Innovative Industrial Properties, Inc.
Q2 2017 Earnings Call Transcript

Published: 10 Aug 2017

[Operator:]

Good afternoon and welcome to the Innovative Industrial Properties Incorporated Second Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Brian Wolfe. Please go ahead.

[Brian Wolfe:]

Thank you for joining the call. Presenting today are Alan Gold, Executive Chairman; Paul Smithers, President and Chief Executive Officer; and Catherine Hastings, Chief Financial Officer. Before we begin, I would like to remind everyone that statements made during today’s conference call maybe deemed forward-looking statements within the meaning of the Safe Harbor of the Private Securities Litigation Reform Act of 1995 and actual results may differ materially due to a variety of risks, uncertainties and other factors. For a detailed discussion of some of the ongoing risks and uncertainties of the company’s business, I refer you to the news release issued yesterday and filed with the SEC on Form 8-K, as well as the company’s reports filed periodically with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Before I hand the call over to Alan, I want to mention that we have limited time for the call today, but we will answer as many questions as we can after our prepared remarks. Alan?

[Alan Gold:]

Thank you, Brian, and welcome everyone. Today, we get a chance to review and share our financial results for the second quarter plus year-to-date 2017 and provide our updated perspective on the business and the industry from our last call in March of this year. On the operational side of our business, our top priority continues to be placing the balance of our proceeds from the December IPO in the best properties and with the best tenants for the long-term benefit of our stockholders. We took another major step this quarter toward completing this – that goal, with our purchase of the property in Capitol Heights, Maryland, a 72,000 square foot building being developed as the start-of-the-art medical-use cannabis cultivation facility. The property is a 100% leased to Holistic Industries for an initial term of 16 years. Holistic is one of 15 companies to receive pre-approval by the Maryland Medical Cannabis Commission to cultivate medical-use cannabis. And one of only three companies to have received licenses enabling full vertical integration, cultivation, processing and dispensing. In addition, after only our second full quarter of operations, we were able to pay a quarterly dividend of $0.15 per share to stockholders of record as of June 30, 2017 having generated $0.23 of adjusted funds from operations per diluted share during the first six months of the year, truly a remarkable achievement for such a young company. Catherine, who I am very excited to say, was promoted to CFO this quarter will provide more detail regarding our financial results. As we discussed in our last call, the medical-use cannabis industry is constantly evolving. Including the strong growth of existing state markets, the rollout of new programs passed the numerous states by a popular vote or legislation in recent years and the change in the presidential administration. Paul will provide further perspective on these changes and other industry trends in our call today in addition to discussing in further detail our two properties and pipeline. This nascent industry that has witnessed amazing growth with state regulated medical-use cannabis markets, now comprising a majority of the United States. We are very optimistic about the future of this industry and our ability to deliver an enduring value to our tenant partners in providing tailored real estate solutions that meet their key operational and capital needs. Now with that, I would like to turn the call over to Paul. Paul?

[Paul Smithers:]

Thanks, Alan. As Alan alluded to this is a rapidly evolving industry. I’ll try to provide as effective an overview as we can with the short-time we have today focusing in on four main topics

[Catherine Hastings:]

Thanks, Paul. Having completed our IPO in December 2016 and having begun real estate operations shortly thereafter with our initial property acquisition in New York, our second quarter 2017 represents just our second full quarter of operations. We had total revenues of $1.3 million in the second quarter of 2017 and $2.6 million during the months ended June 30, which reflected PharmaCann’s cash rents paid for applicable time period. As Paul discussed rent for our property in Maryland, which we acquired in May, is subject to an initial rent abatement of three months. We recognized rental revenue for both leases on a cash basis and expect to begin revenue recognition for our Maryland property later this month. For the three months ended June 30, 2017, the company recorded a net loss of $422,000 funds from operations, which adds back property depreciation to net loss with a loss of $247,000 and adjusted funds from operations which adds back non-cash stock-based compensation expense and severance paid to our former CFO to funds from operations was the positive $471,000. For the six months ended June 30, 2017, we recorded a net loss of $1 million of funds from operations loss of $677,000 and adjusted funds from operations of positive $811,000. And Alan mentioned on July 14th, we paid our first quarterly dividend of $0.15 per share to stockholders of record as of June 30. This dividend represents approximately 65% of our AFFO per diluted share of $0.23 for the six months ended June 30. With that I would like to turn the call back to Alan. Alan?

