Advanced Flower Capital Inc. (AFCG) Earnings Call Transcript

Good day, and thank you for standing by, and welcome to the AFC Gamma Quarter Two 2021 Earnings Call. [Operator Instructions] And please be advised that this conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Ms. Francesca Smith. Ma'am, please go ahead.

Thank you, Mel. Good morning, and welcome to AFC Gamma, Inc.'s Second Quarter 2021 Earnings Conference Call. I'm joined this morning by Leonard Tannenbaum, Chief Executive Officer; Jonathan Kalikow, Head of Real Estate; Robyn Tannenbaum, Head of Origination; and Thomas Geoffroy, Chief Financial Officer. Before we begin, I would like to note that this call is being recorded. Replay information is included in our July 14, 2021, press release and is posted on the Investor Relations section of AFC Gamma's website at afcgamma.com, along with our second quarter 2021 earnings release and investor presentation. Today's conference call includes forward-looking statements and projections that reflect the company's current views with respect to, among other things, anticipated market size, expected consolidation in the industry, future events and financial performance. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ materially from those projected in these forward-looking statements. New risks and uncertainties arise over time, and it is not possible for the company to predict those events or how they may affect it. Therefore, you should not place undue reliance on these forward-looking statements. We ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. During this call, we will refer to distributable earnings, which is a non-GAAP financial measure. Reconciliations of net income, the most comparable GAAP measure to distributable earnings, can be found in our earnings release or in the investor presentation available on our website. The format for today's call is as follows. Len will provide introductory remarks, an overview of our second quarter results and strategic commentary. John will discuss the real estate lending environment. Robyn will discuss the origination pipeline. And Tom will summarize the financials. We will then open the line for Q&A. With that, I will now turn the call over to our Chief Executive Officer, Len Tannenbaum.

