Industrial Logistics Properties Trust quarterly report, Q3 FY2018

Industrial Logistics Properties Trust — Q3 2018 Form 10-Q Summary

Business context and reporting period

Industrial Logistics Properties Trust is a Maryland real estate investment trust focused on owning and leasing industrial and logistics properties. The filing covers the three and nine months ended September 30, 2018. The company completed its initial public offering on January 17, 2018, issuing 20.0 million common shares and becoming a separately traded public company. Accordingly, comparisons with 2017 reflect significant changes in capital structure, public-company expenses and related-party arrangements.

Portfolio: 269 properties, approximately 29.2 million rentable square feet and 245 tenants across Hawaii and 25 other states.
Leasing: 99.3% leased at September 30, 2018, versus 99.9% at September 30, 2017; weighted average remaining lease term was approximately 10.9 years based on annualized rental revenues.
Geographic concentration: Hawaii Properties generated approximately 60.1% of third-quarter revenue and 60.3% of nine-month revenue.

Financial results and key metrics

Metric	Q3 2018	Q3 2017	9M 2018	9M 2017
Total revenues	$40.4 million	$39.1 million	$120.5 million	$117.1 million
Operating income	$22.1 million	$23.5 million	$67.4 million	$66.5 million
Net income	$18.1 million	$22.9 million	$56.1 million	$64.8 million
Net income per diluted share	$0.28	$0.51	$0.88	$1.44
NOI	$32.2 million	$31.8 million	$96.7 million	$95.7 million
FFO	$25.3 million	$29.7 million	$77.0 million	$85.3 million
Normalized FFO	$25.3 million	$29.0 million	$77.0 million	$87.2 million
Normalized FFO per diluted share	$0.39	$0.64	$1.21	$1.94

Q3 revenue increased 3.5% year over year, while operating income decreased 5.7% and net income decreased 20.8%. The principal earnings pressure was substantially higher interest expense, which rose to $4.1 million from $0.6 million. General and administrative expense also increased to $2.9 million from $0.5 million as the company incurred public-company and management costs after the IPO.

For the first nine months, revenue increased 2.9% and operating income increased 1.3%, but net income declined 13.5% because interest expense increased to $11.4 million from $1.7 million. Per-share results were further reduced by the increase in weighted average shares to 63.8 million from 45.0 million.

Operating margins based on reported operating income were approximately 54.7% in Q3 2018 and 55.2% in Q3 2017; nine-month margins were approximately 55.9% and 56.8%, respectively. NOI margin was approximately 79.7% in Q3 2018 and 81.3% in Q3 2017.

Cash flow, debt and liquidity

Nine-month operating cash flow was $70.2 million, compared with $78.7 million in 2017.
Investing cash flow was negative $97.2 million, primarily reflecting $93.6 million of acquisitions and $2.1 million of real estate improvements.
Financing cash flow was positive $38.0 million, including $444.3 million of net IPO proceeds, $370.0 million of net repayments under the revolving facility, and $39.0 million of shareholder distributions.
Cash and cash equivalents were $11.1 million at September 30, 2018, compared with no reported cash balance at December 31, 2017.
Total liabilities were $475.4 million, versus $849.5 million at December 31, 2017, primarily reflecting repayment of revolving debt with IPO proceeds.
Debt consisted principally of $380.0 million drawn on a $750.0 million unsecured revolving credit facility and a $48.75 million mortgage note. The revolver matures December 29, 2021; the mortgage matures in 2020.
The revolver carried a 3.50% interest rate at September 30, 2018, based on LIBOR plus a leverage-based premium. The company reported $370.0 million of additional availability at quarter-end and stated that it was in compliance with its debt covenants.

Management stated that operating cash flow and the revolving credit facility should be sufficient for operating expenses, capital expenditures, debt service and distributions for the next 12 months and the foreseeable future. The company has no employees and relies on RMR LLC for business and property management services.

Material changes versus the prior comparable period

Completed the IPO in January 2018, raising $444.3 million of net proceeds and increasing shares outstanding from 45.0 million to 65.1 million at September 30, 2018.
Reduced revolving debt from $750.0 million at December 31, 2017 to $380.0 million at September 30, 2018, although borrowings increased to $405.0 million by October 25, 2018.
Acquired three properties totaling approximately 666,000 square feet for an aggregate purchase price of $93.6 million, including acquisition costs.
Comparable-property NOI increased only 0.4% for the nine-month period, as operating expense growth outpaced revenue growth.
Q3 leasing activity covered approximately 324,000 square feet at rental rates approximately 12.1% above prior rates. Hawaii rent resets covering approximately 516,000 square feet were completed at rates approximately 20.3% above prior rates.
Declared a regular quarterly distribution of $0.33 per share for payment in November 2018.
John C. Popeo announced his retirement as President and CEO and Managing Trustee effective November 30, 2018. John G. Murray was appointed to succeed him effective December 1, 2018.

Guidance, outlook, risks and unusual items

The company did not provide specific earnings or revenue guidance. Management expects to continue pursuing industrial and logistics acquisitions, primarily newer properties with high-credit-quality tenants and longer lease terms.
In October 2018, the company acquired an Ankeny, Iowa land parcel for $0.45 million and agreed to an approximately 194,000-square-foot expansion at an estimated cost of approximately $15.0 million. It also acquired a Maple Grove, Minnesota property for $27.7 million.
American Tire Distributors, representing approximately 3.1% of annualized rental revenues, filed for Chapter 11 bankruptcy on October 4, 2018. The tenant had paid rent through October 2018, but may reject leases, stop paying future rent or seek renegotiation.
Approximately 5.1% of rented square feet and 2.7% of annualized rental revenue were scheduled to expire by December 31, 2019. Hawaii Properties represented approximately 58.8% of annualized rental revenues and have exposure to market-based rent resets.
SIR owned approximately 69.2% of the company at September 30, 2018. A proposed SIR merger could result in distribution of SIR’s 45.0 million company shares to SIR shareholders, but the distribution remained subject to conditions and was not assured.
Known environmental remediation costs of $7.0 million were accrued. Management stated that environmental conditions could nevertheless result in additional material costs.
A one percentage point increase in interest rates would increase annual interest expense on the outstanding revolver by approximately $3.8 million, or approximately $0.06 per diluted share based on the filing’s sensitivity analysis.
The company expects to qualify as a REIT for federal income tax purposes for 2018 and thereafter, subject to meeting applicable requirements, including distributing at least 90% of REIT taxable income.

Most important facts for investors to verify

Impact of American Tire Distributors’ bankruptcy on rent collections, occupancy and property values.
Progress, cost and tenant commitments related to the planned Iowa expansion.
Interest-rate sensitivity and refinancing requirements for the floating-rate revolver and 2020 mortgage maturity.
Whether the proposed distribution of SIR’s 45.0 million shares occurs and its effect on ownership, trading liquidity and governance.
Sustainability of the $0.33 quarterly distribution relative to operating cash flow, FFO and required capital expenditures.
Future Hawaii rent resets, lease expirations and the effect of occupancy declining from 99.9% to 99.3%.
Costs and potential conflicts associated with the company’s continuing management and property agreements with RMR LLC and other related parties.