Alaris Royalty Corp. (ALARF)
Q2 2022 Earnings Conference Call
August 10, 2022, 11:00 am ET
Company Participants
Amanda Frazer - CFO
Steve King - President & CEO
Conference Call Participants
Nik Priebe - CIBC
Geoff Kwan - RBC
Gary Ho - Desjardins
Zachary Evershed - National Bank Financial
Trevor Reynolds - Acumen Capital
Presentation
Operator
Ladies and gentlemen, thank you for standing by. Welcome to the Alaris Q2 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].
I would now like to turn the call over to your host, Amanda Frazer, Chief Financial Officer. You may begin.
Amanda Frazer
Thank you, Kevin. We appreciate everyone taking the time to join us this morning. We are excited to present our Q2 results. I am joined on this call by Steve King, President and Chief Executive Officer of Alaris.
Before we begin, I'd 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 as a result, 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 heading 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 it 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.
Now for the Q2 highlights. Q2 revenue of $56.5 million was up 62% over the prior period driven largely by $17.2 million of deferred Kimco distributions received upon their redemption early in the quarter. The remaining $39.3 million represents a 13% increase over the prior period. Drivers of this increase include new and follow-on investments year-over-year, receipt of monthly catch-up payments from Planet Fitness and year-over-year increases in average exchange rate.
Cash generated from operations prior to changes in working capital of $44.4 million was an increase of 51% over the $29.4 million in the prior period. Again, mainly as a result of the gain and deferred distributions received from the Kimco redemption.
The increase in the quarter was partially offset by an increase in G&A expenses. $2.5 million of the increase in G&A is due to a change in the mechanics of the bonus calculation. Bonus accruals are now made on a quarterly basis and driven by a percentage of total cash flow available for distribution.
The accrual in current period doesn't change Alaris' expectation for total salaries and benefits expected in fiscal 2022. Another $1.5 million of the increase was due to increased spending on further exploring the corporate implications of the AUM strategy, administrative costs from closing an inactive subsidiary, and increased legal spending in regards to the Sandbox matter. These costs are events specific and not expected to be ongoing in nature.
Quite a few of the fair value changes in Q2. On a net basis, including the common units a decrease of 500,000, as increasing interest rates, impacts discount rates and move multiple slower, we anticipate continued impact into Q3. Despite these factors, we saw increasing fair values for Amur of $6.2 million, fleet of US$4.4 million and BCC US$2.1 million. All of these companies continue to see record highs in their respective businesses with significant growth over prior periods.
Amur continues to see both organic growth and has been entering into new partnerships, which are driving incremental demand. Amur has also grown their base assets under management each quarter, which provides a stable income source that alone would provide an ECR of greater than 1.8 times.
Fleet has been able to generate an increase in syndications through both new customers and growth in current relationships with a large backlog, their outlook for the remainder of 2022 and 2023 continues to be very positive.
BCC continues to see impressive year-over-year growth with record high activity the past number of months. BCC has also improved mix leading to revenue increases per procedure. The combination of which has resulted in an upward revision to our reset metric, same customer sale.
Offsetting these increases were declines in GlobalWide of US$10.8 million, SCR of $4.4 million, and LMS of $1.5 million.
GWM while continuing to maintain a strong ECR has not achieved the growth expected at the time of our investment. This coupled with low interest rates and peak multiples at the time of our common investments and the shift in these metrics in recent months have driven a revision to the common fair value of US$4.5 million. While they are seeing month-over-month top-line growth and the company has diversified their customer base as compared to the prior year, we've decreased our reset expectations to reflect its performance. As a result, the preferred equity value decreased by US$6.3 million. Despite this slower than expected start to their growth and initiative, we've not changed our long-term view on the trajectory of this business and remain confident in the outlook for this investment.
SCR business can be impacted by the timing of project-related work throughout the year. This coupled with inflationary wage pressures and increased competition have impacted our expectations for the cash flow suite for the first half of the year and resulted in a fair value decline. While the first five months were down compared to the last year, their project work through the summer has picked up and we expect the last half of the year to improve. They continue to pay their monthly fixed distributions and with no bank debt in the company, we don't expect any risk to these payments.
