NewLake Capital Partners, Inc.: Form 10-Q for the period ended Sep 30, 2023

SPECIAL NOTE REGARDING FORWARD LOOKING INFORMATION

NewLake Capital Partners, Inc. ("the Company," "we," "our," "us,") makes statements in this Quarterly Report on Form 10-Q (“Form 10-Q”) that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In particular, statements pertaining to our capital resources, property performance, leasing rental rates, future dividends and results of operations contain forward-looking statements. Likewise, all of our statements regarding anticipated growth in our funds from operations, adjusted funds from operations, anticipated market conditions, demographics, and results of operations are forward-looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as “believe,” “continue,” “could,” “expect,” “may,” “will,” “should,” “would,” “seek,” “approximately,” “intend,” “plan,” “pro forma,” “estimates,” “forecast,” “project,” or “anticipate” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions.

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). 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:

• 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;
• general economic conditions;
• adverse economic or real estate developments, either nationally or in the markets in which our properties are located;
• other factors affecting the real estate industry generally;
• increase in interest rates and operating costs;
• the impact of inflation;
• financial market fluctuations;
• the competitive environment in which we operate;
• the estimated growth in and evolving market dynamics of the regulated cannabis market;
• adverse economic effects on the cannabis market;
• the expected medical-use or adult-use cannabis legalization in certain states;
• shifts in public opinion regarding regulated cannabis;
• the additional risks that may be associated with certain of our tenants cultivating adult-use cannabis in our cultivation facilities;
• the risks associated with the development of cultivation centers and dispensaries;
• our ability to successfully identify opportunities in target markets;
• the lack of tenant security deposits will impact our ability to recover rents should our tenants default under their respective lease agreement;
• our status as an emerging growth company and a smaller reporting company;
• our lack of an extensive operating history;
• the concentration of our tenants in certain geographical areas;
• our failure to generate sufficient cash flows to service any outstanding indebtedness;
• defaults on, early terminations of or non-renewal of leases by tenants, including significant tenants;
• our failure to acquire the properties in our identified pipeline successfully, on the anticipated timeline or at the anticipated costs;
• our failure to properly assess employment growth or other trends in target markets and other markets in which we seek to invest;
• lack or insufficient amounts of insurance;
• bankruptcy or insolvency of a significant tenant or a substantial number of smaller tenants;
• our access to certain financial resources, including banks and other financial institutions;
• reduced liquidity of our common stock resulting from limited availability of clearing firms that will settle our

securities offerings;

• our failure to successfully operate acquired properties;
• our ability to operate successfully as a public company;
• our dependence on key personnel and ability to identify, hire and retain qualified personnel in the future;
• conflicts of interests with our officers and/or directors stemming from their fiduciary duties to other entities, including our operating partnership;
• our failure to obtain necessary outside financing on favorable terms or at all;
• general volatility of the market price of our common stock;
• changes in GAAP;
• environmental uncertainties and risks related to adverse weather conditions and natural disasters;
• our failure to maintain our qualification as a REIT for federal income tax purposes;
• changes in governmental regulations or interpretations thereof, such as real estate and zoning laws and increases in real property tax rates and taxation of REITs; and
• the impact of COVID-19 pandemic, or future pandemics, on us, our business, our tenants, or the economy generally.

While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, of new information, data or methods, future events or other changes after the date of this report, except as required by applicable law. You should not place undue reliance on any forward-looking statements that are based on information currently available to us or the third parties making the forward-looking statements.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and the related notes and the discussion under the heading

"Management's Discussion and Analysis of Financial Condition and Results of Operations" for the fiscal year ended December 31, 2022 included in our most recent Annual Report on Form 10-K and our subsequent Quarterly Reports on Form 10-Q.

This discussion, particularly information with respect to our future results of operations or financial condition, business strategy and plans, and objectives of management for future operations, includes forward-looking statements that involve risks and uncertainties as described under the heading "Special Note Regarding Forward-Looking Information" in this Quarterly Report on Form 10-Q. You should review the disclosure under the heading "Risk Factors" in our most recent annual report on Form 10-K for a discussion of important factors that could cause our actual results to differ materially from those anticipated in these forward-looking statements.

