ZONED PROPERTIES, INC. Cautionary Note Regarding Forward-Looking Information and Factors That May Affect Future Results
This annual report on Form 10-K contains forward-looking statements regarding our business, financial condition, results of operations and prospects.The Securities and Exchange Commission (the "SEC") encourages companies to disclose forward-looking information so that investors can better understand a company's future prospects and make informed investment decisions. This annual report on Form 10-K and other written and oral statements that we make from time to time contain such forward-looking statements that set out anticipated results based on management's plans and assumptions regarding future events or performance. We have tried, wherever possible, to identify such statements by using words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "will" and similar expressions in connection with any discussion of future operating or financial performance. In particular, these include statements relating to future actions, future performance or results of current and anticipated sales efforts, expenses, the outcome of contingencies, such as legal proceedings, and financial results. Factors that could cause our actual results of operations and financial condition to differ materially are set forth in the "Risk Factors" section of this annual report on Form 10-K. We caution that these factors could cause our actual results of operations and financial condition to differ materially from those expressed in any forward-looking statements we make and that investors should not place undue reliance on any such forward-looking statements. Further, any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of anticipated or unanticipated events or circumstances. New factors emerge from time to time, and it is not possible for us to predict all of such factors. Further, we cannot assess the impact of each such factor on our results of operations or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. 28
The following discussion should be read in conjunction with our audited financial statements and the related notes that appear elsewhere in this annual report on Form 10-K.
OverviewZoned Properties, Inc. ("Zoned Properties " or the "Company"), was incorporated in theState of Nevada onAugust 25, 2003 . InOctober 2013 , the Company changed its name toZoned Properties, Inc. and inApril 2014 , the Company shifted its business model to address commercial real estate in the regulated cannabis industry. The Company is a real estate development firm for emerging and highly regulated industries, including legalized cannabis. The Company is redefining the approach to commercial real estate investment through its integrated growth services. Headquartered inScottsdale, Arizona ,Zoned Properties has developed a full spectrum of integrated growth services to support its real estate development model; the Company's Property Technology, Advisory Services, Commercial Brokerage, and Investment Portfolio collectively cross-pollinate within the model to drive project value associated with complex real estate projects. With national experience and a team of experts devoted to the emerging cannabis industry,Zoned Properties is addressing the specific needs of a modern market in highly regulated industries.Zoned Properties is an accredited member of theBetter Business Bureau , theU.S. Green Building Council , and theForbes Business Council . The Company does not grow, harvest, sell or distribute cannabis or any substances regulated underUnited States law such as the Controlled Substance Act of 1970, as amended (the "CSA"). We operate our business in two reportable segments consisting of (i) the operations, leasing and management of its leased commercial properties (the "Property Investment Portfolio" segment), and (ii) advisory and brokerage services related to commercial properties (the "Real Estate Services" segment). We are in the process of developing and expanding multiple business divisions, including a property technology division, a property advisory division, a commercial brokerage division, and a property investment portfolio division focused on acquisitions to expand our property holdings. Each of these operating divisions is an important element of the overall business development strategy for long-term growth. We believe in the value of building relationships with clients and local communities to position the Company for long-term portfolio and revenue growth backed by sophisticated, safe, and sustainable assets and clients. The core of our business involves identifying and developing commercial properties that intend to operate within highly regulated industries, including the regulated and legalized cannabis industry. Within highly regulated industries, local municipalities typically develop strict regulations, including zoning and permitting requirements related to commercial real estate, that dictate the specific locations and parameters under which regulated properties can operate. These regulations often include complex permitting processes and can include non-standard codes governing each location; for example, restricting a regulated property or facility from operating within a certain distance of any parks, schools, churches, or residential districts, or restricting a regulated property from operating outside a defined set of hours of operation. When an organization can collaborate with local representatives, a proactive set of rules and regulations can be established and followed to meet the needs of both the regulated operators and the local community. The Company currently maintains a portfolio of properties that we own, develop, and lease. We lease land and/or building space at all five of the properties in our portfolio. All of the properties are leased to licensed and regulated cannabis tenants and are located in areas with established zoning and permitting procedures. Three of the leased properties are zoned and permitted as licensed and regulated cannabis dispensaries, and two of the leased properties are zoned and permitted as licensed and regulated cannabis cultivation and processing facilities. Each regulated property may undergo a non-standard development process. Various development requirements in this process may include initial property identification, zoning authorization, and permitting guidance in order to qualify a commercial property for subsequent architectural design, utility installation, construction and development, property management, facilities management systems, and security system installation. 