Advanced Flower Capital Inc. Q3 FY2021 Earnings Call

Good morning. My name is Kree, and I will be your conference operator today. At this time, I'd like to welcome everyone to the AFC Gamma Q3 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. Thank you. I would now like to turn the conference over to your speaker. You may now begin.

Thank you, Kree. Good morning and thank you for joining the call. I am joined this morning by Leonard Tannenbaum, Chief Executive Officer; Jonathan Kalikow, Head of Real Estate; Robyn Tannenbaum, Head of Origination; and Brett Kaufman, our Chief Financial Officer. Before we begin, I would like to note that this call is being recorded. Replay information is included in our October 13, 2021 press release and is posted on the Investor Relations section of AFC Gamma’s website, along with our third 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 and financial performance. These statements are subject to the inherent uncertainties in predicting future results and conditions, and certain factors could cause 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 these statements. 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 third results and strategic commentary; Jon will discuss the real estate lending environment; Robyn will discuss the origination pipeline; and Brett will summarize our financials. We will then open the line for Q&A. With that, I now turn the call over to our Chief Executive Officer, Leonard Tannenbaum.

Thank you, Gabe, and good morning and welcome to AFC Gamma's third quarter earnings call. For those who are joining us for the first time, AFC Gamma is a leading institutional lender to the cannabis industry. We issue loans that are typically secured by three pillars: cash flow, licenses, and real estate. The companies we lend to are domestic single and multi-state cannabis operators, which include those that are privately held, as well as those listed on the Canadian exchanges. Before we dive into our quarterly results, I'd like to highlight what makes AFC Gamma unique. AFC Gamma combines my expertise in cash flow lending, having run a $5 billion credit-focused asset manager; John's real estate expertise, having run a real estate finance development company with billions of dollars in real estate transactions; and Robin's healthcare investment banking background. The investment committee's expertise combined with the experienced team that we are continuing to build helps differentiate AFC Gamma from other lenders in this market. Over the last quarter, we have further built out our in-house capabilities to continue providing our borrowers with customized financing solutions. One key area that we continue to build out is our in-house construction expertise led by Martin Bickslow III. As John will describe in further detail, we believe our ability to consult on construction projects is unique and valuable, and we have financed our borrowers in building many construction projects. Additionally, as we announced last quarter, we are pleased that Brett Kaufman has joined us as AFC Gamma's Chief Financial Officer. Brett's expertise and leadership have strengthened the executive team and we look forward to him continuing to meet with our investors and analysts. Turning now to our capital structure. A third important differentiator for AFC Gamma is our cost of capital as the first NASDAQ listed lender in the industry. This allows us to access both public and private debt and equity markets. As discussed last quarter, we are striving to establish an industry-leading benchmark for our cost of capital. Subsequent to the quarter end, we are pleased to have received an increase in our credit rating from Egan-Jones moving to a BBB+ investment grade rating. Leveraging our investment grade rating, we closed on an offering of $100 million of unsecured notes due in 2027, led by Seaport Global Securities, which Brett will describe in further detail. We are further encouraged by the fact that the debt raise we completed had strong institutional support. Going forward, we expect to utilize a mix of debt and equity to fund our growth with a target of 0.5 times debt-to-equity. Typically, our lower yielding assets in our portfolio are comprised of larger, more diversified operators. Conceptually, we believe that using leverage against these types of assets in the portfolio is a good way to generate strong returns on equity for our shareholders. With this debt offering as our first step, we continue to remain focused on developing the best cost of capital among the limited number of alternative lenders in the industry. I believe that we have all the necessary components in place to scale this business and serve this rapidly growing industry. As we continue to scale the business, we will aim to improve our cost of capital. Separately, our actionable pipeline continues to remain strong. As we have previously discussed, deals typically take between three and nine months to close, which makes it difficult to predict the timing of closings. In structuring our investments, we lend at different rates to the top MSOs, the midsize operators, and the smallest single-state operators. Due to the size and scale of the top MSOs, we continue to see those operators borrowing at lower yields. Now turning to our quarterly results. During the third quarter, we continued to execute on our pipeline, leading to record originations. We closed on new commitments of $119.2 million and had net fundings of $79.3 million as of November 1, 2021. We have 14 borrowers that have operations in 14 states, which Robin will discuss later during the call. The closing of active deals in our pipeline resulted in distributable earnings of $0.44 per basic weighted average share. This increase in earnings drove a 13.2% increase in our quarterly dividends, moving from $0.38 per share in the second quarter to $0.43 per share in the third quarter. 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. Before turning the call over to Jon, I'd like to highlight a notable transaction that we recently closed. Subsequent to the quarter end, AFC Gamma funded $50 million as part of a new $120 million tranche of Verano Holdings Corp’s credit facility. We are pleased to expand our relationship with Verano and believe the company is a top-tier credit, given a strong brand reputation, real estate ownership, business execution, and experienced management team. With that, I'll turn the call over to Jon.

