Life Storage Inc (LSI) Q4 2019 Earnings Call Transcript

Life Storage Inc (LSI)
Q4 2019 Earnings Call
Feb 20, 2020, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Life Storage fourth-quarter 2019 earnings conference call. [Operator instructions] I would now like to turn the conference over to Dave Dodman, senior vice president, investor relations, and strategic planning. Please go ahead.

Dave Dodman -- Senior Vice President, Investor Relations, and Strategic Planning

Good morning, and welcome to our fourth-quarter 2019 earnings conference call. Leading today's discussion will be Joe Saffire, chief executive officer of Life Storage; and Andy Gregoire, chief financial officer. As a reminder, the following discussion and answers to your questions contain forward-looking statements. Our actual results may differ from those projected due to risks and uncertainties with the company's business.

Additional information regarding these factors can be found in the company's SEC filings. A copy of our press release and quarterly supplement may be found on the Investor Relations page at lifestorage.com. [Operator instructions] At this time, I'll turn the call over to Joe.

Joe Saffire -- Chief Executive Officer of Life Storage

Thanks, Dave, and good morning, everybody. We had another solid quarter and a strong finish to the year. I couldn't be more pleased with my team's execution on our strategic initiatives. I'll start by touching on a few of the many accomplishments we achieved over the past year.

We expanded our footprint to new strategic markets such as Seattle, Baltimore, and Toronto. We completed almost $430 million of acquisitions, which included an important mix of both leased-up and stabilized stores, all of which have higher revenue and growth prospects than the $200 million of stores we divested. We have started this year off well with six additional California properties currently under contract. We successfully grew our third-party management portfolio, which reached almost 300 stores at year-end, with a net addition of 84 stores in 2019.

This portfolio has tripled in just three years as more owners are drawn to our innovative platforms such as Rent Now and Warehouse Anywhere. We capitalized on growth opportunities within our existing portfolio with the completion of $60 million of expansions and enhancements in 2019, and this compares to just $25 million to $35 million in each of the previous three years. We finalized the rollout of Rent Now, our fully digital rental platform that allows customers to self-serve and skip the counter. This achievement now allows us to interact with customers in any manner they so choose, in person, over the phone or online.

Our focus on new technologies has helped with our efforts to improve our operating margins. And our efficiency initiatives, which we discussed on our third-quarter call, have played out earlier than we expected with fourth-quarter same-store property operating expenses down more than 5%, and that excludes property taxes. And lastly, we continue to expand our portfolio of joint venture partners with $25 million of minority investments made in both the U.S. and Canada in 2019.

As it relates to markets, we continue to see positive trends in some of our largest, including Chicago, Buffalo, Las Vegas, and Los Angeles. And we are seeing sequential improvement in several Southeast and Texas markets that have experienced significant new supply, including Miami, Tampa, Austin, and San Antonio. As a result of our performance and our optimism that we are past the peak of new deliveries in some of our larger markets, we are slightly going to increase our 2020 guidance. I will now hand it over to Andy to walk you through these details, as well as our quarterly results.

Andy Gregoire -- Chief Financial Officer

Thanks, Joe. Last night, we reported adjusted quarterly funds from operations of $1.44 per share for the fourth quarter, a 4.3% increase over the same period last year, driven by better-than-expected same-store performance. Our same-store performance was highlighted by NOI growth of 4.2%, achieved by a combination of revenue growth, and extremely well-controlled expenses. Specifically, same-store revenue increased 2.6% over the same period last year, driven by realized rates per square foot that increased 2.6% over the fourth quarter of 2018.

This revenue growth was an acceleration from our third-quarter same-store revenue growth, up 1.8%. Fourth-quarter same-store expenses outside of property taxes decreased 510 basis points over the fourth quarter of 2018. Excluding property taxes and Internet marketing spend, operating expenses decreased in every major line item. Our investments in technology and our focus on efficiencies are producing great results and are evident in the 100-basis point improvement in our year-over-year same-store NOI margin.