29 As ofMarch 28, 2023 , a summary of rental properties owned by us consisted of the following: Tempe, Chino Valley, Green Valley, Kingman, Pleasant Ridge, Location AZ AZ AZ AZ MI Industrial Greenhouse/ Retail Retail Retail Description /Office Nursery (special use) (special use) (special use) Cannabis Cannabis Cannabis Cannabis Cannabis Current Use Facility Facility Dispensary Dispensary Dispensary Date Acquired March 2014 August 2015 October 2014 May 2014 Dec 2022/ Feb 2023 Lease Start Date May 2018 May 2018 May 2018 May 2018 December 2022 Lease End Date April 2040 April 2040 April 2040 April 2040 March 2037
Total No. of Tenants 1 1 1 1 1
Portfolio
Total
Land Area (Acres) 3.65 47.60 1.33 0.32 0.56 53.66
Land Area (Sq. Feet) 158,772 2,072,149 57,769 13,939 24,306
2,326,935
Undeveloped Land Area (Sq. Feet) - 1,782,563 - 6,878 -
1,789,441
Developed Land Area (Sq. Feet) 158,772 289,586 57,769 7,061 24,306
537,494
Total RentableBuilding Sq . Ft. 60,000
97,312 1,440 1,497 17,192 177,441 Vacant Rentable Sq. Ft. - - - - - -
Sq. Ft. rented as of March 28, 2023 60,000 97,312 1,440 1,497 17,192 177,441 Annual Base Rent (*,**) 2023 610,053 1,050,970 42,000 48,000 403,188 2,154,211 2024 610,053 1,050,970 42,000 48,000 494,712 2,245,735 2025 610,053 1,050,970 42,000 48,000 509,553 2,260,576 2026 598,589 1,050,970 42,000 48,000 524,840 2,264,399 2027 590,400 1,050,970 42,000 48,000 540,585 2,271,955 Thereafter 7,281,600 12,961,958 518,000 592,000 5,834,246 27,187,804 Total$ 10,300,748 $ 18,216,808 $ 728,000 832,000 $ 8,307,124$ 38,384,680
* Annual base rent represents amount of cash payments due from tenants.
** For
parking lot space used by a third party as an antenna location.
Annualized $ per Rented Sq. Ft. (Base Rent)
Tempe, Chino Valley, Green Valley, Kingman, Pleasant Ridge,
Year AZ AZ AZ AZ MI
2023 $ 9.8 $ 10.8 $ 29.2 $ 32.1 23.5
2024 $ 9.8 $ 10.8 $ 29.2 $ 32.1 28.8
2025 $ 9.8 $ 10.8 $ 29.2 $ 32.1 29.6
2026 $ 9.8 $ 10.8 $ 29.2 $ 32.1 30.5
2027 $ 9.8 $ 10.8 $ 29.2 $ 32.1 31.4
The Company focused heavily on the growth of a diversified revenue stream in
2022 and is moving to take advantage of new opportunities in 2023 and beyond. We
intend to accomplish this by prospecting new real estate services across the
country for private, public, and municipal clients. We believe that strategic
real estate services are likely to emerge as the growth engine for Zoned
Properties .
30
Pursuant to lease agreements with a Significant Tenant, from the period from May
31, 2020 through September 30, 2022 , a Significant Tenant invested a combined
total of at least $8,000,000 improvements in and to the properties in Chino
Valley . The increase in the rentable area of the leased premises resulted in an
increase in all amounts calculated based on the same, including, without
limitation, base rent.
Results of Operations
The following comparative analysis on results of operations was based primarily
on the comparative financial statements, footnotes and related information for
the periods identified below and should be read in conjunction with the
consolidated financial statements and the notes to those statements for the
years ended December 31, 2022 and 2021, which are included elsewhere in this
annual report on Form 10-K. The results discussed below are for the years ended
December 31, 2022 and 2021.
Comparison of Results of Operations for the Years Ended
Revenues For the years endedDecember 31, 2022 and 2021, revenues by reportable business segments were as follows: Years Ended December 31, 2022 2021 Revenues: Property investment portfolio: Rental revenues$ 1,795,719 $ 1,261,059 Real estate services: Advisory revenues 244,750 146,031 Brokerage revenues 619,621 413,395
Total real estate services revenues 864,371 559,426 Total revenues
$ 2,660,090 $ 1,820,485 For the year endedDecember 31, 2022 , total revenues amounted to$2,660,090 , including Significant Tenants revenues of$1,776,284 , as compared to$1,820,485 , including Significant Tenant revenues of$1,255,130 , for the year endedDecember 31, 2021 , an increase of$839,605 , or 46.1%. For the year endedDecember 31, 2022 , the increase in revenues was attributable to an increase in rental revenue from our tenant of$534,660 , an increase in brokerage revenue of$206,226 related to commission earned on real estate listings, and an increase in advisory revenues of$98,719 . For the year endedDecember 31, 2022 , the increase in rental revenues as compared to the year endedDecember 31, 2021 was attributable to an increase in rental revenue from ourChino Valley property related to a fourth amendment to our lease agreement in connection with an increase in rentable square footage, and due to the signing of a new lease with our new tenant at our recently acquired property located inPleasant Ridge, Michigan which began onDecember 1, 2022 . All of the Company's real estate properties are leased under triple-net leases to the Significant Tenants. Operating expenses For the year endedDecember 31, 2022 , operating expenses amounted to$2,769,041 as compared to$1,775,785 for the year endedDecember 31, 2021 , an increase of$993,256 , or 55.9%. For the years endedDecember 31, 2022 and 2021, operating expenses consisted of the following: Years Ended December 31, 2022 2021 Compensation and benefits$ 1,232,414 $ 488,607 Professional fees 352,643 397,877 Brokerage fees 431,029 265,208
General and administrative expenses 275,862 201,625 Depreciation and amortization
360,493 386,643
Real estate taxes 116,912 87,769
Gain on sale of rental property (312 ) (51,944 )
Total $ 2,769,041 $ 1,775,785
31
? For the year ended December 31, 2022 , compensation and benefit expense
increased by
2021. The increase was attributable to an increase in compensation and
benefits of
related to the addition of multiple new full-time and part-time team members.
