Newlake Capital Partners Inc
OTC:NLCP
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Newlake Capital Partners Inc
Earnings Call Analysis
Summary
Q3-2023
The company's total revenue for Q3 2023 experienced a dip, which was slightly compensated by $600,000 from property acquisitions and rent escalations. Net income for common shareholders decreased 8.4% year-over-year to $6.1 million. Despite this, the portfolio performed solidly, with an Adjusted Funds From Operations (AFFO) of $10.1 million, meeting the full-year guidance of $39.8 to $40.8 million. The firm maintained a healthy dividend of $0.39 per share with a payout ratio of 81.6% and bought back shares worth $10 million. A strong balance sheet was reported, boasting $403 million in gross real estate assets against a meager $2 million debt.
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Good morning. I will be your conference operator today. At this time, I would like to welcome everyone to NewLake Capital Partners Third Quarter 2023 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.
Thank you, operator. Good morning, and welcome, everyone to the NewLake Capital Partners Third Quarter 2023 Earnings Conference Call. I'm joined today by Gordon DuGan, Chairman; 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 may be 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 on some of the ongoing risks and uncertainties in the company's business, I refer you to the press release issued this morning and filed with the SEC on Form 8-K as well as the company's 10-K, 10-Q 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 are supplemental non-GAAP financial measures using 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 that press release for more information.
The company's guidance is based on current plans and assumptions and subject to risks and uncertainties more fully described in the company's filings with the U.S. Securities and Exchange Commission. 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 and 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.
Thank you, Valter, and thank you, everyone, for joining our call today. During a period of volatility in the markets broadly in the cannabis industry specifically, we are pleased with our 2023 third quarter results, which were in line with the guidance we provided last quarter.
For the quarter, we maintained our dividend of $0.39 per share, which was well covered with a payout ratio of 82% for the quarter. After a period of increasing our dividend since going public in 2021, we have maintained our dividend during 2023 as we navigate the challenging environment for the cannabis industry. Also, during 2023, we have maintained our payout ratio within our previously stated range of 80% to 90%.
Our balance sheet remains very strong. Today, we are operating effectively with no leverage and ample capacity to invest in the cannabis sector when we determine that the risk profile and return dynamics will create value for our investors. Until then, we have taken the opportunity to create value for our shareholders by investing in our own stock at accretive prices during the quarter and authorizing a second $10 million tranche of capital to continue doing so at these levels. We continue to believe in the long-term investment opportunities around cannabis real estate, but we'll continue to seek opportunities to create value through our repurchase program.
It is important to note that we recently announced an amendment with one of our tenants, Revolutionary Clinics. I'm pleased the team was able to diligently work through the issues to get a good outcome for our shareholders. Jarrett will provide more details in a moment. But as we have commented many times, we know there will always be the potential for portfolio issues in the net lease business in general and in the cannabis net lease business, specifically. And coming up with solutions is important to maximizing value for our shareholders. That's what we've done in the case of Revolutionary Clinics, we believe, and we're pleased to see this property once again generating income for our shareholders and brought to a successful conclusion at this point.
More broadly though, the cannabis industry continues to work through this period of retrenchment. And I applaud those tenants of ours that have worked hard to address not only their cost structure, but near-term debt maturities, and in one case, issuing equity to pay off debt. I continue to believe this period of difficulty will serve to separate the wheat from the chaff and the survivors will be long-term winners in this sector.
While headwinds remain, I continue to believe in the long-term growth prospects for the industry and see potential catalysts in the form of DEA rescheduling and the recently filed lawsuit by the industry challenging the federal government's ability to regulate intrastate commerce for cannabis. While these initiatives take time, it is undeniable that the march towards a more constructive federal regulatory scheme continues.
With that, I'll turn it over to Anthony.
