2023-03-10 13:41:03 ET
Alaris Royalty Corp. (ALARF)
Q4 2022 Earnings Conference Call
March 10, 2023 11:00 AM ET
Company Participants
Amanda Frazer - Chief Financial Officer
Steve King - President & Chief Executive Officer
Conference Call Participants
Geoff Kwan - RBC
Gary Ho - Desjardins
Zachary Evershed - National Bank Financial
Trevor Reynolds - Acumen Capital
Presentation
Operator
Good day and thank you for standing by. Welcome to the Alaris Q4 2022 Earnings Release. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised today's conference being recorded.
I would now like to hand the conference over to your speaker today, Amanda Frazer, Chief Financial Officer. Please go ahead.
Amanda Frazer
Thank you, Kevin. We appreciate everyone taking the time to join us this morning. We are excited to present our Q4 results. I'm joined on this call by Steve King, President and Chief Executive Officer of Alaris. After a short presentation from Steve and I, there will be a question-and-answer session.
Before we begin, I would like to remind our listeners that all amounts given are in Canadian dollars unless otherwise noted. Listeners are cautioned that comments made today may contain forward-looking information. This forward-looking information is based upon a number of important factors and assumptions and therefore, actual results could differ materially.
Additional information concerning the underlying factors, assumptions and risks, is available in last night's press release and our MD&A under the headings Forward-Looking Statements and Risk Factors, copies of which are available on SEDAR at sedar.com as well as our website.
Non-IFRS data is also presented and may differ from the way other companies present such data. As with the forward-looking statements, please refer to last night's press release and our MD&A for more clarification regarding non-IFRS measures.
Some of the Q4 highlights include: Q4 revenue of CAD 51.1 million with an increase of 36% over the prior period and exceeded previous guidance, due mainly to the receipt of US$ 5.2 million in distributions owed by FMC upon redemption as part of all of our investments, we have a three-year make-whole provision and distributions up to the third anniversary are owing in the event of the transaction.
Also, the catch-up payment of US$ 3 million received in late 2022 from Planet Fitness in regards to amounts deferred during the COVID pandemic. During the year, Planet Fitness made a total of US$ 5.4 million in catch-up payments and US$4.2 million remains outstanding.
For the year revenue of CAD 190 million was an increase of CAD 28.7 million over the prior period, and driven by the redemption of Kimco and FMC during the year, each of which resulted in the collection of deferred and out-of-period distribution.
Also, after the consideration of these out-of-period amounts revenue of CAD 165.7 million was 12.2% higher than in 2021, driven by the follow-on investments in BCC Fleet and Acxiom as well as CAD 13.0 million received in common distributions, an approximate 10% yield on our common equity portfolio and a three times increase over the prior year.
Cash generated from operations prior to changes in working capital of CAD 47.2 million for the quarter and CAD 171 million for the year was an increase of 13% and 22%, respectively over the prior period.
During the year, Alaris generated basic earnings per unit of CAD 2.89 and paid out CAD 1.33 per unit in distributions, resulting in a CAD 1.56 increase in book value. The actual payout ratio was 39% thereby generating CAD 93 million of excess cash flow from operations, which was used to pay down debt and for investing purposes.
Earnings for both the quarter and year-end were impacted by the decrease in fair value gains as compared to the prior period as net realized and unrealized fair value of investments was CAD 20 million lower for the quarter and CAD 55.2 million lower for the year. In the prior year, the portfolio was benefiting from the recovery of COVID declines and resulted in significant gains. In comparison, the portfolio in 2022 was impacted by the increasing interest rates effect on discount rates and multiples. Despite these factors, we saw an overall increase in fair value for Q4 of CAD 4.4 million.
Fleets revenue and EBITDA have both improved as compared to the prior year, primarily due to an increase in syndication of new units. Also in Q4 2022, fleets backlog syndication work for 2023 and into 2024 increased substantially with new contract wins. As a result of this growth in backlog and its impact of fleet's outlook coupled with the strong results during 2022, the fair value of fleet investment increased by USD 15.2 million in the quarter.