Overview

NewLake Capital Partners, Inc., ("the “Company,” "we," "our," "us,") is an internally managed REIT and a leading provider of real estate capital to state-licensed cannabis operators primarily through sale-leaseback transactions, third-party purchases and funding for build-to-suit projects. Our properties are leased to single tenants on a long-term, triple-net basis, which obligates the tenant for the ongoing expenses of the leased property, in addition to its rent obligations.

We were incorporated in Maryland on April 9, 2019. We conduct our business through a traditional umbrella partnership REIT structure, in which properties are owned by an operating partnership, directly or through subsidiaries. We are the sole general partner of our operating partnership and currently own approximately 98% of the OP Units. We have elected to be taxed as a REIT for U.S. federal income tax purposes beginning with our short taxable year ended December 31, 2019 and intend to operate our business so as to continue to qualify as a REIT.

As of September 30, 2023, we owned a geographically diversified portfolio consisting of 32 properties, including one property held for sale, across 12 states with 13 tenants, comprised of 17 dispensaries and 15 cultivation facilities.

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; and
• We are not required to give our stockholders non-binding advisory votes on executive compensation or golden parachute arrangements.

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 $1.2 billion, (ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the exchange, 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 own, interest income we receive from the loans we may originate, the timing of lease expirations, general market conditions, the regulatory environment in the cannabis industry, and the competitive environment for real estate assets that support the cannabis industry.

Rental Revenues

We receive income from rental revenue generated from our real estate properties that we own and expect to acquire in the future. The amount of rental revenue depends upon a number of factors, including:

• Our ability to enter into new leases at market value rents inclusive of annual rent increases; and
• Rent collection, which primarily relates to each of our current and future tenant’s or guarantor’s financial condition and ability to make rent payments to us on time.

For the period ended September 30, 2023, all of our rental revenues were derived from triple-net leases to 13 tenants. Our leases obligate the tenant for all the ongoing expenses of a property, including real estate taxes, insurance, maintenance and utilities, in addition to its rent obligations and include a parent or other affiliate guarantee. Our revenues are, therefore, dependent on our tenants (and related guarantors) ability to meet their respective obligations to us. Our tenants operate in the regulated cannabis industry, which is an evolving and highly regulated space. Further, because the regulated cannabis industry is a relatively new space, some of our existing tenants have limited operating histories and may be more susceptible to payment and other lease defaults. Thus, our operating results will be significantly impacted by the ability of our tenants to achieve and sustain positive financial results.

Financial Performance and Condition of Our Tenants

We have 32 properties, including one that is held for sale, leased to 13 tenants. All of our tenants are performing under their lease agreement with the exception of one tenant discussed below.

We had one tenant, Revolutionary Clinics, Inc., who did not pay contractual rent for the nine months ended September 30, 2023. We held a security deposit of approximately three months of contractual rent, of which the Company applied $945 thousand towards the outstanding rent during the nine months ended September 30, 2023. Approximately $315 thousand of security deposit remains for future application. We will continue to assess and apply the remaining security deposit, as needed. We are currently in discussion with the tenant to negotiate a resolution, which could include rent deferrals, rent concessions or other concessions. Subsequent to September 30, 2023 we reached an agreement to restructure the existing lease agreement. Refer to Recent Development in Item 2 for details.

Market Conditions

Through the nine months ended September 30, 2023, financial markets were volatile in the first half of 2023, reflecting heightened geopolitical risks and material tightening of financial conditions since the U.S. Federal Reserve began increasing interest rates in the spring of 2022. The volatile financial markets have been subdued and lost steam during the quarter, with investors taking a risk-off stance. The tense regional banking crisis was short-lived as the banking system remains strong. Central banks continued to shrink their balance sheets during the quarter, reducing market liquidity. The inverted yield curve and tight monetary policy, have resulted in banks tightening their lending standards across multiple sectors, further reducing market liquidity. There continues to be uncertainty regarding monetary policy and inflation. With less than three months left in the year, most concerns about an economic recession have been pushed to 2024. While inflation is steadily trending downward, there are concerns that inflation may still prove stickier than the market anticipates, creating risks to corporate profit margins. Even though the Federal Reserve left rates unchanged in September, it has been signaling higher rates for longer as it continues to fight inflation, with borrowing costs at the highest level in 22 years. The increasing cost of capital is pressuring many U.S. corporations. U.S. corporate defaults have significantly increased in 2023 compared to 2022. These current market conditions have increased the cost of capital and reduced the availability of capital for us and our tenants.