Partially offsetting these expense efficiencies was an 8.4% increase in property taxes over the fourth quarter of 2018. Our fourth-quarter property tax expense had a tough comp, but our year-to-date property tax expense came in as expected with an annual increase of 5.9%. We do anticipate continued pressure from property tax expense and forecast 5% to 6% increase in 2020. We are very pleased with the continued benefit of our transition to a captive program for tenant insurance as net operating income associated with this program increased more than 20% over last year's fourth quarter.

Since that program transitioned on April 1, 2019, we expect one more quarter of outsized year-over-year performance. Our overall fourth-quarter revenue increase also reflected a 38.7% increase in third-party management fees due to the significant traction we have gained in growing that portfolio of stores. Our balance sheet remains solid, and we continue to have significant flexibility to capitalize on attractive investment opportunities when they meet our return requirements. At quarter-end, we had cash on hand of $17.5 million and $435 million available on our line of credit.

Our net debt-to-recurring EBITDA ratio was 5.6 times, and our debt service coverage was a healthy 4.3 times. We have no debt maturities until August of 2021. Our average debt maturity was seven years, and the percentage of our total debt that is fixed rate was 97% at December 31. Regarding 2020 guidance, we raised the midpoint of full-year guidance to $6.01 with a range of $5.94 to $6.08.

Specifically, we expect same-store revenues to grow between 1.5% and 2.5% for the 2020 fiscal year, up 25 basis points from our expectation in late October. Excluding property taxes, we expect other expenses to decrease between 1.5% and 2.5% as a result of continued discipline on the operating costs and the impact of savings related to Rent Now. The cumulative effect of these assumptions should result in 2.25% to 3.25% growth in same-store NOI, up 25 basis points from our expectations in October. Consistent with our past practices, we are not including in our same-store group any stores acquired in the early stages of lease-up that were less than 80% occupied at market rates as of the beginning of 2019.

Our 2020 same-store pool is expected to increase by 13 stores, from 504 to 517 stores, and we do not expect this change to have a material impact on the same-store growth rates. Based on these assumptions, we anticipate adjusted FFO per share for the first quarter of 2020 to be between $1.36 per share and $1.40 per share. And with that, operator, we will now open the call for questions.

Questions & Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator instructions] Our first question today will come from Ki Bin Kim with SunTrust. Please go ahead.

Ki Bin Kim -- SunTrust Robinson Humphrey -- Analyst

Thanks. Just a broader question first. So we're still not in the spring leasing season. So I'm just curious what you're seeing in your business that gives you confidence to raise same-store revenue guidance at this point in the year.

Joe Saffire -- Chief Executive Officer of Life Storage

Hi, Ki Bin. It's Joe. We felt more comfortable, obviously, with the strong quarter we just finished. The fourth quarter was pleasantly, to us, a bit of a nice surprise.

I think if you look at our three markets where we've had some of the most concerns, Houston, Miami, and Dallas, and I think all three of them are feeling a little bit better about them as we head into the quarter. And as we went through the budgets again for each of our markets, it just felt like it was the right thing to do. You see a little bit of an acceleration from third to fourth quarter. We haven't seen it really change much for January.

I think January was a good month as well. So I think, yes, we're a little bit more comfortable bumping that up just 25 basis points.

Ki Bin Kim -- SunTrust Robinson Humphrey -- Analyst

And you had some pretty outsize expense declines in some of your major markets like New York and Dallas. I can't imagine that's just Rent Now or a couple of things, so I was wondering if you could provide a little more color on that and maybe the longevity of those operating expense declines.

Andy Gregoire -- Chief Financial Officer

Sure, Ki Bin. This is Andy. That was property tax-related. So when you look at -- we had Chicago go the wrong way, right? We had the 18% increase in expenses for the quarter, and that was all driven by property taxes in Chicago.

We had the opposite happen in New York and in Dallas where we won some appeals and just had a better resolution to what we expected in property taxes. So we had been in Dallas accruing quite an increase for the first three quarters and then came in better than expected. So the big swings in property taxes were property -- or in expenses were property tax-related.

Ki Bin Kim -- SunTrust Robinson Humphrey -- Analyst

And if I could squeeze in one more. Your repair and maintenance line item was down. What drove that? And how do you differentiate R&M, which is in the same-store operating expenses, versus capital expenditure line item, which grew $4 million in '19 versus '18?