As a result of the contemplated BCC transaction as of year-end, the fair value of the investment was increased by USD 67 million to bring the total up to the value realized in Q1. As discussed in previous quarters GWM has not realized the growth expected at the time of our investment and a slowdown in early 2023 results has further impacted their growth expectations for the year. This shift in expectations coupled with continued discount rate increases and declining multiples have resulted in a decrease in fair value during the quarter of USD 0.5 million.
LMS's revenue has increased year-over-year. However, as a result of the increase in steel prices, LMS' margins have been compressed and gross profit has declined. Although LMS has worked to include steel price escalation features and new contracts, they still have to work through current lower rate contracts and on-hand higher-priced steel in inventory which is expected to occur during the first half of 2023 with the latter half of the year expected to bring improvements to gross margins.
Based on the expected negative 25% reset for 2023, there was a decrease to the fair value of LMS during the quarter of CAD 4.3 million. Based on Amur's unaudited financial results for the year, the reset in 2023 is expected to be a positive 6%. However, due to rising interest rates in late 2022 and the expected impact this will have on new loan origination demand, there was a net decrease to fair value of this investment of CAD 7.2 million in the quarter.
In FY 2022, redemptions during the year had a cost base of CAD 130 million and attracted annual distributions of CAD 17.2 million. The proceeds from these redemptions included CAD 32 million in realized premiums for total proceeds of CAD 162 million. This is a 25% premium over the investment cost base. Deployment in the year totaled approximately CAD 156 million, which included initial annual contracted distributions of CAD 19 million. As a result of this turnover in the portfolio, we generated increased book value CAD 0.71 per unit of realized gain and increased our annual revenue by 10%.
Subsequent to the quarter, we completed a strategic transaction involving BCC and co-sponsor Brookfield. We exchanged CAD 145 million of our preferred equity for convertible preferred units and redeemed the remaining equity, which resulted in a realized premium of USD 9.7 million. The new convertible preferred units provide a minimum 8.5% yield USD 12.3 million annually on the convertible preferred paid quarterly with the ability to participate in any common distributions in excess of 8.5% as well as an annual CAD 1.5 million transaction fee.
As a result of the BCC redemption of USD 20 million as well as the smaller partial redemptions for Fleet and Unify received on December 30, subsequent to the quarter, we decreased our senior debt outstanding. We currently have USD 104 million, an additional CAD 10 million outstanding and have CAD300 million of available capacity on the facility. This is approximately a 1.4 times senior leverage ratio.
Our portfolio has a weighted average ECR over 1.6 times. The only reason for the decline below 1.7 times was the revision to BCC based on the new transaction. 13 of our 18 partners continue to have an ECR over 1.5, with LMS the only partner below one. And as mentioned earlier, we expect them to be back above one in the later half of the year.
Our anticipated aggregate partners reset totaled 1.2% in 2023, an increase of approximately CAD1.4 million or CAD0.03 per unit. This estimate is reduced due to the redemption and subsequent conversion of BCC's preferred equity into convertible preferred.
Top of the collar resets are expected from 10 of our partners. Our current outlook calls for CAD47 million of revenue in Q1 and a 12-month run rate of CAD151 million. Our G&A expectations have increased from CAD17 million to CAD17.5 million, to reflect the impact of higher FX rates on US denominated expenses, and continued elevated legal spending.
I'll turn it over to Steve now for his further comments.
Steve King
Great. Thanks, Amanda, and thanks, everybody for calling in. The last 12 months have brought a great deal of change for Alaris both in terms of our own business, as well as the world around us. Starting with our own portfolio, we continue to operate at near record levels of portfolio health, despite challenging labor, supplies, and borrowing conditions that have had large negative impacts on other companies.
Having a portfolio of required service companies, as opposed to manufacturing and companies that little or no debt, was a huge contributor to this continued strength. 2022 brought us our 14th consecutive year of positive overall portfolio resets, something I'm extremely proud of as a manager of this company.
