UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
10–K
(Mark One)
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ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the Fiscal Year Ended December 31, 2017
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the Transition Period From _______to ________
Commission File Number:
001-37949
Innovative
Industrial Properties, Inc.
(Exact name of registrant as specified in its
charter)
Maryland
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81-2963381
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(State or other jurisdiction of incorporation or
organization)
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(I.R.S. Employer Identification No.)
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11440 West Bernardo Court, Suite 220, San Diego, CA
92127
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(858) 997-3332
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(Address of principal executive offices)
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(Registrant's telephone number)
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Securities registered pursuant to Section 12(b) of the Act:
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Title of Each Class
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Name of Each Exchange on Which Registered
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Common Stock, par value $0.001 per share
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New York Stock Exchange
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Series A Preferred Stock, par value $0.001 per share
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New York Stock Exchange
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Securities registered pursuant to Section 12(g)
of the Act:
None.
Indicate
by check mark whether the Registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act). YES
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NO
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Indicate
by check mark whether the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934. YES
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NO
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Indicate
by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. YES
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NO
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Indicate
by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). YES
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NO
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Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K.
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Indicate by check mark whether the Registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions
of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging
growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
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Accelerated filer
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Non-accelerated filer
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(Do not check if a smaller reporting company)
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Smaller reporting company
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Emerging growth company
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If an emerging
growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with
any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
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Indicate
by check mark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2). YES
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NO
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The aggregate market value of the common stock held by non-affiliates
of the Registrant was approximately $52.5 million, based upon the last reported sale price of $16.75 per share on the New York
Stock Exchange on June 30, 2017, the last business day of the Registrant's most recently completed second quarter.
As of March 29, 2018, there were 6,782,079 shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Innovative Industrial Properties,
Inc.'s Proxy Statement with respect to its 2018 Annual Meeting of Stockholders to be filed not later than 120 days after the
end of the registrant's fiscal year are incorporated by reference into Part III hereof.
INNOVATIVE INDUSTRIAL PROPERTIES, INC.
FORM 10-K – ANNUAL REPORT
DECEMBER 31, 2017
TABLE OF CONTENTS
Cautionary
Statement Regarding Forward-Looking Statements
We make statements in this report that are
"forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (set forth in
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act")). In particular, statements pertaining to our capital resources,
portfolio performance and results of operations contain forward-looking statements. Likewise, our statements regarding anticipated
growth in our funds from operations and anticipated market and regulatory conditions, our strategic direction, demographics, results
of operations, plans and objectives are forward-looking statements. Forward-looking statements involve numerous risks and uncertainties,
and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods
which may be incorrect or imprecise, and we may not be able to realize them. We do not guarantee that the transactions and events
described will happen as described (or that they will happen at all). You can identify forward-looking statements by the use of
forward-looking terminology such as "believes," "expects," "may," "will," "should,"
"seeks," "approximately," "intends," "plans," "estimates" or "anticipates"
or the negative of these words and phrases or similar words or phrases. You can also identify forward-looking statements by discussions
of strategy, plans or intentions. The following factors, among others, could cause actual results and future events to differ materially
from those set forth or contemplated in the forward-looking statements:
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our business and investment strategy;
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our projected operating results;
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actions and initiatives of the U.S. or state governments and changes
to government policies and the execution and impact of these actions, initiatives and policies, including the fact that cannabis
remains illegal under federal law;
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availability of suitable investment opportunities in the medical-use
cannabis industry;
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concentration of our portfolio of assets and limited number of tenants;
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our understanding of our competition and our potential tenants' alternative
financing sources;
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the estimated growth in and evolving market dynamics of the medical-use
cannabis market;
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the demand for medical-use cannabis cultivation and processing facilities;
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the expected medical-use or adult-use cannabis legalization in certain
states;
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shifts in public opinion regarding medical-use cannabis;
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the state of the U.S. economy generally or in specific geographic
areas;
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economic trends and economic recoveries;
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our ability to access equity or debt capital;
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financing rates for our target assets;
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changes in the values of our assets;
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our expected portfolio of assets;
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our expected investments;
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interest rate mismatches between our assets and our borrowings used
to fund such investments;
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changes in interest rates and the market value of our assets;
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rates of default on leases for our assets;
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the degree to which any interest rate or other hedging strategies
may or may not protect us from interest rate volatility;
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impact of and changes in governmental regulations, tax law and rates,
accounting guidance and similar matters;
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our ability to qualify as a real estate investment trust ("REIT")
and, once qualified, maintain our qualification as a REIT for U.S. federal income tax purposes;
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our ability to maintain our exemption from registration under the
Investment Company Act of 1940 (the "Investment Company Act");
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availability of qualified personnel; and
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market trends in our industry, interest rates, real estate values,
the securities markets or the general economy.
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While forward-looking statements reflect our
good faith beliefs, they are not guarantees of future performance. We disclaim any obligation to update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise. For a further discussion of these and other factors
that could impact our future results, performance or transactions, see Item 1A, "Risk Factors."
Market data and industry forecasts and projections
used in this Annual Report on Form 10-K have been obtained from independent industry sources. Forecasts, projections and other
forward-looking information obtained from such sources are subject to similar qualifications and uncertainties as other forward-looking
statements in this report.
PART I
ITEM 1.
BUSINESS
General
As used herein, the terms "we", "us",
"our" or the "Company" refer to Innovative Industrial Properties, Inc., a Maryland corporation, and any of
our subsidiaries, including IIP Operating Partnership, LP, a Delaware limited partnership, or our Operating Partnership.
We are a self-advised Maryland corporation
focused on the acquisition, ownership and management of specialized industrial properties leased to experienced, state-licensed
operators for their regulated medical-use cannabis facilities. We were incorporated in Maryland on June 15, 2016, and we intend
to elect and continue to operate our business so as to qualify to be taxed as a REIT for U.S. federal income tax purposes, beginning
with our taxable year ended December 31, 2017. We conduct our business through a traditional umbrella partnership real estate investment
trust, or UPREIT structure, in which our properties are owned by our Operating Partnership, directly or through subsidiaries. We
are the sole general partner of our Operating Partnership and own, directly or through a subsidiary, 100% of the limited partnership
interests in our Operating Partnership. As of December 31, 2017, we had six full-time employees.
Our corporate office is located at 11440 West Bernardo Court, Suite
220, San Diego, California 92127. Our telephone number is (858) 997-3332.
2017 Highlights
Properties
We acquired four properties in 2017 and as
of December 31, 2017, we owned five properties that were 100% leased to state-licensed medical-use cannabis operators and comprising
an aggregate of approximately 617,000 rentable square feet in New York, Maryland, Arizona and Minnesota, with a weighted-average
remaining lease term of approximately 14.7 years. As of December 31, 2017, we had invested $68.3 million in the aggregate (excluding
transaction costs) and had committed an additional $5.0 million to reimburse certain tenants for future tenant improvements at
our properties. Our average initial yield on invested capital is approximately 15.8% for these five properties, calculated as the
sum of the initial base rents, supplemental rent (with respect to the lease with PharmaCann LLC ("PharmaCann") at one
of our New York properties) and property management fees, after the expiration of the base rent abatement period (with respect
to the lease with a subsidiary of The Pharm, LLC ("The Pharm") at our Arizona property), divided by our aggregate investment
in these properties (excluding transaction costs and including the aggregate potential tenant reimbursements of $5.0 million).
Dividends
We commenced quarterly dividends to our common stockholders in the
second quarter 2017, which was our second full quarter since we completed our initial public offering and commenced real estate
operations with the acquisition of our first property in December 2016. In the fourth quarter 2017, we increased the quarterly
dividend payable to common stockholders to $0.25 per share, representing a 67% increase over the Company’s third quarter
dividend of $0.15 per share of common stock. During 2017, we declared dividends to our common stockholders totaling $0.55 per share.
Capital Raising
On October 19, 2017, we issued 600,000 shares
of our 9.00% Series A Cumulative Redeemable Preferred Stock ("Series A Preferred Stock") in a public offering, resulting
in net proceeds of approximately $14.0 million, after deducting the underwriters' discounts and commissions and offering expenses.
Subsequent to year-end, on January 22, 2018,
we issued 3,220,000 shares of our common stock in a follow-on public offering, including the exercise in full of the underwriters'
option to purchase an additional 420,000 shares, resulting in net proceeds of approximately $79.3 million, after deducting the
underwriters' discounts and commissions and offering expenses.
Our Properties
As of December 31, 2017, our portfolio consisted of five properties
that were 100% leased to state-licensed medical-use cannabis operators and comprising an aggregate of approximately 617,000 rentable
square feet in New York, Maryland, Arizona and Minnesota.
Generally
We have acquired and intend to continue to acquire specialized industrial
real estate assets operated by state-licensed medical-use cannabis growers through sale-leaseback transactions and third-party
purchases. In sale-leaseback transactions, concurrently upon closing of the acquisition, we lease the properties back to the sellers
under long-term, triple-net lease agreements. We target properties owned by growers that have been among the top candidates in
the rigorous state licensing process and have been granted one or more licenses to operate multiple facilities. Based on our properties
and ongoing review of potential acquisitions, indoor cultivation facilities generally appear to have similar shells as standard
light industrial buildings or greenhouses. However, based on our diligence, the medical-use cultivation process typically requires
a finely tuned environment to achieve consistent high quality and specificity in cannabinoid levels and to maximize yields, which
translates into certain capital improvements in the building's infrastructure. These improvements can include enhanced HVAC systems
for climate and humidity control, high capacity electrical and plumbing systems, specialized lighting systems, and sophisticated
building management, cultivation monitoring and security systems. Through this sale-leaseback strategy, we serve as a source of
capital to these licensed medical-use cannabis growers, allowing them to redeploy their sale proceeds back into their core operations
to grow their business and achieve higher returns. In a third-party purchase of a property, we may also fund the necessary tenant
improvements through a long-term lease with an identified tenant, which also serves to free up capital for the tenant to reinvest
in their business.
PharmaCann NY Property
On December 19, 2016, we completed the
acquisition of a 127,000 square foot industrial property located in New York (the “PharmaCann NY Property”), which
we purchased from PharmaCann for approximately $30.0 million (plus approximately $75,000 in transaction costs) in a sale-leaseback
transaction. Concurrent with the closing of the acquisition, we entered into a triple-net lease with PharmaCann, as tenant for
use as a medical cannabis cultivation and processing facility. PharmaCann is responsible for paying all structural repairs, maintenance
expenses, insurance and taxes related to the PharmaCann NY Property. The lease term is 15 years, with two options to extend the
term of the lease for two additional five-year periods. The initial base rent of the PharmaCann lease is approximately $319,580
per month, subject to annual increases at a rate based on the higher of (i) 4% or (ii) 75% of the consumer price index.
The lease also provides that we receive a property management fee equal to 1.5% of the then-current base rent throughout the term,
and supplemental base rent for the first five years of the term of the lease at a rate of $105,477 per month. Together,
the annualized initial base rent, property management fee and supplemental base rent equate to approximately 17% of the purchase
price (excluding transaction costs) of the PharmaCann NY Property. As of December 31, 2017, the base rent of the PharmaCann lease after the first annual increase was approximately
$332,360 per month.
Holistic MD Property
On May 26, 2017, we purchased an industrial
property located in Maryland (the “Holistic MD Property”), which comprises approximately 72,000 square feet and was
under development at the time of our acquisition. The initial purchase price was $8.0 million (plus approximately $185,000 in transaction
costs), with an additional $3.0 million payable to the seller upon completion of certain development milestones. Concurrent with
the closing of the purchase of the Holistic MD Property, we entered into a triple-net lease agreement with Holistic Industries
LLC (“Holistic”) for use as a medical cannabis cultivation and processing facility. The initial term of the lease is
16 years, with three options to extend the term of the lease for three additional five-year periods. Holistic has an option to
purchase the property upon a qualifying termination event or at the end of the initial lease term and subject to certain conditions,
at the option purchase price that is the greater of fair market value or a 7.5% capitalization rate derived from market rental
rates for industrial properties in the relevant competitive market.
On August 1, 2017, we paid the additional
$3.0 million to the seller upon the seller’s completion of the development milestones at the Holistic MD Property. In August
2017, Holistic received final approvals from the Maryland Medical Cannabis Commission for both cultivation and processing of medical-use
cannabis, and also received provisional approval for dispensing medical cannabis. On September 25, 2017, we amended our lease
with Holistic to, among other things, rescind the $1.9 million rent reserve that we originally established for Holistic under the
lease, and to reimburse up to $1.9 million of additional tenant improvements for Holistic, such that a total of $5.9 million
is reimbursable by us to Holistic for tenant improvements. In connection with that amendment and in lieu of draws on the previously
established rent reserve, Holistic paid to us $205,000 as a stipulated payment for the full base rent and property management fees
for amounts owed from August 26, 2017 (the expiration of the rent abatement period) through September 30, 2017. The personal guaranty
by a principal of Holistic was also amended to guaranty the payment of the base rent and property management fee obligations due
under the lease from September 1, 2017 through May 31, 2018. On September 28, 2017, we approved and accrued for Holistic's draw
request for reimbursement of the full $5.9 million of tenant improvements and funded that amount on October 2, 2017. As a result,
our total investment in the Holistic MD Property was approximately $16.9 million (excluding transaction costs), and, effective
as of October 1, 2017, Holistic’s annualized base rent is approximately $2.6 million, or approximately $213,760 per month,
of which $187,500 is subject to annual escalations of 3.25% for the initial lease term. We also receive a property management fee
under the lease equal to 1.5% of the then-current base rent throughout the initial term.
Vireo NY Property
On October 23, 2017, we completed the acquisition
of a 40,000 square foot industrial property located in New York (the “Vireo NY Property”), which we purchased from
a subsidiary of Vireo Health, Inc. (“Vireo New York”) for approximately $3.4 million (plus approximately $60,000 in
transaction costs) in a sale-leaseback transaction. Concurrent with the closing of the acquisition, we entered into a triple-net
lease with Vireo New York, as tenant for use as a medical cannabis cultivation and processing facility. Vireo New York is responsible
for paying all structural repairs, maintenance expenses, insurance and taxes related to the Vireo NY Property. The lease term is
15 years, with two options to extend the term of the lease for two additional five-year periods. The lease also provides that we
will fund up to $1.0 million as reimbursement for future tenant improvements at the Vireo NY Property, none of which was funded
as of December 31, 2017. The initial base rent of the Vireo New York lease is $55,000 per month, subject to annual increases at
a rate of 3.5%. The initial annualized base rent is equal to 15% of the sum of the purchase price and the tenant improvement allowance
made available for the property (whether or not such tenant improvement allowance is drawn down by the tenant). We also receive
a property management fee under the lease equal to 1.5% of the then-current base rent throughout the term.
Vireo MN Property
On November 8, 2017, we completed the acquisition
of a 20,000 square foot industrial property located in Minnesota (the “Vireo MN Property”), which we purchased from
a subsidiary of Vireo Health, Inc. (“Vireo Minnesota”) for approximately $3.0 million (plus approximately $58,000 in
transaction costs) in a sale-leaseback transaction. Concurrent with the closing of the acquisition, we entered into a triple-net
lease with Vireo Minnesota, as tenant for use as a medical cannabis cultivation and processing facility. Vireo Minnesota is responsible
for paying all structural repairs, maintenance expenses, insurance and taxes related to the Vireo MN Property. The lease term is
15 years, with two options to extend the term of the lease for two additional five-year periods. The lease also provides that we
will fund up to $1.0 million as reimbursement for future tenant improvements at the Vireo MN Property, none of which was funded
as of December 31, 2017. The initial base rent of the Vireo Minnesota lease is $50,000 per month, subject to annual increases at
a rate of 3.5%. The initial annualized base rent is equal to 15% of the sum of the purchase price and the tenant improvement allowance
made available for the property (whether or not such tenant improvement allowance is drawn down by the tenant). We also receive
a property management fee under the lease equal to 1.5% of the then-current base rent throughout the term.
Pharm AZ Property
On December 15,
2017, we completed the acquisition of a property in Arizona (the "Pharm AZ Property") comprising approximately
358,000 square feet of greenhouse and industrial space, which we purchased from a subsidiary of The Pharm for $15.0 (plus
approximately $27,000 in transaction costs) million in a sale-leaseback transaction. Concurrent with the closing of the
acquisition, we entered into a triple-net lease with another subsidiary of The Pharm, as tenant for continued use as a
medical cannabis cultivation and processing facility. The Pharm subsidiary is responsible for paying all structural repairs,
maintenance expenses, insurance and taxes related to the Pharm AZ Property. The lease term is 15 years, with two options to
extend the term of the lease for two additional five-year periods. Under the lease, we are expected to reimburse The Pharm
subsidiary for up to $3.0 million in tenant improvements at the Pharm AZ Property, none of which was funded as of December
31, 2017.
The initial monthly
base rent under the lease is $210,000, which is equal to 14% on an annualized basis of the sum of the purchase price for the Pharm
AZ Property ($15.0 million) and the tenant improvement allowance ($3.0 million), and subject to annual increases of 3.25% during
the lease term. The base rent on $5.0 million of the purchase price ($58,333.33 per month) will be abated until March 31, 2018,
and the base rent attributable to the tenant improvement allowance ($35,000.00 per month) was abated until March 14, 2018. We also
receive a property management fee under the lease equal to 1.5% of the then-current base rent throughout the term.
Pipeline
Subsequent to
December 31, 2017, we executed agreements to purchase two properties for a total investment of $10.5 million. In
addition, we executed two non-binding letters of intent for two properties representing a total expected additional
investment by the Company of approximately $25 million to $30 million, with the final investment determined based on our
review and approval of future tenant improvements at each property.
As of March 28, 2018, we had identified and were in various stages
of reviewing approximately $100 million of additional potential properties for acquisition, which amount is estimated based on
sellers' asking prices for the properties, ongoing negotiations with sellers, our assessment of the values of such properties after
taking into account the current and expected lease revenue, operating history, age and condition of the property, and other relevant
factors. The transactions for which we have executed agreements are subject to our continuing diligence and customary closing conditions,
and we cannot provide assurances that we will complete the purchase of these properties or the other properties in our pipeline
on the terms described herein, or at all.
Our Competitive Strengths
We believe that we have the following competitive
strengths:
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Experienced and Committed Management Team.
Alan
Gold, our executive chairman, and other members of our senior management team have substantial experience in all aspects of the
real estate industry, including acquisitions, dispositions, construction, development, management, finance and capital markets.
In particular, in August 2004, Mr. Gold and Gary Kreitzer, vice chairman of our board of directors, founded BioMed Realty Trust,
Inc. (formerly NYSE: BMR), or BioMed Realty, an internally-managed REIT focused on acquiring, developing, owning, leasing and managing
laboratory and office space for the life science industry, an industry they believed to be underserved by commercial property investors
and lenders and poised for significant growth. Mr. Gold served as chairman of the board of directors and chief executive officer
and Mr. Kreitzer served as executive vice president and a member of the board of directors from the founding of BioMed Realty in
2004 through the acquisition of BioMed Realty by an affiliate of The Blackstone Group, L.P. in 2016.
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Recurring Revenue with Contractual Escalations.
As of December 31, 2017, we had acquired five properties that were 100% leased on long-term, triple-net leasing arrangements with licensed medical-use cannabis cultivators, and which are subject to contractual rental rate increases. Along with our existing portfolio, we expect to continue to enter into additional similar transactions structured to provide recurring revenue with contractual escalations.
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Focus on Underserved Industry with Less Competition.
Our focus on specialized industrial real estate assets leased to tenants in the regulated medical-use cannabis industry may result in significantly less competition from existing REITs and institutional buyers due to the unique nature of the real estate and its tenants. Moreover, we believe the banking industry's general reluctance to finance owners of medical-use cannabis facilities, coupled with the owners' need for capital to fund the growth of their operations, will continue to provide significant opportunities for us to acquire specialized industrial properties and execute long-term leases that are structured to generate stable and increasing rental revenue, along with the potential for long-term appreciation in value.
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Demonstrated Investment Acumen.
We utilize rigorous
underwriting standards for evaluating acquisitions and potential tenants to ensure that they meet our strategic and financial criteria.
Our extensive experience and relationships in the real estate and medical-use cannabis industry enable us to identify, negotiate
and close on acquisitions and leases with growers who have been among the top candidates in the rigorous state licensing process.
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Positive Medical-Use Cannabis Industry Trends.
Based
on the tremendous historical and projected growth for the medical-use cannabis industry, we expect to see significant spending
by state-licensed medical-use cannabis cultivators on their existing and new medical-use cannabis facilities, presenting an opportunity
for us to be a key capital provider in their expansion initiatives.
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Our Business Objectives and Growth Strategies
Our principal business objective is to maximize
stockholder returns through a combination of (1) distributions to our stockholders, (2) sustainable long-term growth in cash flows
from increased rents, which we hope to pass on to stockholders in the form of increased distributions, and (3) potential long-term
appreciation in the value of our properties from capital gains upon future sale. Our primary strategy to achieve our business objective
is to acquire and own a portfolio of specialized industrial properties, including medical-use cannabis facilities leased to tenants
holding the requisite state licenses to operate in the regulated medical-use cannabis industry. This strategy includes the following
components:
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Owning Specialized Industrial Properties and Related Real Estate
Assets for Income.
We primarily acquire medical-use cannabis facilities from licensed growers who will continue
their cultivation operations after our acquisition of the property. We expect to hold acquired properties for investment and to
generate stable and increasing rental income from leasing these properties to licensed growers.
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Owning Specialized Industrial Properties and Related Real Estate
Assets for Appreciation.
We primarily lease our acquired properties under long-term triple-net leases. However,
from time to time, we may elect to sell one or more properties if we believe it to be in the best interests of our stockholders.
Accordingly, we will seek to acquire properties that we believe also have potential for long-term appreciation in value.
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Expanding as Additional States Permit Medical-Use Cannabis Cultivation
and Production.
We acquire properties in the United States, with a focus on states that permit cannabis cultivation
for medical use. We expect that our acquisition opportunities will continue to expand as additional states legalize medical-use
cannabis and license new cultivators.
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Preserving
Financial Flexibility on our Balance Sheet.
We are focused on maintaining a conservative capital structure, in order to
provide us flexibility in financing our Company's growth initiatives.
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Our Target Markets
Our target markets include states that permit
cannabis cultivation for medical use. As of December 31, 2017, we owned five properties located in New York, Maryland, Arizona
and Minnesota. According to the National Conference of State Legislatures, as of December 31, 2017, 29 states and the District
of Columbia have legalized cannabis for medical use, representing a population of over 205 million people as of July 1, 2017, according
to the U.S. Census Bureau. An additional 17 states have approved of the use of "low THC, high cannabidiol (CBD)" products
for medical reasons in limited situations.
Although these states have approved the medical
use of cannabis, the applicable state and local laws and regulations vary widely. For example, most states' laws allow commercial
production and sales through dispensaries and set forth rigorous licensing requirements; in other states the licensing rules are
unclear. In some states, dispensaries are mandated to operate on a not-for-profit basis. Some states permit home cultivation activities.
The states also differ on the form in which cannabis can be sold. For example, some states do not permit cannabis-infused products
such as concentrates, edibles and topicals, while other states ban smoking cannabis.
In addition, we expect other factors will be
important in the development and growth of the medical-use cannabis industry in the United States, including the timeframes for
developing regulations and issuing licenses in states that recently passed laws allowing for medical-use cannabis, and continued
legislative authorization of medical-use cannabis at the state level. Progress in the regulated medical-use cannabis industry,
while encouraging, is not assured and any number of factors could slow or halt progress in this area.
Market Opportunity
The Industrial Real Estate Sub-Market
The industrial real estate sub-market continues
to perform well in this real estate cycle. According to JLL, the U.S. industrial property vacancy rate declined to 5.0% in the
fourth quarter of 2017, the lowest vacancy rate on record, and less than one-half of the vacancy rate of 10.2% recorded in the
first quarter of 2010. Nearly 82 million square feet of industrial real estate were absorbed in 2017, which resulted in most markets
reporting all-time-high asking rental rates, according to JLL.
We believe this supply/demand dynamic creates
significant opportunity for owners of industrial facilities, particularly those focused on niche categories, as options are limited
for tenants requiring specialized buildings. We intend to capitalize on this opportunity by purchasing specialized industrial real
estate assets that are critical to the medical-use cannabis industry.
The Regulated Medical-Use Cannabis Industry
Overview
We believe that a convergence of changing public
attitudes and increased legalization momentum in various states toward regulated medical-use cannabis creates an attractive opportunity
to invest in the industrial real estate sector with a focus on regulated medical-use cannabis facilities. We also believe that
the increased sophistication of the regulated medical-use cannabis industry and the development of strong business, operational
and compliance practices have made the sector more attractive for investment. Increasingly, state-licensed, medical-use cannabis
cultivation and processing facilities are becoming sophisticated business enterprises that use state-of-the-art technologies and
well-honed business and operational processes to maximize product yield and revenues. Additionally, medical-use cannabis growers
and dispensers have developed a growing portfolio of products into which they are able to incorporate legal medical-use cannabis
in a safe and appealing manner.
In the United States, the development and growth
of the regulated medical-use cannabis industry has generally been driven by state law and regulation, and accordingly, the market
varies on a state-by-state basis. State laws that legalize and regulate medical-use cannabis allow patients to consume cannabis
for medicinal reasons with a doctor's recommendation, subject to various requirements and limitations. States have authorized numerous
medical conditions as qualifying conditions for treatment with medical-use cannabis, which vary significantly from state to state
and may include, among others, treatment for cancer, glaucoma, HIV/AIDs, wasting syndrome, pain, nausea, seizures, muscle spasms,
multiple sclerosis, post-traumatic stress disorder (PTSD), migraines, arthritis, Parkinson's disease, Alzheimer's, lupus, residual
limb pain, spinal cord injuries, inflammatory bowel disease, autism spectrum disorders, sleep apnea and terminal illness. As of December 31, 2017, 29 states, plus the
District of Columbia, have passed laws allowing their citizens to use medical cannabis.
We believe that the following conditions, which
are described in more detail below, create an attractive opportunity to invest in industrial real estate assets that support the
regulated medical-use cannabis industry:
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significant industry growth in recent years and expected continued
growth;
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a shift in public opinion and increasing momentum toward the legalization
of medical-use cannabis under state law; and
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limited access to capital by industry participants in light of risk
perceived by financial institutions of violating federal laws and regulatory guidelines for offering banking services to cannabis-related
businesses.
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Industry Growth and Trends
According to Arcview Market Research ("Arcview"),
sales of legal cannabis in North America are projected to grow from $7.3 billion in 2016 to $24.5 billion in 2021, representing
a 28% compound annual growth rate.
According to the Marijuana Policy
Project, a non-profit organization focused on effecting cannabis policy reform, as of February 15, 2018, an estimated 2.5 million
people used or were registered to use legalized medical cannabis in the United States. As the industry continues to evolve, new
ways to consume medical-use cannabis are being developed in order for patients to have the treatment needed for their condition
in a safe and appealing manner. In addition to smoking and vaporizing of dried leaves, cannabis can be incorporated into a variety
of edibles, pills, spray products, transdermal patches and topicals, including salves, ointments, lotions and sprays with no psychoactive
effects.
As with any nascent but growing
industry, operational and business practices evolve and become more sophisticated over time. We believe that the quality and experience
of industry participants and the development of sound business, operational and compliance practices have strengthened significantly
over time, increasing the attractiveness for investment in the regulated medical-use cannabis industry.
Shifting Public Attitudes and State Law
and Legislative Activity
We believe that the growth of
the regulated medical-use cannabis industry has been fueled, in part, by the rapidly changing public attitudes in the United States.
A 2017 poll by Quinnipiac University found that 94% of Americans support patient access to medical-use cannabis, if recommended
by a doctor.
As of December 31, 2017, 29 states, plus the
District of Columbia, have passed laws allowing their citizens to use medical cannabis. The first state to permit the use of cannabis
for medicinal purposes was California in 1996, upon adoption of the Compassionate Care Act. The law allowed doctors to recommend
cannabis for serious medical conditions and patients were permitted to use, possess and grow cannabis themselves. Several other
states adopted medical-use cannabis laws in 1998 and 1999, and the remaining medical-use cannabis states adopted their laws on
various dates through 2017.
Following the approval of medical-use
cannabis, state programs must be developed and businesses must be licensed before commencing cannabis sales. Some states have
developed the necessary procedures and licensing requirements quickly, while other states have taken years to develop their
programs for production and sales of cannabis. Even where regulatory frameworks for medical-use cannabis production and sales
are in place, states tend to revise these rules over time. These revisions often impact sales, making it difficult to predict
the potential of new markets. States may restrict the number of medical-use cannabis businesses permitted, restrict the
method by which medical cannabis can be consumed, limit the medical conditions that are eligible for cannabis treatment or
require registration of doctors and/or patients, each of which can limit growth of the medical-use cannabis industry in those
states. Alternatively, states may relax their initial regulations relating to medical-use cannabis production and sales,
which would likely accelerate growth of the medical-use cannabis industry in such states.
The Federal Legal Landscape
Cannabis is classified as a Schedule I controlled
substance by the Drug Enforcement Agency ("DEA") and the U.S. Department of Justice ("DOJ") with no medical
use, and therefore it is illegal to grow, possess and consume cannabis under federal law. The Controlled Substances Act of 1910
("CSA") bans cannabis-related businesses; the possession, cultivation and production of cannabis-infused products; and
the distribution of cannabis and products derived from it. Moreover, on two separate occasions the U.S. Supreme Court ruled that
the CSA trumps state law. That means that the federal government has the option of enforcing U.S. drug laws, creating a climate
of legal uncertainty regarding the production and sale of medical-use cannabis.
Under the Obama administration, the DOJ previously
issued memoranda, including the so-called “Cole Memo” on August 29, 2013, providing internal guidance to federal prosecutors
concerning enforcement of federal cannabis prohibitions under the CSA. This guidance essentially characterized use of federal law
enforcement resources to prosecute those complying with state laws allowing the use, manufacture and distribution of cannabis as
an inefficient use of such federal resources when state laws and enforcement efforts are effective with respect to specific federal
enforcement priorities under the CSA.
On January 4, 2018, U.S. Attorney
General Jeff Sessions issued a written memorandum rescinding the Cole Memo and related internal guidance issued by the DOJ regarding
federal law enforcement priorities involving cannabis (the “Sessions Memo”). The Sessions Memo instructs federal prosecutors
that when determining which cannabis-related activities to prosecute under federal law with the DOJ’s finite resources, prosecutors
should follow the well-established principles set forth in the U.S. Attorneys’ Manual governing all federal prosecutions.
The Sessions Memo states that “these principles require federal prosecutors deciding which cases to prosecute to weigh all
relevant considerations, including federal law enforcement priorities set by the Attorney General, the seriousness of the crime,
the deterrent effect of criminal prosecution, and the cumulative impact of particular crimes on the community.” The Sessions
Memo went on to state that given the DOJ’s well-established general principles, “previous nationwide guidance specific
to marijuana is unnecessary and is rescinded, effective immediately.” It is unclear at this time what impact the Sessions
Memo will have on the medical-use cannabis industry.
In addition, pursuant to the
current omnibus spending bill previously approved by Congress, the DOJ is prohibited from using funds appropriated by Congress
to prevent states from implementing their medical-use cannabis laws. A similar provision was also included in each prior Congressional
omnibus spending bill since 2014. This provision, however, is currently set to expire on September 30, 2018, and there is no assurance
that Congress will approve inclusion of a similar prohibition on DOJ spending in the appropriations bill for 2019. Although we
are not engaged in the purchase, sale, growth, cultivation, harvesting, or processing of medical-use cannabis products, we lease
our properties to tenants who engage in such activities, and therefore strict enforcement of federal prohibitions regarding cannabis
could irreparably harm our business, subject us to criminal prosecution and/or adversely affect the trading price of our securities.
See “Risk Factors – Risks Relating to Regulation.”
Cannabis reform has gained the support of
a bipartisan coalition of members of Congress, some of whom have introduced legislation on various reform-related topics. If passed,
this legislation would address certain conflicts existing between state and federal law. However, there is no assurance that any
of these proposals will be approved.
Access to Capital
To date, the status of medical-use cannabis
under federal law has significantly limited the ability of state-licensed industry participants to fully access the U.S. banking
system and traditional financing sources. These limitations, when combined with the high costs of maintaining licensed and stringently
regulated medical-use cannabis facilities (including meeting extensive zoning requirements), substantially increase the cost of
production. While future changes in federal and state laws may ultimately open up financing options that have not been available
to date in this industry, we believe that such changes, if they do occur, will take time, thereby creating an opportunity over
the next few years to provide our sale-leaseback and other real estate solutions to state-licensed industry participants that have
limited access to traditional financing sources.
It is also unclear what impact the recent rescission
of the “Cole Memo” will have, but federal prosecutors may increase enforcement activities against institutions or individuals
that are conducting financial transactions related to cannabis activities. The increased uncertainty surrounding financial transactions
related to cannabis activities may also result in financial institutions discontinuing services to the cannabis industry.
Market Opportunity and Associated Risks
We focus on purchasing specialized industrial
real estate assets for the regulated medical-use cannabis industry, with emphasis on properties that we believe also have potential
for long-term appreciation in value. We believe that our sale-leaseback and other real estate solutions offer an attractive alternative
to state-licensed medical-cannabis cultivators who have limited access to traditional financing alternatives. We have acquired
and intend to continue to acquire medical-use cannabis facilities in states that permit medical-use cannabis cultivation.
Notwithstanding the foregoing market opportunity and trends, and
despite legalization at the state level, we continue to believe that the current state of federal law creates significant uncertainty
and potential risks associated with investing in medical-use cannabis facilities, including but not limited to potentially heightened
risks related to the use of such facilities for adult-use cannabis operations, if a state passes such laws. For a more complete
description of these risks, see the sections "Risks Related to Regulation" and "Business — Governmental
Regulation" under Item 1A, "Risk Factors."
Tenant Concentration
As of December 31, 2017, all
of our revenues were derived from five tenants. Our tenant, PharmaCann, comprised approximately 82% and 100% of rental revenues
for the year ended December 31, 2017 and the period from June 15, 2016 (date of incorporation) through December 31, 2016, respectively.
In addition, our tenant Holistic comprised approximately 14% of rental revenues for the year ended December 31, 2017. Each of
our tenants is a start-up business with a limited history of operations, and has not yet been profitable. For some or all of 2018,
we expect our tenants will continue to incur losses as their expenses increase in connection with the expansion of their operations,
and that they have made and will continue to make rent payments to us from proceeds from the sale of the applicable property or
cash on hand, and not funds from operations. Furthermore, while each tenant's current state license is for medical-use cannabis
operations only and adult-use cannabis is not permitted under current laws in the states of New York, Maryland, Arizona and Minnesota,
our lease with each tenant does not prohibit adult-use cannabis operations at the applicable property, provided such operations
are in compliance with applicable state and local laws. As such, one or more these states may in the future permit adult-use cannabis
operations, and our tenant may conduct adult-use cannabis operations at the property it leases from us, which in turn could expose
that tenant, us and our property to different and greater risks, including heightened risks of enforcement of federal laws. See
each of the discussions under Item 1A, "Risk Factors," under the captions "Our existing tenants are, and we expect
that most of our future tenants will be, start-up businesses and may be unable to pay rent with funds from operations or at all,
which could adversely affect our cash available to make distributions to our stockholders or otherwise impair the value of our
common stock," and "Our current real estate portfolio consists of only five properties and will likely be concentrated
in a limited number of properties in the future, which subjects us to an increased risk of significant loss if any property declines
in value or if we are unable to lease a property."
Geographic Concentration
As of December 31, 2017, all of our revenues
were derived from our five properties located in New York, Maryland, Arizona and Minnesota. See each of the discussions under Item
1A, "Risk Factors," under the caption "Our properties are, and are expected to continue to be, geographically concentrated
in states that permit medical-use cannabis cultivation, and we will be subject to social, political and economic risks of doing
business in these states and any other state in which we may own property." The medical-use cannabis market is in its very
early stages, and is subject to strict regulations providing for, among other things, limited medical conditions for treatment
with medical-use cannabis, limitations on the form in which medical cannabis can be consumed and enhanced registration requirements
for patients and physicians, which may result in the market not growing and developing in the way that we or our tenants projected.
Our Financing Strategy
We intend to meet our long-term liquidity needs
through cash flow from operations and the issuance of equity and debt securities, including common stock, preferred stock and long-term
notes. Where possible, we also may issue limited partnership interests in our Operating Partnership to acquire properties from
existing owners seeking a tax-deferred transaction. We expect to issue equity and debt securities at times when we believe that
our stock price is at a level that allows for the reinvestment of offering proceeds in accretive property acquisitions. We may
also issue common stock to permanently finance properties that were previously financed by debt securities. However, we cannot
assure you that we will have access to the capital markets at times and on terms that are acceptable to us. Our ability to access
the capital markets and to obtain other financing arrangements is also significantly limited by our Company’s focus on serving
the medical-use cannabis industry. Our investment guidelines initially provide that our aggregate borrowings (secured and unsecured)
will not exceed 50% of the cost of our tangible assets at the time of any new borrowing, subject to our board of directors' discretion.