The increase in stock-based compensation was from the accretion of stock
option expense offset by a decrease in the value of common shares issued for
services. During the second quarter of 2022, we began to hire additional staff
related to the diversification of our real estate services for the expansion
of both advisory services and brokerage services.
? For the year ended
or 11.4%, as compared to the year ended
primarily attributable to a decrease in consulting fees of
hiring of certain consultants that are now employees, offset by an increase in
accounting fees of
increase in public relations fees of
? For the years ended
amounting to
various percentage-based commission splits we pay to our licensed brokerage
team members who participate in various real estate listing transactions.
? General and administrative expenses consist of expenses such as rent expense,
insurance expense, insurance expense, travel expenses, office expenses,
telephone and internet expenses, advertising and marketing expense, and other
general operating expenses. For the year ended
administrative expenses increased by
year ended
an increase in operating activities related to our real estate services
segment.
? For the year ended December 31, 2022 , depreciation expense decreased by
$26,150 , or 6.8%, as compared to the year ended December 31, 2021 . Thisdecrease was related to the decrease in amortization of intangible assets
which were fully amortized.
? For the year ended
or 33.2%, as compared to the year ended
attributable to an increase in assessed real taxes associated with
improvements made on our
? For the year ended
and equipment of
gain from sale of our Gilbert property of $51,944 .
(Loss) income from operations
As a result of the factors described above, for the year ended December 31,
2022 , loss from operations amounted to $(108,951) as compared to income from
operations of $44,700 for the year ended December 31, 2021 , a negative change of
$153,651 , or 343.7%.
Other (expenses) income
Other (expense) income primarily includes interest expense incurred on debt with third parties and a related party and also includes other income (expense). For the year endedDecember 31, 2022 , total other expenses, net amounted to$465,404 as compared to total other expenses, net of$210,519 , respectively, representing an increase of$254,885 , or 121.1%. This increase was attributable to the recording of a loss on note receivable investment of$210,756 that was deemed uncollectible, the recording of a change in fair value loss from an interest rate swap of$90,237 in connection with our bank note payable, and an increase in interest expense of$39,950 primarily related to an increase in notes payable. These increases were offset by a decrease in loss from unconsolidated joint ventures of$11,215 and a decrease in impairment loss from unconsolidated joint venture of$73,970 which was recorded in 2021. Net loss As a result of the foregoing, for the years endedDecember 31, 2022 and 2021, net loss amounted to$574,355 , or$0.05 per common share (basic and diluted), and$165,819 , or$0.01 per common share (basic and diluted), respectively.
32
Liquidity and Capital Resources
Liquidity is the ability of an enterprise to generate adequate amounts of cash
to meet its needs for cash requirements. We had cash of
Our primary uses of cash have been for compensation and benefits, fees paid to third parties for professional services, real estate taxes, general and administrative expenses, and the development of rental properties and other lines of business. All funds received have been expended in the furtherance of growing the business. We receive funds from the collection of rental income and advisory fees. The following trends are reasonably likely to result in changes in our liquidity over the near to long term:
? An increase in working capital requirements to finance our current business,
? Addition of administrative and sales personnel as the business grows, ? The cost of being a public company, ? An increase in investments in joint ventures and other projects, and ? An increase in investments in rental property. We may need to raise additional funds, particularly if we are unable to continue to generate positive cash flows from our operations. We estimate that based on current plans and assumptions, that our available cash will be sufficient to satisfy our cash requirements under our present operating expectations for the next 12 months from the date of this annual report on Form 10-K. Other than revenue received from the lease of our rental properties, from advisory fees, and from brokerage revenues, and from a bank note, we presently have no other significant alternative source of working capital. We have used these funds to fund our operating expenses, pay our obligations, acquire and develop rental properties, invest in joint ventures and notes receivable, and to grow our company. We may need to raise significant additional capital or debt financing to acquire new properties, to develop existing properties, to assure we have sufficient working capital for our ongoing operations and debt obligations, and to invest in new joint venture and other projects. As discussed elsewhere, during the year endedDecember 31, 2021 , we contributed$86,000 to the Beakon joint venture and we contributed$90,000 to the Zoneomics Green joint venture. Additionally, onDecember 31, 2021 , we recorded an other-than-temporary impairment loss of$73,970 because it was determined that the fair value of our equity method investment in Beakon was less than its carrying value. Based on management's evaluation, it was determined that due to market conditions and lack of committed funding, our ability to recover the carrying amount of the investment in Beakon was impaired as ofDecember 31, 2021 .