Inflation and Supply Chain Constraints

Inflation continues to trend significantly higher than in prior periods, which may be negatively impacting some of our tenants. This inflation has impacted costs for labor and production inputs for regulated cannabis operators, in addition to increasing costs of construction for development and redevelopment projections. Ongoing labor shortages and global supply chain issues, geopolitical issues and the war in Ukraine, also continue to adversely impact costs and timing for completion of these development and redevelopment projects, which are resulting in cost overruns and delays in commencing operations on certain of our tenants' projects.

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, mortgage REITs, hard money lenders, as well as would-be tenants and cannabis operators themselves, all of whom may compete with us in our efforts to acquire real estate zoned for cannabis cultivation, production or dispensary 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 own and expect to acquire, which would adversely affect our financial results.

Critical Accounting Policies and Estimates

In accordance with generally accepted accounting principles in the United State of America, ("GAAP"), our consolidated financial statements require the use of estimates and assumptions that involve the exercise of judgment and use of assumptions. Our most critical accounting policies will involve decisions and assessments that could affect our reported assets and liabilities, as well as our reported revenues and expenses. Actual results could differ materially from those estimates and assumptions.

We believe that all of the decisions and assessments upon which our consolidated financial statements have been based were reasonable at the time made and based upon information available to us at that time. There have been no changes to the Company's critical accounting policies included in Note 2 to the Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the year ended December 31, 2022, except as follows:

Property Held for Sale

We classify real estate held for sale when the following criteria are met: (i) management commits to a plan to sell the property, (ii) the property is available for sale, (iii) the property is actively being marketed for sale at a price that is reasonable, (iv) the sale of the property within one year is considered probable, and (iv) significant change to the plan to sell the property is not expected. A real estate asset held for sale is classified as "Property Held for Sale" in the consolidated balance sheets. A property classified as held for sale is no longer depreciated and is required to be reported at the lower of its carrying value or its fair value less cost to sell.

Financial Instruments - Credit Losses

We adopted ASC 326, Financial Instruments - Credit Losses ("CECL") on January 1, 2023, which did not have a material impact to our financial statements. The CECL expected loss model requires an allowance for all expected credit losses for the life of a loan be recognized when the loan is either originated or acquired. The allowance for credit losses is a valuation account that is deducted from, or added to, the amortized cost basis of the financial asset(s) to present the net amount expected to be collected on the financial asset(s). At each reporting period, the company will update its estimate and adjust the allowance for credit losses accordingly. Increases in the allowance are recorded through net income as credit loss expense. Decreases in the allowance are recorded through net income as a reversal of credit loss expense. This standard does not specify a specific measurement technique for estimating expected credit losses. Approaches can vary based on a variety of factors. We generally use a discounted cash flow model approach to determine the credit loss, if any, for its financial instruments subject to the CECL guidance.

Q3 2023 Highlights

Investment Activity

Real Estate Acquisitions

As of September 30, 2023, we owned a geographically diversified portfolio consisting of 32 properties, including one property held for sale, across 12 states with 13 tenants, comprised of 17 dispensaries and 15 cultivation facilities with a weighted average remaining lease term of 14.2 years. All of our leases, and the secured loan, include a parent or other affiliate guarantee.

The following table presents our investment activity for the nine months ended September 30, 2023 (in thousands):

(1) The Company exercised its option to purchase the adjacent parcel of land to expand our cultivation facility in Missouri and has committed to fund $16.2 million for the expansion.

The following table presents the tenant improvements funded during the nine months ended September 30, 2023 (in thousands):

(1) The tenant had been paying rent on approximately $1.6 million of the TI funded since July 2022 in accordance with the lease agreement. Effective June 1, 2023, the lease agreement was amended to include an additional TI commitment of approximately $6.5 million.

