AFC Gamma Inc

NASDAQ:AFCG

Earnings Call Analysis

AFC Gamma Q4: Solid Earnings, Upcoming Spinoff

In Q4 2023, AFC Gamma earned distributable earnings of $0.49 per share and declared dividends consistent with previous quarters at $0.48 per share. Throughout 2023, 99% of distributable earnings were paid as dividends, totaling $2 per share for the year. The company is preparing to exclusively focus on cannabis industry lending after spinning off its commercial real estate portfolio into a separate REIT, Sunrise Realty Trust, by mid-2024. CEO Daniel Neville emphasized the strategy to support 'Cannabis 3.0' operators, who are innovating and unleashing a new wave of growth fueled by potential legalization in additional states, signifying a positive outlook for business expansion.

Consistent Dividend and Solid Earnings Showcase Stability

AFC Gamma concluded the quarter ended December 31, 2023, with distributable earnings at $0.49 per share, supporting a steady quarterly dividend of $0.48 per share. This performance is in line with their established trend of meeting or surpassing dividends with their earnings – a positive sign of stability for investors. Over the time since AFC Gamma went public, they have disbursed $5.54 in dividends per share, which includes a significant $2 per share for the fiscal year 2023. For the upcoming first quarter's dividend, they've announced another $0.48 per share to be paid in mid-April 2024, indicative of a consistent return to shareholders.

Strategic Focus Shift and Portfolio Evaluation

The recent appointment of Dan as the CEO has led to renewed vigor in portfolio assessment using a 'bottoms-up' investment approach, prioritizing operational efficiency. In strategic corporate developments, AFC Gamma is realigning its focus exclusively to the cannabis industry by spinning off its commercial real estate portfolio into a new entity, Sunrise Realty Trust (SUNS), which would be publicly traded. This structural change is poised to allow AFC Gamma to capitalize on market opportunities within its specialization.

Leadership with Rich Experience in the Growing Cannabis Sector

With over 15 years of experience spanning cannabis operations, mergers and acquisitions, and portfolio management, Dan's leadership is expected to fortify AFC Gamma's position in the booming $30 billion cannabis industry. His background includes significant accomplishments, such as guiding Ascend Wellness Holdings' expansion to a substantial revenue of over $500 million. This expertise will be invaluable in seizing the expansion prospects in a capital-constrained market, particularly with emerging 'cannabis 3.0 players' who demonstrate potential for robust growth.

Exploiting Market Potential: The Rise of Cannabis 3.0 Players

AFC Gamma identifies 'cannabis 3.0 players' as a driving factor for its expanding pipeline. These are seasoned entrepreneurs from various backgrounds making strategic strides in the cannabis industry. The demand for capital is bound to increase with the gradual legalization in the US, and AFC Gamma sees this as a critical avenue for furthering its growth in a market historically limited on capital access. Notably, the company believes that upcoming legalization in states holding an additional 58 million Americans could be a fertile ground for significant capital deployment.

Portfolio Optimizations and Risk-Adjusted Returns

Since his start as CEO, Dan has been proactive in engaging with borrowers and understanding market dynamics, which has reaffirmed AFC Gamma's well-curated portfolio, mostly focused on operators in regions with favorable supply-demand scenarios. The embrace of early-stage and transitioning states, like Missouri and New Jersey, aligns with the company's investment thesis to sustain high risk-adjusted returns. This proactive approach also extends to managing underperforming assets, with current efforts to remedy two borrowers in receivership to optimize their operations.

Troubleshooting Borrower Challenges and Introducing Financial Safeguards

Although AFC Gamma has experienced partial payment issues from one borrower in December, proactive negotiations have generated a plan involving significant equity injections and operational expertise to optimize performance, coupled with a crucial cash sweep mechanism. This strategic intervention is designed to improve borrowers' financial positions in the near term and initiate the repayment of both current and overdue interest, alluding to a structured approach to safeguard investments.

Earnings Call Transcript 2023-Q4

[Operator]

Good morning, and welcome to AFC Gamma's Earnings Conference Call for the Fourth Quarter and Fiscal Year ended December 31, 2023. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the call over to Gabriel Katz. Chief Legal Officer. Please go ahead.