East West Bank Swap and Amended Note
OnJuly 11, 2022 , Zoned Arizona entered into a Loan Agreement (the "Loan Agreement"), dated as ofJuly 11, 2022 , by and betweenZoned Arizona andEast West Bank (the "Bank"). Pursuant to the terms of the Loan Agreement, subject to and upon the satisfaction of the terms and conditions of the Loan Agreement, Zoned Arizona could request advances under a multiple access loan ("MAL") during the MAL. OnJuly 11, 2022 , in connection with the Loan Agreement, Zoned Arizona paid loan and other fees of$176,472 , and in connection with the First Amendment to the Loan Agreement discussed below, paid additional fees of$8,124 . These loan and other fees aggregating$184,596 are reflected as a debt discount and are being amortized ratably and charged to interest expense over the term of the related debt.
The proceeds of each advance under the MAL may be used by Zoned Arizona to refinance the real property at410 S. Madison Drive ,Tempe, AZ 85251 (the "Property") or to conduct certain acts related to the acquisition, improvement and maintenance of real property. On termination of the MAL, all unpaid principal, unpaid and accrued interest, and all other amounts due under the MAL will be immediately due and payable. 33 The Loan Agreement contains representations, warranties and covenants customary for a transaction of this type. Among other things, the Loan Agreement provides as follows: (a) upon the occurrence of an event of default, the outstanding principal balance of the MAL will not at any time exceed 65% of the Property's most recent appraised value; (b) upon the occurrence of an event of default, Zoned Arizona will maintain a minimum Non-Cannabis Debt Service Coverage Ratio (as hereinafter defined) of 1.40 to 1.00; (c) Zoned Arizona will at all times maintain a minimum debt service coverage ratio of 1.50 to 1.0; and (d) ZonedArizona and the Company, collectively, will maintain at all times, liquid assets of at least the sum of all tenant securities deposits under leases, plus$350,000 in operating reserves. All advances under the MAL bear interest at a variable rate equal to the greater of (a) the prime rate plus 2%, or (b) a floor rate equal to the sum of the prime rate as ofJuly 11, 2022 plus 2.25%. FromJuly 11, 2022 toJuly 11, 2023 , ZonedArizona agreed to make interest payments on the outstanding principal balance of the MAL. From and afterJuly 11, 2023 and continuing untilJuly 11, 2028 (the "Maturity Date"), Zoned Arizona will pay principal together with interest on the MAL in 60 monthly installments based on the interest rate set forth in the Note and a principal amortization schedule of 25 years fromJuly 11, 2023 (or if Zoned Arizona makes the Early Amortization Election, from the date such election is made). ZonedArizona may prepay the outstanding principal under the Note, at any time, subject to the provisions of the Note. If Zoned Arizona prepays all, but not less than all, of the outstanding principal balance of the MAL at any time untilJuly 11, 2023 , then Zoned Arizona will also pay a premium equal to 1% of the amount prepaid. OnDecember 7, 2022 , Zoned Arizona and the Bank entered into a First Amendment to Loan Agreement (the "First Amendment"). Pursuant to the terms of the First Amendment, Zoned Arizona has elected to make its Early Amortization Election (defined in the First Amendment and Loan Agreement), which election requires Zoned Arizona to commence paying principal and interest on the MAL as set forth in the Swap Note (defined below). Except as provided in the First Amendment, the terms of the Loan Agreement remain in full force and effect. Pursuant to the terms of the Loan Agreement and First Amendment, onDecember 7, 2022 , ZonedArizona issued an Amended and Restated Promissory Note (the "Swap Note") to the Bank. The Swap Note has an original principal amount of$4,500,000 , a 50% loan-to-value as determined by the bank-ordered appraisal completed on theTempe Property. The Swap Note requires Zoned Arizona to pay monthly principal and interest payments to the Bank at an interest rate equal to the prime rate plus 0.75%. The Swap Note matures 10 years after its effective date and payments are calculated based on a 30-year amortization schedule. In connection with the Swap Note, Zoned Arizona received net proceeds of$4,315,404 which is net of fees of$184,596 .
Zoned
Also as previously disclosed, onJuly 11, 2022 and pursuant to the terms of the Loan Agreement, the Company executed a Guaranty (the "Guaranty") in favor of the Bank, pursuant to which the Company agreed to guarantee all indebtedness of Zoned Arizona to the Bank arising under or in connection with the MAL or any of the loan documents. OnDecember 7, 2022 , the Company executed an Acknowledgement of Amendment and Reaffirmation of Guaranty (the "Reaffirmation") in favor of the Bank. The Reaffirmation reaffirms the Guaranty and provides the Company's consent to the First Amendment and Swap Note. OnDecember 7, 2022 , Zoned Arizona and the Bank entered into an Interest Rate Swap Transaction Confirmation (the "Confirmation"). The Confirmation incorporates by reference the 2002 ISDA Master Agreement as published by theInternational Swaps and Derivatives Association, Inc. as if the parties to the Confirmation executed such agreement in such form. The Confirmation provides the terms and conditions governing the interest rate swap transaction afforded to Zoned Arizona, including a fixed interest rate of 7.65%. The Company recorded the swap at fair value in the consolidated balance sheets with changes in fair value recorded contemporaneously in earnings. The Company has entered into an interest rate swap to mitigate variability in interest payments on its variable-rate debt.