Joe Saffire -- Chief Executive Officer of Life Storage

Yeah. Thank you, Ki Bin. I'll let Andy answer the second part of that question. But really, you probably saw that in the third quarter as well.

The reduction in R&M, it's really related to more discipline and also a different software that we've been implementing over 2019, providing us more controls over what's being spent and who authorizes the spend. I'd say a lot more focus on that area, just similar to other costs throughout the company. We've been focused on many different things, and R&M is no exception. So we're pleased with the way the team has been focused on that.

In terms of how we decide between R&M and capex, Andy can chat about that.

Andy Gregoire -- Chief Financial Officer

Yeah. A couple of things to point out, Ki Bin. There was a big increase. We did buy some $3 million worth of trucks.

So that was some of the bump in capex that you're seeing, those trucks get capitalized. Otherwise, we just follow the GAAP accounting. Significant improvement that extends the useful life of the building, the real estate, it gets capitalized. Otherwise, it gets expensed.

Ki Bin Kim -- SunTrust Robinson Humphrey -- Analyst

All right. Thank you, guys.

Joe Saffire -- Chief Executive Officer of Life Storage

OK.

Operator

Our next question will come from Todd Thomas with KeyBanc Capital Markets. Please go ahead.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Hi, thanks. Just in terms of the 2020 guidance and, I guess, occupancy specifically, I think you previously mentioned that the year would start off negative year over year. But you'd expect to build occupancy throughout the year, implying that you'd see some occupancy growth in the second half of '20. But you're almost there now, I guess, and current trends suggest you might start the year off with higher year-over-year occupancy.

Can you just talk about trends for occupancy a little bit further, help us understand what's embedded in the guidance?

Joe Saffire -- Chief Executive Officer of Life Storage

Yeah. Hi, Todd, it's Joe. Thanks for that question. It's a good one.

Yes, it's actually part of the reason why we bumped up the revenue guidance as well. We haven't focused on occupancy, as you know. We think we have some room to improve there, especially with some of the new tactics we have in RevMan and also marketing. Some of the fourth-quarter top-line results were because of that improvement in occupancy, but we gave some of it back in January, I think 20 basis points back in Jan.

But it is going to be a focus for us. Depending on how successful we are, we'll see how we get on in the leasing period. That will obviously affect the top line, so it's a focus for us. And I think we have some room to further improve our occupancy, and I think we'll achieve what we've put on the guidance.

Hopefully, we can do better.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

But when you say you gave back 20 basis points in January, is that on the 2019 same-store pool, or is that on the new same-store pool?

Andy Gregoire -- Chief Financial Officer

That was on the 2019 same-store pool. So it went from -- I think at the end of the year, we ended down 30 basis points, Todd, and then January, we're down 50 basis points. It's that combination of rate and special and occupancy that we're trying to maximize revenue. And you'll see some of that, but we expect over the year that that gap will continue to decrease and then turn probably.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

OK. Great. And then just a second question on the third-party management, the pipeline there, I just wanted to dig in a little bit. I think you also, last quarter, mentioned that you had sort of an expectation of adding 50 for the year.

You added 20 this quarter, and it sounds like there's some good momentum in that business. Was there a revision at all to your outlook for additions to third-party management, and what are your expectations there?

Joe Saffire -- Chief Executive Officer of Life Storage

No, Tom. I mean, there is a pipeline. We have some visibility in some of the stores we've signed up last couple of years that were under construction that should open this year. I think we're doing a good job of winning some stabilized stores.

And I think 50, that's a net 50. So some of the stores we're buying in California, that will come out of the third-party management pool, and those will be wholly owned, so I still think we should be able to get at least a net 50 growth in third-party management. We'll see how we get on throughout the year and adjust it accordingly.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

OK. All right. Thank you.

Operator

Our next question will come from Samir Khanal with Evercore. Please go ahead.

Samir Khanal -- Evercore ISI -- Analyst

Hey, Joe. Good morning. Can you talk a little bit more about some of your major markets? I know in the past, you've talked about sort of a reversal in Houston in the second half as it relates to revenue growth. And then maybe along the same topic, just kind of walk us through some of your major markets and what's embedded in guidance here.