Held for Sale Real Estate

On August 25, 2023, we entered into a purchase and sale agreement for the sale of our Massachusetts property that is leased to Mint, subject to customary buyer's due diligence. In connection with the agreement, the buyer deposited $100,000 into an escrow account. The escrow deposit was fully refundable if the contract was terminated during the due diligence period. As of September 30, 2023, the due diligence period had expired and $75,000 of the escrow deposit became non-refundable in the event the buyer terminated the contract. The escrow deposit was not recorded in the accompanying consolidated balance sheet as of September 30, 2023. The sale closed subsequent to September 30, 2023 refer Recent Development in Item 2 for additional information.

Financing Activity

Seller Financing

In January 2023, we made our annual principal payment of $1.0 million. The loan's outstanding balance as of September 30, 2023 was $1.0 million and the remaining unamortized discount was $3.4 thousand. The final principal payment is due in January 2024.

Revolving Credit Facility

The outstanding borrowings under the Revolving Credit Facility were $1.0 million as September 30, 2023. Refer to Note 6 in the Notes to Consolidated Financial Statements in Part I – Item 1 for further information.

Capital Markets Activity

Stock Repurchase Program

On November 7, 2022, our board of directors approved a repurchase program of up to $10.0 million of our common stock through December 31, 2023. On September 15, 2023, our board of directors authorized an amendment to the stock repurchase program for the repurchase of up to an additional $10.0 million of our outstanding common stock and extended the program through December 31, 2024. During the nine months ended September 30, 2023, pursuant to the repurchase plan, we acquired 713,831 shares of common stock with an average price, including commissions, of $12.96, totaling approximately $9.3 million.

Recent Developments

Tenant Improvements

We funded approximately $2.9 million of tenant improvements for the expansion of our cultivation facilities located in Arizona and Missouri subsequent to quarter end.

Leases

Revolutionary Clinics

In October 2023, we entered into a lease amendment and forbearance agreement (the “Agreements”) for our existing lease agreement with Revolutionary Clinics on our cultivation facility in Massachusetts, where Revolutionary Clinics is the sole tenant. Under the terms of the Agreements, the lease term was extended by five years. We received $480 thousand of unpaid rent and applied the remaining $315 thousand of security deposit; these amounts will be recognized as income in the fourth quarter of 2023. Additionally, we received October and November contractual rent payments pursuant to the amended lease. The new reduced rental payments are expected to represent approximately 6.1% of our estimated fourth quarter 2023 portfolio contractual rental income. The rental payments may escalate as the tenant’s business achieves certain gross revenue metrics. Under the Agreements, we provided forbearance for approximately $2.0 million of back rental income. Lastly, we received 9.95% of equity in Revolutionary Clinics in the form of warrants.

Calypso

Calypso did not make their weekly October rent payments. However, they resumed their weekly rent payments in November. Calypso continues to work towards a sale of its business.

Disposition of Real Estate

In October 2023, we closed on the sale of our cultivation facility in Palmer, Massachusetts, for $2.0 million, which was leased to Mint. Our investment in the property was approximately $1.9 million. Upon closing, Mint's lease agreement was terminated and they paid a portion of the closing costs, resulting in a break-even sale of the property.

Results of Operations

General

We derive substantially all our revenue from rents received from single tenants of each of our properties under triple-net leases. Our triple-net leases obligate the tenant for all the ongoing expenses of a property, including real estate taxes, insurance, maintenance and utilities, in addition to its rent obligations. Our leases also typically include annual rent escalations (typically within the range of 2-3%) as a set percentage or based on an inflation index, which generally provides us with contractual revenue growth and inflation-protected returns. All of our leases include a parent or other affiliate guarantee.

Comparison of the three months ended September 30, 2023 and 2022 (in thousands):

Revenues

Rental Income

Rental income for the three months ended September 30, 2023 decreased by approximately $0.3 million to approximately $11.3 million, compared to approximately $11.6 million for the three months ended September 30, 2022. The decrease in rental income was mainly attributable to one non-performing tenant, Revolutionary Clinics, that failed to pay contractual rent of approximately $1.3 million for three months ended September 30, 2023. We applied 25% or $315 thousand of the security deposit towards the outstanding rent. In October, we entered into a lease amendment and forbearance agreement with Revolutionary Clinics. Refer to Recent Development in Item 2 of this Form 10-Q for details. Also, to a lesser extent the sale of one of our properties in Massachusetts during 2022 contributed to the decrease in rental income.

