The RMR Group Inc.

Good day and welcome to the RMR fiscal third quarter 2022 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note, today's event is being recorded. I would now like to turn the conference over to Michael Kodesh, Director of Investor Relations. Please go ahead, sir.

Good afternoon, and thank you for joining RMR's third quarter of fiscal 2022 conference call. With me on today's call are President and CEO Adam Portnoy and Chief Financial Officer Matt Jordan. In just a moment, they'll provide details about our business and quarterly results, followed by a question and answer session. 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. 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 5, 2022, 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 those differences is contained in our filings with the Securities and Exchange Commission, which can be found on our website at www.rmrgroup.com. 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 net income adjusted earnings per share, adjusted EBITDA, and adjusted EBITDA margin. The reconciliation of net income determined in accordance with U.S. generally accepted accounting principles to adjust net income, adjusted earnings per share, adjusted EBITDA, and the calculation of adjusted EBITDA margin can be found in our earnings release. And now I would like to turn the call over to Adam.

Thanks, Michael, and thank you for joining us this afternoon. We are pleased to report another strong quarter of financial results. with adjusted net income of 59 cents per share and adjusted EBITDA of $29.4 million, representing sequential quarter increases of 18% and 14%, respectively. As an alternative asset manager focused primarily on core commercial real estate, RMR's unique structure remains highly attractive in today's operating environment. Our competitive advantage is rooted in over 35 years of experience in managing commercial real estate, as well as our large size and scale, which includes over 2,100 properties located throughout North America. This expertise is especially important today as we navigate the ongoing macroeconomic challenges related to rising inflation, increasing interest rates, and slowing economic activity. These trends have resulted in significant reductions in commercial real estate transaction activity as buyers and sellers adjust to this new environment. While we have historically seen increases in AUM from growth at our existing publicly trade equity REITs, the last two years have demonstrated our success in raising private capital to grow our AUM away from these equity REITs. From almost $0 of private capital under management just two years ago, we have built a platform that currently has almost $4 billion of private capital assets under management, Access to private capital markets gives RMR an additional path for continued growth, especially during times like these with pronounced market volatility. With that said, there remains significant revenue opportunity within our publicly traded equity REITs. For the third fiscal quarter, almost 75% of our revenues came from our managed public real estate capital clients. with our publicly traded equity REITs representing the vast majority of these revenues. Based on the capital structures of these equity REITs today, there is significant fee durability and limited downside to the revenues we generate from this AUM. Moreover, there is significant fee revenue upside without the need to grow AUM at these equity REITs, as we are highly incentivized to increase their respective share prices. To put this in perspective, If we close the gap between enterprise value and the historical cost of the equity REIT's underlying assets, we could generate approximately $53 million of incremental revenues annually with close to 100% flow through to EBITDA. This number is all the more remarkable because it excludes the potential for any incentive fees. Ultimately, this two-pronged approach, growing internally and externally through both public and private capital markets, enhances RMR's ability to thrive within almost any economic environment. Furthermore, our operating results this quarter highlight the benefits of this approach. RMR arranged almost 5 million square feet of leases on behalf of our clients this quarter, more than doubling the previous quarter's activity, with a weighted average lease term of approximately 19 years and a weighted average roll-up in rent of almost 26%. Almost 80% of this quarter's leasing activity was executed at ILPT-owned assets, highlighting the continued robust demand for industrial and logistics properties and supporting our recent focus on acquiring well-leased and attractive industrial assets. Earlier this year, ILPT closed on the strategic acquisition of Monmouth Real Estate Investment Corporation, which includes approximately 26 million square feet of high-quality e-commerce-focused industrial assets. ILPT's consolidated portfolio of well-located assets are currently 99% leased by strong credit-quality tenants with a 9.2 years weighted average lease term. On prior calls, we discussed ILPT's long-term financing plans for the Monmouth acquisitions. which included the sale of additional equity interest in an industrial joint venture that includes Monmouth assets and property sales. However, given the current interest rate environment, which has led to a meaningful deterioration in real estate market conditions, ILPT made the decision to pause any discussions with potential joint venture partners and buyers of assets. In conjunction with these decisions, ILPT reduced its quarterly dividend to preserve liquidity in the short term, We are comfortable that ILPT will weather these short-term challenges as the core operating fundamentals remain robust and represent strong tailwinds until permanent financing solutions are put in place. OPI recently reported strong results this quarter that included growth in both same property cash NOI and normalized FFO. Despite this quarter's strength, office fundamentals remain in a period of transition. as tenants continue to assess their longer-term space needs and possible hybrid work environments. Over the last three years, OPI has carefully curated its portfolio, recycling capital into stronger, well-leased core assets, while continuing to have the security of the U.S. government as one of its largest tenants. Despite headwinds in the office space sector, we remain encouraged by OPI's leasing trends And our internal tenant activity metrics suggests OPI is seeing tenant engagement across its portfolio that exceeds national office sector averages. Turning