RMR Group Inc (RMR) 2017 Q3 法說會逐字稿

Good afternoon, and welcome to the RMR Group Third Quarter 2017 Conference Call. (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, sir.

Thank you, Laura, and good afternoon, 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 third quarter of 2017. They will then take questions.

I would like to note that the recording and retransmission of the 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, August 9, 2017, 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 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'll be discussing non-GAAP numbers during this call, including 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 EBITDA and the 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 third quarter of fiscal 2017, which ended on June 30, we reported net income attributable to RMR of $6.9 million, or $0.43 per share. As of June 30, RMR had approximately $27.9 billion of total assets under management, which is an increase of over $1.1 billion in AUM as compared to the same period last year.

During the quarter, RMR was active, assisting its client companies to grow their businesses and simultaneously pursuing our long-term goal to diversify revenues. During the quarter, one of our managed REITs, Government Properties Income Trust, or GOV, entered a definitive agreement to acquire all of the outstanding common shares of First Potomac Realty Trust, or FPO, for the aggregate consideration of approximately $1.4 billion. The transaction with FPO will enable GOV to expand its business strategy to include the acquisition, ownership and operation of office properties leased to both government and private sector tenants in the metropolitan Washington, D.C. market area. This area is one of the largest office markets in the U.S. and the nation's largest beneficiary of spending by the U.S. government.

Furthermore, because of the synergies available to our client companies by contracting with RMR for Management Services, GOV expects to realize approximately $11 million of annual G&A expense savings compared to FPO on a standalone basis. GOV's acquisition of FPO is subject to the approval of at least the majority of FPO's common shareholders and other customary conditions, but we are targeting a closing prior to year-end 2017.

In preparation for closing the FPO acquisition, GOV has raised almost $800 million of both equity and debt capital, and now has the necessary funds available to close the transaction without having to draw any funds under a bridge loan facility that GOV obtained when it announced this acquisition.

Finally, we are excited about integrating the FPO properties into our Real Estate Management Services platform as well as having a number of talented FPO employees join RMR to grow our presence in the metro Washington, D.C. market area.

From an operations perspective, our client companies had another strong quarter. On a combined basis, we arranged over 800,000 square feet of leases during the quarter on behalf of our managed REITs for a 3.3% roll-up in rent and a weighted average term of 12.2 years. We also supervised approximately $25 million in capital improvements at our managed REITs during the quarter.

Hospitality Properties Trust reported a 4.8% year-over-year increase in normalized FFO. During the quarter, HPT completed several acquisitions, totaling approximately $200 million and in July, HPT entered an agreement to acquire 14 extended-stay hotels with over 1,600 rooms for a purchase price of $138 million.

Senior Housing Properties Trust continues to work through industry-wide challenges associated with a temporary oversupply of senior living communities in the market. In light of these challenges, cash basis NOI remain relatively flat for the quarter as compared to the same period in the previous year. Subsequent to quarter-end, SNH amended its $1 billion revolving credit facility, extending its maturity to 2022 and lowering the interest rate. SNH also amended and lowered the interest rate under its 5-year $200 million unsecured term loan facility.

Select Income REIT was again active in the leasing space, as it executed leases for over 200,000 square feet during the quarter. The weighted average lease term for these leases was over 31 years. Also during the quarter, SIR raised $350 million of 4.25% senior notes.

In addition to the FPO transaction, GOV continued to focus on its operations. During the quarter, GOV completed leases totaling almost 300,000 square feet for a 13.5% roll up in rent and a weighted average lease term of over 7 years.

Also during the quarter, RMR was actively engaged in exploring various means to diversify its revenues, including conducting diligence on acquisition opportunities and making an initial SEC filing for a commercial mortgage REIT to be managed by a wholly owned subsidiary of RMR. These initiatives resulted in RMR incurring approximately $1.8 million or $0.04 per share of elevated G&A expenses associated with legal and other third-party costs during the quarter. With regards to the commercial mortgage REIT filing, because of SEC restrictions, we are unable to provide any additional commentary on this initiative at this time.

