Advanced Flower Capital Inc. Q3 FY2023 Earnings Call

Good day and welcome to the AFC Gamma Q3 2023 Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. As a reminder this call is being recorded. I would now like to turn the call over to Gabriel Katz, Chief Legal Officer. You may begin.

Good morning and thank you all for joining AFC Gamma's earnings call for the quarter ended September 30, 2023. I'm joined this morning by Leonard Tannenbaum, our Chief Executive Officer; Brandon Hetzel, our Chief Financial Officer; and Robyn Tannenbaum our President. Before we begin, I would like to note that this call is being recorded. Replay information is included in our October 18, 2023 press release and is posted on the Investor Relations section of AFC Gamma's website at afcgamma.com, along with our third quarter 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 developments and financial performance in 2023 and beyond. These statements are subject to inherent uncertainties in predicting future results and conditions. Please refer to AFC Gamma's most recent periodic filings with the SEC for certain significant factors that could cause actual results to differ materially from these forward-looking statements and projections. During this call, we will also 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 AFC Gamma's earnings release and investor presentation available on AFC Gamma's website. The format for today's call is as follows. Len will provide introductory remarks and an overview of our third quarter 2023 performance and strategic commentary, Brandon will summarize our financial results and we will then open the line for Q&A. With that, I will now turn the call over to our Chief Executive Officer, Leonard Tannenbaum.

Thank you Gabe. Good morning and welcome to AFC Gamma's earnings call for the quarter ended September 30, 2023. I would like to thank everyone for joining us today to discuss our results. Before turning to the quarterly results, we are very excited, and I am personally excited to announce the appointment of Dan Neville, the new Chief Executive Officer of AFC Gamma effective this coming Monday. As Dan joins us in his new role, I will transition from Chairman of the Board and Chief Executive Officer to Executive Chairman of the Board and Chief Investment Officer. Dan joins us from Ascend Wellness Holdings, a leading multi-state vertically integrated cannabis operator where he's held various roles including Interim CEO and most recently as Chief Financial Officer. Dan joined Ascend as one of its first employees and he was instrumental in helping grow the company to an operator with seven states, over 2000 employees and more than $500 million in revenue. Dan's expertise in cannabis operations, M&A activity and deal structuring uniquely positions him to lead AFC Gamma as CEO. We have noticed that as a lending area has become increasingly important to have in-house operating expertise to contribute to the underwriting and portfolio management of cannabis credits. Therefore, Dan's operating and M&A expertise combined with my 25 years of direct lending experience position AFC Gamma to continue as a leading debt provider in the cannabis industry. We are very excited to have Dan join us as the team and I have worked closely with him on several matters when he was at Ascend. For example, we had the opportunity to witness Dan's expertise firsthand as he led Ascend's acquisition of certain assets of two of our portfolio companies. We've also been in frequent communication about the industry and investment opportunities with him over the years. We look forward to working with him to continue building AFC Gamma as we enter the next phase of the cannabis industry. The appointment of Dan as CEO reaffirms AFC Gamma's commitment to lending to the cannabis industry. As we have discussed on a quarterly basis over the last year, we are increasingly seeing cannabis 3.0 operators emerge and we are excited to deploy capital and expand AFC Gamma's platform as operators have a difficult time accessing the capital markets. I believe AFC Gamma is uniquely positioned to capitalize on the opportunity to provide capital to existing borrowers and new well-capitalized operators that are looking to build and/or expand by buying distressed assets or assets at a significant discount. Turning to the quarterly results. For the third quarter of 2023, AFC Gamma generated distributable earnings of $0.49 per basic weighted average share of common stock. As a reminder, distributable earnings is the primary metric that the Board considers when declaring AFC Gamma's quarterly dividend. The Board of Directors declared a $0.48 dividend per share in the September quarter. Since going public, we have generated distributable earnings that have met or exceeded our dividend each quarter and paid out $5.06 in dividends per share. In June of this year, management stated that we anticipated the $0.48 dividend represented a sustainable dividend level on the current portfolio for 2023, assuming no significant nonaccruals and without any additional investments. Despite our investment in private company G being put on nonaccrual for a period of time, we continue to believe that this is true for the remainder of 2023. Since mid-2022, given the volatility in the cannabis market, we have become increasingly selective on these new investments and maintained ample cash to capitalize on opportunities that may arise. We are excited about the new opportunities we are seeing, driven by an uptick in acquisition activity, both from existing operators buying distressed assets, as well as new investors coming into the market to purchase assets at significant discounts. The capital formation around these assets is promising and we are focused on well-capitalized operators in attractive states, such as Missouri, Georgia, Maryland, Arizona and Ohio to name a few. Following our thesis during the quarter, we funded a new cannabis investment to private company M of approximately $25 million into one of the newly formed well-capitalized operators that we believe will continue to consolidate valuable assets in key limited license states. We continue to have liquidity to make additional investments in operators in limited license states that we believe have strong risk-adjusted profiles. Additionally, we are pleased to see that the ballot initiative to introduce adult-use in Ohio passed yesterday, which we believe will be a large positive for operators in the state. AFC Gamma has exposure to Ohio through two of our larger credit facilities, including our $84 million commitment to a subsidiary of a public company and a $63 million commitment to private company L. We believe both operators should materially benefit from Ohio moving to a recreational model. As we are focused on active portfolio management, two borrowers have been placed into receivership to optimize operations and maximize value for the benefit of the creditors. One of the borrowers, private company A, has been actively liquidating certain assets and has so far paid down over $48 million in principal to AFC Gamma and syndicate partners, of which $27 million was received during the quarter, primarily from the sale of its Maryland and Arizona operations. As we have discussed during the last several quarters, a subsidiary of private company G, which we continue to closely monitor, continues to have cash flow challenges as it completes a valuable construction project in New Jersey. As we stated last quarter, we put a subsidiary of private company G on nonaccrual for the month of June. As we did not receive interest payments in July and August, the borrower remained on nonaccrual for those two months. To ensure the borrower has adequate working capital in New Jersey, we have modified interest payments for the remainder of the year. AFC Gamma has received its portion of the $800,000 in cash interest that was due for the month of September and the $1 million of cash interest that was due in the month of October and $1 million in cash interest is due in November and December. As it relates to this loan, we are currently not accruing any interest into income that's not been paid in cash. We continue to remain excited about the near-term prospects in New Jersey and look forward to the full optimization of their cultivation facility. As I previously discussed, we have recently focused on reducing payment-in-kind interest as a component of our income. During the first quarter of 2023, PIK or Payment-in-Kind as a percentage of income was 25%. Now for the quarter ended September 30, 2023, we have decreased that level to a much more normalized level of 10%. We are pleased about the significant decrease in PIK, which is mainly due to our active management. As we have said in past calls, we believe there are credible new cannabis operators entering the market that are well-capitalized to take advantage of the current market environment. We are also pleased to have Dan join us and look forward to introducing him to our analysts and investors in the coming months. I will now turn the call over to Brandon to review our financial results.