Thank you, Gordon, and welcome, everyone. I'm very pleased with our Q3 results and, in particular, our recent announcement regarding Revolutionary Clinics, where we had a choice to either evict and retenant the building or find a path forward with the tenant. Revolutionary Clinics is one of the largest wholesalers in Massachusetts and has some of the leading brands to distribute, particularly Kiva, a leading edibles brand, not to mention 2 new adult-use dispensaries opened in the past 6 months.
We believe a revitalized Revolutionary Clinics with the fresh third-party capital that they have raised is the path that will provide the best return for our investors. Notably, we have the opportunity to participate in equity upside in Revolutionary Clinics via the warrants we own as a result of the transaction. We also announced today that while Calypso did not make its weekly October rent payments, they have resumed their weekly payments in November, and Jarrett will discuss more on this in a moment.
Turning to our quarterly results. During the third quarter, we generated AFFO of $10.1 million or $0.47 per diluted share. As Gordon mentioned, we've bought approximately $9.3 million of our own stock and now have authorization for another $10 million to continue doing so. Our stock purchases thus far this year have resulted in more than 3% accretion to book value and AFFO per share. For our shareholders, myself and our insiders included, we would obviously prefer that our stock reflects the value of our portfolio. However, at these levels, we will continue to take advantage of the opportunity to create value by investing in our own stock.
Turning to some developments on the federal front. The United States Department of Health and Human Services responded to President Biden's request by recommending to the DEA, a rescheduling of cannabis from Schedule I to Schedule III. If this does occur, the onerous taxation on the cannabis industry in the form of IRS Code 280E would be removed. This would provide significant cash flow relief for the industry moving forward, which in turn would be a meaningful improvement in the credit profile of our tenant base. It's hard to predict the outcome or the timing of this taking place. Therefore, we're not basing any decisions on this potential catalyst, but we do share the industry's optimism that this could become a reality in 2024.
On previous calls, we've discussed the SAFE Banking Bill. That bill has since been revised and is now known as the SAFER Banking Bill. During late September, the Senate Banking Committee passed the bill out of committee on a bipartisan basis. While SAFE had tested the house 7x, this is the first time the cannabis banking legislation passed out of a Senate Committee. This is a positive step for sure, but we still see a difficult path for the bill to become law before next year's election cycle.
I actually think one of the more interesting developments in the cannabis sector is the lawsuit recently filed on behalf of a group of industry participants against the federal government. The lawsuit challenges the ability of the federal government to use the Controlled Substances Act to regulate intrastate commerce regarding cannabis. I won't go into detail here, but I do invite you to consider this lawsuit in the context of cannabis cases in some of the circuit courts including a pending case in Florida.
Given this activity and potential conflicting opinions among federal circuit courts, I actually believe that there is a viable chance cannabis makes it to the Supreme Court. And in fact, Justice Thomas seems to invite the challenge in a statement he wrote in connection with the court's decision not to hear a cannabis case in 2021 where Justice Thomas said, that the federal ban on cultivation and use of Marijuana within states may no longer -- in his words, "May no longer be necessary or proper." And he also noted that the inconsistent enforcement led to traps for marijuana businesses. So this legal strategy for sure will take time to play out, but it is another important opportunity for the industry to close that state and federal gap without waiting for action from the legislative branch.
Additionally, I'd like to comment about Ohio. Ohio held a ballot referendum yesterday on Tuesday to approve adult-use cannabis sales in the state. The measure passed with nearly 57% of voters supporting the measure. Ohio will become the 24th state to legalize adult use, and we expect the program to launch in mid-2024 or early 2025. This outcome shouldn't be surprising when you consider that Gallup announced yesterday that 70% of U.S. adults believe cannabis should be legal.
Consider that in the past 12 months, you have had Missouri, Maryland and now Ohio approve adult use, adding a combined population of 24 million people to the adult-use market. Today, more than half of our country resides in a state with adult-use cannabis. The march towards a legalized market is firmly in place, which will only serve to strengthen the credit quality of our tenant base and expand our growth opportunities.
And with that, I'll turn the call over to Jarrett.