Our track record shows a remarkable level of consistency of cash flow for our shareholders over our 19-year history. The steep increase in interest rates that we've seen over the last year has been a bit of a store for us.
On the negative side, the impact that higher rates than the tighter debt market has had on the private equity and the entire capital markets industry has reduced the number of quality assets that have come to market. We've seen a recent pickup in deal flow, which we hope continues and grows throughout the year.
On the positive side, our structured equity model now looks far more attractive than most companies as compared to traditional private equity that relies on high debt levels or straight debt options that are now extremely expensive compared to where we were just months ago. This will allow us to win a higher percentage of transactions that we're bidding on, and it also means that we'll see a significant decrease in redemptions compared to the norm. As a result, I'm quite confident in the strong net deployment outcome for 2023.
The other very exciting change during this past year was the introduction of our first asset management initiative. I believe that, the recently announced transaction with BCC ourselves and Brookfield is a significant complementary piece to our business. Not only did the transaction allow us to keep US$145 million deployed in a world-class company, it allowed us to increase our upside participation dramatically by not only having an increased return profile on our own investment, but also an economic interest on the full US$400 million that Brookfield put in.
The partnership not only underlines the quality of our portfolio, but also the value seen by Brookfield and Alaris on our team Creating a return on third-party capital is something that we feel, will have a very positive impact on our return on equity, while also improving our net deployment outlook.
Future asset management initiatives are being considered down the road, but the focus remains on deploying capital into more great companies like the ones that allowed us to post another record year of results like we just announced.
Kevin, happy to open it up to questions from the crowd.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Geoff Kwan with RBC. Your line is open.
Geoff Kwan
Hi, good morning. Just wanted to ask on the Brookfield transaction. If you're able to just kind of see if there's been any discussions about additional transactions that you might work to get on either within the existing portfolio or stuff you might be looking at going forward? And also just in general too just anything you can give in terms of an update in terms of expanding that third-party capital business?
Steve King
Yes. Geoff, there has not been any material discussions on any of our other portfolio companies. I think suffice to say that several of the groups that we went marketing to on BCC have expressed interest in other parts of our portfolio. But that's not something that's on the front burner.
Every company in our portfolio has its own story in terms of management and owner needs and also where they are in their growth cycle and whatnot. So we don't see anything imminent in terms of another kind of continuation fund like we just did with BCC.
I think one thing that we still are considering is a common equity fund with third-party capital then we'll take advantage of our proprietary deal flow caused by doing our preferred equity business. So that's probably the next thing that you'll see from us. But again, that's not anything that's going to be short-term. We're going to roll this out relatively slowly, really still focusing on growing our business, expanding our portfolio with more prep deals.
Geoff Kwan
Okay. And when you talk about the deal flow being better than last year that makes a lot of sense. But I'm just kind of curious, what you see in the deal flow right now? I mean how you would characterize what you see today versus call it like a more normalized deal environment?
Steve King
Yes. It seems, I would say compared to – like compared to 2019, I think the number of deals would be very comparable. I still think the quality of the deals is maybe a little less than what it would have been in 2019, but certainly better than what it was at this time last year, as interest rates were really starting to pick up steam and people just really left the market. So we're seeing good deal flow now.
We're seeing good quality. It's certainly not at record levels. But like I said in my notes, again where we were competing against very, very inexpensive capital both on the equity and debt side and as kind of a hybrid between the two, this is really a perfect environment for us, where the kind of cash returns that we're looking for on our preferred shares don't have the same sticker shock that they did in 2019 for entrepreneurs.
We're seeing senior interest rates, senior debt interest rates in the US now in the private debt market well into the double-digits. So for us targeting a 14%, 15% cash return, that's actually not that much off of what senior rates are right now. So it's going to be a real positive for us.
And on traditional equity offers those multiples are having to come down because they just can't get the debt in their structures that they could even a year ago. So it's been a huge change for our competitors much less so for us. So I think we're going to see a much higher win rate and we are starting to see that in reality. So we hope to be pretty active here with our deployment in the short-term.
