NewLake Capital Partners, Inc.
Q4 2022 Earnings Call Transcript

Published: 9 Mar 2023

[Operator:]

Good morning. I will be your conference operator today. At this time, I would like to welcome everyone to the NewLake Capital Partners Fourth Quarter and Full Year 2022 Earnings Conference Call. Today’s call is being recorded. I will now turn the call over to Valter Pinto, Managing Director of KCSA Strategic Communications. Please go ahead.

[Valter Pinto:]

Thank you, operator. Good afternoon and welcome everyone to the NewLake Capital Partners fourth quarter and full year 2022 earnings conference call. I am joined today by Gordon DuGan, Chairman of the Board; Anthony Coniglio, President and Chief Executive Officer; Lisa Meyer, Chief Financial Officer; and Jarrett Annenberg, Senior Vice President and Head of Investments. Before we begin, I’d 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 and uncertainties and other factors. For a detailed discussion of some of the ongoing risks and uncertainties in the company’s business, I refer you to the press release issued yesterday evening and filed with the SEC on Form 8-K as well as the company’s 10-K and other 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. FFO and AFFO, our supplemental non-GAAP financial measures used in the real estate industry to measure and compare the operating performance of real estate companies. A complete reconciliation containing adjustments from GAAP net income attributable to common shareholders to FFO and AFFO and definitions of terms are included at the end of our press release. Please refer to the press release for more information. The company’s guidance is based on current plans and assumptions and subject to the risks and uncertainties more fully described in the company’s filings with the SEC. This outlook reflects management’s view of current and future market conditions, including assumptions such as the pace of future acquisitions and dispositions, rental rates, occupancy levels, leasing activity, uncollectible rents, operating and general administrative expenses, weighted average diluted shares outstanding and interest rates. With that, it’s my pleasure to turn the call over to Mr. Gordon DuGan. Gordon, please go ahead.

[Gordon DuGan:]

Thanks, Valter and good morning and thank you all for joining our call. During 2022, NewLake delivered outstanding financial results despite a challenging year for the cannabis industry, which continues into this year. With 100% of 2022 rent collected, our annual revenue grew nearly 60% and our annual AFFO grew more than 75% versus the prior year. Additionally, we continue to consistently raise our dividend each quarter during the year and in fact, our fourth quarter dividend which was paid in January was our sixth consecutive quarterly increase to $0.39 per share of common stock or $1.56 annualized. These are impressive results in any year, but significant – but particularly so in a year where the sector experienced such significant headwinds. And as many of you have heard me say, I like to think of our business model as supplying the shovels and picks we give the cannabis industry capital and capacity through our real estate transactions and that will continue to be a very important part of the cannabis sector going forward. I would also like to point out if you look at our income statement, our revenue of roughly $44.8 million and AFFO of $38.7 million, those are the best margins of any REIT around. So, we have a terrific business model as we drive very significant earnings from the revenues we received. We are proud of these results and believe we have benefited from a rigorous underwriting process developed over the years. Having said that, we are cognizant of the continuing challenges in the cannabis sector, some of which will impact our Q1 2023 revenue. While we have had an impressive track record since the company’s founding 4 years ago, NewLake is not immune to the issues surrounding the cannabis sector. While there have been ups and downs for the cannabis industry in the past, the sector is going through a particularly difficult period. We can’t underestimate the difficult environment the operators are enduring. However, if we have learned anything from our collective experience and observing other industries that have gone through similar difficulties, it’s those operators that make it to the other side that are well positioned to dominate the industry for years to come. Now more than ever, it’s critical to work with the operators that will truly be the long-term winners in this sector. Having said that, my conviction remains very strong, regarding the long-term growth of this industry. The cannabis industry has evolved from sales of $15 billion in 2019 when we started the company to over $26 billion in 2022. And according to Cowen Securities, they expect the U.S. cannabis market to be in excess of $40 billion by 2027. There are few industries that continue to present such attractive growth dynamics. The NewLake will be a key real estate partner for the industry as it scales up by providing attractive non-dilutive capital. I believe our team is well-positioned to navigate the credit challenges of today and take advantage of the growth prospects ahead. We benefit from an experienced management team and Board that collectively have diverse backgrounds and expertise in real estate, cannabis and financial services. In particular, we have a number of team members with significant backgrounds in distressed asset investments and restructurings, which is particularly beneficial in dealing with the issues that may arise in our portfolio. I would recommend that anyone go on our website and look specifically at Joyce Johnson and Alan Carr’s resume says they are both very experienced workout people. We utilize this cumulative experience to manage through difficult situations and maximize long-term value for shareholders. Before I turn it over to Anthony, I just want to say I think despite the difficulty in the cannabis industry, currently, we are extremely well-positioned we have no debt to speak of essentially. We have a reasonable payout ratio on our dividend, which we have managed conservatively. And we have a $90 million credit facility available to us, so tons of liquidity and capital available to take advantage of opportunities. With that, I will turn the call over to Anthony.