to our hotel and service retail businesses. At Travel Science of America, business was remarkably strong with adjusted EBITDA of almost $123 million this quarter, representing a 67% year-over-year improvement. While inflation and a possible recession represent possible headwinds, TA has established a resilient business model that should withstand possible pressures on operating margins in the future. At SVC, growth in normalized FFO and adjusted EBITDA reflects the continued benefits of SVC's portfolio diversity, a distinguishing factor when compared to other hotel-focused REITs. Just under half of SVC's assets are in the service retail sector, led by its leases with TA. As I previously highlighted, TA's results continue to reinforce the strength of SVC's service retail portfolio, with aggregate coverage of its net lease portfolio's minimum rents being a very robust 2.8 times as of June 30th. With regards to SVC's owned hotels, The portfolio has benefited from the ongoing improvements to lodging industry fundamentals. Specific to SVC, hotel average daily rates this quarter were at historical peak levels, and RevPar growth exceeded the broader hotel industry average by over 18%. Since the beginning of the year, SVC has sold 59 hotels for almost $510 million and repaid $500 million of senior notes. The strength of SVC's results has led to it now being in compliance with all debt covenants, well ahead of prior expectations. DHC reported yet another sequential quarter of NOI growth in its same property shop segment due primarily to rate increases and occupancy stabilization. A year ago, DHC began the process of transitioning management of 107 communities to new third-party regional operators. which completed late last year. This quarter, occupancy in the transition communities increased 210 basis points, and NOI continues to improve, both positive signs that these regionally focused operators are driving improved operating results. During the quarter, DHC repaid $500 million of 9.75% debt, sold an additional 10% equity interest in its existing Boston Life Science property joint venture, and is making progress towards regaining compliance with its debt covenants. We are encouraged by recent trends at DHC and with continued capital investments in DHC's senior living assets and the recently announced restructuring plan at Alaris Life, we are hopeful that DHC's operating results will continue to improve in the coming quarters. Finally, at our commercial mortgage rate, Seven Hills Realty Trust, We continue to believe that the business has attractive long-term growth prospects. During the quarter, Seven Hills portfolio remained default free and with new originations, its aggregate committed capital was $735 million at quarter end. We expect that Seven Hills will benefit from the current rising interest rate environment because its portfolio consists of 100% floating rate loan investments. which leaves it well-positioned for continued earnings growth. In closing, our public and private managed vehicles collectively have over $37 billion in assets under management today, which represents over $1.3 billion of growth per year on average since going public seven years ago. As I highlighted earlier, there also remain significant opportunities for revenue growth without any AUM growth, through share price improvements at our existing publicly traded equity REITs. Additionally, we remain optimistic that there are ample opportunities to grow private capital AUM, either organically or through possible M&A activity in the years to come. With that, 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. In the third fiscal quarter, we reported adjusted net income of $9.8 million, or 59 cents per share, and adjusted EBITDA of $29.4 million, both representing significant sequential quarter increases, and each metric finishing above the midpoint of our guidance. Total revenues were $53 million this quarter, which was over $7 million higher on a year-over-year basis, and almost $4 million higher on a sequential quarter basis. The sequential quarter increase in revenues was primarily attributable to the full quarter impact of ILPT's Monmouth acquisition, increases in construction management fees, and fee growth tied to the continued strong operating performance of Synesta and TA. Looking ahead to the fourth quarter, we expect to generate between $50 and $52 million of revenues based on the current enterprise values of our managed equity REITs, as well as our expectations of continued increases in construction management Turning to expenses for the quarter. Cash compensation this quarter was $32.2 million, which was an increase of $500,000 sequentially, and our corresponding cash reimbursement rate improved slightly this quarter to approximately 44%. While wage inflation and labor scarcity both remain a headwind, especially in Greater Boston, our employee retention rates have remained ahead of industry benchmarks, and we continue to leverage technology, secondary hiring locations, and select outsourcing solutions to mitigate these headwinds. Looking ahead, we expect cash compensation to remain at approximately $32 million for the fourth quarter, and our reimbursement rate to remain at 44%. As a result of these collective expectations, guidance for the fourth quarter remains unchanged, with adjusted earnings per share forecasted to range from 57 to 60 cents per share, and adjusted EBITDA should range from 28 to $30 million. RMR's quarterly dividend of 40 cents per share remains well covered at a current payout ratio of approximately 55%. We close the quarter with almost $200 million in cash and continue to have no debt. We believe our balance sheet leaves us well positioned to pursue a variety of strategies to expand our platform. Before we begin the question and answer portion of the call, I would like to first acknowledge RMR's recently published sustainability report. Our sustainability report provides a comprehensive overview of our long-term ESG goals, including RMR's zero emission promise, whereby we have pledged to reach net zero greenhouse gas emissions across the properties we directly manage by 2050, with a target of reaching a 50% reduction by 2030. We would encourage those listening to go to RMR's sustainability website, where readers can see a collective overview of the successes we've had thus far, in driving energy, emissions, water, and waste reductions, as well as our contributions to the communities we operate in and the investments we are making in our people. That concludes our formal remarks. Operator, would you please open the line to questions?