The decrease was partially offset by increases in rental income from the following;

• A full quarter of rental income from a cultivation facility that converted from a mortgage loan to a 20 year sale-leaseback on August 5, 2022. The increase also includes a full quarter of rental income from

exercising our option to acquire the adjacent land parcel to expand one of our existing cultivation facility in Missouri during the first quarter of 2023. These acquisitions generated approximately $0.3 million of rental income during the three months ended September 30, 2023.

• Funding of tenant improvements at our Arizona and Missouri cultivation facilities which generated approximately $0.1 million of additional rental income during the three months ended September 30, 2023.
• Annual escalations on our portfolio generated an increase of approximately $0.2 million of rental revenue during the three months ended September 30, 2023.

Interest Income from Loans

Interest income from loans decreased by approximately $0.3 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. The decrease of approximately $0.3 million was attributable to the conversion of the $30.0 million mortgage loan we entered into during the fourth quarter of 2021 that converted to a 20 year sale-leaseback, in accordance with the loan agreement, on August 5, 2022.

Expenses

Depreciation and Amortization Expense

Depreciation and amortization expense was relatively flat quarter over quarter.

General and Administrative Expense

Total general and administrative expenses for the three months ended September 30, 2023 increased by approximately $0.2 million, to $1.9 million, compared to $1.7 million for the three months ended September 30, 2022. The increase in general and administrative expense is described below by category.

Compensation Expense

Compensation expense includes compensation to employees and officers of the Company and stock-based compensation awards. Compensation expense increased by approximately $0.1 million for the three months ended September 30, 2023 compared to the three months ended September 30, 2022. The increase was attributable to a full quarter of compensation expense for two new hires in the second and third quarters of 2022 and an increase in stock based compensation from 2023 RSU and PSU grants. The increase was partially offset by one-time severance payments related to the retirement and separation of certain executive officers during 2022.

Professional Fees

Professional fees were relatively flat quarter over quarter.

Other General and Administrative Expenses

Other general and administrative expense was relatively flat quarter over quarter.

Other Income (Expense)

Interest income increased during the three months ended September 30, 2023 by approximately $171 thousand, to $178 thousand compared to $7 thousand for the three months ended September 30, 2022, primarily due to higher interest rates on our cash balances in our money market accounts.

Interest expense remained relatively flat quarter over quarter.

Comparison of the nine months ended September 30, 2023 and 2022 (in thousands):

Revenues

Rental Income

Rental income for the nine months ended September 30, 2023 increased by approximately $3.4 million to approximately $33.6 million, compared to approximately $30.2 million for the nine months ended September 30, 2022. The increase in rental income was primarily attributable to:

• A full nine months of rental income from two cultivation facilities acquired at the end of the second quarter of 2022 and one cultivation facility that converted from a mortgage loan to a 20 year sale-leaseback in August of 2022. The increase also includes a full six months of rental income from exercising our option to acquire the adjacent land parcel to expand one of our existing cultivation facilities in Missouri during the first quarter of 2023. These acquisitions generated approximately $3.6 million of rental income during the nine months ended September 30, 2023.
• Funding of tenant improvements at our Arizona, Florida and both Missouri cultivation facilities which generated approximately $2.1 million of additional rental income during the nine months ended September 30, 2023.
• Annual escalations on our portfolio generated an increase of approximately $0.5 million of rental revenue during the nine months ended September 30, 2023.

The increase in rental revenue was partially offset by a decrease of approximately $2.9 million in rental income attributable to one non-performing tenant Revolutionary Clinics, that failed to pay contractual rent under its lease agreement. During the nine months ended September 30, 2023, this tenant did not pay approximately $3.9 million of contractual rent to which we applied $945 thousand of their security deposit towards the outstanding rent. As of September 30, 2023, $315 thousand of the original security deposit remains available to be applied in future periods if needed. In October, we entered into a lease amendment and forbearance agreement with Revolutionary Clinics. Refer to Recent Development in Item 2 of this Form 10-Q for details. Also, to a lesser extent the sale of one of our properties in Massachusetts during 2022 contributed to the partial offset in the increase in rental income.