LMS is reset for the current year was adjusted due to the finalization of their 2022 audit. As a result, our reset was revised down from 18% to 21%. This change drove the decline in the fair value and no changes to any current expectations were made to the calculation.
Other less significant movements in DNT, Edgewater, Heritage, and Planet Fitness rounded out the changes in the quarter.
In addition to a small follow-on with Heritage for US$3.5 million during the quarter, we deployed a further US$26 million into our existing partner Accscient earlier this week. The follow-on investment included US$16 million of preferred equity and US$10 million of common equity. These two investments bring our year-to-date deployment to a $116 million.
During the quarter, we decreased our senior debt outstanding by US$77 million as a result of both the US$67 million Kimco redemption as well as US$10 million through cash flow as a result of our low payout ratio. Following the Accscient investment earlier this week, we currently have $287 million of senior debt outstanding resulting in $113 million of available capacity.
Our portfolio continues to have a weighted average ECR of over 1.75 times with 14 of 18 partners continuing to have an ECR over 1.5 and 11 of those being over two times. Our current outlook calls for $39.3 million of revenue in Q3 and a 12-month run rate of $159.3 million, up from $154.8 million last quarter.
I'll now turn it over to Steve for his comments.
Steve King
Great. Thanks, Amanda, and thanks everybody for tuning in today.
Obviously really excited about another record quarter of revenue and earnings. It's a nice profits that we get from steady monthly distributions from our 18 partners and combined with intermittent earnings from the sale of assets like we just had with Kimco continues to build both our book value as well as provide our shareholders a really valuable stable yield.
So while we're in statistically a period of economic decline, our portfolio remains as strong as ever with most of our companies still putting up record results on a monthly basis. And as discussed before our portfolio is ideally suited to be a defensive vehicle, even that our partners share some of the -- some very important features.
First of all, our companies are almost all required service businesses that don't show very much economic sensitivity historically. While some of them may have slight declines in short-term periods, these companies have been operating for an average of 25 years and have all shown strong performance in various environments.
The second factor is low debt levels. The majority of our partners don't have any long-term debt on their balance sheets and the ones that do have much lower than industry comparables. The combination of potential earning declines and borrowing cost increases and lender increased conservatism that will impact many companies will not have a material effect on our portfolio.
Thirdly, our structure itself is ideally suited to the environment we're in today. The fact that our distributions from our partners increase with revenue and not from the bottom line insulates us from the impact of inflation. And in fact, that actually benefits us since the revenue in an inflationary environment will go up and we get protected because we don't share in the increased cost below the top-line.
The final shared factor is the alignment and quality of our management teams, each of these groups has chosen us specifically for being able to stay in control of their businesses and keep more of the economic upside. Having top people that are heavily incented and are in fact majority owners of the businesses also allows a portfolio to be more resilient in challenging times. The best management teams always find a way to get through and even flourish in these types of environments. We also have on average 75% cash flow buffer from our partners to pay their distributions and we ourselves have a record low payout ratio of just over 60% that we payout to our shareholders.
From a deployment point of view, we have seen a higher flow of new deals come across our desk over the first six months of the year. But the quality of those -- of those companies has been lower than in previous years and we are very strict in our investment criteria. This is not unexpected and it's actually in keeping with what we saw in 2009, as we came out of the Great Recession, simply the best companies make the decision not to go to the market during the times like this. They wait until markets are better because they can.
With all that said we're starting to see rebound in the quality of opportunities and expect to be active in the second half with not only more follow-on transactions, but also adding new partners to our stable.
On a broader viewpoint, a higher interest rate environment is a huge positive to our deployment opportunities going forward. As a cash pay investor, the cost of our preferred shares compared to debt always looks far more attractive when debt rates are higher, which we haven't seen in obviously a number of years.
Higher interest rates also means more challenging deal terms being offered by traditional common equity competitors. We expect our win rate to improve from previous years and our total deployment to increase as higher quality companies return to the market. We've been in the lowest interest rate environment in history over the last decade. So we're very much looking forward to competing in a higher capital cost setting.