On December 1, 2017, we filed a shelf registration
statement, which was subsequently declared effective by the SEC, which may permit us, from time to time, to offer and sell common
stock, preferred stock, warrants and other securities to the extent necessary or advisable to meet our liquidity needs.
Risk Management
As of December 31, 2017, we owned five properties
located in New York, Maryland, Arizona and Minnesota. We will continue to attempt to diversify the investment size and location
of our portfolio of properties in order to manage our portfolio-level risk. Over the long term, we intend that no single property
will exceed 25% of our total assets and that no single tenant will exceed 30% of our total assets.
We expect that single tenants will continue
to occupy our properties pursuant to triple-net lease arrangements in general and, therefore, the success of our investments will
be materially dependent on the financial stability of these tenants. Our existing tenants are, and we expect that most of our tenants
will be in the future, start-up businesses that have little or no revenue and, at least initially, will make rent payments to us
from the sale proceeds of a sale-leaseback transaction with us or cash on hand. We also expect the success of our tenants, and
their ability to make rent payments to us, to significantly depend on the projected growth and development of the applicable state
market; as many of these state markets have a very limited history, and other state markets are still forming their regulations,
issuing licenses and otherwise establishing the market framework, significant uncertainty exists as to whether these markets will
develop in the way that we or our tenants project.
We evaluate the credit quality of our tenants
and any guarantors on an ongoing basis by reviewing, where available, the publicly filed financial reports, press releases and
other publicly available industry information regarding our tenants and any guarantors. In addition, we monitor the payment history
data for all of our tenants and, in some instances, we monitor our tenants by periodically conducting site visits and meeting with
the tenants to discuss their operations. In many instances, we will generally not be entitled to financial results or other credit-related
data from our tenants. See the section "Risks Related to Our Business" under Item 1A, "Risk Factors."
Competition
The current market for properties that meet
our investment objectives is limited. In addition, we believe finding properties that are appropriate for the specific use of allowing
medical-use cannabis growers may be limited as more competitors enter the market, and as medical-use cannabis growers obtain greater
access to alternative financing sources, including but not limited to equity and debt financing sources. We face significant competition
from a diverse mix of market participants, including but not limited to, other companies with similar business models, independent
investors, hedge funds and other real estate investors, hard money lenders, and cannabis operators themselves, all of whom may
compete with us in our efforts to acquire real estate zoned for medical-use cannabis facilities. In some instances, we will be
competing to acquire real estate with persons who have no interest in the cannabis industry, but have identified value in a piece
of real estate that we may be interested in acquiring.
These competitors may prevent us from
acquiring desirable properties or may cause an increase in the price we must pay for properties. Our competitors may have
greater financial and operational resources than we do and may be willing to pay more for certain assets or may be willing to
accept more risk than we believe can be prudently managed. In particular, larger companies may enjoy significant competitive
advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. Our competitors
may also adopt transaction structures similar to ours, which would decrease our competitive advantage in offering flexible
transaction terms. In addition, due to a number of factors, including but not limited to potential greater clarity of the
laws and regulations governing medical-use cannabis by state and federal governments, the number of entities and the amount
of funds competing for suitable investment properties may increase substantially, resulting in increased demand and increased prices paid
for these properties. If we pay higher prices for properties, our profitability may decrease, and you may experience a lower
return on our common stock. Increased competition for properties may also preclude us from acquiring those properties that
would generate attractive returns to us.
Governmental Regulation
Agricultural Regulation
The medical-use cannabis properties that we
acquire are used primarily for cultivation and production of medical-use cannabis and are subject to the laws, ordinances and regulations
of state, local and federal governments, including laws, ordinances and regulations involving land use and usage, water rights,
treatment methods, disturbance, the environment, and eminent domain.
Each governmental jurisdiction has its own
distinct laws, ordinances and regulations governing the use of agricultural lands. Many such laws, ordinances and regulations seek
to regulate water usage and water runoff because water can be in limited supply, as is the case in certain locations where our
properties are located. In addition, runoff from rain or from irrigation is governed by laws, ordinances and regulations from state,
local and federal governments. Additionally, if any of the water used on or running off from our properties flows to any rivers,
streams, ponds, the ocean or other waters, there may be specific laws, ordinances and regulations governing the amount of pollutants,
including sediments, nutrients and pesticides, that such water may contain.
We believe that our existing properties have,
and other properties that we acquire in the future will have, sources of water, including wells and/or surface water that provide
sufficient amounts of water necessary for the current operations at each location. However, should the need arise for additional
water from wells and/or surface water sources, we may be required to obtain additional permits or approvals or to make other required
notices prior to developing or using such water sources. Permits for drilling water wells or withdrawing surface water may be required
by federal, state and local governmental entities pursuant to laws, ordinances, regulations or other requirements, and such permits
may be difficult to obtain due to drought, the limited supply of available water within the districts of the states in which our
properties are located or other reasons.
In addition to the regulation of water usage
and water runoff, state, local and federal governments also seek to regulate the type, quantity and method of use of chemicals
and materials for growing crops, including fertilizers, pesticides and nutrient rich materials. Such regulations could include
restricting or preventing the use of such chemicals and materials near residential housing or near water sources. Further, some
regulations have strictly forbidden or significantly limited the use of certain chemicals and materials. Licenses, permits and
approvals must be obtained from governmental authorities requiring such licenses, permits and approvals before chemicals and materials
can be used at grow facilities. Reports on the usage of such chemicals and materials must be submitted pursuant to applicable laws,
ordinances, and regulations and the terms of the specific licenses, permits and approvals. Failure to comply with laws, ordinances
and regulations, to obtain required licenses, permits and approvals or to comply with the terms of such licenses, permits and approvals
could result in fines, penalties and/or imprisonment.
The use of land for agricultural purposes in
certain jurisdictions is also subject to regulations governing the protection of endangered species. When agricultural lands border,
or are in close proximity to, national parks, protected natural habitats or wetlands, the agricultural operations on such properties
must comply with laws, ordinances and regulations related to the use of chemicals and materials and avoid disturbance of habitats,
wetlands or other protected areas.
Because properties we own may be used for growing
medical-use cannabis, there may be other additional land use and zoning regulations at the state or local level that affect our
properties that may not apply to other types of agricultural uses. For example, certain states in which our properties are located
require stringent security systems in place at grow facilities, and require stringent procedures for disposal of waste materials.
As an owner of agricultural lands, we may be
liable or responsible for the actions or inactions of our tenants with respect to these laws, regulations and ordinances.
Environmental Matters
Our properties and the operations thereon are subject to federal,
state and local environmental laws, ordinances and regulations, including laws relating to water, air, solid wastes and hazardous
substances. Our properties and the operations thereon are also subject to federal, state and local laws, ordinances, regulations
and requirements related to the federal Occupational Safety and Health Act, as well as comparable state statutes relating to the
health and safety of our employees and others working on our properties. Although we believe that we and our tenants are in material
compliance with these requirements, there can be no assurance that we will not incur significant costs, civil and criminal penalties
and liabilities, including those relating to claims for damages to persons, property or the environment resulting from operations
at our properties.
Real Estate Industry Regulation
Generally, the ownership and operation of real
properties are subject to various laws, ordinances and regulations, including regulations relating to zoning, land use, water rights,
wastewater, storm water runoff and lien sale rights and procedures. These laws, ordinances or regulations, such as the Comprehensive
Environmental Response and Compensation Liability Act and its state analogs, or any changes to any such laws, ordinances or regulations,
could result in or increase the potential liability for environmental conditions or circumstances existing, or created by tenants
or others, on our properties. Laws related to upkeep, safety and taxation requirements may result in significant unanticipated
expenditures, loss of our properties or other impairments to operations, any of which would adversely affect our cash flows from
operating activities.
Our property management activities, to the
extent we are required to engage in them due to lease defaults by tenants or vacancies on certain properties, will likely be subject
to state real estate brokerage laws and regulations as determined by the particular real estate commission for each state.
State Laws Applicable to the Medical-Use Cannabis Industry
In most states that have legalized medical-use
cannabis in some form, the growing and/or dispensing of cannabis generally requires that the operator obtain one or more licenses
in accordance with applicable state requirements. In addition, many states regulate various aspects of the growing and/or dispensing
of medical-use cannabis. For example, New York limits the types of treatable medical conditions, requires registration of both
patients and recommending physicians, limits the types of strains that can be grown, sets prices through the State Program Commissioner,
requires that a registered pharmacist be on the premises of all dispensaries during hours of operation, and prohibits cannabis
in flower form. Local governments in some cases also impose rules and regulations on the manner of operating cannabis businesses.
As a result, applicable state and local laws and regulations vary widely. As a result of licensing requirements, if our tenants
default under their leases, we may not be able to find new tenants that have the requisite license to engage in the cultivation
of medical cannabis on the properties.
Federal Laws Applicable to the Medical-Use Cannabis Industry
Cannabis is a Schedule I controlled substance
under the CSA. Even in those jurisdictions in which the manufacture and use of medical cannabis has been legalized at the state
level, the possession, use, cultivation, and transfer of cannabis remains a violation of federal law. Federal law criminalizing
the use of cannabis preempts state laws that legalize its use for medicinal or adult-retail purposes, and therefore strict enforcement
of federal law regarding cannabis would likely result in our inability to execute our business plan.
Under the Obama administration, the DOJ previously
issued memoranda, including the so-called “Cole Memo” on August 29, 2013, providing internal guidance to federal prosecutors
concerning enforcement of federal cannabis prohibitions under the CSA. This guidance essentially characterized use of federal law
enforcement resources to prosecute those complying with state laws allowing the use, manufacture and distribution of cannabis as
an inefficient use of such federal resources when state laws and enforcement efforts are effective with respect to specific federal
enforcement priorities under the CSA.
On January 4, 2018, U.S. Attorney
General Jeff Sessions issued a written memorandum rescinding the Cole Memo and related internal guidance issued by the DOJ regarding
federal law enforcement priorities involving cannabis (the “Sessions Memo”). The Sessions Memo instructs federal prosecutors
that when determining which cannabis-related activities to prosecute under federal law with the DOJ’s finite resources, prosecutors
should follow the well-established principles set forth in the U.S. Attorneys’ Manual governing all federal prosecutions.
The Sessions Memo states that “these principles require federal prosecutors deciding which cases to prosecute to weigh all
relevant considerations, including federal law enforcement priorities set by the Attorney General, the seriousness of the crime,
the deterrent effect of criminal prosecution, and the cumulative impact of particular crimes on the community.” The Sessions
Memo went on to state that given the DOJ’s well-established general principles, “previous nationwide guidance specific
to marijuana is unnecessary and is rescinded, effective immediately.” It is unclear at this time what impact the Sessions
Memo will have on the medical-use cannabis industry.
In addition, pursuant to the
current omnibus spending bill previously approved by Congress, the DOJ is prohibited from using funds appropriated by Congress
to prevent states from implementing their medical-use cannabis laws. A similar provision was also included in each prior Congressional
omnibus spending bill since 2014. This provision, however, is currently set to expire on September 30, 2018, and there is no assurance
that Congress will approve inclusion of a similar prohibition on DOJ spending in the appropriations bill for 2019. In
USA
vs. McIntosh
, the United States Circuit Court of Appeals for the Ninth Circuit held that this provision prohibits the U.S.
Department of Justice from spending funds from relevant appropriations acts to prosecute individuals who engage in conduct permitted
by state medical-use cannabis laws and who strictly comply with such laws. However, the Ninth Circuit's opinion, which only applies
in the states of Alaska, Arizona, California, Hawaii and Idaho, also held that persons who do not strictly comply with all state
laws and regulations regarding the distribution, possession and cultivation of medical-use cannabis have engaged in conduct that
is unauthorized, and in such instances the U.S. Department of Justice may prosecute those individuals.
Furthermore, while we target the acquisition
of medical-use cannabis facilities, our leases do not prohibit cannabis cultivation for adult-use that is permissible under the
state and local laws where our facilities are located. Consequently, certain of our tenants may subsequently cultivate adult-use
cannabis in our medical-use cannabis facilities, if permitted by such state and local laws now or in the future, which may in turn
subject the tenant, us and our properties to greater and/or different federal legal and other risks than exclusively medical-use
cannabis facilities, including not providing protection under the above Congressional spending provision.
Federal prosecutors have significant discretion
and no assurance can be given that the federal prosecutor in each judicial district where we purchase a property will not choose
to strictly enforce the federal laws governing cannabis production or distribution. Any change in the federal government's enforcement
posture with respect to state-licensed cultivation of medical-use cannabis, including the enforcement postures of individual federal
prosecutors in judicial districts where we purchase properties, would result in our inability to execute our business plan, and
we would likely suffer significant losses with respect to our investment in medical-use cannabis facilities in the United States,
which would adversely affect the trading price of our securities. Furthermore, following any such change in the federal government's
enforcement position, we could be subject to criminal prosecution, which could lead to imprisonment and/or the imposition of penalties,
fines, or forfeiture. See “Risk Factors – Risks Relating to Regulation.”
Laws Applicable to Banking for Medical-Use Cannabis Industry
All banks are subject to federal law, whether
the bank is a national bank or state-chartered bank. At a minimum, all banks maintain federal deposit insurance which requires
adherence to federal law. Violation of federal law could subject a bank to loss of its charter. Financial transactions involving
proceeds generated by cannabis-related conduct can form the basis for prosecution under the federal money laundering statutes,
unlicensed money transmitter statutes and the Bank Secrecy Act. For example, under the Bank Secrecy Act, banks must report to the
federal government any suspected illegal activity, which would include any transaction associated with a cannabis-related business.
These reports must be filed even though the business is operating in compliance with applicable state and local laws. Therefore,
financial institutions that conduct transactions with money generated by cannabis-related conduct could face criminal liability
under the Bank Secrecy Act for, among other things, failing to identify or report financial transactions that involve the proceeds
of cannabis-related violations of the CSA.
The Financial Crimes Enforcement Network ("FinCen")
issued guidance in February 2014 which clarifies how financial institutions can provide services to cannabis-related businesses
consistent with their obligations under the Bank Secrecy Act. Concurrently with the FinCen guidance, the U.S. Department of Justice
issued supplemental guidance directing federal prosecutors to consider the federal enforcement priorities enumerated in the Cole
Memo with respect to federal money laundering, unlicensed money transmitter and Bank Secrecy Act offenses based on cannabis-related
violations of the CSA. The FinCen guidance sets forth extensive requirements for financial institutions to meet if they want to
offer bank accounts to cannabis-related businesses, including close monitoring of businesses to determine that they meet all of
the requirements established by the U.S. Department of Justice, including those enumerated in the Cole Memo. This is a level of
scrutiny that is far beyond what is expected of any normal banking relationship.
As a result, many banks are hesitant to offer
any banking services to cannabis-related businesses, including opening bank accounts. While we currently have a bank account, our
inability to maintain that account or the lack of access to bank accounts or other banking services in the future, would make it
difficult for us to operate our business, increase our operating costs, and pose additional operational, logistical and security
challenges. Similarly, if our proposed tenants are unable to access banking services, they will not be able to enter into triple-net
leasing arrangements with us, as our leases will require rent payments to be made by check or wire transfer.
Furthermore, it is unclear what impact the
recent rescission of the “Cole Memo” will have, but federal prosecutors may increase enforcement activities against
institutions or individuals that are conducting financial transactions related to cannabis activities. The increased uncertainty
surrounding financial transactions related to cannabis activities may also result in financial institutions discontinuing services
to the cannabis industry. See “Risk Factors – Risks Relating to Regulation.”
Seasonality
Our business has not been, and we do not expect
it to become subject to, material seasonal fluctuations.
Available Information
The Company makes available to the public free
of charge through its internet website the Company’s Definitive Proxy Statement, Annual Report on Form 10-K, Quarterly Reports
on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange as soon as reasonably practicable after the Company electronically files such reports with, or furnishes
such reports to, the SEC. The Company’s internet website address is www.innovativeindustrialproperties.com. You can also
access on our website our Code of Business Conduct and Ethics, Corporate Governance Guidelines, Audit Committee Charter, Compensation
Committee Charter, and Nominating and Corporate Governance Committee Charter.
The public may read and copy any materials
that the Company files with the SEC at the SEC’s Public Reference Room located at 100 F Street, NE, Washington, DC 20549.
The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also
maintains electronic versions of the Company’s reports on its website at www.sec.gov.
ITEM IA.
RISK FACTORS
Risks Related to Our Business
We have a very limited operating history, and
may not be able to operate our business successfully or generate sufficient cash flow to sustain distributions to our
stockholders.
We completed our initial public offering
and commenced real estate operations with the acquisition of our first property in December 2016, and have a very limited
operating history. We owned only five properties as of December 31, 2017. We are subject to many of the business risks and
uncertainties associated with any new business enterprise. We cannot assure you that we will be able to operate our business
successfully or profitably or find additional suitable investments. Our ability to provide attractive risk-adjusted returns
to our stockholders over the long term is dependent on our ability both to generate sufficient cash flow to pay an attractive
dividend and to achieve capital appreciation, and we cannot assure you we will do either. There can be no assurance that we
will be able to continue to generate sufficient revenue from operations to pay our operating expenses and make distributions
to stockholders. The results of our operations and the implementation of our business plan depend on several factors,
including the availability of additional opportunities for investment, the performance of our existing properties and
tenants, the availability of adequate equity and debt financing, the federal and state regulatory environment relating to the
medical-use cannabis industry, conditions in the financial markets and economic conditions.
Our current real estate portfolio consists of only five
properties and will likely be concentrated in a limited number of properties in the future, which subjects us to an increased risk
of significant loss if any property declines in value or if we are unable to lease a property.
We currently own only five properties. Two
of our tenants, PharmaCann (at one of our New York properties) and Holistic (at our Maryland property), represented approximately
82% and 14%, respectively, of our rental revenues for the year ended December 31, 2017. Lease payment defaults by any of our tenants
or a significant decline in the value of any single property would materially adversely affect our business, financial position
and results of operations, including our ability to make distributions to our stockholders. Our lack of diversification also increases
the potential that a single underperforming investment could have a material adverse effect on our cash flows and the price we
could realize from the sale of our properties. Any adverse change in the financial condition of any of our tenants, including but
not limited to the state medical-use cannabis markets not developing and growing in ways that we or our tenants projected, or any
adverse change in the political climate regarding medical-use cannabis where our properties are located, would subject us to a significant
risk of loss.
In addition, failure by any our tenants to
comply with the terms of its lease agreement with us could require us to find another lessee for the applicable property. We may
experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-leasing
that property. Furthermore, we cannot assure you that we will be able to re-lease that property for the rent we currently receive,
or at all, or that a lease termination would not result in our having to sell the property at a loss. The result of any of the
foregoing risks could materially and adversely affect our business, financial condition and results of operations and our ability
to make distributions to our stockholders.
Competition for the acquisition of properties suitable for
the cultivation and production of medical-use cannabis may impede our ability to make acquisitions or increase the cost of these
acquisitions, which could adversely affect our operating results and financial condition.
We compete for the acquisition of properties
suitable for the cultivation and production of medical-use cannabis with other entities engaged in agricultural and real estate
investment activities, including corporate agriculture companies, cultivators and producers of medical-use cannabis, private equity
investors, and other real estate investors (including public and private REITs). We also compete as a provider of capital to medical-use
cannabis operators with alternative financing sources to these companies, including both equity and debt financing alternatives.
These competitors may prevent us from acquiring desirable properties, may cause an increase in the price we must pay for properties
or may result in us having to lease our properties on less favorable terms than we expect. Our competitors may have greater financial
and operational resources than we do and may be willing to pay more for certain assets or may be willing to accept more risk than
we believe can be prudently managed. In particular, larger companies may enjoy significant competitive advantages that result from,
among other things, a lower cost of capital and enhanced operating efficiencies. Our competitors may also adopt transaction structures
similar to ours, which would decrease our competitive advantage in offering flexible transaction terms. In addition, due to a number
of factors, including but not limited to potential greater clarity of the laws and regulations governing medical-use cannabis by
state and federal governments, the number of entities and the amount of funds competing for suitable investment properties may
increase, resulting in increased demand and increased prices paid for these properties. If we pay higher prices for properties
or enter into leases for such properties on less favorable terms than we expect, our profitability and ability to generate cash
flow and make distributions to our stockholders may decrease. Increased competition for properties may also preclude us from acquiring
those properties that would generate attractive returns to us.
Our growth will depend upon future acquisitions of medical-use
cannabis facilities, and we may be unable to consummate acquisitions on advantageous terms.
Our growth strategy is focused on the acquisition
of specialized industrial real estate assets on favorable terms as opportunities arise. Our ability to acquire these real estate
assets on favorable terms is subject to the following risks:
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competition from other potential acquirers or increased availability
of alternative debt and equity financing sources for tenants may significantly increase the purchase price of a desired property;
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we may not successfully purchase and lease our properties to meet
our expectations;
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we may be unable to obtain the necessary equity or debt financing
to consummate an acquisition on satisfactory terms or at all;
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agreements for the acquisition of properties are typically subject
to closing conditions, including satisfactory completion of due diligence investigations, and we may spend significant time and
money and divert management attention on potential acquisitions that we do not consummate; and
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we may acquire properties without any recourse, or with only limited
recourse, for liabilities, whether known or unknown, against the former owners of the properties.
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Our failure to consummate acquisition on advantageous
terms without substantial expense or delay would impede our growth and negatively affect our results of operations and our ability
to generate cash flow and make distributions to our stockholders.
There may only be a limited number of medical-use cannabis
facilities operated by suitable tenants available for us to acquire, which could adversely affect the return on our common stock.
We target medical-use cannabis facilities
for acquisition and leasing to licensed growers under triple-net lease agreements. We also target properties owned by growers
that have been among the top candidates in the rigorous state licensing process and have been granted one or more licenses to
operate multiple facilities. In light of the current regulatory landscape regarding medical-use cannabis, including but not
limited to, the rigorous state licensing processes, limits on the number of licenses granted in certain states and in
counties within such states, zoning regulations related to medical-use cannabis facilities, the inability of potential
tenants to open bank accounts necessary to pay rent and other expenses and the ever-changing federal and state regulatory
landscape, we may have only a limited number of medical-use cannabis facilities available to purchase that are operated by
licensees that we believe would be suitable tenants. These tenants may also have increased access to alternative equity and
debt financing sources over time, which may limit our ability to negotiate leasing arrangements that meet our investment criteria. Our
inability to locate suitable investment properties and tenants would have a material adverse effect on our ability to
generate cash flow and make distributions to our stockholders.
Our existing tenants are, and we expect that most of our
future tenants will be, start-up businesses and may be unable to pay rent with funds from operations or at all, which could adversely
affect our cash available to make distributions to our stockholders or otherwise impair the value of our common stock.
Single tenants currently occupy our properties,
and we expect that single tenants will occupy our properties that we acquire in the future. Therefore, the success of our investments
will be materially dependent on the financial stability of these tenants. We rely on our management team to perform due diligence
investigations of our potential tenants, related guarantors and their properties, operations and prospects, of which there is generally
little or no publicly available operating and financial information. We may not learn all of the material information we need to
know regarding these businesses through our investigations. As a result it is possible that we could enter into a sale-leaseback
arrangement with tenants or otherwise lease properties to tenants that ultimately are unable to pay rent to us, which could adversely
impact our cash available for distributions.
Our existing tenants are, and
we expect that most of our future tenants will be, start-up businesses that have little or no revenue when they enter triple-net
leasing arrangements with us and therefore, may be unable to pay rent with funds from operations. Each of our current tenants is
not profitable and has experienced losses since inception. As a result, our current tenants have made, and we expect that most
our future tenants will make, initial rent payments to us from proceeds from the sale of the property, in the case of sale-leaseback
transactions, or other cash on hand.
In addition, in general, as start-up
businesses, our tenants are more vulnerable to adverse conditions resulting from federal and state regulations affecting their
businesses or industries and have limited access to traditional forms of financing. The success of our tenants will heavily depend
on the growth and development of the state markets in which the tenants operate, many of which have a very limited history or are
still in the stages of establishing the regulatory framework. For example, New York’s medical-use cannabis market is in its
early stages, and is subject to strict regulations providing for, among other things, limited medical conditions for treatment
with medical-use cannabis, limitations on the form in which medical cannabis can be consumed and enhanced registration requirements
for patients and physicians, which may result in the New York market not growing and developing in the way that we or our tenants
projected. In Maryland, the medical-use cannabis market is also in its very early stages, with commercial operations commencing
upon the issuance of the first round of final licenses in late 2017, after significant delays in the development of the state's
regulatory framework and litigation surrounding the application process.
In our evaluation of our existing leases with
tenants at our properties, we determined to record associated revenue on a cash basis due to the uncertainty of collectability
of lease payments from tenants due to their lack of operating history and the federal regulatory uncertainty surrounding the medical-use
cannabis industry (see the section entitled "Critical Accounting Policies — Revenue Recognition and Accounts Receivable"
in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for more information).
Some of our tenants may also be subject to
significant debt obligations. Tenants that are subject to significant debt obligations may be unable to make their rent payments
if there are adverse changes in their business plans or prospects, the regulatory environment in which they operate or in general
economic conditions. In addition, the payment of rent and debt service may reduce the working capital available to tenants for
the start-up phase of their business. Furthermore, we may be unable to monitor and evaluate tenant credit quality on an on-going
basis.
In addition, many states issue licenses for
medical-use cannabis operations for a limited time period, which must be renewed periodically. If one or more of our tenants is
unable to renew or otherwise maintain its license, or if it is unable to renew or otherwise maintain other requisite authorizations
on state and local levels for business operations, that tenant will not be able to operate its business, and may default on its
lease payments to us.
Any lease payment defaults by a tenant could
adversely affect our cash flows and cause us to reduce the amount of distributions to stockholders. In the event of a default by
a tenant, we may also experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment
and re-leasing our property as operators of medical-use cannabis cultivation and production facilities are generally subject to
extensive state licensing requirements. Furthermore, we will not operate any of the facilities that we purchase.
We acquired our properties, and may acquire other properties,
"as-is," which increases the risk of an investment that requires us to remedy defects or costs without recourse to the
prior owner.
We acquired our properties, and may acquire
other real estate properties, "as is" with only limited representations and warranties from the property seller regarding
matters affecting the condition, use and ownership of the property. There may also be environmental conditions associated with
properties we acquire of which we are unaware despite our diligence efforts. In particular, medical-use cannabis facilities may
present environmental concerns of which we are not currently aware. If environmental contamination exists on properties we acquire
or develops after acquisition, we could become subject to liability for the contamination. As a result, if defects in the property
(including any building on the property) or other matters adversely affecting the property are discovered, including but not limited
to environmental matters, we may not be able to pursue a claim for any or all damages against the property seller. Such a situation
could harm our business, financial condition, liquidity and results of operations.
Our properties are, and are expected to continue to be,
geographically concentrated in states that permit medical-use cannabis cultivation, and we will be subject to social, political
and economic risks of doing business in these states and any other state in which we may own property.
Our current properties are located in New York,
Maryland, Arizona and Minnesota, and we expect that the properties that we acquire will be geographically concentrated in these
states and other states that permit medical-use cannabis cultivation. Circumstances and developments related to operations in these
markets that could negatively affect our business, financial condition, liquidity and results of operations include, but are not
limited to, the following factors:
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the responsibility of complying with multiple and, in some respects,
conflicting state and federal laws in the United States, including with respect to cultivation and distribution of medical-use
cannabis, licensing, banking and insurance;
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difficulties and costs of staffing and managing operations;
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unexpected changes in regulatory requirements and other laws;
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potentially adverse tax consequences;
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the state medical-use cannabis market fails to develop and grow in
ways that we or our tenants projected;
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the impact of national, regional or state specific business cycles
and economic instability; and
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access to capital may be more restricted, or unavailable on favorable
terms or at all in certain locations.
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Because our real estate investments consist of primarily
industrial properties suitable for cultivation and production of medical-use cannabis, our rental revenues are significantly influenced
by demand for these facilities generally, and a decrease in such demand would likely have a greater adverse effect on our rental
revenues than if we owned a more diversified real estate portfolio.
Because our portfolio of properties consists
of industrial properties used in the regulated medical-use cannabis industry, we are subject to risks inherent in investments in
a single industry. A decrease in the demand for medical-use cannabis cultivation facilities would have a greater adverse effect
on our rental revenues than if we owned a more diversified real estate portfolio. Demand for medical-use cannabis cultivation facilities
has been and could be adversely affected by changes in current favorable state or local laws relating to cultivation and production
of medical-use cannabis or any change in the federal government's current enforcement posture with respect to state-licensed cultivation
of medical-use cannabis, among others. To the extent that any of these conditions occur, they are likely to affect demand and market
rents for medical-use cannabis cultivation facilities, which could cause a decrease in our rental revenue. Any such decrease could
impair our ability to make distributions to you. We do not currently and do not expect in the future to invest in other real estate
or businesses to hedge against the risk that industry trends might decrease the profitability of our medical-use cannabis cultivation
facilities.
If our properties' access to adequate water and power supplies
is interrupted, it could harm our ability to lease the properties for medical-use cannabis cultivation and production, thereby
adversely affecting our ability to generate returns on our properties.
In order to lease the properties that we acquire,
these properties require access to sufficient water and power to make them suitable for the cultivation and production of medical-use
cannabis. Although we expect to acquire properties with sufficient access to water, should the need arise for additional
wells from which to obtain water, we would be required to obtain permits prior to drilling such wells. Permits for drilling water
wells are required by state and county regulations, and such permits may be difficult to obtain due to the limited supply of water
in areas where we acquire properties. Similarly, our properties may be subject to governmental regulations relating to the quality
and disposition of rainwater runoff or other water to be used for irrigation. In such case, we could incur costs necessary in order
to retain this water. If we are unable to obtain or maintain sufficient water supply for our properties, our ability to lease them
for the cultivation and production of medical-use cannabis would be seriously impaired, which would have a material adverse impact
on the value of our assets and our results of operations.
Historically, states that have legalized medical-use
cannabis cultivation have typically required that such cultivation take place indoors. Indoor cultivation of medical-use cannabis
requires significant power for growing lights and ventilation and air conditioning to remove the hot air generated by the growing
lights. While outdoor and greenhouse cultivation is gaining acceptance in many states with favorable climates for such growth,
we expect that a significant number of our properties will continue to utilize indoor cultivation methods. Any extended interruption
of the power supply to our properties, particularly those using indoor cultivation methods, would likely harm our tenants' crops,
which could result in their inability to make lease payments to us for our properties. Any lease payment defaults by a tenant could
adversely affect our cash flows and cause us to reduce the amount of distributions to stockholders.
Some of our tenants could be susceptible to bankruptcy,
which would affect our ability to generate rents from them and therefore negatively affect our results of operations.
In addition to the risk of tenants being unable
to make regular rent payments, certain of our tenants may depend on debt, which could make them especially susceptible to bankruptcy
in the event that their cash flows are insufficient to satisfy their debt. Any bankruptcy, if allowed, of one of our tenants would
result in a loss of lease payments to us, as well as an increase in our costs to carry the property.
Additionally, under bankruptcy law generally,
a tenant who is the subject of bankruptcy proceedings generally has the option of continuing ("assuming") or giving up
("rejecting") any unexpired lease of non-residential real property. If a bankrupt tenant decides to give up (reject)
a lease with us, any claim we might have for breach of the lease, excluding a claim against (1) collateral securing the lease,
or (2) a guarantor guaranteeing lease obligations, would be treated as a general unsecured claim in the tenant's bankruptcy case.
The laws governing bankruptcy cases would impact the treatment of our general unsecured claim. Our claim would likely be capped
at the amount the tenant owed us for unpaid rent prior to the bankruptcy unrelated to the termination, plus the greater of one
year of lease payments or 15% of the lease payments payable under the remaining term of the lease, but in no case more than three
years of lease payments. In addition to the cap on our damages for breach of the lease, even if our claim is timely submitted to
the bankruptcy court, there is no guaranty that the tenant's bankruptcy estate would have sufficient funds to satisfy the claims
of general unsecured creditors. Finally, a bankruptcy court could re-characterize a net lease transaction as a disguised secured
lending transaction. If that were to occur, we would not be treated as the owner of the property, but might have additional rights
as a secured creditor. This would mean our claim in bankruptcy court could be limited to the amount we paid for the property, which
could adversely impact our financial condition.
Furthermore, U.S. bankruptcy courts have generally
refused to grant bankruptcy protections to cannabis businesses. The inability of our tenants to seek bankruptcy protection may
impact their ability to secure financing for their operations and prevents our tenants from utilizing the benefits of reorganization
of their businesses under bankruptcy protection to operate in a financially sustainable way, thereby reducing the probability that
such a tenant would be able to honor its lease obligations with us.
Our real estate investments consist of primarily industrial
properties suitable for cultivation and production of medical-use cannabis, which may be difficult to sell or re-lease upon tenant
defaults or early lease terminations, either of which would adversely affect returns to stockholders.
While our business objectives consist of principally
acquiring and deriving rental income from industrial properties used in the regulated medical-use cannabis industry, we expect
that at times we will deem it appropriate or desirable to sell or otherwise dispose of certain properties we own. These types of
properties are relatively illiquid compared to other types of real estate and financial assets. This illiquidity could limit our
ability to quickly dispose of properties in response to changes in regulatory, economic or other conditions. Therefore, our ability
at any time to sell assets may be restricted and this lack of liquidity may limit our ability to make changes to our portfolio
promptly, which could materially and adversely affect our financial performance. We cannot predict the various market conditions
affecting the properties that we expect to acquire that will exist in the future. Due to the uncertainty of regulatory and market
conditions which may affect the future disposition of the real estate assets we expect to acquire, we cannot assure you that we
will be able to sell these assets at a profit in the future. Accordingly, the extent to which we will realize potential appreciation
on the real estate investments we expect to acquire will depend upon regulatory and other market conditions. In addition, in order
to qualify as a REIT and maintain our REIT status, we may not be able to sell properties when we would otherwise choose to do so,
due to market conditions or changes in our strategic plan.
Furthermore, we may be required to make expenditures
to correct defects or to make improvements before a property can be sold and we cannot assure you that we will have funds available
to correct such defects or to make such improvements. With these kinds of properties, if the current lease is terminated or not
renewed, we may be required to make expenditures and rent concessions in order to lease the property to another tenant. In addition,
in the event we are forced to sell or re-lease the property, we may have difficulty finding qualified purchasers who are willing
to buy the property or tenants who are willing to lease the property on terms that we expect, or at all. These and other limitations
may affect our ability to sell or re-lease properties, which may adversely affect returns to our stockholders.
Liability for uninsured losses could adversely affect our
financial condition.
While the terms of our leases with our tenants
generally require that they carry property and casualty insurance, losses from disaster-type occurrences, such as earthquakes,
floods and weather-related disasters, and other types of insurance, such as landlord's rental loss insurance, may be either uninsurable
or not insurable on economically viable terms. Should an uninsured loss occur, we could lose our capital investment or anticipated
profits and cash flows from one or more properties.
Contingent or unknown liabilities could materially and adversely
affect our business, financial condition, liquidity and results of operations.
We acquired our properties and may in the future
acquire properties, subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities.
As a result, if a claim were asserted against us based on ownership of any of these properties, we may have to pay substantial
amounts to defend or settle the claim. If the magnitude of such unknown liabilities is high, individually or in the aggregate,
our business, financial condition, liquidity and results of operations would be materially and adversely affected.
The assets we acquire may be subject to impairment
charges.
We periodically evaluate the real estate investments
we acquire and other assets for impairment indicators. The judgment regarding the existence of impairment indicators is based upon
factors such as market conditions, tenant performance and legal structure. For example, the termination of a lease by a tenant
may lead to an impairment charge. If we determine that an impairment has occurred, we would be required to make an adjustment to
the net carrying value of the asset which could have an adverse effect on our results of operations in the period in which the
impairment charge is recorded.
We may purchase properties subject to ground leases that
expose us to the loss of such properties upon breach or termination of the ground leases.
A ground lease agreement permits a tenant to
develop and/or operate a land parcel (property) during the lease period, after which the land parcel and all improvements revert
back to the property owner. Under a ground lease, property improvements are owned by the property owner unless an exception is
created and all relevant taxes incurred during the lease period are paid for by the tenant. Ground leases typically have a long
duration generally ranging from 50 to 99 years with additional extension options. As a lessee under a ground lease, we would be
exposed to the possibility of losing the property upon termination, or an earlier breach by us, of the ground lease, which could
have a material adverse effect on our business, financial condition and results of operations, our ability to make distributions
to our stockholders and the trading price of our common stock.