[Alan Gold:]

Thanks, Catherine. It has been a very eventful first few months as a public company and we are excited about the opportunities to come. I want to thank the stockholders for your continued support and we look forward to continuing to service this very promising industry as a long-term real estate and capital provider and to creating sustainable long-term value for our stockholders. With that I'd like to open it up to questions. Operator, could you please open the call up for questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Dan Donlan with Ladenburg Thalmann. Please go ahead.

[Dan Donlan:]

Thank you and good morning.

[Alan Gold:]

Good morning, Dan. How you’re doing?

[Dan Donlan:]

Good, good. I just wanted to talk about the pipeline of $100 million. It's roughly on par to what it was, I think, in May early this year. Just kind of curious did you – have you seen some properties drop out of that? And then as a follow-up to that, could you maybe characterize the range of cap rate that you're looking at and maybe the size of transactions you’ve had? You've done something for about $15 million, you’ve done one for about $30 million. Can they go as low as $5 million? Just kind of curious if you could give us a little bit more characterization there?

[Paul Smithers:]

Okay. Well, so, yes, yes, it was about the same size. And I think it will – as I've been in this industry for – in the real estate industry for many years, the pipeline will continue to evolve and we can certainly talk about a much larger pipeline than $100 million. But we're comfortable with that because it makes sense with the amount of capital that we have available to ourselves. And it doesn't make sense to throw everything in and that we've been receiving on the pipeline and throw out a big number.

[Dan Donlan:]

Sure.

[Paul Smithers:]

So we have seen transactions fall off the pipeline and for a variety of reasons including our analysis of the real estate and the underwriting of the management team. And so, we have seen that and we have seen new and very exciting transactions come back on or coming through the pipeline. Transactions on the pipeline range anywhere from $3.5 million to $4 million and size range up to $50 million to $60 million in size range. We've seen transactions up to that size. Our pipeline is ranging anywhere from $3 million to about $20 million in size, okay. The cap rates, we've seen people looking for yields or trying to do transactions as high as 20% and as well as 10% to 11%. We're still focused on doing high quality transactions with the highest quality growers that have the greatest amount of experience and strong management team and most importantly very strong financial backers and looking at yields ranging in the – from the 14% to 16% range.

[Dan Donlan:]

Okay, that's very helpful. And then in terms of competition, you're maybe the only publicly traded REIT that is focused on this and can be focused on this. You know given those yields, have you seen kind of more private companies come into the business and start to look at this? Just kind of curious is you’re underwriting acquisitions if you're running up against the type of private companies you maybe running up against has that changed at all since the IPO?

[Paul Smithers:]

I think that there has been the change. There – initially I think that there were – a lot of the competition was from the groups that are looking for or to raise capital and they're looking at it from a variety of different – our growers who are looking to raise capital look at to raising capital from a variety of different sources, including real estate companies such as ourselves and private equity or private capital from the broader market. What we're seeing is that some of that private market capital has already been placed and there's an increasing demand for – for the consistent type of capital that we can provide. We aren't seeing any new real estate players really come into the market. We've heard of a group up in Seattle trying to raise a fund, but haven't raised the fund. We know of Kalex reverse merger, but we haven't seen them actually placing any of the capital yet, although we believe that they're out there competing and will be a strong and confident competitor. So we still think that we are in the first mover pioneer position. We still believe that we have a very strong reputation in brand and the best growers are looking to partner with us and we're very excited about the opportunities we have in front of us and going forward.

[Dan Donlan:]

Okay, I appreciate that. I've got one more general question and just two housekeeping ones if you don’t mind. Just talking about the regulatory environment, it seems that the New York market, the restrictions on the qualifying conditions have held that market back now that you have chronic pain has really accelerated dramatically in terms of the patient population. So just kind of curious do you see that hoping in enough other opportunities in markets in terms of – can you just give the growth you’ve seen in New York? And then maybe just on the technology side or the science behind some of these – some of the cannabinoids and things that they're producing. Is the science gets better, do you think that helps some of the profitability increase in the sales? I mean I guess what I'm asking is how much is the improvement in science is going to help as much as maybe reducing some of the regulatory hurdles that that exist.