Thank you, Len. Today, we wanted to highlight one of our core competencies and key differentiating factors as a lender focused on the cannabis industry. That is our ability to finance construction projects. Because the legal cannabis industry is still in its infancy, we believe construction financing will be a dominant part of our cannabis cultivation, production, and dispensary lending program. Most banks and lenders shun such financing, given their lack of requisite know-how and the expertise and experience that our team has. Lending to cannabis operators adds an additional layer of complexity. Besides zoning, permitting, and environmental factors, cannabis cultivation facilities require specialized heating, cooling, ventilation, backup power generation, and enhanced lighting to create an optimal growth environment. Many jurisdictions have ordinances requiring fire suppression, life safety, and security measures, well in excess of those required on other types of real estate. This is where our in-house construction expertise becomes a vital component of our strategy. We know firsthand the issues that often arise and how to mitigate them, information we are happy to share with our borrowers. Construction loans have drawn over time, and with each draw, we ensure we have all the needed lien releases, that the building aligns with construction documents, and that construction remains in compliance with state and local ordinances. We also ensure that the borrower stays on budget and on schedule. Of course, we have a vested interest in the quality of our collateral underpinning our loans. Now, let me turn the call over to Robyn.

Thank you, Jon. As of November 1, 2021, AFC management acted as agent for about 76% of our current commitments. From January 2020 through November 1, 2021, we have sourced approximately $9.4 billion of transactions, which represents over 400 deals. We continue to expand our lending platform and our reputation as a trusted vendor in the industry continues to grow. 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 one lender when changes or amendments need to be completed versus going to a large 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. We see ourselves as a relationship lender, financing cannabis operators to build successful businesses. Our origination platform is focused on both expanding loans with a variety of our existing borrowers and continually sourcing new borrowers. When sourcing deals, incumbency has proven to give us an important edge. In the third quarter, we expanded upon our initial loans to two borrowers, Nature’s Medicines and Justice Cannabis Company. In addition, during the fourth quarter, we expanded upon our initial loan to Verano, providing the company with another $50 million of debt. I will now turn the call over to Brett to talk about our financial results.