[Gabe Katz, executive]

Good morning, and thank you all for joining AFC Gamma's Earnings Call for the Fourth Quarter and Fiscal Year ended December 31, 2023. I'm joined this morning by Leonard Tannenbaum, our Executive Chairman; Daniel Neville, our Chief Executive Officer; Robyn Tannenbaum, our President; and Brandon Hetzel, our Chief Financial Officer. .

Before we begin, I would like to note that this call is being recorded. Replay information is included in our January 31, 2024, press release and is posted on the Investor Relations portion of AFC Gamma's website at afcgamma.com, along with our fourth quarter and fiscal year 2023 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, future market developments, anticipated portfolio yield and financial performance and projections in 2024 and beyond. These statements are subject to inherent uncertainties in predicting future results. Please refer to AFC Gamma's most recent periodic filings with the SEC for certain conditions and significant 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 AFC Gamma's earnings release and investor presentation available on AFC Gamma's website. The format for today's call is as follows. Len and Dan will provide introductory remarks, an overview of our fourth quarter and full year performance as well as some strategic commentary. Brandon will summarize our financial results, and we will then open the lines for Q&A.

With that, I will now turn the call over to our Executive Chairman, Leonard Tannenbaum.

[Leonard Tannenbaum, executive]

Good morning, and welcome to AFC Earnings Call for the Quarter and Fiscal Year Ended December 31, 2023. I would like to thank everyone for joining us today to discuss our results. For the quarter ended December 31, 2023, AFC generated distributable earnings of $0.49 per basic weighted average share of common stock. As a reminder, distributable earnings is the primary metric the Board considers when declaring AFC's quarterly dividend. The Board of Directors declared a $0.48 dividend per share for the December quarter, which was in line with the previous 2 quarters. Since going public, we have generated distributable earnings that have met or exceeded our dividend each quarter and paid out $5.54 per share in dividends, including paying out $2 per share during fiscal 2023.

For the full year 2023, AFC paid out approximately 99% of its distributable earnings in the form of dividends. For the first quarter of the Board of Directors has declared a fourth consecutive $0.48 dividend, which will be paid on April 15 to shareholders as of record March 31, 2024. Since Dan's appointment as CEO in mid-November, the team has been very busy as we continue to evaluate our portfolio with Dan's operating lens and bottoms-up investment approach.

I am pleased with the progress the team has made on some of our underperforming assets. As we have discussed 2 weeks ago, AFC will return to its exclusive focus on lending to the cannabis industry after the spin-off of our commercial real estate portfolio is complete. As a reminder, the commercial real estate portfolio will spin off into an independent, publicly traded REIT, Sunrise Realty Trust, which is expected to trade on the NASDAQ Exchange under the ticker symbol SUNS upon completion of the separation.

We have decided to pursue this transaction because we believe that both AFC and SUNS will be better positioned to grow and realize their full potential as independent, pure-play capital providers in the cannabis and commercial real estate space, respectively. The separation will allow each company to focus on its respective portfolio, articulate their own clear investment thesis and have the flexibility to tailor their business strategies to best capture market opportunities within their specialization. We expect the spinoff to be completed by mid-2024, subject to SEC review as well as final approval by our Board of Directors.

As executive Chairman and the largest shareholder of both entities post spin-off, I am very excited about the future for AFC and SUNS. CRE debt markets today represent a significant opportunity to capitalize on market dislocations, precipitated by the rise in interest rates, declining liquidity and a pullback of regional banks from CRE lending. We are also seeing a large increase in CRE deal flow in the past few weeks. With that, I will pass it to Dan to discuss our AFC cannabis portfolio.

[Daniel Neville, executive]

Thanks, Glenn. Good morning. I'm excited to be speaking to you for my first earnings call as CEO of AFC. It has been a busy and productive 4 months since I joined AFC as CEO and delved into our portfolio and future opportunities. Before turning to our portfolio, pipeline and the state of the industry, I wanted to take a minute to introduce myself to analysts and investors. I bring over 15 years of leadership experience in the areas of cannabis operations, M&A and portfolio management. Previously, I was at Ascend Wellness Holdings, a multistate vertically integrated cannabis operator where I held various roles, including CFO and a stint at Interim CEO. I was one of the first employees at Ascend and have the valuable opportunity to help grow the company's operation across 7 states to 2,200 employees and over $500 million in revenue.

