INNOVATIVE INDUSTRIAL PROPERTIES INC quarterly report, Q1 FY2024

Innovative Industrial Properties, Inc. — Q1 2024 Form 10-Q

Reporting period: Three months ended March 31, 2024; comparative period is Q1 2023. Amounts are in U.S. dollars. The company is an internally managed REIT that owns specialized properties leased primarily to state-licensed cannabis operators on a triple-net basis.

Business context and portfolio

• Owned 108 properties in 19 states, comprising 8.9 million square feet, including space under development or redevelopment; leased to 30 cannabis tenants and three non-cannabis tenants.
• The 103-property operating portfolio was 95.2% leased, with a 14.8-year weighted-average remaining lease term.
• Had invested approximately $2.4 billion in properties and committed another $41.3 million for property improvements and construction draws; $10.4 million of that commitment was incurred but not funded at quarter-end.

Financial results and liquidity

Metric	Q1 2024	Q1 2023
Total revenue	$75.5 million	$76.1 million
Operating income	$42.0 million	$43.4 million
Net income	$39.4 million	$41.1 million
Net income attributable to common stockholders	$39.1 million	$40.8 million
Diluted EPS	$1.36	$1.43
Operating cash flow	$71.6 million	$64.6 million
Cash, cash equivalents and restricted cash at period-end	$153.5 million	$39.1 million

• Rental revenue was $74.9 million, down 1% year over year. Operating margin was approximately 55.7%, versus 57.0%; net margin was approximately 52.3%, versus 54.0%.
• Net income declined about 4%; diluted EPS declined about 5%. Management cited lower rents from properties retaken since March 2023 and lease reclassifications, partly offset by rent escalations, lease amendments and new leases.
• FFO per diluted share was $1.98 versus $2.04; Normalized FFO per diluted share was $1.98 versus $2.06; AFFO per diluted share was $2.21 versus $2.25. These are company-reported non-GAAP measures and are not substitutes for GAAP results or operating cash flow.
• Investing activities used $14.4 million, mainly for property improvement and construction funding. Financing activities used $45.4 million, primarily for common and preferred dividends and repayment of Exchangeable Senior Notes.
• Debt at March 31 was $300 million principal of 5.50% senior notes due May 2026; no borrowings were outstanding under the $45 million secured revolving credit facility. The notes’ carrying value was $296.8 million. Management said the company was in compliance with debt covenants.
• Quarter-end total assets were $2.40 billion and stockholders’ equity was $1.96 billion. The company declared a $1.82-per-share common dividend and a $0.5625-per-share Series A preferred dividend, paid April 15, 2024.

Material changes and unusual items

• Rental revenue fell by $0.6 million: a $5.6 million reduction associated with properties taken back since March 2023 and a $1.3 million reduction from two leases reclassified as sales-type leases were largely offset by $6.0 million of higher contractual rent and fees, plus higher tenant reimbursements.
• Property expenses increased $1.1 million to $6.7 million, including higher costs for properties not yet leased. General and administrative expense declined $0.8 million to $9.6 million, mainly due to lower litigation-related and compensation costs.
• The company completed the exchange or repayment of its remaining Exchangeable Senior Notes: it paid $4.3 million cash and issued 28,408 common shares for exchanged notes, and repaid the remaining $0.1 million at maturity in February.
• In January, lease extensions for two properties changed their classification from operating to sales-type leases, but did not meet completed-sale criteria. Lease payments received and future payments are recorded as a deposit liability pending satisfaction of those criteria; $1.5 million had been received by quarter-end.
• In January, amendments to four 4Front leases extended lease terms; the Illinois project has faced significant construction delays, and its amendment reduced near-term base rent and adjusted later rent. A February PharmaCann amendment increased construction funding by $16 million and adjusted rent.
• After quarter-end, the company sold its Los Angeles property for $9.1 million and received a $3.9 million lease termination fee in May, for $13.0 million total consideration excluding reimbursement of closing costs. The Q1 cash flow discussion also reports $4.8 million received in advance in connection with the expected sale and termination.

Outlook, risks and contingencies

• The filing provides no specific earnings, revenue, acquisition or dividend guidance. Management expects liquidity needs to be met through cash and investments, operating cash flow, the revolving facility and potential capital-market transactions, and believes available sources are adequate, while noting financing may not be available on acceptable terms.
• Management highlighted cannabis-operator pressures from falling product prices, high taxes, illicit-market competition, inflation, labor and supply-chain costs, and constrained access to capital. These factors may impair tenants’ ability to pay rent, sustain operations or obtain required licenses.
• Cannabis remains illegal under U.S. federal law. Regulatory changes, tenant concentration and the limited financing options available to cannabis operators are material business risks. The five largest tenants represented 50% of Q1 rental revenue; PharmaCann alone represented 17%.
• Rent collection is recognized on a cash basis for operating leases because of uncertainty around tenant collectability. Some retaken properties are re-leased but will not generate rent until required operating approvals are obtained; some also have temporary abatements.
• Outstanding commitments included $24.1 million of tenant improvement allowances, $6.8 million of vendor construction commitments and $1.0 million remaining on a construction loan. A $22 million California construction loan was extended to June 30, 2024, with a conditional extension option to December 31, 2024.
• A securities class action and several derivative actions remain unresolved. The class action motion to dismiss the second amended complaint was pending at quarter-end; derivative proceedings were stayed. The company recorded no litigation accrual because outcomes could not be predicted. No impairment losses were recorded in Q1.
• Management reported effective disclosure controls as of March 31, 2024 and no material change in internal control over financial reporting during the quarter.

Investor verification priorities

• Track rent collections, tenant financial condition and the timing of operating approvals and rent commencement at re-leased properties.
• Review tenant concentration and exposures to the largest operators, especially PharmaCann and Ascend, and monitor any further property takebacks or lease concessions.
• Confirm progress and funding needs for delayed development projects, the California construction loan, and the $41.3 million property-improvement commitment.
• Assess dividend coverage against cash generation and recurring investment needs; note that reported Q1 operating cash flow included $4.8 million received in advance for the subsequent Los Angeles sale and lease termination.
• Monitor refinancing plans for the $300 million 2026 notes, covenant compliance, access to capital and the terms of any revolving-credit borrowings.
• Follow the lease-accounting treatment of the two sales-type leases and the outcomes of the securities and derivative litigation.