Earnings Call Transcript - AFCG Q1 2021

Operator, Operator

Welcome to the AFC Gamma Q1 2021 Earnings Conference Call. I would now like to hand the conference over to your speaker today, Francesca Smith. Thank you. Please go ahead.

Leonard Tannenbaum, CEO

Thank you, Francesca, and welcome to AFC Gamma's first quarter earnings conference call. I would like to thank our current shareholders, prospective shareholders, and analysts for joining us today. We are excited to have gone public on NASDAQ as the first U.S.-listed cannabis lender on March 19, 2021. With the IPO process behind us, our team is focused on continuing to build a leading institutional cannabis lending platform. Today, I want to provide an overview of AFC Gamma and the many opportunities that we have in front of us. First, let me share who we are and what we do. AFC Gamma is an institutional provider of loans to the cannabis industry, structured as a real estate investment trust. The loans that we make are typically secured by three 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. Since the IPO, we have completed several deals and expanded into a number of new states, including Texas, Missouri, and New Jersey. Just some highlights on those three states: We are really excited about Texas as there are currently only three licenses in the state, and given its potential market size, we believe it's going to be one of the largest revenue-generating states. Missouri is a really interesting state given patient growth, but also the fact that the residency requirement makes it difficult for multistate operators to enter, which should provide our borrowers an opportunity to make outsized returns. And New Jersey, which recently legalized adult-use cannabis, we believe will also see significant growth and require almost $1 billion in build-out. Our robust pipeline of potential borrowers includes many operators expanding into new states. We believe that a company loan is preferred over a sale-leaseback, though we do see both sources of financing being successful given the extremely high demand for capital in the current environment. Turning to the industry, the cannabis market continues to rapidly evolve and grow. I've heard it likened to dog years; one year in cannabis is equal to seven. We continue to be excited about massive opportunities ahead as more states legalize both medicinal and/or adult-use cannabis. This dynamic is causing an increased demand for capital to quickly scale, meet their license requirements, and build a presence in that given state. For instance, when New Jersey legalized late last year, we estimated the amount of capital needed to build that state is close to $1 billion. And with its bordering state in New York recently legalizing adult use, we believe that capital buildout could reach $3 billion to $5 billion, which supports the forecast for New York for 2025 cannabis revenue of over $5 billion. We closely monitor the industry and have also watched the recent M&A boom with many large public multistate operators using a combination of equity, debt, and cash as currencies to acquire smaller single-state operators. We believe we are in a one- to two-year period of consolidation where the big operators will continue to get bigger. We remain focused on lending to operators in limited license markets as we believe the licenses in those states have additional value as a form of security. Additionally, our business contains many barriers to entry, including licensing approval by various state regulatory agencies in states such as New Jersey, Ohio, Arizona, and Missouri. Our goal is to be the lender of choice to half of the top 15 multistate operators as well as companies that are seeking to achieve scale or seek to be acquired by a multistate operator. We lend at different rates to the top MSOs, the midsized operators, and the smaller single-state operators. We maintain a high degree of selectivity and a stringent lending criteria backed by our three pillars: cash flows, licenses, and real estate. Turning to our capital structure, we are pleased to be a NASDAQ-listed company and have already found that the visibility into our capital structure is a competitive differentiator. Many borrowers have found that one of the challenges in the industry is finding lenders that can commit to the full amount of capital without having to raise it from a third party. The IPO has helped us compete for and win deals as our available capital and hold size has greatly expanded. As we continue to source and evaluate new transactions, we have grown our team and continue to build out our corporate infrastructure. And as I mentioned, our pipeline remains robust. Since January of 2020, we have viewed over $5 billion in transactions, and we currently have an actionable pipeline of over $500 million. As a reminder, the actionable pipeline could take between three and nine months to close upon a transaction, and many of the deals that we complete are high touch in nature and require significant due diligence and potentially regulatory approval, making it difficult to predict the exact timing of closes. We are pleased that our Board of Directors has declared a quarterly dividend of $0.38 per share for the June quarter. We intend to pay regular quarterly dividends that are covered by our distributable earnings. Additionally, our dividend policy is to pay 90% to 100% of distributable earnings over the year, with a special dividend at the end of the year if necessary, paid in January of the following year. Lastly, as a newly listed company, we plan on having a higher level of communication regarding our progress and outlook this year. I will now turn it over to our partner, Jon.