Thank you, Len. For the quarter ended September 30, 2023, we had GAAP net income of $8 million or earnings of $0.39 per basic weighted average common share and generated net interest income of $15.3 million and distributable earnings of $9.9 million or $0.49 per basic weighted average common share. As previously mentioned, we believe providing distributable earnings is helpful to shareholders in assessing the overall performance of AFC Gamma's business. Distributable earnings represents the net income computed in accordance with GAAP excluding non-cash items such as stock compensation expense and the unrealized gains or losses, provision for current expected credit losses also known as CECL, taxable REIT subsidiary income or loss net of dividends and other non-cash items recorded in net income or loss for the period. We ended the third quarter of 2023 with $397.8 million of principal outstanding spread across 12 borrowers. Subsequent to September 30, 2023, we received select principal prepayments of debt relating to private company A of $1.7 million. As of November 30, 2023, AFC Gamma had $395.1 million of principal outstanding across 12 borrowers. As of September 30, 2023, the CECL reserve represents approximately 4.7% of our loans at carrying value consistent with 4.7% as of June 30, 2023. The weighted average portfolio yield to maturity, which is measured for each loan over the life of such loan was approximately 19% as of September 30, 2023, and November 30, 2023. Next, let's take a look at our balance sheet which remains strong. As of September 30, 2023, we had total assets of $445.1 million in cash and cash equivalents of $73.2 million. Additionally, we had zero drawn on our line of credit, which provides us up to $60 million in available funds that can be drawn as needed. Currently, the majority of our cash is earning interest of approximately 4.5% to 5.4%. As of September 30, 2023, our total shareholder equity was $338.8 million and our book value per share was $16.56. On October 30, 2023, AFC Gamma paid a dividend of $0.48 per common share for the third quarter to shareholders of record as of September 30, 2023. Year-to-date, we have paid out dividends of approximately 99% of our distributable earnings. As a reminder, on an annual basis, our dividend policy is to pay between 85% and 100% of distributable earnings over the year. With that I will now turn it back over to the operator to start the Q&A.