On
34
Woodward Property Note Payable
OnDecember 5, 2022 , in connection with the acquisition of the Woodward Property located inPleasant Ridge, Michigan , the Company entered into a land contact note in the amount of$1,425,000 (the "Woodward Property Note Payable"). The Woodward Property Note Payable bears interest at 9% per annum and is due in
full as follows:
1) 60 monthly payments of principal and interest of
1, 2023, and
2) A balloon payment of
on or before December 1, 2028 .
On
Our future operations are dependent on our ability to manage our current cash balance, on the collection of rental and advisory revenues and the attainment of new advisory clients. Our real estate properties are leased to Significant Tenants under triple-net leases for which terms vary. We monitor the credit of these tenants to stay abreast of any material changes in credit quality. We monitor tenant credit by (1) reviewing financial statements and related metrics and information that are publicly available or that are provided to us upon request, and (2) monitoring the timeliness of rent collections. As ofDecember 31, 2022 and 2021, we had an asset concentration related to our Significant Tenant leases. As ofDecember 31, 2022 and 2021, these Significant Tenants represented approximately 59.8% and 79.2% of total assets, respectively. If our Significant Tenants are prohibited from operating due to federal or state regulations or due to COVID-19, or cannot pay their rent, we may not have enough working capital to support our operations and we would have to seek out new tenants at rental rates per square less than our current rate per square foot. We may secure additional financing to acquire and develop additional and existing properties. Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses or experience unexpected cash requirements that would force us to seek alternative financing. Furthermore, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock. The inability to obtain additional capital may restrict our ability to grow our business operations. Cash Flow
For the Years Ended
Net cash flow provided by operating activities was$871,901 for the year endedDecember 31, 2022 , as compared to net cash flow provided by operating activities of$489,257 for the year endedDecember 31, 2021 , representing an increase
of$382,644 .
? Net cash flow provided by operating activities for the year ended
2022 primarily reflected a net loss of
non-cash items consisting of depreciation of
of
on note receivable investments of
allowance for uncollectible amounts, a loss from unconsolidated joint ventures
of
swap of
primarily consisting of an increase in contract liabilities of
attributable to the receipt of cash of a
reflected in contract liabilities on the accompanying consolidated balance
sheet and will be amortized into rental revenue on a straight-line basis over
the remaining term of the lease, and an increase in security deposits payable
of
our Tempe property.
? Net cash flow provided by operating activities for the year ended
2021 primarily reflected a net loss of
non-cash items consisting of depreciation of
of
stock-based stock option expense of
of
ventures of
primarily consisting of an increase in accounts receivable of
decrease in prepaid expenses of
$11,244 , an increase in accrued expenses of$16,278 , and a decrease in deferred rent receivable of$8,987 . During the year endedDecember 31, 2022 , net cash flow used in investing activities amounted to$2,009,213 as compared to net cash provided by investing activities of$3,348 , a change of$2,012,561 . During the year endedDecember 31, 2022 , net cash used in investing activities was attributable to an increase in lease incentive receivables related to the disbursement of$500,000 to a Significant Tenant to be used for leasehold improvements, the purchase of rental property of$867,549 in connection with the acquisition of property inPleasant Ridge, Michigan , the purchase of property and equipment of$3,764 , an increase in escrow deposits of$590,000 in connection with the acquisition of additional property inPleasant Ridge, Michigan which closed inFebruary 2023 , and cash used to invest in equity securities of$50,000 . These uses of cash in investing activities were offset by proceeds from the sale of property and equipment of$2,100 . During the year endedDecember 31, 2021 , cash provided by investing activities was attributable to proceeds from the sale of rental property of$322,332 , offset by cash used for an investment in a convertible note receivable of$100,000 , cash used in the improvement of rental properties of$40,360 , cash used for the purchase of property and equipment of$2,624 , and cash used for investment in joint ventures of$176,000 . 35 During the year endedDecember 31, 2022 , net cash provided by financing activities amounted to$4,281,212 and consisted of net proceeds from notes payable of$4,315,404 , offset by the repayment of notes payable of$14,192 and the repayment of notes payable - related party of$20,000 . We did not have any cash flows from financing activities during the year endedDecember 31, 2021 .