Hello, everyone. I'm very happy to be participating in my first AFC Gamma earnings call and look forward to speaking with many of you soon. For those of you who have not met me, I have over 25 years of capital markets experience within global organizations overseeing accounting and finance. Prior to coming on board with AFC Gamma, I served as CFO at Ladenburg Thalmann Financial Services for 12 years. Prior to that, I spent nine years at Bear Stearns, serving in various roles of increasing responsibility, including Managing Director and Director of Financial Planning and Analysis. For the quarter ended September 30th, 2021, we had GAAP net income of $7.9 million or earnings of $0.48 per basic weighted average common share. For the three months ended September 30th, 2021, we generated total interest income of $10.6 million and distributable earnings of $7.2 million or $0.44 per basic weighted average common share. We believe providing distributable earnings is helpful to stockholders in assessing the overall performance of our business. Distributable earnings represents the net income computed in accordance with GAAP, excluding non-cash items such as equity compensation expense, any unrealized gains or losses, provision for current expected credit losses, also known as CECL, or other non-cash items recorded in net income or loss for the period. CECL was early adopted by AFC Gamma in its 2020 fiscal year. As of September 30th, 2021, the CECL reserve represents approximately 1.18% of our loans at carrying value compared to approximately 1.09% at June 30th, 2021. 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. On October 15th, 2021, AFC Gamma paid a dividend of $0.43 per common share outstanding for the September quarter, which represented an increase of 13.2% from the prior quarter. The company has distributed $14.4 million of distributable earnings for the nine months ended September 30th, 2021 or approximately 89% of its distributable income. At the end of the third quarter, our total stockholders' equity was $274.5 million and our book value per share was $16.69 as compared to $14.83 as of December 31st, 2020. The increase in our book value per share as of September 30th, 2021 compared to December 31st, 2020 was primarily attributable to our IPO and follow-on equity offering in the first and second quarters of 2021 respectively, each of which was accretive to our book value. As Len mentioned, we recently hit another milestone as a public company. On November 3rd, 2021, we closed on a $100 million aggregate principal amount of senior unsecured notes. This was a private offering available to qualified institutional buyers. The notes have a fixed cash interest rate of 5.75% and do not mature until 2027. In connection with the closing of our senior notes offering and subsequent to quarter-end, we executed a second amendment to our revolving credit facility. The amendment increases the revolving credit commitment from $50 million to $75 million, lowers our interest rate from 6% to 4.75% per annum and extends the maturity date of our revolving facility from December 31st, 2021 to September 30th, 2022. The second amendment also requires that all payments of interest and fees will be paid directly or indirectly to support charitable organizations. For the three and nine months ended September 30th, 2021 and through November 3rd, 2021, the company has not drawn on the revolving credit facility or incurred any interest expense related to the revolving credit facility. Turning to our portfolio, we ended the third quarter of 2021 with total assets of $303.9 million, as compared to $278.5 million at June 30th, 2021. Portfolio investments totaled $244.1 million of principal outstanding spread across 15 companies as of September 30th, 2021. As of the end of the third quarter, AFC Gamma's portfolio consisted of $296.9 million of current commitments with $243 million funded. Following quarter end, we closed an additional $50 million of new commitments; we sold a $5 million loan and also funded $52.3 million of new and existing commitments. As of November 1st, 2021 we have $341.9 million of current commitments with $292.4 million of principal outstanding across 14 companies. All of our loans in the portfolio are current and performing. The weighted average portfolio yield to maturity, which is measured for each loan over the life of such loan, was approximately 21% as of September 30th, 2021, compared to the weighted average yield to maturity of the portfolio of approximately 20% as of November 1st, 2021. With that, we will now open the call to questions.

I would now like to turn the call over to the operator to start the Q&A.

Hi, good morning. Thank you for taking the questions. In the third quarter, you clearly had a lot of momentum toward the end of the quarter, starting on Labor Day with several deal announcements. This momentum has continued into the fourth quarter with a $50 million announcement from Verano. You've mentioned seasonality in the lending business before; could you provide an update on what you're seeing in the market and whether you anticipate this level of momentum to persist throughout the fourth quarter? Any insights you could share would be appreciated. Thank you.

Thanks, Gerald, for the question. There certainly is and always has been strong demand in the fourth quarter. I've operated in this middle market industry for over a decade. The fourth quarter is usually the strongest, as people want to get things done before year end, and it sometimes materializes quickly. However, remember that in cannabis, there is a three to nine-month cycle; I can imagine that some of the things in the fourth quarter could slip into January and the first quarter. To accurately estimate where we are is really difficult, only because deals take a long time to complete. There’s a lot of diligence involved, including environmental assessments and quality of earnings before we can make loans. That said, we do anticipate the fourth quarter to be the strongest, but whether it’s solely the fourth quarter or if we include January into February, I can't tell.