As we've alluded to in our disclosure, we continue to make progress on our asset management strategy that we've communicated in previous quarters. There are several opportunities that have presented themselves to us all at various stages of certainty. And I'm quite excited about these opportunities. I think it'll be a great add to our revenue and earnings without requiring capital. And it'll also very much benefit our preferred shared deployment capabilities.
So Kevin, we'll open it up to questions if you can.
Question-and-Answer Session
Operator
[Operator Instructions].
Our first question comes from Nik Priebe from CIBC. Your line is open.
Nik Priebe
Wanted to start with a pair of questions on a couple of private company partners in the quarter. You'd made some good comments on GWM and what you're seeing there with the negative fair value change as well as revenue and EBITDA being down on a year-to-date basis. I think in the qualitative script in the MD&A, you had alluded to the fact there was a lower earnings contribution from the legacy performance division. Can you help us just understand what share the business mix that might represent? And also what the magnitude of the enterprise wide decline might look like? I don't think it moved ECR bands in the quarter. So I'm just wondering how meaningful that that shift in performance has been?
Steve King
Yes. We don't think it's going to be meaningful long-term. This was always a division that was essentially being wind down. They had a large customer last year. It was actually TikTok that represented the majority of that performance business. TikTok changed their kind of medium in terms of their digital advertising. So that dropped right off. So that was the -- essentially the main cause for the decline in the performance business. This is purely a programmatic play for us as an investor and programmatic has been growing. And the company actually has a much bigger backlog than they've ever had in their history. So they are very confident in the second half of this year based on that that book backlog. So we're -- we -- as Amanda said we haven't changed at all our expectations for this investment over our investment horizon, but certainly the first half of the year was impacted by that one customer.
Nik Priebe
Okay. Understood. That's helpful. And then just moving on to SCR, I was wondering if you could expand a little bit on some of the headwinds that they're facing and your outlook there. I know they dropped down to a lower ECR band. I suspect that that's the type of business that would have a pipeline of work in front of it. Do you have good visibility and that gives you confidence in the sustainability of the current distributions you're receiving from that investment.
Amanda Frazer
Yes. The investment is really project based and the timing of where those projects falls can move at any time during the year. And that's what we saw here we did have a slower start in the first five months of the year as compared to the prior year. And we've seen that rebound in the last few months and we do have good visibility to the end of the year. So we don't foresee this continued decline. We think things will level off and continue to work pretty closely with management with regards to the forecast further out.
Nik Priebe
Okay. Okay. Very good. And last one for me before I pass the line. You had some comments in the press release around the progress you've been making on the development of the third-party asset management platform. Maybe it's still early days, but do you have a sense of what level of AUM might be necessary to achieve breakeven. I'm just trying to triangulate how large that that might need to scale before it's capable of producing kind of an independent earnings contribution.
Steve King
Well, if it really doesn't require much at all in any assets that we manage will have a work fee as well as a carry and that work fee will more than cover our expenses. We already have essentially the infrastructure fully in place to do this type of thing. So we don't anticipate needing to add very many people. And so it should be -- everything should be quite incremental to our revenue and earnings when it comes to the addition of asset management and assets under management. So we're pretty excited about it as I said, we do have a few things; we've learned a lot and have been approached on different types of concepts.
So we're still getting things sorted out there. There is some kind of infrastructure to put in place from a regulatory point of view and making sure that any conflicts of interest are sorted out. All of those kind of things have added to our expenses. But that should be more or less a one-time cost in advance of setting up the asset management division and we don't expect those kind of expenses to persist.
Operator
And one moment for our next question. Our next question comes from Geoff Kwan with RBC. Your line is open.
Geoff Kwan
Hi, good morning. Just to your comments on the existing partners and potential acquisitions you're doing. Are these acquisitions that they kind of signed and you're just waiting to close? Are these ones that you have some insight of what they may potentially be looking at trying to do in the second half of the year?
Steve King
Yes. We've got a few partners that are like Accscient that just we just closed this week. An environment like we're in today actually presents more opportunities for companies like our partners that have the financial wherewithal and backing to go out and acquire companies. So it's a little too early stage to talk about probabilities and sizes, but which the nice thing about having a large portfolio is that in any given quarter we're likely working on probably one or two follow-on deals with our current partner. So it's a nice kind of steady stream of deployment opportunities for us.