Due to our involvement in the regulated medical-use cannabis
industry, we may have a difficult time obtaining the various insurance policies that are desired to operate our business, which
may expose us to additional risks and financial liabilities.
Insurance that is otherwise readily available,
such as workers' compensation, general liability, and directors' and officers' insurance, is more difficult for us to find and
more expensive, because we lease our properties to companies in the regulated medical-use cannabis industry. There are no guarantees
that we will be able to find such insurance in the future, or that the cost will be affordable to us. If we are forced to go without
such insurance, it may prevent us from entering into certain business sectors, may inhibit our growth, and may expose us to additional
risk and financial liabilities.
The occurrence of cyber incidents could disrupt our operations,
result in the loss of confidential information and/or damage our business relationships and reputation.
We rely on technology to run our business,
and as such we are subject to risk from cyber incidents, including attempts to gain unauthorized access to our systems to disrupt
operations, corrupt data or steal confidential information, and other electronic security breaches. While we have implemented
measures to help mitigate these threats, such measures cannot guarantee that we will be successful in preventing a cyber incident.
The occurrence of a cyber incident could disrupt our operations, compromise the confidential information of our employees
or tenants, and/or damage our business relationships and reputation.
We cannot predict every event and circumstance that may
affect our business, and therefore, the risks and uncertainties discussed herein may not be the only ones you should consider.
We are not aware of any other publicly-traded
REIT that focuses on the acquisition, ownership and management of medical-use cannabis facilities. Therefore, as we commence the
operation of our business, we may encounter risks of which we are not aware at this time, which could have a material adverse impact
on our business.
Risks Related to Regulation
Medical-use cannabis remains illegal
under federal law, and therefore, strict enforcement of federal laws regarding medical-use cannabis would likely result in our
inability and the inability of our tenants to execute our respective business plans.
Cannabis is a Schedule I controlled substance
under the CSA. Even in those jurisdictions in which the manufacture and use of medical cannabis has been legalized at the state
level, the possession, use and cultivation all remain violations of federal law that are punishable by imprisonment and substantial
fines. Moreover, individuals and entities may violate federal law if they intentionally aid and abet another in violating these
federal controlled substance laws, or conspire with another to violate them. The U.S. Supreme Court has ruled in
United
States v. Oakland Cannabis Buyers' Coop.
and
Gonzales v. Raich
that it is the federal government that
has the right to regulate and criminalize cannabis, even for medical purposes. We would likely be unable to execute our business
plan if the federal government were to strictly enforce federal law regarding cannabis.
In January 2018, the DOJ rescinded certain
memoranda, including the so-called “Cole Memo” issued on August 29, 2013 under the Obama Administration, which had
characterized enforcement of federal cannabis prohibitions under the CSA to prosecute those complying with state regulatory systems
allowing the use, manufacture and distribution of medical cannabis as an inefficient use of federal investigative and prosecutorial
resources when state regulatory and enforcement efforts are effective with respect to enumerated federal enforcement priorities
under the CSA. The impact of the DOJ's recent rescission of the Cole Memo and related memoranda is unclear, but may result in the
DOJ increasing its enforcement actions against the regulated cannabis industry generally, including our tenants and us.
Congress previously enacted an omnibus spending
bill that includes a provision prohibiting the DOJ (which includes the DEA) from using funds appropriated by that bill to prevent
states from implementing their medical-use cannabis laws. This provision, however, expires on September 30, 2018, and must be renewed
by Congress. In
USA vs. McIntosh
, the U.S. Court of Appeals for the Ninth Circuit held that this provision prohibits
the DOJ from spending funds from relevant appropriations acts to prosecute individuals who engage in conduct permitted by state
medical-use cannabis laws and who strictly comply with such laws. However, the Ninth Circuit's opinion, which only applies to the
states of Alaska, Arizona, California, Hawaii, and Idaho, also held that persons who do not strictly comply with all state laws
and regulations regarding the distribution, possession and cultivation of medical-use cannabis have engaged in conduct that is
unauthorized, and in such instances the DOJ may prosecute those individuals. Furthermore, while we target the acquisition of medical-use
cannabis facilities, our leases do not prohibit cannabis cultivation for adult-use that is permissible under the state and local
laws where our facilities are located. Consequently, certain of our tenants may subsequently cultivate adult-use cannabis in our
medical-use cannabis facilities, if permitted by such state and local laws now or in the future, which may in turn subject the
tenant, us and our properties to greater and/or different federal legal and other risks as compared to facilities where cannabis
is cultivated exclusively for medical use, including not providing protection under the Congressional spending bill provision described
above.
Additionally, financial transactions involving
proceeds generated by cannabis-related conduct can form the basis for prosecution under the federal money laundering statutes,
unlicensed money transmitter statutes and the Bank Secrecy Act. Prior to the DOJ's rescission of the “Cole Memo”, supplemental
guidance from the DOJ issued under the Obama administration directed federal prosecutors to consider the federal enforcement priorities
enumerated in the “Cole Memo” when determining whether to charge institutions or individuals with any of the financial
crimes described above based upon cannabis-related activity. It is unclear what impact the recent rescission of the “Cole
Memo” will have, but federal prosecutors may increase enforcement activities against institutions or individuals that are
conducting financial transactions related to cannabis activities.
Federal prosecutors have significant discretion
and no assurance can be given that the federal prosecutor in each judicial district where we purchase a property will not choose
to strictly enforce the federal laws governing cannabis production or distribution. Any change in the federal government's enforcement
posture with respect to state-licensed cultivation of medical-use cannabis, including the enforcement postures of individual federal
prosecutors in judicial districts where we purchase properties, would result in our inability to execute our business plan, and
we would likely suffer significant losses with respect to our investment in medical-use cannabis facilities in the United States,
which would adversely affect the trading price of our securities. Furthermore, following any such change in the federal government's
enforcement position, we could be subject to criminal prosecution, which could lead to imprisonment and/or the imposition of penalties,
fines, or forfeiture.
If our tenants engage in operations for the adult-use cannabis
industry in addition to or in lieu of operations for the medical-use cannabis industry, our tenants, we and our properties may
be subject to additional risks associated with such adult-use cannabis operations.
Our existing leases at our properties
do not, and we expect that leases that we enter into with future tenants at other properties we acquire will not, prohibit cannabis
cultivation for adult-use that is permissible under state and local laws where our facilities are located, which may subject our
tenants, us and our properties to different and greater risks, including those related to enforcement of federal laws. In addition,
while we may purchase properties in states that only permit medical-use cannabis at the time of acquisition, such states may in
the future authorize by state legislation or popular vote the legalization of adult-use cannabis, thus permitting our tenants to
engage in adult-use cannabis operations at our properties.
New laws that are adverse to the business of our tenants
may be enacted, and current favorable national, state or local laws or enforcement guidelines relating to cultivation and production
of medical-use cannabis may be modified or eliminated in the future.
We have acquired and are targeting for acquisition
properties that are owned by state-licensed cultivators and producers of medical-use cannabis. Relevant state or local laws may
be amended or repealed, or new laws may be enacted in the future to eliminate existing laws permitting cultivation and production
of medical-use cannabis. If our tenants involved in the cultivation and production of medical-use cannabis were forced to close
their operations, we would need to replace those tenants with tenants who are not engaged in the cannabis industry, who may pay
significantly lower rents. Moreover, any changes in state or local laws that reduce or eliminate the ability to cultivate and produce
medical-use cannabis would likely result in a high vacancy rate for the kinds of properties that we seek to acquire, which would
depress our lease rates and property values. In addition, we would realize an economic loss on any and all improvements made to
properties that were specific to the medical-use cannabis industry.
Our ability to grow our business depends on state laws pertaining
to the cannabis industry.
Continued development of the medical-use cannabis
industry depends upon continued legislative authorization of cannabis at the state level. The status quo of, or progress in, the
regulated medical-use cannabis industry is not assured and any number of factors could slow or halt further progress in this area.
While there may be ample public support for legislative action permitting the manufacture and use of cannabis, numerous factors
impact the legislative process. For example, many states that voted to legalize medical and/or adult-use cannabis have seen significant
delays in the drafting and implementation of industry regulations and issuance of licenses. In addition, burdensome regulation
at the state level could slow or stop further development of the medical-use cannabis industry, such as limiting the medical conditions
for which medical cannabis can be recommended by physicians for treatment, restricting the form in which medical cannabis can be
consumed, imposing significant registration requirements on physicians and patients or imposing significant taxes on the growth,
processing and/or retail sales of cannabis, which could have the impact of dampening growth of the cannabis industry and making
it difficult for cannabis businesses, including our tenants, to operate profitably in those states. Any one of these factors could
slow or halt additional legislative authorization of medical-use cannabis, which could harm our business prospects.
FDA regulation of medical-use cannabis and the possible
registration of facilities where medical-use cannabis is grown could negatively affect the medical-use cannabis industry, which
would directly affect our financial condition.
Should the federal government legalize cannabis
for medical-use, it is possible that the U.S. Food and Drug Administration ("FDA") would seek to regulate it under the
Food, Drug and Cosmetics Act of 1938. Additionally, the FDA may issue rules and regulations including certified good manufacturing
practices, or cGMPs, related to the growth, cultivation, harvesting and processing of medical cannabis. Clinical trials may be
needed to verify efficacy and safety. It is also possible that the FDA would require that facilities where medical-use cannabis
is grown register with the FDA and comply with certain federally prescribed regulations. In the event that some or all of these
regulations are imposed, we do not know what the impact would be on the medical-use cannabis industry, including what costs, requirements
and possible prohibitions may be enforced. If we or our tenants are unable to comply with the regulations or registration as prescribed
by the FDA, we and or our tenants may be unable to continue to operate their and our business in its current form or at all.
We and our tenants may have difficulty accessing the service
of banks, which may make it difficult to contract for real estate needs.
Financial transactions involving proceeds generated
by cannabis-related conduct can form the basis for prosecution under the federal money laundering statutes, unlicensed money transmitter
statute and the Bank Secrecy Act. Previous guidance issued by the FinCen, a division of the U.S.
Department of the Treasury, clarifies how financial institutions can provide services to cannabis-related businesses consistent
with their obligations under the Bank Secrecy Act. Prior to the DOJ’s announcement in January 2018 of the rescission of the
“Cole Memo” and related memoranda, supplemental guidance from the DOJ directed federal prosecutors to consider the
federal enforcement priorities enumerated in the “Cole Memo” when determining whether to charge institutions or individuals
with any of the financial crimes described above based upon cannabis-related activity. It is unclear what impact the recent rescission
of the “Cole Memo” will have, but federal prosecutors may increase enforcement activities against institutions or individuals
that are conducting financial transactions related to cannabis activities. The increased uncertainty surrounding financial transactions
related to cannabis activities may also result in financial institutions discontinuing services to the cannabis industry.
Consequently, those businesses involved in
the regulated medical-use cannabis industry continue to encounter difficulty establishing banking relationships, which may increase
over time. Our inability to maintain our current bank accounts would make it difficult for us to operate our business, increase
our operating costs, and pose additional operational, logistical and security challenges and could result in our inability to implement
our business plan.
The terms of our leases require that our tenants
make rental payments via check or wire transfer. The inability of our current and potential tenants to open accounts and continue
using the services of banks will limit their ability to enter into triple-net lease arrangements with us or may result in their
default under our lease agreements, either of which could materially harm our business and the trading price of our securities.
Owners of properties located in close proximity to our properties
may assert claims against us regarding the use of the property as a medical cannabis cultivation and processing facility, which
if successful, could materially and adversely affect our business.
Owners of properties located in close proximity
to our properties may assert claims against us regarding the use of our properties for medical cannabis cultivation and processing,
including assertions that the use of the property constitutes a nuisance that diminishes the market value of such owner's nearby
property. Such property owners may also attempt to assert such a claim in federal court as a civil matter under the Racketeer Influenced
and Corrupt Organizations Act. If a property owner were to assert such a claim against us, we may be required to devote significant
resources and costs to defending ourselves against such a claim, and if a property owner were to be successful on such a claim,
our tenants may be unable to continue to operate their business in its current form at the property, which could materially adversely
impact the tenant's business and the value of our property, our business and financial results and the trading price of our securities.
Laws and regulations affecting the regulated cannabis industry
are constantly changing, which could materially adversely affect our proposed operations, and we cannot predict the impact that
future regulations may have on us.
Local, state and federal cannabis laws and
regulations are broad in scope and subject to evolving interpretations, which could require us to incur substantial costs associated
with compliance or alter our business plan. In addition, violations of these laws, or allegations of such violations, could disrupt
our business and result in a material adverse effect on our operations. It is also possible that regulations may be enacted in
the future that will be directly applicable to our proposed business. We cannot predict the nature of any future laws, regulations,
interpretations or applications, nor can we determine what effect additional governmental regulations or administrative policies
and procedures, when and if promulgated, could have on our business.
Applicable state laws may prevent us from maximizing our
potential income.
Depending on the laws of each particular state,
we may not be able to fully realize our potential to generate profit. For example, some states have residency requirements for
those directly involved in the medical-use cannabis industry, which may impede our ability to contract with cannabis businesses
in those states. Furthermore, cities and counties are being given broad discretion to ban certain cannabis activities. Even if
these activities are legal under state law, specific cities and counties may ban them.
Assets leased to cannabis businesses may be forfeited to
the federal government.
Any assets used in conjunction with the violation
of federal law are potentially subject to federal forfeiture, even in states where cannabis is legal. In July 2017, the U.S. Department
of Justice issued a new policy directive regarding asset forfeiture, referred to as the "equitable sharing program."
Under this new policy directive, federal authorities may adopt state and local forfeiture cases and prosecute them at the federal
level, allowing for state and local agencies to keep up to 80% of any forfeiture revenue. This policy directive represents a reversal
of the U.S. Department of Justice's policy under the Obama administration, and allows for forfeitures to proceed that are not in
accord with the limitations imposed by state-specific forfeiture laws. This new policy directive may lead to increased use of asset
forfeitures by local, state and federal enforcement agencies. If the federal government decides to initiate forfeiture proceedings
against cannabis businesses, such as the medical-use cannabis facilities that we have acquired and intend to acquire, our investment
in those properties may be lost.
The properties that we acquire are subject to extensive
regulations, which may result in significant costs and materially and adversely affect our business, financial condition, liquidity
and results of operations.
Our properties are and other properties that
we expect to acquire will be subject to various local laws and regulatory requirements. Local property regulations, including restrictive
covenants of record, may restrict the use of properties we acquire and may require us to obtain approval from local authorities
with respect to the properties that we expect to acquire, including prior to acquiring a property or when developing or undertaking
renovations. Among other things, these restrictions may relate to cultivation of medical-use cannabis, the use of water and the
discharge of waste water, fire and safety, seismic conditions, asbestos-cleanup or hazardous material abatement requirements. We
cannot assure you that existing regulatory policies will not materially and adversely affect us or the timing or cost of any future
acquisitions, developments or renovations, or that additional regulations will not be adopted that would increase such delays or
result in additional costs. Our failure to obtain such regulatory approvals could have a material adverse effect on our business,
financial condition, liquidity and results of operations.
Compliance with environmental laws could materially increase
our operating expenses.
There may be environmental conditions associated
with properties we acquire of which we are unaware. If environmental contamination exists on properties we acquire, we could become
subject to liability for the contamination. The presence of hazardous substances on a property may materially and adversely affect
our ability to sell the property and we may incur substantial remediation costs. In addition, although we may require in our leases
that tenants operate in compliance with all applicable laws and indemnify us against any environmental liabilities arising from
a tenant's activities on the property, we could nonetheless be subject to liability by virtue of our ownership interest and we
cannot be sure that our tenants would satisfy their indemnification obligations to us. Such environmental liability exposure associated
with properties we acquire could harm our business, financial condition, liquidity and results of operations.
Risks Related to Financing Our Business
Our growth depends on external sources of capital, which
may not be available on favorable terms or at all. In addition, banks and other financial institutions may be reluctant to enter
into lending transactions with us, particularly secured lending, because we acquire properties used in the cultivation and production
of medical-use cannabis. If this source of funding is unavailable to us, our growth may be limited and our levered return on the
properties we purchase may be lower.
We expect to acquire additional real estate
assets, which we intend to finance primarily through newly issued equity or debt. We may not be in a position to take advantage
of attractive investment opportunities for growth if we are unable, due to global or regional economic uncertainty, changes in
the state or federal regulatory environment relating to the medical-use cannabis industry, our own operating or financial performance
or otherwise, to access capital markets on a timely basis and on favorable terms or at all. In addition, U.S. federal income tax
law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, without regard to the deduction
for dividends paid and excluding net capital gain and that it pay U.S. federal income tax at regular corporate rates to the extent
that it annually distributes less than 100% of its taxable income. Because we intend to grow our business, this limitation may
require us to raise additional equity or incur debt at a time when it may be disadvantageous to do so.
Our access to capital will depend upon a number
of factors over which we have little or no control, including general market conditions and the market's perception of our current
and potential future earnings. If general economic instability or downturn leads to an inability to borrow at attractive rates
or at all, our ability to obtain capital to finance the purchase of real estate assets could be negatively impacted. In addition,
banks and other financial institutions may be reluctant to enter into lending transactions with us, particularly secured lending,
because we intend to acquire properties used in the cultivation and production of medical-use cannabis. If this source of funding
is unavailable to us, our growth may be limited and our levered return on the properties we purchase may be lower.
If we are unable to obtain capital on terms
and conditions that we find acceptable, we likely will have to reduce the number of properties we can purchase. In addition, our
ability to refinance all or any debt we may incur in the future, on acceptable terms or at all, is subject to all of the above
factors, and will also be affected by our future financial position, results of operations and cash flows, which additional factors
are also subject to significant uncertainties, and therefore we may be unable to refinance any debt we may incur in the future,
as it matures, on acceptable terms or at all. All of these events would have a material adverse effect on our business, financial
condition, liquidity and results of operations.
Any future indebtedness reduces cash available for distribution
and may expose us to the risk of default under debt obligations that we may incur in the future.
Payments of principal and interest on borrowings
that we may incur in the future may leave us with insufficient cash resources to operate the properties that we expect to acquire
or to pay the distributions currently contemplated or necessary to satisfy the requirements for REIT qualification. Our level of
debt and the limitations imposed on us by these debt agreements could have significant material and adverse consequences, including
the following:
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our cash flow may be insufficient to meet our required principal and
interest payments;
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we may be unable to borrow additional funds as needed or on favorable
terms, or at all;
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we may be unable to refinance our indebtedness at maturity or the
refinancing terms may be less favorable than the terms of our original indebtedness;
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to the extent we borrow debt that bears interest at variable rates,
increases in interest rates could materially increase our interest expense;
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we may be forced to dispose of one or more of the properties that
we expect to acquire, possibly on disadvantageous terms;
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we may default on our obligations or violate restrictive covenants,
in which case the lenders may accelerate these debt obligations; and
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our default under any loan with cross default provisions could result
in a default on other indebtedness.
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If any one of these events were to occur, our
financial condition, results of operations, cash flow, and our ability to make distributions to our stockholders could be materially
and adversely affected.
Risks Related to Our Organization and Structure
We are dependent on our key personnel for our success.
We depend upon the efforts, experience, diligence,
skill and network of business contacts of our senior management team, and our success will depend on their continued service. The
departure of any of our executive officers or key personnel could have a material adverse effect on our business. If any of our
key personnel were to cease their employment, our operating results could suffer. Further, we do not intend to maintain key person
life insurance that would provide us with proceeds in the event of death or disability of any of our key personnel.
We believe our future success depends upon
our senior management team's ability to hire and retain highly skilled managerial, operational and marketing personnel. Competition
for such personnel is intense, and we cannot assure you that we will be successful in attracting and retaining such skilled personnel.
If we lose or are unable to obtain the services of key personnel, our ability to implement our investment strategies could be delayed
or hindered, and the value of our common stock may decline.
Furthermore, we may retain independent contractors
to provide various services for us, including administrative services, transfer agent services and professional services. Such
contractors have no fiduciary duty to us and may not perform as expected or desired.
Our senior management team manages our portfolio subject
to very broad investment guidelines.
Our senior management team has broad discretion
over our investments, and our stockholders will have no opportunity to evaluate the terms of transactions or other economic or
financial data concerning our investments that are not described in periodic filings with the SEC. We rely on the senior management
team's ability to execute acquisitions and dispositions of medical-use cannabis facilities, subject to the oversight and approval
of our board of directors. Our senior management team is authorized to pursue acquisitions and dispositions of real estate investments
in accordance with very broad investment guidelines, subject to approval of our board of directors.
Our board of directors may change our investment objectives
and strategies without stockholder consent.
Our board of directors determines our major
policies, including with regard to financing, growth, debt capitalization, REIT qualification and distributions. Our board of directors
may amend or revise these and other policies without a vote of the stockholders. Under our charter and Maryland General Corporation
Law (the "MGCL"), our stockholders generally have a right to vote only on the following matters:
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the election or removal of directors;
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the amendment of our charter, except that our board of directors may
amend our charter without stockholder approval to:
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change the name or other designation or the par value of any class
or series of stock and the aggregate par value of our stock;
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increase or decrease the aggregate number of shares of stock that
we have the authority to issue;
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increase or decrease the number of our shares of any class or series
of stock that we have the authority to issue; and
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effect certain reverse stock splits;
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our liquidation and dissolution; and
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our being a party to a merger, consolidation, sale or other disposition
of all or substantially all of our assets or statutory share exchange.
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All other matters are subject to the discretion
of our board of directors.
Certain provisions of Maryland law could inhibit changes
in control.
Under the MGCL, "business combinations"
(including a merger, consolidation, statutory share exchange or, in certain circumstances, an asset transfer or issuance or reclassification
of equity securities) between a Maryland corporation and an "interested stockholder" or an affiliate of an interested
stockholder are prohibited for five years after the most recent date on which the interested stockholder becomes an interested
stockholder. An interested stockholder is defined as: (a) any person who beneficially owns 10% or more of the voting power of the
then-outstanding voting stock of the corporation; or (b) an affiliate or associate of the corporation who, at any time within the
two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then-outstanding
stock of the corporation.
A person is not an interested stockholder under
the statute if the board of directors approved in advance the transaction by which the person otherwise would have become an interested
stockholder. A Maryland corporation's board of directors may provide that its approval is subject to compliance with any terms
and conditions determined by the board of directors prior to the time that the interested stockholder becomes an interested stockholder.
Thereafter, any such business combination must
generally be recommended by the board of directors of such corporation and approved by the affirmative vote of at least:
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80% of the votes entitled to be cast by holders of outstanding voting
stock of the corporation; and
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two-thirds of the votes entitled to be cast by holders of voting stock
of the corporation, other than shares held by the interested stockholder with whom (or with whose affiliate) the business combination
is to be effected, or held by an affiliate or associate of the interested stockholder unless, among other conditions, the corporation's
common stockholders receive a minimum price (as defined in the MGCL) for their shares and the consideration is received in cash
or in the same form as previously paid by the interested stockholder for its shares.
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A Maryland corporation's board of directors
may provide that its approval is subject to compliance with any terms and conditions determined by it. These provisions of the
MGCL do not apply, however, to business combinations that are approved or exempted by a Maryland corporation's board of directors
prior to the time that the interested stockholder becomes an interested stockholder.
The "control share" provisions of
the MGCL provide that, subject to certain exceptions, a holder of "control shares" of a Maryland corporation (defined
as shares which, if aggregated with all other shares of stock owned by the acquirer or in respect of which the acquirer is able
to exercise or direct the exercise of voting power (except solely by virtue of a revocable proxy), entitle the stockholder to exercise
one of three increasing ranges of voting power in electing directors) acquired in a "control share acquisition" (defined
as the direct or indirect acquisition of ownership or control of issued and outstanding "control shares") has no voting
rights with respect to such shares except to the extent approved by our stockholders by the affirmative vote of at least two-thirds
of all the votes entitled to be cast on the matter, excluding votes entitled to be cast by the acquirer of control shares, our
officers and our personnel who are also our directors. Our bylaws contain a provision exempting from the control share acquisition
statute any and all acquisitions by any person of shares of our stock. Our bylaws contain a provision exempting from the control
share acquisition statute any and all acquisitions by any person of shares of our stock. There can be no assurance that such provision
will not be amended or eliminated at any time in the future by our board of directors.
The "unsolicited takeover" provisions
of Title 3, Subtitle 8 of the MGCL, or Subtitle 8, permit our board of directors, without stockholder approval and regardless of
what is currently provided in our charter or bylaws, to implement certain takeover defenses, some of which (for example, a classified
board) we do not yet have. Our charter provides that vacancies on our board may be filled only by the remaining directors and for
the remainder of the full term of the directorship in which the vacancy occurred. Through provisions in our charter and bylaws
unrelated to Subtitle 8, we already (i) require the affirmative vote of stockholders entitled to cast not less than two-thirds
of all of the votes entitled to be cast generally in the election of directors for the removal of any director from the board,
only with cause, (ii) vest in the board of directors the exclusive power to fix the number of directorships and (iii) require,
unless called by our chairman of the board, our chief executive officer or our board of directors, the written request of stockholders
entitled to cast not less than a majority of all votes entitled to be cast at such a meeting to call a special meeting of our stockholders.
These provisions may have the effect of inhibiting
a third party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control of us under
the circumstances that otherwise could provide the holders of shares of common stock with the opportunity to realize a premium
over the then current market price.
Our authorized but unissued shares of common and preferred
stock may prevent a change in our control.
Our charter permits our board of directors
to authorize us to issue additional shares of our authorized but unissued common or preferred stock. In addition, our board of
directors may, without stockholder approval, amend our charter to increase the aggregate number of our shares of stock or the number
of shares of stock of any class or series that we have the authority to issue and classify or reclassify any unissued shares of
common or preferred stock and set the terms of the classified or reclassified shares. As a result, our board of directors may establish
a class or series of shares of common or preferred stock that could delay or prevent a transaction or a change in control that
might involve a premium price for shares of our common stock or otherwise be in the best interest of our stockholders.
Severance agreements with our executive officers could be
costly and prevent a change in our control.
The severance agreements that we entered into
with our executive officers provide that, if their employment with us terminates under certain circumstances (including upon a
change in our control), we may be required to pay them significant amounts of severance compensation, including accelerated vesting
of equity awards, thereby making it costly to terminate their employment. Furthermore, these provisions could delay or prevent
a transaction or a change in our control that might involve a premium paid for our common stock or otherwise be in the best interests
of our stockholders.
Because of our holding company structure, we depend on our
Operating Partnership and its subsidiaries for cash flow and we will be structurally subordinated in right of payment to the obligations
of such operating subsidiary and its subsidiaries.
We are a holding company with no business operations
of our own. Our only significant asset is and will be the general and limited partnership interests in our Operating Partnership.
We conduct, and intend to conduct, all of our business operations through our Operating Partnership. Accordingly, our only source
of cash to pay our obligations is distributions from our Operating Partnership and its subsidiaries of their net earnings and cash
flows. We cannot assure our stockholders that our Operating Partnership or its subsidiaries will be able to, or be permitted to,
make distributions to us that will enable us to make distributions to our stockholders from cash flows from operations. Each of
our Operating Partnership's subsidiaries is or will be a distinct legal entity and, under certain circumstances, legal and contractual
restrictions may limit our ability to obtain cash from such entities. In addition, because we are a holding company, your claims
as stockholders will be structurally subordinated to all existing and future liabilities and obligations of our Operating Partnership
and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets and those of our Operating
Partnership and its subsidiaries will be able to satisfy your claims as stockholders only after all of our and our Operating Partnership's
and its subsidiaries' liabilities and obligations have been paid in full.
Our Operating Partnership may issue additional limited partnership
interests to third parties without the consent of our stockholders, which would reduce our ownership percentage in our Operating
Partnership and would have a dilutive effect on the amount of distributions made to us by our Operating Partnership and, therefore,
the amount of distributions we can make to our stockholders.
We are the sole general partner of our Operating
Partnership and own, directly or through a subsidiary, 100% of the outstanding partnership interests in our Operating Partnership.
We may, in connection with our acquisition of properties or otherwise, cause our Operating Partnership to issue additional limited
partnership interests to third parties. Such issuances would reduce our ownership percentage in our Operating Partnership and affect
the amount of distributions made to us by our Operating Partnership and, therefore, the amount of distributions we can make to
our stockholders. Because our stockholders will not directly own any interest in our Operating Partnership, our stockholders will
not have any voting rights with respect to any such issuances or other partnership level activities of our Operating Partnership.
If we issue limited partnership interests in our Operating
Partnership in exchange for property, the value placed on such partnership interests may not accurately reflect their market value,
which may dilute your interest in us.
If we issue limited partnership interests in
our Operating Partnership in exchange for property, the per unit value attributable to such interests will be determined based
on negotiations with the property seller and, therefore, may not reflect the fair market value of such limited partnership interests
if a public market for such limited partnership interests existed. If the value of such limited partnership interests is greater
than the value of the related property, your interest in us may be diluted.
Our rights and the rights of our stockholders to take action
against our directors and officers are limited, which could limit your recourse in the event of actions not in your best interests.
We have entered into indemnification agreements
with each of our executive directors and officers that provide for indemnification to the maximum extent permitted by Maryland
law. Maryland law permits us to include in our charter a provision eliminating the liability of our directors and officers and
our stockholders for money damages except for liability resulting from:
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actual receipt of an improper benefit or profit in money, property
or services; or
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active and deliberate dishonesty that was established by a final judgment
and was material to the cause of action.
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Our charter authorizes us to obligate ourselves
and our bylaws obligate us, to the fullest extent permitted by Maryland law in effect from time to time, to indemnify and, without
requiring a preliminary determination of the ultimate entitlement to indemnification, pay or reimburse reasonable expenses in advance
of final disposition of a proceeding to:
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any present or former director or officer who is made or threatened
to be made a party to or witness in the proceeding by reason of his or her service in that capacity; or
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any individual who, while a director or officer of our company and
at our request, serves or has served as a director, officer, partner, manager, member or trustee of another corporation, REIT,
partnership, limited liability company, joint venture, trust, employee benefit plan or any other enterprise and who is made or
threatened to be made a party to or witness in the proceeding by reason of his or her service in that capacity.
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Our charter contains provisions that make removal of our
directors difficult, which could make it difficult for our stockholders to effect changes to our management.
Our charter provides that, subject to the rights
of holders of any series of preferred stock, a director may be removed only with cause upon the affirmative vote of stockholders
entitled to cast at least two-thirds of the votes entitled to be cast generally in the election of directors. Vacancies may be
filled only by a vote of the majority of the remaining directors in office, even if less than a quorum. These requirements make
it more difficult to change our management by removing and replacing directors and may prevent a change in control of our company
that is in the best interests of our stockholders.
Ownership limitations may restrict change in control or
business combination opportunities in which our stockholders might receive a premium for their shares.
In order for us to qualify as a REIT under
the Internal Revenue Code of 1986, as amended (the "Code"), shares of our stock must be owned by 100 or more persons
during at least 335 days of a taxable year of 12 months (other than the first year for which an election to be a REIT has been
made) or during a proportionate part of a shorter taxable year. Also, not more than 50% of the value of the outstanding shares
of our stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities)
during the last half of a taxable year (other than the first year for which an election to be a REIT has been made). In order for
us to qualify as a REIT under the Code, the relevant sections of our charter provide that, subject to certain exceptions, no person
or entity may own, or be deemed to own, by virtue of the applicable constructive ownership provisions of the Code, more than 9.8%
(in value or number of shares, whichever is more restrictive) of the aggregate of our outstanding shares of stock or more than
9.8% (in value or number of shares, whichever is more restrictive) of our outstanding common stock or any class or series of our
outstanding preferred stock, including our Series A Preferred Stock. These ownership limits and other restrictions could have the
effect of discouraging a takeover or other transaction in which holders of our common stock might receive a premium for their shares
over the then prevailing market price or which holders might believe to be otherwise in their best interests.
The requirements of being a public company
impose costs and demands upon our management, which could make it difficult to manage our business, particularly after we are
no longer an “emerging growth company.”
Complying with the reporting and other
regulatory requirements of the Exchange Act and the requirements of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley
Act") is time-consuming and costly and could have a negative effect on our business, financial condition and results of
operations. The Exchange Act requires that we file annual, quarterly and current reports with respect to our business and
financial condition. The Sarbanes-Oxley Act requires that we maintain effective disclosure controls and procedures and
internal controls over financial reporting. To maintain and improve the effectiveness of our disclosure controls and
procedures and internal control over financial reporting, we have committed additional resources and provided additional
management oversight. We expect these resources and management oversight requirements to continue. These activities may
divert management’s attention from other business concerns, which could have a material adverse effect on our
business, financial condition and results of operations.
As an “emerging growth company”
as defined in the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"), we benefit from certain temporary exemptions
from various reporting requirements, including, but not limited to, not being required to comply with the auditor attestation requirements
of Section 404 of the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation in our periodic reports
and proxy statements. In addition, we have elected under the JOBS Act to delay adoption of new or revised accounting pronouncements
applicable to public companies until such pronouncements are made applicable to private companies. When these exemptions cease
to apply, we expect to incur additional expenses and devote increased management effort toward ensuring compliance with them. We
cannot predict or estimate the amount of additional costs we may incur as these exemptions cease to apply.
We plan to continue to operate our business so that we are
not required to register as an investment company under the Investment Company Act.
We engage primarily in the business of investing
in real estate and we have not and do not intend to register as an investment company under the Investment Company Act. If our
primary business were to change in a manner that would require us register as an investment company under the Investment Company
Act, we would have to comply with substantial regulation under the Investment Company Act which could restrict the manner in which
we operate and finance our business and could materially and adversely affect our business operations and results.
Risks Related to Our Stock
The market prices and trading volumes of our common stock and preferred stock have been and may continue to be volatile.
We completed our initial public offering in
December 2016 and our public offering of Series A Preferred Stock in October 2017, and the market prices for our common stock and
Series A Preferred Stock have been, and may continue to be, volatile. In addition, the trading volume in our common stock and Series
A Preferred Stock has fluctuated and may continue to fluctuate, resulting in significant price variations.
Some of the factors that could negatively affect
the share price or result in fluctuations in the price or trading volume of our common stock and preferred stock include:
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our actual or projected operating results, financial condition, cash
flows and liquidity or changes in business strategy or prospects;
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our ability to make acquisitions on preferable terms or at all;
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the performance of our current properties and additional properties
that we acquire;
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equity issuances by us, or share resales by our stockholders, or the
perception that such issuances or resales may occur;
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actual or anticipated accounting problems;
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publication of research reports about us or the real estate industry;
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changes in market valuations of similar companies;
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adverse market reaction to any increased indebtedness we may incur
in the future;
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additions to or departures of our senior management team;
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speculation in the press or investment community;
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our failure to meet, or the lowering of, our earnings estimates or
those of any securities analysts;
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changes in governmental policies, regulations or laws;
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failure to qualify, or maintain our qualification, as a REIT;
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refusal of securities clearing firms to accept deposits of our securities;
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a delisting of our common stock or Series A Preferred Stock from the
NYSE;
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the realization of any of the other risk factors presented in this
report;
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actions by institutional stockholders;
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price and volume fluctuations in the stock market generally; and
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·
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market and economic conditions generally, including the current state
of the credit and capital markets and the market and economic conditions.
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Market factors unrelated to our performance
could also negatively impact the market price of our common stock and preferred stock. One of the factors that investors may consider
in deciding whether to buy or sell our common stock or preferred stock is our distribution rate as a percentage of our stock price
relative to market interest rates. If market interest rates increase, prospective investors may demand a higher distribution rate
or seek alternative investments paying higher dividends or interest. As a result, interest rate fluctuations and conditions in
capital markets can affect the market value of our common stock or preferred stock.
Common stock and preferred stock eligible for future sale
may have material and adverse effects on our share price.
Subject to applicable law, our board of directors,
without stockholder approval, may authorize us to issue additional shares of our common stock or to raise capital through the issuance
of preferred stock (including equity or debt securities convertible into preferred stock), options, warrants and other rights,
on terms and for consideration as our board of directors in its sole discretion may determine. Any such issuance could result in
dilution of the equity of our stockholders. Sales of substantial amounts of shares of our common stock in the public market, or
the perception that such sales might occur, could adversely affect the market price of our common stock.