Prior to that, I was a Managing Director at SLS Capital, a special situations hedge fund. And before that, I was an investment banker at Credit Suisse. Turning to AFC. We are one of the leading debt providers of institutional capital to the cannabis industry, which is a growing $30 billion market with a limited supply of institutional capital. We are seeing our pipeline expand, mainly driven by what we call cannabis 3.0 players. These are entrepreneurs that have founded businesses in cannabis or other industries were successful and are now entering or reentering the cannabis industry.

Many of these companies are building through a combination of organic growth and opportunistically acquiring distressed assets. We are excited to finance many of these operators that have clean capital stacks and are unburdened with debt sale leasebacks or legacy tax liabilities. As the march toward legalization continues, demand for capital will only increase. between Ohio, Pennsylvania, Florida and Virginia, an additional 58 million Americans could gain access to adult-use cannabis in the next few years.

Additionally, states like North Carolina, South Carolina and Kentucky are likely to implement medical programs. This is all incremental demand that will also require significant additional capital to increase growth capacity, production and distribution infrastructure and retail points of distribution. We see these Cannabis 3.0 operators along with the continued march toward legalization in the U.S. as the opportunities to expand AFC's platform in a market that has continually experienced a lack of access to capital.

Since joining AFC in November, I have met with and continue to have regular points of contact with all the borrowers in AFC's portfolio. I've done deep dives on 6 markets, flown over 40,000 miles and visited and toured 11 cultivations and 28 dispensaries. The main takeaway from my travels is that AFC's portfolio is well positioned in a volatile yet rapidly growing cannabis industry. Our portfolio is concentrated on operators in solid, limited license states with attractive supply-demand dynamics. Also, through our existing borrowers, we have good exposure to early-stage and expected near-term adult-use transition states such as Missouri, New Jersey, Ohio and Pennsylvania.

I firmly believe that our investment thesis has and will continue to set us up well to generate strong risk-adjusted returns. Turning to our portfolio. We continue to make progress on reducing our exposure to underperforming assets and are actively managing our portfolio. Two borrowers remain in receivership to optimize operations and maximize value for the benefit of all stakeholders. One of our borrowers, private company A has been actively liquidating assets and has so far paid down over $53 million in principle to AFC and syndicate partners, of which $4 million of principal paydown was received during the quarter. As we have discussed during the last several quarters, we are working closely with subsidiary of private company G, which continues to have cash flow challenges.

Last quarter, we mentioned that we modified interest payments for the remainder of 2023 to ensure the borrower had adequate working capital. AFC received the $1 million cash interest that was due in the month of October and November. However, the borrower only made a partial payment for December. The parties have negotiated a joint plan that requires the borrower to make a significant equity contribution and install top operators in each of Pennsylvania and New Jersey to optimize operations in exchange for a reduced interest rate. This will decrease the financial burden of debt service on the borrower in the near term.

We also introduced a significant cash sweep for the remainder of the loan that we anticipate will pay down both current and unpaid interest and begin to amortize the loan through maturity. The New Jersey operations will now be fully managed by Chief Restructuring Officer with significant operating and turnaround experience in the cannabis industry. The borrower will also enter into a management services agreement with one of the top single-state operators in Pennsylvania to both supply and operate their dispensaries.

With both of these attractive assets, in the hands of skilled operators with significant cannabis experience, we anticipate better performance from these assets in the coming quarters. In early January 2024, private company L entered into an agreement to sell their operations in Missouri. This sale will translate into a $20 million reduction in principal on private company L loans, offset by $10 million in future draws to fund their cultivation build-out in Ohio.