Jonathan Kalikow, Head of Real Estate

Thanks, Len. As Len mentioned, cannabis is currently regulated at the state level. Each state that has legalized cannabis has decided whether to allow recreational or medicinal use. Each of these states has also decided how many cultivation and dispensary licenses it would offer. AFC Gamma focuses on states that have a limited number of licenses, such as Florida and Arizona, and tends to avoid states like California, Oregon, and Washington with fewer controls on the number of cannabis licenses available. Since we are structured as a mortgage REIT, we have a lean on the commercial real estate underpinning the loans we're originating. Our real estate-centric approach to lending is critical to generating attractive risk-adjusted returns in this industry. However, real estate is only one aspect of the collateral package, the other components being the equipment, the license, and the company's operations. Before we make a loan, we perform rigorous diligence on borrowers and on the real estate to ensure there are no material issues. We wish to minimize risks that could diminish the borrowers' collateral value should the worst-case scenario result in a borrower defaulting on our loan. It is incumbent upon our team to ensure that each aspect of the property is addressed prior to the origination of the loan. Proper permitting, environmental issues, and zoning must all be vetted ahead of time. At AFC Gamma, when we couple the real estate with licenses and equipment, if a borrower gets into trouble and defaults with no option but to transfer title, we can offer and deliver a higher value collateral package to a buyer versus one where only the value of the property was considered. Now let me turn the call over to Robyn who will speak about the origination process.

Robyn Tannenbaum, Head of Origination

Thank you, Jon. The job of the origination team is to be in the center of the industry and see all deals in the market to understand the lending environment, overall market opportunity, and state-by-state dynamics. We have more than 90 third-party relationships that we source deals from. We do both direct outreach to companies and third parties, and we also receive inbound interest based on our track record, borrower relationships, and deals that we have completed. We have found that incumbency also gives us an important edge when sourcing potential deals as our borrowers continue to grow both organically and via acquisitions. We believe that we are in the center of the cannabis ecosystem with deep relationships with many of the companies. As a relationship lender, we strive to help great entrepreneurs build their businesses and succeed. We are also proud that two of our portfolio companies and one in our actionable pipeline are led by female CEOs. As Len mentioned, from January 2020 through April 30, 2021, we have sourced over $5 billion of transactions, which represents over 285 deals. So how do we structure the loans? It starts with our over $5 billion of loans that we've looked at and narrows those down to over $500 million of an actionable pipeline. As Jon outlined, it's an arduous process. We filter to get to the states we want to loan in, then we closely examine each target company's profile, including cash flow, reputation, real estate coverage, license value, and competitive positioning within the state. In these initial quarters ahead, our deal flow will be an important gauge to monitor performance. We plan to announce each deal we close to provide greater transparency and measure our progress to the investment community when we are a lead agent. In summary, we are proud of the strong reputation AFC has already built in the industry as an institutional lender and believe our borrowers can feel confident that we are a lender they can trust. When we say we will do something, we do it. I will now turn it over to Tom to talk about the financials.

Thomas Geoffroy, CFO

Thank you, Robyn. We ended the first fiscal quarter of 2021 with total assets of $221.5 million as compared to $93.6 million at December 31, 2020. Portfolio investments totaled $97.2 million of principal outstanding, with a carrying value of $92.6 million spread across eight companies as of March 31, 2021. In March 2021, the company completed its initial public offering, which resulted in the issuance of 7,187,500 shares at $19 per share, with total net proceeds after fees and expenses of $124 million. At the end of the March quarter, book value per share was $16.18 as compared to $14.83 at the end of the December quarter, an increase of 9.1%. As of March 31, 2021, AFC Gamma portfolio consisted of $130.7 million of transactions, with $97.2 million funded. Following the quarter end, we closed an additional $50 million of transactions, with $48.3 million funded across seven borrowers. Currently, we have completed $165.6 million of transactions, with $133.4 million of funded principal outstanding to 10 companies in 12 states. All loans in the portfolio are current and performing. The weighted average portfolio yield to maturity is approximately 23% as of March 31, 2021, compared to 21.7% at December 26, 2020, as previously disclosed in the company's Form S-11. The weighted average yield to maturity of the portfolio as of April 30, 2021, was approximately 21% as adjusted to exclude the impact of prepayments and exit fees collected, which resulted in higher, and not necessarily indicative of expected yield-to-maturity for the other loans in the portfolio. For the quarter ended March 31, 2021, we had GAAP net income of $1.4 million or earnings of $0.20 per basic weighted average common share. For the three months ended March 31, 2021, we generated a total investment income of $4.7 million and distributable earnings of $3.2 million or $0.45 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 was early adopted by the company in fiscal year 2020. As of March 31, 2021, the CECL reserve represented approximately 1.25% of loan-carrying value compared to 1.32% at December 31, 2020. One of the adjustments to arrive at distributable earnings is a one-time noncash stock compensation expense of $0.22 per basic weighted average common share, pursuant to stock option grants effective as of the initial public offering. All other adjustments in aggregate to arrive at distributable earnings of $0.45 per basic weighted average share of common stock amounted to $0.03 per basic weighted average common share and included both the impact of the noncash adjustment 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. We generally intend to pay dividends to our stockholders at an amount between 90% and 100% of our taxable income. On May 7, 2021, the Board of Directors declared a dividend of $0.38 per common share outstanding for the June quarter, payable on June 30, 2021, to shareholders of record on June 15, 2021. Our Board of Directors currently believes that our distributable earnings in the second quarter will be in excess of our declared dividend and the dividend will represent 75% to 90% of estimated second quarter distributable earnings. 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 expense were incurred related to the revolving credit facility. The revolving credit facility is an important component of 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.

