Business context and reporting period
The RMR Group Inc. is a holding company whose business is conducted principally through RMR LLC, which manages real estate investment trusts, operating companies and advisory clients. The unaudited report covers the quarter and nine months ended June 30, 2017; the nine-month comparison is against the same period in 2016. Amounts below are in millions unless otherwise noted.
Financial performance and liquidity
| Metric | Three months ended June 30, 2017 | Three months ended June 30, 2016 | Nine months ended June 30, 2017 | Nine months ended June 30, 2016 |
|---|---|---|---|---|
| Total revenue | $55.5 | $52.2 | $215.1 | $210.7 |
| Operating income | $21.7 | $21.8 | $119.5 | $123.3 |
| Net income | $17.6 | $17.4 | $95.6 | $103.5 |
| Net income attributable to RMR Inc. | $6.9 | $6.7 | $37.3 | $29.9 |
| Diluted EPS | $0.43 | $0.42 | $2.31 | $1.87 |
| Operating margin | 39.1% | 41.8% | 55.5% | 58.5% |
Quarterly revenue rose 6.3%, while operating income was nearly flat as expenses grew 11.2%. For the nine-month period, revenue increased 2.1%, but operating income declined 3.1%. Nine-month RMR Inc.-attributable income rose 24.7%; the prior-year comparison includes $26.6 million of incentive fee income allocated to ABP Trust, affecting the allocation between RMR Inc. and noncontrolling interest. The quarterly $52.4 million incentive fee from HPT was earned in the first fiscal quarter, not the quarter ended June 30.
For the nine months, operating cash flow was $122.9 million, compared with $97.4 million in 2016; investing cash outflow was $0.6 million and financing cash outflow was $50.4 million. Cash and cash equivalents were $137.7 million at June 30, versus $65.8 million at September 30, 2016. Management attributed the increase principally to operating cash generation, including collection of the 2016 incentive fee. The filing reports no credit facilities and no material off-balance-sheet arrangements; it does not present outstanding borrowings as a material balance-sheet item.
At June 30, current assets were $173.0 million and current liabilities were $41.2 million. Total liabilities were $111.5 million, including a $64.9 million tax receivable agreement liability, of which $2.9 million was expected to be paid in the fourth quarter of fiscal 2017. RMR LLC distributed $56.2 million for members’ taxes during the nine months. RMR Inc. paid $12.1 million in common-share distributions and declared a further $0.25 per Class A and Class B-1 share for payment in August 2017.
Material changes and operating drivers
- Quarterly management services revenue increased $2.8 million, mainly from higher base fees tied to HPT and SNH market capitalization and higher property-management fees. Advisory revenue increased $0.4 million, largely reflecting the Tremont business acquired in August 2016.
- Nine-month management services revenue was essentially unchanged. Higher base management and property-management fees were largely offset by a $9.9 million year-over-year reduction in HPT incentive fees. Reimbursable payroll revenue rose $3.0 million and advisory revenue rose $1.3 million.
- Compensation and benefits increased 9.0% for the quarter and 10.6% year to date, reflecting staffing, salary and benefit increases and the Tremont acquisition. General and administrative expense rose 39.8% for the quarter and 12.6% year to date, including transaction costs and the fraud-related loss and expenses.
- Almost all revenue came from related parties: 99.1% for the quarter and 99.3% for the nine months. The Managed REITs contributed 87.9% of nine-month revenue, representing significant client concentration.
Outlook, risks and unusual items
- Management said operating cash flow should be sufficient for working capital and commitments over the next 12 months and foreseeable future. No earnings or revenue guidance was provided.
- Management cited real estate market and interest-rate sensitivity, noting that rising rates or declines in client-company market capitalization or business revenues could reduce fees. It believes selected property types and locations may offer growth opportunities, while cautioning that some property valuations may exceed replacement cost and acquisitions should be selective.
- GOV agreed to acquire First Potomac Realty Trust for approximately $1.4 billion, subject to shareholder approval and other conditions. RMR said fees from GOV may increase if completed, but there is no assurance of higher fees or earnings; additional management costs could exceed added fees.
- A Tremont Advisors-sponsored commercial mortgage REIT filed for a proposed IPO. Tremont Advisors bears the offering and organizational costs whether or not it proceeds; approximately $1.4 million had been incurred by June 30.
- A business email compromise fraud caused a $0.590 million loss and $0.095 million of related expenses. Recovery is uncertain. The company strengthened electronic-payment controls; management judged disclosure controls effective.
- RMR’s property-management agreement with TA was not renewed effective July 31, 2017. The related fees were small: $0.027 million for the nine months ended June 30, 2017.
- Other key risks include dependence on a limited number of clients, potential termination of management agreements, related-party relationships and conflicts-of-interest concerns, and the discretionary nature of dividends. The company stated its regular quarterly dividend intention was $0.25 per eligible share, subject to board discretion.
Important facts for investors to verify
- Whether core fee revenue and operating profitability can grow despite higher compensation and administrative costs and the decline in nine-month operating income.
- The extent to which future results depend on incentive fees, including whether any estimated $61.1 million of fees at June 30 would actually be earned at the applicable measurement dates.
- Client concentration, related-party governance arrangements and the implications of ABP Trust’s 48.2% economic interest in RMR LLC.
- Recovery prospects for the $0.590 million fraud loss and whether the enhanced payment controls prevent further losses.
- Whether GOV’s proposed acquisition closes and whether it increases RMR’s net earnings after additional costs; and whether the proposed Tremont-sponsored IPO proceeds.
- Cash available after tax distributions, tax receivable agreement payments and shareholder distributions, and the board’s continued support for the stated dividend.