[Anthony Coniglio:]

Thank you, Gordon and thank you everyone for joining our call today. I’d like to pick up on Gordon’s comments regarding the industry. Indeed, the cannabis industry continues on its long-term secular growth trend. 2022 was a slower and much more difficult year for the industry, but we see this as a natural part of its evolution as an emerging high growth industry as opposed to a shift in future growth trends. The sector’s correction isn’t too surprising when you consider that the state legal industry, which is relatively young and rapidly expanding, is trying to convert illegal sales to legal channels with minimal help from the federal government today. As a result, operators need to navigate multiple state regulatory structures that create micro economies across the mosaic of legalized states, each one impacted by variables different than next. In today’s environment, operators are learning and adapting as are the state regulators. We see companies both big and small, right-sizing staffing levels, modifying production levels, optimizing processes, pausing capital expenditures, slowing expansion, exiting operations, and in some cases, calling off M&A transactions. These are all difficult, but necessary steps for the industry. We see them within our portfolio and more broadly across the industry. Like any other sector that experiences hardships, the result will be that long-term players who remain disciplined will become stronger. We believe our tenants are in this category and we are targeting these types of organizations for our pipeline. We see the current environment as an adjustment period for the industry with a longer term trend upward. With over 400,000 jobs according to Leafly, the cannabis industry is a significant component of the U.S. economy, it’s growing and indeed it has a bright future ahead. In fact, legalization at the state levels – at the state level continues to expand and we are now seeing progress for cannabis policy in more of the historically politically conservative states. For example, Missouri residents voted in favor of adult-use in November and sales commenced recently in February or take Mississippi which recently started its medical program or even North Carolina where last week, the State Senate approved a medical cannabis bill with an overwhelming majority of the Republican controlled Senate. The march of legalization will continue. Having commented on that state progress, we certainly are all frustrated by the lack of progress in Washington. But the truth is we have never been closer to accomplishing cannabis’ legislative goals. The progress is slow, but there is progress nonetheless. In December, President Biden signed into law a cannabis research bill, which followed his executive action to pardon federal prisoners for cannabis possession. The lame-duck period saw cannabis in the mainstream dialogue of legislative activity and has continued into this Congress with the Senate of – excuse me, the Senate Veterans Affairs Committee 3 weeks ago, approving the VA Medicinal Cannabis Research Act, which is intended to require the VA to research the therapeutic potential of cannabis for veterans with PTSD and chronic pain. I think that’s progress indeed. It will still take some time to see legislation on banking or full legalization, but in my opinion, it’s undeniable that cannabis policy is getting closer to fruition. In the meantime, the industry is proving it can be recession resistant, which is an important factor, given an uncertain economic environment ahead. We certainly saw the impact of inflation on the cannabis consumer in 2022, but price points and basket sizes appear to be adjusting to consumer behavior and the significant volatility from 2022 appears to have subsided. In fact, lost in the focus on pricing volatility is the fact that industry sales extended 4% during 2022, demonstrating the continued demand for cannabis products. Looking forward, there are meaningful catalysts for industry growth and profitability on the horizon as more states legalize medical and adult-use as states decouple their tax structure with 280e which is the proposal making its way through New Jersey, as the federal government provides access to the U.S. banking system and then ultimately the elimination of 280e and legalization of cannabis. We are still in the early innings of the industry’s development and I am excited about its future. Turning to rent, as Gordon mentioned, we collected 100% of our rent in 2022. We are proud of the quality of our investments and our track record of having industry leading rent collection since the inception of our company. With that being said, we have consistently communicated to you that any net lease business with a 14-year remaining average lease term will encounter tenant disruptions at some point. We are seeing that across the industry. And we previously discussed that we have been closely watching all tenants with a keen focus on certain states and particularly those tenants that are not vertically integrated. Thus far in Q1, all tenants are current on payment except one revolutionary clinics. Jarrett will provide more detail on that. But I want to reiterate my message from previous quarters. Our focus has been to be prepared for tenant disruption, so our team can quickly address issues when they arise and maximize returns for our shareholders. Looking specifically at Q1 2023, we expect to collect 90% to 93% of rent, which may include a portion of revolutionary clinics security deposit. Also thus far in Q1, we have exercised our option with respect to expansion in Missouri and signed an LOI to provide additional TI to our build-to-suit project in Phoenix. So, we continue to look for growth opportunities. Lastly, we continue to receive questions about uplifting to a major exchange. While I have nothing new to report, we understand the importance of this and will be relentless in our pursuit of a path to uplifting. With that, I will hand it over – I will hand it over to our Head of Investments, Jarrett Annenberg to walk through our portfolio in more detail. Jarrett, over to you.