Got it. That makes total sense. Just in terms of your outlook for next year. I know you haven't guided for anything, but you do have a target, which I believe is 700 in gross originations. It seems like the top credits started with Verano at 8.5, and I know that's the headline rate. But then the day after Verano we saw Jushi raise a 100 at 9.5, which is probably lower than the rate would have been a couple of months prior. And so, as you think about building out your loan portfolio, can you just talk about the ideal mix and how you think about the relative spreads for the top credits amid a yield-compressing environment? Given the numbers you've shared, it seems like your own cost of capital is also coming down. So, just some color on the spread would be helpful.

Look, I do think that larger MSOs are borrowing between 10% and 12%, inclusive of fees and other costs that you may not see in a headline rate. Many funds and hedge funds that have participated are filled up, and we're seeing syndicated transactions being weaker than expected, leading us to believe that yields are leveling off around that 10% to 12% total internal rate of return. Keep in mind, when discussing yields, we refer to yields to maturity, but it's very rare for something ever to be held to maturity. It's almost always repaid quicker. Additionally, our effective yields are usually higher because we're able to maintain around a 20% yield to maturity on the current portfolio despite accommodating companies like Verano. So, I think we’re maintaining those types of yield to maturities. I anticipate a mix of larger MSOs and smaller mid-sized operators next year, potentially at a 50-50 ratio, though that is a rough projection.

Super helpful color. Thanks very much, Len.

Yes. Thanks for taking my questions. In terms of the Verano credit facility, $50 million commitment, is there a percentage of that that you believe goes out the door immediately? Is it a longer-term draw-down? Any thoughts around the timeframe that commitments go out the door?

In this case, all $50 million is funded. You're right, sometimes we do part-funding and part-commitment, in which case we charge an unused fee on the balance until it's drawn. We have one-year drop periods, typically, sometimes a little longer. But in the case of Verano, they had immediate use for the capital and we funded all $50 million.

Roger that. And then I know you talked about a 50-50 split, possibly next year with larger MSOs and smaller operators. Any thoughts on more near-term, maybe fourth-quarter pipeline? If we were going to have a mix, I understand there could be variability in how much money goes out the door, but any thoughts about near-term versus next year, large MSOs versus smaller operators?

I think yields will continue to be lumpy when things close, but we will see a mix in the fourth quarter and likely all next year, between the larger operators, more established with diversified operations, and the smaller operators that are ramping cash flows and construction. So, you'll see a mix in the fourth quarter and throughout next year.

Right. And then lastly, regarding the amended credit facility for some five great rates. Any details on the other fees that we need to consider? Maybe undrawn fees?

So remember, I'm still writing this credit facility, and I'm directing all the proceeds net of taxes to charity, specifically benefiting children in our operational states. We plan to support the AFC Foundation. The cost of this is generally modest, about 25 basis points upfront, and another 25 basis points for unused funds in some cases. There are other fees and legal costs associated, which are significant, but the total added cost per year is likely around $100,000.

Thank you for taking my question. Two quick ones. I wanted to chat on how you view the balance of debt and equity and where you see your optimal leverage going over the next quarters?

Thank you for asking the question because I wanted to clarify a bit. I mentioned that our target is a 0.5 times leverage, which I mean to achieve by the end of next year. This will be a stair-step approach. We're monitoring the interest and continuing to talk to institutions about our debt now that we have a $100 million tranche. We're also looking at equity issuance to balance that. We aim to reach that 0.5 times debt-to-equity ratio by the end of next year.

Okay, thank you. And the last question I have is just around the competitive space. Your competitors are coming up. Anything on the regulatory side around the SAFE Act as well?

I think there are a number of competitors trying to enter the space, but none that match the institutional experience and relationships we have built. Our team has extensive knowledge in both middle-market lending and real estate expertise. While we can differentiate ourselves, if larger firms like Apollo, Oaktree, or others decide to enter our space, it could become a more significant challenge for us. However, our expertise and data we have gathered put us in a solid position in the 14-16 states we operate in.

At this time, there are no questions. I would like to return the call back over to management for closing remarks.

Thank you all for listening. We look forward to reporting our year-end results next year.

This concludes today’s conference call. You may now disconnect.