Interest Income from Loans

Interest income from loans decreased by approximately $1.9 million for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. Approximately $2.1 million of the decrease was attributable to the conversion of the $30.0 million mortgage loan we entered into during the fourth quarter of 2021 that converted to a 20 year sale-leaseback, in accordance with the loan agreement, on August 5, 2022. The decrease was offset by an increase of approximately $0.2 million of interest income in connection with a $5.0 million unsecured loan that was originated on June 10, 2022, in connection with the purchase of a Missouri cultivation facility.

Expenses

Depreciation and Amortization Expense

Depreciation and amortization expense for the nine months ended September 30, 2023 increased by approximately $1.6 million to approximately $10.7 million compared to approximately $9.1 million for the nine months ended September 30, 2022. The increase in depreciation was attributable to: (i) the acquisition of three cultivation facilities and one dispensary acquired during 2022; (ii) the mortgage loan that converted to a twenty year sale-leaseback property on August 5, 2022; (iii) the expansion at an existing cultivation facility in Florida; and (iv) approximately $30.7 million of improvements that were placed into service during 2022 and subsequent.

General and Administrative Expense

Total general and administrative expenses for the nine months ended September 30, 2023 decreased by approximately $2.0 million, to $6.0 million, compared to $8.0 million for the nine months ended September 30, 2022. The decrease in general and administrative expense is described below by category.

Compensation Expense

Compensation expense includes compensation to employees and officers of the Company and stock-based compensation awards. Compensation expense decreased by approximately $1.7 million during the nine months ended September 30, 2023 compared to nine months ended September 30, 2022. The decrease was primarily due to one-time severance payments of approximately $1.7 million from the retirement and separation of certain executive officers of the Company during the nine months ended September 30, 2023 and a decrease in stock-based compensation of approximately $0.2 million primarily due to the accelerated expense on RSUs related to the retirement and separation of certain executive officers. These decreases were partially offset by an increase in compensation expense due to new hires during 2022.

Professional Fees

Professional fees for the nine months ended September 30, 2023, decreased by approximately $500 thousand to approximately $986 thousand, compared to approximately $1.5 million for the nine months ended September 30, 2022. The decrease was mainly attributable to the reduction of approximately $115 thousand related to the elimination of outsourced accounting functions, a decrease of approximately $181 thousand in recruiting fees not incurred during 2023, a decrease of approximately $80 thousand in consulting fees and a decline of approximately $168 thousand in legal fees associated with a potential restructuring. These decreases were offset by an increase in general legal and tax preparation fees.

Other General and Administrative Expenses

For the nine months ended September 30, 2023, other general and administrative expenses increased by approximately $150 thousand to approximately $1.5 million, compared to $1.4 million for the nine months ended September 30, 2022. Other general and administrative expenses is comprised of director and officer insurance, information technology, public relations fees, filing and regulatory fees and various other expenses. The increase was mainly attributable to higher reporting costs, public relations fees, information technology costs and corporate rent, offset by lower director and officer insurance costs.

Loss on Sale of Real Estate

The Company did not sell any properties during the nine months ended September 30, 2023.

On March 21, 2022, we sold our PharmaCann Massachusetts property for approximately $800 thousand. We recognized a loss on sale of the property of $60 thousand during the nine months ended September 30, 2022.

Other Income (Expense)

Interest income increased during the nine months ended September 30, 2023 by approximately $504 thousand, to $607 thousand compared to $103 thousand for the nine months ended September 30, 2022, primarily due to higher interest rates on our cash balances in our money market accounts.

Interest expense increased during the nine months ended September 30, 2023 by approximately $117 thousand to approximately $284 thousand, compared to $167 thousand for the nine months ended September 30, 2022. The increase was mainly attributable to a full nine months of interest expense on the draw of $1.0 million from the Revolving Credit Facility we entered into on May 6, 2022, and the associated non-cash interest expense which increased by approximately $181 thousand related to the amortization of deferred financing costs incurred in connection with this facility. The increase was partially offset by a decrease in interest expense on our loan payable in connection with the $1.0 million principal pay down in January 2023.

Non-GAAP Financial Information and Other Metrics

Funds from Operations and Adjusted Funds from Operations

FFO and AFFO are non-GAAP financial measures and should not be viewed as alternatives to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that FFO and AFFO are useful to investors because they are widely accepted industry measures used by analysts and investors to compare the operating performance of REITs.

