Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Our Management’s Discussion and Analysis should be read in conjunction with our unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this quarterly report.
Forward-Looking Statements
This quarterly report contains forward-looking statements and information relating to us that are based on the beliefs of our management as well as assumptions made by, and information currently available to, our management. When used in this report, the words “believe,” “anticipate,” “expect,” “will,” “estimate,” “intend”, “plan” and similar expressions, as they relate to us or our management, are intended to identify forward-looking statements. Although we believe that the plans, objectives, expectations and prospects reflected in or suggested by our forward-looking statements are reasonable, those statements involve risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements, and we can give no assurance that our plans, objectives, expectations and prospects will be achieved. Important factors that might cause our actual results to differ materially from the results contemplated by the forward-looking statements are contained in the “Risk Factors” section of and elsewhere in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 and in our subsequent filings with the SEC, and include, among others, the following: marijuana is illegal under federal law, competition, our business is dependent on laws pertaining to the marijuana industry, government regulation, our business model depends on the availability of private funding, we will be subject to general real estate risks and the availability, if debt payments to note holder are not made we could lose our investment in our real estate properties, terms and deployment of capital. The terms “MJ Holdings, Inc.,” “MJ Holdings,” “MJ,” “we,” “us,” “our,” and the “Company” refer to MJ Holdings, Inc.
Business Overview
MJ Holdings acquires and leases real estate to licensed marijuana operators. As of March 31, 2015, we have acquired two real estate properties in Colorado that are leased to state licensed marijuana operators and generating $44,268 in monthly rental income.
Additionally, MJ Holdings plans to explore ancillary opportunities in the regulated marijuana industry.
The Company does not and will not, until such time as Federal law allows, grow, harvest, distribute or sell marijuana or any substances that violate the laws of the United States of America.
As a participant in the regulated marijuana industry, we intend to:
- Acquire and lease real estate zoned for legalized marijuana operations;
- Finance real estate acquisitions and facilitate loan programs backed by real estate assets;
- Offer real estate structures that maximize working capital to legal marijuana operators; and,
- Position ourselves to operate legal marijuana operations in the U.S. if and when Federal laws reconcile with state laws and marijuana becomes legal under federal law.
We have devised our current business strategy based on certain limitations related to the legal status of marijuana under federal law and the fact that we are a public company and make certain representations and warranties in connection with our public filings with the United States Securities and Exchange Commission. We recognize the significant opportunities in the legalized marijuana space and believe that using our current business model, we can position ourselves to not only develop a significant business along our current path, but be able to leverage our position, relationships and assets to capitalize on additional opportunities in the future, if and when federal law reconciles with state law; resulting in the federal legalization of marijuana.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are 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. Actual results may differ from these estimates.
An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimate that are reasonably likely to occur, could materially impact the consolidated financial statements. We believe that the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the consolidated financial statements:
Deferred Leasing Costs
Commissions and other direct costs associated with the acquisition of tenants, or lessees, are capitalized and amortized on a straight-line basis over the terms of the related leases. Costs associated with unsuccessful leasing opportunities are expensed.
Deferred leasing costs charged to property expenses for the three months ended March 31, 2015 and 2014, were $6,731 and $0, respectively. As of March 31, 2015, $178,304 of deferred leasing costs are included on the Balance Sheet as a deferred asset.
Debt Issuance Costs
Costs associated with obtaining, closing, and modifying loans and/or debt instruments such as, but not limited to placement agent fees, attorney fees and state documentary fees are capitalized and charged to interest expense over the term of the loan.
Debt issuance costs charged to interest expense for the three months ended March 31, 2015 and 2014, were $2,459 and $0, respectively. As of March 31, 2015, $11,475 of debt issuance costs are included on the Balance Sheet within the Prepaid expenses and other assets.