Our first question comes from Michael Elias with TD Cowen. Your line is open.

Great. Thanks for taking the question. A few if I may. First, could you provide a bit of color on why now was the time to make the CEO change? And perhaps as part of that how we should think about the strategy moving forward, particularly as it relates to commercial real estate?

Okay. Let's start with the CEO change. I'm really pleased to welcome Dan. When Rob and I found ourselves overwhelmed with portfolio management, as we've discussed before, I feel optimistic about how things are progressing for the company. I’m happy we have turned a corner. However, I realized after 20 years in direct lending how time-consuming portfolio management can be, and it is indeed a significant effort. Dan is an absolute expert in that area. We asked ourselves who we wanted in this industry—excluding the founders, who are excellent but unavailable—and the only name that came to mind was Dan. I was thrilled when he expressed interest in joining us. He has already added value by engaging with our sponsors and deal partners. We assist many of our sponsors in monetizing their non-core or even core assets to reduce debt and streamline their portfolio. Dan is truly an expert in this area, and while I possess some of those skills, he excels far beyond me. It’s a relief to fill this role with someone of his caliber. I'm still serving as Executive Chairman and Chief Investment Officer, and it’s gratifying to have such a strong replacement. Regarding your second question, we have not yet completed our real estate transactions; the option for the company to allocate up to 35% of our assets to real estate remains open. We have significant undrawn capital and liquidity, and thanks to our effective portfolio management, we are recovering more capital. Moving forward, we are optimistic about activating both our cannabis initiatives, as we've already closed one deal, and our real estate efforts. We have the company working efficiently to deploy resources across the board.

I understand. Following up on that, I've observed that the cannabis pipeline has seen a significant increase while the commercial real estate pipeline has decreased. Could you provide insights into the dynamics and changes in the commercial real estate market that you've encountered and how AFC Gamma's perceived market opportunity in that sector has progressed?

Hi. This is Robyn. So on the cannabis side, I think we have reinvigorated our origination effort as we've seen more 3.0 players as Len discussed enter the market. And there's been an uptick in acquisition activity by those players which is why you've seen the cannabis pipeline increase. On the commercial real estate side, I think that how we're positioning AFC Gamma is more of a syndicate partner on that side, where we're not necessarily going to be leading transactions, but we do see opportunities in the commercial real estate sector where we can leverage other's expertise to be a co-lender in those situations. So that's why you've seen that pipeline decrease a little bit and I think that's where you're getting the balance this quarter.

Got it. And last question for me is, could you just give us a sense of what to expect at your Analyst Day in December? And as part of that, is there an expectation for like a long-term financial outlook? Any color there in terms of setting expectations would be helpful. Thank you.

Come on you have to have a surprise otherwise it's no fun. I'm previewing it a little bit with my board who were meeting over the next two days and introducing the Board to Dan. I think that has to happen first. And let Dan get his feet wet, and I think you should expect Dan to present for Analyst Day and therefore all of our investors his vision in terms of the cannabis industry, where we see opportunities and how we're going to approach it differently. And I think that's pretty exciting.

Awesome. Thanks for the color.

Thank you. Our next question comes from John Hecht with Jefferies. Your line is open.

Good morning. Thank you for taking my question. You mentioned the recent election in Ohio, but I'm curious if there are any federal regulations or changes in other states that might open up a market or create new opportunities for your company.

There are three key states that everyone is paying attention to: Ohio, Pennsylvania, and Florida. Regarding the lawsuits in Florida that are either ongoing or just concluded, it's important to monitor how they develop, particularly with the governor's challenge. Personally, I have a feeling that Florida might not be straightforward, but it’s hard to say for sure. The governor seems quite opposed, and he is contesting four different phrasing options. If just one of those options fails, the whole effort might not succeed based on my understanding. We’ll have to wait and see what happens, likely in the coming days. As for Ohio, I was optimistic it would pass with over 60%, but it ended up passing with around 57%. The state senate might oppose this, and there are serious concerns about it being revisited next year during the election cycle, which is not preferable for the Republicans. I hope they respect the will of the people who voted 57% in favor. I could be wrong, but it seems the cannabis initiative passed with an even slightly higher approval rate than the abortion measure that was on the ballot, which I view as a positive indicator for the cannabis sector in Ohio, benefiting many operators, including several of our clients. Lastly, with Pennsylvania, even if legislation gets passed, the implementation process is lengthy. This is a state where liquor sales happen exclusively through state-run stores, highlighting the distinct regulatory environment.

