Innovative Industrial Properties, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; comparison is with Q1 2022. The company is a REIT that owns specialized properties leased, generally on a triple-net basis, to state-licensed cannabis operators. At quarter-end, it owned 108 properties in 19 states; 103 operating properties were reported 100% leased, with a weighted-average remaining lease term of about 15.1 years.
Financial performance and position
- Revenue: $76.1 million, up 18% from $64.5 million. Rental revenue was $75.5 million, up 18%; reported rental revenue included applications of tenant security deposits.
- Profit: Net income was $41.1 million, up 17% from $35.1 million. Net income attributable to common stockholders was $40.8 million; basic and diluted EPS were $1.45 and $1.43, versus $1.35 and $1.32.
- Margins: Operating margin was approximately 57.0% (43.4/76.1), compared with 61.8% in Q1 2022. Net margin was approximately 54.0%, compared with 54.3%. These are calculated from reported GAAP results.
- REIT measures: Diluted FFO was $57.5 million, or $2.04 per share; Normalized FFO was $58.1 million, or $2.06 per share; AFFO was $63.4 million, or $2.25 per share. The filing cautions these non-GAAP measures are not substitutes for GAAP income or cash flow.
- Cash flow: Operating cash flow was $64.6 million, up from $59.9 million. Investing used $62.7 million and financing used $51.4 million, principally reflecting property and improvement funding and dividends. Cash, cash equivalents and restricted cash ended at $39.1 million, down $49.5 million during the quarter.
- Liquidity and assets: Cash and cash equivalents were $37.7 million; investments were $164.0 million; restricted cash was $1.5 million. Total assets were $2.41 billion and stockholders’ equity was $1.96 billion at March 31, 2023.
- Debt: Outstanding principal was $304.4 million: $300.0 million of 5.50% notes due 2026 and $4.4 million of 3.75% exchangeable notes due 2024. Management said it was in compliance with the 2026 notes’ financial covenants.
- Dividend: The company declared a common dividend of $1.80 per share for Q1, totaling $50.7 million, and a preferred dividend of $0.5625 per share, totaling $0.3 million.
Changes versus Q1 2022
- Revenue increased $11.6 million, chiefly from rent escalations and lease amendments at previously acquired properties; Q1 acquisitions contributed about $0.5 million of the increase.
- Property expenses rose $3.6 million to $5.6 million, primarily from higher property taxes and insurance. General and administrative expense rose $1.6 million to $10.4 million, including about $0.6 million of litigation-related expense.
- Interest and other income increased to $2.2 million from $0.1 million, primarily due to higher rates on interest-bearing investments. Interest expense declined to $4.5 million from $4.8 million, partly due to exchanges of exchangeable notes.
- Operating cash flow increased $4.7 million, while investing cash use decreased by $18.4 million. Financing cash use increased by $31.2 million, mainly because Q1 2022 included $21.1 million of common-stock issuance proceeds and Q1 2023 dividends paid were higher.
Outlook, risks and unusual items
- Outlook: The filing gives no specific earnings or investment guidance. Management expects liquidity needs to be met through cash and short-term investments, operating cash flow, and potential capital-market sources, and believes current resources are adequate. It cautions that market volatility has reduced access to capital and that adequate funding on acceptable terms is not assured.
- Tenant credit and collections: Reported rent collection was approximately 98%, including about $4.2 million of security deposits applied for rent for Green Peak, Parallel and Holistic. The company reported approximately $1.8 million of Q1 non-collection from Green Peak, Vertical affiliates and Parallel. Kings Garden, Parallel and Green Peak had rent defaults; Green Peak entered receivership. These tenant issues could affect future rent and property costs.
- Lease relief and funding: Amendments for certain tenants deferred or reduced rent, extended lease terms, increased improvement funding, or applied security deposits. The company had approximately $57.9 million of improvement-allowance commitments and $4.6 million remaining on a construction-loan commitment.
- Unusual disposition: A four-property California portfolio was transferred for $16.2 million with a $16.1 million secured loan to the buyer. The transaction did not qualify for sale recognition; the assets remain on the balance sheet and consideration is recorded as a deposit liability until sale criteria are met.
- Contingencies: Securities class-action and derivative lawsuits remain pending; the company had not accrued amounts because outcomes could not be predicted. In the Kings Garden matter, approximately $9.8 million of project costs were under review for possible overpayment; the company said a loss was reasonably possible but not estimable.
- Regulatory and market risks: Cannabis remains illegal under federal law. The filing highlights tenant operating pressures from falling product prices, inflation, labor and supply constraints, limited capital access and banking restrictions, along with regulatory and competitive uncertainty.
- Controls: Disclosure controls were deemed ineffective at March 31, 2023 due to a material weakness in review and approval controls for property-improvement funding disbursements. Management reported no resulting financial-statement misstatement and described remediation work; remediation was not yet complete.
Important facts for investors to verify
- Whether rent collection remains sustainable after excluding security-deposit applications, and how the Green Peak, Parallel and Kings Garden defaults affect rent, recoveries and property costs.
- Progress and financial implications of the Kings Garden project-cost review and related litigation, as well as the other tenant and shareholder lawsuits.
- Whether the funding-disbursement control weakness is fully remediated and tested, and whether any additional control issues emerge.
- Cash and investment availability relative to dividends, improvement commitments, construction funding and debt maturities, especially if capital markets remain constrained.
- Whether cannabis-market, banking and regulatory conditions affect tenants’ ability to operate and pay rent, and whether the unrecognized California property disposition later qualifies for sale accounting.