Real Estate Property
Real estate property is recorded at cost, less accumulated depreciation and amortization. Real estate property, excluding land, is depreciated using the straight-line method over the estimated useful life of the respective assets. Leasehold improvements are amortized using the straight-line method over the shorter of the related lease term or useful life. Maintenance, repairs, and minor improvements are charged to expense as incurred; major renewals and betterments that extend the useful life of the associated asset are capitalized. When real estate property is sold or retired, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is included in results of operations for the period.
Revenue Recognition
Before revenue can be recognized, four basic criteria must be met: persuasive evidence of an arrangement exists; the delivery has occurred or services have been rendered; the fee is fixed or determinable; and collectability is reasonably assured.
The Company's revenues are rental income generated by leasing acquired real estate properties to licensed marijuana operators. All leases are classified as operating leases. Rental income is recognized on a straight-line basis over the terms of the leases. Straight-line rent is recognized for all tenants with contractual fixed increases in rent. Deferred rent receivable represents rental revenue recognized on a straight-line basis in excess of billed rents. Reimbursements from tenants for real estate taxes and other recoverable operating expenses are recognized as rental income in the period the applicable costs are incurred.
Stock-Based Compensation
The Company estimates the fair values of share-based payments on the date of grant using a Black-Scholes option pricing model, which requires assumptions for the expected volatility of the share price of our common stock, the expected dividend yield, and a risk-free interest rate over the expected term of the stock-based financial instrument.
Since the number of outstanding and free-trading shares of the Company’s common stock is limited and the trading volume is relatively low, we do not have sufficient company specific information regarding the volatility of our share price on which to base an estimate of expected volatility. As a result, we use the average historical volatilities of similar entities within our industry as the expected volatility of our share price.
The expected dividend yield is 0% as the Company has not paid any dividends on its common stock and does not anticipate it will pay any dividends in the foreseeable future.
The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant date with a remaining term equal to the expected term of the stock-based award.
For stock-based financial instruments issued to parties other than employees, we use the contractual term of the financial instruments as the expected term of the stock-based financial instruments.
The assumptions used in calculating the fair value of stock-based financial instruments represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.
Results of Operations For the Three Months Ended March 31, 2015 Compared to the Three Months Ended March 31, 2014
Revenue
Revenue for the three months ended March 31, 2015, was $132,804 compared with revenue of $0 for the three months ended March 31, 2014. Revenue for the three months ended March 31, 2015, was generated as a result of rental income from operating leases for two real estate properties acquired in June 2014 and September 2014.
Certain property expenses are reimbursable to the Company through our existing leasing arrangements. During the three months ended March 31, 2015, the Company recorded $11,753 of revenue pursuant to operating lease agreements to offset a portion of the property expenses incurred during the respective periods.
Operating Expenses
Property expenses consist of those costs associated with acquiring and leasing real estate properties. These expenses include costs for commissions, appraisals, real property taxes, insurance, repairs and maintenance. For the three months ended March 31, 2015, we incurred property expenses of $55,703 compared with $0 for the three months ended March 31, 2014. The property expenses for the three months ended March 31, 2015, were the result of costs incurred from the two real estate properties acquired in June 2014 and September 2014 and from costs incurred as a result of analyzing potential real estate acquisition opportunities.
General and administrative expenses for the three months ended March 31, 2015, increased by $60,649 to $73,508 compared with general and administrative expenses of $12,859 for the three months ended March 31, 2014. The increase in general and administrative expenses for the three months ended March 31, 2015, was attributed to increases in professional fees, legal fees, and overhead expenses due to the ramp up of our business during the latter portion of 2014, of which $20,000 was for non-cash stock-based compensation for consulting services.
Depreciation expense for the three months ended March 31, 2015, was $20,163 compared with depreciation expense of $0 for the three months ended March 31, 2014. Depreciation expense for the three months ended March 31, 2015, was associated with the deprecation of two real estate properties acquired in June 2014 and September 2014.
Other Expenses
Interest expense for the three months ended March 31, 2015, increased by $46,254 to $47,459 compared with interest expense of $1,205 for the three months ended March 31, 2014. The increase in interest expense for the three months ended March 31, 2015, was primarily due to $45,000 of interest expense incurred on a $1.8 million promissory note from a related party used to fund a $2.2 million real estate property acquisition in June 2014.