Thank you, Francesca, and welcome to AFC Gamma's Second Quarter Earnings Conference Call. I would like to thank our current shareholders, prospective shareholders and analysts for joining us. Today, I will provide you with an update on AFC Gamma's business, the many opportunities we have ahead of us and the current state of the cannabis industry. AFC Gamma is an institutional provider of loans to the cannabis industry, typically secured by 3 pillars: cash flow, licenses and real estate. The companies that we lend to are domestic, single and multistate operators, which include those that are privately held as well as those listed on the Canadian exchanges. During the second quarter, we closed on new commitments of $71.3 million. As of August 1, 2021, we lent to 14 borrowers, which have operations in 14 states. We are pleased that we have continued to diversify our portfolio across states and borrowers. In mid-June, we experienced a significant increase in the actionable pipeline, which was driven by an inflow of deals from large multistate operators as well as smaller multistate and single-state operators. Notably, this increase in the pipeline excludes any capital tied to New York, which recently allowed adult-use cannabis, as the legislation there is not yet finalized. Since mid-June, our actionable pipeline has remained at elevated levels, which was the primary reason for the follow-on offering that we completed in June. As a reminder, the deals in our actionable pipeline, should they convert, could take between 3 and 9 months to close. Many of the deals that we complete are high touch, require significant due diligence and potentially require regulatory approval, making it difficult to predict the exact timing of closings. Our robust pipeline of potential borrowers includes many operators expanding into new states. Growth and demand for debt capital that we provide will come from the issuance of new licenses in states such as Georgia and additional new licenses in states such as Ohio, Illinois and Florida. We are pleased that one of the recently issued Georgia licenses was awarded to our largest borrower, Nature's Medicines. We've also noticed that our customers are accelerating construction to meet the state-imposed limitation on build time and to gain a first-mover advantage. During the quarter, we received an investment-grade rating of BBB- from Egan-Jones rating company. This is an important step when we seek to issue debt. As our actionable pipeline converts into signed deals, it is our intention to seek long-term unsecured financing for part of this capital needs. We believe issuing debt and establishing a benchmark for our debt cost of capital is important as we continue to execute on our business plans. Conceptually, we believe that using leverage against lower yielding assets of the portfolio is a good way to generate strong returns on equity for our shareholders. In addition, we are pleased that AFC Gamma was added to Russell 2000, and we expect inclusion in this world-class market index will bring increased visibility across the investment community. Turning to the industry. The legislative environment surrounding the cannabis market continues to evolve. Senator Schumer of New York recently put forth the Cannabis Administration & Opportunity Act, which, if passed in its current form, would, among other things, remove marijuana from the Controlled Substances Act. Given the current political landscape, we believe it is very unlikely that this piece of legislation will succeed. That said, we remain optimistic that legislation consistent with the goals of the SAFE Act will eventually pass. The SAFE Act may allow for credit cards to be used at cannabis dispensaries and should certainly increase the number of banks accepting deposits from the industry. We recognize that increased competition because of the SAFE Act may drive lower yields for our borrowers. However, the SAFE Act will also potentially lower AFC Gamma's cost of capital as more banks could lend to us and more institutions could invest in us. Additionally, we continue to believe the states will have the right to set regulations around their own cannabis programs and will attempt to protect the significant source of tax revenue and job creation that cannabis provides to these states. The M&A boom that we mentioned during last quarter's earnings call continues with many large, public, multistate operators using a combination of equity, debt and cash as methods to acquire smaller single-state operators. We believe that we are in a 1- to 2-year period of rapid consolidation, where the big operators will continue to get bigger. Our goal is to be the lender of choice to at least half of the top 15 multistate operators as well as companies that are seeking to achieve scale or be acquired by an MSO. We lend at different rates to the top MSOs, the midsized operators and the smaller state operators. We are seeing some yield compression for the top-tier multistate operators due to their size, scale and access to capital. Going forward, we will continue to employ a high degree of selectivity in the deals that we underwrite and invest in. As we continue to source and evaluate new transactions, we have further expanded our team to over 20 employees and continue to build our corporate infrastructure to support our business plan. We are pleased to announce the hiring of Brett Kaufman, the new Chief Financial Officer for AFC Gamma. For 12 years, Brett served as CFO at Ladenburg Thalmann, a diversified financial services company, which is $1.5 billion in trailing 12-month revenue prior to its sale in 2020. Before that, he spent 9 years at Bear Stearn, serving in various roles of increasing responsibility, including Managing Director and Director of Financial Planning and Analysis. We are very excited to have Brett join our team and look forward to introducing him to our investors and analysts in the coming months. We also would like to thank Tom Geoffroy for his contributions, hard work and diligence as AFC Gamma's CFO. Tom will continue in his role as CFO of AFC Gamma's external manager, AFC Management. Turning to our dividend policy. The Board of Directors intends to declare a dividend for the September quarter on or about September 15, which will have a record date of September 30 and be payable October 15. It is anticipated that the quarterly dividend declared by the Board will be greater than or equal to the $0.38 dividend that was paid in the June quarter. This dividend schedule is similar to many other REITs. We intend to follow this schedule for future quarters, as this timing provides our Board with additional visibility into the earnings of that given quarter when declaring the dividend. As a reminder, our dividend policy is to pay between 90% and 100% of distributable earnings over the year with a special dividend at the end of the year, if necessary. I will now turn it over to Jon.

Thank you, Len. One of our core competencies and key differentiating factors as a lender focused on cannabis is our expertise and experience in construction financing. Construction lending itself is complex, and cannabis adds an additional layer of complexity. For example, cannabis facilities require unique heating and cooling units to regulate the temperature effectively to create the optimal grow environment. These units may require the building's roof to be reinforced and must be installed correctly to prevent mold. Our in-house construction manager and team of construction professionals make sure that the borrower and its contractors understand these nuances. As a secured lender, we want to make sure the collateral securing our loan is built to the best possible standards by builders with requisite size and experience. As of August 1, about 70% of our loans at face value are construction loans. Construction loans are drawn over time. And with each draw, we must make sure we have all needed lien releases. We must make sure our borrowers remain in material compliance with state and local ordinances and build in line with construction plans. Construction loans are relatively new to the cannabis industry. In fact, prior to AFC Gamma, sale leasebacks were a major source of external financing available to cannabis companies. Under a sale leaseback, a cannabis company would sell its property and take a long-term lease, one with annual rent escalations. Locking into such long-term and potentially expensive obligations is no longer necessary. The potential for legislation such as the SAFE Act, along with more flexible financing options, encourages borrowers to own their real estate and to take loans they could refinance in 3 to 5 years. And if borrowers expect that financing costs will decrease over time, then a loan, such as those provided by AFC Gamma, would provide more flexibility over the near and long term. Now let me turn the call over to Robyn.

