Innovative Industrial Properties, Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. The company is a REIT that owns specialized industrial properties leased primarily on a triple-net basis to state-licensed cannabis operators.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Total revenue | $70.9 million | $53.9 million | $205.9 million | $145.6 million |
| Operating income | $41.4 million | $36.3 million | $125.4 million | $96.9 million |
| Net income | $37.6 million | $30.1 million | $112.9 million | $85.4 million |
| Net income attributable to common stockholders | $37.3 million | $29.8 million | $111.9 million | $84.3 million |
| Diluted EPS | $1.32 | $1.20 | $4.06 | $3.41 |
| Operating margin, calculated | 58.3% | 67.4% | 60.9% | 66.6% |
Quarterly rental revenue rose 31%; nine-month rental revenue rose 40%. Growth primarily reflected rent from properties acquired in prior periods, contractual escalations, and lease amendments that increased improvement or construction funding and base rent. Q3 rent revenue included $2.6 million from Kings Garden security deposits applied to defaults. Non-collection from Kings Garden and Vertical reduced Q3 rental revenue by about $5.7 million and nine-month rental revenue by about $6.5 million.
Q3 general and administrative expense increased to $10.8 million from $5.3 million, including $2.1 million of litigation-related expense. Depreciation and amortization also increased with portfolio growth and projects placed in service. Q3 interest expense fell to $4.5 million from $6.3 million, mainly following exchanges of the company’s exchangeable notes; nine-month interest expense increased to $13.8 million from $11.9 million, reflecting the 2026 notes issued in 2021.
Cash flow, balance sheet and capital
- Nine-month operating cash flow was $178.8 million, up from $141.0 million. Investing cash outflow was $401.7 million, largely for real estate, tenant improvements and construction funding. Financing cash inflow was $215.1 million.
- Cash and cash equivalents were $76.9 million; restricted cash was $1.6 million; investments were $239.7 million at September 30. Total assets were $2.43 billion and stockholders’ equity was $1.97 billion.
- Debt principal outstanding was $306.4 million: $300.0 million of 5.50% notes due 2026 and $6.4 million of 3.75% exchangeable notes due 2024. Management said the company complied with debt covenants. The filing reports management’s view that liquidity and capital sources are adequate, while noting capital-market access may be constrained.
- The April common-stock offering and ATM sales generated approximately $352.0 million in net proceeds during the nine months. The company declared a $1.80-per-share Q3 common dividend, versus $1.75 in each of the first two 2022 quarters.
Portfolio, changes and outlook
At quarter-end, the company owned 111 properties across 19 states, including 109 operating properties that were 100% leased, with a weighted-average remaining lease term of about 15.5 years. Reported rent collection for the operating portfolio was approximately 97% for the nine months, excluding security deposits applied to Kings Garden defaults. The company acquired properties for an aggregate purchase price of $166.1 million during the period and funded approximately $316.5 million for property improvements and construction.
No specific earnings or investment guidance is provided in the supplied filing text. Management highlighted inflation, labor shortages, supply-chain delays and construction cost increases as pressures on tenants and projects. It also cited reduced capital availability for cannabis operators and the company, evolving state markets, competition, and the continued federal illegality of cannabis as material uncertainties.
Material risks, contingencies and unusual items
- Kings Garden: The tenant defaulted on rent and other obligations under six leases in July. Q3 monetary default was approximately $5.2 million; the company applied about $2.6 million of security deposits and received a $10.0 million partial settlement payment. It expects to recover a further approximately $6.0 million and is investigating approximately $9.8 million of potential overpayments. The company said a loss is reasonably possible but could not estimate it.
- Controls: Disclosure controls were deemed ineffective due to a material weakness in management review and approval of tenant-improvement funding disbursements. The company reported no resulting financial-statement misstatement and described remediation efforts, which remain ongoing.
- Litigation: Securities class-action and shareholder derivative lawsuits are pending; the company intends to defend them, but outcomes are not predictable and no amounts were accrued.
- Other: The company has approximately $127.6 million of improvement-allowance commitments and about $0.8 million remaining under a construction-loan commitment. It reported no impairment losses for the nine-month period.
Important facts for investors to verify
- Whether Kings Garden recoveries materialize, the status of its remaining properties and construction projects, and any resulting impairment or loss.
- Rent collections and tenant credit quality, particularly exposure to major tenants; PharmaCann represented 14% of Q3 rental revenue, while Parallel and Ascend each represented 10%.
- Progress and effectiveness of remediation of the material weakness in construction-funding controls.
- Availability and cost of capital, completion and funding needs for development projects, and compliance with debt covenants.
- Developments in the class-action and derivative litigation, and whether any financial impact becomes estimable.