Our charter also authorizes our board of directors,
without stockholder approval, to designate and issue one or more classes or series of preferred stock (including equity or debt
securities convertible into preferred stock) and to set or change the voting, conversion or other rights, preferences, restrictions,
limitations as to dividends or other distributions and qualifications or terms or conditions of redemption of each class of shares
so issued. If any preferred stock is publicly offered, the terms and conditions of such preferred stock (including any equity or
debt securities convertible into preferred stock) will be set forth in a registration statement registering the issuance of such
preferred stock or equity or debt securities convertible into preferred stock. Because our board of directors has the power to
establish the preferences and rights of each class or series of preferred stock, it may afford the holders of any series or class
of preferred stock preferences, powers, and rights senior to the rights of holders of common stock or other preferred stock. If
we ever create and issue additional preferred stock or equity or debt securities convertible into preferred stock with a distribution
preference over common stock or preferred stock, payment of any distribution preferences of new outstanding preferred stock would
reduce the amount of funds available for the payment of distributions on the common stock and junior preferred stock. Further,
holders of preferred stock are normally entitled to receive a preference payment if we liquidate, dissolve, or wind up before any
payment is made to the common stockholders, likely reducing the amount common stockholders would otherwise receive upon such an
occurrence. In addition, under certain circumstances, the issuance of additional preferred stock may delay, prevent, render more
difficult or tend to discourage a merger, tender offer, or proxy contest, the assumption of control by a holder of a large block
of our securities, or the removal of incumbent management.
Furthermore, we filed a shelf registration
statement, which was subsequently declared effective by the SEC, which may permit us, from time to time, to offer and sell common
stock, preferred stock, warrants and other securities to the extent necessary or advisable to meet our liquidity needs.
Additionally, from time to time we also may
issue shares of our common stock or operating partnership units of our Operating Partnership in connection with property acquisitions.
We may grant additional demand or piggyback registration rights in connection with these issuances. Sales of substantial amounts
of our common stock or operating partnership units of our Operating Partnership, or the perception that these sales could occur,
may adversely affect the prevailing market price of our common stock or may adversely affect the terms upon which we may be able
to obtain additional capital through the sale of equity securities.
We cannot assure you of our ability to make distributions
in the future. We may be unable to pay or maintain cash dividends, and may borrow money, sell assets or use offering proceeds to
make distributions to our stockholders, if we are unable to make distributions from cash flows from operations.
U.S. federal income tax law generally requires
that a REIT distribute annually at least 90% of its REIT taxable income, determined without regard to the deduction for dividends
paid and excluding net capital gain (which does not equal net income as calculated in accordance with U.S. generally accepted accounting
principles ("GAAP")), and that it pay U.S. federal income tax at regular corporate rates to the extent that it annually
distributes less than 100% of its taxable income. We may not continue our current level of distributions to stockholders. Our board
of directors will determine future distributions based on a number of factors, including cash available for distribution, economic
conditions, operating results, our financial condition, especially in relation to our anticipated future capital needs, then current
expansion plans, the distribution requirements for REITs, and other factors our board deems relevant. In addition, we may borrow
money, sell assets or use offering proceeds to make distributions to our stockholders, if we are unable to make distributions from
cash flows from operations.
Our charter permits us to pay distributions from any source
and, as a result, the amount of distributions paid at any time may not reflect the performance of our properties or as cash flow
from operations.
Our organizational documents permit us to make
distributions from any source. To the extent that our cash available for distribution is insufficient to cover our distributions,
we expect to use our cash on hand, the proceeds from the issuance of securities in the future, the proceeds from borrowings or
other sources to pay distributions. It is possible that any distributions declared will be paid
from our cash on hand or future issuances of shares of our common stock or preferred stock, which would constitute a return of
capital to our stockholders. If we fund distributions from borrowings, sales of properties, future issuances of securities or cash
on hand, we will have fewer funds available for the acquisition of additional properties resulting in potentially fewer investments,
less diversification of our portfolio and a reduced overall return to our stockholders. In addition, the value of our shares of
common stock and preferred stock may be diluted because funds that would otherwise be available to make investments would be diverted
to fund distributions.
The market price of our common stock and existing preferred
stock could be materially and adversely affected by our level of cash distributions.
The market value of our common stock and existing
preferred stock is based primarily upon the market's perception of our growth potential and our current and potential future cash
distributions, whether from operations, sales or re-financings, and is secondarily based upon the real estate market value of our
underlying assets. For that reason, our stock may trade at prices that are higher or lower than our net asset value per share.
To the extent we retain operating cash flow for investment purposes, working capital reserves or other purposes, these retained
funds, while increasing the value of our underlying assets, may not correspondingly increase the market price of our stock. Our
failure to meet the market's expectations with regard to future earnings and cash distributions likely would materially and adversely
affect the market price of our common stock and existing preferred stock.
Future offerings of debt or preferred equity securities,
which may rank senior to our common stock and existing preferred stock, may materially and adversely affect the market price of
our common stock.
If we decide to issue debt securities in the
future, which would rank senior to our common stock and existing preferred stock, it is likely that they will be governed by an
indenture or other instrument containing covenants restricting our operating flexibility. Additionally, any preferred equity securities
or convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable
than those of our common stock and/or existing preferred stock and may result in dilution to owners of our common stock and existing
preferred stock. We and, indirectly, our stockholders will bear the cost of issuing and servicing such securities. Because our
decision to issue debt or preferred equity securities in any future offering will depend on market conditions and other factors
beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common
stock and existing preferred stock will bear the risk of our future offerings reducing the market price of our common stock and
existing preferred stock and diluting the value of their stock holdings in us.
We are an “emerging growth company” and we cannot
be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive
to investors.
We are an “emerging growth company,”
and we benefit from certain exemptions from various reporting requirements that are applicable to other public companies that are
not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation
requirements of Section 404 of the Sarbanes-Oxley Act, which may increase the risk that weaknesses or deficiencies in our internal
control over financial reporting go undetected, and reduced disclosure obligations regarding executive compensation in our periodic
reports and proxy statements, which may make it more difficult for investors and securities analysts to evaluate our company. In
addition, we have elected under the JOBS Act to delay adoption of new or revised accounting pronouncements applicable to public
companies until such pronouncements are made applicable to private companies. As a result of this election, our financial statements
may not be comparable to companies that comply with public company effective dates. If some investors find our common stock and
existing preferred stock less attractive as a result, there may be a less active trading market for our common stock and existing
preferred stock, and corresponding stock prices may be more volatile. We may take advantage of these reporting exemptions until
we are no longer an “emerging growth company,” which in certain circumstances could be up to five years.
Risks Related to Our Taxation as a REIT
Our failure to qualify or remain qualified as a REIT would
subject us to U.S. federal income tax and applicable state and local taxes, which would reduce the amount of cash available for
distribution to our stockholders and have significant adverse consequences on the market price of our common stock and existing
preferred stock.
We have been organized and we intend to operate
in a manner that will enable us to qualify as a REIT for U.S. federal income tax purposes commencing with our taxable year ended
December 31, 2017. We have not requested and do not intend to request a ruling from the Internal Revenue Service (the "Service")
that we qualify as a REIT, and the statements in this report are not binding on the Service or any court. Qualification as a REIT
involves the application of highly technical and complex Code provisions and regulations promulgated by the U.S. Treasury Department
thereunder ("Treasury Regulations") for which there are limited judicial and administrative interpretations. Accordingly,
we cannot provide assurance that we will qualify or remain qualified as a REIT.
To qualify as a REIT, we must meet, on an ongoing
basis, various tests regarding the nature and diversification of our assets and our income, the ownership of our outstanding stock,
and the amount of our distributions to stockholders. Our ability to satisfy these asset tests depends upon the characterization
and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain
independent appraisals. Our compliance with the REIT income and quarterly asset requirements also depends upon our ability to manage
successfully the composition of our income and assets on an ongoing basis. Moreover, new legislation, court decisions or administrative
guidance, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT.
Thus, while we intend to operate in a manner to qualify as a REIT, in view of the highly complex nature of the rules governing
REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances, we cannot
provide assurance that we will so qualify for any particular year. These considerations also might restrict the types of income
we can realize, or assets that we can acquire in the future.
If we fail to qualify as a REIT in any taxable
year, and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax, including
any applicable alternative minimum tax, on our taxable income at regular corporate rates. We will not be able to deduct distributions
to our stockholders in any year in which we fail to qualify, nor will we be required to make distributions to our stockholders.
In such a case, we might need to borrow money, sell assets, or reduce or even cease making distributions in order to pay our taxes.
Our payment of income tax would reduce significantly the amount of cash available for distribution to our stockholders. If we fail
to qualify as a REIT, all distributions to stockholders, to the extent of current and accumulated earnings and profits, will be
taxable to the stockholders as dividend income (which may be subject to tax at preferential rates) and corporate distributions
may be eligible for the dividends received deduction if they satisfy the relevant provisions of the Code. Furthermore, if we fail
to qualify as a REIT, we no longer would be required to distribute substantially all of our net taxable income to our stockholders.
In addition, unless we were eligible for certain statutory relief provisions, we could not re-elect to qualify as a REIT until
the fifth calendar year following the year in which we failed to qualify. We might not be entitled to the statutory relief described
in this paragraph in all circumstances.
The REIT distribution requirements could adversely affect
our ability to execute our business plan, require us to borrow funds during unfavorable market conditions or subject us to tax,
which would reduce the cash available for distribution to our stockholders.
To qualify as a REIT, we must distribute to
our stockholders, on an annual basis, at least 90% of our REIT taxable income, determined without regard to the deduction for dividends
paid and excluding net capital gain. In addition, we will be subject to U.S. federal income tax at regular corporate rates to the
extent that we distribute less than 100% of our net taxable income (including net capital gain) and will be subject to a 4% nondeductible
excise tax on the amount by which our distributions in any calendar year are less than a minimum amount specified under U.S. federal
income tax laws. We intend to distribute our net income to our stockholders in a manner intended to satisfy the REIT 90% distribution
requirement and to avoid U.S. federal income tax and the 4% nondeductible excise tax. However, we can provide no assurances that
we will have sufficient cash or other liquid assets to meet these requirements. Difficulties in meeting the distribution requirements
might arise due to competing demands for available funds or timing differences between tax reporting and cash receipts. In addition,
if the Service were to disallow certain of our deductions, such as employee salaries, depreciation or interest expense, by alleging
that we, through our rental agreements with our state-licensed medical cannabis tenants, are primarily or vicariously liable for
"trafficking" a Schedule 1 substance (cannabis) under Section 280E of the Code or otherwise, we would be unable to meet
the distribution requirements and would fail to qualify as a REIT. Likewise, if any governmental entity were to impose fines on
us for our business involvement in state-licensed medical-use cannabis, such fines would not be deductible and the inability to
deduct such fines could also cause us to be unable to satisfy the distribution requirement.
We may also generate less cash flow than taxable
income in a particular year. In such event, we may be required to use cash reserves, incur debt or liquidate assets at rates or
times that we regard as unfavorable or, to the extent possible, make a taxable distribution of our stock in order to satisfy the
REIT 90% distribution requirement and to avoid U.S. federal income tax and the 4% nondeductible excise tax in that year. Under
certain circumstances, we may be able to rectify a failure to meet the distribution requirement for a year by paying "deficiency
dividends" to stockholders in a later year, which may be included in our deduction for dividends paid for the earlier year.
Thus, we may be able to avoid being taxed on amounts distributed as deficiency dividends; however, we will be required to pay penalties
and interest based upon the amount of any deduction taken for deficiency dividends. If we do not have sufficient cash to distribute,
we may incur U.S. federal income tax, U.S. federal excise tax and/or our REIT status may be jeopardized.
If we are deemed to be subject to Section 280E of the Code
because of the business activities of our tenants, the resulting disallowance of tax deductions could cause us to incur U.S. federal
income tax and jeopardize our REIT status.
Section 280E of the Code provides that, with
respect to any taxpayer, no deduction or credit is allowed for expenses incurred during a taxable year "in carrying on any
trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in
controlled substances (within the meaning of Schedule I and II of the CSA) which is prohibited by federal law or the law of any
State in which such trade or business is conducted." Because cannabis is a Schedule I controlled substance under the CSA,
Section 280E by its terms applies to the purchase and sale of medical-use cannabis products. Although we will not be engaged in
the purchase, sale, growth, cultivation, harvesting, or processing of medical-use cannabis products, we will lease our properties
to tenants who will engage in such activities, and therefore our tenants will likely be subject to Section 280E. If the Service
were to take the position that, through our rental agreements with our state-licensed medical-use cannabis tenants, we are primarily
or vicariously liable under federal law for "trafficking" a Schedule 1 substance (cannabis) under section 280E of the
Code or for any other violations of the CSA, the Service may seek to apply the provisions of Section 280E to our company and disallow
certain tax deductions, including for employee salaries, depreciation or interest expense. If such tax deductions are disallowed,
we would be unable to meet the distribution requirements applicable to REITs under the Code, which could cause us to incur U.S.
federal income tax and fail to qualify as a REIT. Because we are not engaged in the purchase and/or sale of a controlled substance,
we do not believe that we will be subject to the disallowance provisions of Section 280E, and neither we nor our tax advisors are
aware of any tax court cases or guidance from the Service in which a taxpayer not engaged in the purchase or sale of a controlled
substance was disallowed deductions under Section 280E. However, there is no assurance that the Service will not take such a position
either currently or in the future.
Complying with REIT requirements may cause us to forego
otherwise attractive business opportunities or liquidate otherwise attractive investments.
To qualify as a REIT, we must ensure that we
meet the REIT gross income tests annually. In addition, we must ensure that, at the end of each calendar quarter, at least 75%
of the value of our total assets consists of cash, cash items, government securities and qualified REIT real estate assets, including
certain mortgage loans, certain kinds of mortgage-backed securities and certain securities issued by other REITs. The remainder
of our investment in securities (other than government securities, securities of corporations that are treated as TRSs, and qualified
REIT real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more
than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value
of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer,
no more than 25% (20% for taxable years beginning after December 31, 2017) of the value of our total securities can be represented
by securities of one or more TRSs, and, the aggregate value of debt instruments issued by public REITs held by us that are not
otherwise secured by real property may not exceed 25% of the value of our total assets. If we fail to comply with these asset requirements
at the end of any calendar quarter, we generally must correct the failure within 30 days after the end of the calendar quarter
or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences.
To meet these tests, we may be required to
take or forgo taking actions that we would otherwise consider advantageous. For instance, in order to satisfy the gross income
or asset tests applicable to REITs under the Code, we may be required to forego investments that we otherwise would make. Furthermore,
we may be required to liquidate from our portfolio otherwise attractive investments. In addition, we may be required to make distributions
to stockholders at disadvantageous times or when we do not have funds readily available for distribution. These actions could have
the effect of reducing our income and amounts available for distribution to our stockholders. Thus, compliance with the REIT requirements
may hinder our investment performance.
The tax on prohibited transactions could limit our ability
to engage in certain transactions or subject us to a 100% penalty tax.
We are subject to a 100% tax on any income
from a prohibited transaction. "Prohibited transactions" generally include sales or other dispositions of property (other
than property treated as foreclosure property under the Code) that is held as inventory or primarily for sale to customers in the
ordinary course of a trade or business by a REIT, either directly or indirectly through certain pass-through subsidiaries. Although
we do not intend to hold a significant amount of assets as inventory or primarily for sale to customers in the ordinary course
of our business, the characterization of an asset sale as a prohibited transaction depends on the particular facts and circumstances.
The Code provides a safe harbor that, if met, allows a REIT to avoid being treated as engaged in a prohibited transaction. It is
likely that we may sell certain properties that have not met all of the requirements of such safe harbor if we believe the transaction
would not be a prohibited transaction based on a facts and circumstances analysis. If the Service were to successfully argue that
such a sale was in fact a prohibited transaction, we would be subject to a 100% penalty tax with respect to such sale.
If we were considered to actually or constructively pay
a "preferential dividend" to certain of our stockholders, our status as a REIT could be adversely affected.
In order to qualify as a REIT, we must annually
distribute to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated in accordance
with GAAP), determined without regard to the deduction for dividends paid and excluding net capital gain. In order for distributions
to be counted as satisfying the annual distribution requirements for REITs, and to provide us with a REIT-level tax deduction,
the distributions must not be "preferential dividends." A dividend is not a preferential dividend if the distribution
is pro rata among all outstanding shares of stock within a particular class, and in accordance with the preferences among different
classes of stock as set forth in our organizational documents. Currently, there is uncertainty as to the Service's position regarding
whether certain arrangements that REITs have with their stockholders could give rise to the inadvertent payment of a preferential
dividend (e.g., the pricing methodology for stock purchased under a distribution reinvestment program inadvertently causing a greater
than 5% discount on the price of such stock purchased). There is no de minimis exception with respect to preferential dividends;
therefore, if the Service were to take the position that we inadvertently paid a preferential dividend, we may be deemed to have
failed the 90% distribution test, and our status as a REIT could be terminated for the year in which such determination is made
if we were unable to cure such failure. While we believe that our operations will be structured in such a manner that we will not
be treated as inadvertently paying preferential dividends, we can provide no assurance to this effect.
The "preferential dividend" prohibition
described above does not apply to a "publicly offered REIT," which generally is a REIT that is required to make regular
filings with the SEC under the Exchange Act. While we intend to qualify as a "publicly offered REIT" and therefore expect
that the preferential dividend prohibition will not apply to us, we cannot provide you with assurance that we will so qualify and,
accordingly, we may be subject to the prohibition.
The ability of our board of directors to revoke our REIT
election without stockholder approval may cause adverse consequences to our stockholders.
Our charter provides that the board of directors
may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if the board of directors determines
that it is no longer in our best interest to attempt to, or continue to, qualify as a REIT. If we cease to qualify as a REIT, we
would become subject to U.S. federal income tax on our net taxable income and we generally would no longer be required to distribute
any of our net taxable income to our stockholders, which may have adverse consequences on our total return to our stockholders.
Dividends payable by REITs do not qualify for the reduced
tax rates on dividend income from regular corporations, which could adversely affect the value of our common stock.
The maximum U.S. federal income tax rate for
certain qualified dividends payable to U.S. stockholders that are individuals, trusts and estates is 20%. Dividends (other than
capital gain dividends) payable by REITs, however, generally are not eligible for the reduced rates. Although the reduced U.S.
federal income tax rate applicable to dividend income from regular corporate dividends does not adversely affect the taxation of
REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate dividends could cause investors who
are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks
of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of our common stock.
Complying with REIT requirements may limit our ability to
hedge our liabilities effectively and may cause us to incur tax liabilities.
The REIT provisions of the Code may limit our
ability to hedge our liabilities. Any income from a hedging transaction we enter into to manage risk of interest rate changes,
price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets, if
properly identified under applicable Treasury Regulations, does not constitute "gross income" for purposes of the 75%
or 95% gross income tests. To the extent that we enter into other types of hedging transactions, the income from those transactions
will likely be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, we
may need to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost
of our hedging activities because our TRSs would be subject to tax on gains or expose us to greater risks associated with changes
in interest rates than we would otherwise want to bear. In addition, losses in a TRS generally will not provide any tax benefit,
except for being carried forward against future taxable income of such TRS.
Non-U.S. stockholders will generally be subject to withholding
tax with respect to our ordinary dividends.
Non-U.S. stockholders generally will be
subject to U.S. federal withholding tax on ordinary dividends received from us at a 30% rate, subject to reduction under an applicable
treaty or a statutory exemption under the Code.
Legislative, regulatory or administrative
changes could adversely affect us or our stockholders.
At any time, the U.S. federal income tax laws
or Treasury Regulations governing REITs or the administrative interpretations of those laws or regulations may be changed, possibly
with retroactive effect, and may adversely affect us and our stockholders. We cannot predict if or when any new U.S. federal income
tax law, regulation or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation
or administrative interpretation, will be adopted, promulgated or become effective or whether any such law, regulation or interpretation
may take effect retroactively.
It is unclear at this time what impact
the recent rescission of the Cole Memo by U.S. Attorney General Jeff Sessions may have on our ability to qualify as a REIT. If
rescission of the Cole Memo is followed by strict enforcement of federal prohibitions regarding cannabis, the Service could seek to apply the provisions of Section 280E of the Code to our company. Section 280E of the Code provides that,
with respect to any taxpayer, no deduction or credit is allowed for expenses incurred during a taxable year “in carrying
on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking
in controlled substances (within the meaning of Schedule I and II of the CSA) which is prohibited by federal law or the law of
any State in which such trade or business is conducted.” Because cannabis is a Schedule I controlled substance under the
CSA, Section 280E of the Code by its terms applies to the purchase and sale of medical-use cannabis products. If the Service were to take the position that, through our rental agreements with our state-licensed medical-use cannabis tenants, we
are primarily or vicariously liable under federal law for “trafficking” a Schedule 1 substance (cannabis) under Section
280E of the Code or for any other violations of the CSA, the Service may apply the provisions of Section 280E
of the Code to our company and disallow certain tax deductions, including for employee salaries, depreciation or interest expense.
If such tax deductions are disallowed, we would be unable to meet the distribution requirements applicable to REITs under the Code,
which could cause us to incur U.S. federal income tax and fail to qualify as a REIT.
In addition, tax legislation originally introduced
as the Tax Cuts and Jobs Act and signed into law in December 2017 (the “TCJA”) makes numerous changes to the tax rules
that do not affect the REIT qualification rules directly, but may otherwise affect us or our stockholders. Among the changes made
by the TCJA are permanently reducing the generally applicable corporate tax rate, generally reducing the tax rate applicable to
individuals and other non-corporate taxpayers for tax years beginning after December 31, 2017 and before January 1, 2026, eliminating
or modifying certain previously allowed deductions (including substantially limiting interest deductibility and, for individuals,
the deduction for non-business state and local taxes), and, for taxable years beginning after December 31, 2017 and before January
1, 2026, providing for preferential rates of taxation through a deduction of up to 20% (subject to certain limitations) on most
ordinary REIT dividends and certain trade or business income of non-corporate taxpayers. The TCJA also imposes new limitations
on the deduction of net operating losses, which may result in us having to make additional taxable distributions to our stockholders
in order to comply with REIT distribution requirements or avoid taxes on retained income and gains. The effect of the significant
changes made by the TCJA is highly uncertain, and administrative guidance will be required in order to fully evaluate the effect
of many provisions. The effect of any technical corrections with respect to the TCJA could have an adverse effect on us or our
stockholders.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
PROPERTIES
As of December 31, 2017, we owned the
following five properties, which were 100% leased with a weighted-average remaining lease term of approximately 14.7 years:
Property
|
|
Market
|
|
Closing Date
|
|
Rentable
Square Feet
(1)
|
|
|
Investment
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
PharmaCann NY
|
|
New York
|
|
December 19, 2016
|
|
|
127,000
|
|
|
$
|
30,000
|
|
Holistic MD
|
|
Maryland
|
|
May 26, 2017
|
|
|
72,000
|
|
|
|
16,900
|
(2)
|
Vireo NY
|
|
New York
|
|
October 23, 2017
|
|
|
40,000
|
|
|
|
3,400
|
(3)
|
Vireo MN
|
|
Minnesota
|
|
November 8, 2017
|
|
|
20,000
|
|
|
|
3,000
|
(3)
|
Pharm AZ
|
|
Arizona
|
|
December 15, 2017
|
|
|
358,000
|
|
|
|
15,000
|
(4)
|
Total
|
|
|
|
|
|
|
617,000
|
|
|
$
|
68,300
|
|
|
(1)
|
Rentable square feet at time of acquisition.
|
|
(2)
|
Includes total purchase price of $11.0 million and tenant improvement allowance of $5.9 million, which was fully funded as
of December 31, 2017.
|
|
(3)
|
Excludes tenant improvement allowance of $1.0 million for each property, of which no amount was funded for either property
as of December 31, 2017.
|
|
(4)
|
Excludes tenant improvement allowance of $3.0 million, of which no amount was funded as of December 31, 2017.
|
See Item 1. "Business — Our Properties"
for more information about our properties.
ITEM 3
.
LEGAL PROCEEDINGS
We may,
from time to time, be a party to legal proceedings, which arise in the ordinary course of our business. We are not aware of any
pending or threatened litigation that, if resolved against us, would have a material adverse effect on our consolidated financial
position, results of operations or cash flows.
ITEM 4
.
MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5
.
MARKET FOR REGISTRANT'S
COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information.
Our common stock began trading on the New York
Stock Exchange under the symbol "IIPR" on December 1, 2016. On March 28, 2018, the closing price of our common stock
reported on the New York Stock Exchange was $26.32 per share. The high and low common stock sales prices per share during the
periods indicated were as follows:
Price per share of common
stock(1):
|
|
Quarter Ended
|
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Mar. 31
|
|
|
June 30
|
|
|
Sept. 30
|
|
|
Dec. 31
|
|
|
Year
|
|
Fiscal year 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High
|
|
$
|
19.94
|
|
|
$
|
18.95
|
|
|
$
|
18.86
|
|
|
$
|
32.52
|
|
|
$
|
32.52
|
|
Low
|
|
$
|
15.45
|
|
|
$
|
16.54
|
|
|
$
|
15.72
|
|
|
$
|
17.94
|
|
|
$
|
15.45
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal year 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High
|
|
|
$ N/A
|
|
|
|
$ N/A
|
|
|
|
$ N/A
|
|
|
$
|
20.52
|
|
|
$
|
20.52
|
|
Low
|
|
|
$ N/A
|
|
|
|
$ N/A
|
|
|
|
$ N/A
|
|
|
$
|
15.45
|
|
|
$
|
15.45
|
|
|
(1)
|
Our shares began trading on December 1, 2016, and we completed the initial public offering
of shares of our common stock on December 5, 2016.
|
Approximate Number of Holders of Our Common Shares
As of March 28, 2018 there were 11
holders of record of our common shares. This number excludes our common shares owned by stockholders holding under nominee
security position listings.
Distribution Information
We intend to elect and qualify to be treated
as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2017. U.S. federal income tax
law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, determined without regard to the
deduction for dividends paid and excluding net capital gain (which does not equal net income as calculated in accordance with GAAP),
and that it pay U.S. federal income tax at regular corporate rates to the extent that it annually distributes less than 100% of
its taxable income.
As of March 28, 2018, we have declared and
paid the following distributions to stockholders:
Declaration Date
|
|
Security Class
|
|
Amount
Per Share
|
|
|
Period Covered
|
|
Dividend Payable
Date
|
|
Dividend
Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
May 30, 2017
|
|
Common stock
|
|
$
|
0.15
|
|
|
April 1, 2017 to June 30, 2017
|
|
July 14, 2017
|
|
$
|
525
|
|
September 15, 2017
|
|
Common stock
|
|
$
|
0.15
|
|
|
July 1, 2017 to September 30, 2017
|
|
October 13, 2017
|
|
$
|
525
|
|
December 15, 2017
|
|
Common stock
|
|
$
|
0.25
|
|
|
October 1, 2017 to December 31, 2017
|
|
January 16, 2018
|
|
$
|
875
|
|
December 15, 2017
|
|
Series A preferred stock
|
|
$
|
0.5375
|
|
|
October 19, 2017 to January 14, 2018
|
|
January 16, 2018
|
|
$
|
323
|
|
To satisfy the requirements to qualify as a
REIT and generally not be subject to U.S. federal income tax, we intend to make quarterly distributions of all or substantially
all of our taxable income to holders of our common stock out of assets legally available therefor. However, we cannot assure you
that distributions will be made or sustained. Any distributions we make will be at the direction of our board of directors and
will depend upon a number of factors, including our actual results of operations, economic conditions, maintenance of REIT qualification
and the applicable provisions of the MGCL and such other factors as our board may determine in its sole discretion.
Our organizational documents permit us to make
distributions from any source. If our cash available for distribution is insufficient to cover our distributions, we expect to
use the proceeds from our initial public offering, the proceeds from the issuance of securities in the future, the proceeds from
borrowings or other sources to pay distributions. During our initial years of operation, we expect that a portion of our distributions
declared may be paid from offering proceeds, which would constitute a return of capital to our stockholders.
We anticipate that our distributions generally
will be taxable as ordinary income to our stockholders, although a portion of the distributions may be designated by us as qualified
dividend income or capital gain or may constitute a return of capital. We will furnish annually to each of our stockholders a statement
setting forth distributions paid during the preceding year and their characterization as ordinary income, return of capital, qualified
dividend income or capital gain.
Use of Proceeds from Registered Securities
On November 30, 2016, our registration statement
on Form S-11/A (File No. 333-214148) was declared effective for our initial public offering, pursuant to which we registered and
sold 3,350,000 shares of Class A common stock at a public offering price of $20.00 per share, resulting in net proceeds to the
Company of approximately $61.1 million after deducting underwriting discounts and commissions and our offering expenses.
As of December 31, 2017, we had deployed
all of the net proceeds from our initial public offering, as follows: (1) approximately $30.1 million (including transaction costs)
of the net proceeds have been used to acquire our property in New York from PharmaCann LLC; (2) approximately $17.1 million (including
transaction costs) of the net proceeds have been used to acquire our property in Maryland and reimburse the seller for certain
development costs and tenant improvements; (3) approximately $4.5 million (including estimated transaction costs) of the net proceeds
have been used to acquire our property in New York from a subsidiary of Vireo Health, LLC, including $1.0 million made available
to the tenant to fund future tenant improvements at the property; (4) approximately $4.1 million (including estimated transaction
costs) of the net proceeds have been used to acquire our property in Minnesota from a subsidiary of Vireo Health, LLC, including
$1.0 million made available to the tenant to fund future tenant improvements at the property; and (5) the remaining balance of
approximately $5.3 million of the net proceeds have been used to fund part of the purchase price for our acquisition of a property
in Arizona from an affiliate of The Pharm, LLC.
ITEM 6.
SELECTED FINANCIAL DATA
Not applicable.
ITEM 7
.
MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read
in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. We make statements
in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion
of forward-looking statements, see the section above entitled "Cautionary Statement Regarding Forward-Looking Statements."
Certain risk factors may cause our actual results, performance or achievements to differ materially from those expressed or implied
by the following discussion. For a discussion of such risk factors, see Item 1A, "Risk Factors."
Overview
We are a self-advised Maryland corporation
focused on the acquisition, ownership and management of specialized industrial properties leased to experienced, state-licensed
operators for their regulated medical-use cannabis facilities. We have acquired and intend to continue to acquire our properties
through sale-leaseback transactions and third-party purchases. We lease and expect to continue to lease our properties on a triple-net
lease basis, where the tenant is responsible for all aspects of and costs related to the property and its operation during the
lease term, including structural repairs, maintenance, taxes and insurance.
We were incorporated in Maryland on June 15,
2016, and we intend to elect and to operate our business so as to qualify to be taxed as a REIT for U.S. federal income tax purposes,
beginning with our taxable year ended December 31, 2017. We conduct our business through a traditional umbrella partnership real
estate investment trust, or UPREIT structure, in which our properties are owned by our Operating Partnership, directly or through
subsidiaries. We are the sole general partner of our Operating Partnership and own, directly or through a subsidiary, 100% of the
limited partnership interests in our Operating Partnership.
As of December 31, 2017, we owned five properties located in New
York, Maryland, Arizona and Minnesota, totaling approximately 617,000 rentable square feet, which were 100% leased with weighted-average
remaining lease term of approximately 14.7 years. As of December 31, 2017, we had invested $68.3 million in the aggregate (excluding
transaction costs) and had committed an additional $5.0 million to reimburse certain tenants for future tenant improvements at
our properties. Our average initial yield on invested capital is approximately 15.8% for these five properties, calculated as the
sum of the initial base rents, supplemental rent (with respect to the lease at our PharmaCann NY Property) and property management
fees, after the expiration of the base rent abatement period (with respect to the lease at our Pharm AZ Property), divided by our
aggregate investment in these properties (excluding transaction costs and including aggregate potential tenant reimbursements of
$5.0 million).
Emerging Growth Company
We have elected to be an emerging growth company,
as defined in the JOBS Act. An emerging growth company may take advantage of specified reduced reporting requirements and is relieved
of certain other significant requirements that are otherwise generally applicable to public companies. As an emerging growth company,
among other things:
|
·
|
we are exempt from the requirement to obtain an attestation and report
from our auditors on the assessment of our internal control over financial reporting pursuant to the Sarbanes-Oxley Act;
|
|
·
|
we are permitted to provide less extensive disclosure about our executive
compensation arrangements;
|
|
·
|
we are not required to give our stockholders non-binding advisory
votes on executive compensation or golden parachute arrangements; and
|
|
·
|
we have elected to use an extended transition period for complying
with new or revised accounting standards.
|
We may take advantage of the other provisions
for up to five years or such earlier time that we are no longer an emerging growth company. We will cease to be an emerging growth
company upon the earliest to occur of: (i) the last day of the first fiscal year in which our annual gross revenues exceed $1.07
billion, (ii) the date that we become a "large accelerated filer" as defined in Rule 12b-2 under the Exchange Act, which
would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business
day of our most recently completed second fiscal quarter, or (iii) the date on which we have issued more than $1 billion in non-convertible
debt during the preceding three-year period.
Factors Impacting Our Operating Results
Our results of operations are affected by a
number of factors and depend on the rental revenue we receive from the properties that we acquire, the timing of lease expirations,
general market conditions, the regulatory environment in the medical-use cannabis industry, and the competitive environment for
real estate assets that support the regulated medical-use cannabis industry.
Rental Revenues
We receive income primarily from rental revenue
generated by the properties that we acquire. The amount of rental revenue depends upon a number of factors, including:
|
·
|
our ability to enter into leases with increasing or market value rents
for the properties that we acquire; and
|
|
·
|
rent collection, which primarily relates to each of our future tenant's
financial condition and ability to make rent payments to us on time.
|
The properties that we acquire consist of real
estate assets that support the regulated medical-use cannabis industry. Changes in current favorable state or local laws in the
cannabis industry may impair our ability to renew or re-lease properties and the ability of our tenants to fulfill their lease
obligations and could materially and adversely affect our ability to maintain or increase rental rates for our properties.
Conditions in Our Markets
Positive or negative changes in regulatory,
economic or other conditions, and natural disasters in the markets where we acquire properties may affect our overall financial
performance.
Competitive Environment
We face competition from a diverse mix of market
participants, including but not limited to, other companies with similar business models, independent investors, hedge funds and
other real estate investors, hard money lenders, as well as would be clients, cannabis operators themselves, all of whom may compete
with us in our efforts to acquire real estate zoned for cannabis cultivation and production operations. Competition from others
may diminish our opportunities to acquire a desired property on favorable terms or at all. In addition, this competition may put
pressure on us to reduce the rental rates below those that we expect to charge for the properties that we acquire, which would
adversely affect our financial results.
Operating Expenses
Our operating expenses include general and
administrative expenses, including personnel costs, legal, accounting, and other expenses related to corporate governance, public
reporting and compliance with the various provisions of U.S. securities laws. We generally expect to structure our leases so that
the tenant is responsible for taxes, maintenance, insurance, and structural repairs with respect to the premises throughout the
lease term. Increases or decreases in such operating expenses will impact our overall financial performance.
Our Qualification as a REIT
We have been organized and we intend to elect,
and to operate our business so as to qualify, to be taxed as a REIT, for U.S. federal income tax purposes, commencing with our
taxable year ended December 31, 2017. Shares of our common stock are subject to restrictions on ownership and transfer that are
intended, among other purposes, to assist us in qualifying and maintaining our qualification as a REIT. In order for us to qualify
as a REIT under the Code, the relevant sections of our charter provide that, subject to certain exceptions, no person or entity
may own, or be deemed to own, by virtue of the applicable constructive ownership provisions of the Code, more than 9.8% (in value
or number of shares, whichever is more restrictive) of the aggregate of our outstanding shares of stock or more than 9.8% (in value
or number of shares, whichever is more restrictive) of our outstanding common stock or any class or series of our outstanding preferred
stock.