Geoff Kwan
Okay. And if I can just maybe ask one last question. On LMS, is that investment is going to be something that will be with you over the long-term, or is there a scenario that would see that investment get redeemed at some point? And what scenario might that look like?
Steve King
Yeah. Every investment has its life cycle. LMS, I don't see an exit in the near-term. And I hope we don't to be quite honest. It's a wonderful company run by wonderful people. And they've gone through a very strange environment here with the steel prices having gone through what they went through over the last year. But based on the forecast that we've built out just with their work on hand, we're going to be looking at a really significant gain on LMS in the next 12 months.
So probably a bigger gain than we've ever had on any reset in our history. So it's -- we've been with LMS for about 16 years already. And like I say, we're certainly not looking to exit. I think there's some things that we can do going forward after we get this large positive reset that we'll be able to smooth it out into the future, but we're certainly not looking to exit it.
Geoff Kwan
Okay. Thank you.
Operator
One moment for our next question. Our next question comes from Gary Ho, Desjardins. Your line is open.
Gary Ho
Thanks. Great, and good morning. Steve just wondering with the higher interest rate environment, does that change the way you look at capital deployment industries that might -- that you might want to avoid or how you underwrite a deal? Just want to pick your brain on that.
Steve King
Yeah. I mean, we are very long-term in our horizon Gary as you know. So we try not to be a flavor of the day investors. We're looking for solid cash flow streams that exist in any kind of economic and interest rate environment. And so nothing is going to change there. And it's largely why we have been untouched if you will from things that have happened over the last few years, because of that focus that we've always had.
So there's not many companies in our portfolio that are impacted by it. There's really -- if something that we see in terms of a new deal has a really big dependence on low interest rates obviously we're going to evaluate that. But again we keep an open mind. We've kept our same investment criteria for 19 years. And so we've got a lot of smart people within the company looking at these companies and a lot of third-party advisers that help us out. So I really don't see too much change there and it isn't really an area that has or will impact us.
Gary Ho
Got it. Okay. That's helpful. And then my next question maybe for Amanda. Just on the ECR change to 1.6 times, I think you did mention in your prepared remarks some of it is related to BCC. Can you, kind of, walk me through that piece? Was the Brookfield’s investment considered as debt or debt like? Just not sure how we can -- not sure if you can parse out how much of the ECR crop was BCC related.
Amanda Frazer
So, the change in their ECR is really driven by having a larger amount of now that prop attracting the 8.5%. And I sort of added to my remarks that we do expect that with the growth trajectory that BCC has, we will see that tick up over the course of the year. So I don't think it's going to be too many quarters before we see that BCC ECR move back above 1.5.
Gary Ho
Okay. But was that the biggest contributor from the drop from 1.7 down to 1.6 was the BCC?
Amanda Frazer
Yes. If BCC hadn't have moved that metric would have remained above 1.7.
Gary Ho
Got it. Okay.
Amanda Frazer
So that drop is entirely BCC. Yes.
Gary Ho
Okay. And then, just maybe on the discount rate increase you mentioned, have you now marked it up to market, or is there going to be more gradual increases over time trying to see if there could be further fair value markdowns just looking out?
Amanda Frazer
So, yes, our discount rates are currently marked to current -- the interest rates as of December. Canada is holding flat, seems now. So that should cease to be pressure on our Canadian portfolio. We'll have to see what the US continues to do, because as they continue to change rates that will impact further the US portion of our portfolio.
Gary Ho
Okay. Got it. Okay. Those are my questions. Thank you.
Operator
One moment for our next question. Our next question comes from Zachary Evershed with National Bank Financial. Your line is open.
Zachary Evershed
Thank you. Good morning, everyone. Congrats on the quarter.
Steve King
Hi, Zach.
Zachary Evershed
So we got some good color on the deal pipeline from an earlier question. Maybe you could give us a little bit of color around the redemption outlook for 2023. It does seem to be lower. But is there anything that's headed that way?