Absolutely. If you would like to ask a question, please press star then 1 on your touch-tone phone. If you're using a speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. Once again, that's star than one if you have a question. Today's first question comes from Brian Maher with B. Reilly FBR. Please go ahead.

Good afternoon, Adam and Matt, and thanks for those comments. A couple of questions for me. On the Senesta front, you know, we know that you bought, you know, Senesta bought four properties in Manhattan earlier this year in conjunction with SVC's contribution. Do you have any thoughts on Sonesta's growth trajectory kind of going forward over the next year or two as it relates to buying more hotels in gateway markets?

Sure. Good afternoon, Brian. Thanks for that question about Sonesta. Yes, Sonesta, you're right to focus on Sonesta. It's really had a great quarter in really showcasing the improvements they're having in the operations, especially over the last quarter into the summer. With regard specifically to your question about how it's planning to grow, I would say the real focus at Synesta is on growing its franchising business. We're not ruling out that it could also make acquisitions, outright acquisitions of hotels, but I would say the focus is really on growing its franchise, the number of hotels it franchises. It has a really good base, about 1,200 hotels, roughly 300 it manages itself, and then around 900 that it franchises. Its franchising business is really starting to pick up pace. And I expect that's going to be the majority of where you'll see unit growth coming. And again, just to tie it all back together, that's, of course, as we grow revenues at Senesta, that benefits RMR. And of course, as we grow cash flow at Senesta, that indirectly helps SVC through its 34% ownership in Senesta. So that's principally how we're thinking about growing at Senesta, and we feel pretty good about it.

Okay. Thanks for that. And then over the years, you've talked a lot about acquisition opportunities. You have a lot of cash on the balance sheet. I think if memory serves me, that might've slowed down a little bit, but you were getting inbound inquiries that you were looking at. Is there anything going on there given the capital markets dislocation of the past, you know, couple of few months and, you know, talk on wall street of, you know, weakness, cause there's no deal activities. Is that ramping up at all with people approaching you to revisit some of that?