Results of Operations
We were formed on June 15, 2016. We commenced
active real estate operations in December 2016 with the acquisition of our PharmaCann NY Property. During the year ended December
31, 2017, we acquired four properties totaling approximately 490,000 rentable square feet for approximately $38.3 million, excluding
transaction costs:
Property
|
|
Market
|
|
Closing Date
|
|
Rentable
Square Feet
(1)
|
|
|
Investment
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
Holistic MD
|
|
Maryland
|
|
May 26, 2017
|
|
|
72,000
|
|
|
$
|
16,900
|
(2)
|
Vireo NY
|
|
New York
|
|
October 23, 2017
|
|
|
40,000
|
|
|
|
3,400
|
(3)
|
Vireo MN
|
|
Minnesota
|
|
November 8, 2017
|
|
|
20,000
|
|
|
|
3,000
|
(3)
|
The Pharm AZ
|
|
Arizona
|
|
December 15, 2017
|
|
|
358,000
|
|
|
|
15,000
|
(4)
|
Total
|
|
|
|
|
|
|
490,000
|
|
|
$
|
38,300
|
|
|
(1)
|
Rentable square feet at time of acquisition.
|
|
(2)
|
Includes total purchase price of $11.0 million and tenant improvement allowance of $5.9 million, which was fully funded as
of December 31, 2017.
|
|
(3)
|
Excludes tenant improvement allowance of $1.0 million for each property, of which no amount was funded for either property
as of December 31, 2017.
|
|
(4)
|
Excludes tenant improvement allowance of $3.0 million, of which no amount was funded as of December 31, 2017.
|
Comparison of the Year Ended December
31, 2017 and the Period from June 15, 2016 (date of incorporation) through December 31, 2016
As a result of the timing of our formation
in June 2016, and the initial public offering and commencement of real estate operations with the acquisition of our first property
in December 2016, comparative operating results are not relevant to a discussion of operations for the year ended December 31,
2017 and the period from June 15, 2016 (date of incorporation) through December 31, 2016. We expect revenue and expenses to increase
in future periods as we acquire additional properties. The following table sets forth the results of our operations (in thousands):
|
|
Year Ended
December 31,
2017
|
|
|
Period from
June 15, 2016
(date
of
incorporation)
through
December 31,
2016
|
|
Revenues:
|
|
|
|
|
|
|
|
|
Rental
|
|
$
|
6,302
|
|
|
$
|
180
|
|
Tenant reimbursements
|
|
|
118
|
|
|
|
87
|
|
Total revenues
|
|
|
6,420
|
|
|
|
267
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
Property expenses
|
|
|
118
|
|
|
|
87
|
|
General and administrative expense
|
|
|
5,497
|
|
|
|
828
|
|
Severance
|
|
|
113
|
|
|
|
—
|
|
Forfeited Class B common shares
|
|
|
—
|
|
|
|
3,707
|
|
Organization costs
|
|
|
—
|
|
|
|
64
|
|
Depreciation expense
|
|
|
915
|
|
|
|
27
|
|
Total expenses
|
|
|
6,643
|
|
|
|
4,713
|
|
Loss from operations
|
|
|
(223
|
)
|
|
|
(4,446
|
)
|
Interest income
|
|
|
151
|
|
|
|
54
|
|
Net loss
|
|
|
(72
|
)
|
|
|
(4,392
|
)
|
Preferred stock dividend
|
|
|
323
|
|
|
|
—
|
|
Net loss attributable to common stockholders
|
|
$
|
(395
|
)
|
|
$
|
(4,392
|
)
|
Revenues
.
Rental
. Our rental revenues related to rent and property
management fees generated from leases at one property that we acquired in December 2016 and four properties that we acquired in
2017.
Tenant Reimbursements
. Tenant reimbursements related to reimbursements
by tenants for property insurance premiums paid at certain properties.
Expenses
.
Property Expenses
. Property expenses related to property
insurance premiums at certain of our properties, which were reimbursed by the tenants.
General and Administrative Expense
. General and administrative
expense for the year ended December 31, 2017 was primarily related to compensation and occupancy costs for our employees and corporate
office. Compensation expense for the year ended December 31, 2017 included approximately $1.7 million in non-cash stock-based compensation.
Stock-based compensation for equity awards is based on the grant date fair value of restricted stock that was granted to certain
of our employees and non-employee members of our board of directors during 2016 and during the year ended December 31, 2017, which
is recognized over the requisite service period.
General and administrative expense for the period from June 15,
2016 (date of incorporation) through December 31, 2016 was approximately $828,000, of which approximately $566,000 was related
to consulting services provided by IGP Advisers LLC, a company that was owned by certain of our officers, in connection with our
initial public offering, and approximately $262,000 was for compensation and occupancy costs related to our employees and corporate
office. Compensation expense for the period from June 15, 2016 (date of incorporation) through December 31, 2016 included approximately
$58,000 in non-cash stock-based compensation.
Severance
. During the year ended December 31, 2017, we incurred
$113,000 in severance expense related to the cessation of employment of one of our executive officers in June 2017.
Forfeited Class B Common Shares.
We recognized non-cash stock-based
compensation expense of approximately $3.7 million for the period from June 15, 2016 (date of incorporation) through December 31,
2016, related to the issuance of Class B common stock to our founders at $0.001 per share (par value) and subsequent redemption
of all such shares of Class B common stock by us for $0.001 per share (par value) immediately prior to the completion of our initial
public offering in December 2016. We estimated the fair value of these shares at the June 15, 2016 grant date and at subsequent
modification dates using a Monte Carlo simulation model. The fair value calculation was primarily based on management's estimates
of the probability of its initial public offering and the estimated proceeds of such offering. As a result of the redemption of
all shares of Class B common stock, although GAAP requires that we record this non-cash stock-based compensation expense, none
of the founders received any value from their purchase of the shares of Class B common stock, as all such shares of Class B common
stock were redeemed by us at the original purchase price prior to our initial public offering.
Organization Costs.
Organization costs for the period from
June 15, 2016 (date of incorporation) through December 31, 2016 were primarily costs related to our formation.
Depreciation Expense.
Depreciation expense related to depreciation
on our buildings and tenant improvements at our properties.
Interest Income
. Interest income primarily related to a credit
received relating to our banking accounts in 2016 and interest earned on our cash and cash equivalents.
Preferred Stock Dividend
. In October 2017, we completed our
public offering of 600,000 shares of Series A Preferred Stock. Preferred stock dividend relates to the pro rata dividend that we
paid on January 16, 2018 to our Series A Preferred stockholders of record as of December 29, 2017, for the period from and including
the original issue date to and including January 14, 2018.
Liquidity and Capital Resources
Liquidity is a measure of our ability to meet
potential cash requirements. We expect to use significant cash to acquire our target properties, pay dividends to our stockholders,
fund our operations, and meet other general business needs.
Sources and Uses of Cash
We derive all of our revenues from the leasing
of our properties, collecting rental income and operating expense reimbursements based on contractual arrangements with our tenants.
This source of revenue represents our primary source of liquidity to fund our dividends, general and administrative expenses, property
operating expenses and other expenses incurred related to managing our existing portfolio and investing in additional properties.
To the extent additional resources are needed, we expect to fund our investment activity generally through equity or debt issuances
either in the public or private markets. Where possible, we also may issue limited partnership interests in our Operating Partnership
to acquire properties from existing owners seeking a tax-deferred transaction.
On December 5, 2016, we completed our initial
public offering of 3,350,000 shares of our common stock at a public offering price of $20.00 per share. We received net proceeds
of approximately $61.1 million from the offering.
On October 19, 2017, we issued 600,000 shares
of our 9.00% Series A Cumulative Redeemable Preferred Stock in a public offering, resulting in net proceeds of approximately $14.0
million, after deducting the underwriters' discounts and commissions and offering expenses.
On January 22, 2018, we issued 3,220,000 shares
of common stock in a public offering, including the exercise in full of the underwriters' option to purchase an additional 420,000
shares, resulting in net proceeds of approximately $79.3 million, after deducting the underwriters' discounts and commissions and
offering expenses.
On December 1, 2017, we filed a shelf registration
statement, which was subsequently declared effective by the SEC, which may permit us, from time to time, to offer and sell common
stock, preferred stock, warrants and other securities to the extent necessary or advisable to meet our liquidity needs.
We expect to meet our liquidity needs through
cash on hand, cash flows from operations and cash flows from sources discussed above. We believe that our liquidity and sources
of capital are adequate to satisfy our cash requirements. We cannot, however, be certain that these sources of funds will be available
at a time and upon terms acceptable to the Company in sufficient amounts to meet its liquidity needs. Our investment guidelines
also provide that our aggregate borrowings (secured and unsecured) will not exceed 50% of the cost of our tangible assets at the
time of any new borrowing, subject to our board of directors' discretion.
Operating Activities
Cash flows provided by operating activities for
the year ended December 31, 2017 were approximately $5.0 million. Cash flows provided by operating activities were generally
provided by contractual rent and security deposits from our properties, partially offset by costs of operating our properties.
Cash flows provided by operating activities for the period
from June 15, 2016 (date of incorporation) through December 31, 2016 were approximately $1.7 million. Cash flows provided
by operating activities were generally provided by contractual rent and security deposits from our PharmaCann NY Property, partially
offset by costs of operating the property.
Investing Activities
Cash flows used in investing activities for
the year ended December 31, 2017 were approximately $38.6 million, relating to the purchases of four properties in 2017 and
the subsequent funding of certain tenant improvements at one of those properties. Our investments in the properties were funded
from the net proceeds of our initial public offering and part of the net proceeds from our Series A Preferred Stock offering.
Cash flows used in investing activities for the period from
June 15, 2016 (date of incorporation) through December 31, 2016 were approximately $30.0 million, for the purchase of our
PharmaCann NY Property. Our investment in the PharmaCann NY Property was funded from the net proceeds of our initial public offering.
Financing Activities
Cash flows provided by financing activities for
the year ended December 31, 2017 were approximately $12.4 million, primarily related to approximately $14.0 million in net
proceeds from our preferred stock offering, partially offset by approximately $1.1 million in dividend payments to holders of our
common stock and Series A Preferred Stock, approximately $276,000 in costs incurred relating to our initial public offering and
approximately $298,000 in withholding taxes paid by us related to net share settlement of restricted stock awards that vested for
certain employees.
Cash flows provided by financing activities for the period
from June 15, 2016 (date of incorporation) through December 31, 2016 were approximately $61.3 million. In December 2016, the
Company completed its initial public offering and received net proceeds of approximately $61.1 million, after deducting the underwriters'
discounts and commissions and offering expenses, including expenses subsequently paid in January 2017. See Note 3 to the Consolidated
Financial Statements for more details.
Dividends
The Company is required to pay dividends to
its stockholders at least equal to 90% of its taxable income in order to qualify and maintain its qualification as a REIT. As a
result of this distribution requirement, our Operating Partnership cannot rely on retained earnings to fund its ongoing operations
to the same extent that other companies whose parent companies are not REITs can. During 2017, the Company declared cash dividends
on its common stock equal to $0.15 per share, $0.15 per share and $0.25 per share on May 30, 2017, September 15, 2017 and December
15, 2017, respectively, and a cash dividend on its Series A Preferred Stock of $0.5375 per share on December 15, 2017. Our ability
to continue to pay dividends is dependent upon our ability to continue to generate cash flows and make accretive new investments.
Funds from Operations and Adjusted Funds from Operations
Funds from operations (“FFO”) and
FFO per share are operating performance measures adopted by the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”).
NAREIT defines FFO as the most commonly accepted and reported measure of a REIT’s operating performance equal to “net
income (computed in accordance with GAAP), excluding gains (or losses) from sales of property, plus depreciation and amortization
related to real estate properties, and after adjustments for unconsolidated partnerships and joint ventures.”
Management believes that net income (loss),
as defined by GAAP, is the most appropriate earnings measurement. However, management believes FFO and FFO per share to be supplemental
measures of a REIT’s performance because they provide an understanding of the operating performance of our properties without
giving effect to certain significant non-cash items, primarily depreciation expense. Historical cost accounting for real estate
assets in accordance with GAAP assumes that the value of real estate assets diminishes predictably over time. However, real estate
values instead have historically risen or fallen with market conditions. We believe that by excluding the effect of depreciation,
FFO and FFO per share can facilitate comparisons of operating performance between periods. We report FFO and FFO per share because
these measures are observed by management to also be the predominant measures used by the REIT industry and by industry analysts
to evaluate REITs and because FFO per share is consistently reported, discussed, and compared by research analysts in their notes
and publications about REITs. For these reasons, management has deemed it appropriate to disclose and discuss FFO and FFO per share.
Management believes that adjusted funds from
operations (“AFFO”) and AFFO per share are also appropriate supplemental measures of a REIT’s operating performance.
We calculate AFFO by adding to FFO certain non-cash expenses, consisting of non-cash stock-based compensation expense, severance
expense and forfeited Class B common shares.
Our computation of FFO and AFFO may differ
from the methodology for calculating FFO and AFFO utilized by other equity REITs and, accordingly, may not be comparable to such
REITs. Further, FFO and AFFO do not represent cash flow available for management's discretionary use. FFO and AFFO should not be
considered as an alternative to net income (loss) (computed in accordance with GAAP) as an indicator of our financial performance
or to cash flow from operating activities (computed in accordance with GAAP) as an indicator of our liquidity, nor is it indicative
of funds available to fund our cash needs, including our ability to pay dividends or make distributions. FFO and AFFO should be
considered only as supplements to net income computed in accordance with GAAP as measures of operations.
The table below is a reconciliation of net
loss to FFO and AFFO for the year ended December 31, 2017 and period from June 15, 2016 (date of incorporation) through December
31, 2016. Included in our net loss for the period from June 15, 2016 (date of incorporation) through December 31, 2016 was approximately
$3.7 million, or $3.85 per common share (basic and diluted), of noncash forfeited Class B common shares, related to the issuance
of Class B common stock to our founders at $0.001 per share (par value) and subsequent redemption of all such shares of Class B
common stock by us for $0.001 per share (par value) immediately prior to the completion of our initial public offering in December
2016. As a result of the redemption of all shares of Class B common stock, although GAAP requires that we record this as stock-based
compensation expense, none of the founders received any value from their purchase of the shares of Class B common stock, as all
such shares of Class B common stock were redeemed by us at the original purchase price prior to our initial public offering.
|
|
Year Ended
December 31,
|
|
|
For the Period
June 15, 2016
(date of
incorporation)
through
December 31,
|
|
(In thousands, except share and per share amounts)
|
|
2017
|
|
|
2016
|
|
Net loss attributable to common stockholders
|
|
$
|
(395
|
)
|
|
$
|
(4,392
|
)
|
Real estate depreciation
|
|
|
915
|
|
|
|
27
|
|
FFO available to common stockholders
|
|
$
|
520
|
|
|
$
|
(4,365
|
)
|
Stock-based compensation
|
|
|
1,719
|
|
|
|
58
|
|
Forfeited Class B common shares
|
|
|
—
|
|
|
|
3,707
|
|
Severance
|
|
|
113
|
|
|
|
—
|
|
AFFO available to common stockholders
|
|
$
|
2,352
|
|
|
$
|
(600
|
)
|
FFO per common share – basic and diluted
|
|
$
|
0.15
|
|
|
$
|
(4.53
|
)
|
AFFO per common share – basic
|
|
$
|
0.70
|
|
|
$
|
(0.62
|
)
|
AFFO per common share – diluted
|
|
$
|
0.67
|
|
|
$
|
(0.62
|
)
|
Weighted-average common shares outstanding – basic
|
|
|
3,375,284
|
|
|
|
962,775
|
|
Weighted-average common shares outstanding – diluted
|
|
|
3,507,145
|
|
|
|
962,775
|
|
Critical Accounting Policies
Our consolidated financial statements have
been prepared in accordance with GAAP, which require us to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting periods. Actual results could differ materially from those estimates
and assumptions. Set forth below is a summary of our accounting policies that we believe are critical to the preparation of our
consolidated financial statements. Our accounting policies are more fully discussed in Note 2 to the consolidated financial statements.
Acquisition of Rental Property, Depreciation and Impairment
In order to prepare our consolidated financial
statements according to the rules and guidelines set forth by GAAP, many subjective judgments must be made with regard to critical
accounting policies. One of these judgments is our estimate for useful lives in determining depreciation expense for our properties.
We depreciate each of our buildings and improvements over its estimated remaining useful life, not to exceed 35 years. We depreciate
tenant improvements at our buildings over the shorter of the estimated useful lives or the terms of the related leases. If we use
a shorter or longer estimated useful life, it could have a material impact on our consolidated results of operations.
Management must make significant assumptions
in determining the fair value of assets acquired and liabilities assumed. Upon acquisition of property, we allocate the purchase
price based upon the relative fair values of all assets acquired and liabilities assumed. For transactions that are an asset acquisition,
acquisition costs are capitalized as incurred. All of our acquisitions have been recorded as asset acquisitions.
Another significant judgment must be made as
to if, and when, impairment losses should be taken on our properties when events or a change in circumstances indicate that the
carrying amount of the asset may not be recoverable. A provision is made for impairment if estimated future operating cash flows
(undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are less than the current book value
of the property. Key inputs that we utilize in this analysis include projected rental rates, estimated holding periods, capital
expenditures, and property sales capitalization rates. If a property is held for sale, it is carried at the lower of carrying cost
or estimated fair value, less estimated cost to sell. The carrying value of our real estate is anticipated to be the largest component
of our consolidated balance sheet. Our strategy of primarily holding properties, long-term, directly decreases the likelihood of
their carrying values not being recoverable, thus requiring the recognition of an impairment. However, if our strategy, or one
or more of the above assumptions were to change in the future, an impairment may need to be recognized. If events should occur
that require us to reduce the carrying value of our real estate by recording provisions for impairment, they could have a material
impact on our consolidated results of operations.
Revenue Recognition
Our existing tenant leases and future tenant
leases are generally expected to be triple-net leases, an arrangement under which the tenant maintains the property while paying
us rent and property management fees. We account for our leases as operating leases. Under this method, leases that have fixed
and determinable rent increases are recognized on a straight-line basis over the lease term, unless the collectability of minimum
lease payments is not reasonably predictable. Rental increases based upon changes in the CPI are recognized only after the changes
in the indexes have occurred and are then applied according to the lease agreements. Contractually obligated reimbursements from
tenants for recoverable real estate taxes and operating expenses will be included in tenant reimbursements in the period when such
costs are incurred. Contractually obligated real estate taxes that are paid directly by the tenant to the tax authorities are not
reflected in our consolidated financial statements.
We record revenue for each of our properties
on a cash basis due to the uncertainty of collectability of lease payments from each tenant due to its limited operating history
and the uncertain regulatory environment in the United States relating to the medical-use cannabis industry.
Stock-Based Compensation
Stock-based compensation for equity awards
is based on the grant date fair value of the equity instrument and is recognized over the requisite service period. If awards are
forfeited prior to vesting, we reverse any previously recognized expense related to such awards in the period during which the
forfeiture occurs and reclassify any non-forfeitable dividends previously paid on these awards from retained earnings to compensation
expense.
Income Taxes
We have been organized and we intend to elect,
and to operate our business so as to qualify, to be taxed as a REIT, for U.S. federal income tax purposes, commencing with our
taxable year ended December 31, 2017. Under the REIT operating structure, we are permitted to deduct dividends paid to our stockholders
in determining our taxable income for U.S. federal income tax purposes. As long as our dividends equal or exceed our taxable net
income, we generally will not be required to pay U.S. federal income tax on such income.
The Tax Cuts and Jobs Act was enacted in December 2017 and is generally effective for tax years beginning
in 2018. This new legislation is not expected to have a material adverse effect on the Company's business and contains several
potentially favorable provisions.
Adoption of New or Revised Accounting Standards
As an "emerging growth company" under
the JOBS Act, we can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for
complying with new or revised accounting standards. In other words, an "emerging growth company" can delay the adoption
of certain accounting standards until those standards would otherwise apply to private companies. An "emerging growth company"
may opt out of the extended transition period for complying with new or revised accounting standards. A decision to opt out, however,
is irrevocable. We have elected not to opt out of such extended transition period, which means that when a standard is issued or
revised and it has different application dates for public or private companies, we can adopt the standard for the private company.
This may make comparison of our financial statements with a public company that either is not an "emerging growth company"
or is an "emerging growth company" that has opted out of using the extended transition period difficult or impossible
as different or revised accounting standards may be used.
Impact of Real Estate and Credit Markets
In the commercial real estate market, property
prices generally continue to fluctuate. Likewise, during certain periods, the U.S. credit markets have experienced significant
price volatility, dislocations, and liquidity disruptions, which may impact our access to and cost of capital. We continually monitor
the commercial real estate and U.S. credit markets carefully and, if required, will make decisions to adjust our business strategy
accordingly.
Off-Balance Sheet Arrangements
We have no unconsolidated investments or any
other off-balance sheet arrangements.
Interest Rate Risk
We have not issued any debt and have no debt
outstanding, so we are not exposed to interest rate changes. At this time, we have no plans to issue debt instruments. It is possible
that a property we acquire in the future would be subject to a mortgage, which we may assume.
Impact of Inflation
We intend to enter into leases that generally
provide for limited increases in rent as a result of increases in the CPI (typically subject to ceilings) or fixed increases. We
expect these lease provisions to result in rent increases over time. During times when inflation is greater than increases in rent,
as provided for in the leases, rent increases may not keep up with the rate of inflation.
Seasonality
We do not expect our business to be subject
to material seasonal fluctuations.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA
The information required by this Item 8 is
incorporated by reference to our Financial Statements beginning on page F-1 of this report.
ITEM 9.
CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls
and Procedures
Our management, under the supervision and with
the participation of our principal executive and principal financial officers, has evaluated the effectiveness of our disclosure
controls and procedures in ensuring that the information required to be disclosed in our filings under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the SEC's rules and forms, including ensuring that such
information is accumulated and communicated to our company's management, as appropriate, to allow timely decisions regarding required
disclosure. Based on such evaluation, our principal executive and principal financial officers have concluded that such disclosure
controls and procedures were effective as of December 31, 2017 (the end of the period covered by this Annual Report).
Management’s Report on Internal
Control Over Financial Reporting
Management
is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act
Rules 13a-15(f) and 15(d)-15(f)). Our management, including our principal executive officer and principal financial
officer, evaluated, as of December 31, 2017, the effectiveness of our internal control over financial reporting using the framework
in
Internal Control – Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based
on that evaluation, our principal executive officer and financial officer concluded that our internal controls, as of December
31, 2017, were effective.
Changes in Internal Control Over
Financial Reporting
There were no changes during the quarter ended
December 31, 2017 in our internal control over financial reporting that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
Limitations on Controls
Our system of internal control over financial
reporting was designed to provide reasonable assurance regarding the preparation and fair presentation of published financial statements
in accordance with accounting principles generally accepted in the United States. All internal control systems, no matter how well
designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance
and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject
to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies
or procedures may deteriorate.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
The information concerning our directors, executive
officers and corporate governance required by Item 10 will be included in the Proxy Statement to be filed relating to Innovative
Industrial Properties, Inc.'s 2018 Annual Meeting of Stockholders and is incorporated herein by reference.
Pursuant to instruction G(3) to Form 10-K,
information concerning audit committee financial expert disclosure set forth under the heading "Information Regarding the
Board — Committees of the Board — Audit Committee" will be included in the Proxy Statement to be filed relating
to Innovative Industrial Properties, Inc.'s 2018 Annual Meeting of Stockholders and is incorporated herein by reference.
Pursuant to instruction G(3) to Form 10-K,
information concerning compliance with Section 16(a) of the Exchange Act concerning our directors and executive officers set forth
under the heading entitled "General — Section 16(a) Beneficial Ownership Reporting Compliance" will be included
in the Proxy Statement to be filed relating to Innovative Industrial Properties, Inc.'s 2018 Annual Meeting of Stockholders
and is incorporated herein by reference.
ITEM 11.
EXECUTIVE COMPENSATION
The information concerning our executive compensation
required by Item 11 will be included in the Proxy Statement to be filed relating to Innovative Industrial Properties, Inc.'s 2018 Annual
Meeting of Stockholders and is incorporated herein by reference.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information concerning the security ownership
of certain beneficial owners and management and related stockholder matters required by Item 12 will be included in the Proxy Statement
to be filed relating to Innovative Industrial Properties, Inc.'s 2018 Annual Meeting of Stockholders and is incorporated
herein by reference.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,
AND DIRECTOR INDEPENDENCE
The information concerning certain relationships
and related transactions and director independence required by Item 13 will be included in the Proxy Statement to be filed relating
to Innovative Industrial Properties, Inc.'s 2018 Annual Meeting of Stockholders and is incorporated herein by reference.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information concerning our principal accountant
fees and services required by Item 14 will be included in the Proxy Statement to be filed relating to Innovative Industrial Properties,
Inc.'s 2018 Annual Meeting of Stockholders and is incorporated herein by reference.
PART IV
ITEM 15.
EXHIBITS AND FINANCIAL
STATEMENT SCHEDULES
(a)(1) and (2) Financial Statements and
Schedules:
Please refer to the Index to Consolidated Financial
Statements included under Part II, Item 8, Financial Statements and Supplementary Data.
(3) Exhibits
Exhibit Number
|
|
Description of Exhibit
|
3.1
|
|
Second Articles of Amendment and Restatement of Innovative Industrial Properties, Inc. (including Articles Supplementary Classifying Innovative Industrial Properties, Inc.'s 9.00% Series A Cumulative Redeemable Preferred Stock).(1)
|
3.2
|
|
Amended and Restated Bylaws of Innovative Industrial Properties, Inc.(2)
|
4.1
|
|
Form of Certificate for Common Stock.(3)
|
10.1
|
|
Agreement of Limited Partnership of IIP Operating Partnership, LP.(2)
|
10.2+
|
|
2016 Omnibus Incentive Plan.(2)
|
10.3+
|
|
Form of Restricted Stock Award Agreement for Officers.(4)
|
10.4+
|
|
Form of Restricted Stock Award Agreement for Directors.(4)
|
10.5+
|
|
Form of Indemnification Agreement between Innovative Industrial Properties, Inc. and each of its Directors and Officers.(2)
|
10.6+
|
|
Form of Restricted Stock Purchase Agreement dated June 15, 2016 between Innovative Industrial Properties, Inc. and the purchaser named therein.(2)
|
10.7+
|
|
Form of Redemption Agreement between Innovative Industrial Properties, Inc. and the holder named therein.(5)
|
10.8+
|
|
Severance and Change of Control Agreement dated as of January 18, 2017 among Innovative Industrial Properties, Inc., IIP Operating Partnership, LP and Alan Gold.(6)
|
10.9+
|
|
Severance and Change of Control Agreement dated as of January 18, 2017 among Innovative Industrial Properties, Inc., IIP Operating Partnership, LP and Paul Smithers.(6)
|
10.10+
|
|
Severance and Change of Control Agreement dated as of January 18, 2017 among Innovative Industrial Properties, Inc., IIP Operating Partnership, LP and Robert Sistek.(6)
|
10.11+
|
|
Severance and Change of Control Agreement dated as of January 18, 2017 among Innovative Industrial Properties, Inc., IIP Operating Partnership, LP and Brian Wolfe.(6)
|
10.12+
|
|
Severance and Change of Control Agreement dated as of June 7, 2017 among Innovative Industrial Properties, Inc., IIP Operating Partnership, LP and Catherine Hastings.(7)
|
10.13+
|
|
Employment Transition Agreement dated as of June 30, 2017 among Innovative Industrial Properties, Inc., IIP Operating Partnership, LP and Robert Sistek.(8)
|
10.14+
|
|
Director Compensation Policy.(9)
|
10.14
|
|
Funding Agreement between Innovative Industrial Properties, Inc. and IGP Advisers LLC.(2)
|
10.16
|
|
Consulting Agreement between Innovative Industrial Properties, Inc. and IGP Advisers LLC.(2)
|
10.17
|
|
Purchase Agreement dated as of August 22, 2016 between IIP Operating Partnership, LP and PharmaCann LLC.(2)
|
10.18
|
|
Amendment No. 1 dated September 16, 2016 to Purchase Agreement dated as of August 22, 2016 between IIP Operating Partnership, LP and PharmaCann LLC.(2)
|
10.19
|
|
Amendment No. 2 dated November 23, 2016 to Purchase Agreement dated as of August 22, 2016, as amended, between IIP Operating Partnership, LP and PharmaCann LLC.(5)
|
10.20
|
|
Lease Agreement, dated as of December 19, 2016, between IIP-NY 1 LLC and PharmaCann LLC.(10)
|
10.21
|
|
Purchase and Sale Agreement and Joint Escrow Instructions dated as of May 1, 2017 between IIP Operating Partnership, LP and PGHI LLC.(11)
|
10.22
|
|
Lease Agreement, dated as of May 26, 2017, between IIP-MD 1 LLC and Holistic Industries LLC.(12)
|
10.23
|
|
First Amendment dated September 25, 2017 to Lease Agreement, dated as of May 26, 2017, between IIP-MD 1 LLC and Holistic Industries LLC.(13)
|
10.24
|
|
Purchase and Sale Agreement and Joint Escrow Instructions dated as of November 21, 2017 between IIP Operating Partnership, LP and Flying Dutchman Real Estate Holdings, LLC.(14)
|
10.25
|
|
Lease Agreement, dated as of December 15, 2017, between IIP-AZ 1 LLC and Sun Grown Solutions, LLC.(15)
|
21.1*
|
|
List of Subsidiaries of Innovative Industrial Properties, Inc.
|
23.1*
|
|
Consent of BDO USA, LLP.
|
23.2*
|
|
Consent of Martin
Hood LLC.
|
23.3*
|
|
Consent of Grossberg Company LLP.
|
31.1*
|
|
Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
31.2*
|
|
Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
32.1*
|
|
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
101.INS*
|
|
XBRL Instance Document.
|
101.SCH*
|
|
XBRL Taxonomy Extension Schema Document.
|
101.CAL*
|
|
XBRL Taxonomy Extension Calculation Linkbase Document.
|
101.DEF*
|
|
XBRL Taxonomy Extension Definition Linkbase Document.
|
101.LAB*
|
|
XBRL Taxonomy Extension Label Linkbase Document.
|
101.PRE*
|
|
XBRL Taxonomy Extension Presentation Linkbase Document.
|
* Filed herewith.
+ Indicates management contract or compensatory plan.
|
(1)
|
Incorporated herein by reference to Innovative Industrial
Properties, Inc.'s Quarterly Report on Form 10-Q filed with the SEC on November 9, 2017.
|
|
(2)
|
Incorporated herein by reference to Innovative Industrial
Properties, Inc.’s Registration Statement on Form S-11, as amended (File No. 333-214148), filed with the SEC on October 17,
2016.
|
|
(3)
|
Incorporated by reference to Innovative Industrial Properties, Inc.’s Registration Statement on Form S-11, as amended
(File No. 333-214148), filed with the SEC on November 17, 2016.
|
|
(4)
|
Incorporated by reference to Innovative Industrial Properties, Inc.'s Registration Statement on Form S-8 (File No. 333-214919),
filed with the SEC on December 6, 2016.
|
|
(5)
|
Incorporated by reference to Innovative Industrial Properties, Inc.'s Registration Statement on Form S-8 (File No. 333-214919),
filed with the SEC on November 25, 2016.
|
|
(6)
|
Incorporated herein by reference to Innovative Industrial Properties, Inc.'s Current Report on Form 8-K filed with the SEC
on January 24, 2017.
|
|
(7)
|
Incorporated herein by reference to Innovative Industrial Properties, Inc.’s Current Report on Form 8-K filed with the
SEC on June 8, 2017.
|
|
(8)
|
Incorporated herein by reference to Innovative Industrial Properties, Inc.’s Current Report on Form 8-K filed with the
SEC on July 3, 2017.
|
|
(9)
|
Incorporated herein by reference to Innovative Industrial Properties, Inc.’s Current Report on Form 8-K filed with the
SEC on January 9, 2018.
|
|
(10)
|
Incorporated herein by reference to Innovative Industrial Properties, Inc.'s Current Report on Form 8-K filed with the SEC
on December 21, 2016.
|
|
(11)
|
Incorporated herein by reference to Innovative Industrial Properties, Inc.’s Current Report on Form 8-K filed with the
SEC on May 4, 2017.
|
|
(12)
|
Incorporated herein by reference to Innovative Industrial Properties, Inc.’s Current Report on Form 8-K filed with the
SEC on May 30, 2017.
|
|
(13)
|
Incorporated herein by reference to Innovative Industrial Properties, Inc.’s Current Report on Form 8-K filed with the
SEC on September 25, 2017.
|
|
(14)
|
Incorporated herein by reference to Innovative Industrial Properties, Inc.’s Current Report on Form 8-K filed with the
SEC on November 28, 2017.
|
|
(15)
|
Incorporated herein by reference to Innovative Industrial Properties, Inc.’s Current Report on Form 8-K filed with the
SEC on December 18, 2017.
|
ITEM 16.
FORM 10-K SUMMARY
None.
SIGNATURES
Pursuant to the requirements of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.
INNOVATIVE INDUSTRIAL PROPERTIES, INC.
|
|
|
|
By:
|
/s/ Paul Smithers
|
|
Paul Smithers
|
|
President, Chief Executive Officer and Director
|
|
(Principal Executive Officer)
|
|
|
|
By:
|
/s/ Catherine Hastings
|
|
Catherine Hastings
|
|
Chief Financial Officer, Chief Accounting Officer and Treasurer
|
|
(Principal Financial Officer and Principal Accounting Officer)
|
|
Dated March 29, 2018
Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
Name
|
|
Capacity
|
|
Date
|
|
|
|
|
|
/s/ Alan Gold
|
|
Executive Chairman
|
|
March 29, 2018
|
Alan Gold
|
|
|
|
|
|
|
|
|
|
/s/ Gary Kreitzer
|
|
Vice Chairman
|
|
March 29, 2018
|
Gary Kreitzer
|
|
|
|
|
|
|
|
|
|
/s/ Paul Smithers
|
|
President, Chief Executive Officer and Director
|
|
March 29, 2018
|
Paul Smithers
|
|
|
|
|
|
|
|
|
|
/s/ Scott Shoemaker
|
|
Director
|
|
March 29, 2018
|
Scott Shoemaker
|
|
|
|
|
|
|
|
|
|
/s/ David Stecher
|
|
Director
|
|
March 29, 2018
|
David Stecher
|
|
|
|
|
INDEX TO FINANCIAL STATEMENTS
Innovative Industrial Properties, Inc.
Report of Independent Registered Public Accounting Firm
|
F-2
|
Consolidated Balance Sheets as of December 31, 2017 and 2016
|
F-3
|
Consolidated Statements of Operations for the year ended December 31, 2017 and the period from June 15, 2016 (date of incorporation) through December 31, 2016
|
F-4
|
Consolidated Statements of Stockholders' Equity for the year ended December 31, 2017 and the period from June 15, 2016 (date of incorporation) through December 31, 2016
|
F-5
|
Consolidated Statements of Cash Flows for the year ended December 31, 2017 and the period from June 15, 2016 (date of incorporation) through December 31, 2016
|
F-6
|
Notes to Consolidated Financial Statements
|
F-7
|
PharmaCann LLC
Holistic Industries LLC
Independent Auditor's Report
|
F-35
|
Balance Sheets as of December 31, 2017, 2016 and 2015
|
F-36
|
Statements
of Operation for the years ended December 31, 2017 and 2016 and the period from July 1, 2015 (inception) through December 31,
2015
|
F-37
|
Statements of Changes in Members' Equity for the years ended December
31, 2017 and 2016 and the period from July 1, 2015 (inception) through December 31, 2015
|
F-38
|
Statements of Cash Flows for the years ended December 31, 2017 and 2016 and the period from July 1, 2015 (inception) through December 31, 2015
|
F-39
|
Notes to Financial Statements
|
F-40
|
Report of
Independent Registered Public Accounting Firm
Stockholders and Board of Directors
Innovative Industrial Properties,
Inc.
San Diego, California
Opinion
on the Consolidated Financial Statements
We
have audited the accompanying consolidated balance sheets of Innovative Industrial Properties, Inc. (the “Company”)
and subsidiaries as of December 31, 2017 and 2016, the related consolidated statements of operations, stockholders’ equity,
and cash flows for the year ended December 31, 2017 and for the period from June 15, 2016 (date of incorporation) through December
31, 2016, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion,
the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries
at December 31, 2017 and 2016, and the results of their operations and their cash flows for the year ended December 31, 2017 and
for the period from June 15, 2016 (date of incorporation) through December 31, 2016
,
in conformity with accounting principles
generally accepted in the United States of America.
Basis
for Opinion
These
consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an
opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered
with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with
respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities
and Exchange Commission and the PCAOB.
We
conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether
due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over
financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting
but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.
Accordingly, we express no such opinion.
Our audits included
performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error
or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence
regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting
principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated
financial statements. We believe that our audits provide a reasonable basis for our opinion.
We have served
as the Company's auditor since 2016.
San Diego, California
March
29, 2018
Innovative Industrial Properties, Inc.