Okay, that's helpful. The second question is that things have changed a little bit regarding your underwriting for survivors or consolidators in the cannabis sector. It seems like you are focusing on commercial real estate opportunities. How have you altered the underwriting and investment approval process given that the scope has changed?

We have enhanced our investment approval process, and I continue to serve as Chief Investment Officer. Our committee now includes four members, and we have recently welcomed a highly skilled individual, Bernie Berman, which was a necessary addition. Currently, we have two entities in receivership. Bernie brings significant expertise in this area, and we are pleased to have him on board. Additionally, Dan will join the Investment Committee on Monday, further expanding our skill set to thoughtfully consider various opportunities. From a broader perspective, new players in the market are acquiring assets at substantially reduced prices, often around $0.50 on the dollar. Cannabis companies have invested heavily in building facilities and dispensaries, often exceeding budgets and facing delays in permitting and construction. Those without sale leasebacks, which have escalated to around 15% in some instances, and those burdened by excessive debt, particularly with high interest costs even among the largest multistate operators, face significant challenges. This situation provides a competitive edge to well-capitalized new companies. We are confident that these firms possess not only a financial advantage but are also led by capable operators with valuable experience in the industry, and we are eager to support their growth.

Great. Thanks very much.

Thank you. Our next question comes from Mark Smith with Lake Street. Your line is open.

Hi, guys. Len you just gave us a good update on some of the new states and things that you're watching. Can you just give us a quick update on states where you are today any that maybe you're seeing some signs of improvement or any that maybe haven't bottomed yet and have moved down lower?

I believe all states have reached their bottom, although they are still at very low levels, particularly in California, Oregon, Washington, Colorado, and much of Michigan. In states with unlimited licenses, the price per pound has fallen below the marginal production cost, significantly impacting non-vertically integrated operators. This creates a situation where, if the market price is below production costs, operators may just want to procure products for their dispensaries to maintain some margin. Arizona is a notable example of this, and we've certainly seen it in Michigan as well. On the other hand, we do have high-end brands or well-regarded brands, like the one we support in Michigan, which despite facing challenges, continues to pay interest in cash and generate strong cash flow in a tough environment. This is due to its solid reputation. There are areas of potential success even within unlimited license states. We feel positive about how our one investment is performing. Additionally, we have operators like our credit partner in Pennsylvania, which generates substantial cash flow, allowing for significant loan paydowns almost by half each quarter.

A little less than half, yes.

Yes. We expect to be fully repaid on that loan unless we can persuade them to consider a dividend recap or another option by next year because they are doing exceptionally well and generating substantial cash flow. This loan includes an exit fee that we anticipate receiving upon full repayment. Therefore, we expect to benefit next year from that. It's important to note that not all loans are inherently bad or good. Oregon is one state that poses challenges, but this situation is more about company-specific operations and their market positioning.

Perfect. And then last question for me. Any updated thoughts as you look at the portfolio and where you want to be in fixed versus variable rates?

I believe it's no longer a significant issue. I have previously managed portfolios, including a $5 billion asset manager that I sold to Oaktree. It's beneficial to be in variable rates when rates are increasing and in fixed rates when they are decreasing. Currently, I don't think focusing more on variable rates is essential. Personally, I would prefer to have a mix of fixed and floating rates at this time. In my view, the Federal Reserve has likely halted interest rate increases or is very close to doing so. I also expect the inverted yield curve to normalize next year. Therefore, it seems like a good time to prioritize fixed rates over floating rates. While we've successfully benefited from having more floating rate exposure, if I were to originate a new loan today, I would choose a fixed rate.

Great. Thank you.

Thank you. There are no further questions at this time. I'd like to turn the call back over to Len Tannenbaum for closing remarks.

Thank you all for attending. As was mentioned on the call, we look forward as Dan takes over the CEO slot to provide you more information about his vision and our new very strong push into cannabis. So thanks very much.

Thank you for your participation. This does conclude the program and you may now disconnect. Everyone have a great day.