General and administrative expenses during the quarter also includes approximately $700,000 or $0.01 per share of costs associated with RMR being the victim of a criminal fraud that law enforcement authorities refer to as a business e-mail compromise fraud. This event caused funds to be mistakenly sent to an illegitimate business account. We are working with law enforcement authorities and the banks involved in the wire transfer to investigate this matter and possibly recover these misdirected funds.

Overall, we are pleased with our operating results this quarter and the progress we have made in assisting our client companies to grow their businesses and simultaneously pursuing our long-term goal to diversify revenues. These results continue to reflect the strength of RMR's operating platform and speak to the tireless efforts of our over 475 real estate professionals working at over 35 offices throughout the United States.

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. We reported net income of $6.9 million or $0.43 per share for the quarter ended June 30, 2017. As Adam highlighted earlier, net income this quarter includes approximately $2.5 million or $0.05 per share of costs associated with activities outside of our recurring operations. Accordingly, without these costs, earnings per share this quarter would have been $0.48 per share.

Adjusted EBITDA was $27.4 million, resulting in an adjusted EBITDA margin of 57.2%. Adjusted EBITDA of $27.4 million represents an increase on both the year-over-year and sequential quarter basis, primarily due to revenue growth of the managed REITs.

Management Services revenues of $44.6 million this quarter represents a $2.8 million increase on a year-over-year basis, primarily due to share price appreciation at the managed REITs, most significantly HBT and SNH. Management Services revenue increased $1.4 million on a sequential quarter basis, primarily due to the favorable impact of seasonality at certain of our managed operators as well as growth in our property management fees, driven from increases in development and construction activities at the managed REITs.

As a reminder, we are only able to record GAAP revenues for incentive fees at December 31 of each year. If June 30, 2017, is at the end of a measurement period, we would have earned approximately $61 million in incentive fees as it relates to the 3-year measurement period that ends December 31, 2017, or over $122 million on a full year basis.

Turning to expenses for the quarter. Total compensation and benefits expense was $24.8 million, comprised of $23.7 million in cash compensation and $1.1 million in noncash share-based payments. Cash compensation of $23.7 million represents an increase of $3.1 million on a year-over-year basis and approximately $700,000 on a sequential quarter basis. These increases are primarily due to headcount addition to support growth at our client companies as well as the impact of annual merit and benefit increases. It's important to note that while cash compensation is controllable, noncash share-based payments will fluctuate over time based on the share price activity of our client companies.

Looking ahead to our fiscal fourth quarter, annual grants of RMR restricted share rewards to certain of our employees historically occurred each September, which will result in stock compensation expense of approximately $750,000 related to the portion of the share to divest upon award.

G&A expense for the quarter was $8.5 million, which includes $2.5 million of nonrecurring items previously outlined. The resulting recurring G&A cost of $6 million remain consistent with our historical levels.

Regarding our balance sheet. We continue to maintain a conservative balance sheet, and we ended the quarter with approximately $138 million of cash and no debt.

As it relates to the business e-mail compromise fraud, approximately $100,000 of the $700,000 expense is related to additional third-party costs we have incurred in response to this matter. Since this event, we have made enhancements to our internal controls relating to electronic payments. These enhancements increase the ability of our personnel to identify and block attempts by third parties to fraudulently receive electronic payments from us.

Finally, as it relates to the growth opportunities Adam discussed earlier, upon successful closing of the transaction, GOV's acquisition of FPO is expected to generate approximately $12 million in annual service revenues for RMR before the impact of any potential strategic asset sales by GOV. We are currently assessing our infrastructure needs, but expect that some corporate office resources and other related costs will be necessary to support this acquisition.

That concludes our formal remarks for this quarter. Operator, would you please open the line to questions?

(Operator Instructions) And our first question will come from Bryan Maher of FBR Capital Markets.

Couple of questions. Your cash is starting to build fairly meaningfully. And I guess, my question on that regard would be, are you more inclined to think that, that would be reinvested in growth initiatives? Or do you suspect there might be some return of capital associated with that cash?