We calculate FFO in accordance with the current National Association of Real Estate Investment Trusts (“NAREIT”) definition. NAREIT currently defines FFO as follows: net income (loss) (computed in accordance with GAAP) excluding depreciation and amortization related to real estate, gains and losses from the sale of certain real estate assets, and impairment write-downs of certain real estate assets and investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by an entity. Other REITs may not define FFO in accordance with the NAREIT definition or may interpret the current NAREIT definition differently than we do and therefore our computation of FFO may not be comparable to such other REITs.

We calculate AFFO by starting with FFO and adding back non-cash and certain non-recurring transactions, including non-cash components of compensation expense and our internalization costs. Other REITs may not define AFFO in the same manner as we do and therefore our calculation of AFFO may not be comparable to such other REITs. You should not consider FFO and AFFO to be alternatives to net income as a reliable measure of our operating performance; nor should you consider FFO and AFFO to be alternatives to cash flows from operating, investing or financing activities (as defined by GAAP) as measures of liquidity.

The table below is a reconciliation of net income attributable to common stockholders to FFO and AFFO for the three and nine months ended September 30, 2023 and 2022 (in thousands):

Liquidity and Capital Resources

Our cash requirements include the payment of dividends, to our shareholders, distributions to our OP Unit holders, general and administrative expenses, debt service, other expenses related to managing our existing portfolio as well as acquisition and unfunded tenant improvement costs. The sources of liquidity to fund these cash requirements include rental revenue from the leasing of our properties, which is our primary source of cash flow, borrowings under our revolving credit facility and equity and debt issuances either in the public or private markets, if markets permit. Where possible, we also may issue OP Units to acquire properties from existing owners seeking a tax-deferred transaction.

As of September 30, 2023, we had $120.1 million of liquidity comprised of $31.1 million of cash and cash equivalents and $89.0 million available on our $90.0 million revolving credit facility, subject to sufficient collateral in the borrowing base. The ongoing challenges posed by the increase in interest rates and inflation could adversely impact our cash flow from continuing operations but we expect that cash flow from continuing operations over the next twelve months, together with cash on hand, will be adequate to fund our business operations, cash dividends to our shareholders, distributions to our OP Unit holders and debt service. Acquisitions and unfunded tenant improvement costs may require funding from borrowings, equity issuance and/or issuance of OP units. We cannot, however, be certain that these sources of funds will be available at a time and upon terms acceptable to us in sufficient amounts in the future.

Summary of Cash Flows

The following summary discussion of our cash flows is based on the consolidated statements of cash flows in our consolidated financial statements and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below (in thousands):

38

Net Cash Provided by Operating Activities:

Net cash provided by operating activities for the nine months ended September 30, 2023 and 2022 were approximately $27.6 million and $23.5 million, respectively. Net cash flows provided by operating activities for the nine months ended September 30, 2023 and 2022 were primarily related to contractual rent and security deposits received from our properties, partially offset by our general and administrative expenses.

Net Cash Used in Investing Activities:

Net cash used in investing activities for the nine months ended September 30, 2023 and the nine months ended September 30, 2022 were approximately $6.0 million and $83.2 million, respectively. Cash used in investing activities for the nine months ended September 30, 2023 related to approximately $350 thousand used to purchase an adjacent parcel of land by an existing cultivation facility in Missouri and approximately $5.6 million used to fund tenant improvements. Net cash used in investing activities for the nine months ended September 30, 2022 related to approximately $35.4 million used to purchase three cultivation facilities, approximately $43.5 million used to fund tenant improvements and $5.0 million used to fund an unsecured loan receivable at our cultivation facility in Missouri, partially offset by approximately $0.8 million of proceeds received from sale of our Franklin, Massachusetts property.