Geoff Kwan
Okay. And just my second question was you kind of talked about you seeing still good I guess a quantity of deals come in on your plate, but the quality isn't quite as good. Is it -- is it you're bringing shown sectors that you don't have interest? Is it some companies may have leverage or are you getting referrals from you people outside your kind of traditional network of referral partners?
Steve King
Yes. It's a combination of all those things. So we certainly have seen more what I would call cyclical companies come to the market, trying to get a deal done maybe before things get tough. We've also seen companies with higher leverage numbers come to the market, trying to refinance their balance sheet. That's again not really something that we do.
So -- but it's all -- it never lasts very long. At the end of the day, the good companies will require capital. And I think with any recession, with anything in the public markets, even in the private the kind of the concept of an impending recession is usually worse than the recession itself when it -- when you're in it. So we just need to get through this period of uncertainty and whatever the world looks like once we know what it looks like, that's when the companies move back in, the good companies move back in and take advantage of whatever opportunities they have. So we're already starting to see a return to some better opportunities, but we've been doing this for almost 19 years now. So we've been through the cycles, we've seen it before and we’re pretty confident in how it's going to end up.
Operator
One moment for our next question. Our next question comes from Gary Ho with Desjardins. Your line is open.
Gary Ho
Steve – yes, you mentioned your model benefits in inflationary period. Just wondering on the reset side, you probably have seven months of data, how does the 2023 rate reset kind of looks right now or tracking just maybe you comment on your -- on the larger investments, looking at the portfolio summary table kind of top five looks pretty healthy here just increases on revenue year-over-year and decent EBITDA growth as well.
Amanda Frazer
Yes. At this point, I mean, we'll have to wait and see how the back half of the year plays out. And if this sort of economic slowdown that people are expecting materializes, but at the moment, we're looking at probably a fairly healthy reset across the Board. The more meaningful partners are doing well as well as a number of the smaller partners and it all adds up to a fairly decent increase from expected reset.
Steve King
One of the swing factors that we've had is the one uncolored partner in LMS, where we had a pretty large decline last year, which muted the really significant growth that the rest of our portfolio had. And we are hoping that that LMS gets a little bit of that back this year. Things on the steel side have stabilized. And so I think they're expecting a better second half of the year than they had the first. And certainly going into next year I think it's going to be a very good environment for them because the demand from their customers is still extremely high, was really just a margin issue with the price of steel more than doubling in a very short period of time.
Gary Ho
Okay. Got it. And then my next one. Just going back to the capital deployment side, good to see the two follow-ons. Did notice the higher yields, 15% did notice for Heritage. Is that a trend that we should expect on future deployment like slight bump versus the 13% we've seen in recent deployment? Or is that more of a one-off?
Steve King
No. I think it is something that you can expect more of. Some of the deals that we're bidding on right now, we are able to get a 15% as opposed to probably traditionally a 14%. That is another advantage of a higher interest rate environment is, we're seeing a lot of these companies getting debt reads on senior debt at 8% to 10%. So having this kind of preferred equity that shares in the business risk and gives them eliminates refinance risk because they never have to pay it back if they don't want to. The value of our offering is much higher than it was before in the previous environment.
So yes, I think you can expect a few more 15s still some 14s in there, maybe the odd follow-on like Accscient, the follow-on deal where we have almost no costs and a trusted partner. We did that at 13.3%. So but yes, you'll certainly see some new deals at 15% moving forward.
Gary Ho
Okay. And then just on the other side, any potential redemptions in the second half of this year that we should monitor.
Steve King
Oh, redemption. I mean, as always with an 18 company portfolio, so our average hold period over the 18 years has been about 5.5 years. So just doing the math, we should get a couple each year. So there are a couple of companies that that expressed a desire to sell and move on. So quite frankly, I would quite welcome that eight of our partners, we now have common equity in, out of the 18. And having some liquidity, some crystallization of profits on our common, I think would be very good to show and would also really dramatically increase the kind of the operating leverage we have where we'll have money coming in, that we weren't getting much credit for that we'll be able to then redeploy into new investments that'll generate cash.