Net Loss
We had a net loss of $64,029, or a basic and diluted loss per share of $0.005, for the three months ended March 31, 2015, compared with a net loss of $14,064, or a basic and diluted loss per share of $0.001, for the three months ended March 31, 2014. The increase in the net loss was primarily due to increases in operating expenses and interest expense as a result of the change in our business model in February 2014 to acquire and lease real estate to licensed marijuana operators.
Liquidity and Capital Resources
The following table summarizes the cash flows for the three months ended March 31, 2015 and 2014:
| | For the Three Months Ended
March 31, | |
| | 2015 | | | 2014 |
|
Cash Flows: | | | | | | | | |
Net cash provided by (used in) operating activities | | $ | 37,424 | | | $ | (7,643 | ) |
Net cash used in investing activities | | | (98,393 | ) | | | — | |
Net cash provided by financing activities | | | — | | | | 900,277 | |
| | | | | | | | | |
Net increase (decrease) in cash | | | (60,969 | ) | | | 892,634 | |
Cash at beginning of period | | | 175,792 | | | | 478 | |
| | | | | | | | | |
Cash at end of period | | $ | 114,823 | | | $ | 893,112 | |
| | | | | | | | | |
The Company had cash of $114,823 at March 31, 2015, compared with cash of $175,792 at December 31, 2014, a decrease of $60,969. The decrease in cash during the three months ended March 31, 2015, was primarily attributed to $98,393 of cash used for improvements to one of our real estate properties, partially offset by cash provided by operating activities of $37,424.
Operating Activities
We had net cash provided by operating activities of $37,424 for the three months ended March 31, 2015, which consisted of a decrease of $52,422 in prepaid and other assets, non-cash charges of $39,556, and a decrease in deferred leasing costs of $17,510, partially offset by a net loss of $64,029 and a decrease of $8,035 in accounts payable and accrued liabilities.
We had net cash used in operating activities of $7,643 for the three months ended March 31, 2014, which consisted of a net loss of $14,064, partially offset by an increase of $5,215 in accounts payable and accrued liabilities and an increase in accrued interest on stockholder loans of $1,206.
Investing Activities
Pursuant to the terms of the lease agreement for the real estate property located in Aurora, Colorado, the Company agreed to contribute $150,000 to improvements to the property. For the three months ended March 31, 2015, we incurred $98,393 for building improvements to the property in Aurora, Colorado. As of March 31, 2015, the Company had paid $121,026 of the $150,0000 towards the improvements to the property.
Financing Activities
We had $900,277 in net cash provided by financing activities for the three months ended March 31, 2014, which consisted of proceeds of $895,000 received from the sale of common stock and proceeds of $5,277 received from loans from the principal stockholders.
Although we can provide no assurances, we believe our cash on hand, coupled with revenues generated by rental income and our ability to refinance our equity in the real estate we own, will provide sufficient liquidity and capital resources to fund our business for the next twelve months. In the event we experience liquidity and capital resources constraints because of unanticipated operating losses, we may need to raise additional capital in the form of equity and/or debt financing. If such additional capital is not available on terms acceptable to us or at all then we may need to curtail our operations and/or take additional measures to conserve and manage our liquidity and capital resources, any of which would have a material adverse effect on our business, results of operations and financial condition.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Seasonality
We do not consider our business to be seasonal.
Inflation and Changing Prices
Neither inflation or changing prices for the three months ended March 31, 2015, had a material impact on our operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not required for smaller reporting companies.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Co-Chief Executive Officers and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of March 31, 2015. Based on that evaluation, our Co-Chief Executive Officers and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2015.
Changes in Internal Control Over Financial Reporting
During the quarter ended March 31, 2015, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Securities Exchange Act Rules 13a-15 or 15d-15 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
This quarterly report does not include an attestation report of the Company’s registered public accounting firm regarding internal controls over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this quarterly report.