[Jarrett Annenberg:]

Thanks, Anthony. I will be covering our current portfolio activity in Q4 and full year 2022, provide updates on a few tenants and outlook for the rest of 2023. As of today, we have committed a total of $421 million across 17 dispensaries and 15 cultivation facilities in 12 states with 13 tenants, inclusive of one tenant that has been provided along with the sale leaseback, representing approximately 1.7 million square feet covered. For retail, our basis across the portfolio is $389 per square foot. For cultivation, our basis across the portfolio is $243 per square foot, well below current replacement cost. 64% of our fully committed capital is with publicly traded operators. 90.5% is committed to properties in which the tenant is vertically integrated in the state. EBITDAR coverage for the latest available quarter was 5.5x for cultivation and 10.4x for dispensaries. Please note that we use estimates where appropriate given each company reports slightly differently on a property level basis. As of December 31, 2022, our portfolio had a weighted average lease term remaining of 14.6 years and an approximate 12.1% yield with built in growth through unfunded tenant improvements and lease escalators. To recap 2022, we committed $69 million across four new transactions with two new operators, Ayr and C3, one expansion for Curaleaf in Florida and a retail location we purchased from PharmaCann in Ohio. We also deployed $24.3 million of TI in addition to the Cureleaf Florida expansion. Thus far in Q1, we have deployed $1.4 million in TI. Additionally, we closed on the previously announced option for C3’s expansion in Missouri. We purchased the adjacent parcel for $350,000 and committed $16.15 million of TI to build out a 57,000 square foot expansion to their cultivation facility as the adult-use market kicks off in Missouri. The total building will be approximately 95,000 square feet and our basis will be $29 million or $306 per square foot. Additionally, we have signed a non-binding LOI to provide our tenant demands with up to $7.5 million of improvements for the 100,000 square foot cultivation and processing facility in Phoenix. If the transaction closes and we finish our total funding, our basis in the facility will be $22 million or $220 per square foot. Including the Mint LOI, we have approximately $25.3 million in unfunded commitments, which is almost entirely comprised of the mentioned C3 transactions. We expect the C3 project to be completed over the next 15 months and the Mint facility to be operational by the end of Q3. Next, I am going to provide updates on two tenants we have been tracking closely now for the last few quarters. Revolutionary Clinics is our third largest tenant representing approximately 10% of our current portfolio. We own their cultivation and processing facility in Massachusetts. As Anthony mentioned, they have not yet paid rent in Q1. Delays in opening their adult-use dispensaries and issues with the recent harvest have limited current cash flow for the company. That said, the company has a leading edible in Massachusetts with Kiva and a leading pre-roll brand with Big Papi. We see long-term value in the company and are working with them as they navigate this period. We currently hold 3 months security deposit on the property. I also wanted to provide an update on Calypso, a tenant in Pennsylvania we have discussed over the past two quarters. The company has done a nice job of adjusting their operations since last summer’s reorganization and continues to pay their originally contracted rents although we have allowed them to temporarily pay on a weekly schedule to better match their cash flow. Beyond Revolutionary Clinics, all tenants are current and we continue to watch the portfolio closely for potential issues. We methodically review property level and parent level financial information we received quarterly. We also monitor each state to understand the operating environment and maintain close contact with all of our tenants. The variables impacting the industry are many, some of which I will touch on momentarily. So, it is imperative for us to remain vigilant. Now, I will talk a little bit about those variables provide a bit more color on the state of the industry and how that shapes our opportunities for the rest of the year. Price compression across all state markets increased COGS, the impact of 280e and lack of access to capital are forcing operators to optimize operations and focus on their existing footprints. Price compression was inevitable and this is a normal even healthy cycle for a new industry. Operators who are able to navigate this environment should be able to expand margins, pick up market share and come out the other side stronger. In addition to price compression, new markets that are the driver of growth in the industry have slowed in their implementation of their programs, as we have seen in New York and Georgia. Even New Jersey, which started adult-use sales in April last year, has fewer than 25 stores currently open in the state allowed to sell adult-use product. While this has all led to slower capital markets, we are excited about the opportunities in front of us. Recent debt transactions in the industry show that the effective cost of capital is in excess of 15% for even the top MSOs. There is a general lack of capital in the industry. And with our available $90 million credit line at 5.65%, we are confident we will be able to execute accretive transactions with quality partners. Our long-term success will be defined by quality, not quantity. And we remain vigilant in our underwriting process and confident in our ability to execute in the current environment. With that, I will hand it over to our CFO, Lisa Meyer to walk through our financial results in more detail. Lisa?