Leonard Tannenbaum, CEO

Thanks, Tom. Before we move on to the Q&A portion of this call, I want to address the legislative environment, which is an important area of interest for our stakeholders. Recently, the United States House of Representatives passed the SAFE Banking Act for the fourth time which may, once again, face obstacles passing the Senate. We believe this piece of legislation will be beneficial to the industry and to AFC Gamma. The SAFE Banking Act may allow for operators to have more banks to deposit their cash in. It may also allow the ability for consumers to use credit cards in dispensaries where cash is currently the predominant currency. In relation to AFC Gamma, while it may provide for increased competition from state-chartered banks, we believe that our autoship could provide us with more cost-efficient capital. Today, AFC Gamma has a strong balance sheet, increased access to capital, and a best-in-class team with years of combined lending experience and real estate experience. We believe that we are ideally positioned as a first mover in a rapidly growing market, poised to deliver enhanced value for our shareholders. I will now turn it back over to the operator to start the Q&A.

Operator, Operator

Your first question comes from Aaron Hecht with JMP Securities.

Aaron Hecht, Analyst

Congrats on holding your first earnings call.

Leonard Tannenbaum, CEO

Thanks, Aaron.

Aaron Hecht, Analyst

Yes. So in terms of the committed capital, the invested capital, it sounded like committed is up around $60 million since the IPO. And if I heard correctly, $40 million to $50 million has been invested, and that sounds like a pretty quick pace that you guys are putting money to work. Is it reasonable to assume that, that pace holds? And then once you get the full deployment of your liquidity, how would you rank your options for additional capital?

Leonard Tannenbaum, CEO

I'll let Robyn answer the first part, and I'll take the second part.

Robyn Tannenbaum, Head of Origination

So thanks, Aaron, for your question. Year-to-date, we originated about $70 million of deals. And how we think about it is if you extrapolate that out, you can assume about $200 million of originations for the year. We expect that our origination volume should increase over time as our team continues to grow and new states come online. Of our actionable pipeline of approximately $500 million, we believe that about two-thirds of deals will come to fruition. Although, as we've stated, deals may take three to nine months to close. And as cannabis is a fast-moving industry, it's difficult to predict how and when our pipeline will convert to close deals. For instance, as Len described earlier, while we're very excited about the state in New York, we do not currently have any deals for New York in the actionable pipeline. So, as I said earlier, I monitor our press releases where we plan—and let me clarify my earlier statement, plan to really announce deals that we are the lead agent on. So if you follow us there, you'll be able to see as we convert pipeline deals to closed deals.

Leonard Tannenbaum, CEO

I think as you pointed out, too, it's— for the second part of your question, Aaron, it's difficult to predict when deals close and what quarter they close them. However, we're constantly monitoring that and going to match our available capital against those prospects and those potential closings. We'll continue to monitor it as we close deals.

Operator, Operator

Your next question comes from Owen Bennett with Jefferies.

Unidentified Analyst, Analyst

And I just wanted to come back to the pipeline, please, and a couple of questions related to that. And firstly, obviously, we've seen additional geographic diversification now. Can we expect more of that with the pipeline as it stands right now? And then secondly, obviously, the demand for capital is increasing, while at the same time, we've generally seen the cost of capital coming in. Are you finding that you're having to offer more favorable terms for new deals now? And if so, what sort of delta versus maybe sort of six months ago?

