Innovative Industrial Properties, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. The company is a REIT acquiring and leasing specialized properties to state-licensed medical-cannabis operators, generally under triple-net leases. At quarter-end it owned 22 properties across 11 states; the portfolio was 100% leased, with a 15.3-year weighted-average remaining lease term.
Financial performance and position
- Q2 revenue: $8.6 million, up 160% from $3.3 million a year earlier. Rental revenue was $8.3 million, up 155%.
- Q2 earnings: Operating income was $4.1 million versus $1.2 million; net income was $3.4 million versus $1.5 million. Net income attributable to common stockholders was $3.1 million, or $0.31 basic and $0.30 diluted per share, versus $1.2 million, or $0.18 and $0.17. Approximate operating and net margins were 47% and 40%, respectively; prior-year margins were about 37% and 47%.
- First-half results: Revenue was $15.4 million versus $6.1 million; net income was $7.1 million versus $2.5 million. Common-stockholder net income was $6.4 million, or $0.64 basic and diluted per share, versus $1.8 million, or $0.28 basic and $0.27 diluted.
- REIT operating measures: Q2 FFO was $4.7 million ($0.49 basic per share) and AFFO was $5.8 million ($0.60 basic per share). First-half FFO was $9.2 million ($0.95 basic per share) and AFFO was $11.1 million ($1.15 basic per share). These are non-GAAP supplemental measures, not substitutes for GAAP earnings or cash flow.
- Cash flow: For the first half, operating cash flow was $14.6 million, investing cash outflow $99.2 million, and financing cash inflow $129.0 million. Cash, cash equivalents and restricted cash ended at $57.5 million, compared with $21.2 million a year earlier.
- Liquidity and balance sheet: Cash and cash equivalents were $47.4 million, restricted cash $10.0 million, and short-term investments $138.7 million. Total assets were $430.7 million. Total liabilities were $164.5 million, including $133.7 million net carrying value of exchangeable senior notes; stockholders’ equity was $266.2 million.
- Debt: In February, the operating partnership issued $143.75 million of 3.75% exchangeable senior notes due 2024, generating approximately $138.5 million net proceeds. Q2 interest expense was $1.8 million; first-half interest expense was $2.6 million.
- Dividends: Common dividends declared were $0.60 per share for Q2, versus $0.25 a year earlier; first-half declarations totaled $1.05 per share versus $0.50. The Series A preferred stock carries a 9% cumulative dividend.
Changes and material developments
- Growth in rental revenue and earnings primarily reflected properties acquired in 2018 and 2019, lease escalations, and lease amendments. Six-month real estate purchases totaled $62.2 million; the company also funded tenant improvements and construction.
- General and administrative expense increased to $2.6 million for Q2 and $4.5 million for the first half, mainly due to higher compensation, public-company, travel and occupancy costs. Depreciation rose with acquisitions and improvements placed in service.
- The new notes introduced interest expense absent in the 2018 comparable periods. Interest and other income also rose, mainly due to higher interest-bearing investments.
- After quarter-end, the company issued 1,495,000 common shares for approximately $188.4 million gross proceeds and acquired four properties for approximately $25.1 million, with up to $62.8 million of additional tenant construction and improvement funding commitments.
Outlook, risks and contingencies
- No specific earnings or FFO guidance was provided. Management said liquidity and capital sources were believed adequate for cash needs, while noting funding may not be available on acceptable terms or in sufficient amounts. Capital needs include acquisitions, dividends, operations and debt service.
- Management cited federal illegality of cannabis, evolving state regulation, tenant credit and collection risk, limited tenant concentration, competition for properties and alternative financing, and market and economic conditions as material risks. PharmaCann accounted for about 29% of Q2 rental revenue and 30% for the first half.
- The company had $32.9 million of tenant-improvement commitments, additional construction funding commitments of $4.3 million and $10.6 million, and $0.7 million of California development-milestone commitments at quarter-end. Subsequent acquisitions added up to $62.8 million of potential construction and improvement funding.
- The company reported no material pending litigation known to it and no impairment losses in the periods presented. It warned that expected loss of emerging-growth-company status on December 31, 2019 would bring additional compliance costs and management demands. Disclosure controls were reported effective as of June 30, 2019.
Important facts for investors to verify
- Whether tenants can meet lease obligations and construction milestones, particularly given tenant and property revenue concentration.
- Actual funding and timing of committed tenant improvements, development projects and post-quarter acquisitions.
- Cash generation and dividend coverage after acquisitions, tenant funding requirements and interest payments; FFO and AFFO are not cash-flow substitutes.
- Terms and potential dilution or settlement effects of the exchangeable notes, and the use of proceeds from the July equity offering.
- Regulatory developments affecting cannabis operators, financing access, competition and the company’s REIT qualification and compliance costs.