Joe Saffire -- Chief Executive Officer of Life Storage

Yes. I mean, I'll let Andy kind of go a little deeper. But as I said at the beginning of my Q&A, the three biggest markets, Houston, Miami, and Dallas, where we've had the most concern, we're feeling better about it. We still think that Houston, we like the trends.

The revenue we sell has gotten less over the last few quarters. We still have it projected to be slightly negative for the balance of the year. But I think toward the second half of the year, we'll see how we go. But occupancy has been nice in Houston.

And then, obviously, street rates, they've been negative as well throughout 2019, but it's getting less negative as we move on. So we're feeling a little bit better about that. And then obviously, Houston is one of the top 20 MSAs with the lowest new supply coming on, and we've seen that from a number of companies out there that manage that. And we also look at it internally, so we don't see a ton of new supply coming on in Houston.

Miami, I think you've heard from a few of us that it seems to be getting a little better. It's starting to stabilize. Miami is our 10th largest market, so not a huge impact on us. But we think it will probably stay flat through 2020.

And then Dallas, Dallas has kind of been an interesting one for us. Obviously, there's been a new supply on there. And they're still getting new supply more so than Houston. But you saw fourth quarter, revenue was up over 200 basis points, so we're feeling pretty good about Dallas.

Occupancy has been strong. So in those terms, we feel pretty good about our most concerning markets. And then some of our strongest markets have been Chicago, Vegas, and Buffalo. Those are important markets to us, not a ton of new supply, although there's some coming on in Vegas.

But we feel pretty good about those as well. And then some of the other ones we're watching, Austin and Atlanta, I think there's some new supply. Obviously, Austin has been pleasantly a good surprise, given some of the new supply, but it's held up well. So overall, we obviously went through market by market for our budget to taking all these things into consideration.

But like I said, I think we're feeling pretty good in terms of the peak deliveries, and our major markets are behind us. The last few years has been tough in Houston, and we think it's turning, and it's built into our guidance.

Samir Khanal -- Evercore ISI -- Analyst

Yeah. No, thanks for that. And I guess my second question is, Joe, look, I mean you've been proactive on the utility management side. That's generated savings for you.

You reduced payroll expense through Rent Now. Can you talk broadly about, to the extent you can, about what other initiatives there are out there? I guess how big is that opportunity set for you to sort of further improve margins here?

Joe Saffire -- Chief Executive Officer of Life Storage

Well, you've seen a big improvement. I mean, obviously, we've been focused on a lot of things. Rent Now is definitely something that's new and something that differentiates us from our peers, and we've been able to capitalize on that payroll savings. We'll see where Rent Now goes.

I mean, each quarter, it's gotten a little bit more in terms of how many of our customers are using it. It was around 9%, 10% and saw 11% in the fourth quarter. We'll see how that goes in terms of how many more of our customers use it. If we ever get up to 50%, that would be great, but that's not built into our guidance.

So I think that's probably the biggest unknown at the moment, but we're going to continue to embrace new technologies, Samir. We've been doing it across the board. ESG is increasingly a huge focus for us. Obviously, that's something you'll see more about throughout 2020.

But we're finding ways to put our arms around ESG and also save some money, and that's utility management. We've got rid of some older, less-efficient trucks. So we're doing a number of things, Samir. We're going to keep looking, but we have pretty strong guidance in terms of our ability to control costs in 2020, and we feel pretty good that we'll be able to deliver on that.

Samir Khanal -- Evercore ISI -- Analyst

OK. Thanks, guys.

Joe Saffire -- Chief Executive Officer of Life Storage

Thanks, Samir.

Operator

Our next question will come from Smedes Rose with Citi. Please go ahead.

Smedes Rose -- Citi -- Analyst

Hi, thanks. I just wanted to ask you on the Rent Now program. You mentioned it was about 11%. So it continues to tick up a little bit in terms of incoming customers.

Can you just talk a little bit about what kind of the -- I think maybe what the margin implications are for someone that chooses to come through that program versus just coming through the counter?