[Paul Smithers:]

Oh, I met on a complicated question. There's a lot of thing. I mean there's some really interesting science that is occurring and that’s – and with any evolving product type that's going to be – that is going to help the industry certainly with the testing and being able to test and provide a higher quality and more consistent type of products. That is going to be helpful. But I think what you're seeing is the push and pull of – moving product off the black market and patients away from the black market and into the – what we think is a much safer and the better – the safer market of being buying from the medical marijuana providers with approved licenses and approved dispensaries. It’s really what you're seeing right now. And there's a tremendous amount of growth and opportunity for that to continue and to provide tremendous value for our growers and wholesalers. And hopefully, we believe science is coming rapidly to the industry. We think we see – we continue to see new – actually biotech companies looking at starting up exploring the medical cannabis industry. We've seen other states that don't have a medical cannabis program, relax their rules or regulations to allow universities and research institutions to have the ability to grow cannabis for research. And we think all of that. It will be positive in growing this nascent industry into a very large industry over the long-term.

[Dan Donlan:]

Okay, I appreciate that and then just Catherine just two housekeeping things here. When does the rent abatement for the Maryland facility burn off? And is that rent abatement will be retroactive for the improvements as well or the rent release just starts – the abatement starts kind of when you invested the first amount of money and then you'll get the rent regardless of when you paid for the improvements, just kind of curious just for modeling purposes there.

[Catherine Hastings:]

Yeah, the rent abatement period burns off at the end of August and then we will begin recognizing revenue for Maryland. So the way that the rent increases work is at 15% on the sum of the initial purchase price and that additional $3 million that we just started in August. So, starting in September we’ll have revenue on to sum of those two.

[Paul Smithers:]

Cash revenue.

[Dan Donlan:]

Okay. Right, okay, perfect. And then as far as the cash G&A run rate, we just averaged the first two quarters. Is that good for the back half or with – Rob no longer with the company, is there any bit of savings there, just curious for modeling purposes.

[Paul Smithers:]

I think using the first two quarters is good for now. We're still moving through the process of making sure that we’re fully staffed and can deal with all the regulatory requirements of being a public company. So I am comfortable I think with the run rate that by averaging the first two quarters.

[Dan Donlan:]

Okay, perfect. Thank you so much.

[Operator:]

Your next question comes from Steve Shaw with Compass Point. Please go ahead.

[Steve Shaw:]

Hey, guys. I may have missed this. When you were talking about potential target markets, do you have favorite one or two obviously California is probably more mature than the others – might an asset that are not yield as much or what are you – how would you rank those target markets?

[Paul Smithers:]

So I don't – we don't have a favorite target market. Recall that we are focused on medical-use cannabis and it's very easy for us to be focused on or it’s more important for us to be focused on states, which have only a medical-use environment. Now, we are looking at states that have both medical and adult-use environments. California while we believe will be a favorite market or a very strong market and market that have tremendous opportunities for placing of capital. That regulatory environment is still evolving. The new licensing won't come out until sometime in the first quarter we believe and it could be delayed of 2018 in California. So with that we are being very careful in underwriting our transactions with those growers in California that have a longstanding history in California and in providing product and growing, but our – equally focused in other states where the environment is a little bit more clear.

[Steve Shaw:]

Okay. And then in terms of the pipeline, I know you discussed that in some detail. Did you guys mention a timing standpoint of something you might be comfortable with in terms of the next acquisition or two?

[Paul Smithers:]

Well, I mean, on timing process, I mean, we have immediate opportunities that we're very, very confident in right today. But what I want to bring you back to is when we completed the IPO and even after our first call, we made it really clear that we believe that we'll be able to fully deploy the capital within a six to twelve month period of time and we are highly confident that we're going to achieve that goal.

[Steve Shaw:]

Thanks.

[Paul Smithers:]

Thanks.

[Operator:]

Due to time constraints, this concludes our question-and-answer session. I would like to turn the conference back over to Alan Gold for any closing remarks.

[Alan Gold:]

Well, I want to thank everybody for joining us here today. We very much appreciate your spending time with us. And with that we’ll end the call.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.