Contractual Obligations and Off-Balance Sheet Arrangements
Contractual Obligations
We have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant assumptions used in our determination of amounts presented in the tables, in order to assist in the review of this information within the context of our consolidated financial position, results of operations, and cash flows. The following tables summarize our contractual obligations as ofDecember 31, 2022 (dollars in thousands), and the effect these obligations are expected to have on our liquidity and cash flows in future periods. Payments Due by Period Less than Contractual obligations: Total 1 year 1-3 years 3-5 years 5 + years Convertible notes$ 2,000 $ - $ - $ -$ 2,000 Interest on convertible notes 880 150 240
240 250
Notes payable 5,911 63 145 172 5,531
Total $ 8,791 $ 213 $ 385 $ 412 $ 7,781 Off-balance Sheet Arrangements
Other than discussed below, we have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholders' equity. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us. Our off-balance sheet arrangement includes the notional amount of our interest rate swaps which we use to hedge a portion of our exposure to interest rate fluctuations. Currently, our interest rate swap fixes the variable rate interest on our bank swap note payable. We intend to fund our interest rate swap payments utilizing cash flows from operations. As ofDecember 31, 2022 , the notional amount of our interest rate swaps was$4,500,000 .
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States . The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our estimates, including those related to income taxes, and the valuation of equity transactions. We base our estimates on historical experience and on various other assumptions that we believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Any future changes to these estimates and assumptions could cause a material change to our reported amounts of revenues, expenses, assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the audited consolidated financial statements. 36
Fair value of financial instruments
The carrying amounts reported in the consolidated balance sheets for cash, accounts receivable, prepaid expenses and other assets, accounts payable, accrued expenses, and other payables approximate their fair market value based on the short-term maturity of these instruments.
TheFinancial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 820, Fair Value Measurement ("ASC 820"), requires companies to determine fair value based on the price that would be received to sell the asset or paid to transfer the liability to a market participant. ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement.
The guidance requires that assets and liabilities carried at fair value be classified and disclosed in one of the following categories:
? Level 1: Quoted market prices in active markets for identical assets or
liabilities.
? Level 2: Observable market-based inputs or unobservable inputs that are
corroborated by market data.
? Level 3: Unobservable inputs that are not corroborated by market data.
Other than the interest rate swap, the Company did not identify any other assets
or liabilities that are required to be presented on the balance sheets at fair
value, on a recurring basis, in accordance with ASC Topic 820.
Interest rate swap
In connection with a bank loan executed in 2022, the Company entered into an
interest rate swap agreement to management interest rate risk related to debt
that accrues interest at variable rates The Company accounts for its interest
rate swap agreement in accordance with the guidance related to derivatives and
hedging activities. The Company is exposed to market risk from changes in
interest rates. The Company agrees to exchange, at specified intervals, the
difference between fixed and variable interest amounts calculated by reference
to an agreed upon notional principal amount. Interest payments receivable and
payable under the terms of the interest rate swap agreement are accrued over the
period to which the payment relates and the net difference is treated as an
adjustment of interest expense related to the underlying liability. Because the
variable interest rates used to calculate payments under the terms of the swap
agreement are calculated using different benchmarks than those included in the
Company's variable rate debt agreement, the swap agreement is not considered an
effective cash flow hedge.
Accordingly, changes in the underlying market value of the remaining swap
payments are recognized into income as an increase or decrease to other income
(expense) each reporting period. In accordance with ASC 820, Fair Value
Measurements and Disclosures, the Company believes values provided by its
counterparty represent the fair value of its swap agreement. The Company
believes that the quality of the counterparty to its swap agreement mitigates
the counterparty credit risk.
The estimated fair value of the interest rate swap agreement is reflected as a
derivative liability on the accompanying balance sheet with changes in the fair
value reflected in interest expense in the accompanying statements of
operations. The Company uses derivative financial instruments only to manage
interest rate risks and not as investment vehicles.
Information regarding the interest rate swap is as follows:
Fair Value of Fair Value of
Liability on Liability on
Notional Interest December 31, December 31,
Description Amount Rate Maturity 2022 2021
December
December 7, 2022 interest rate swap $ 4,500,000 7.65 % 10, 2032 $ 90,237 $ -
37
Rental properties
Rental properties are carried at cost less accumulated depreciation and
amortization. Betterments, major renovations and certain costs directly related
to the improvement of rental properties are capitalized. Maintenance and repair
expenses are charged to expense as incurred. Depreciation is recognized on a
straight-line basis over estimated useful lives of the assets, which range from
5 to 39 years. Tenant improvements are amortized on a straight-line basis over
the lives of the related leases, which approximate the useful lives of the
assets.
Upon the acquisition of real estate, we assess the fair value of acquired assets
(including land, buildings and improvements, identified intangibles, such as
acquired above-market leases and acquired in-place leases) and acquired
liabilities (such as acquired below-market leases) and allocate the purchase
price based on these assessments. The Company assesses fair value based on
estimated cash flow projections that utilize appropriate discount and
capitalization rates and available market information. Estimates of future cash
flows are based on a number of factors including historical operating results,
known trends, and market/economic conditions.
Our properties are individually reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. An impairment exists when the carrying amount of an asset
exceeds the aggregate projected future cash flows over the anticipated holding
period on an undiscounted basis. An impairment loss is measured based on the
excess of the property's carrying amount over its estimated fair value.
