Alaris Royalty Corp. (OTC:ALARF) Q2 2023 Earnings Conference Call August 3, 2023 11:00 AM ET
Company Participants
Amanda Frazer – Chief Financial Officer
Steve King – President & Chief Executive Officer
Conference Call Participants
Nik Priebe – CIBC Capital Markets
Gary Ho – Desjardins
Jeff Fenwick – Cormark
Zachary Evershed – National Bank Financial
Operator
Good day, and thank you for standing by and welcome to Alaris Q2 2023 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded.
I would now like to introduce your host for today’s call Amanda Frazer, CFO. Please go ahead.
Amanda Frazer
Thank you, Justin. We appreciate everyone taking the time to join us this morning as we present our Q2 results. I’m joined on this call by Steve King, President and Chief Executive Officer of Alaris.
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 plus 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 MD&A for more clarification regarding non-IFRS measures.
Now for the Q2 highlights. Q2 revenue of CAD 36.9 million was down 35% over the prior period driven largely by CAD 17.2 million of deferred Kimco distributions received upon their redemption in 2022.
The remaining Q2 2022 revenue of CAD 39.3 million as compared to the Q2 2023 represents a 6.2% decrease over the prior period. Drivers of this decrease include the deferral of the Q2 LMS distribution, which we’ll be resuming in Q3 and a reduction in BCC distributions as a result of the strategic transaction announced last quarter.
Cash generated from operations prior to changes in working capital of CAD 28.3 million was a decrease of 36% over the CAD 44.4 million in the prior period again mainly as a result of the deferred distributions received from Kimco’s redemption last year. After adjusting the Q2 2022 results for Kimco’s distribution, the adjusted change in cash from operations prior to changes in working capital is a decrease of — an increase, I’m sorry of 4.2%.
Also contributing to the adjusted increase in cash generated from operations prior to changes in working capital for Q2 was a 26% decrease in G&A. And after adjusting for the settlement of the Sandbox litigation, which was resolved in the quarter, although accrued in Q1, the six months 2023 G&A amount is down 19%.
With ongoing legal and accounting fees returning to historical levels with the wrap up of the Sandbox matter and salaries and wages based on more normalized operations as compared to an unusually profitable 2022, we expect G&A to maintain these lower levels and have updated our outlook to reflect an anticipated CAD 15.5 million in a good 12-month G&A.
Quite a few fair value changes in Q2 on a net basis including the common units an increase of CAD 9.9 million as net changes in market rates had a positive impact on discount rates and strong performance in a number of our partners resulted in increases in fair value.
We saw increasing fair values for BCC of US$8.5 million, Fleet of US$4.9 million and Ohana Growth Partners formerly Planet Fitness Growth Partners of US$3.6 million. All of these companies continue to see record highs in their respective businesses with significant growth over prior periods.
BCC continues to see impressive year-over-year growth with record high activity in the past number of months as they execute on their development plans. Fleet has been able to continue to generate increases in syndications through both new customers and growth in current relationships. With a large backlog their outlook for the remainder of 2023 and 2024 continues to be very positive.
Ohana Partners saw a rebound in fair value after a number of quarters with adjustments related to increasing discount rates as a result of movement in the risk — equity risk premium. This coupled with increasing year-over-year memberships and the expectation of a positive reset on the preferred distributions for 2024 which drove increase in fair value.
Offsetting these increases were declines in Accscient to US$7.7 million and SCR of CAD 3.5 million. Accscient — while the business continues to maintain high levels of revenue pressure on margins and an investment in corporate supports and structure has impacted EBITDA, while they expect month-over-month improvements in results these pressures are expected to continue throughout 2023. As a result, the common and preferred equity value decreased further in the quarter.
As a result of an adjustment to the timing of SCR’s project-based revenue the cash we’ve anticipated for 2022 was decreased. SCR’s business can be impacted by the timing of project-related work throughout the year. SCR’s distributions were previously adjusted to include a monthly fixed distribution and a cash sweep that varies with the profitability of the business.
Expectations for future cash week distributions have also been revised to reflect current market conditions and resulted in the fair value decline. Results for the first five months are up compared to last year and we expect the last half of the year to remain consistent. Other less significant movements included D&M, Edgewater and GWM.
As previously announced during the quarter we invested $36.5 million into a new partner FMP, a professional services firm that provides workforce and organizational management solutions to the public sector. The investment includes $30.5 million of preferred equity and $6 million of common equity. This brings our year-to-date deployment to CAD 49.5 million.