On January 3, 2024, the company received the first portion of funds leading to a reduction in principal of $11.4 million. We expect to receive the remaining $8.3 million by the end of the first half of 2024. Turning to the originations front. We have been quite active in states such as Ohio, Pennsylvania and Florida where transaction activity picked up due to the potential for adult use cannabis transitions in the near term. Additionally, we are pursuing opportunities in states such as Georgia and Alabama, where medical programs were recently implemented. We currently have a signed cannabis term sheet and are in documentation phase for a borrower that we are excited to lend to in a strong limited license date. We look forward to updating our analysts and investors on the transaction once closed, which we expect will be in the next month or so.

As of March 1, 2024, our active pipeline of cannabis deals is currently $279 million. I am particularly pleased with the quality of the operators and the deals in the pipeline. It's largely comprised of people who have done it before, know how to execute, and we're confident we'll be able to create value for all of their stakeholders. We continue to have liquidity to make additional investments and given the limited supply of institutional capital, we believe this will allow us to move up the quality curve while still achieving mid- to high-teens IRRs.

We firmly believe that AFC is uniquely positioned to be the go-to provider of capital for this growing industry. Looking ahead in 2024, my key priorities are: first, to substantially address the issues at select portfolio companies through an active portfolio management approach; second, to continue to underwrite new deals with an operator's eye and diversify our portfolio; and third, and finally, to originate over $100 million of new deals with strong risk-adjusted returns. Now I'll turn it over to Brandon to discuss our financials.

[Brandon Hetzel, executive]

Thank you, Dan. We are pleased to report strong results in the fourth quarter and fiscal year 2023. Beginning with the quarterly results. For the quarter ended December 31, 2023, we generated net interest income of $16 million and distributable earnings of $10 million or $0.49 per basic weighted average common share and had a GAAP net loss of $9.2 million or $0.45 per basic weighted average common share. .

The difference between our distributable earnings of $10 million and our GAAP net loss of $9.2 million is mainly driven by an increase in our unrealized losses on loans held at fair value of $7.4 million and an increase in our CECL reserve of $12 million for the fourth quarter. On an annual basis, for the year ended December 31, 2023, we generated net interest income of $64.2 million and distributable earnings of $41.4 million or $2.04 per basic weighted average common share and had GAAP net income of $21 million or earnings of $1.02 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's business. Distributable earnings represent the net income computed in accordance with GAAP, excluding noncash items such as stock compensation expense, any 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 noncash items recorded in net income or loss for the period.

We ended the fourth quarter of 2023 with $388.3 million of principal outstanding spread across 12 borrowers. Subsequent to December 31, 2023, AFC committed $56.4 million, of which $48.9 million was funded across 2 commercial real estate mezzanine loans, and we continue to see attractive CRE deals and have an active pipeline of $701 million. As of March 1, 2024, our portfolio consisted of $416.3 million of principal outstanding across 14 loans. The weighted average portfolio yield to maturity, which is measured for each loan over the life of such loan was approximately 21% as of December 31, 2023, and March 1, 2024.

Next, let's take a look at our balance sheet, which remains strong. As of December 31, 2023, we had total assets of $466.6 million, including cash and cash equivalents of $121.6 million and had $42 million drawn on our line of credit, which was subsequently repaid in full on January 2, 2024. Our line of credit provides us with 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 5.3%. As of December 31, 2023, the CECL reserve was $26.4 million or approximately 8.7% of our loans at carrying value, which increased $12 million or 4% from the September 30, 2023 reserve of $14.4 million or 4.7%.

In addition to the increased CECL reserve, during the fourth quarter, we had an increase in our unrealized losses on loans at fair value of $7.4 million. We currently have 4 borrowers on nonaccrual, which represents 25% of our portfolio. As of December 31, 2023, our total shareholder equity was $320.1 million and our book value per share was $15.64. On January 12, 2024, AFC paid a dividend of $0.48 per common share for the fourth quarter to shareholders of record as of December 31, 2023.

For the fiscal year 2023, we 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. For the first quarter of 2024, the Board of Directors declared a $0.48 dividend, which will be paid on April 15, 2024, to shareholders of record as of March 31, 2024. With that, I will now turn it back over to the operator to start the Q&A.

[Operator]

[Operator Instructions] Our first question comes from the line of [indiscernible] and Associates.