Consolidated Balance Sheets
(In thousands, except share and per share
amounts)
|
|
December 31,
2017
|
|
|
December 31,
2016
|
|
Assets
|
|
|
|
|
|
|
Real estate, at cost:
|
|
|
|
|
|
|
|
|
Land
|
|
$
|
11,514
|
|
|
$
|
7,600
|
|
Buildings and improvements
|
|
|
51,315
|
|
|
|
22,475
|
|
Tenant improvements
|
|
|
5,901
|
|
|
|
—
|
|
Total real estate, at cost
|
|
|
68,730
|
|
|
|
30,075
|
|
Less accumulated depreciation
|
|
|
(942
|
)
|
|
|
(27
|
)
|
Net real estate held for investment
|
|
|
67,788
|
|
|
|
30,048
|
|
Cash and cash equivalents
|
|
|
11,758
|
|
|
|
33,003
|
|
Prepaid insurance and other assets, net
|
|
|
482
|
|
|
|
276
|
|
Total assets
|
|
$
|
80,028
|
|
|
$
|
63,327
|
|
|
|
|
|
|
|
|
|
|
Liabilities and stockholders’ equity
|
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses
|
|
$
|
1,082
|
|
|
$
|
70
|
|
Dividends payable
|
|
|
1,198
|
|
|
|
—
|
|
Offering cost liability
|
|
|
41
|
|
|
|
276
|
|
Rent received in advance and tenant security deposits
|
|
|
4,158
|
|
|
|
2,542
|
|
Total liabilities
|
|
|
6,479
|
|
|
|
2,888
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies (Notes 7 and 10)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity
|
|
|
|
|
|
|
|
|
Preferred stock, par value $0.001 per share, 50,000,000
shares authorized: 9.00% Series A cumulative redeemable preferred stock, $15,000 liquidation preference ($25.00 per share),
600,000 shares and no shares issued and outstanding at December 31, 2017 and 2016, respectively
|
|
|
14,009
|
|
|
|
—
|
|
Common stock, par value $0.001 per share, 50,000,000 shares authorized: 3,501,147 shares and no shares issued and outstanding at December 31, 2017 and 2016, respectively
|
|
|
4
|
|
|
|
—
|
|
Class A common stock, par value $0.001 per share, no shares and 49,000,000 shares authorized, and no shares and 3,416,508 shares issued and outstanding as of December 31, 2017 and 2016, respectively
|
|
|
—
|
|
|
|
3
|
|
Class B common stock, par value $0.001 per share, no shares and 1,000,000 shares authorized and no shares issued and outstanding as of December 31, 2017 and 2016, respectively
|
|
|
—
|
|
|
|
—
|
|
Additional paid-in-capital
|
|
|
64,000
|
|
|
|
64,828
|
|
Accumulated deficit
|
|
|
(4,464
|
)
|
|
|
(4,392
|
)
|
Total stockholders' equity
|
|
|
73,549
|
|
|
|
60,439
|
|
Total liabilities and stockholders' equity
|
|
$
|
80,028
|
|
|
$
|
63,327
|
|
See the accompanying notes to the consolidated
financial statements.
Innovative Industrial Properties, Inc.
Consolidated Statements of Operations
(In thousands, except share and
per share amounts)
|
|
Year ended
December 31,
2017
|
|
|
Period from
June 15, 2016
(date of
incorporation)
through
December 31,
2016
|
|
Revenues:
|
|
|
|
|
|
|
|
|
Rental
|
|
$
|
6,302
|
|
|
$
|
180
|
|
Tenant reimbursements
|
|
|
118
|
|
|
|
87
|
|
Total revenues
|
|
|
6,420
|
|
|
|
267
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
Property expenses
|
|
|
118
|
|
|
|
87
|
|
General and administrative expense
|
|
|
5,497
|
|
|
|
828
|
|
Severance
|
|
|
113
|
|
|
|
—
|
|
Forfeited Class B common shares
|
|
|
—
|
|
|
|
3,707
|
|
Organization costs
|
|
|
—
|
|
|
|
64
|
|
Depreciation expense
|
|
|
915
|
|
|
|
27
|
|
Total expenses
|
|
|
6,643
|
|
|
|
4,713
|
|
Loss from operations
|
|
|
(223
|
)
|
|
|
(4,446
|
)
|
Interest income
|
|
|
151
|
|
|
|
54
|
|
Net loss
|
|
|
(72
|
)
|
|
|
(4,392
|
)
|
Preferred stock dividend
|
|
|
323
|
|
|
|
—
|
|
Net loss attributable to common stockholders
|
|
$
|
(395
|
)
|
|
$
|
(4,392
|
)
|
Net loss attributable to common stockholders per share (basic and diluted) (Note 6)
|
|
$
|
(0.13
|
)
|
|
$
|
(4.56
|
)
|
Weighted average shares outstanding
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
3,375,284
|
|
|
|
962,775
|
|
Dividends declared per common share
|
|
$
|
0.55
|
|
|
$
|
—
|
|
See accompanying notes to the consolidated
financial statements.
Innovative Industrial Properties, Inc.
Consolidated Statements of Stockholders' Equity
(In thousands, except share and
per share amounts)
|
|
Series A
Preferred Stock
|
|
|
Shares of
Common Stock
|
|
|
Common
Stock
|
|
|
Additional
Paid-In-
Capital
|
|
|
Accumulated
Deficit
|
|
|
Total
Stockholders'
Equity
|
|
Balance, June 15, 2016
|
|
$
|
—
|
|
|
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Issuance of Class B common stock
|
|
|
—
|
|
|
|
508,065
|
|
|
|
1
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1
|
|
Redemption of Class B common stock
|
|
|
—
|
|
|
|
(508,065
|
)
|
|
|
(1
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(1
|
)
|
Forfeited Class B common shares
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,707
|
|
|
|
—
|
|
|
|
3,707
|
|
Issuance of Class A common stock
|
|
|
—
|
|
|
|
3,350,000
|
|
|
|
3
|
|
|
|
61,063
|
|
|
|
—
|
|
|
|
61,066
|
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(4,392
|
)
|
|
|
(4,392
|
)
|
Stock-based compensation
|
|
|
—
|
|
|
|
66,508
|
|
|
|
—
|
|
|
|
58
|
|
|
|
—
|
|
|
|
58
|
|
Balance, December 31, 2016
|
|
$
|
—
|
|
|
|
3,416,508
|
|
|
$
|
3
|
|
|
$
|
64,828
|
|
|
$
|
(4,392
|
)
|
|
$
|
60,439
|
|
Reclassification of Class A and Class B common stock to common stock
|
|
|
—
|
|
|
|
*
|
|
|
|
*
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Net proceeds from sale of preferred stock
|
|
|
14,009
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
14,009
|
|
Preferred stock dividend
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(323
|
)
|
|
|
—
|
|
|
|
(323
|
)
|
Common stock dividend
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(1,925
|
)
|
|
|
—
|
|
|
|
(1,925
|
)
|
Net issuance of unvested restricted stock
|
|
|
—
|
|
|
|
84,639
|
|
|
|
—
|
|
|
|
(298
|
)
|
|
|
—
|
|
|
|
(298
|
)
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(72
|
)
|
|
|
(72
|
)
|
Stock based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
1
|
|
|
|
1,718
|
|
|
|
—
|
|
|
|
1,719
|
|
Balance, December 31, 2017
|
|
$
|
14,009
|
|
|
|
3,501,147
|
|
|
$
|
4
|
|
|
$
|
64,000
|
|
|
$
|
(4,464
|
)
|
|
$
|
73,549
|
|
* Effective as of January 26, 2017, each share of the Company’s
outstanding Class A common stock and Class B common stock was reclassified as, and became one share of, a new single class of common
stock named “common stock”. There were no shares of Class B common stock outstanding as of January 26, 2017, as all
such shares were redeemed by the Company for $0.001 per share (par value) immediately prior to the Company's initial public offering
in December 2016.
See accompanying notes to the consolidated
financial statements.
Innovative Industrial Properties, Inc.
Consolidated Statements of Cash Flows
(In thousands)
|
|
Year ended
December 31,
2017
|
|
|
Period from
June 15, 2016
(date of
incorporation)
through
December 31,
2016
|
|
Cash flows from operating activities
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(72
|
)
|
|
$
|
(4,392
|
)
|
Adjustments to reconcile net loss to net cash provided by operating activities
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
915
|
|
|
|
27
|
|
Stock-based compensation
|
|
|
1,719
|
|
|
|
58
|
|
Forfeited Class B common shares
|
|
|
—
|
|
|
|
3,707
|
|
Changes in assets and liabilities
|
|
|
|
|
|
|
|
|
Prepaid insurance and other assets, net
|
|
|
(155
|
)
|
|
|
(276
|
)
|
Accounts payable and accrued expenses
|
|
|
992
|
|
|
|
27
|
|
Rents received in advance and tenant security deposit
|
|
|
1,616
|
|
|
|
2,542
|
|
Net cash provided by operating activities
|
|
|
5,015
|
|
|
|
1,693
|
|
Cash flows from investing activities
|
|
|
|
|
|
|
|
|
Purchases of investments in real estate
|
|
|
(32,734
|
)
|
|
|
(30,032
|
)
|
Capital expenditures
|
|
|
(5,911
|
)
|
|
|
-
|
|
Net cash used in investing activities
|
|
|
(38,645
|
)
|
|
|
(30,032
|
)
|
Cash flows from financing activities
|
|
|
|
|
|
|
|
|
Issuance of Class B common stock
|
|
|
—
|
|
|
|
1
|
|
Redemption of Class B common stock
|
|
|
—
|
|
|
|
(1
|
)
|
Issuance of Class A common stock, net of offering costs
|
|
|
(276
|
)
|
|
|
61,342
|
|
Dividends paid to common stockholders
|
|
|
(1,050
|
)
|
|
|
—
|
|
Issuance of Series A Preferred Stock, net of offering costs
|
|
|
14,009
|
|
|
|
—
|
|
Taxes paid related to net share settlement of equity awards
|
|
|
(298
|
)
|
|
|
—
|
|
Net cash provided by financing activities
|
|
|
12,385
|
|
|
|
61,342
|
|
Net (decrease)/increase in cash and cash equivalents
|
|
|
(21,245
|
)
|
|
|
33,003
|
|
Cash and cash equivalents, beginning of period
|
|
|
33,003
|
|
|
|
—
|
|
Cash and cash equivalents, end of period
|
|
$
|
11,758
|
|
|
$
|
33,003
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
Supplemental disclosure of non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrual for common and preferred stock dividends declared
|
|
$
|
1,198
|
|
|
$
|
—
|
|
Invoices accrued for capitalized costs
|
|
|
20
|
|
|
|
43
|
|
Invoices accrued for offering costs
|
|
|
41
|
|
|
|
276
|
|
See accompanying notes to the consolidated
financial statements.
Innovative Industrial Properties, Inc.
Notes to Consolidated Financial Statements
1. Organization
As used herein, the terms "we", "us",
"our" or the "Company" refer to Innovative Industrial Properties, Inc., a Maryland corporation, and any of
our subsidiaries, including IIP Operating Partnership, LP, a Delaware limited partnership (our "Operating Partnership").
We acquire, own and manage specialized industrial
properties leased to experienced, state-licensed operators for their regulated medical-use cannabis facilities. We have acquired
and intend to continue to acquire our properties through sale-leaseback transactions and third-party purchases. We lease and expect
to continue to lease our properties on a triple-net lease basis, where the tenant is responsible for all aspects of and costs related
to the property and its operation during the lease term, including structural repairs, maintenance, taxes and insurance.
We were incorporated in Maryland on June 15,
2016, and we intend to elect and to operate our business so as to qualify to be taxed as a real estate investment trust ("REIT")
for U.S. federal income tax purposes, beginning with our taxable year ended December 31, 2017. We conduct our business through
a traditional umbrella partnership real estate investment trust, or UPREIT structure, in which our properties are owned by our
Operating Partnership directly or through subsidiaries. We are the sole general partner of our Operating Partnership and own, directly
or through a subsidiary, 100% of the limited partnership interests in our Operating Partnership. As of December 31, 2017,
we had six full-time employees.
As of December 31, 2017, we owned five properties
that were 100% leased to state-licensed medical-use cannabis operators and comprising an aggregate of approximately 617,000 rentable
square feet (unaudited) in New York, Maryland, Arizona and Minnesota.
2. Summary of Significant Accounting Policies and Procedures
and Recent Accounting Pronouncements
Basis of Presentation.
The
consolidated financial statements include all of the accounts of the Company, the Operating Partnership and all of our wholly owned
subsidiaries, presented in accordance with U.S. generally accepted accounting principles.
Reclassifications
. Certain reclassifications
have been made to prior period amounts to conform to current period presentation. Such reclassifications have no effect on net
loss as previously reported.
Federal Income Taxes.
We
intend to elect and continue to operate our business so as to qualify, and to be taxed, as a REIT for U.S. federal income tax purposes,
commencing with our taxable year ended December 31, 2017. Under the REIT operating structure, we are permitted to deduct dividends
paid to our stockholders in determining our taxable income. Assuming our dividends equal or exceed our taxable net income, we generally
will not be required to pay federal corporate income taxes on such income.
Use of Estimates.
The preparation
of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to
make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements.
Actual results may differ materially from these estimates and assumptions.
Acquisition of Real Estate Properties.
Our
investment in real estate is recorded at historical cost, less accumulated depreciation. Upon acquisition of a property, the tangible
and intangible assets acquired and liabilities assumed are initially measured based upon their relative fair values. We estimate
the fair value of land by reviewing comparable sales within the same submarket or/or region and the fair value of buildings on
an as-if vacant basis. Acquisition costs are capitalized as incurred. All of our acquisitions to date were recorded as asset acquisitions.
Organization, Offering and Transaction Costs.
IGP
Advisers LLC ("IGP Advisers"), a company that was owned by Alan Gold, our executive chairman, Paul Smithers, our president,
chief executive officer and director, and Gregory Fahey, our former chief accounting officer, funded our organization, certain
offering and transaction costs. Organization costs incurred by the Company were expensed. Offering costs incurred were recorded
to stockholders' equity as a reduction to additional paid-in capital. Transaction costs incurred by the Company were capitalized
as incurred. Through December 31, 2016, on behalf of the Company, IGP Advisers incurred offering costs of $338,000, organization
costs of $34,000 and transaction costs of $8,000. The Company incurred additional offering costs of $906,000, organization costs
of $30,000 and transaction costs of $67,000 as of December 31, 2016. Following the completion of our initial public offering, our
agreements with IGP Advisers terminated and IGP Advisers was dissolved. No amounts were incurred by IGP Advisers on behalf of the
Company in 2017.
Depreciation.
We are required
to make subjective assessments as to the estimated useful lives of our depreciable assets. We consider the period of future benefit
of the assets to determine the appropriate estimated useful lives. Depreciation of our assets is charged to expense on a straight-line
basis over the estimated useful lives. We depreciate each of our buildings and improvements over its estimated remaining useful
life, not to exceed 35 years. We depreciate tenant improvements at our buildings over the shorter of the estimated useful lives
or the terms of the related leases.
We depreciate office equipment and furniture
and fixtures over estimated useful lives ranging from three to six years.
Provision for Impairment.
Another
significant judgment must be made as to if, and when, impairment losses should be taken on our property when events or a change
in circumstances indicate that the carrying amount of the asset may not be recoverable. A provision is made for impairment if estimated
future operating cash flows (undiscounted and without interest charges) plus estimated disposition proceeds (undiscounted) are
less than the current book value of the property. Key inputs that we utilize in this analysis include projected rental rates, estimated
holding periods, capital expenditures, and property sales capitalization rates. As of December 31, 2017, no impairment losses were
recognized.
Revenue Recognition.
Our
leases and future tenant leases are expected to be triple-net leases, an arrangement under which the tenant maintains the property
while paying us rent and property management fee. We anticipate that all leases will be accounted for as operating leases. Under
this method, leases that have fixed and determinable rent increases are recognized on a straight-line basis over the lease term,
unless the collectability of minimum lease payments is not reasonably predictable. Rental increases based upon changes in the consumer
price index are recognized only after the changes in the indexes have occurred and are then applied according to the lease agreements.
Contractually obligated reimbursements from tenants for recoverable real estate taxes and operating expenses are included in tenant
reimbursements in the period when such costs are incurred. Contractually obligated real estate taxes that are paid directly by
the tenant to the tax authorities are not reflected in our consolidated financial statements.
We record revenue for each of our properties
on a cash basis due to the uncertainty of collectability of lease payments from each tenant due to its limited operating history.
Cash and Cash Equivalents
. We consider
all highly-liquid investments with original maturities of three months or less to be cash equivalents. As of December 31, 2017
and 2016, $8.9 million and $32.7 million, respectively, were invested in short-term money market funds and certificates of deposit.
Stock-Based Compensation.
Stock-based
compensation for equity awards is based on the grant date fair value of the equity investment and is recognized over the requisite
service period. If awards are forfeited prior to vesting, we reverse any previously recognized expense related to such awards in
the period during which the forfeiture occurs and reclassify any nonforfeitable dividends previously paid on these awards from
retained earnings to compensation expense.
Recently Adopted Accounting Pronouncements.
In May 2015, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU")
No. 2015-07 that eliminates the requirement to categorize investments within the fair value hierarchy if their fair value is measured
using the net asset value per share practical expedient in the FASB’s fair value measurement guidance. The amendments also
limit certain disclosures to investments for which the entity has elected to measure at fair value using the net asset value per
share practical expedient. The amendments were applied retrospectively by removing from the fair value hierarchy any investments
for which fair value is measured using the net asset value per share practical expedient. Adoption of this guidance did not have
an impact on the Company’s financial position or results of operations.
Recent Accounting Pronouncements.
In
May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"). ASU 2014-09 outlines a
comprehensive model for companies to use in accounting for revenue arising from contracts with customers, and will apply to transactions
such as the sale of real estate. ASU 2014-09 is effective for years beginning after December 15, 2018 as a result of the Company’s
election as an emerging growth company. The majority of our revenues related to rental income from leasing arrangements, which
is excluded from ASU 2014-09. The Company is currently evaluating the impact that ASU 2014-09 will have on any non-lease components
and revenues generated from activities other than leasing.
In February 2016, the FASB issued ASU 2016-02, Leases ("ASU 2016-02") which introduces a lessee model that brings most leases
on the balance sheet. Under this new standard the large majority of operating leases are expected to remain classified as operating
leases, and lessors should continue to recognize lease income for those leases on a generally straight-line basis over the lease
term. ASU 2016-02 is effective for years beginning after December 15, 2019 as a result of the Company’s election as an emerging
growth company, using a modified retrospective transition approach for leases existing at, or entered into after, the beginning
of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are continuing
to evaluate this guidance and the impact to us, as both lessor and lessee, on our Consolidated Financial Statements.
In March 2016, the FASB issued ASU 2016-09,
Compensation — Stock Compensation; Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09").
The FASB issued ASU 2016-09 to simplify several aspects of the accounting for share-based payment transactions, including classification
of awards as either equity or liabilities, estimation of forfeitures, and classification on the statement of cash flows. ASU 2016-09
is effective for years beginning after December 15, 2017 as a result of the Company’s election as an emerging growth company,
and early adoption is permitted. ASU 2016-09 is not expected to have a material impact on our consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13,
Financial Instruments-Credit Losses, which changes the impairment model for most financial assets and certain other instruments.
For trade and other receivables, held-to-maturity debt securities, loans and other instruments, companies will be required to use
a new forward-looking “expected loss” model that generally will result in the earlier recognition of allowances for
losses. For available-for-sale debt securities with unrealized losses, companies will measure credit losses in a manner similar
to what they do today, except that the losses will be recognized as allowances rather than as reductions in the amortized cost
of the securities. Companies will have to disclose significantly more information, including information they use to track credit
quality by year of origination for most financing receivables. Companies will apply the standard’s provisions as a cumulative-effect
adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. This standard
is effective for years beginning after December 15, 2020 as a result of the Company’s election as an emerging growth company
with early adoption permitted. The Company is in the initial stage of evaluating the impact of this new standard.
In February 2017, the FASB has issued ASU No.
2017-05, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the
Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets ("Subtopic 610-20"). A
contract may involve the transfer of both nonfinancial assets and financial assets (e.g., cash and receivables). The amendments
clarify that a financial asset is within the scope of Subtopic 610-20 if it meets the definition of an in substance nonfinancial
asset. The amendments also define the term in substance nonfinancial asset. The amendments clarify that nonfinancial assets within
the scope of Subtopic 610-20 may include nonfinancial assets transferred within a legal entity to a counterparty. For example,
a parent may transfer control of nonfinancial assets by transferring ownership interests in a consolidated subsidiary. A contract
that includes the transfer of ownership interests in one or more consolidated subsidiaries is within the scope of Subtopic 610-20
if substantially all of the fair value of the assets that are promised to the counterparty in a contract is concentrated in nonfinancial
assets. The amendments clarify that an entity should identify each distinct nonfinancial asset or in substance nonfinancial asset
promised to a counterparty and derecognize each asset when a counterparty obtains control of it. The amendments are effective at
the same time Topic 606,
Revenue from Contracts with Customers,
is effective. This new standard is effective for years beginning
after December 15, 2018 as a result of the Company’s election as an emerging growth company. We do not expect this amendment
to have an effect on our consolidated financial statements.
In August 2016, the FASB issued ASU No. 2016-15,
Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments, which clarifies or provides guidance
relating to eight specific cash flow classification issues. The standard should be applied retrospectively for each period presented,
as appropriate. This new standard is effective for years beginning after December 15, 2018 as a result of the Company’s election
as an emerging growth company. The impact of this new guidance will depend on future transactions, though the impact will only
be related to the classification of those items on the statement of cash flows and will not impact the Company's cash flows or
its consolidated results of operations.
Concentration of Credit Risk
. Our properties
are located in the states of New York, Maryland, Arizona and Minnesota. The ability of any of our tenants to honor the terms
of its lease is dependent upon the economic, regulatory, competition, natural and social factors affecting the community in which
that tenant operates. During the year ended December 31, 2017, the tenant at one of our properties in New York and the tenant at
our property in Maryland accounted for 82% and 14%, respectively, or our rental revenues. At December 31, 2017, one of our properties
in New York, our property in Maryland and our property in Arizona accounted for 43%, 25% and 22%, respectively, of our net real
estate held for investment.
We have deposited cash with a financial institution
that is insured by the Federal Deposit Insurance Corporation ("FDIC") up to $250,000. As of December 31, 2017,
we had cash accounts in excess of FDIC insured limits. We have not experienced any losses in such accounts.
3. Common Stock
As of December 31, 2017, the Company was authorized
to issue up to 50,000,000 shares of common stock, par value $0.001 per share, and there were 3,501,147 shares of common stock issued
and outstanding.
In June 2016, we issued 508,065 shares of Class
B Common Stock for $508 to certain of our executive officers, directors and a co-founder. Each of our founders subsequently entered
into a redemption agreement with us pursuant to which such shares of Class B Common Stock were redeemed by us in their entirety
for $0.001 per share and cancelled immediately before the closing of our initial public offering.
In connection with the Company's issuance of
its Class B Common Stock, the Company obtained a third-party valuation to determine the fair value of the shares at the June 15,
2016 grant date and at subsequent modification dates using a Monte Carlo simulation. The fair value calculation was primarily based
on management's estimates of the probability of an initial public offering and the estimated proceeds of the offering at the time.
The Company recognized stock compensation expense of approximately $3.7 million for the period from June 15, 2016 (date of incorporation)
through December 31, 2016 related to issuance of the Class B Common Stock, notwithstanding that fact that all such shares of Class
B Common Stock were redeemed by us at par value $0.001 per share, resulting in no value received by any of the executive officers,
directors and a co-founder for their purchase of the Class B Common Stock.
Effective as of January 26, 2017, the Company
amended its charter to reclassify all shares of Class A Common Stock and Class B Common Stock of the Company as a single class
of common stock, par value $0.001 per share. As described above, there were no shares of Class B common stock outstanding as of
January 26, 2017, as all such shares were redeemed prior to the Company's initial public offering in December 2016.
4. Preferred Stock
The Company is authorized to issue up to 50,000,000
shares of preferred stock, par value $0.001 per share. On October 19, 2017, the Company completed an underwritten public offering
of 600,000 shares of 9.00% Series A Cumulative Redeemable Preferred Stock, $0.001 par value per share (the “Series A Preferred
Stock”), at a price to the public of $25.00 per share, resulting in net proceeds of approximately $14.0 million, after deducting
the underwriters' discounts and commissions and offering expenses. Dividends on the Series A Preferred Stock are payable quarterly
in arrears on or about the 15th day of January, April, July and October of each year, with the first dividend paid on January 16,
2018. The Series A Preferred Stock ranks senior to the Company’s common stock with respect to dividend rights and rights
upon our liquidation, dissolution or winding up. The Series A Preferred Stock has no stated maturity date and is not subject to
mandatory redemption or any sinking fund.
Generally, the Company is not permitted to
redeem the Series A Preferred Stock prior to October 19, 2022, except in limited circumstances relating to the Company’s
ability to qualify as a REIT and in certain other circumstances related to a change of control/delisting (as defined in the articles
supplementary for the Series A Preferred Stock). On or after October 19, 2022, the Company may, at its option, redeem the
Series A Preferred Stock, in whole or in part, at any time or from time to time, for cash at a redemption price of $25.00 per share,
plus all accrued and unpaid dividends on such Series A Preferred Stock up to, but excluding the redemption date. Holders of the
Series A Preferred Stock generally have no voting rights except for limited voting rights if the Company fails to pay dividends
for six or more quarterly periods (whether or not consecutive) and in certain other circumstances.
5. Dividends
The following table describes the dividends
declared by the Company during the year ended December 31, 2017:
Declaration Date
|
|
Security Class
|
|
Amount
Per Share
|
|
|
Period Covered
|
|
Dividend Payable
Date
|
|
Dividend
Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
May 30, 2017
|
|
Common stock
|
|
$
|
0.15
|
|
|
April 1, 2017 to June 30, 2017
|
|
July 14, 2017
|
|
$
|
525
|
|
September 15, 2017
|
|
Common stock
|
|
$
|
0.15
|
|
|
July 1, 2017 to September 30, 2017
|
|
October 13, 2017
|
|
$
|
525
|
|
December 15, 2017
|
|
Common stock
|
|
$
|
0.25
|
|
|
October 1, 2017 to December 31, 2017
|
|
January 16, 2018
|
|
$
|
875
|
|
December 15, 2017
|
|
Series A preferred stock
|
|
$
|
0.5375
|
|
|
October 19, 2017 to January 14, 2018
|
|
January 16, 2018
|
|
$
|
323
|
|
6. Net Income (Loss) Per Share
Grants of restricted stock of the Company in
share-based payment transactions are considered participating securities prior to vesting and, therefore, are considered in computing
basic earnings per share under the two-class method. The two-class method is an earnings allocation method for calculating earnings
per share when a company’s capital structure includes either two or more classes of common stock or common stock and participating
securities. Earnings per basic share under the two-class method is calculated based on dividends declared on common shares and
other participating securities (“distributed earnings”) and the rights of participating securities in any undistributed
earnings, which represents net income remaining after deduction of dividends accruing during the period. The undistributed earnings
are allocated to all outstanding common shares and participating securities based on the relative percentage of each security to
the total number of outstanding participating securities. Earnings per basic share represents the summation of the distributed
and undistributed earnings per share class divided by the total number of shares.
Through December 31, 2017, all of the Company’s
participating securities received dividends at an equal dividend rate per share. As a result, distributions to participating securities
for the year ended December 31, 2017 have been included in net loss attributable to common stockholders to calculate net loss per
basic and diluted share. For the year ended December 31, 2017, the Company incurred a net loss and therefore had distributions
in excess of earnings. As such, 106,839 of unvested restricted shares outstanding at December 31, 2017 have been excluded from
the calculation of net loss per diluted share for the year ended December 31, 2017 as the impacts were anti-dilutive. Computations
of net loss per basic and diluted share (in thousands, except share data) were as follows:
|
|
Year Ended
December 31,
|
|
|
For the Period
June 15, 2016
(date of
incorporation)
through
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Net loss
|
|
$
|
(72
|
)
|
|
$
|
(4,392
|
)
|
Preferred stock dividend
|
|
|
(323
|
)
|
|
|
—
|
|
Distributions to participating securities
|
|
|
(59
|
)
|
|
|
—
|
|
Net loss attributable to common stockholders used to compute net loss per share
|
|
$
|
(454
|
)
|
|
$
|
(4,392
|
)
|
Weighted average common shares outstanding- basic and diluted
|
|
|
3,375,284
|
|
|
|
962,775
|
|
Net loss per share attributable to common stockholders – basic and diluted
|
|
$
|
(0.13
|
)
|
|
$
|
(4.56
|
)
|
7. Properties
On December 19, 2016, we completed
the acquisition of a 127,000 square foot (unaudited) industrial property located in New York (the “PharmaCann NY Property”),
which we purchased from PharmaCann LLC (“PharmaCann”) for approximately $30.0 million (plus approximately $75,000 in
transaction costs) in a sale-leaseback transaction. Concurrent with the closing of the acquisition, we entered into a triple-net
lease with PharmaCann, as tenant, for use as a medical cannabis cultivation and processing facility. PharmaCann is responsible
for paying all structural repairs, maintenance expenses, insurance and taxes related to the PharmaCann NY Property. The lease term
is 15 years, with two options to extend the term of the lease for two additional five-year periods. The initial base rent of the
PharmaCann lease was approximately $319,580 per month, subject to annual increases at a rate based on the higher of (i)
4% or (ii) 75% of the consumer price index. The lease also provides that we receive a property management fee equal to 1.5% of
the then-current base rent throughout the term, and supplemental base rent for the first five years of the term of the lease at
a rate of $105,477 per month. As of December 31, 2017, the base rent of the
PharmaCann lease after the first annual increase was approximately $332,360 per month.
On May 26, 2017, we purchased an industrial
property located in Maryland (the “Holistic MD Property”), which comprises approximately 72,000 square feet (unaudited)
and was under development at the time of our acquisition. The initial purchase price was $8.0 million (plus approximately $185,000
in transaction costs), with an additional $3.0 million payable to the seller upon completion of certain development milestones.
Concurrent with the closing of the purchase of the Holistic MD Property, we entered into a triple-net lease agreement with Holistic
Industries LLC (“Holistic”) for use as a medical cannabis cultivation and processing facility. The initial term of
the lease is 16 years, with three options to extend the term of the lease for three additional five-year periods. Holistic has
an option to purchase the property upon a qualifying termination event or at the end of the initial lease term and subject to certain
conditions, at the option purchase price that is the greater of fair market value or a 7.5% capitalization rate derived from market
rental rates for industrial properties in the relevant competitive market.
On August 1, 2017, we paid the additional
$3.0 million to the seller upon the seller’s completion of the development milestones at the Holistic MD Property. On September 25,
2017, we amended our lease with Holistic to, among other things, rescind the $1.9 million rent reserve that we originally established
for Holistic under the lease, and to reimburse up to $1.9 million of additional tenant improvements for Holistic, such that a total
of $5.9 million is reimbursable by us to Holistic for tenant improvements. On September 28, 2017, we approved and accrued
for Holistic's draw request for reimbursement of the full $5.9 million of tenant improvements and funded that amount on October
2, 2017. As a result, as of December 31, 2017, our total investment in the Holistic MD Property was approximately $16.9 million
(excluding transaction costs), and, effective as of October 1, 2017, Holistic’s base rent is approximately $213,760 per month,
of which $187,500 is subject to annual escalations of 3.25% for the initial lease term. We also receive a property management fee
under the lease equal to 1.5% of the then-current base rent throughout the initial term.
On October 23, 2017, we completed the acquisition
of a 40,000 square foot (unaudited) industrial property located in New York (the “Vireo NY Property”), which we purchased
from a subsidiary of Vireo Health, Inc. (“Vireo New York”) for approximately $3.4 million (plus approximately $60,000
in transaction costs) in a sale-leaseback transaction. Concurrent with the closing of the acquisition, we entered into a triple-net
lease with Vireo New York, as tenant, for use as a medical cannabis cultivation and processing facility. Vireo New York is responsible
for paying all structural repairs, maintenance expenses, insurance and taxes related to the Vireo NY Property. The lease term is
15 years, with two options to extend the term of the lease for two additional five-year periods. The lease also provides that we
will fund up to $1.0 million as reimbursement for future tenant improvements at the Vireo NY Property, none of which was funded
as of December 31, 2017. The initial base rent of the Vireo New York lease is $55,000 per month, subject to annual increases at
a rate of 3.5%. We also receive a property management fee under the lease equal to 1.5% of the then-current base rent throughout
the term.
On November 8, 2017, we completed the acquisition
of a 20,000 square foot (unaudited) industrial property located in Minnesota (the “Vireo MN Property”), which we purchased
from a subsidiary of Vireo Health, Inc. (“Vireo Minnesota”) for approximately $3.0 million (plus approximately $58,000
in transaction costs) in a sale-leaseback transaction. Concurrent with the closing of the acquisition, we entered into a triple-net
lease with Vireo Minnesota, as tenant for use as a medical cannabis cultivation and processing facility. Vireo Minnesota is responsible
for paying all structural repairs, maintenance expenses, insurance and taxes related to the Vireo MN Property. The lease term is
15 years, with two options to extend the term of the lease for two additional five-year periods. The lease also provides that we
will fund up to $1.0 million as reimbursement for future tenant improvements at the Vireo MN Property, none of which was funded
as of December 31, 2017. The initial base rent of the Vireo Minnesota lease is $50,000 per month, subject to annual increases at
a rate of 3.5%. We also receive a property management fee under the lease equal to 1.5% of the then-current base rent throughout
the term.
On December 15, 2017,
we completed the acquisition of a property in Arizona (the "Pharm AZ Property") comprising approximately 358,000 square
feet (unaudited) of greenhouse and industrial space, which we purchased from a subsidiary of The Pharm, LLC ("The Pharm")
for $15.0 million (plus approximately $27,000 in transaction costs) in a sale-leaseback transaction. Concurrent with the closing
of the acquisition, we entered into a triple-net lease with another subsidiary of The Pharm, as tenant for continued use as a medical
cannabis cultivation and processing facility. The Pharm subsidiary is responsible for paying all structural repairs, maintenance
expenses, insurance and taxes related to the Pharm AZ Property. The lease term is 15 years, with two options to extend the term
of the lease for two additional five-year periods. The lease also provides that we will fund up to $3.0 million as reimbursement
for future tenant improvements at the Pharm AZ Property, none of which was funded as of December 31, 2017.
The initial monthly
base rent under the lease is $210,000 and is subject to annual increases of 3.25% during
the lease term. The base rent on $5.0 million of the purchase price ($58,333.33 per month) will be abated until March 31, 2018,
and the base rent attributable to the tenant improvement allowance ($35,000.00 per month) was abated until March 14, 2018. We also
receive a property management fee under the lease equal to 1.5% of the then-current base rent throughout the term.
Future contractual minimum rent (including
base rent, supplemental base rent (for the PharmaCann NY Property) and property management fees) under the operating leases as
of December 31, 2017 for future periods is summarized as follows (in thousands):
Year
|
|
Contractual Minimum Rent
|
|
2018
|
|
$
|
11,543
|
|
2019
|
|
|
12,170
|
|
2020
|
|
|
12,549
|
|
2021
|
|
|
12,898
|
|
2022
|
|
|
12,083
|
|
Thereafter
|
|
|
140,589
|
|
Total
|
|
$
|
201,832
|
|
8. Fair Value of Financial Instruments
Fair value is defined as the price that would
be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement
date. Accounting guidance also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs
and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be
used to measure fair value:
Level 1—Observable inputs that reflect
quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2—Includes other inputs that are
directly or indirectly observable in the marketplace.
Level 3—Unobservable inputs that are
supported by little or no market activities, therefore requiring an entity to develop its own assumptions.
At December 31, 2017 and 2016, cash equivalent
instruments consisted of $5.0 million and $14.7 million in short-term money market funds that were measured using the net asset
value per share that have not been classified using the fair value hierarchy. The fund invests primarily in short-term U.S. Treasury
and government securities.
The carrying amounts of financial instruments
such as cash equivalents invested in certificates of deposit, receivables, accounts payable, accrued expenses and other liabilities
approximate their relative fair values due to the short-term maturities and market rates of interest of these instruments.
|
9.
|
Common Stock Incentive Plan
|
Our board of directors adopted our 2016 Omnibus
Incentive Plan (the "2016 Plan"), to enable us to motivate, attract and retain the services of directors, employees and
consultants considered essential to our long-term success. The 2016 Plan offers our directors, employees and consultants an opportunity
to own our stock or rights that will reflect our growth, development and financial success. Under the terms of the 2016 Plan, the
aggregate number of shares of our common stock subject to options, restricted stock, stock appreciation rights, restricted stock
units and other awards, will be no more than 1,000,000 shares. The 2016 Plan has a term of ten years from the date it was adopted
by our Board of Directors. The plan became effective on December 5, 2016 on which the shares of the Company's voting common stock
were first sold to the public pursuant to an effective registration statement filed by the Company under the Securities Act of
1933, as amended.
A summary of the activity under the 2016 Plan
and related information for the period from June 15, 2016 (date of incorporation) through December 31, 2017 is included in
the table below.
|
|
Unvested
Restricted
Shares
|
|
|
Weighted-
Average Date
Fair Value
|
|
Balance at June 15, 2016
|
|
|
—
|
|
|
$
|
—
|
|
Granted
|
|
|
66,508
|
|
|
|
17.47
|
|
Balance at December 31, 2016
|
|
|
66,508
|
|
|
|
17.47
|
|
Granted
|
|
|
115,011
|
|
|
|
18.63
|
|
Vested
|
|
|
(44,308
|
)
|
|
|
18.47
|
|
Forfeited (1)
|
|
|
(30,372
|
)
|
|
|
18.49
|
|
Balance at December 31, 2017
|
|
|
106,839
|
|
|
$
|
18.01
|
|
|
(1)
|
Includes 16,792 shares that were forfeited to cover the employees’ tax withholding obligation upon vesting.
|
The remaining unrecognized compensation cost
of $1.4 million will be recognized over a weighted-average amortization period of approximately two years as of December 31, 2017.
