Earnings Call Transcript - LAND Q2 2023

Operator, Operator

Greeting and welcome to the Land Corporation Second Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. As a reminder, this content is being recorded. It is now my pleasure to introduce your host, David Gladstone, Chairman and Chief Executive Officer. Thank you, sir. You may begin.

David Gladstone, CEO

Okay. Thank you, Latanya for that nice introduction. You've done it many times for us and we appreciate your efforts. This is David Gladstone, and welcome to the quarterly conference call for Gladstone Land. Thank you all for calling in today. We appreciate you taking the time out of your day to listen to our presentation. But before I begin, we have to hear from Michael LiCalsi, he's our General Counsel. So Michael.

Michael LiCalsi, General Counsel

Thanks, David. Good morning, everybody. Today's report may include forward-looking statements under the Securities Act of 1933 Securities Exchange Act of 1934, including notes regarding our future performance. And these forward-looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable. Many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements including all risk factors in our Forms 10-Q, 10-K, and other documents we file with the SEC; find them on our website at GladstoneLand.com, specifically go to the Investors page, or on the SEC’s website that's www.sec.gov. And we undertake no obligation to publicly update or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Today we will discuss FFO, which is funds from operations. FFO is a non-GAAP accounting term, defined as net income, excluding the gains or losses from the sale of real estate and any impairment losses from property, plus depreciation and amortization of real estate assets. We may also discuss core FFO, which we generally define as FFO adjusted for certain non-recurring revenues and expenses, and adjusted FFO, which further adjusts core FFO for certain non-cash items, such as converting GAAP rents to normalized cash rents. We believe these are better indications of our operating results and allow better comparability of our period-over-period performance. Now we ask you to take the opportunity to visit our website, once again that’s GladstoneLand.com, sign up for our email notification service there, you could stay up-to-date on the company. You could also find us on Facebook, keyword there is The Gladstone Companies and Twitter which is @Gladstonecomps. And today’s call is an overview of our results, so we ask that you review our press release and Form 10-Q, both issued yesterday for more detailed information. Again, go to the Investors page of our website to find them. Now I'll turn the presentation back to David Gladstone.

David Gladstone, CEO

Thank you, Michael. I'll begin by providing a concise overview of our Farmland Holdings. We currently own approximately 116,000 acres spread across 69 farms, along with about 45,000 acre-feet of bank water, which is equivalent to around 14.7 billion gallons. This substantial water resource is utilized for irrigation during periods of scarcity. Together, we estimate the value of both the land and water at around $1.6 billion. Our farms are located in 15 states and 29 distinct growing regions. Including the one farm we operate ourselves, our properties are fully leased to over 90 unrelated tenant farmers who cultivate more than 60 varieties of crops, primarily fruits, vegetables, and nuts, ensuring diversification across our holdings. In the first quarter, we had to replace one tenant and temporarily operated the farm with the assistance of a third-party management group. Although we had aimed to finalize a new lease by this quarter, we are still in discussions with potential tenants and hope to resolve this during the third quarter. We're also considering managing the farm directly, but prefer leasing as our main strategy. Due in part to surplus production in the market, we've experienced issues with some tenants; one is making partial payments and may be closing their operations, while another has made collections challenging, leading us to terminate their lease and sign a short-term agreement with a new grower. As a result of these challenges, our net operating income declined by approximately $318,000 in the second quarter and around $613,000 year-to-date. As mentioned in past calls, we're being more selective with our farm acquisitions, focusing on finding reliable farmers. Consequently, acquisition activity is slow. With inflation above the Fed's target and rising interest rates, coupled with recession risks, we find it prudent to adopt a conservative approach with our capital investments. Despite the inflationary pressures and higher food prices stemming from interest rates, farm prices remain high and are not adjusting downwards, an ongoing challenge for us. Nevertheless, our farmland portfolio is performing essentially as anticipated, aside from the issues with a couple of tenants. We have successfully renewed all expiring leases without any downtime and mostly at higher rates, with one exception I’ll mention later. On a positive note, we sold a portion of one farm, a 138-acre non-farmable parcel in Florida, realizing a gain of $6.4 million and a 343% return on our original investment. We retain ownership and leasing rights for the remainder of the farm. Since the start of the quarter, we have renewed 13 leases across five states, which are expected to decrease our annual net operating income by about $469,000 compared to previous leases. This includes four leases replacing a previous tenant on blueberry farms in Michigan, where we offered lower rent in exchange for maintaining and restoring the blueberry bushes for future long-term leasing. The remaining nine leases are anticipated to increase annual net operating income by approximately $209,000, or 3%, over past leases. Looking forward, we have eight leases expiring in the next six months, accounting for about 5% of total annual leases. We are in negotiations with existing tenants for extensions and exploring options with prospective new tenants. While we expect rental rates for renewals to remain stable, we do not foresee any downtimes due to these expirations. On a few more points, while inflation is persisting, it’s showing signs of slowing down as the effects of the Fed's interest rate hikes are taking hold. Nonetheless, recent inflation figures of 3% still exceed the Fed's 2% target. Core inflation levels remain high, with food prices showing some cooling yet still outpacing general inflation, particularly affecting the "food at home" category, which rose 4.7% over the past 12 months. We believe food price persistence will help mitigate operational cost burdens for our farmers. Additionally, we’re engaged in water improvement projects in California, focusing on enhancing our portfolio's compliance with state groundwater restrictions amid this year's significant rainfall. We identified several initiatives to strengthen long-term water supplies to meet our current crop demands. Our strategy is designed to maximize water supply opportunities during wet years while reducing risks during drier seasons. Lastly, while there are concerns in the media regarding water depletion in the Colorado River, none of our properties depend on this river or its tributaries. Therefore, we aren't affected by headlines surrounding that region. I’ll conclude here and pass it over to our CFO, Lewis Parrish, for a discussion of the financial numbers.