That's a really good equation. It increases our growth rate without needing to go to the market. So redemptions are not something that I'm afraid of. I'm hoping they -- we -- I'm hoping we get a couple in the second half of this year.
Gary Ho
And then maybe just follow-on to that, Steve is that some of those redemptions that they kind of top five, like just trying to pick how big those can be?
Steve King
Yes. That I'm certain at this point, Gary.
Operator
One moment for our next question. Our next question comes from Zachary Evershed with National Bank Financial. Your line is open.
Zachary Evershed
For SCR, could you help us quantify the risk of an interruption in distributions?
Amanda Frazer
Yes. At this point, like there -- the lack of debt within that business, there's really no reason that we would be turned off. And that 4 point, I think it's $2 million of fixed distributions. We're quite comfortable with that. We don't really see there being any risk to those payments at this point in time.
Zachary Evershed
Good color. Thanks. And then just more macro to get my head, right. Markets are turbulent. So deployments have slowed a little, but with rates moving up, as you mentioned, shouldn't there be more interest in Alaris from higher quality companies given the lower spread to debt?
Steve King
Yes. It really and this is what I was trying to say over the course of our 18 years, especially through 2008/2009. We did see an increase in demand for our product, but there was a lag because if you're a really successful cash rich company, you're just not going to go to the market when things are this turbulent. And so you do end up waiting, companies that can't wait are in the market, companies that can wait, which is think of the market sector that we're interested in. They have waited. So but that never lasts long like we've never seen anything more than a like a six-month interruption in that flow.
And we are starting to see some good opportunities now. So for us, there's no feeling of pressure to do deals. They have to be the right deals. So if just like in 2009/2010, we didn't do a whole lot of new stuff. We focused on our current portfolio and helped them grow. So it's been a similar situation this year, not as pronounced as it was in 2009, but I think we'll benefit from being patient and waiting for those good companies to come back and they are.
Operator
One moment for our next question. Our next question comes from Trevor Reynolds with Acumen Capital. Your line is open.
Trevor Reynolds
Just on the Accscient common equity, is there any expectations around dividends from them?
Steve King
Probably not in the short-term. No, they have a little bit of debt on their balance sheet and they always have growth opportunities. So I think the vast majority of their cash flow will go into those growth opportunities. That's -- this is a company that we've wanted to own common shares in since the start of our investment with them. And quite honestly, when we sat down with the principal of Accscient and worked through the math of how much common equity value we had created for him over the last four years, it really was a matter of, you know what, you're right. It's probably right to share some of that with you going forward. So we're quite ecstatic to be common equity partners with their management team and we -- we've got a partner there that has shown a really outstanding ability to create value and that's not going to stop, but yet it'll be more exit weighted than dividend weighted.
Trevor Reynolds
Great. And then this has kind of been a theme in some of your follow-on investments is adding the common equity portion. Is this something we should expect on some of the follow-on investments that you have expect for this year?
Steve King
It is. Yes. I think at the end of the day, we've been doing the common equity investments for the last, I guess three years now. And we're really excited about what it is providing to us both in terms of increased deal flow. But mostly just a much better return profile for our total investment. And I really like the alignment of it with the management teams. So, yes, that is something that you can expect. I -- we still won't be able to get it in all cases. There's still companies that just refuse to issue any common equity because they know that that's the most expensive capital that you can issue, but where we can we would like to have kind of a small part of our investment being common along with our kind of bread and butter craft business.
Operator
And I'm not showing any further questions at this time. I'd like to turn the call back to Steve King for any closing remarks.
Steve King
Okay. Well, thanks again, everybody for tuning in and we see more good things for the rest of this year. So we look forward to sitting with you over the next three months and sharing our next results in November. So thanks very much.
Operator
Ladies and gentlemen that does conclude today's presentation. You may now disconnect and have a wonderful day.
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Alaris Royalty Corp.'s (ALARF) CEO Steve King on Q2 2022 Results - Earnings Call Transcript