ILPT (2019 - Q1)

Good morning, and welcome to the Industrial Logistics Properties Trust First Quarter 2019 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would like to now turn the conference over to Olivia Snyder, Manager of Investor Relations. Please go ahead. Olivia S

Thank you, and good morning, everyone. Thanks for joining us today. With me on the call are ILPT's President, John Murray; and Chief Financial Officer, Rick Siedel. In just a moment, they will provide details about our business and our performance for the first quarter of 2019 followed by a question-and-answer session with analysts. First, 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. Also, note that 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 ILPT's beliefs and expectations as of today, Monday, April 29, 2019, 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 or SEC, which can be accessed from our website ilptreit.com or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP numbers during this call including normalized fund from operations or normalized FFO and cash-based net operating income or cash-based NOI. A reconciliation of these non-GAAP figures to net income in the components to calculate cash available for distribution or CAD are available in our supplemental operating and financial data package which also can be found on our website. And now, I will turn the call over to John.

Thank, you Olivia. Good morning everyone and welcome to ILPT's first quarter earnings call. This morning we reported first quarter normalized FFO of $26.4 million or $0.41 per share. As of the end of the first quarter, ILPT's portfolio consisted of 277 primarily warehouse and distribution properties with 33.2 million square feet located in 28 states. Approximately 52% of ILPT's annualized revenues came from 16.8 million square feet of industrial land located on the Island of Oahu in Hawaii. Our Mainland portfolio consisted of 51 properties with $16.4 million square feet located in 27 states that were 100% leased with an average lease term of approximately 6.5 years as of quarter-end. Including our recently announced transactions, we owned a total of 296 properties with 42.4 million square feet located in 30 states and our Mainland portfolio consists of 70 properties with 25.6 million square feet located in 29 states that are 100% leased with an average lease term of approximately 7.4 years. During the first quarter, we continue to execute on our business plan with strong leasing activity and Mainland acquisitions. Starting with acquisitions, as we discussed during our fourth quarter 2018 earnings call; during the first quarter of 2019, we agreed to acquire two portfolios with a total of 26 properties containing 12.9 million square feet for a combined purchase price of $904.7 million at a weighted average cap rate of 6.3%. 700 properties closed during the first quarter and 19 subsequent quarter-end. Since 19 of the properties were acquired subsequent to quarter-end, we have provided enhanced disclosure in our financial supplemental including the list of properties acquired, as well as pro forma portfolio information such as Top 10 and concentration and tenant credit characteristics. Post acquisitions our Top 3 tenants are Amazon, Procter & Gamble and FedEx; representing 14.7%, 3.8% and 3.4% of total annualized rental revenues respectively. Investment grade rated tenants or subsidiaries of investment grade rated parent entities make up 62% of our Mainland revenues. Looking at the entire portfolio, nearly 75% of revenue comes from those investment grade tenants or subsidiaries or from our secured Hawaiian land leases. Top 3 markets after Hawaii at 40.9% are Indiana, Ohio and Virginia, representing 9.8%, 8.3% and 5.2% of our total annualized rental revenues respectively. We're very pleased with these acquisitions of well-located high-quality industrial properties leased to strong credit tenants that we expect to provide growing cash flows to enhance our ability to grow distributions to shareholders in the coming quarters. Also, as a reminder, over 70% of the total purchase price was funded by our mortgage financing in Hawaii that was completed in January and demonstrated the tremendous value of our unique Huwaiian industrial land assets. Turning to leasing; we executed lease renewals for approximately 271,000 square feet, all in Hawaii at rents that were 15.8% higher than prior rents from the same space with an average lease term of 9.4 years and leasing capital per square foot per lease year of approximately $0.03. We also completed rent resets in Hawaii for 483,000 square feet at rents that were 28% higher than prior rental rates. Portfolio occupancy as of the end of the first quarter was 99.4%, up from 99.3% last quarter. We have no significant near-term lease explorations on the Mainland with only 0.2% of total annualized rents expiring over the remainder of 2019 and less than 2% expiring by the end of 2020. Moving to Hawaii; we have 394,000 square feet of leases for $862,000 with total annualized rent scheduled to expire during the remainder of 2019. In addition to 1.2 million square feet for $1.9 million of annualized rent that is scheduled to reset. The industrial market on the island of Oahu continues to be favorable to landlords this quarter with continued positive net absorption, occupancy rates over 98%, and average rents for warehouse space at their second highest level since the end of the Great Recession. As a reminder, ILPT's Hawaii portfolio occupancy has never fallen below 98% since it was first acquired in the early 2000s. We continue to be encouraged by our leasing results and look forward to executing on the more than 50% of our Hawaii leases that were mark-to-market either through rent resets or as leases rollover over the next five years. As you may have seen in our proxy statement that was filed earlier this month, we've begun to undertake changes to our governance policies in response to shareholder engagement and feedback. First, we've adopted a proxy access by law which enables a shareholder or a group of upto 20 shareholders to include trustee nominations in the Company's proxy materials for the annual meeting as opposed to being responsible for their own solicitations. We're also starting the process to expand our Board with additional independent trustees. We have engaged an executive search firm to help us identify qualified and diverse candidates and we will keep you updated on the expansion process which is expected to take place over several years. Also, in response to shareholder suggestions, we changed the benchmark index by which potential incentive management fees paid to the RMR Group are measured from the SNL U.S. REIT Equity Index to the SNL U.S. REIT Industrial Index, effective January 1, 2019. Building and keeping shareholder confidence is an important part of our business in long-term value creation. I'll now turn the call over to Rick Siedel to provide details on this quarter's financial results.