[Lisa Meyer:]

Thank you, Jarrett. For 2022, our portfolio generated total revenue of $44.8 million, an increase of 59.6% compared to $28.1 million in 2021. For the fourth quarter of 2022, our portfolio generated total revenue of $12.2 million, an increase of 35.7% compared to the same period in 2021. Property acquisitions, tenant improvement allowances at existing properties, and an expansion in our Florida cultivation facility all totaling approximately $112.2 million mainly drove the increase in total revenue in 2022. Net income attributable to common shareholders for the full year of 2022 totaled $22 million as compared to $11.2 million for the full year of 2021. Net income for 2022 was impacted by $1.9 million of one-time severance payments from the retirement and separation of certain executive officers of the company and restructuring costs associated with exploring uplifting options. Net income attributable to common shareholders for the fourth quarter of 2022 increased to $6.7 million compared to net income attributable to common shareholders of $3.4 million for the same period in 2021. For the full year of 2022, FFO totaled $35.2 million, an increase of 79% year-over-year. For the fourth quarter AFFO for 2022, FFO of $10.5 million, compared to $7 million for the same period in 2021. AFFO for the full year of 2022, totaled $38.7 million, an increase of 78% year-over-year. For the fourth quarter of 2022, AFFO totaled $10.9 million, an increase of 52% compared to the same period in 2021. In 2022, our general and administrative expenses totaled $6.2 million, excluding one-time severance costs of $1.8 million and non-cash stock based compensation of $1.5 million. On December 15, 2022, the company declared a fourth quarter 2022 cash dividend of $0.39 per share, equivalent to an annualized dividend of $1.56 per share of common stock. The dividend was paid on January 13, 2023 to stockholders of record at the close of business on December 31, 2022. At December 31, 2022, we continue to have a strong balance sheet with $425.1 million in growth real estate assets, and total debt of only $3 million. We have $89 million available on our credit facility and we believe the company is well positioned to execute on our business strategy to grow earnings for investors as we deploy capital. As Anthony mentioned, our rent collection for the first quarter of 2023 is expected to be in the range of 90% to 93% as a result of deferring rent for one tenant, which may include the application of a portion of their security deposit. On March 8, 2023, the company declared a first quarter 2023 cash dividend of $0.39 per share of common stock. The dividend is payable on April 14, 2023 to stockholders of record at the close of business on March 31, 2023. Operator, please open up the call to Q&A.

[Operator:]

[Operator Instructions] Our first question comes from John Massocca with Ladenburg Thalmann. Please proceed with your question.

[John Massocca:]

Good morning.

[Anthony Coniglio:]

Hi John.

[John Massocca:]

Good morning. You touched on it a little bit in the prepared remarks. But can you provide some more color on the factors driving the revolutionary non-payment of rent in 1Q ‘23?

[Anthony Coniglio:]

Yes. I mean I think it’s direct in the prepared remarks. They have been delayed in opening adult-use dispensaries, which is a driver of growth and have had issues with recent harvests. And those are the two pieces.

[John Massocca:]

Anything specific particularly on the harvest front, I mean, is that just a one-time operational issue or is that indicative of issues with pricing in the market?