Lewis Parrish, CFO

Thank you, Dave, and good morning, everyone. I'll start by discussing our financing activities. We did not take on any new debt during the quarter, but we repaid about $6 million in loans since the start of the quarter, in line with our scheduled repayments. On the equity side, we raised net proceeds of around $3 million from selling our Series E Preferred stock and $2 million from common stock sales through our ATM programs. Now, moving on to our financial results for the second quarter, we reported a net income of approximately $7.9 million and a net income attributable to common shareholders of $1.7 million, which translates to $0.05 per common share. For the discussion of operations, I'll compare the second quarter of 2023 with the same quarter in 2022. Adjusted Funds From Operations (AFFO) for this quarter was about $3.8 million, or $10.7 per share, down from $4.5 million, or $12.9 per share, in the same quarter last year. The decrease in AFFO was mainly due to higher costs related to uninvested capital on our balance sheet, though there was a partial offset from increased top-line revenues. Fixed base cash rents rose by approximately $512,000, or 3%, compared to the same quarter last year, largely due to additional revenues from new farms we acquired over the past year. This increase was somewhat countered by lower revenues from self-operated and non-accrual properties, along with a lease change from the fourth quarter of 2022 that reduced the fixed base rent but increased the participation rate component, which we will know more about later this year. Regarding non-accrual properties, we will continue to recognize revenues from these leases on a cash basis until it's likely we can collect full future rental payments. As David noted, we successfully replaced one tenant during the quarter and are nearing final terms for replacing a second tenant, while our third tenant is up to date with rent payments. We are optimistic that all these properties will return to earning revenues by the end of the year. On a same-property basis, including participation rents, our Q2 2023 lease revenues saw a slight increase of just over $100,000, or around 1%, compared to the same quarter last year. On the expense front, excluding reimbursable costs and certain one-time or non-cash expenses, our core operating expenses grew by about $210,000 from the previous year. Fees from related parties rose by about $156,000, primarily due to the addition of new assets to our portfolio in the past year. Excluding these related party fees, our core operating expenses increased only by $54,000. Property operating expenses increased by about $97,000, largely due to added legal fees for drafting new lease agreements and rent collection efforts from some tenants, although this was partially offset by a reduction in repairs and maintenance costs this year. Additionally, general and administrative expenses fell by about $43,000, mainly because expenses related to the 2023 annual shareholder meeting were recognized earlier in the first quarter. Moreover, other income rose because of additional interest income from money market accounts due to higher rates, and interest expenses decreased due to loan repayments made over the past year. Now, regarding our net asset value, we had 62 farms appraised during the quarter through third-party evaluations. Overall, these farms' values increased slightly by about $850,000 compared to their previous appraisals from a year ago. Therefore, as of June 30, our portfolio was valued at around $1.6 billion, supported by third-party appraisals or purchase prices. Based on these updated valuations and considering the fair value of our debt and preferred securities, our net asset value per common share as of June 30 was $19.15, up over $2 from the March 31 value. This increase was largely due to the change in valuation of our fixed-rate debt and preferred securities, particularly the Series C preferred stock, which transitioned from being valued at liquidation value based on the waterfall approach to market price following its NASDAQ listing in June, consistent with our valuation policy for publicly listed preferred securities. As for liquidity, considering our available lines of credit and undrawn notes, we currently have over $185 million in dry powder and about $145 million in unpledged properties. More than 99.9% of our borrowings are at fixed rates, averaging 3.35% for another 4.6 years, so we've faced minimal impact from recent interest rate rises. However, these rises affect our capacity to finance new acquisitions and inform our decisions on whether to repay or refinance maturing loans. We believe we're well-positioned to handle any future interest rate increases regarding our current debt load. In terms of upcoming debt maturities, we have approximately $34 million due over the next 12 months, of which about $17 million represents various loans. The properties securing these loans have grown in value by a total of $7 million since their acquisitions, so we do not anticipate issues refinancing these loans if we decide to. Excluding those maturities, we have about $17 million in amortizing principal payments due in the next 12 months, which is less than 3% of our current outstanding total. Lastly, we recently increased our common dividend to $0.462 per share per month, marking the 31st increase in our common dividend over the last 34 quarters, resulting in an overall rise of 54% during that time.