Bryan, it's Adam. Thanks for that question. I guess, the short answer is my hope is that we will be able to find growth initiatives that we can use a good portion of that cash to invest in to help us launch, so that we can create recurring fee streams for the business for going forward. That all being said, I'm not sure we will find enough growth initiatives to put all that cash to work. And I think, as Matt pointed out, we also are a little bit in a wait-and-see mode in terms of where we end up at the end of the year with incentive fees. It's different if we have, let's say, $138 million of cash, as we do right now, or is it a $138 million plus $122 million that Matt talked, come the beginning of 2018. So in a perfect world, my bias is I'd love to invest the cash into businesses that, I believe, are synergistic to our existing operation and that we can grow those businesses and add additional fee revenue and assets under management. But I'm not sure there's going to be enough initiatives like that to put the cash to work and depends on how much cash we have.

Got it. And then my second question is, Adam, you have insights into a lot of what's going on in the commercial real estate world with your 4 externally managed REITs. Are you seeing anything out there, here, as we ended the third quarter, that's particularly alarming to you or where there is more opportunities than not?

You're right. We do see a lot and touch a lot of different parts of the real estate sector. I don't see anything alarming or particularly noteworthy. I will tell you that in the areas of the real estate we've touched, and I'll just go through them, the areas that cap rates are probably the lowest that we touch, the industrial world -- or industrial real estate and the MOBs, are 2 areas where we see very aggressive pricing, still, areas where, I'd say, there's -- people are being a little bit more cautious, and it really depends on where the asset is located, is more office, hotel, senior living. And then the area where I think we probably play the least in is retail. But what we do see in the retail space personally is that if there's any activity going on, it's really sort of folks bottom fishing, looking for bargains if they exist, given all the dislocation there. The one area we don't touch is apartments or multifamilies so I really don't have good insight into that. But that's sort of a rundown of what we're seeing in the marketplace.

And the next question will come from Chris Kotowski of Oppenheimer.

Yes. I wonder, when the GOV acquisition closes -- let's just for -- to make life easy, assume it closes December 31, 2017, maybe I missed it, but what is the impact of that on RMR's base management fee? And does it, in any way, change the calculation of the incentive? And I guess, my understanding is that it wouldn't because it's -- the incentive is kind of done on an all-in per-share basis, right?

Yes. This is Matt. Let me answer in 2 parts. So as we talked about in our prepared remarks, we expect, on a full year basis, FPO, before any possible strategic sales of legacy GOV assets or FPO assets, that it will contribute $12 million, which roughly is $7 million in business management fees and approximately, say, $5 million in property management and construction fees. And then secondly, the incentive fee -- nothing -- it wouldn't have a direct impact other than how the share price is reacting in the measurement period.

Okay. Right. So it is purely on the per-share basis.

Correct.

Right, okay. And the $122 million that you suggested, that is just assuming the share prices at June 30 carry through to year-end.

Yes, as well -- and the market stays stable.

And our next question comes from Brandon Dobell of William Blair.

First, just a real quick one. Should we expect any -- even small, any nonrecurring one-time charges in the next quarter? Or is this kind of an overhang from what's already happened with the fraud stuff and the things you've dealt with this quarter?

Definitely not from the fraud. I think based on how the mortgage REIT plays out, there will be transaction costs associated with that.

Got it. Care to put any kind of sizing around that on the mortgage REIT side?

It's too early. We just can't comment on that at this point.

Got it. Yes, no worries. Okay. From a broader perspective, only other publicly traded peers that you guys have in the market has made some investments in start-ups of companies that sell into or service into the operating businesses or REITs that they manage. Have you guys thought about that, I guess, potential use of capital or that as a strategy given the types of properties you manage and what -- either technology companies could be involved with those properties or something similar?