Subsequent to the quarter, proceeds from excess cash flow were used to repay debt, bringing the outstanding amount to approximately CAD 184 million resulting in CAD 266 million of available capacity. Our portfolio continues to perform well and has maintained a weighted average ECR of approximately $1.6. Our current outlook calls for CAD 37.6 million of revenue in Q3 and a 12-month run rate of CAD 157.3 million.
I’ll turn it over to Steve now, for his comments.
Steve King
Great. Thanks Amanda. A quarter of very stable results for our portfolio and as indicated from the fair value adjustments the value of our portfolio has increased quarter-over-quarter to around CAD 0.21 a share of net increase in our book value per share from the fair value rate ups.
Specifically we’re pleased to see the recovery from LMS, who have worked very hard through their way of short-term inventory issues and then the port strike in the West Coast over the last couple of months and expect full distributions to return this month.
GWM is another country — company, that’s come through some underperformance in the past and is now on a very solid trajectory. Our largest partners BCC and Planet Fitness Ohana continue to be among our strongest performers.
And I would point out that the decision that we made as management to trade in our traditional preferred shares with a capped growth option for preferred shares that are convertible into common shares without any cap has really started to show its benefits with the large rate up this quarter which we expect more of.
On the negative side as Amanda said, the Axion and SCR have been under pressure for very different reasons. So Alaris management is digging in and helping those companies as much as we can. Overall, we’ve seen the portfolio-wide earnings coverage remain very stable.
And I would say the bell curve for our 2019 company portfolio is a little higher than what you would expect. With half the year already reported in by our partners, we’re starting to get a good sense for what our distribution resets are going to be for 2024. And it’s looking like another strong year.
Looking forward we’ve seen a very productive increase in the deployment opportunities from our advisory community after a relatively slow 18-month period largely attributable to the private equity markets finding its footing. I mean, rapidly rising interest rates activity appears to be higher in Q3 and indications from the M&A advisers in the US is that Q4 will be a very busy quarter.
Alaris has several transactions in process that we believe will allow us to meet or exceed our deployment targets that we’ve set for the year. And along with good opportunities the other part of our growth is access to appropriately priced capital.
While our current share price doesn’t make equity offerings economic we are in a very strong position in our balance sheet by using the CAD 266 million on our credit facility as well as our free cash flow that we generate every month.
So Justin, we’ll open it up to questions, if you would please.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] And one moment for our first question. Our first question comes from Nik Priebe from CIBC Capital Markets. Your line is now open.
Nik Priebe
Okay. Thanks for the question. For companies like, LMS that have experienced temporary headwinds, you’ve demonstrated a willingness to be accommodating regarding a temporary suspension of distributions until cash flow pressures abate.
Have you ever contemplated, less conventional workout efforts like, a conversion of some component of the preferred equity investment into common? Like is that an option that could be considered to help layer in more common equity exposure overtime?
Steve King
Yeah. It definitely could Nik, and it has been considered in the past. And in all these cases it really depends on what the situation is. In LMS’ case, it really was a very — almost a formulaic issue that they had that wasn’t — we knew exactly what their backlog of orders were exactly what the margins were on those contracts exactly what price their inventory was at.
So we knew, not to the day, but we knew pretty well when this issue was going to resolve itself and we worked with the company and their lenders at BMO to get through it. And so it all came out in the wash almost exactly as we had hoped. And these guys — we’ve been partners with LMS for 17 years. They’ve been running this business for over 30.
So, a lot of familiarity a lot of trust in that situation and again it was a very kind of formulaic type of situation. In other situations where you may not have as good a handle on the outcome, then kind of shifting the capital structure like what you suggested could be a good solution for it but each one has its own kind of story.
Nik Priebe
Yeah. Okay. No, that makes sense. And then can we spend a little bit of time on D&M leasing just revisiting that partner? It sounds like higher interest rates are pushing vehicle leasing rates higher, which in turn is having an impact on demand.
Is that business also impacted by the chip shortage and the corresponding curtailment of new vehicle supply? Just be interested to hear a bit more about some of the headwinds impacting that business and maybe your outlook there on a go-forward basis?
Amanda Frazer
It has been impacted by the chip shortage and just the general supply of new vehicles into the market. What we saw last year with high used vehicle pricing and lower interest rates was that a lot of people were able to get out of and renew leases sooner and get into newer and maybe a step-up level of cars just because of the value that was in the used car that they were returning.
And that pulls a lot of their volume forward. So their results I think in last year and the year before that were quite a bit higher than we were expecting as they were able to turn over their customers faster.
Now that we’re getting into a period where interest rates are higher, it’s really starting to see a lot of people hold on to their vehicles for a longer period of time, although they’ve been able to bring in a lot of new customers to fill that gap, which they turn their customers, they have a lot of repeat business. So in the long-term we see this as a big advantage for them. They have seen those vehicle access improved in the last year. So that’s bearing on them a lot less than it had in the past.