David Gladstone, CEO

Okay, thank you, Lewis that was a nice report. We continue to stay active in the marketplace should a good opportunity present itself. But as mentioned, we're being more cautious on the acquisition front. This is really due to the cost of borrowing and the price of farms, farms haven't fallen even though the cost to borrow them is really much higher than it was before the Fed kept raising rates. A few items to finally point to. We believe that investing in farmland crops that contribute to the healthy lifestyle such as fruits and vegetables and nuts is where we should be following this trend. We're seeing the market today. It's a good place to be because it's not susceptible to some of the changes in market demand that you'd see if you were in only corn or any of those corn crops. Overall demand for prime farmland that are growing berries and vegetables remains stable, too strong in almost all the areas where our farms are located, particularly along each of the coast. Overall, farmland in the United States is performing well. For example, the NCREIF farmland index has about $16.2 billion worth of farms and all of our $1.6 billion is in that calculation that NCREIF does. That agricultural property index is a good one, we hope to be exactly like them because their return has been 11.4% over the past 25 years, with no negative years during that period. This is better than both the S&P index and the overall REIT indexes, each of which had six or more negative years over the same timeframe versus zero for the farmland index. So in closing, we can go over a couple of items and then move on to questions. Please remember that if you're purchasing stock in this company, it's a long-term investment. It's dirt, it's farmland, and this investment is our stock gives two parts to it. It's similar to gold in that it's a hard asset farmland that has intrinsic value because there's a limited amount of good farmland in the United States. And it's being used by urban development, especially in California and Florida, where we have many farms. And second, unlike gold and other alternative assets, it's an active asset with cash flows to investors. And we believe we're better than a bond fund because we keep increasing the dividend. We expect inflation, particularly in the food sector to continue to increase, and we expect the values of underlying farmland to increase as a result. And we expect this to be especially true in the fresh produce area, as the trends are in our favor that more people in the United States are eating healthy foods and they continue to grow in that direction.

Operator, Operator

Our first question comes from Rob Stevenson with Janney Montgomery.

Rob Stevenson, Analyst

Good morning, guys. David, any acquisitions on your contract today? And then given your commentary on how robust the market pricing for farms is, any thoughts about selling more assets in the back half of this year?

David Gladstone, CEO

Well, if we could find somebody that would bind the nonperforming or the problem that some farms have, we'd certainly be willing to sell. But Rob, my goal is to amass as many assets as possible in the farming area. They've continued to go up in price farms that I bought 20 years ago are now about 4x the price that I paid. So it's a good area. It has low downside risk. And so we don't have anything under contract right now. We have some discussions going on with farmers. And believe me, the guys and gals here are chomping at bits to buy something. So I'm not going to buy a farm that would pay me on a cap rate of, say, 5.5% and then borrow money at 5.5%. That's a good way to be long-term in the wrong direction. But I do wish the interest rates would come down. These federal lenders are in a position and have been in a position for some time to drop their rates and allow us to get back to the business of buying farms. These farmers that we buy from are not in a hurry. And so they're only going to do it if they get the price that they want. So we're kind of on hold. We are concentrating a lot of our effort right now on water. As you know, we have plenty of water now. However, we are fixing some of our farms so that we can store water on them by putting in some firms and allowing us to go in. And believe it or not, the state of California is encouraging everyone to do that. I think we are way ahead of the curve in terms of putting water in place. I think we've got enough water today for the next two years, and we've got a couple of transactions that would push us into the direction of 2040 in terms of having enough water underground. These aquifers that are there have gone down some, so they're trying to fill them all back up during this time of plenty of water. But in terms of buying new farms, we don't want to buy the farmers starting to talk about different cap rates, and I think it will happen. Some of them, as you know, the average farmer is about 58 now, and more than 40% of the farms in the United States are owned by individuals. So somewhere along the way as people continue to get older and have to settle up their estate, things are going to happen. We'll be ready for that as long as we can borrow some reasonably priced water. We've talked about having an offering and raising more equity. I don't think it's quite the time to do that, but we'll certainly be talking to your people if we get along that line, but I hope I answered your question.