Leonard Tannenbaum, CEO

Two good questions. There’s no—we definitely are looking forward to continued geographical diversification. I think we're in 12 states today, and we look forward to continuing to invest in new states like New York and other states as they open. Georgia has a big license that are going to be granted, and we look forward to doing some deals in Georgia as well, for example. As for demand for capital, and I think what we're getting here—what we're getting towards here in the question is yield compression and potentially, your compression in the market. There’s no question, as I said in my part, I think, that the big multistate operators are becoming more competitive in their demand for terms. And that’s partially because, by the way, that these big multistate operators are having substantial cash flow. And so to take Verano or Terrascend or a lot of them or Curaleaf or a lot of the different big multistate operators that are out there, they’ve really hit through the cash inflection point in terms of generating a lot of cash flow versus their build-out stage, which was before. And therefore, they demand much better terms in terms of their debt providing. We still believe that there's a great arbitrage between the Canadian-listed firms and our ability to source capital in America, and we look forward to providing capital to those large multistate operators.

Operator, Operator

Your next question comes from the line of Christopher Nolan with Ladenburg Thalmann.

Christopher Nolan, Analyst

I guess first question is on the CECL reserve, is there a particular target of reserves to loans that you're going to try to keep going forward?

Thomas Geoffroy, CFO

Well, the CECL reserve is not really a target number that we're looking at. We evaluate every loan individually. We use multiple data points as inputs into our calculation, including things like loan loss statistics. We have a third-party model that goes into our calculation, our knowledge of the borrowers and whether those loans are current and performing, and calculate a reserve each quarter based on those inputs.

Christopher Nolan, Analyst

Okay. Great. And— I mean, earlier, did you mention that in the second quarter, distributable EPS will be in excess of the dividend or vice versa? I kind of missed it.

Thomas Geoffroy, CFO

The distributable earnings would be in excess of the dividend.

Christopher Nolan, Analyst

Great. And I guess for Len, going—how are you thinking more about economic inflation being a potential factor in the coming months? How do you think you're going to be positioning the company to handle that, if at all, given that you got no debt?

Leonard Tannenbaum, CEO

I think we're well positioned. I think we're—about half of our loans are floating rate, but half of our loans are fixed rate. I expect that proportion to continue. So if you think about—if we eventually someday get to 1:1 leverage, and that’s floating, we’re actually—and we keep that proportion, we’re well hedged against inflation in interest rates.

Operator, Operator

Your next question comes from Gerald Pascarelli with Cowen.

Vivien Azer, Analyst

It's actually Vivien Azer on for Gerald. I was hoping you could discuss a little bit kind of the balance between partnering with large-scale U.S. MSOs and your aspirations there and juxtapose that with the potential for deflation in the market. Seemingly, from my perspective, some of the opportunities that you talked about, like Missouri, which is prohibitive to MSOs should, in fact, drive more sustainable price inflation in the marketplace which I would think would be good for you guys as a lender. So if you can just talk about that dynamic, that would be helpful.

Leonard Tannenbaum, CEO

I think we're looking at two different— so we're looking at two different baskets. One basket is the single state or two state operators that we may want to be a big multistate operator or ultimately as we're seeing rapid acquisitions—city state operators may get acquired. And we're seeing the large multistate operators very acquisitive, but still listed in Canada, which, even though they have great market caps, it's not so easy to do equity offerings. And so they're using debt and equity and cash as a part of those acquisitions as we're watching that happen. And we really—we'd like to invest with the top multi-state operators. We think the creditworthiness is terrific. We think that the yields—the risk-adjusted yields are really strong. And as that—if that becomes a large proportion of our portfolio, the good news is we can borrow at less rates and drop the spread down to our investors. So I'm excited for that business model. I think that's more of the business model for 2022 than 2021, but we’re investing some amounts. We’re in the terrascend loan, for example, and so we're investing some with the multistate operators this year.

Operator, Operator

Your next question comes from Russell Stanley with Beacon Securities.

Russell Stanley, Analyst

One of the higher-profile MSOs last night on the earnings call predicted that the center majority leaders want to wait to bill may finally be introduced this month, and there's talk that this would be prioritized over SAFE Banking in the Senate. Just wondering what you're hearing with respect to Tumorous Bill, its inclusions, and how you're preparing for that to the extent you can at this point?

Leonard Tannenbaum, CEO

I'm not yet up to speed to answer the question on a view there, but I will have a view probably. I understand what Tumorous initiatives have been and what the cannabis council has been developing; we pay attention to it. There’s been lots of back and forth, for example, SAFE Banking Act, as you probably noticed, doesn't even have a capital markets provision in it. And so I think that all of these bills, should they pass, if they have a social equity component, won't pass because the Senate won't approve it. If they don't have a social equity component, they may pass, and it will most likely be good for the industry. But they're constantly in flux. And so we are paying attention, but every day, we hear a different twist to it.

Operator, Operator

There are no further questions. I'd like to turn the call over to Len Tannenbaum, CEO.

Leonard Tannenbaum, CEO

Thank you, everyone, for attending our first quarterly conference call, and we look forward to continue to communicate in the future.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.