Impairment analyses are based on our current plans, intended holding periods and
available market information at the time the analyses are prepared. If our
estimates of the projected future cash flows, anticipated holding periods, or
market conditions change, our evaluation of impairment losses may be different
and such differences could be material to our consolidated financial statements.
The evaluation of anticipated cash flows is subjective and is based, in part, on
assumptions regarding future occupancy, rental rates and capital requirements
that could differ materially from actual results.
We have capitalized land, which is not subject to depreciation.
Lease accounting
The FASB's Accounting Standards Update ("ASU") 2016-02, "Leases (Topic 842)"
sets out the principles for the recognition, measurement, presentation and
disclosure of leases for both parties to a contract (i.e., lessees and lessors).
The standard requires lessees to apply a dual approach, classifying leases as
either finance or operating leases based on the principle of whether or not the
lease is effectively a financed purchase by the lessee. This classification will
determine whether lease expense is recognized based on an effective interest
method or on a straight-line basis over the term of the lease. A lessee is also
required to recognize a right-of-use asset and a lease liability for all leases
with a term of greater than 12 months regardless of their classification. Leases
with a term of 12 months or less will be accounted for similar to existing
guidance for operating leases today. The new standard requires lessors to
account for leases using an approach that is substantially equivalent to
existing guidance for sales-type leases, direct financing leases and operating
leases.
For leases entered into on or after the effective date, where the Company is the
lessor, at the inception of the contract, the Company assesses whether the
contract is a sales-type, direct financing or operating lease by reviewing the
terms of the lease and determining if the lessee obtains control of the
underlying asset implicitly or explicitly. If a change to a pre-existing lease
occurs, the Company evaluates if the modification results in a separate new
lease or a modified lease. A new lease results when a modification provides
additional right of use. The new lease or modified lease is then reassessed to
determine its classification based on the modified terms. As disclosed in Note
3, on January 1, 2019 , the Chino Valley lease was modified to increase the
monthly base rent from $35,000 to $40,000 . On May 31, 2020 , the Chino Valley
lease was modified to decrease the monthly base rent from $40,000 to $32,800 and
the Tempe lease was modified to increase the monthly base rent from $33,500 to
$49,200 . On August 23, 2021 and effective September 1, 2021 , the Chino Valley
lease was amended, and the monthly base rent was increased to $55,195 due to
additional space of 27,312 square feet being leased to the lessee. On January
24, 2022 and effective on March 1, 2022 , the Chino Valley lease was amended and
the monthly base rent was increased to $87,581 due to additional space of 30,000
square feet being leased to the lessee, increasing the premises to a total of
97,312 square feet of operational space. In connection with this lease
amendment, the Company paid $500,000 to the tenant as a tenant improvement
allowance or lease incentive for investment into the premises, which was
capitalized as a lease incentive receivable and is recognized on a straight-line
basis over the remaining lease term as a reduction to the lease income. The
increase in monthly rent was commensurate with the additional space being
leased; therefore, this modification qualifies as a separate contract under ASC
842 which does not require lease classification reassessment.
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The Company records revenues from rental properties for its operating leases
where it is the lessor on a straight-line basis. Any revenue on the
straight-line basis exceeding the monthly payment amount required on the
operating lease is reflected as a deferred rent receivable. Effective May 31,
2020 , the Company amended its leases for which it is the lessor on its Chino
Valley , Tempe , Kingman and Green Valley properties. The amendments resulted in
an abatement of rent for the months of June and July 2020 . Additionally, in
connection with an operating lease on the Company's Michigan property acquired
in December 2022 , the Company abated certain lease payments for the period from
December 2022 to March 2023 . These rent abatements resulted in an aggregate
deferred rent receivable as of December 31, 2022 and 2021 of $204,079 and
$164,770 , respectively (see Note 3). Additionally, if the lease provides for
tenant improvements, the Company determines whether the tenant improvements, for
accounting purposes, are owned by the tenant or the Company. When the Company is
the owner of the tenant improvements, the tenant is not considered to have taken
physical possession or have control of the physical use of the leased asset
until the tenant improvements are substantially completed. When the tenant is
the owner of the tenant improvements, any tenant improvement allowance
(including amounts that can be taken in the form of cash or a credit against the
tenant's rent) that is funded is treated as a lease incentive receivable and
amortized as a reduction of revenue over the lease term.
For contracts entered into on or after the effective date, where the Company is
the lessee, at the inception of a contract, the Company assesses whether the
contract is, or contains, a lease. The Company's assessment is based on: (1)
whether the contract involves the use of a distinct identified asset, (2)
whether we obtain the right to substantially all the economic benefit from the
use of the asset throughout the period, and (3) whether we have the right to
direct the use of the asset. The Company allocates the consideration in the
contract to each lease component based on its relative stand-alone price to
determine the lease payments. For leases where the Company is a lessee,
primarily for the Company's administrative office lease, the Company analyzed if
it would be required to record a lease liability and a right of use asset on its
consolidated balance sheets at fair value upon adoption of ASU 2016-02.
