Business context and reporting period
The RMR Group Inc. is a holding company; substantially all operations are conducted through majority-owned RMR Group LLC. It provides business, property management and advisory services, principally to a concentrated group of real estate investment trusts and operating companies. This unaudited Form 10-Q covers the three months ended December 31, 2017, compared with the three months ended December 31, 2016. Unless noted, amounts below are in U.S. dollars, millions.
Financial performance and position
- Revenue: $218.5, up 107.6% from $105.3. Incentive business management fees were $155.9 versus $52.4; other revenue categories also increased.
- Profit: Operating income was $182.4, up 141.1%, on expenses of $36.1. Net income was $159.3 versus $60.2; net income attributable to RMR Inc. was $71.1 versus $23.5. Basic and diluted EPS were $4.40 and $4.39, respectively, compared with $1.46 for both measures.
- Margins: Operating margin was approximately 83.5%, compared with 71.8%. Results include substantial annual incentive fees and significant tax-related items, so these margins and earnings may not represent recurring performance.
- Cash flow: Operating cash flow was $40.5, compared with $24.4. Investing cash use was $0.2; financing cash use was $22.9, including $18.9 of distributions to noncontrolling interests and $4.0 to common shareholders. Cash increased $17.3 to $126.0.
- Liquidity and balance sheet: Current assets were $309.9 and current liabilities $60.2. Receivables due from related parties rose to $180.6 current from $25.2 at September 30, largely reflecting fees earned near period-end; the related-party balance including long-term amounts was $188.3. Total assets were $529.8 and total liabilities $103.3.
- Debt: The filing reports no credit facilities available for borrowing and no material off-balance-sheet arrangements. It does not identify debt as a material source of financing.
Material changes versus the prior comparable period
- Incentive fees rose to $155.9 from $52.4. The 2017 fees were earned from HPT ($74.6), SIR ($25.6) and SNH ($55.7) based on calendar-year performance and were paid in January 2018.
- Management services revenue increased 13.7% to $48.6, principally from higher base management fees and property management fees. Reimbursable payroll and other costs increased 38.9% to $12.7.
- Compensation and benefits rose 24.5% to $28.9, primarily due to increased staffing and annual compensation increases. General and administrative expense increased 14.8% to $6.7.
- Net income attributable to RMR Inc. increased 202.5%; the comparison is affected by incentive-fee variability and the tax-related items described below.
Outlook, commentary, risks and unusual items
- Tax Act effects: The December 2017 tax law change caused a $19.8 deferred tax asset remeasurement charge, increasing income tax expense. The lower federal corporate rate is expected to phase in at approximately 24.5% for fiscal 2018 and 21.0% for subsequent fiscal years. Separately, the company reduced its tax receivable agreement liability by $24.7, recorded as a remeasurement benefit. The filing says the lower tax rate may reduce future tax obligations and increase net income and operating cash flow.
- Liquidity outlook: Management expects cash on hand and operating cash flow to be sufficient for operating needs for the next 12 months and the foreseeable future. The company expects to continue quarterly distributions; it declared a $0.25-per-share dividend in January 2018. Dividends remain at the board’s discretion.
- Business outlook: Management said growth depends on the performance and expansion of client companies. It cited selective acquisition opportunities, cautioned that property values may exceed replacement cost in some markets, and noted that rising interest rates could pressure real estate values and client market capitalizations.
- New client: ILPT completed its IPO on January 17, 2018, and RMR LLC entered into business and property management agreements with it. ILPT’s success and the expected growth in industrial and logistics property values are uncertain.
- Key risks: Revenue is highly variable and concentrated: related parties generated 99.7% of revenue, and the Managed Equity REITs represented 95.2%. Loss or termination of management contracts, declining client performance or market capitalization, rising rates, conflicts-of-interest allegations, litigation and retention of key personnel could adversely affect results. The company states that incentive fees may not recur. No material changes to previously disclosed risk factors were reported.
- Other unusual item: An executive retired effective December 31, 2017; accelerated vesting of his share awards resulted in $0.3 of compensation expense. Controls and procedures were concluded to be effective, with no material change in internal control reported.
Important facts for investors to verify
- How much of reported earnings and cash generation is repeatable, given the $155.9 of annual incentive fees and their dependence on client share performance relative to benchmarks?
- Whether the $180.6 current related-party receivable was collected as expected, including the incentive fees reported as paid in January 2018.
- The net and continuing effect of the Tax Act: the $19.8 deferred-tax charge, $24.7 tax receivable agreement benefit, and future tax payments and savings.
- Client concentration, contract termination provisions and potential conflicts arising from the extensive related-party and governance relationships.
- Whether ILPT and other new mandates add durable revenue, and how rising interest rates or weaker real estate markets affect clients and RMR’s fee base.