10. Commitments and Contingencies
Office Lease
. As of December 31, 2017,
we had approximately $236,000 outstanding in commitments related to our office lease, with approximately $75,000 to be paid in
2018, approximately $89,000 to be paid in 2019 and approximately $72,000 to be paid in 2020.
Tenant Improvement Allowance
. See Note
7.
Environmental Matters
. We follow the
policy of monitoring our properties, both targeted acquisition and existing properties, for the presence of hazardous or toxic
substances. While there can be no assurance that a material environmental liability does not exist, we are not currently
aware of any environmental liabilities that would have a material adverse effect on our financial condition, results of operations
and cash flow, or that we believe would require disclosure or the recording of a loss contingency.
Litigation
.
We
may, from time to time, be a party to legal proceedings, which arise in the ordinary course of our business. We are not aware of
any pending or threatened litigation that, if resolved against us, would have a material adverse effect on our consolidated financial
position, results of operations or cash flows.
11. Related Party Transactions
Private Airplane Reimbursement
. Alan
Gold, our executive chairman, utilizes a private airplane from time to time exclusively for company business travel purposes, which
airplane is owned by an entity controlled by Mr. Gold. We reimburse Mr. Gold for the company-related use of the airplane by Mr.
Gold and our other executives, including out-of-pocket operating costs, on terms we believe are comparable to those we could secure
from an independent third party. As approved by our audit committee, for the year ended December 31, 2017, we paid $30,000 to Mr.
Gold on account of such expenses. No amounts were paid on account of such expenses for the period from June 15, 2016 (date of incorporation)
through December 31, 2016.
Founder
Shares
.
As disclosed in Note 3, in June 2016, we issued 508,065
shares of Class B Common Stock for $508 to certain of our executive officers, directors and a co-founder. Each of our founders
subsequently entered into a redemption agreement with us pursuant to which such shares of Class B Common Stock were redeemed by
us in their entirety for $0.001 per share and cancelled immediately before the closing of our initial public offering.
Reimbursement of IGP Advisers
. During
the period from June 15, 2016 (date of incorporation) through December 31, 2016, a portion of the net proceeds from our initial
public offering were used to reimburse IGP Advisers for out-of-pocket expenses it incurred in connection with the formation of
our Company and initial public offering. In addition, we entered into a consulting agreement with IGP Advisers that provided for,
upon the completion of the initial public offering, a consulting fee of $566,000 to IGP Advisers for services rendered to assist
us in completing the initial public offering. We also used $375,000 of the net proceeds of the initial public offering to reimburse
IGP Advisers for an earnest money deposit that IGP Advisers funded on our behalf, as required by the purchase agreement for our
PharmaCann NY Property. Following the completion of our initial public offering, our agreements with IGP Advisers terminated and
IGP Advisers was dissolved; as such we do not expect to transact business with, or incur costs related to, IGP Advisers in the
future, as all of our employees were employed directly by us following the completion of our initial public offering.
The amounts reimbursed to IGP Advisers were
as follows (in thousands):
Offering Costs
|
|
$
|
338
|
|
Organizational Costs
|
|
|
34
|
|
Corporate Assets
|
|
|
52
|
|
Transaction Costs
|
|
|
8
|
|
Earnest Money Deposit
|
|
|
375
|
|
Consulting Fee
|
|
|
566
|
|
Total
|
|
$
|
1,373
|
|
12. Subsequent Events
On January 22, 2018, we issued 3,220,000 shares of common stock,
including the exercise in full of the underwriters' option to purchase an additional 420,000 shares, resulting in net proceeds
of approximately $79.3 million, after deducting the underwriters' discounts and commissions and offering expenses.
On March 15, 2018, our board of directors declared a dividend
of $0.25 per share of common stock and a dividend of $0.5625 per share of Series A Preferred Stock, which are payable on
April 16, 2018 to all stockholders of record as of March 29, 2018.
INDEPENDENT AUDITOR’S REPORT
To the Board of Members
PharmaCann LLC and Subsidiaries
Oak Park, Illinois
We have audited the accompanying consolidated financial statements
of PharmaCann LLC and Subsidiaries (the Company), which comprise the consolidated balance sheets as of December 31, 2017 and 2016,
and the related consolidated statements of income, members’ equity, and cash flows for the years then ended, and the related
notes to the consolidated financial statements.
Management’s Responsibility for the Consolidated Financial
Statements
Management is responsible for the preparation and fair presentation
of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of
America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation
of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion
on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence
about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s
judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due
to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation
and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly,
we express no such opinion. An audit also includes evaluating the appropriateness of accounting principles used and the reasonableness
of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial
statements.
We believe that the audit evidence we obtained is sufficient and
appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial position of PharmaCann LLC and Subsidiaries as of December 31,
2017 and 2016, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles
generally accepted in the United States of America.
Emphasis of Matter
As discussed in Note 1 to the consolidated financial
statements, the Company’s business operations are in the medical cannabis industry which is currently considered illegal
under federal law. If the federal government or the states in which the Company operates change the laws with respect to the medical
cannabis industry and/or the federal government elects to enforce existing laws, it could be financially harmful to the Company
as it could be prosecuted and result in the Company being liquidated.
/s/ Martin Hood LLC
Champaign, Illinois
March 20, 2018
PHARMACANN LLC AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2017 and 2016
|
|
2017
|
|
|
2016
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current Assets
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
20,208,499
|
|
|
$
|
20,775,333
|
|
Cash Held in Escrow
|
|
|
234,920
|
|
|
|
200,000
|
|
Accounts Receivable
|
|
|
426,537
|
|
|
|
57,958
|
|
Note Receivable, Net
|
|
|
—
|
|
|
|
199,100
|
|
Inventory
|
|
|
20,543,035
|
|
|
|
5,965,188
|
|
Prepaid Expenses
|
|
|
987,585
|
|
|
|
727,434
|
|
Deposits
|
|
|
—
|
|
|
|
81,000
|
|
Total Current Assets
|
|
|
42,400,576
|
|
|
|
28,006,013
|
|
|
|
|
|
|
|
|
|
|
Property and Equipment, Net
|
|
|
52,111,098
|
|
|
|
51,874,031
|
|
|
|
|
|
|
|
|
|
|
Other Assets
|
|
|
|
|
|
|
|
|
Restricted Cash
|
|
|
301,000
|
|
|
|
301,000
|
|
Intangibles, Net
|
|
|
157,591
|
|
|
|
18,841
|
|
Goodwill
|
|
|
253,375
|
|
|
|
—
|
|
Deferred Loss on the Sale of Property
|
|
|
952,754
|
|
|
|
1,020,808
|
|
Deposits
|
|
|
2,583,490
|
|
|
|
2,292,309
|
|
Total Other Assets
|
|
|
4,248,210
|
|
|
|
3,632,958
|
|
Total Assets
|
|
$
|
98,759,884
|
|
|
$
|
83,513,002
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND MEMBERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current Liabilities
|
|
|
|
|
|
|
|
|
Accounts Payable
|
|
$
|
1,970,352
|
|
|
$
|
759,875
|
|
Construction Payable
|
|
|
317,086
|
|
|
|
757,910
|
|
Accrued Expenses
|
|
|
3,142,791
|
|
|
|
1,129,602
|
|
Notes Payable, Current
|
|
|
999,995
|
|
|
|
1,999,989
|
|
Capital Lease Obligation, Current
|
|
|
395,437
|
|
|
|
203,434
|
|
Convertible Notes Payable, Current
|
|
|
43,782,437
|
|
|
|
4,650,606
|
|
Total Current Liabilities
|
|
|
50,608,098
|
|
|
|
9,501,416
|
|
|
|
|
|
|
|
|
|
|
Long-Term Liabilities
|
|
|
|
|
|
|
|
|
Notes Payable, Net of Current Portion
|
|
|
—
|
|
|
|
999,995
|
|
Notes Payable, Member
|
|
|
500,000
|
|
|
|
—
|
|
Capital Lease Obligation
|
|
|
28,892,276
|
|
|
|
29,318,611
|
|
Convertible Notes Payable
|
|
|
—
|
|
|
|
23,582,437
|
|
Contingent Consideration on Business Combination
|
|
|
550,000
|
|
|
|
—
|
|
Total Long-Term Liabilities
|
|
|
29,942,276
|
|
|
|
53,901,043
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
80,550,374
|
|
|
|
63,402,459
|
|
Members’ Equity
|
|
|
|
|
|
|
|
|
Members’ Capital
|
|
|
52,664,266
|
|
|
|
37,794,957
|
|
Retained Deficit
|
|
|
(34,454,756
|
)
|
|
|
(17,684,414
|
)
|
Total Members’ Equity
|
|
|
18,209,510
|
|
|
|
20,110,543
|
|
Total Liabilities and Members’ Equity
|
|
$
|
98,759,884
|
|
|
$
|
83,513,002
|
|
See Accompanying Notes
PHARMACANN LLC AND SUBSIDIARIES
Consolidated Statements of Income
For the Years Ended December 31, 2017 and
2016
|
|
2017
|
|
|
2016
|
|
Revenues
|
|
|
|
|
|
|
|
|
Net Sales
|
|
$
|
12,214,436
|
|
|
$
|
3,622,993
|
|
Management Services Revenue, including Interest Income of $445,851
|
|
|
1,644,091
|
|
|
|
—
|
Total Revenues
|
|
|
13,858,527
|
|
|
|
3,622,993
|
|
Cost of Sales
|
|
|
|
|
|
|
|
|
Cost of Sales
|
|
|
7,584,430
|
|
|
|
2,503,871
|
|
Loss on Inventory Adjustment to Lower of Cost or Market
|
|
|
736,283
|
|
|
|
3,343,710
|
|
Total Cost of Sales
|
|
|
8,320,713
|
|
|
|
5,847,581
|
|
Gross Profit (Loss)
|
|
|
5,537,814
|
|
|
|
(2,224,588
|
)
|
Operating Expenses
|
|
|
|
|
|
|
|
|
Compensation & Benefits
|
|
|
7,043,746
|
|
|
|
4,346,669
|
|
Profession Fees
|
|
|
5,066,299
|
|
|
|
2,204,862
|
|
Bad Debt Expense
|
|
|
4,184,512
|
|
|
|
—
|
|
Occupancy
|
|
|
1,137,244
|
|
|
|
687,243
|
|
Unit Option Based Compensation
|
|
|
1,024,617
|
|
|
|
—
|
|
Marketing
|
|
|
709,423
|
|
|
|
1,274,305
|
|
Depreciation and Amortization
|
|
|
531,131
|
|
|
|
390,507
|
|
Licenses & Permits
|
|
|
454,493
|
|
|
|
273,450
|
|
Travel & Entertainment
|
|
|
366,967
|
|
|
|
165,075
|
|
Insurance
|
|
|
227,736
|
|
|
|
176,831
|
|
Business Development
|
|
|
59,731
|
|
|
|
25,597
|
|
Interest Expense
|
|
|
—
|
|
|
|
574,634
|
|
Other
|
|
|
511,242
|
|
|
|
265,340
|
|
Total Operating Expense
|
|
|
21,317,141
|
|
|
|
10,384,513
|
|
Income (Loss) from Operations
|
|
|
(15,779,327
|
)
|
|
|
(12,609,101
|
)
|
Other Income (Expense)
|
|
|
|
|
|
|
|
|
Interest Expense
|
|
|
(993,535
|
)
|
|
|
(430,720
|
)
|
Interest Income
|
|
|
12,993
|
|
|
|
9,126
|
|
Loss on the Sale of Property
|
|
|
(68,054
|
)
|
|
|
(214,773
|
)
|
Other Income (Expense)
|
|
|
57,581
|
|
|
|
6,362
|
|
Total Other Income (Expense)
|
|
|
(991,015
|
)
|
|
|
(630,005
|
)
|
Net Income (Loss)
|
|
$
|
(16,770,342
|
)
|
|
$
|
(13,239,106
|
)
|
See Accompanying Notes
PHARMACANN LLC AND SUBSIDIARIES
Consolidated Statements of Members’
Equity
For the Years Ended December 31, 2017 and
2016
|
|
Series A
Preferred
|
|
|
Class A
|
|
|
Purchase of
Member
Units on
Subscription
|
|
|
Unit Option
Based
Compensation
|
|
|
Total
Members’
Capital
|
|
|
Retained
Deficit
|
|
|
Total
Members’
Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Members’ Equity at December 31, 2015
|
|
$
|
40,646,976
|
|
|
$
|
1,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
40,647,976
|
|
|
$
|
(4,445,308
|
)
|
|
$
|
36,202,668
|
|
Contributions from Members
|
|
|
—
|
|
|
|
4,979,475
|
|
|
|
(4,979,975
|
)
|
|
|
—
|
|
|
|
(500
|
)
|
|
|
—
|
|
|
|
(500
|
)
|
Redemption of Members
|
|
|
—
|
|
|
|
(4,979,975
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(4,979,975
|
)
|
|
|
—
|
|
|
|
(4,979,975
|
)
|
Distribution to Members
|
|
|
(10,954
|
)
|
|
|
—
|
|
|
|
|
|
|
|
—
|
|
|
|
(10,954
|
)
|
|
|
—
|
|
|
|
(10,954
|
)
|
Payments on Subscriptions
|
|
|
—
|
|
|
|
—
|
|
|
|
2,138,410
|
|
|
|
—
|
|
|
|
2,138,410
|
|
|
|
—
|
|
|
|
2,138,410
|
|
Net Income (Loss)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(13,239,106
|
)
|
|
|
(13,239,106
|
)
|
Members’ Equity at December 31, 2016
|
|
$
|
40,636,022
|
|
|
$
|
500
|
|
|
$
|
(2,841,565
|
)
|
|
$
|
—
|
|
|
$
|
37,794,957
|
|
|
$
|
(17,684,414
|
)
|
|
$
|
20,110,543
|
|
Series A Preferred Units Purchased
|
|
|
12,900,00
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
12,900,000
|
|
|
|
—
|
|
|
|
12,900,000
|
|
Re-Purchase of Members Units
|
|
|
(999,926
|
)
|
|
|
(98
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(1,000,024
|
)
|
|
|
—
|
|
|
|
(1,000,024
|
)
|
Distribution to Members
|
|
|
(1,038
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(1,038
|
)
|
|
|
—
|
|
|
|
(1,038
|
)
|
Payments on Subscriptions
|
|
|
—
|
|
|
|
—
|
|
|
|
1,945,754
|
|
|
|
—
|
|
|
|
1,945,754
|
|
|
|
—
|
|
|
|
1,945,754
|
|
Vested Unit Options (Unit Based Compensation)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,024,617
|
|
|
|
1,024,617
|
|
|
|
—
|
|
|
|
1,024,617
|
|
Net Income (Loss)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(16,770,342
|
)
|
|
|
(16,770,342
|
)
|
Members’ Equity at December 31, 2017
|
|
$
|
52,535,058
|
|
|
$
|
402
|
|
|
$
|
(895,811
|
)
|
|
$
|
1,024,617
|
|
|
$
|
52,664,266
|
|
|
$
|
(34,454,756
|
)
|
|
$
|
18,209,510
|
|
See Accompanying Notes
PHARMACANN LLC AND SUBSIDIARIES
Consolidated Statements of Income
For the Years Ended December 31, 2017 and
2016
|
|
2016
|
|
|
2015
|
|
Cash Flows from Operating Activities
|
|
|
|
|
|
|
|
|
Net Income (Loss)
|
|
$
|
(16,770,342
|
)
|
|
$
|
(13,239,106
|
)
|
Adjustment to Reconcile Net Income (Net Loss) to
|
|
|
|
|
|
|
|
|
Net Cash Provided by (Used in) Operating Activities:
|
|
|
|
|
|
|
|
|
Depreciation and Amortization
|
|
|
531,131
|
|
|
|
390,507
|
|
Loss on Sale of Property
|
|
|
68,054
|
|
|
|
214,773
|
|
Provision for Allowances on Notes Receivable
|
|
|
4,184,512
|
|
|
|
—
|
|
Vested Unit Options (Unit Based Compensation)
|
|
|
1,024,617
|
|
|
|
—
|
|
(Increase) Decrease in Assets:
|
|
|
|
|
|
|
|
|
Escrow
|
|
|
(34,920
|
)
|
|
|
4,087,282
|
|
Restricted Cash
|
|
|
—
|
|
|
|
125,000
|
|
Receivables
|
|
|
(368,579
|
)
|
|
|
191,507
|
|
Inventory
|
|
|
(11,509,303
|
)
|
|
|
(4,621,871
|
)
|
Prepaid Expenses
|
|
|
(260,151
|
)
|
|
|
(178,951
|
)
|
Deposits
|
|
|
(210,181
|
)
|
|
|
(141,217
|
)
|
Increase (Decrease) in Liabilities:
|
|
|
|
|
|
|
|
|
Accounts Payable
|
|
|
1,210,477
|
|
|
|
546,452
|
|
Accrued Expenses
|
|
|
2,013,189
|
|
|
|
568,723
|
|
Net Adjustments
|
|
|
(3,351,154
|
)
|
|
|
1,182,205
|
|
Net Cash Provided by (Used in) Operating Activities
|
|
|
(20,121,496
|
)
|
|
|
(12,056,901
|
)
|
Cash Flows from Investing Activities
|
|
|
|
|
|
|
|
|
Payments on Construction Payables
|
|
|
(440,824
|
)
|
|
|
(6,089,636
|
)
|
Proceeds on the Sale of Property and Equipment
|
|
|
—
|
|
|
|
30,000,000
|
|
Issuance of Notes Receivable
|
|
|
(2,910,685
|
)
|
|
|
(199,100
|
)
|
Acquisition of Business
|
|
|
(963,102
|
)
|
|
|
—
|
|
Purchases of Property and Equipment
|
|
|
(3,790,492
|
)
|
|
|
(12,768,103
|
)
|
Net Cash Provided by (Used in) Investing Activities
|
|
|
(8,105,103
|
)
|
|
|
10,943,161
|
|
Cash Flows from Financing Activities
|
|
|
|
|
|
|
|
|
Principal Advances on Convertible Note Payable
|
|
|
15,549,394
|
|
|
|
23,582,437
|
|
Receipts from Subscriptions Receivable
|
|
|
1,945,754
|
|
|
|
2,138,410
|
|
Payments on Notes Payable
|
|
|
(1,999,989
|
)
|
|
|
(999,995
|
)
|
Principal Advances on Notes Payable, Member
|
|
|
500,000
|
|
|
|
5,000,000
|
|
Payments on Notes Payable, Member
|
|
|
—
|
|
|
|
(5,000,000
|
)
|
Payments on Capital Lease Obligation
|
|
|
(234,332
|
)
|
|
|
(32,755
|
)
|
Deferred Loss on the Sale of Property
|
|
|
—
|
|
|
|
(1,020,808
|
)
|
Security Deposit related to Capital Lease Obligation
|
|
|
—
|
|
|
|
(2,112,474
|
)
|
Re-Purchase of Member Units
|
|
|
(1,000,024
|
)
|
|
|
—
|
|
Redemption of Members
|
|
|
—
|
|
|
|
(979,996
|
)
|
Series A Preferred Units Purchased
|
|
|
12,900,000
|
|
|
|
—
|
|
Distribution to Members
|
|
|
(1,038
|
)
|
|
|
(11,454
|
)
|
Net Cash Provided by (Used in) Financing Activities
|
|
|
27,659,765
|
|
|
|
20,563,365
|
|
Net Change in Cash
|
|
|
(566,834
|
)
|
|
|
19,449,625
|
|
Cash, Beginning of Year
|
|
|
20,775,333
|
|
|
|
1,325,708
|
|
Cash, End of Year
|
|
$
|
20,208,499
|
|
|
$
|
20,775,333
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Paid During the Year for Interest
|
|
$
|
5,131,998
|
|
|
$
|
579,583
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Non-Cash Financing Information
|
|
|
|
|
|
|
|
|
Purchases of Property and Equipment via Construction Payable
|
|
$
|
—
|
|
|
$
|
757,910
|
|
Interest Expense Capitalized into Property and Equipment
|
|
$
|
44,389
|
|
|
$
|
673,689
|
|
Purchase of Property and Equipment via Capital Lease Obligation
|
|
$
|
—
|
|
|
$
|
29,554,800
|
|
Issuance of Members’ Capital through Subscription Receivable
|
|
$
|
—
|
|
|
$
|
4,979,975
|
|
Redemption of Members through Notes Payable
|
|
$
|
—
|
|
|
$
|
3,999,979
|
|
|
|
|
|
|
|
|
|
|
Acquisition of Business
|
|
|
|
|
|
|
|
|
Net Identifiable Assets Acquired
|
|
$
|
1,074,727
|
|
|
$
|
—
|
|
Non-Compete Agreement
|
|
|
185,000
|
|
|
|
|
|
Goodwill Acquired
|
|
|
253,375
|
|
|
|
—
|
|
Net Assets Acquired
|
|
|
1,513,102
|
|
|
|
—
|
|
Contingent Considerations
|
|
|
(550,000
|
)
|
|
|
—
|
|
Cash Consideration for Acquisition of Business
|
|
$
|
963,102
|
|
|
$
|
—
|
|
See Accompanying Notes
PHARMACANN LLC AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
PharmaCann LLC and Subsidiaries’ (the Company)
principle activities include cultivating, distributing and dispensing medical cannabis to be used by qualified patients for medical
use. PharmaCann, LLC is an Illinois limited liability company established in 2014 for the purpose of fulfilling the principle activities.
The Company has established the following wholly-owned
subsidiaries (year of formation) that will be used to fulfill the principle activities:
|
·
|
2015 – PharmaCann of New York, LLC, a wholly owned subsidiary
of PharmaCann LLC, is a New York limited liability company established in 2015, but did not have any activity for the years ended
December 31, 2017 and 2016 as the transactions flow through PharmaCann LLC,
|
|
·
|
2016 – PharmaCann Mass LLC (referred to as “MASS”),
a wholly owned subsidiary of PharmaCann LLC, is a Massachusetts limited liability company established in 2016 to act as a management
company for future cultivation and dispensary locations in Massachusetts licensed to a third party not-for-profit,
|
|
·
|
2017 – PharmaCannis Labs LLC, an Illinois limited liability
company, with the primary purpose of research and development of pharmaceutical cannabis strains,
|
|
·
|
2017 – Sunbiz Acquisition LLC, a Florida limited liability company,
which purchased Breakthrough Junction Corp., a Florida corporation that was subsequently converted to PharmaCann Florida LLC, a
Florida limited liability company,
|
|
·
|
2017 – PharmaCann DC LLC, a District of Columbia limited liability
company, which has applied for a dispensary license,
|
|
·
|
2017 – PharmaCann Ohio LLC, an Ohio limited liability company,
which has plans for cultivation, processing and dispensing upon receiving licenses,
|
|
·
|
2017 – PharmaCann Penn LLC, a Pennsylvania limited liability
company, was awarded a dispensary license in Pennsylvania, which will allow them to operate up to three dispensary locations near
Philadelphia,
|
|
·
|
2017 – PharmaCann Michigan LLC, a Michigan limited liability
company, which is in the application process to obtain licenses to operate in Michigan.
|
|
·
|
2017 – PCL Management LLC, an Illinois limited liability company,
which will act as the entity for processing payroll for all employees of the Company.
|
All transactions and balances between these entities
have been eliminated upon consolidation.
The Company is currently applying for and has been granted
licenses in other states, but only operates in Illinois and New York exclusively as of December 31, 2017, with the exception of
the management agreement for PharmaCann Mass LLC.
In Illinois, the Company operates two cultivation centers
permitted to grow and process medical cannabis products, which are distributed to Illinois registered medical cannabis dispensaries,
both owned and third-party. The Company operates four registered medical cannabis dispensaries in Illinois that sell medical cannabis
and ancillary products to patients that have been certified by the State of Illinois to use medical cannabis.
In New York, the Company is a registered organization
and operates one manufacturing facility to grow and process medical cannabis products which are distributed to four New York dispensaries
operated by the Company. The Company’s New York dispensaries sell medical cannabis and ancillary products to patients that
have been certified by the New York State Department of Health to use medical cannabis.
|
2.
|
Summary of Significant Accounting Policies
|
|
a.
|
Inventories are valued at lower of cost or market. Cost is determined using the first-in first-out (FIFO) method.
|
|
b.
|
Property and equipment is recorded at cost. Minor additions are expensed in the year incurred. Major additions over $5,000
are capitalized and depreciated over their estimated useful lives using straight-line or accelerated methods. Useful lives are
5-12 years for equipment, 10 years for furniture and fixtures, 15 years for leasehold improvements, and 39 years for buildings.
|
|
c.
|
The Company reduces notes receivable by a valuation allowance that reflects management’s best estimate of probable losses
determined principally on historical experience and operations for the debtor. As of December 31, 2017 and 2016, the total allowance
was $4,184,512 and $0, respectively. The entire allowance is related to the not-for-profit entity discussed in Note 5.
|
|
d.
|
Intangibles include non-compete agreements. The non-compete agreements are being amortized over 3 years. The Company will test
its intangibles for impairment upon the occurrence of an event or circumstance that may indicate the fair value is less than its
carrying amount. Amortization expense related to the intangibles was $46,250 for the year ended December 31, 2017.
|
|
e.
|
Goodwill is reviewed for possible impairment at least annually, or more frequently upon the occurrence
of an event or circumstances indicate that the carrying amount is greater than the fair value. Management has determined that there
is no impairment for the year ended December 31, 2017.
|
|
f.
|
The Company recognizes revenue when the transaction is completed upon delivery of the final product to the customers at the
point of sale.
|
|
g.
|
The Company expenses shipping and handling costs as they are incurred. Shipping and handling expenses incurred on products
sold are included in cost of sales.
|
|
h.
|
Illinois cultivation tax is 7 percent of cannabis sales on wholesale sales to third parties and the Company’s sales to
their own dispensaries from cultivation facilities based on the selling price attributed to the amount of cannabis in the product.
The Company is paying the cultivation tax on the sales from the cultivation facilities to the owned dispensaries under protest
because it is not a true sale. The tax is included in cost of goods sold and totaled $247,674 and $57,452 for the years ended December
31, 2017 and 2016, respectively. In New York, there is no cultivation tax, but there is a 7 percent excise tax on sales at the
dispensaries that is remitted to the state of New York.
|
|
i.
|
Advertising costs are charged to operations when incurred. Advertising expenses totaled $233,224 and $21,165 for the years
ended December 31, 2017 and 2016.
|
|
j.
|
Losses from sale-leaseback transactions are deferred and recognized over the life of the underlying leased asset as disclosed
in Note 17.
|
|
k.
|
As a limited liability company, the Company’s taxable income or loss is allocated to members in accordance with the Company’s
member agreement. Therefore, no provision or liability for income taxes has been included in the consolidated financial statements.
On or before March 31 of each year, the Company is required to make mandatory tax distributions on a pro-rata basis in accordance
with the member agreement based upon thirty-six percent of the Company’s net taxable income for the previous calendar year.
The Company is in the process of amending the member agreement to extend the tax distribution deadline to April 10 of each year.
|
|
l.
|
The preparation of consolidated financial statements in
conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported
amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements,
and revenue and expenses during the reporting period. Accordingly, actual results could differ from those estimates.
|
Compensation expense recognized related
to the issuance of member unit options is based on the intrinsic method of valuing the underlying options in relation to the estimated
value of the Company. Allocation of overhead costs to work in process is based on an estimate of time and resources dedicated to
the production of inventory, and the estimate of per unit material costs to be relieved into cost of goods sold upon product sales.
Due to the uncertainties inherent in the estimation process, it is at least reasonably possible that compensation expense and the
overhead cost allocation will be revised.
As discussed in the Emphasis of
Matter paragraph, cannabis is still considered a Schedule 1 substance under the Controlled Substance Act. As such, there is an
inherent risk related to the federal government’s position on cannabis; however, the Company has deemed it not reasonable
to estimate a potential liability related to the possible enforcement of laws against the medical cannabis industry.
|
m.
|
As of December 31, 2017, the federal and Illinois tax filings since inception remain open for review by tax authorities.
|
|
3.
|
Collateralization of Deposits
|
Cash is a financial instrument that potentially subjects
the Company to a concentration of credit risk. As of December 31, 2017, the Company has bank deposits in financial institutions
in excess of the amounts insured by the Federal Deposit Insurance Corporation in the amount of $20,443,377, including cash held
in escrow and restricted cash balances.
|
4.
|
Cash Held in Escrow and Restricted Cash
|
Cash held in escrow consists of four escrow accounts
for $50,000 each related to one of four dispensary locations totaling $200,920 and $200,000 as of December 31, 2017 and 2016, respectively,
as required by the Illinois Division of Financial and Professional Regulation for medical cannabis dispensaries in Illinois. The
balance must remain in escrow as long as the Company maintains its license to operate the dispensaries in Illinois. The Company
had an additional $34,000 held in three other miscellaneous escrow accounts.
Restricted cash consists of cash deposits serving as
collateral for the two surety bonds in the amount of $250,000 at December 31, 2017 and 2016, respectively, and secured credit facilities
in the amount of $51,000 at December 31, 2017 and 2016. The Company also held an irrevocable letter of credit in the amount of
$250,000 as of December 31, 2016 through December 9, 2017, which served as collateral for the balance of the surety bonds. The
letter of credit was not renewed upon expiration on December 9, 2017.
In 2016, the Company issued a line of credit to a not-for-profit
entity (NFP) in the amount of $350,000. As of December 31, 2017, the outstanding balance on the line of credit was $396,440, of
which the additional $49,027 is interest receivable. As of December 31, 2016, the outstanding balance on the line of credit was
$199,100. The note matures on December 31, 2018 and bears interest of 16 percent, which is added to the principal balance. Interest
payments will be payable in cash each month starting March 1, 2018, which is 365 days after the interest commencement date. This
note is secured by all assets and all personal property of the borrowers. MASS holds a management services agreement with the NFP
after the business acquisition disclosed in Note 21.
On January 27, 2017, the Company issued a working capital
loan to the same NFP for an amount not to exceed $4,000,000 with a maturity of January 2027. The NFP can use this working capital
line for normal operations, including personnel charges at set rates for various assistance for Company employees, payment of prorated
annual royalties of $250,000 to MASS, and a 15 percent surcharge on the cost of any good or services provided by MASS on behalf
of the NFP. Interest accrues monthly at 18 percent and is added to the principal balance. Interest payments will be payable in
cash each month starting two years after the commencement date. As of December 31, 2017, the outstanding balance on the working
capital note receivable was $2,570,977.
The Company also purchased a note receivable in the business
acquisition disclosed in Note 21 with a balance as of $1,217,095, which includes $447,537 of interest receivable. The note matures
on January 1, 2021 and bears interest of 18.5 percent.
Due to the unlikeliness of repayment, the Company has
recorded an allowance for the entire balance of the three notes and related interest in the amount of $4,184,512 as of December
31, 2017.
The major classes of inventory are
as follows as of December 31:
|
|
2017
|
|
|
2016
|
|
Materials Inventory
|
|
$
|
573,538
|
|
|
$
|
185,275
|
|
Work in Process
|
|
|
19,522,426
|
|
|
|
5,447,173
|
|
Finished Goods
|
|
|
447,071
|
|
|
|
332,740
|
|
Total Inventory
|
|
$
|
20,543,035
|
|
|
$
|
5,965,188
|
|
Due to the federal laws against cannabis,
the Company is unable to move inventory across state lines to their other locations.
|
7.
|
Property and Equipment, Net
|
Property and equipment consist of the following as of
December 31:
|
|
2017
|
|
|
2016
|
|
Land
|
|
$
|
516,946
|
|
|
$
|
—
|
|
Building
|
|
|
14,289,185
|
|
|
|
12,893,730
|
|
Leasehold Improvements
|
|
|
6,684,585
|
|
|
|
6,632,705
|
|
Equipment
|
|
|
4,176,948
|
|
|
|
2,633,355
|
|
Furniture and Fixtures
|
|
|
186,981
|
|
|
|
171,133
|
|
Construction in Progress
|
|
|
1,567,115
|
|
|
|
1,300,347
|
|
Capital Leased Asset
|
|
|
29,554,800
|
|
|
|
29,554,800
|
|
Total Property and Equipment
|
|
|
56,976,560
|
|
|
|
53,186,070
|
|
Less: Accumulated Depreciation and Amortization
|
|
|
(4,865,462
|
)
|
|
|
(1,312,039
|
)
|
Property and Equipment, Net
|
|
$
|
52,111,098
|
|
|
$
|
51,874,031
|
|
Depreciation and amortization expense was $3,618,678
and $1,173,424 for the years ended December 31, 2017 and 2016, of which $3,068,544 and $782,917 related to the production of inventory
was capitalized into work in process, respectively.
Interest expense was $5,980,697 for the year ended December
31, 2017, of which $44,389 was capitalized into Construction in Progress, respectively. Of the total interest expense for 2017,
$4,942,773 is related to the capital lease disclosed in Note 17.
Interest expense was $1,689,043 for the year ended December
31, 2016, of which $673,689 was capitalized into Construction in Progress, respectively.
Prepaid expenses consist of the following as of December
31:
|
|
2017
|
|
|
2016
|
|
Insurance
|
|
$
|
331,061
|
|
|
$
|
291,936
|
|
Licenses and Fees
|
|
|
429,888
|
|
|
|
260,162
|
|
Other Prepaids
|
|
|
226,636
|
|
|
|
175,336
|
|
Total Prepaid Expenses
|
|
$
|
987,585
|
|
|
$
|
727,434
|
|
Accrued expenses consist of the following as of December
31:
|
|
2017
|
|
|
2016
|
|
Accrued Interest
|
|
$
|
1,387,089
|
|
|
$
|
538,390
|
|
Accrued Settlement
|
|
|
677,000
|
|
|
|
—
|
|
Accrued Compensation
|
|
|
661,743
|
|
|
|
406,631
|
|
Accrued Consulting
|
|
|
200,000
|
|
|
|
—
|
|
Accrued Sales Tax
|
|
|
55,149
|
|
|
|
8,271
|
|
Other Accrued Expenses
|
|
|
161,810
|
|
|
|
176,310
|
|
Total Accrued Expenses
|
|
$
|
3,142,791
|
|
|
$
|
1,129,602
|
|
The Company has a $1,000,000 revolving note agreement
with a related party, at a fixed interest rate of 10 percent. The line of credit is payable in arrears on the first day of each
calendar quarter beginning July 1, 2017. The principal portion of the revolving line-of-credit is payable in full upon maturity
on May 4, 2019. At December 31, 2017, the line of credit had a balance of $500,000 outstanding. Per the permitted use of the funds
under this agreement, no additional funds may be drawn under this revolving note.
|
11.
|
Convertible Notes Payable
|
During 2016, the Company had convertible
notes payable with six parties with balances totaling $23,782,437 as of December 31, 2017. The notes accrue interest at 3.0 percent
annually with lump payment due on February 28, 2018. These notes are convertible at maturity or change in control into Series A
preferred member units, of which the number will be determined by a strike price of the lesser of (A) quotient of $175,000,000
divided by all issued and outstanding units of the Company as of immediately prior to the Maturity Date on a Fully Diluted Basis,
or (B) per unit price of the most recently completed sale of Equity Securities by the Company pursuant to a bona fide arm’s
length transaction. The notes are also convertible automatically in the event of Qualified Equity Financing (QEF). In the event
of a QEF, the noteholder will receive equity securities in the amount of principal and accrued but unpaid interest at the discounted
per unit price equivalent to the QEF price per unit plus a 20 percent discount, unless the amount of the discounted per-unit price
for conversion of the note is greater than the per unit cap price, then the per unit cap price is used for conversion.
As of December 31, 2017, the Company
had entered into nine new convertible notes payable in 2017 with one party with balances totaling $20,000,000. The notes accrue
interest at 3.0 percent annually with lump payment due on December 31, 2018. These notes are convertible at maturity or change
in control into Series A preferred member units, of which the number will be determined by a strike price of the lesser of (A)
quotient of $218,750,000 divided by all issued and outstanding units of the Company as of immediately prior to the Maturity Date
on a Fully Diluted Basis, or (B) per unit price of the most recently completed sale of Equity Securities by the Company pursuant
to a bona fide arm’s length transaction. The notes are also convertible automatically in the event of Qualified Equity Financing
(QEF). In the event of a QEF, the noteholder will receive equity securities in the amount of principal and accrued but unpaid interest
at the discounted per unit price equivalent to the QEF price per unit plus a 20 percent discount, unless the amount of the discounted
per-unit price for conversion of the note is greater than the per unit cap price, then the per unit cap price is used for conversion.
Each of the convertible notes payable
is due to mature in 2018; thus, the full balance of $43,782,437 is presented as a current liability on Exhibit A.