Steve King
We actually don't see anything on the horizon this year, Zach. Obviously, things can change but just speaking individually with each of our partners and knowing that, for the companies that maybe would have been interested in selling in the normal environment, but be not interested in selling in this environment. So the plain reason that we are seeing fewer high quality deals is the exact same reason that our high-quality companies are not interested in doing anything in terms of selling.
So, yes, I think it will be a very light year and unusually late year for redemptions, which obviously, we're find that, especially given how well our companies are performing.
Zachary Evershed
Makes sense. Thanks. And then we noticed some fixed rate hedging disclosures. Are you going to continue to hedge interest rates or let that expire?
Amanda Frazer
We do have another hedge rolling on. So, we've got two interest swaps that roll off in June and another one that rolled on. I think with the level of debt that we currently have outstanding, we're still pretty well-covered even once that switch on happens. I think it's a $50 million swap, so that would be 50% of our debt.
I don't think that we would do anything near-term. I think those longer view swaps are lower, you're looking at around 3%. We might book something further out beyond when that current 2023 swap rolls off, but yes, I don't think we would layer on anything additionally at this point.
Zachary Evershed
That’s helpful. Thanks. I'll turn it over.
Operator
And I'm not showing any further questions at this time. I'd like to turn the call back over to Steve for any closing remarks.
Steve King
Great. Thank you very much everybody. And I will just make a brief comment on the rates that are used to value our fair values. And obviously, especially in an environment like this like I just talked about where redemptions are going to be very unlikely, I don't to be honest pay too much attention to the decline in fair values that are based on the rates that are used by KPMG and the valuations.
Operator
Pardon me, Steve, didn't mean to interrupt. We just have had another person queue up. Just give me one moment to promote the line, okay.
Steve King
Okay. That’s fine.
Operator
Our next question comes from Trevor Reynolds with Acumen Capital. Your line is open.
Trevor Reynolds
Hey guys. Just on that deal pipeline, what -- is there any related to kind of add-on deals? Are you seeing any potential there from the partners?
Steve King
We're actually seeing significant potential there Trevor. And again another offshoot from a difficult market for a lot of people. If you think about it, there's going to be more companies that find themselves in a position where they need to sell. If they need to refinance their balance sheet for example. This is now an extremely difficult environment to do that in.
So, we're seeing more acquisition opportunities for our partners. We're working on several of them as we speak and it could be a fairly significant part of our deployment budget for this year.
Trevor Reynolds
Great. And then are you able to provide any more color on GWM and kind of what's driving that? Maybe just when you start to see that turning around potentially?
Steve King
Yes. The management team at GWM is still extremely bullish and it's one of those things that I almost find is misleading on these fair values as this is still a very good company and we're not looking at a company that's in a huge state of decline. This is just kind of using a fairly conservative flat outlook for them for the next year as opposed to the traditional growth curve that they had.
So still a very good company. They did have some of their end users large advertisers that cut back their budget trying to be conservative leading into potentially a recession in the US. So that was fairly standard throughout the advertising industry throughout the US. So they kind of just went along with the industry. We do expect them to get back on that growth trajectory and they've got several initiatives that they're extremely excited about. So I think it's still a very good holding for us.
Trevor Reynolds
Great. Thanks for taking that question.
Steve King
Yes. No problem.
Operator
And I'm not showing any other questions at this time.
Steve King
Okay. So just to finish my comment and GWM actually is a good segue into that. You know, being a public company in the private equity space having to fair value these types of assets on a quarterly basis is not overly relevant. We're happy to do it and we keep on showing growth in that number. But with this discount rates rising, it makes a really material impact on valuation. So it's not something that I get to talk about. I am very much still a cash flow-based investor at Alaris and to have a 39% payout ratio and the kind of coverage ratios that we have and all of our investments is -- leaves us in a really tremendous place to grow and to keep on deploying capital.
So happy to chat with anybody offline, if you have any more questions. But in the meantime thank you very much for tuning in. We'll talk to you next quarter.
Operator
Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.
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Alaris Royalty Corp. (ALARF) Q4 2022 Earnings Call Transcript