Thanks, Anthony. I'll be covering our current portfolio, including further details on Rev Clinics and Calypso, as well as activity in the third quarter and outlook for the rest of the year.
In regard to our current portfolio, I'll start with Revolutionary Clinics. As Anthony and Gordon noted, we finalized the lease amendment and forbearance agreement subsequent to quarter end on the 145,000 square foot property we own in Massachusetts. To provide more color, under the terms of the agreements, the lease was extended by 5 years. NewLake received $480,000 for previously unpaid rent and applied the remaining $315,000 of security deposit to rent, all of which will be recognized as income in the fourth quarter. Additionally, NewLake has received the reduced contractual rent payments for October and November. While we do not disclose individual lease terms, the reduced rental payments will represent approximately 6.1% of scheduled fourth quarter contractual income.
The rent payments may escalate in the event Rev Clinics hit certain gross revenue metrics. Under the forbearance agreement, NewLake provided forbearance for approximately $2 million of back rental income. These amounts come due and payable in the event of a future default. Lastly, we received 9.95% of equity in Rev Clinics in the form of warrants. Anthony also mentioned that Calypso did not pay weekly rent in October but is back to paying on a weekly cadence in November. As we have noted, each of the past few quarters, Calypso has been weathering a difficult Pennsylvania market for independent operators and has been paying rent on a weekly schedule since the first quarter to better match their cash flow.
While we still believe that the Calypso sale will be finalized, we are also encouraged by the recent movement in the Pennsylvania legislature, with a bill that would provide dispensaries to independent operators in the state. This verticality would be very helpful for Calypso and has already driven additional interest in the asset in the event the currently proposed transaction is not executed.
One additional portfolio update is the sale of an industrial facility that was leased to The Mint in Massachusetts. This was a mutual decision made with The Mint in response to the difficult environment in Massachusetts and Mint's desire to focus on its existing footprint, including growth in their home state of Arizona, where they have 6 operational stores. Our basis in the Massachusetts property was $1.95 million and we sold the property for $2 million. The remaining $3 million in TI allowance that was to be used for the build out in Massachusetts was moved to The Mint's cultivation facility in Phoenix earlier this year.
As a refresher, we purchased a property in Phoenix, Arizona with The Mint for the build-out of 100,000 square foot cultivation and processing facility. As of quarter end, we've invested $15.3 million of the $21 million committed to the property with construction scheduled to be completed during the first quarter of 2024. As of September 30, we have committed a total of $425 million across 17 dispensaries, 14 cultivation facilities in 12 states with 13 tenants, inclusive of 1 tenant that has been provided with the loan along with the sale leaseback, representing approximately 1.6 million square feet covered.
Our basis in the retail properties is $389 per square foot and cultivation properties is $252 per square foot. Both metrics are well below replacement costs. 64% of our fully committed capital is with publicly traded operators, 92.5% is committed to properties in which the tenant is vertically integrated in the state.
EBITDA coverage for the latest available quarter at our properties was 4x for cultivation and 9.8x for dispensaries. While these are decreases from the previous quarter of 0.51 and 1, respectively, they're within the standard deviation over the past 6 quarters. Please note that we use estimates where appropriate, given each company reports slightly differently on a property level basis.
Moving to capital deployment. In the third quarter, we disbursed $2.6 million of tenant improvement allowance. As of September 30, we had approximately $20.2 million in unfunded commitments, which is almost entirely comprised of The Mint and C3 transactions. As I mentioned, we expect the Mint, which represents $5.7 million of TI outstanding, to be finished in Q1 and C3, which represents $13.7 million, to be completed over the next 9 months.
Taking a step back, the industry continues to work through growing pains as operators work on efficiencies and focus on balance sheet management. That said, we are encouraged to see stabilization in states that saw significant price compression and new markets showing signs of strength. The U.S. average wholesale price for indoor flower is now closer to $1,400 per pound, up from just over $1,300 per pound last quarter.
