Ladies and gentlemen, this will conclude our question-and-answer session. At this time, I'd like to turn the conference back over to Adam Portnoy for any closing remarks.

Thank you for joining us. We will be at the B. Riley FBR conference in late May. We also look forward to updating you on our progress during the fourth quarter conference call. Operator, that concludes our call.

Thank you, sir. The conference has now concluded. We thank everyone for joining today's presentation and you may now disconnect your lines.