Thanks, John, and good morning everyone. Normalized FFO for the first quarter of 2019 was $26.4 million or $0.41 per share. Adjusted EBITDA for the quarter was $34.1 million, up 10% from last quarter and 14% year-over-year. Our quarterly dividend of $0.33 per share continues to be well covered with a low payout ratio of 80.5%. Total revenues for the first quarter of 2019 increased by $5.4 million to $46 million representing a 13.3% increase over prior year results; this increase primarily reflects our acquisition activity, as well as lease renewals and rent resets at our Hawaii properties. Total portfolio same-store cash basis NOI increased by 4.6% over the prior year. Hawaii cash basis NOI increased by 5.5% over the prior year reflecting increases in rents from lease renewals and resets. We also collected percentage rent of $1.2 million which was $220,000 more than that received in the prior year period. As a reminder, this percentage rent is recognized annually during the first quarter of the year. Mainland cash basis NOI increased by 3.5% over the prior year reflecting our leasing activity and decreases in seasonal expenses including snow removal costs from the prior year. Our recurring capital expenditures for the quarter totaled $215,000. The majority of these expenditures were leasing capital, specifically commissions related to our Mainland lease extension, as well as renovations at one of our 13-owned buildings in Hawaii. General and administrative expense for the first quarter totaled $3.8 million, and depreciation expense was $9.6 million. The increase in both primarily reflects our acquisition activity. Interest expense increased by $3.8 million to $7.6 million, primarily due to the $650 million mortgage loan that was obtained in January of 2019 at just over 45% loan-to-value, which was discussed on last quarter's earnings call. The 10-year non-amortizing loan at fixed interest rate of 4.31% was used to pay down floating rate debt on our revolving credit facility and provided an attractive source of low-cost capital to fund our acquisition. We finished the quarter with $50 million outstanding on our revolver resulting in debt to adjusted EBITDA of 5.5 times. As mentioned last quarter, pro forma leverage for the two portfolio acquisitions will be higher than our long-term target, but we've remained comfortable at this level due to our stable, predictable, and growing cash flows and well-covered dividend. We do not plan to seek investment-grade ratings in 2019 and accordingly can be patient with higher leverage levels which also allows more flexibility to increase our dividend now that the $905 million of acquisitions have closed. We have received a few investor questions about the shelf-registration statement we filed last week. As a general rule, our policy is to always have a shelf available to maximize flexibility, but the timing of our filings was tied to the completion of the audit of the financial statements for the acquired portfolios. We want to be clear that we have no plans to raise equity through the sale of shares at today's market prices. That concludes our prepared remarks. Operator, we're now ready to take questions.

[Operator Instructions] The first question today comes from Bryan Maher of B.Riley FBR. Please go ahead.

Good morning, John and Rick. Just two questions from me. One, we came across the article on -- I guess, it was SNL or something like that a week or two ago on Hawaii legislation looking to bill REITs. I'm sure you guys are familiar with this legislation that's out there; can you give us a couple of comments as to what you think about that -- the prospects for it's passage and we did run some back at the envelope numbers on how it might impact you and it did not seemed material, but we just wanted to confirm that.

I'll start, Bryan. Thank you, that's a good question. And Rick will fill in the blanks if I miss something. But there -- for a number of years, there has been this litigation potential regarding doing away with the dividends paid deduction in Hawaii; in prior years it hasn't made it as far as it has this year but it has passed each of the houses in Hawaii and they reconciled the two different bills and presented it back for a final vote and it got approved; so it's heading for the Governor's desk. We're hopeful based on prior commentary that we've heard that the Governor may veto [ph] the bill, although there is certainly no assurance that that will happen. Because we have seen this bill get voted on in prior years, we've been careful about how we have structured different transactions we've done and we believe that there are ways to take advantage of depreciation deductions and interest deductions and other allocations of revenue among the states such that we can minimize what gets a portion to Hawaii. And as a result, we feel like the expected impact is going to be -- is not going to be material to ILPT.

Okay, great. And then, John, in your comments in your earnings release this morning, you kind of hinted at a dividend increase in the near-term. You're at normalized FFO payout ratio about 80.5%; what were you getting at there? Is that something we could see in the next quarter or two? How material might it be? I know that it's up to the Board but you opened the floodgate there on the questions so I'll throw it back to you.