Joe Saffire -- Chief Executive Officer of Life Storage

Thanks, Smedes. Well, I mean I think from a margin perspective, maybe Andy has something there, but obviously, it's definitely more efficient for the company. You have less people spending 30, 40 minutes at the counter, taking up our store manager's time. So more people who self-serve, the more efficient you're going to be as an organization.

They're not calling the call center, so it's a great tool. And we're going to look at ways to see if we can get more customers to use Rent Now going forward. So that's already built into our payroll savings. Majority of that is Rent Now, and there's obviously other things that we're doing with other technologies such as online auctions and other things that we could do to make our store teams more efficient so that, again, we can have less hours at the stores.

So we're going to continue to embrace Rent Now and new technologies to, obviously, improve our overall margins for the company.

Andy Gregoire -- Chief Financial Officer

And Smedes, those customers that are using Rent Now are pretty -- the length of stay, we're not seeing any different. They're taking the insurance, and they're paying the admin fees. So it's a very similar margin customer.

Smedes Rose -- Citi -- Analyst

OK. I also just wanted to ask you a bigger picture. You mentioned -- I mean, you bought some stabilized properties through the management platform. Can you just talk about any changes you're seeing in pricing or cap rates by market, if you can?

Joe Saffire -- Chief Executive Officer of Life Storage

Yeah. You're still seeing a lot of competition out there for good deals. It's going to be market by market. California and New York, they're going to be low caps, but there's still some low-hanging, I mean, fruit when you're looking at your third-party management portfolio.

I think there's opportunities to get deals off market. You're not competing. It's not going out to bid. There's no broker involved.

And obviously, you know how those stores are operating, whether you feel pretty good about the budgets when you're penciling out year 1, year 2, year 3. But there's definitely compression. I think it's harder to find good deals. Obviously, cost of capital is low.

Cost of debt is low. So we don't think that's going to change, but there's still very good opportunities out there.

Smedes Rose -- Citi -- Analyst

OK. Thank you.

Operator

Our next question will come from Shirley Wu with Bank of America. Please go ahead.

Shirley Wu -- Bank of America Merrill Lynch -- Analyst

Hey, guys. Thanks for taking the questions. So my first question, just kind of expanding on Rent Now a little bit more. Assuming you guys had the payroll savings over the last year in terms of, let's say, having less people at the counter and just those efficiencies, what are you thinking about in terms of incremental efficiencies going into 2020 from Rent Now if you're already operating at a lower personnel cost? So in terms of how much you've put into your guidance, where is that really coming from and which buckets?

Andy Gregoire -- Chief Financial Officer

Well, part of it is the payroll. We didn't have those savings for the whole year. So obviously, it's an easier comp in the first half of the year from a payroll point of view. It gets a tougher comp as we go through the year, but we knew that going in when we issued guidance back in October.

But again, we expected in this guidance that the take rate would be 10% or so. It's upticked to 11%, as Joe said, in the fourth quarter, but no significant change yet in the number of customers using that. It's not an overnight where you can flick the switch. If it does all of a sudden shoot to 20%, that we could flip the switch and change payroll that quickly, it does take time to work that into the system.

And sometimes, not replacing those associate hours, you still need your manager on site to take care of that customer.

Joe Saffire -- Chief Executive Officer of Life Storage

Yeah.

Shirley Wu -- Bank of America Merrill Lynch -- Analyst

Got it. And my second question, on your revenue management system, you guys have talked about the improvements and how you do see this as an improvement to your strategy moving forward. So could you talk a little bit more about some of the things that you've been doing on that end?

Joe Saffire -- Chief Executive Officer of Life Storage

Yeah. I mean, we're still working on some things. We don't want to talk too much about it on a conference call. A lot of it is proprietary.

But we have a new head of revenue management. He's got a very deep knowledge in data science and machine learning and AI. And we're implementing many of those tools out there, just like many other companies and many different industries are embracing new technologies and how do you use data better. And we've been really focused on how to embrace those things out there that will help us make smarter decisions and not necessarily give everything away with free rent and rate cuts.

So I think it's still early in the game, Shirley, but we like some of the things we've been seeing over the last few months. And we think it will continue, but we're very excited about what we're doing there. I think we are going to see some benefits throughout 2020 in terms of rate and occupancy, and a lot of that is built into our guidance already.