Thank you, Jon. As a relationship lender, we strive to help operators build their businesses and succeed while acting as a flexible partner to help sell capital needs along the way. Incumbency has proven to give us an important edge when sourcing potential deals, as we've expanded loans with a variety of our existing borrowers as they continue to grow both organically and via acquisitions. For example, when one of our borrowers decided to purchase a dispensary rather than lease it, we were able to provide a simple amendment to increase the size of the loan to provide them with the capital they needed to execute on their business plans. Once we complete a loan, we have all of the documentation in place to grow with that borrower. In addition to our construction expertise that Jon mentioned, another key differentiator is AFC Gamma's available capital and the ability of its external manager to act as agent. This allows our borrowers to deal with 1 lender when changes or amendments need to be completed versus going to a larger syndicate of lenders. AFC Gamma seeks to hold a majority of a borrower's debt tranche and its external manager's ability to act as lead agent is another differentiating factor that provides our borrowers with flexibility and ease of execution. As of August 1, 2021, AFC management agented about 76% of our loans at face value. From January 2020 through June 30, 2021, we have sourced over $6.7 billion of transactions, which represents over 344 deals. We have built strong relationships with our borrowers, and we believe our reputation in the industry for being a trusted lender continues to grow. I will now turn it over to Tom to talk about the financials.

Thank you, Robyn. We ended the second fiscal quarter of 2021 with total assets of $278.5 million as compared to $221.5 million at March 31, 2021. Portfolio investments totaled $164 million of principal outstanding with a carrying value of $153.3 million spread across 13 companies as of June 30, 2021. In July 2021, the company completed its secondary offering, which resulted in the issuance of 2,750,000 shares at $20.50 per share, with total net proceeds after fees and expenses of $52.6 million. In July 2021, the underwriters partially exercised their over-allotment option to purchase an additional 269,650 shares at $20.50 per share with $5.2 million in net proceeds to the company after fees and expenses. Currently, AFC Gamma has 16,386,527 shares outstanding. At the end of the June quarter, book value per share was $16.66 as compared to $16.18 and $14.83 for the quarters ended March 2021 and December 2020, respectively. As of June 30, 2021, AFC Gamma's portfolio consisted of $187.7 million of transactions with $163.7 million funded. As of August 1, 2021, we've completed $195.3 million of transactions with $175.3 million of principal outstanding to 14 companies in 14 states. All of the loans in the portfolio are current and performing. The weighted average portfolio yield to maturity, which is measured for each loan for the life of the loan, is approximately 21% as of June 30, 2021, compared to 21% as of March 31, 2021. The weighted average yield to maturity of the portfolio as of August 1, 2021, was also approximately 21%, which is consistent with the last 2 quarters ended March and June of 2021. For the quarter ended June 30, 2021, we had GAAP net income of $4.6 million or earnings of $0.34 per basic weighted average common share. For the 3 months ended June 30, 2021, we generated total investment income of $8.7 million and distributable earnings of $5.8 million or $0.43 per basic weighted average common share. Distributable earnings represents the net income computed in accordance with GAAP, excluding noncash items such as noncash equity compensation expense, any unrealized gains or losses, provision for current expected credit losses, commonly referred to as CECL, or other noncash items recorded in net income for the period. CECL is early adopted by the company in fiscal year 2020. As of June 30, 2021, the CECL reserve represents approximately 1.1% of loans at carrying value compared to approximately 1.3% at March 31, 2021. Adjustments to arrive at distributable earnings of $0.43 per basic weighted average common share of common stock amounted to $0.09 per basic weighted average common share in aggregate and included both the impact of noncash adjustments to the CECL reserve and change in unrealized gains. We believe providing distributable earnings is helpful to stockholders in assessing the overall performance of our business. As a REIT, we are required to distribute at least 90% of our annual REIT taxable income. We believe that dividends are generally one of the principal reasons that stockholders invest in our common stock, and we generally intend to pay dividends to our stockholders in an amount between 90% and 100% of our annual taxable income. On June 30, 2021, AFC Gamma paid a dividend of $0.38 per common share outstanding for the June quarter, which represented approximately 87% of distributable earnings for the quarter. The company has distributed $7.3 million of distributable earnings for the 6 months ended June 30, 2021, or approximately 80% of its distributable income. The Board of Directors intends to declare a dividend for the September quarter on or about September 15, which will have a record date of September 30 and be payable on October 15. It is anticipated that the quarterly dividend declared by the Board of Directors will be greater than or equal to the $0.38 dividend that was paid for the June quarter. In May 2021, the company amended its secured revolving credit loan agreement to, among other things, increase the loan commitment from $40 million to $50 million, decrease the interest rate from 8% to 6% per year and extend the maturity date up to December 31, 2021. Currently, no draws on the revolving credit facility have occurred during the fiscal year-to-date and no interest or fee expenses were incurred related to the revolving credit facility. The revolving credit facility is an important component to the company's business strategy to offer greater flexibility, manage liquidity and bridge its investment commitments through future capital raises, thereby potentially reducing the impact of cash drag on the returns to investors. I will now turn it back over to Len.