Okay, that's good question also. We completed $905 million of acquisitions earlier this year, and as a result, expect our cash available for distribution to increase. And so I think that under normal circumstances that would be reasonable for our shareholders to expect that we would be raising the dividend -- probably the next dividend would probably -- roughly be the timing, now that since we have closed on all the properties. I think the wildcard is that a share price hasn't really reacted well so far to the investment activity and maybe some of that has to do with the fact that we filed the shelf last week, maybe it's just concerned over our leverage levels. But if the dividend rate gets too high, then people think that maybe there is a problem that they are missing and negatively impacts the share price. So, I think our Board's got a lot of thinking to do about what message we're sending and where we already have the highest dividend I think in the sector or certainly one of the highest in the sector. And so, if shareholders are telling us that they are more concerned about leverage than dividend levels, then maybe we'll use the cash to reduce leverage instead. So, the Board has to make a decision there but normally based on the acquisition activity we've completed, we would raise the dividend, probably with this coming dividend payment.

The next question comes from Mitch Germain of JMP Securities. Please go ahead.

Good morning. John, maybe, I think you said that the Board expansion was going to -- obviously, you hired a search firm and it may take a little time to transpire. What specifically -- what type of candidates are you looking to add maybe from background, whether it be real estate experience or financial auditing type experience? Is there a certain profile of what you're looking at?

Well, I think that we're trying to increase the diversity in our Board. We only have five trustees today, we have diversity among those Board members today, but we could add more diversity. And so I think we'll be looking for -- for that we'll be looking for different backgrounds; real estate backgrounds, public company backgrounds, just general business background. I think we haven't drawn any specific targets that we need a certain amount of people from certain categories. We're looking to increase the number of independent trustees and increase the diversity of our Board members.

And is the goal for these trustees to be independent of other RMR entities as well?

I think that's the goal, yes.

Okay. Last one from me; I know that -- given where the stock price as you've said, equity seems to be out of the picture for now. I know you've mentioned some joint ventures; if you sell some properties into some sort of joint venture with an institutional partner, do you envision that being assets in the Mainland portfolio or maybe selling off a minority piece of Hawaii?

I think that if we do go down the path of some sort of joint venture for tax basis reasons, right now it seems like doing something with the Mainland portfolio would be easier than trying to structure something with the Hawaiian portfolio. Maybe the Hawaiian tax legislation may make us think a little bit differently about that but I don't think so right now. I think most likely it would be a Mainland portfolio.

Our next question comes from Michael Carroll with RBC Capital Markets. Please go ahead.

I just want to go off of Mitch's last question. I mean, how are you thinking about joint ventures right now? Have you started discussions with anybody or is that still just a thought process right now?

We've spent some time internally talking about either selling a property or two or taking on a JV partner to recycle some capital and demonstrate to the market the value of our Mainland portfolio. We'd like to think that the Hawaii financing with the appraisal of being out there publicly and fairly larger banks getting behind it is kind of supported the value of our Hawaiian assets and wondering if doing something on the Mainland would be helpful. Again, here at the RMR Group, we've got a number of relationships; there are a few JVs in the portfolios, and we know how the process works, it's just a matter of determining that that's the best course of action and going forward with it.

But you haven't had any discussions with any other potential partners to joint venture of your assets yet?

There is always some discussions with various partners but nothing that we're prepared to announce at this point.

Okay. And then I think Rick, did it -- is it going to take about roughly 12 months to execute a joint venture once those discussions start, is that correct?

It varies on the portfolio. Some of these are pretty straightforward and I think folks could get their diligence a lot faster. So, it's hard to say. I mean it depends on the partner, and it depends on the assets. Most of our Mainland assets are pretty straightforward with great credit tenants, in a hot sector right now; so I'd like to think we could do it faster than a year, but again, we're in no rush, we like the cash flow from the properties right now and are comfortable with leverage levels where they are.

Okay. And then just real quick on the dividend policy, is there a target payout ratio that the Board looks at when setting the dividend?

I don't think we've stated it publicly but post acquisitions with the current dividend, we're down in the low 70s; so it's fairly low relative to all peers I believe or most of the peers. Just in general, that feels like a level that was supported but to John's point earlier, the question about a dividend increase being spitting in the wind is not lost on us. So, we'll continue to model it and the Board has some thinking to do and a decision to make.

Okay. And then when you think about the dividend increase, is this something that you typically want to do every year -- I guess, we're through the first quarter and we didn't get the dividend increase since the IPO was completed or is it as you kind of look at when you have a big acquisition or earnings pop, that's when you'll think about the dividend increase, I guess. What does the Board think about and when do they think about increasing it?

The Board discusses the dividend at every meeting. There has been a lot of change that's happened since the IPO in that recent acquisitions and financing of the Hawaiian properties. And so I think there isn't a formal policy but we'd like to be in a position where we're raising the dividend on a regular basis, preferably annually. But we haven't sort of set policy or a target quarter for when those increases may occur, it's just -- it depends on activity and what else was going on within the company.

This concludes our question-and-answer session. I would like to turn the conference back over to John Murray for any closing remarks.

Thank you, everyone for joining today's call. We've had a busy and successful start to 2019, and look forward to earnings growth and value creation for shareholders over the course of the year. We hope to see many of you at the upcoming Navy [ph] Conference in June. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.