This is Adam. Yes, we have thought a lot about that and we certainly get pitched on those types of opportunities quite often. To be honest with you, I've been a little reluctant in pushing those type of opportunities because my view has been on most of them, the amount of effort required, both maybe capital and also just time for the organization, people's effort in it isn't worth the investment today. We're much more focused, I think, as an organization, on trying to build out the true assets under management, diversifying the type of real estate assets that we're managing. The stuff you're talking about, let's say, investing, let's say, in a real estate tech company, we've been pitched that quite often. And some of it can be interesting. But again, the amount of time that would be devoted to doing something like that for the organization, the staff, I'm just not sure it's the best use of energy in the organization today. But that's not to say we wouldn't do it. And there might be cases where something comes along that could be quite compelling for us to think about. So I will tell you, yes, we're pitched it and we're looking at it quite often, but I have sort of discouraged that type of growth sort of in the short- to medium-term.

Got it. And then final one for me. On the multifamily space where we spend more time and we've heard some of the software companies talk about the U.S.-based multifamily REITs looking into the U.K., in particular, but also Continental Europe for growth opportunities, ways to deploy capital, et cetera, have you guys thought about that non-U. S? And maybe it's just Canada or maybe it's the U.K.? The non-U. S. opportunities with various -- the various businesses that you guys deal with relative to deploying capital, especially as things get pricey in some parts of the U.S. Are there opportunities to look outside your typical regions for putting money to work at the REITs?

Yes. Thanks for that question. We do -- we have looked quite often. We have looked at opportunities on the office side and the health care side and the hotel side outside the United States. Historically, we have owned -- RMR has managed assets in Australia, historically. We currently have a couple of assets up in Canada. I'll tell you that from short- to medium-term outlook, it's not a priority for us in terms -- to look outside the U.S. And the reason for that is that we continue to find quite a number of opportunities to evaluate here domestically. We have -- we're able to take advantage, I think, of a pretty broad reach within the U.S. We got 36 offices. We got close to 500 people. We see a lot of different opportunities here, so no shortage of opportunities. And then on top of that, when we have looked overseas, sometimes, we have seen some compelling opportunities, but they always sort of get -- you got to hedge against them because you're often dealing with -- if you got, say, a deal in Europe, oftentimes, you're dealing in multiple jurisdictions in terms of tax regimes, which can be complicated for an investment, unless it's, let's say, just 1 country. But if you, let's say, make an investment in a Pan European portfolio, you're dealing with a whole bunch of tax regimes. Then the other obvious issue is currency risk that you end up taking. And how do you deal with that? You hedge against it. Do you put natural hedge with debt? It's just -- it's compelling if the opportunities have been -- there are always sort of additional costs layered into them by just going overseas. And so that has always tempered our enthusiasm for it and I think the fact that we have no shortage of things to do here in the U.S.

The next question will come from Michael Kodesch of Canaccord Genuity.

First one, as it relates to the business incentive fees, the accruals in particular. So $61 million year-to-date has been accrued. But I'm wondering, can you give us some insight into that process? I mean, are you looking at 6/30 and then taking that number? Or do you -- because you have a month of visibility, I guess, until you report earnings. I mean, does that go into the process as well? Do you build any conservative -- conservatism in there?

We're purely reporting the June numbers, which the REITs have generally spoken to as well if they've had to accrue. We obviously, and as you can imagine, are looking at the incentive fee every month. It can be quite volatile, as you well know. So yes, we're watching both. And I don't think we have any reason to believe at this time that the $122 million will materially change at this point, but it could.

Okay. That's helpful. And then, I guess, moving on to transaction costs, just to follow up on an earlier question. Can you quantify maybe what that might look like in the fourth quarter? Will it be more or less than what we saw in the third quarter? And then is there any interest in presenting that on -- or presenting EPS on an adjusted basis just to kind of normalize for those one-offs?

So this is Adam. Unfortunately, it's really hard to predict those costs. I -- we make -- in the beginning of this call, we have our forward-looking statement, which says that this is our view as of today. Our view as of today is that, I think, it might be lower than it was in the third quarter, but that is as of this point in time today. And I can't even really say by how much. Now that could all change depending on what happens with the mortgage REIT and/or other opportunities that might present themselves. But I've given you -- my best guess as of today, when I think it would be, I think it might be lower than it was in the third quarter. And what was the second part of your question, I'm sorry?