[Anthony Coniglio:]

John, it’s a private company, and we want to be careful about what we say since they are private. I would make two comments here. Jarrett mentioned in the prepared remarks, we believe that there is long-term value of the company. And we are working with them to help get them through this period. We do currently see it as a temporary period. I also would say that my second point is if you look at other operators in the state, where you have a cultivation facility, similarly situated to the one we own plus three dispensaries that, especially at this pricing level today, they are doing fine. And so we think this is more of a temporary disruption as opposed to a systemic issue or a systemic problem, you would see what the business model that maybe you would see in some of the more unlimited licensed states that are out there.

[John Massocca:]

Okay. It maybe this is something you can’t speak on at the moment. But any color you can provide on potential plans going forward with Revolutionary, if they are – they continue to be unable to pay rent?

[Jarrett Annenberg:]

So, we don’t want to predict the exact, how the timing of Rev Clinics, but we will continue to provide updates as appropriate. And we are working with the company to get through the temporary period Anthony mentioned.

[John Massocca:]

Okay. And then in terms of the security deposit, is that the delta between the 90% and 93% collection guidance? And I guess, maybe just either in terms of rent per month or on a gross number, how much security deposit do you have from the tenant?

[Anthony Coniglio:]

There are 3 months security deposit that we have from the tenant, the 90% to 93% is the range of what we may or may not do. As Jarrett pointed out, they represent 10% of our investment, which is roughly equivalent to what they represent around revenue.

[John Massocca:]

Okay.

[Jarrett Annenberg:]

It’s fair to say that the range we have given does not assume a full drawdown of the security deposit, which we may do. So, we may or may not do.

[John Massocca:]

And then maybe beyond Revolutionary in Calypso, how does the rest of the portfolio look from a tenant credit watch list perspective?

[Jarrett Annenberg:]

So, Calypso has done, as I have said, a nice job of restructuring the business and continues to pay rent albeit on a weekly schedule. And for the rest of the companies, we vigilantly watch the financials. We are in constant communication with our tenants. We also revamped our tenant credit metrics, the past two quarters to really focus in on the three pieces, which is facility level, tenant level, state level and guarantor level financials. So, we are constantly watching everybody.

[John Massocca:]

Okay. And how are you thinking about new investments in capital deployment, both broadly, and specifically with operators not currently in the portfolio, given the current cannabis market and interest rate conditions?

[Jarrett Annenberg:]

Sure. So, we have always been focused on quality, not quantity. I will say our pipeline is slightly smaller today than it has been historically. But I also think that it’s more focused than it has been historically, as we have seen some less serious operators exit the space. And from a pricing perspective, I think we all know interest rates with where they are to have expanded, then it’s really going to be a focus on partnering with both existing operators that we like entering new markets and potentially new tenants out there that we don’t currently have in the portfolio.

[John Massocca:]

Any kind of rough tracks on the size of the pipeline today?

[Jarrett Annenberg:]

No, we have never really given guidance on the size of the pipeline.

[John Massocca:]

Okay. And then just one last one for me, on the med transaction, how did that kind of come about just any color on the logic and the conversation behind that deal?

[Jarrett Annenberg:]

Sure. So, we always actually in our original lease had additional TI plan for the med at the facility. And as they are finishing the project, we basically looked at the original lease, and re-pricing generally in the construction market, and given the additional TI to finish the majority of the interior rooms at the facility on the cultivation side.

[Anthony Coniglio:]

Yes. I am going to add to that John. If you go back to the beginning way back when we underwrote that a couple of years ago, there was some uncertainty around how that market would evolve. And so in order to not go long and have a very high basis, in a building, in a market where we knew it was going to undergo a transition from medical to adult use, we wanted to watch how it developed. And so that’s why we had that mechanism in there that earmarked potential for future TI. And so now, having observed that, having watched the tenant, having seen how the tenant is financially performing, we are excited to unlock this additional value. And when you look at the completion, Phoenix being one of the hotter industrial markets in the country right now, when you look at our bases after additional TI, very, very attractive bases in a very attractive market.

[John Massocca:]

Okay. That makes sense. Very helpful. That’s it for me as well. Thank you.

[Operator:]

[Operator Instructions] We have reached the end of the question-and-answer session. I would now like to turn the call over to Anthony Coniglio for closing comments.

[Anthony Coniglio:]

Thank you very much. Thank you everyone for joining our call today. We hope to have a great quarter and we look forward to our next call. Thank you. Bye-bye.

[Operator:]

This concludes today’s conference. You may disconnect your lines at this time and we thank you for participating.