Industrial Logistics Properties Trust quarterly report, Q2 FY2018

Business Context and Reporting Period

Industrial Logistics Properties Trust filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2018. The REIT owned 267 industrial and logistics properties totaling approximately 28.8 million rentable square feet across Hawaii and 24 other states. The portfolio was 99.1% leased to 240 tenants, with a weighted average remaining lease term of approximately 11.1 years.

The company completed its initial public offering on January 17, 2018. Comparisons with 2017 are therefore affected by the change from a wholly owned subsidiary of Select Income REIT to a separately traded public company.

Financial Performance and Liquidity

Metric	Three Months Ended June 30	Six Months Ended June 30
Total revenues	$39.4 million, up 2.1%	$80.0 million, up 2.5%
Operating income	$22.2 million, up 0.4%	$45.3 million, up 5.1%
Net income	$18.7 million, down 13.2%	$38.0 million, down 9.5%
Net income per share	$0.29, versus $0.48	$0.60, versus $0.93
Net operating income	$32.0 million, up 1.4%	$64.5 million, up 0.9%
FFO	$25.6 million, versus $28.4 million	$51.7 million, versus $55.6 million
Normalized FFO	$25.6 million, versus $28.7 million	$51.7 million, versus $58.3 million

Approximate second-quarter margins were 56.4% for operating income, 81.2% for NOI and 47.5% for net income. Six-month margins were approximately 56.6%, 80.6% and 47.4%, respectively.

Cash flow from operating activities was $45.8 million for the six months, compared with $52.9 million in 2017.
Investing cash outflows were $44.8 million, primarily reflecting the $43.3 million acquisition of a 240,283-square-foot property in Doral, Florida.
Financing cash flow was $14.6 million, including $444.3 million of net IPO proceeds, $470.0 million of revolving debt repayments, $17.6 million of shareholder distributions and $4.2 million of debt issuance costs.
Cash and cash equivalents were $15.6 million at June 30, 2018.
Debt consisted primarily of $335.0 million outstanding under a $750.0 million unsecured revolving facility and a $48.8 million mortgage note. The company reported $415.0 million of unused revolving capacity.
The revolving facility carried a 3.38% interest rate at quarter end and matures December 29, 2021, subject to extension options. The mortgage note bears fixed interest at 3.99% and matures in 2020.
Management stated that it was in compliance with its credit agreement covenants and believed available liquidity would meet operating, capital, debt service and distribution needs for the next 12 months and foreseeable future.

Material Changes Versus the Prior Comparable Period

Revenue growth was modest, primarily from leasing activity, rent resets and higher tenant reimbursements.
Net income and FFO declined because substantially higher interest expense more than offset operating growth. Second-quarter interest expense increased to $3.6 million from $0.6 million; six-month interest expense increased to $7.4 million from $1.1 million.
Per-share results declined further because the IPO increased weighted average shares by 44.5% in the quarter and 40.5% for the six months.
Six-month general and administrative expense decreased 24.1% to $5.5 million, mainly because 2017 included allocated estimated business management incentive fees, partly offset by higher costs of operating as a standalone public company.
Portfolio occupancy decreased to 99.1% from 99.6% a year earlier, while average effective rental rates increased to $5.58 per square foot from $5.44 in the quarter and to $5.65 from $5.51 for the six months.
During the quarter, the company leased or renewed approximately 218,000 square feet at weighted average rental rates approximately 34.5% above prior rates for the same areas.
Select Income REIT remained the largest shareholder, owning approximately 69.2% of outstanding shares at June 30, 2018.

Guidance, Outlook, Commentary, Risks and Unusual Items

Management did not provide formal earnings guidance. It stated that future acquisitions, capital expenditures, distributions and financing activities will depend on operating performance, acquisition opportunities, capital markets and covenant capacity.
The company declared a regular quarterly distribution of $0.33 per share, approximately $21.5 million, payable in August 2018. It expects to fund the distribution with existing cash and revolving borrowings.
In July 2018, the company agreed to acquire a single-tenant, 221,000-square-foot property in Upper Marlboro, Maryland for $29.25 million, subject to conditions and expected to close before the end of the third quarter. Closing was not assured.
Approximately 59.5% of annualized rental revenue came from Hawaii Properties. Hawaii leases frequently reset based on fair market values; future rent increases are not assured.
Tenant concentration is material: subsidiaries of Amazon accounted for approximately 10.3% of six-month revenue and 10.0% of annualized rental revenue at June 30, 2018.
Interest-rate exposure is significant because the revolving facility has floating-rate debt. A one-percentage-point increase in rates would increase annual interest expense by approximately $3.35 million on the $335.0 million outstanding balance and by approximately $7.5 million if the facility were fully drawn.
Accrued environmental remediation costs were $7.0 million. Management did not believe known environmental conditions were materially adverse, but future remediation costs could differ.
The company has no employees and relies on RMR LLC for business and property management. Related-party relationships with RMR LLC and Select Income REIT create potential conflicts of interest and continuing fees.
There were no material changes to previously disclosed risk factors, no material off-balance-sheet arrangements and no swaps, hedges or other derivatives at quarter end.
The company is assessing the future effects of new lease, credit-loss and nonemployee share-based payment accounting standards. The revenue standard adopted in 2018 had no material impact.

Important Facts for Investors to Verify

Whether the company can maintain near-full occupancy and renew leases as approximately 5.2% of rented square feet expire in 2019 and 4.2% expire in 2021.
The sustainability of the $0.33-per-share quarterly distribution relative to FFO, cash flow, required capital spending and increasing interest costs.
Exposure to LIBOR and other floating-rate increases, including the effect of further revolver borrowings to fund distributions or acquisitions.
Completion, timing and final terms of the proposed Upper Marlboro acquisition.
Future Hawaii rent resets and the ability to achieve historical rent growth without adversely affecting occupancy.
Tenant credit quality and concentration, particularly the contribution from Amazon and other major tenants.
Environmental remediation obligations and the adequacy of insurance coverage.
Fees, governance implications and potential conflicts arising from the company’s management agreements with RMR LLC and relationship with Select Income REIT.