Shirley Wu -- Bank of America Merrill Lynch -- Analyst

Got it. Thank you.

Operator

Our next question will come from Ryan Lumb with Green Street Advisors. Please go ahead.

Ryan Lumb -- Green Street Advisors -- Analyst

Hi, good morning. Just circling back to the margin improvement. Just curious if you have any specific targets that you guys can share in terms of sort of the magnitude of what you guys are anticipating to achieve or the timing of what you're looking to achieve that.

Andy Gregoire -- Chief Financial Officer

And Ryan...

Joe Saffire -- Chief Executive Officer of Life Storage

Ryan, what was for -- sorry, targets for which one?

Ryan Lumb -- Green Street Advisors -- Analyst

The margin improvement that you guys have been referencing.

Joe Saffire -- Chief Executive Officer of Life Storage

Oh, OK.

Andy Gregoire -- Chief Financial Officer

Yeah. I mean, our program looks to 50 basis points of margin improvement in 2020 over 2019. And beyond that, we don't want to talk about, but we think there's probably more potential. But it's really looking under every stone and seeing what we can do differently and challenging how we've done things, and you can see that showing up in, like I say, every line item just about you're seeing improvement.

And that's blocking and tackling, and it happens every day here. And we'll keep doing that, and we expect it to show up in the margin.

Joe Saffire -- Chief Executive Officer of Life Storage

Yeah. And it's not just on the expense side, Ryan. I mean, obviously, we've been focused on margins through our asset recycling, just selling off some older stores that are not as margin-friendly. They're smaller.

They're lower rates. And pretty much everything we've been buying has been bigger stores, better rates, more revenue per store. And that's helping as well, so we're going at it in many different angles. You can't do much about property tax in certain markets like Chicago.

I mean, Chicago is a tough one for margins, but it's been very good for us in terms of revenue growth and a lot of new supply. So it's a mix of things. And like Andy said, it's a 50 basis points target for 2020, but it doesn't mean we're not going to keep looking for ways to improve it. And we'll continue to expand in some of the newer markets that we think are better margins, some of the ones that we just entered.

California has always been a target for us. It's hard to find properties. And we're excited about the six pack. All of these things will help us to continue to work on our margins.

And obviously, technology has been a big one for us, and Rent Now clearly has helped. But we're going to be looking for other technologies as well.

Ryan Lumb -- Green Street Advisors -- Analyst

OK. Great. And then just curious, you dipped your toe in with some international growth in Toronto last year. Just curious what your appetite for international growth is in the year ahead.

Joe Saffire -- Chief Executive Officer of Life Storage

Yeah. I mean, it's interesting. Obviously, I have a big international experience. I think it's great.

I think there's a lot we need to do in the U.S. and still a lot of opportunities. I think Canada was a no-brainer for us, and we're doing well there. We'll see where that goes this year.

Aside from that, we're really not looking too far across the borders. But I think there are opportunities internationally, and you saw that last year when we entered Canada. And we'll focus on the U.S. and Canada for now.

Ryan Lumb -- Green Street Advisors -- Analyst

Sure. Thanks, guys.

Joe Saffire -- Chief Executive Officer of Life Storage

Thanks, Ryan.

Operator

This will conclude today's question-and-answer session. I would now like to turn the conference back over to Joe Saffire for any closing remarks.

Joe Saffire -- Chief Executive Officer of Life Storage

I'll just thank you all for joining our call and have a great rest of the week.

Operator

[Operator signoff]

Duration: 31 minutes

Call participants:

Dave Dodman -- Senior Vice President, Investor Relations, and Strategic Planning

Joe Saffire -- Chief Executive Officer of Life Storage

Andy Gregoire -- Chief Financial Officer

Ki Bin Kim -- SunTrust Robinson Humphrey -- Analyst

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Samir Khanal -- Evercore ISI -- Analyst

Smedes Rose -- Citi -- Analyst

Shirley Wu -- Bank of America Merrill Lynch -- Analyst

Ryan Lumb -- Green Street Advisors -- Analyst

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