I'm not sure that ramping up is the right word, but we are in discussions or have had discussions with groups. You know, just to recap for you, maybe less so, but for others, Brian, you know, in 2020 and 2021, we had a very concerted outgoing group. you know, engagement where we were actively calling on partners, we were calling them, we were asking for meetings. Really, beginning last six months or so, we've been stepping back and not so much go making outbound calls, we're getting, we're sort of sitting back and waiting for inbound calls. And they have been occurring. I would say every quarter, we get one, two, three inquiries, either from groups that we've talked to in the past that circle back and want to check in and or talk at a high level about something and or there's something going on in the market where a potential acquisition has actually retained an advisor and is engaged in a process. And, of course, we're on the short list of folks that they would call. So, you know, there's nothing, you know, imminent to speak of in terms of, you know, we're not in the process of negotiating a PSA, a purchase and sale agreement or anything like that. But we have pretty regular dialogue. It comes and goes, but I'd say on average every quarter there's at least a couple of conversations that occur.

Yeah, just two more for me. On the JV front, which you referenced in your prepared comments, which has really grown quite a bit over the past couple few years, can you talk a little bit more about the JV partners or potential partners? Has that broadened out over the past, you know, year or two as, you know, whatever sovereign wealth funds or other large private capital sources have seen what you've done and want to participate in that. Can you give us some more color on that?

Well, there's nothing to point to specifically in terms of, you know, we suddenly taking on a mandate with a new partner to speak of. But I can tell you that, yes, very much so we have had increasing dialogue over time with groups. I would say the groups that we are focused on talking to or we've had the most conversation with tend to be other sovereign wealth funds, and that's because, and I think this is a good thing, the sovereign wealth funds we are doing business with us have referred us to other sovereign wealth funds, and sometimes without our prompting. which is no greater compliment than that, that they say they're enjoying the relationship with us and they suggest us to others. And so we immediately get a pretty good audience through that. And that's happened on a handful of occasions already. And so we are in dialogue with other folks. We mentioned a few quarters ago that we have had a more direct and focused effort in and around family offices and high net worth individuals. There's definitely been several conversations with that sort of constituent of potential partners that have occurred as well. And so I'd say the dialogue is progressing well. And that's why you've heard us tactfully a couple of quarters ago say things like, we're more focused on sort of growing it internally, organically ourselves, rather than relying on having to jumpstart it through M&A. Doesn't mean we won't engage in M&A. just means that we are increasingly gaining confidence that we are going to be able to continue to grow the business or grow that sort of AUM growth through that means and that channel, just doing it ourselves.

Okay. And just last for me, you're sitting on almost $200 million in cash. I think about a year ago, you did that big $7 per share special dividends. You know, clearly you don't have the nearly $400 million you had a year ago, but is there any thought as we look out over the next quarter to, you know, have a potential, you know, special dividend or otherwise return capital?

Yeah, it's probably a little early for us to have any sort of serious dialogue around that at the board. I think what we've been thinking about is, you know, using that capital sort of similar, just sort of ties back to your private capital, you know, sourcing question prior. As we think about growing private capital AUM and additional separate managed accounts, joint ventures, possibly engaging in fundraising around a specific fund of some sort, I think we more and more are thinking that some of that capital could be used for co-investment. Typically, if you're going to put a vehicle together, in the simplest example, you put a couple hundred million dollars of equity together As a sponsor, they typically look for some sort of investment. As you sort of start off in that business, your co-investment is probably going to be a little larger than it might be when you're more established. And so that's sort of why we keep that money in reserve, is sort of to help us think through those types of strategies and to have it there as those opportunities present. We also, as I said, we're not, you know, we talk about M&A and it's opportunistic, but we do get inbound calls. Some of them are interesting conversations. We like to keep that liquidity if any of those conversations actually came to fruition.

Okay, that's all for me. Thank you very much.

Thank you. And ladies and gentlemen, as a reminder, if you'd like to ask a question, please press star then one at this time. We'll pause momentarily to assemble our roster. And ladies and gentlemen, this concludes our question and answer session. I'd like to turn the conference back over to Adam Portnoy for any closing.

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

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.