Net Cash Used in Financing Activities:

Net cash used in financing activities for the nine months ended September 30, 2023 and the nine months ended September 30, 2022 were approximately $35.8 million and $22.4 million, respectively. Cash used in financing activities for the nine months ended September 30, 2023, related to approximately $25.5 million in dividend payments to holders of our common stock, as well as distributions to OP Units and RSU holders, $1.0 million to pay down our loan payable, approximately $9.3 million to buy back stock under the stock repurchase program and approximately $28 thousand in deferred financing costs related to obtaining our Revolving Credit Facility. Net cash used in financing activities for the nine months ended September 30, 2022, were related to approximately $21.6 million in dividend payments to holders of our common stock, as well as distributions to OP Units and RSU holders and $1.8 million to pay down our loan payable, offset by $1.0 million drawn on our revolving credit facility.

Dividends

To maintain our qualification as a REIT, U.S. federal income tax law generally requires that we distribute at least 90% of our REIT taxable income annually, determined without regard to the deduction for dividends paid and excluding capital gains. We must pay tax at regular corporate rates to the extent that we annually distribute less than 100% of our taxable income. We evaluate each quarter to determine our ability to pay dividends to our stockholders based on our net taxable income if and to the extent authorized by our board of directors. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service payments. If our cash available for distribution is less than our net taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution.

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 the nine months ended September 30, 2023, we declared, and our board of directors approved, cash dividends on our common stock and restricted stock units and in our capacity as general partner of the Operating Partnership, authorized distributions on our OP Units totaling approximately $25.2 million. During the nine months ended September 30, 2022, we declared, and our board of directors approved, cash dividends on our common stock and restricted stock units and in our capacity as general partner of the Operating Partnership, authorized distributions on our OP Units totaling approximately $22.9 million.

Contractual Obligations and Commitments

Unfunded Commitments

As of September 30, 2023, the Company had aggregate unfunded commitments of $20.2 million to develop and improve our existing cultivation facilities in Arizona, Missouri, and Pennsylvania.

Corporate Office Lease

As of September 30, 2023, the Company is the lessee under one office lease for a term of four years, subject to annual escalations. The annual rent payments range from approximately $72 thousand in year one to approximately $85 thousand in year four. The office lease has a remaining weighted average term of approximately 2.9 years.

Revolving Credit Facility

As of September 30, 2023, the Company had $1.0 million drawn on our Revolving Credit Facility which bears interest at a rate of 5.65% per annum.

Adoption of New or Revised Accounting Standards

We are an emerging growth company, as defined in the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our consolidated financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates.

Interest Rate Risk

Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We are subject to interest rate risk in connection with our Revolving Credit Facility. As of September 30, 2023, we had $1.0 million principal drawn on our Revolving Credit Facility, at a fixed interest rate of 5.65% through May 2025 and a floating rate thereafter. Therefore, if interest rates decrease, our required interest payments may exceed those based on current market rates. If interest rates remain higher for longer, our cost of financing will significantly increase when the Revolving Credit facility adjusts to a floating rate subsequent to May 2025.

Impact of Inflation

The U.S. economy has experienced an increase in inflation rates recently. We enter into leases that generally provide for annual fixed increases in rent at a fixed rate. In some instances, leases provide for annual increases in rent based on the increase in annual CPI. 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.

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.

Our management, including our Chief Executive Officer (the CEO) and Chief Financial Officer (the CFO), reviewed and evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act) as of the end of the period covered by this report. Based on that review and evaluation, the CEO and CFO have concluded that our current disclosure controls and procedures, as designed, (1) were effective in ensuring that information required to be disclosed by the Company in reports it files or submits under the Securities Exchange Act is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure and (2) were effective in ensuring that information required to be disclosed by the Company in reports it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms.

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.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal controls over financial reporting that occurred during the three months ended September 30, 2023 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

There have been no material changes to the risk factors set forth in the section titled “Risk Factors” included in our Annual Report on Form 10-K, dated March 9, 2023, filed with the SEC. Our business involves significant risks. You should carefully consider the risks and uncertainties described in our Annual Report on Form 10-K, together with all of the other information in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements and related notes as disclosed in our Annual Report. The risks and uncertainties described in our Annual Report are not the only ones we face. Additional risk and uncertainties that we are unaware of or that we deem immaterial may also become important factors that adversely affect our business. The realization of any of these risks and uncertainties could have a material adverse effect on our reputation, business, financial condition, results of operations, growth and future prospects as well as our ability to accomplish our strategic objectives. In that event, the market price of our common stock could decline and you could lose part or all of your investment.