AFC Gamma has a best-in-class team, strong balance sheet and increased access to capital. Entering the second half of 2021, we are well positioned as a first mover and leader in the rapidly growing cannabis lending market. I will now turn it back over to the operator to start Q&A. Operator?

[Operator Instructions] We have the first question that comes from Gerald Pascarelli of Cowen.

Len, I think it's definitely encouraging that the notable pipeline increase that the company has seen from early June through current day doesn't include New York. But just sticking with the Northeast, can you just talk about how you view the potential white space opportunity, not only in New York but in states like Connecticut and Virginia and New Jersey that recently legalized for adult use that are presumably going to require notable capital expenditures to build out capacity over the medium to long term? Any color you could provide there would be helpful.

I think it's very exciting that a lot of people that have been sitting on their licenses, watching them appreciate in value are actually starting to take action in building those licenses and building to the benefit of the consumers in that state. And the states are all waking up to the fact that they issue these licenses for a purpose, right, to have these cultivation and dispensaries built. And states like Missouri and others, we're watching them pull licenses from people that haven't started building or not building according to plan. So that goes for New Jersey as well. But circling back to your question, there's a number of New Jersey licenses that just haven't built yet. And so what we're seeing is a huge demand for capital to start building out these licenses as per the agreements and why they got issued in the first place. And that is a large supply of the demand.

Got it. That's helpful. Just another one for me is just on the competitive landscape. As of today, you're the only cannabis mortgage REIT, trading on a major exchange. I guess, like, over the past few months in your conversations, what are your expectations for the evolution of the competitive landscape maybe over the back half of this year into early 2022 with more competition coming online to capitalize on these high yields?

Look, I think, from a public standpoint, and obviously, the public currency is really important, it's very hard for a new competitor to get in the scale. Every day that passes increases the moat around our position and our competitive position, at least from a public standpoint. I will say that there's plenty of competition to large multi-state operators. There are large private companies, large hedge funds and large institutions that are investing with the multistate operators' debt. And so it's really about there. It's about relationship, what we can deliver, helping them in their business plan, helping them as a partner even more than capital because there is plenty of capital at the very high end, where it seems like the new institutions or large institutions feel most comfortable.

We have the next question that comes from the line of Aaron Hecht of JMP Securities.

Great job putting capital to work this quarter. I had a question around that. The active pipeline, obviously, up pretty significantly about $300 million, give or take, quarter-to-quarter. The terms in that pipeline, the yield profile, is that changing much? And I guess that's -- part of that is going to be involved with the larger MSOs and kind of the exposure there. So any insight on the exposure to larger MSOs within that pipeline would be helpful.

So the pipeline itself has a mixture of the large MSOs, which are much safer and lower yielding; the mid-tier providers, which are a couple of states with operations that are looking to expand; and the single-state operators, which are starting to build a license. And so we back them. We have them put a certain amount of equity in. There are some seller notes or sometimes there's unsecured debt. And then we lend the senior debt, the first liens on the property. They all hold different yields, as we said before. As I -- as we look forward to the deals that we've done and the deals we've announced and we look at the quarters, we've held consistent with over 20% weighted average yield held to maturity. And by the way, when I say that, we all know that things aren't held to maturity. There's going to be velocity. Therefore, the yields are actually even higher if a deal pays off early. So when we say it's a 20% held [ year for ] maturity, that's actually -- I know that sounds very high. That's actually conservative. Having said that, it just depends on which deals we close and when we close them and how that weighted average yield changes. And I think you heard me say in the transcript that if we did sign a big multistate operator at lower yields and higher safety, we would just be -- our intention is to relever the return to increase the return on equity for the investors just by applying a better cost to our cost of leverage versus their cost of leverage and capturing a spread. And so it's hard to tell where weighted average yield goes, it depends on the mix, but we're very focused on the return on equity to our shareholders.

Great. Great. Makes sense. And then the deployment pace, obviously, very strong in the second quarter. If we look into the first month or so, the third quarter a little bit slower, but the commitments are up in total. Any insight you can give us on pace of deployment over the remainder of the year or how we should think about it? Is this going to be a chunky situation?