[Unknown Analyst]

Congratulations on all the progress the company is making. Just regarding the comment, I think you made in the prepared remarks about the regional banks pulling out of the industry. Can you give more color or context on that. On the one hand, we [ Bank Needham ] getting more active in the space, some refinancing there. Report talked about First Citizens Bank, 19th largest bank, entering the space in terms of lending. I don't know if there are exceptions or more of a trend. If you can just give more color in terms of the competition you're seeing from the banking side.

[Daniel Neville, executive]

Yes. So Pablo, thanks for the question. This is Dan. You are seeing a little bit more activity. Needham did come into the space. They were looking to grow their loan book ahead of their IPO transaction Our understanding is that now that they've deployed some of the capital into the space, they're kind of taking a step back and digesting a bit. For the most part, Needham has been lending to larger public companies. Those companies often do not have the real estate coverage that we require for REIT status. .

So I still see very good opportunities, and we're not really running into some of the commercial banks like Needham or others that have played in the space. And the second thing I'd say is that this is a $30 billion industry that's sitting within a $100 billion industry between the legal and illicit market. And so as more and more states flip, there's going to be a lot more capital that is required. I was just thinking last night, North Carolina is a great example. That state is going to have 10 verticals, 13 million people. It's a very attractive market, and it probably implements a medical program sometime in the next year or 2.

Those 10 verticals come with 8 stores apiece. So 1 vertical is $20 million for a grow and $2 million per store. That's $36 million of capital multiplied by the 10 verticals. When we look at [ state ] flipping and $360 million of capital -- incremental capital demand that seems like a pretty good opportunity. And I think there continues to be a mismatch between the supply of available institutional capital and the demand for that capital.

[Unknown Analyst]

And maybe as a follow-up. In terms of the, maybe for Len or Robyn, but maybe just more context about the pivot that you've made, right? A year ago, the idea was that you were exiting, diversifying to commercial real estate. And then now, of course, you're obviously doubling down on cannabis [indiscernible] What is it that you're seeing, right, that I guess, made you change. On the one hand, we see more deflation, more licensing in some states, creating more competition, so tougher industry conditions. But of course, on the other hand -- and no progress at the federal level, But on the other hand, of course, we are seeing more states going medical or going direct, right? But just remind us of why the change and I guess why the more apparently more positive view about industry trends that made you refocus on cannabis again.

[Leonard Tannenbaum, executive]

I think the positives that happened was Ohio going rec, Pennsylvania probably going rec, and really a very good experience that we had in Missouri with our borrowers and that's really helped out a lot of the quality of the earnings. I'm actually very excited about Georgia. I think George is going to be a great state, too. I think there's a number of other positive states in the horizon. And of course, where we're sitting in Florida where the governor has changed his view after he's left the presidential race and started to support rec here. It's years away, by the way. But that dynamic creates a lot of demand, as Dan sort of outlined. And so we see that. And plus you see the Cannabis 3.0 players. I've literally said this for 6 consecutive quarters. We're sitting -- we're going to wait for the cannabis 3.0 and 2.0 is done. I think a lot of the legacy players have a lot of problems. We are happy to get the liquidations and exits that we did. We think we did a good job. Dan has done a phenomenal job really from an operating lens taking a look at these -- their operating businesses, what they're worth and how they should be run. And that's a very different approach. Maybe I should have done that a year or 2 ago. But happy to have Dan here now. with that approach. So I'm excited about cannabis, and I'm equally excited about real estate. Look, our shareholders AFC is going to own about 1/3 of their their stock in Sun and Sun will be spun out. And I'm pretty excited about that, too. The opportunity in real estate, I'm a direct lender by background. I build a $5 billion direct lending industry, direct lending also direct-lending real estate, direct lending and private equity is same thing. The regionals are pulled back. They are taking lower LTCs and that opportunity set is going to be phenomenal for SUNS and we're excited about -- I'm excited about the opportunities set there and the cannabis. So I think you've got 2 really great opportunities that are going to be led by 2 great leaders. .

[Operator]

That concludes today's question-and-answer session. This concludes today's conference call. Thank you for participating. You may now disconnect.