Innovative Industrial Properties, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Amounts are in U.S. dollars; financial statement figures are in thousands except per-share data. The company is a REIT-focused owner and lessor of specialized properties used by state-licensed medical-use cannabis operators, generally under triple-net leases.
Business context
At quarter-end, the company owned seven properties, all 100% leased, totaling approximately 764,000 rentable square feet, including approximately 58,000 square feet under development, across six states. It had six full-time employees. Revenue is primarily rent; the company recognizes lease revenue on a cash basis because of tenant collectability and regulatory uncertainty.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $3.314 million | $1.289 million | $6.078 million | $2.579 million |
| Operating income (loss) | $1.236 million | ($465,000) | $1.960 million | ($1.091 million) |
| Net income (loss) | $1.542 million | ($422,000) | $2.487 million | ($1.013 million) |
| Net income (loss) attributable to common stockholders | $1.204 million | ($422,000) | $1.811 million | ($1.013 million) |
| Basic / diluted EPS | $0.18 / $0.17 | ($0.13) / ($0.13) | $0.28 / $0.27 | ($0.31) / ($0.31) |
| FFO available to common stockholders | $1.740 million | ($247,000) | $2.823 million | ($677,000) |
| AFFO available to common stockholders | $2.103 million | $471,000 | $3.516 million | $811,000 |
Q2 operating margin, calculated as operating income divided by revenue, was approximately 37%; the prior-year quarter had an operating loss. Rental revenue increased to $3.246 million from $1.289 million in Q2, mainly reflecting acquisitions and rent escalations. General and administrative expense was $1.474 million in Q2, versus $1.466 million; depreciation increased to $536,000 from $175,000. Interest and other income rose to $306,000 from $43,000, primarily due to larger interest-bearing balances and higher rates.
Cash, liquidity, debt, and capital
- At June 30, cash and cash equivalents were $21.185 million and short-term investments were $57.419 million; total assets were $161.699 million. Total liabilities were $10.114 million and stockholders’ equity was $151.585 million.
- The company reported no debt outstanding and said it had no current plans to issue debt. Its investment guidelines generally limit aggregate borrowings to 50% of tangible-asset cost at the time of a new borrowing, subject to board discretion.
- Six-month operating cash flow was $3.694 million; investing cash outflow was $69.959 million; financing cash inflow was $75.692 million. Cash increased by $9.427 million to $21.185 million.
- Investing cash outflow included $57.2 million net purchases of short-term investments and approximately $12.8 million for real estate acquisitions and tenant-improvement/construction funding.
- A January common-stock offering raised approximately $79.3 million net from 3.22 million shares. Common shares outstanding increased from 3.50 million at year-end 2017 to 6.79 million at June 30, 2018.
- The company declared common dividends of $0.25 per share in each of the first two quarters; it reported the most recent annualized common dividend rate as $1.00 per share. Future dividends remain at the board’s discretion.
Material changes, investments, and outlook
- In April, the company acquired a Pennsylvania property for approximately $5.8 million, with initial annual base rent of approximately $1.3 million and up to approximately $2.8 million available for tenant improvements.
- In May, it acquired a Massachusetts property for $3.0 million and agreed to provide up to $15.5 million of construction funding. If fully funded, total investment is expected to be $18.5 million; initial annual base rent is approximately $2.7 million after a six-month abatement.
- After quarter-end, it acquired a Massachusetts property on July 12 for $12.75 million, with initial annual base rent of approximately $1.9 million. On August 2, it acquired a Michigan property for approximately $5.5 million; additional purchase-price and tenant-improvement funding could bring total investment to approximately $13 million, with expected initial annual base rent of approximately $2.0 million.
- At June 30, remaining commitments included approximately $4.9 million for tenant improvements and $12.4 million for construction funding; approximately $206,000 remained on office and equipment leases. The filing says the construction tenant was to use commercially reasonable efforts to complete the buildings by August 2019.
- No specific earnings or investment guidance is provided. Management expects to use cash on hand, operating cash flow, and potential equity or debt financing to fund acquisitions, dividends, and operations; it said current liquidity and capital sources were adequate, while noting future funding availability and terms are not assured.
Risks and unusual items
- Cannabis remains illegal under U.S. federal law. Changes in federal or state policy could affect tenants, leases, property use, access to capital, and the company’s ability to operate or maintain REIT status. The filing also flags additional exposure if tenants conduct adult-use cannabis operations.
- Tenant and property concentration remains material: in Q2, the New York, Maryland, and Arizona tenants represented 41%, 20%, and 20% of rental revenue, respectively. The same states’ properties represented 36%, 20%, and 20% of net real estate at quarter-end.
- Management reports no material pending or threatened litigation and no known environmental liabilities requiring recognition or disclosure. No impairment losses were recognized as of June 30.
- Revenue collection is subject to tenant credit and regulatory uncertainty; the company therefore recognizes rental revenue on a cash basis. It also had cash accounts exceeding FDIC-insured limits, though it reported no losses.
- Management said there were no material changes to previously disclosed risk factors apart from the adult-use cannabis risk update. Disclosure controls were considered effective at quarter-end; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Tenant rent-payment capacity and the effect of federal and state cannabis regulation, including adult-use operations, on each lease.
- Actual timing and amount of the Pennsylvania, Massachusetts, and Michigan construction and tenant-improvement funding, and whether projects are completed as planned.
- Tenant concentration, lease escalators, rent abatements, and the cash-basis revenue recognition policy when assessing recurring revenue and collectability.
- Cash and short-term investment availability after commitments, acquisitions, and dividend payments, and the terms and potential dilution of any future capital raises.
- Dividend sustainability relative to operating cash flow and AFFO; FFO and AFFO are non-GAAP supplemental measures, not substitutes for cash flow or GAAP earnings.
- REIT qualification and the company’s ability to maintain access to suitable investments and capital on acceptable terms.