Rob Stevenson, Analyst

That's helpful. Louis, where are the issues with the operators? Is it affecting the revenue line, the property expense line, or both? The reason I ask is that property operating expenses in the first half increased by more than $600,000, which is about 44%, a significant rise for a net lease REIT. I wanted to understand the situation better and if the $2 million in operating expenses for the first half is a reasonable estimate for the second half.

Lewis Parrish, CFO

It’s evident in both areas. Aside from cash received, we haven't recognized any revenue from those properties. For the first half of the year, the year-over-year effect on our net operating income is approximately $600,000, which stems from both revenue and property operating expenses. Specifically, we experienced a decrease of around $400,000 in revenue year-over-year. The remainder is reflected in property operating expenses, with a significant portion attributed to legal fees we incurred for drafting new leases and pursuing collections of rent amounts, as well as addressing the potential vacating of those properties. The increase in costs is mainly due to two factors. While I don’t have the precise figures for these categories, one factor is the repair and maintenance expenses for hurricane damage on the Florida farms, alongside a couple of hundred thousand dollars spent on the West Coast for flood repairs. The other factor involves rising costs associated with protecting water rights on farms in California.

Rob Stevenson, Analyst

That's helpful. For my last question, you usually experience a significant increase in revenues, around 10% to 20% from the second to the third quarter, followed by another notable rise between the third and fourth quarters. In past years, much of this growth can be attributed to acquisitions, as you have completed several that started providing benefits in the latter half of the year. However, you haven't made any acquisitions this year. How should we approach the seasonality of revenues in the second half of the year? Will we still see a substantial increase due to the percentage of rents in some crops that are going to be sold, or will it be less significant without new acquisitions? How should we think about this?

Lewis Parrish, CFO

The increase this year is likely to be smaller than in previous years since, as you mentioned, we don't have the boost from acquisitions this time around. Therefore, the fixed base rent will be much flatter compared to past years. However, I want to note that if we can resolve the tenant issues and fully restore those properties to accrual status, which I hope we can do by the fourth quarter, we might see a slight uptick. The majority of our growth in the latter half of the year will come from participation rents as it has in previous years. Last year, we generated about $7 million in participation rents and around $5 million the year before. We're still assessing yield and pricing, which are the main factors, and we're gathering data on our farms' yields. It's too early to predict where we'll end up, but it may be somewhat less than last year's figures. Last year was quite strong for participation rents, and we should have a clearer picture on that by the next quarter's earnings call.

Operator, Operator

Our next question comes from Edwin Najarian with EF Hutton. Please proceed.

Edwin Najarian, Analyst

Good morning, guys. You mentioned the biggest change in terms of the valuation of the preferred stock within the Series C. I was just wondering if you could kind of go through the change in the B, C, and Series E real quickly, just so we can get sort of a sense of how much each of those drove the change in the NAV calculation. Thanks.

Lewis Parrish, CFO

The B has been listed for over a year and has been valued at its market price for several quarters. As a fixed income security, its demand decreases as interest rates rise. The Series E is still non-listed and is valued at its liquidation value of $25 per share. I believe that about 90% of the change comes from the Series C security. Last quarter, before it was listed, the Series C was valued at its liquidation value of $25 per share based on a waterfall approach. However, it was listed in June and was trading closer to $20 per share by June 30. After listing, we adjust the value based on its public market price. Thus, the valuation changed from $25 to $20, resulting in a decrease from approximately $250 million in value at March 31 to about $200 million by June 30.

Edwin Najarian, Analyst

Okay. Okay. That's helpful. So really, the vast majority from the C and very well, actually, I guess, no change in the E and then little change in the B, correct?

David Gladstone, CEO

Correct.

Operator, Operator

As there are no further questions in the queue, I would like to turn the call back over to you for closing comments.

David Gladstone, CEO

Well, thank you all very much for asking questions. We always hope there are more questions than we get at these meetings. So we'll have to wait until next quarter to answer your questions. So thanks again, and that's the end of this.

Operator, Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation, and have a great day.