As far as new markets, Maryland launched adult-use sales in July and total sales in the state for the third quarter were over $270 million. Missouri, which commenced adult-use sales in February and where we own 2 cultivation facilities, is on pace to eclipse $1.2 billion in total sales for 2023. Both markets were set up for success with medical operators transitioning to adult use, providing proper supply and retail outlets for consumers.
We also continue to see growth in states that were slower to start, like Connecticut, which crossed the $25 million a month in sales in September. We expect to see continued growth as more dispensaries come online, combined with Connecticut's recent increase on sale of limitations per customer.
For potential new markets, as Anthony mentioned, voters in Ohio voted in favor of adult-use sales, making it the 24th state to do so. On Tuesday, Virginia's House and Senate both turned Democratic, which could provide the adult-use market in the state. Additionally, in Kentucky, Andy Beshear won his reelection campaign for Governor. Governor Beshear signed the law back in March for medical use in Kentucky, with the program slated to start in 2025. All that said, our capital deployment continues to be at a slower pace given that operators are focused on existing operations, states have been slower to launch and the interest rate environment has continued to put pressure on the cost of capital.
With that, I'll hand it over to our CFO, Lisa Meyer, to walk through our financial results in more detail.
Thank you, Jarrett. For the third quarter of 2023, our portfolio generated total revenue of $11.5 million, a decrease of 4.9% compared to the same period in 2022. The decrease was mainly driven by the nonpayment of rents from Revolutionary Clinics during the third quarter, which was approximately $1.3 million, and we applied 25% or $315,000 from their security deposit to partially offset the decrease in rental revenue. As mentioned earlier on the call, the company entered into a recommitment and a forbearance agreement after quarter end, and Revolutionary Clinics is current on its rental payments under the amended lease.
The decrease in total revenue for the third quarter of 2023, when compared to the same period in 2022, was partially offset by $600,000 of rental income generated from property acquisitions, tenant improvement allowances at existing property including the development and expansion of our Arizona and Missouri cultivation facility as well as annual rent escalation.
Net income attributable to common shareholders for the third quarter of 2023 decreased to $6.1 million, a decrease of 8.4% when compared to net income attributable to common shareholders of $6.6 million for the same period in 2022.
On a sequential basis, our financial results in the third quarter of 2023 were relatively flat from the second quarter of 2023. Our rent collection for the third quarter of 2023 was in line with our guidance of 92%, reflecting Revolutionary Clinics delinquency.
Our portfolio continues to perform well and in line with our expectations, which is a direct result of the quality of our investments. For the third quarter of 2023, our portfolio generated FFO of $9.6 million or $0.45 per diluted share. AFFO of $10.1 million or $0.47 per diluted share. We are maintaining our AFFO guidance for the full year of 2023 of $39.8 million to $40.8 million.
We declared a cash dividend of $0.39 per common share, and our dividend was fully supported by the earnings power of our portfolio with Q3 payout ratio of 81.6%. The dividend was paid on October 13, 2023, to stockholders of record at the close of business on September 30, 2023, equivalent to $1.56 per share of common stock.
Also in the third quarter to improve shareholder value, pursuant to our stock repurchase program, we acquired 608,152 shares of common stock. We amended our existing program to purchase an additional $10 million of our outstanding common stock and extended the program to December 31, 2024. As of September 30, 2023, we acquired 713,831 shares of our common stock at an average price of $12.96 per share. The remaining availability under the program at September 30, 2023, was approximately $10.7 million.
On September 30, 2023, we continue to have a strong balance sheet with $403 million in gross real estate assets and a total debt of only $2 million. We had $89 million available on our revolving credit facility, and we believe the company is well positioned to execute on our business strategy to grow earnings for investors as we deploy that capital.
And now I will turn the call over to the operator for Q&A.
[Operator Instructions] Our first question is from Pablo Zuanic with Zuanic & Associates.