The Company and its members have entered into an agreement
which, among other matters, governs the distributions, liquidation preferences, and transferability of its membership interests.
The Class A Unit holders’ distribution and liquidation
rights are subject to and qualified by the rights, powers and preferences of the holders of Series A Preferred Units as summarized
below.
Distributions and Conversion
The holders of Series A Preferred Units participate in
all distributions of net cash flow on an as-if-converted to Class A Units basis. Each Series A Preferred Unit is convertible (upon
the election of the holders of a majority of the Series A Preferred Units) into one Class A Unit at the time of issuance, subject
to certain adjustments for unit splits or combinations. The Company’s Amended and Restated Certificate of Designation for
the Series A Preferred Units sets forth the mechanics for such conversion.
Holders of Series A Preferred Units are not entitled
to any form of dividend.
Liquidation Preferences
In the event of any liquidation event or deemed liquidation
event, the holders of Series A Preferred Units shall be entitled to receive, prior and in preference to any proceeds of the liquidation
to the holders of Class A Units the greater of (1) the original issue price of the Series A Preferred Units or (2) the distribution
they would be entitled to receive on an as-if-converted to Class A Unit basis. If liquidation proceeds are insufficient to cover
all members, holders of the Series A Preferred Units will be distributed the full proceeds ratably among themselves.
Transferability
In the event that any Class A Member wishes to transfer
any or all of its membership interest in the Company, the Class A Member must first offer to sell the membership interest to the
Company and then to the Series A Preferred Members by providing written notice of intent.
|
13.
|
Redemption of Members
|
In 2016, the Company entered into purchase agreements
with two significant members. Under agreements, the Company redeemed 100 percent of the members’ units for $4,979,975, which
was based on the estimated fair value of the Company as agreed upon by the parties. The purchase was paid $979,996 in cash and
the remaining $3,999,979 of the purchase price was paid through issuance of promissory notes.
As of December 31, 2017, the Company had paid a total
of $2,999,984, of which $1,999,989 was paid in 2017 on these notes, leaving a balance of $999,995 at year end to be paid in 2018.
|
14.
|
Re-Purchase of Member Units
|
During 2017, the Company exercised
its option to repurchase 98,133 Class A units from a founding member for a per unit purchase price of $10.1905 and an aggregate
purchase price of $1,000,024.
During the year, the Company has granted 21,791 options
to six employees for the purchase of common B member units with per-unit strike prices ranging from $59.14 to $76.71. These options
vest over a period up to three or four years and expire ten years from the date of issuance.
A summary of the unit options for the years ended December
31, 2017 and 2016 is as follows:
|
|
2017
|
|
|
2016
|
|
|
|
Shares
|
|
|
Weighted-
Average
Exercise
Price
|
|
|
Shares
|
|
|
Weighted-
Average
Exercise
Price
|
|
Common Stock options:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at beginning of year
|
|
|
111,309
|
|
|
$
|
48.80
|
|
|
|
46,391
|
|
|
$
|
58.20
|
|
Granted
|
|
|
21,791
|
|
|
|
73.55
|
|
|
|
69,579
|
|
|
|
49.45
|
|
Forfeited
|
|
|
(17,005
|
)
|
|
|
58.20
|
|
|
|
(4,661
|
)
|
|
|
48.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31
|
|
|
116,095
|
|
|
$
|
66.31
|
|
|
|
111,309
|
|
|
$
|
55.77
|
|
|
|
Options Outstanding
|
|
|
Options Exercisable
|
|
|
|
Number
Outstanding
|
|
|
Weighted-
Average
Remaining
Contractual
Life
|
|
|
Number
Outstanding
|
|
|
Weighted-
Average
Remaining
Contractual
Life
|
|
Options exercisable at year end:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Member Unit Stock options
|
|
|
116,095
|
|
|
|
8.23 years
|
|
|
|
44,976
|
|
|
|
8.58 years
|
|
The Company has elected to value these options using
the intrinsic method. Under this method, the options are valued at the date of issuance and any excess of the current per unit
value of the Company over the strike price of the options is recognized as compensation expense over the vesting period. Compensation
expense of $1,024,617 and $0 was recognized for these options for the years ended December 31, 2017 and 2016, respectively.
|
16.
|
Operating Lease Commitments
|
The Company has various non-cancellable operating leases
for equipment, land, parking lots and office space, with monthly payments ranging from $167 to $21,124, expiring through June 2054.
Future minimum lease payments under operating leases
as of December 31, 2017 are as follows:
Year
|
|
|
|
2018
|
|
$
|
1,209,439
|
|
2019
|
|
|
580,259
|
|
2020
|
|
|
548,058
|
|
2021
|
|
|
445,425
|
|
2022
|
|
|
312,430
|
|
Thereafter
|
|
|
1,134,086
|
|
Total Future Minimum Lease Payments
|
|
$
|
4,229,697
|
|
Rental expense from the operating
leases noted above and other month-to-month leases amounted to $1,008,073 and $732,499 for the years ended December 31, 2017 and
2016, respectively.
|
17.
|
Capital Lease and Sale-Leaseback
|
During 2016, the Company sold their New York cultivation
plant and specified equipment for $30,000,000 at a loss of $1,235,581, of which $214,773 was recognized immediately and $1,020,808
will be recognized over the term of the lease. As of December 31, 2017 and 2016, the deferred loss on the sale was $952,754 and
$1,020,808, respectively; therefore, $68,054 was recognized for the year ended December 31, 2017.
Upon the sale in 2016, the Company immediately entered
into an agreement to lease the property with an initial lease term of 15 years with two options to extend for five years each.
The lease requires monthly payments of the following: $319,580 for base rent, $105,477 for supplemental rent in the first five
years of the lease, and 1.5 percent of the current base rent as additional rent for a management fee. The base rent will increase
each year at either 4 percent, or 75 percent of the Consumer Price Index, whichever is greater. The total monthly rent payment
for the first twelve months is $429,907.
In relation to the lease, the Company has a security
deposit of $2,112,474. Between month seven and month sixty of the lease, the security deposit will be reduced to $1,056,237 if
the Company achieves annualized EBITDA of $10,000,000, measured over a continuous six-month period.
For the year ended December 31, 2017, payments totaled
$5,184,723, of which $4,942,773 was applied to interest, and capitalized into Work in Process inventory. The balance of the lease
as of December 31, 2017 was $29,287,713.
Future minimum lease payments under capital lease as
of December 31, 2017 are as follows:
Year
|
|
|
|
|
2018
|
|
$
|
4,884,576
|
|
2019
|
|
|
5,489,868
|
|
2020
|
|
|
5,658,835
|
|
2021
|
|
|
5,729,082
|
|
2022
|
|
|
4,751,588
|
|
Thereafter
|
|
|
51,494,877
|
|
Net Minimum Capital Lease Payments
|
|
|
78,008,826
|
|
Less: Amount Representing Interest
|
|
|
(48,721,113
|
)
|
Present Value of Net Minimum Lease Payments
|
|
$
|
29,287,713
|
|
|
18.
|
Related-Party Transactions
|
The Company contracts architectural and construction
services to companies related through common ownership. The following is a summary of the related party activities for the years
ended December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
Accounts
|
|
|
|
|
|
Accounts
|
|
|
|
Payments
|
|
|
Payable
|
|
|
Payments
|
|
|
Payable
|
|
Vendor A
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
214,678
|
|
|
$
|
-
|
|
Vendor B
|
|
|
731,416
|
|
|
|
—
|
|
|
|
225,385
|
|
|
|
30,082
|
|
Vendor C
|
|
|
1,211,977
|
|
|
|
—
|
|
|
|
16,538,250
|
|
|
|
699,962
|
|
A related party was also created during 2017, PharmaCannis
Foundation, Inc., an Illinois not-for-profit organization, with the primary purpose of educating the public about the legal, regulated,
and responsible use of high quality medical cannabis for legally-registered medical cannabis patients.
|
19.
|
Significant Concentrations
|
Financial instruments which potentially subject the Company
to concentrations of credit risk consist principally of cash. At times, cash in banks is in excess of the FDIC insurance limit.
The Company has not experienced any loss as a result of those deposits and does not expect any in the future.
The Company has been granted a license to cultivate and
distribute cannabis for medical purposes pursuant to the laws of Illinois, Massachusetts, and New York. The Company has also been
granted a dispensary licenses in Maryland and Pennsylvania. Presently, this industry is illegal under federal law. The Company
has and intends to continue to adhere strictly to the statutes in the states in which it operates.
|
20.
|
Commitments and Contingencies
|
During 2017, the Company started the process to cancel
a lease agreement in Massachusetts due to the landlord’s unwillingness to fix a leaking roof. The landlord was demanding
a settlement to cancel the lease that was still being negotiated as of December 31, 2017; however, the Company accrued $677,000
that they believe was the best estimate based on the status of the negotiations.
The Company has entered into certain construction and
project contracts related to the building of cultivation centers and the development of a new ERP system. The remaining commitment
associated with these contracts totaled approximately $3,755,000 as of December 31, 2017.
As part of the sale-leaseback transaction in Note 17,
the Company is required to perform specified improvements to build-out greenhouse zones that are not yet completed. These improvements
do not qualify as continued involvement for sales-leaseback treatment because the sale is not contingent on the improvements being
completed. The improvements must be completed no later than June 30, 2020 but can be deferred until June 30, 2022 if the Company
achieves annualized EBITDA of $10,000,000, measured over a trailing six-month period on the date ninety days prior to June 30,
2020. Due to uncertainty in construction costs over the next 6 years, the Company is not able to accurately estimate the commitment;
however, the Company believes that improvements will cost approximately $4,500,000 based on a current estimate. This estimate could
change significantly over the four-year period.
In late 2017, the Company entered into a consulting agreement
with an investment manager (IM) for fundraising purposes. Of the amount raised by the IM, the IM is to receive cash equal 1 percent
of the amount raised less the monthly retainer of $12,000, and 1 percent of the amount raised in “at-the-money” Series
A Preferred Units. As of December 31, 2017, the IM was responsible for raising $12,400,000 of the $15,000,000 necessary for a QEF
event, noted in the subsequent section. As such, the Company accrued $200,000 for the amounts due to the IM.
In June 2017, PharmaCann Ohio LLC, a wholly owned subsidiary
of the Company, entered into an agreement to purchase 25 acres for $700,000 for a cultivation site contingent on due diligence
inspections. If the Company is dissatisfied with the inspections for any reason, the agreement could be terminated within 195 days.
After the 195-day period, the due diligence period can be extended for an additional six months for $10,000 per month. The Company
exercised the first extension option in January 2018 and intends to extend the option until receipt of licenses in Ohio.
The Company entered into and executed an Option and Purchase
Agreement for a 15-acre property in Massachusetts for $3,000,000 in order to build a cultivation facility. The initial term of
this purchase option expired October 12, 2017. However, the Company had two, 30-day optional extensions that it may elect not later
than 10 days prior to the then expiration date, of which the Company exercised both extension options for $20,000 each. Only one
extension was able to be applied against the purchase price. The other extension payment was expensed. The Company then exercised
the purchase option and was required to deliver a non-refundable deposit in the amount of $250,000. The Company is still working
through the conditions to close, in which $2,730,000 payment is required.
In October and November 2017, the Company entered into
four purchase agreements totaling $2,245,000, one purchase option for $300,000, and one lease option for monthly rent of $8,500
with a 3 percent annual increase. All six of the agreements are located in Ohio and are contingent upon receiving a license to
dispense medical marijuana from the State of Ohio Board of Pharmacy.
In September 2017, PharmaCann Florida LLC, a wholly owned
subsidiary of the Company, entered into an agreement to purchase a property in Florida for $1,450,000 to develop a Medical Marijuana
Treatment Center (MMTC). As part of the agreement, $25,000 was to be paid within 7 days of executing the agreement, and $120,000
is to be paid within 7 days of the Company being awarded a license to operate a MMTC in the state of Florida. The remaining balance
will be paid at closing, which is contingent upon being awarded the license.
|
21.
|
Acquisition of Business
|
On January 19, 2017, MASS entered into an asset purchase
agreement with the owners of Massachusetts Recovery Services Inc., a Massachusetts corporation. The total consideration included
$963,102 in cash and $550,000 related to a contingent consideration.
The contingent consideration is to be paid by means of
“Holdback Units” totaling 6,279, which are Class A units in PharmaCann LLC. Within the first 60 days after receipt
of first final Certificate of Registration from Massachusetts Department of Public Health, 3,767 units must be delivered. After
receiving the second and third Certificate of Registration, 1,256 units must be delivered each time within 60 days of receiving
the respective certificates. If no Certificates of Registration are received, the units remain within the Company.
As of the date of the asset purchase, the Company performed
an analysis to determine that the fair value of the total contingent consideration was $550,000, or $87.59 a unit. The Company
has classified contingent consideration as a liability on Exhibit A.
The Acquisition was accounted for in accordance with
the FASB guidance related to Business Combination, which requires the Company to measure and record all of the identifiable assets
acquired and liabilities assumed at their fair value on the Acquisition Date. Goodwill is recognized as the excess of consideration
paid over fair value of the net identifiable assets acquired, which is attributable to synergies
gained from the acquisition related to potential cannabis licenses. The Non-Compete Agreement is being amortized over 3 years,
which coincides with the term of the agreement.
The following table summarizes the fair value of the
consideration paid and the assets acquired and liabilities assumed at the acquisition date:
Consideration:
|
|
|
|
Cash
|
|
$
|
963,102
|
|
Contingent Consideration
|
|
|
550,000
|
|
Total Consideration
|
|
$
|
1,513,102
|
|
|
|
|
|
|
Recognized amount of identifiable assets acquired:
|
|
|
|
Note Receivable
|
|
$
|
769,558
|
|
Interest Receivable
|
|
|
305,169
|
|
Non-Compete Agreement
|
|
|
185,000
|
|
Total Identifiable Assets Acquired
|
|
|
1,259,727
|
|
Goodwill
|
|
|
253,375
|
|
|
|
$
|
1,513,102
|
|
Subsequent to year-end in January 2018, the Company paid-off
the full balance of $500,000 on the Note Payable, Member due in Note 10.
In January 2018 the Company entered into a contract for
HVAC installation at one of the Illinois cultivation centers for approximately $2,000,000.
On January 17, 2018, the Company executed a purchase
agreement for a 4.7-acre plot in Michigan for $590,000, with a deposit of $35,000. The agreement is contingent upon the seller
obtaining appropriate municipal and governmental approvals required for the build-out and the Company being duly authorized to
transact business in the State of Michigan.
PharmaCann LLC assigned the $3,000,000 purchase option
in Note 20 to Brighton Health Advocates, Inc., a Massachusetts not-for-profit managed by PharmaCann Mass LLC. On February 28, 2018,
the property was sold via a purchase agreement to IIP-MA 1 LLC for $3,000,000, contingent upon inspections. This sale will close
no later than March 30, 2018; however, the Company is in negotiations to extend the closing date. After the sale is complete, the
Company plans to enter into a Lease Agreement with the purchaser, with a security deposit of $108,750 and a monthly rent expense
of $36,250. This lease provides two options to extend for five years each.
In addition to the $12,900,000 of Series A Preferred
Units purchased during 2017, the Company received the funding for an additional $2,100,000 in Series A Preferred that was committed
as of year-end, with the last portion received January 18, 2018. The receipt of remainder of the funding to result in $15,000,000
total raised triggered a conversion event defined as a QEF in Note 11. As such, the full $43,782,437 of Convertible Notes Payable
outstanding at December 31, 2017 converted to Series A Preferred Units, as well.
On February 2, 2018, the Company received a commitment
to purchase an additional $505,000 of Series-A Preferred units at $114.10 per unit.
On February 15, 2018, the Company provided a notice to
exercise its option to purchase a property that was being leased for cultivation purposes in Illinois. This purchase included four
parcels of land, totaling $1,798,500.
During February 2018, the Company settled the Massachusetts
landlord issue for $950,000, which included $677,000 due from the Company and accrued as of year-end plus a $273,000 security deposit
from Brighton Health Advocates (the tenant).
Initially, the Company was not granted licenses for the
state of Ohio; however, they challenged the decision. In February 2018, Ohio released a statement that the scoring used in the
licensing process was incorrect due to a clerical error, and the Company should have been granted licenses to operate in the state.
Ohio is still working through the steps to remediate the error; however, the Company believes that they should receive the licenses
no later than September 2018 when the medical cannabis program is started in Ohio.
On February 22, 2018, the Company started the process
to convert Brighton Health Advocates to a for-profit entity. Initially, licenses in Massachusetts were to be held by a not-for-profit
entity by state law; however, the state granted this option for conversion after the medical cannabis program was already in progress.
As of the date of this report, the not-for-profit was converted to a corporation, in which PharmaCann Mass owns all 1,000 of the
common shares. The entity name was also changed from Bright Health Advocates to PharmaCannis Massachusetts Inc. Due to the equity
impact, this is a non-recognized subsequent event in the financial statements as of December 31, 2017.
The Company has evaluated subsequent events through March
20, 2018, the date which the consolidated financial statements were available to be issued.
INDEPENDENT AUDITOR’S REPORT
To the Board of Managers
Holistic Industries LLC
We have audited the accompanying financial
statements of Holistic Industries LLC which comprise the balance sheets as of December 31, 2017 and 2016, the related statements
of operations, members’ equity, and cash flows for the years then ended, and the related notes to the financial statements.
management’s
responsibility for the financial statements
Management is responsible
for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted
in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the
preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.
auditor’s
responsibility
Our responsibility is to
express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards
generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free from material misstatement.
An audit involves performing
procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend
on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether
due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation
and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express
no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant
accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit
evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
unmodified
opinion
In our opinion, the financial statements
referred to above present fairly, in all material respects, the financial position of Holistic Industries LLC at December 31, 2017
and 2016, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Grossberg Company LLP
Bethesda, MD
March 29, 2018
HOLISTIC INDUSTRIES LLC
(A LIMITED LIABILITY COMPANY)
BALANCE SHEETS
DECEMBER 31, 2017 AND 2016
Assets
|
|
2017
|
|
|
2016
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
1,313,283
|
|
|
$
|
10,200
|
|
Inventory (Note 3)
|
|
|
4,486,642
|
|
|
|
—
|
|
Prepaid expenses
|
|
|
661,280
|
|
|
|
—
|
|
Total current assets
|
|
|
6,461,205
|
|
|
|
10,200
|
|
|
|
|
|
|
|
|
|
|
Property and equipment:
|
|
|
|
|
|
|
|
|
Leasehold improvements
|
|
|
2,656,259
|
|
|
|
—
|
|
Furniture and equipment
|
|
|
1,934,836
|
|
|
|
—
|
|
Computer hardware and software
|
|
|
37,425
|
|
|
|
—
|
|
Vehicles
|
|
|
43,108
|
|
|
|
—
|
|
|
|
|
4,671,628
|
|
|
|
—
|
|
Accumulated depreciation
|
|
|
(235,499
|
)
|
|
|
—
|
|
Property and equipment - net
|
|
|
4,436,129
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Other asset:
|
|
|
|
|
|
|
|
|
Security deposit (Note 4)
|
|
|
562,500
|
|
|
|
—
|
|
Other deposits
|
|
|
2,800
|
|
|
|
10,000
|
|
License costs, net of accumulated
amortization of $316,619 (none in 2016)
|
|
|
1,247,150
|
|
|
|
850,104
|
|
Total other asset
|
|
|
1,812,450
|
|
|
|
860,104
|
|
|
|
$
|
12,709,784
|
|
|
$
|
870,304
|
|
Liabilities
and Members' Equity
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
112,862
|
|
|
$
|
—
|
|
Accrued expenses
|
|
|
310,033
|
|
|
|
38,604
|
|
Accrued interest (Note 8)
|
|
|
564,908
|
|
|
|
—
|
|
Total current liabilities
|
|
|
987,803
|
|
|
|
38,604
|
|
|
|
|
|
|
|
|
|
|
Other liabilities:
|
|
|
|
|
|
|
|
|
Deferred rent obligation (Note 4)
|
|
|
1,065,911
|
|
|
|
—
|
|
Notes payable (Note 8)
|
|
|
9,000,000
|
|
|
|
—
|
|
Total other liabilities
|
|
|
10,065,911
|
|
|
|
—
|
|
Total liabilities
|
|
|
11,053,714
|
|
|
|
38,604
|
|
|
|
|
|
|
|
|
|
|
Members' equity
|
|
|
1,656,070
|
|
|
|
831,700
|
|
|
|
$
|
12,709,784
|
|
|
$
|
870,304
|
|
See accompanying notes.
HOLISTIC INDUSTRIES LLC
(A LIMITED LIABILITY COMPANY)
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
General and administrative expenses:
|
|
|
|
|
|
|
|
|
Start up costs
|
|
|
225,574
|
|
|
|
6,402
|
|
Organization cost
|
|
|
—
|
|
|
|
447
|
|
Legal and accounting
|
|
|
4,400
|
|
|
|
—
|
|
Insurance
|
|
|
2,374
|
|
|
|
—
|
|
Travel and entertainment
|
|
|
2,627
|
|
|
|
—
|
|
Depreciation
|
|
|
3,652
|
|
|
|
—
|
|
Total general and administrative expenses
|
|
|
238,627
|
|
|
|
6,849
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(238,627
|
)
|
|
|
(6,849
|
)
|
|
|
|
|
|
|
|
|
|
Other income (expenses):
|
|
|
|
|
|
|
|
|
Interest expense (Note 8)
|
|
|
(52,323
|
)
|
|
|
—
|
|
Political contributions
|
|
|
(1,010
|
)
|
|
|
(41,500
|
)
|
Total other income (expenses) - net
|
|
|
(53,333
|
)
|
|
|
(41,500
|
)
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(291,960
|
)
|
|
$
|
(48,349
|
)
|
See accompanying notes.
HOLISTIC INDUSTRIES LLC
(A LIMITED LIABILITY COMPANY).
STATEMENTS OF CHANGES IN MEMBERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Balance, beginning of year
|
|
$
|
831,700
|
|
|
$
|
427,768
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(291,960
|
)
|
|
|
(48,349
|
)
|
Capital contributions
|
|
|
1,116,330
|
|
|
|
452,281
|
|
|
|
|
|
|
|
|
|
|
Balance, end of year
|
|
$
|
1,656,070
|
|
|
$
|
831,700
|
|
See accompanying notes.
HOLISTIC INDUSTRIES LLC
(A LIMITED LIABILITY COMPANY)
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
|
|
2017
|
|
|
2016
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(291,960
|
)
|
|
$
|
(48,349
|
)
|
Adjustments to reconcile net loss to net
|
|
|
|
|
|
|
|
|
cash used for operations
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
3,652
|
|
|
|
—
|
|
Changes in operating assets and liabilities
|
|
|
|
|
|
|
|
|
Security deposit
|
|
|
(562,500
|
)
|
|
|
—
|
|
Other deposits
|
|
|
(2,800
|
)
|
|
|
—
|
|
Inventory
|
|
|
(3,938,176
|
)
|
|
|
—
|
|
Prepaid expenses
|
|
|
(661,280
|
)
|
|
|
—
|
|
Accounts payable
|
|
|
112,862
|
|
|
|
—
|
|
Accrued expenses
|
|
|
271,429
|
|
|
|
23,604
|
|
Accrued interest
|
|
|
564,908
|
|
|
|
—
|
|
Deferred rent obligation
|
|
|
1,065,911
|
|
|
|
—
|
|
Net cash used for operating activities
|
|
|
(3,437,954
|
)
|
|
|
(24,745
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchases of property and equipment
|
|
|
(4,671,628
|
)
|
|
|
—
|
|
Expenditures paid for licenses
|
|
|
(713,665
|
)
|
|
|
(407,336
|
)
|
Equipment deposit
|
|
|
10,000
|
|
|
|
(10,000
|
)
|
Net cash used for investing activities
|
|
|
(5,375,293
|
)
|
|
|
(417,336
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Principal proceeds from notes payable
|
|
|
9,000,000
|
|
|
|
—
|
|
Contributions from members
|
|
|
1,116,330
|
|
|
|
452,281
|
|
Net cash provided by financing activities
|
|
|
10,116,330
|
|
|
|
452,281
|
|
|
|
|
|
|
|
|
|
|
Increase in cash
|
|
|
1,303,083
|
|
|
|
10,200
|
|
|
|
|
|
|
|
|
|
|
Cash, beginning of period
|
|
|
10,200
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Cash, end of period
|
|
$
|
1,313,283
|
|
|
$
|
10,200
|
|
See accompanying notes.
HOLISTIC
INDUSTRIES, LLC
(a LIMITED LIABILITY
COMPANY)
NOTES
TO FINANCIAL STATEMENTs
December 31,2017
AND 2016
Nature of operations
- Holistic Industries LLC (the “Company”) was formed as a limited liability company under the laws of the State of
Maryland, on July 1, 2015, and is to continue in business until December 31, 2199, unless sooner dissolved pursuant to the operating
agreement. The Company was organized to engage in the business of growing, processing and dispensing medical-use marijuana in the
State of Maryland (the “State”) in accordance with all Maryland laws and regulations.
The Company received Medical
Cannabis Processor and Grower Licenses in Maryland effective August 15, 2017. The Company was also approved for a Medical Cannabis
Dispensary License in Senatorial District 18 of the State of Maryland on January 25, 2018.
Use of estimates
- The Company prepares its financial statements in conformity with accounting principles generally accepted in the United States
of America, which require management to make estimates and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses, as well as the disclosure of contingent assets and liabilities at the date of the financial statements.
Actual results could differ from those estimates.
Inventory
- Inventories
are stated at the lower of cost or market, with cost determined using the first-in, first-out method.
License costs
-
The costs associated with obtaining the three Medical Cannabis licenses from the Maryland Medical Cannabis Commission (the “Commission”)
have been capitalized. The licenses have initial two-year terms after the final awards are made. Each of the three licenses (grower,
processor and dispensary) are renewable every two years, subject to: (a) meeting the State’s compliance requirement based
upon an inspection of the relevant facility and (b) payment of the applicable renewal fee. The State has imposed certain restrictions
on the transferability of the licenses.
The Company amortizes the costs
associated with procuring the licenses over the two-year period beginning upon final approval by the Commission. Final approval
was received on August 15, 2017 for the grower and processor licenses and January 25, 2018 for the dispensing license. Amortization
included in inventory was $316,619 for the year ended December 31, 2017 (none for the year ended December 31, 2016). Amortization
of the license costs is expected to be $760,051 for 2018, $465,266 for 2019 and $1,833 for 2020 ($1,247,150 in the aggregate).
Property and equipment
- We record property and equipment at cost. Depreciation is computed using the straight-line method over the estimated useful lives
of the related assets, which are generally five years. Leasehold improvements are amortized over the lives of the respective leases
or the service lives of the improvements, whichever is shorter. Depreciation expense for the year ended December 31, 2017 aggregated
$3,652. Depreciation expense included in inventory for the year ended December 31, 2017 aggregated $231,847.
Real estate taxes
- Real estate taxes paid are included in inventory over the period covered by the assessment.
Subsequent events
- We have evaluated subsequent events through March 29, 2018, which is the
date these financial statements were available to be issued. All subsequent events requiring recognition as of December 31, 2017
have been incorporated into these statements.
HOLISTIC
INDUSTRIES, LLC
(a LIMITED LIABILITY
COMPANY)
NOTES
TO FINANCIAL STATEMENTs
December 31,2017
AND 2016
We maintain our cash and cash
equivalents in deposit accounts with a national and a regional bank. The balances are insured by the Federal Deposit Insurance
Corporation (FDIC) up to $250,000 per bank. At December 31, 2017, the cash balances exceeded the FDIC insurance limit by approximately
$1,135,000. We have not experienced any losses in these accounts and do not believe we are exposed to any significant credit risk
on our deposits.
Inventory includes finished goods,
work-in-process, and supplies. Finished goods represent products available for sale. Work-in-process inventories represent products
in the processing stage, harvested product, and plants in one of three phases of growth; immature phase, vegetative phase, and
flowering phase. Costs of finished goods and work-in-process inventories include labor and benefits, depreciation, amortization,
rent, interest, overhead costs and other necessary costs associated with the growing and production process. Corporate general
and administrative costs and selling costs are not included in inventory.
Inventories at December 31, 2017
(none at December 31, 2016) consist of:
Finished goods
|
|
$
|
906,495
|
|
Work-in-process
|
|
|
3,487,890
|
|
Supplies
|
|
|
92,257
|
|
|
|
$
|
4,486,642
|
|
The Company entered into a lease
with IIP-MD 1 LLC on May 26, 2017 (see Note 6) to lease the land and building, containing approximately 72,471 of rentable square
feet, where it is operating its growing and processing segments (Building Lease). The Building Lease has a sixteen (16) year term,
initially expiring on May 31, 2033, with three options to extend the term for five (5) years each. The lease is secured by a limited
guaranty from an affiliate of one of the members of the Company. Base rent as of December 31, 2017 was $213,760 per month. Rent
included as inventory for the year ended December 31, 2017 under the Building Lease was $1,920,628.
On May 12, 2017, the Company
entered into a lease with an affiliate of an indirect owner of the Company for the dispensary (Dispensary Lease). The Dispensary
Lease commenced on January 1, 2018 and has an initial term of ten (10) years, expiring on December 31, 2027. The Company has the
option of extending the lease for two additional periods of ten (10) years each. Annual base rent of $105,000 will be due monthly
with a 2.5% annual escalation. Provided the lease is not in default, base rent will be abated for the first lease year.
As additional rent under the
Dispensary Lease, the Company is to reimburse the landlord for additional tenant improvement costs over the initial sixty (60)
months of the lease. Payments of additional rent equals $10,645 per month.
Pursuant to the terms of both
leases, the Company is also liable, as additional rent, for its respective share of operating expenses, as defined, and real estate
taxes.
The lease agreements provide
for fixed annual escalations of rental payments. As required by U.S. GAAP, the Company recognizes the portion of rental payments
that represent base rents in inventory or expense ratably over the term of the lease. The deferred lease obligation at December
31, 2017 represents the cumulative amount of rent added to inventory or expense recognized for financial statement purposes in
excess of the actual cash payments for base rents through such dates.
Future minimum payments due under
the leases are as follows:
|
|
Building
|
|
|
Dispensary
|
|
|
Total
|
|
Year ending
December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
$
|
2,635,978
|
|
|
$
|
117,096
|
|
|
$
|
2,753,074
|
|
2019
|
|
|
2,711,406
|
|
|
|
235,366
|
|
|
|
2,946,772
|
|
2020
|
|
|
2,789,285
|
|
|
|
238,057
|
|
|
|
3,027,342
|
|
2021
|
|
|
2,869,696
|
|
|
|
240,814
|
|
|
|
3,110,510
|
|
2022
|
|
|
2,952,719
|
|
|
|
243,641
|
|
|
|
3,196,360
|
|
Thereafter
|
|
|
36,401,582
|
|
|
|
635,087
|
|
|
|
37,036,669
|
|
|
|
$
|
50,360,666
|
|
|
$
|
1,710,061
|
|
|
$
|
52,070,727
|
|
The above amounts
only include future minimum lease payments due during the current lease term.
HOLISTIC
INDUSTRIES, LLC
(a LIMITED LIABILITY
COMPANY)
NOTES
TO FINANCIAL STATEMENTs
December 31,2017
AND 2016
The Company is treated as a partnership
for income tax purposes. Therefore, the Company is not liable for income taxes and no provision for income taxes has been provided
for in the accompanying financial statements. All members are required to report their allocable share of the Company’s income,
gains, losses and deductions on their tax returns.
The nature of the Company’s
business creates uncertain tax position for the members. The business consists of trafficking in controlled substances, which is
prohibited by federal law (medical cannabis licensure is authorized under Maryland state law); as such, the business is limited
in taking deductions. These tax positions do not affect the Company because any loss of deduction would be reported on the members’
own returns.
The Company is subject to state
and Federal income tax examinations by tax authorities generally for three years after the returns have been filed.
|
6.
|
Related party transactions
|
The Company utilizes the services
of Willco Construction Company, Inc. (“Willco”) for asset management, development/construction management, general
administrative, legal, and accounting duties. Willco is owned by an affiliate of an indirect owner of the Company. Fees for services
rendered prior to the Company having its own employees totaled $225,000 and are included in licensing costs. Thereafter, annual
fees of $225,000 are due which will be paid monthly. For services rendered in relation to the build-out of the building, Willco
was paid a construction management fee of $610,000, a portion of which has been capitalized into tenant improvements. Willco is
also due one percent of the Company’s net revenue generated each quarter, which will be payable once the Net Invested Capital,
as defined in the operating agreement, for all holders of Class A Units has been reduced to zero. The fees will be payable on a
quarterly basis from that point forward. Management fees included in inventory related to Willco for the year ended December 31,
2017 totaled $84,375.
The Company entered into a
management agreement with Liberty Management LLC, an affiliate of an officer of the Company, to oversee the Company’s day-to-day
operations. Annual fees of $225,000 are due and payable monthly from the date the Company received its grower’s license,
August 15, 2017, until the Net Invested Capital for all holders of Class A Units has been reduced to zero. Liberty Management LLC
is also due one percent of the Company’s net revenue, which will be due quarterly once the Net Invested Capital for all holders
of Class A Units has been reduced to zero. Management fees paid to Liberty Management LLC included in inventory for the year ended
December 31, 2017 totaled $84,375.
On December 2, 2016, the Company
entered into a build-to-suit lease with PGHI LLC, an affiliate of an indirect owner of the Company, to lease certain land and a
building to be constructed containing approximately 72,471 of rentable square feet. PGHI, LLC sold the facility to IIP –
MD 1 LLC, an indirect wholly owned subsidiary of Innovative Industrial Properties Inc., a publicly-traded company, on May 26, 2017,
at which time the current lease was signed.
The Company’s Dispensary
Lease was also entered into with an affiliate of an indirect owner of the Company, as disclosed in Note 4.
HOLISTIC
INDUSTRIES, LLC
(a LIMITED LIABILITY
COMPANY)
NOTES
TO FINANCIAL STATEMENTs
December 31,2017
AND 2016
The Commission is currently
being sued by multiple parties alleging the regulators improperly considered geographic diversity and failed to consider racial
diversity when selecting applicants. The Company was granted its motion to intervene in the geographic diversity lawsuit. If, as
a result of the lawsuit, the Commission is required to re-examine the approval process, the Company may be required to re-apply
for its grow license. The Company does not believe the plaintiffs in these lawsuits will prevail and, accordingly, is continuing
operations on such basis. The racial diversity lawsuit was settled in 2018 with the Company’s portion of the settlement totaling
$32,143 which was accrued as of December 31, 2017.
In addition, the Company is
conducting its business in violation of federal laws, and is unable to predict what actions, if any, the U.S. Department of Justice
or other applicable Federal agencies will initiate in the future.
In the event the manager, the
founding member and/or any of their affiliates are required to guarantee any payment obligation of the Company, the Company shall
pay to such person(s) an aggregate, annual fee of two percent of the amount of the payment obligation so guaranteed. For the year
ended December 31, 2017, the affiliate providing the limited guaranty of the Building Lease is due a fee of $37,315, which has
been accrued and included in inventory.
|
8.
|
Members’ ownership interests
|
Transfers of a member’s
ownership interest in the Company of 5% or more is subject to approval by the Commission. In addition, the Company’s Operating
Agreement also places certain restrictions on the transfer of ownership interests. On May 12, 2017, the operating agreement of
the Company was amended and restated to admit additional members into the Company.
On May 12, 2017, the Company
offered $9,000,000 of unsecured promissory notes that are convertible into Class A Units and bear interest at a rate of 10% per
annum until conversion. All notes were fully committed in June of 2017. As of December 31, 2017, accrued interest on the convertible
promissory notes totaled $564,908, a portion has been expensed with the remainder in inventory and property and equipment. The
notes converted to equity on March 1, 2018.
|
9.
|
Change in accounting for leases
|
On February 25, 2016, the Financial
Accounting Standards Board (FASB) issued
Accounting Standards Update (ASU) No. 2016-02
,
Leases (Topic 842)
which
establishes new accounting principles applicable to leases, including leases for office space.
When implemented
the new standards will require us to do the following:
|
1.
|
Recognize a right-of-use asset and a lease liability, initially measured at the present value of
the lease payments, in the balance sheet
|
|
2.
|
Recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease
term on a generally straight-line basis
|
|
3.
|
Classify all cash payments within operating activities in the statement of cash flows.
|
In addition, also consistent
with current accounting standards, a lessee (and a lessor) should exclude most variable lease payments in measuring lease assets
and lease liabilities, other than those that are in substance fixed payments.
Nonpublic companies will have
to begin applying the new standards for fiscal years that start after December 15, 2019, while early implementation ahead of the
effective date is permitted.
We have not yet evaluated the
impact of the new standard on our financial statements, nor made a decision as to whether we will implement the standard prior
to its effective date.
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