Operating lease right of use asset represents the right to use the leased asset
for the lease term and operating lease liability is recognized based on the
present value of the future minimum lease payments over the lease term at
commencement date. As most leases do not provide an implicit rate, the Company
used its incremental borrowing rate of 6% based on the information available at
the adoption date or execution of a lease agreement in determining the present
value of future payments. Lease expense for minimum lease payments is amortized
on a straight-line basis over the lease term and is included in general and
administrative expenses in the consolidated statements of operations.
Investment in joint ventures
We have equity investments in various privately held entities. We account for
these investments either under the equity method or cost method of accounting
depending on our ownership interest and level of influence. Investments
accounted for under the equity method are recorded based upon the amount of our
investment and adjusted each period for our share of the investee's income or
loss. Investments are reviewed for changes in circumstance or the occurrence of
events that suggest an other than temporary event where our investment may not
be recoverable. We evaluate our investments in these entities for consolidation.
We consider our percentage interest in the joint venture, evaluation of control
and whether a variable interest entity exists when determining whether or not
the investment qualifies for consolidation or if it should be accounted for as
an unconsolidated investment under either the equity method of accounting. If an
investment qualifies for the equity method of accounting, our investment is
recorded initially at cost, and subsequently adjusted for equity in net income
(loss) and cash contributions and distributions. The net income or loss of an
unconsolidated investment is allocated to its investors in accordance with the
provisions of the operating agreement of the entity. The allocation provisions
in these agreements may differ from the ownership interest held by each
investor. Differences, if any, between the carrying amount of our investment in
the respective joint venture and our share of the underlying equity of such
unconsolidated entity are amortized over the respective lives of the underlying
assets as applicable. These items are reported as a single line item in the
statements of operations as income or loss from investments in unconsolidated
affiliated entities.
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Revenue recognition
We follow ASC Topic 606, Revenue from Contracts with Customers ("ASC 606"). This
standard establishes a single comprehensive model for entities to use in
accounting for revenue arising from contracts with customers and supersedes most
of the existing revenue recognition guidance. ASC 606 requires an entity to
recognize revenue to depict the transfer of promised goods or services to
customers in an amount that reflects the consideration to which the entity
expects to be entitled in exchange for those goods or services and also requires
certain additional disclosures.
Rental income includes base rents that each tenant pays in accordance with the
terms of its respective lease and is reported on a straight-line basis over the
non-cancellable term of the lease, which includes the effects of rent abatements
under the leases. The Company commences rental revenue recognition when the
tenant takes possession of the leased space or controls the physical use of the
leased space and the leased space is substantially ready for its intended use.
Currently, the Company's leases provide for payments with fixed monthly base
rents over the term of the leases. The leases also require the tenant to remit
estimated monthly payments to the Company for property taxes. These payments are
recorded as rental income and the related property tax expense reflected
separately on the statements of operations.
Revenues from advisory services is recognized when the Company performs services pursuant to its agreements with clients and collectability is reasonably assured.
Brokerage revenues primarily consists of real estate sales commissions and are recognized upon the successful completion of all required services have been performed which is when escrow closes. In accordance with the guidelines established for Reporting Revenue Gross as a Principal versus Net as an Agent in the ASC Topic 606, the Company records commission revenues and expenses on a gross basis. Of the criteria listed in ASC Topic 606, the Company is the primary obligor in the transaction, does not have inventory risk, performs all or part of the service, has credit risk, and has wide latitude in establishing the price of services rendered and discretion in selection of agents and determination of service specifications. Brokerage revenue that are payable upon payment of rent or other events beyond the Company's control are recognized upon the occurrence of such events. Stock-based compensation
Stock-based compensation is accounted for based on the requirements of ASC 718 - "Compensation -Stock Compensation", which requires recognition in the financial statements of the cost of employee, director, and non-employee services received in exchange for an award of equity instruments over the period the employee, director, or non-employee is required to perform the services in exchange for the award (presumptively, the vesting period). The ASC also requires measurement of the cost of employee, director, and non-employee services received in exchange for an award based on the grant-date fair value of the award. The Company has elected to recognize forfeitures as they occur as permitted under ASU 2016-09 Improvements to Employee Share-Based Payment Accounting.
Recent Accounting Pronouncements
InJune 2016 , the FASB issued ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" ("ASU 2016-13"). ASU 2016-13 requires financial assets measured at amortized cost to be presented at the net amount expected to be collected. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances. ASU 2016-13 is effective for annual reporting periods beginning afterDecember 15, 2019 , including interim periods within those fiscal years, and a modified retrospective approach is required, with a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. In November of 2019, the FASB issued ASU 2019-10, which delayed the implementation of ASU 2016-13 to fiscal years beginning afterDecember 15, 2022 for smaller reporting companies which applies to the Company. The Company is currently evaluating the impact of ASU 2016-13 on its future consolidated financial statements. 40
Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying consolidated financial statements.
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