Anthony, I mean, obviously, on the reform front, a lot of good news, right, tailwinds, and you highlighted them all. Something that's new to some extent is that some companies, including some of your clients, are speaking publicly about changing the way they think about their tax liabilities, right? So they are going to pay the corporate tax and not the 280E tax and they will even ask for rebates for prior years. And people are thinking about that in different ways, obviously. But I'm just thinking from your perspective, how do you think about that from a credit evaluation perspective? Or you are just agnostic to that?
No, we're certainly not agnostic. When we underwrite, we look at those liabilities and we have to assume that those liabilities will come due. We haven't seen anybody in their published results actually state that they have a lower tax liability. I think that might be going a step too far, but we consider the full federal 280E liability in the way we underwrite the sector.
Okay. And now in terms of a share repurchase program, yes, nice to see that going on, but it's also a reflection of the opportunities out there, right? So to some extent, given all these tailwinds that you highlighted and more states going recreational, I would assume that there's more better quality opportunities out there. So you have more opportunities to deploy capital in new loans as opposed to repurchasing shares. Can you just try to reconcile the 2?
Yes. Our guiding light and our guiding principle is creating value for shareholders. And when we look at the evolving cost of capital for us and everyone across the industry. And relative to the risk profile of the opportunities we're looking at, we're going to consistently look to make sure we're making the right decision to create that value for shareholders. And right now, with such volatility in capital markets, Pablo, I think it is difficult to have a high degree of confidence that with some of the recent lowered expectations for pricing out of the industry because they think that hope is around the corner for federal reform, it's hard in some cases to see the pricing on the opportunity to meet the pricing for us to create value relative to the share buyback program that you mentioned.
Right. One last one. I mean -- and given all that and given the context where we are, right, which is still challenging, but let's say, light at the end of the tunnel and a lot of positive tailwinds. I'm just trying to understand the competition that you face, say, in a place like Maryland, that's supposedly obviously, sales more than double, right, potential for reform in Pennsylvania and Ohio, how the operators there that supposedly some of them will want to expand and are looking for capital?
When they talk to you in terms of your niche in terms of lending, are you in a better position compared to other types of lenders out there that follow, let's say, a different model or in a weaker position? I'm just trying to understand the competitive dynamics in terms of your model versus others in the current context when you are pitching to someone saying in Maryland, which would be an attractive state with good economics, of course, and growth potential.
Yes. There have been relatively no new entrants into what we do, or providing capital around real estate opportunities in the cannabis sector. No new entrants for at least 12 to 24 months that I'm aware of, of any scale. And so from a competitive standpoint, there are only a couple of us that do what we do and can do it in scale. And when we look at the amount of available capital out there for whether it be sale-leaseback or even loans, it's a fairly limited set of providers.
So when opportunities exist, I can't say that we see every opportunity in the industry, but we see just about every opportunity in the industry. As far as funding some of these new growth markets, you're absolutely right. We spent a lot of time quantifying what the needed cultivation square footage is on a state-by-state basis as well as the need for retail capacity on a state-by-state basis.
And so yes, as states come and approve adult use, there is a growing opportunity set. Having said that, quite a few of the operators have been fairly judicious. And I want to say I applaud their cautiousness around taking on new CapEx projects until they've finalized the work that they're doing on stabilizing their cash flows from operations today. And so yes, there's a confluence of growth opportunity because states are going adult use, but cautiousness on the part of the operators not to take on meaningful CapEx in this environment because those are the deals for the future.
Right. If I can add one more in terms of just the interest rate environment, obviously, at the end year coming down somewhat, supposedly, interest rates peaking, some people think. How does that affect the way you think about the way you structure your loans, if in any way?
And again, we primarily focus on sale-leaseback transactions. And the capital markets environment informs us around weighted average cost of capital for our business. And we look at that as we consider investment opportunities to make sure that we're creating value for our shareholders. And so we'll continue to look at that as the capital markets evolve.
[Operator Instructions] There are no further questions. I would like to turn the conference back over to Anthony for closing comments.
Thank you, everybody. We appreciate you joining our call today. Have a wonderful day.
Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.