Any interest in presenting EPS on an adjusted basis just to sort of normalize for that?

Sure. We'll take that. We'll consider it. I've often thought about doing that. Me and Matt have -- this is Adam -- me and Matt have talked about that a few times. Should we do that? Yes, we'll take that under consideration.

I mean, we do try and articulate in our press release the impact on a per-share basis for each of these items. But we can definitely take that under advisement.

Yes.

Great. And then just one last one, if I might. For FPO, you talked about bringing some FPO employees into RMR. I was wondering if you could quantify the impact, both to compensation and benefits and the G&A of kind of bringing that platform on?

We still -- as we talked about in the prepared remarks, we're not comfortable at this point speaking to exact numbers, but what I would -- I guess I would broadly guide is all the personnel that impact the properties will be fully reimbursable just like they are today for the properties we currently manage. So the bulk of the employees coming over from FPO will be those that manage the assets on a daily basis and will now be RMR employees. So those will be fully recoverable. And then on the corporate overhead-type roles and other related G&A cost, we are still in the process of working through the integration. And we'll probably update you next quarter on what those costs are.

And the next question comes from Mitch Germain of JMP Securities.

So just, Matt, if you could, I'm just trying to understand what the G&A number was this quarter on a more normalized basis. You had the legal and other third-party costs. Is there anything else in there that I need to think about?

We had the $1.8 million of transaction and then you had the fraud item that was approximately $700,000. So the recurring G&A number is $6.1 million.

And that's kind of where you think is an appropriate run rate, excluding any costs associated with the mortgage REIT in the fourth quarter.

Correct. That, and I think we've been pretty good about hitting that number, give or take, $100,000 here or there. But $6 million is our run rate.

And then in the -- in 3Q, or is it in 4Q, or, I guess, your fiscal 1, where there is comp-related charges?

In this upcoming 9 -- September 30 quarter, our fiscal Q4, there will be stock comp charges for employees, but that will be in the compensation and benefits line. And as you -- the only other -- the only time stock hits the G&A line is the annual Director Awards that happens in the March 31 quarter each year. And I think we covered that on our prepared remarks last quarter. I think it was about $0.5 million in our G&A line last quarter.

Great. And then maybe being a little bit more direct here, Adam. You've been talking about the mortgage REIT almost since you took -- or some sort of mortgage product, I should say, since listing or taking on more -- public. What's next? I mean, is it really looking at maybe a co-mingled fund? You've talked about you're seeing a lot of opportunities. I'm just trying to maybe put some meat behind, specifically where your head is with regards to what might be the next move here.

Sure, Mitch. I think the other things that we're thinking about are very similar or right down the middle of the fairway in terms of what we have talked about or I have talked about through the last several quarters. And to give you an example of something that we're spending some time -- a lot of time thinking about is there ability to continue -- to focus on our core competency around buying, operating, managing commercial real estate, but accessing capital differently? And so instead of doing it through a public vehicle is there an opportunity to raise private capital around doing that? I would say that's something that we're spending a lot of time thinking about. I think there's also -- we're spending a lot of time trying to figure out how to grow the Securities Management business. That's probably the toughest nut to crack of our businesses, but it's something I do think we want to try to grow because I think it's a core competency of ours and something that has a natural synergy to what we do every day in terms of managing real estate. So those are the 2 areas that, I'll tell you today, I'm spending a lot of time thinking about.

Great. And then last, maybe, Matt. I just want to -- just to verify here. I apologize if it was in the press release. Which ones are earning fees based on market cap versus historical cost?

So on a market cap, HPT and SIR, as of June 30, we're paying business management fees on that basis. And SNH and GOV, as of June 30, we're on an invested capital. In the month of July, SNH has flipped to market cap.

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

Thank you for joining us this afternoon. We look forward to updating you on our earnings in our fourth quarter conference call. Operator, that concludes our call.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.