Nik Priebe
Okay. That’s good color. And then last one for me. It sounds like you’re optimistic about the pipeline of transaction activity that you have in front of you. Just on the other side of the coin as you look across the portfolio today, do you see potential for any redemption activity in the second half of the year?
Steve King
We don’t have anything that’s on the radar in terms of redemptions. I guess, it’s one of the nice things about having an unsteady capital markets out there that most companies know that this is probably not the right time to get their optimal sale price. So, no, we don’t anticipate any redemptions in the second half.
Nik Priebe
Yeah. Okay. Very good. That’s it for me. Thank you.
Steve King
Thanks Nik.
Operator
And thank you. And one moment for our next question. And our next question comes from Gary Ho from Desjardins. Your line is now open.
Gary Ho
Thanks. Good morning. Steve, just to start off here, just going back to your comments on the active deal pipeline for the back half of the year. Wondering if you can share what you’re looking at any update on the PE environment and general valuations and the type of deals that come across your desk here?
Steve King
Yeah it’s a good cross-section of deals that we’ve seen I would say quality has improved. The same, kind of, comment I was just saying to Nik about the lack of redemptions expected. It’s the same thing on the deployment side where we saw a lot of the best companies just stay away from the market for the last 18 months. That seems to be coming back.
And I would say the reason they’re coming back is because the PE market has recovered quite a bit in terms of valuations, and it is still a very aggressive competitive environment and the amount of capital that is uninvested in PE overrides the fact that credit is still more expensive and tighter than it used to be a couple of years ago. So the liquidity in the private equity industry is still very, very high. And so multiples really have not come down very much from where they would have been pre-interest rate increases. So it’s an interesting phenomenon, different industries are treated differently within that. But overall that’s the environment we’re seeing.
Gary Ho
Okay. Thanks for the color. And then the second question I just want to touch on the BCC, of course, back here. So decent fair value right up CAD8.5 million, I think you provided some hurdles related to the allocation of profit in the MD&A certain targets are achieved. Maybe can you just refresh me on the mechanics of that? Is that only recognized upon monetization? And also remind me is there a catch-up distribution piece at year-end at all if the business continues to perform as expected?
Amanda Frazer
So with regards to the hurdles, those will be realized in the financial statements as they’re hit. I think there’s a note in there that says we have not hit any of those profit allocation hurdles as of yet. But when we do, it will start to impact the fair value further of BCC as they’ll be reported as part of that number we see in the financials.
What was the second part of the question?
Gary Ho
Well, the make up…?
Amanda Frazer
The makeup. So if at the end of the year BCC’s common equity declares a dividend in excess of that 8.5%, we will see a catch-up payment. So it is possible that the BCC return may be higher than that 8.5% for the year, but that isn’t something that we’re in control of and we’ll have to wait and see what the common shareholders decide at the end of the year.
Steve King
Yeah. And we wouldn’t expect that this year in the first year. The investment potentially next year would be the earliest.
Gary Ho
Okay. And then also just going back to the first piece of the answer here, the hurdles. Could that be significant, or is that going to be like gradual — and then since that you guys are hitting those hurdles?
Amanda Frazer
I would expect it to be gradual.
Gary Ho
Okay, okay. Great. And then just my last question. Steve, any update on the managing kind of third-party capital piece outside of BCC here?
Steve King
Yes. We do have one of the things that is in process that we’re working on would be a similar type of transaction to BCC. So we’re excited about that. I think that is a really interesting kind of boost to our return on equity and our earnings possibilities, when we can make profits on other people’s money as well.
So — and from capital raise perspective, we’re not out of share price, as I mentioned that, we would ever raise equity. So being able to grow our company and increase our earnings without needing to raise any of our own capital really effective in this type of environment.
Gary Ho
Okay. Got it. Those are my questions. Thank you.
Steve King
Thanks, Gary.
Operator
Thank you. And one moment for our next question. And our next question comes from Jeff Fenwick from Cormark. Your line is now open.
Jeff Fenwick
Hi. Good morning, everyone. Maybe we can start with a couple of follow-ups on the BCC discussion. And Amanda, could you maybe just give us a quick overview on how the fair value is calculated for that one. It is obviously a bit of a different structure. And you — as you mentioned you haven’t actually surpassed certain hurdles yet. So what is it that takes the fair value higher in the way you’re calculating it?
Amanda Frazer
So right now we have based a fair value of its discounted cash flow model based on them achieving the forecast that was and their business plan that was laid out at the time we did the deal. And just as time passes we will see, we will see — as time passes that may they hit that forecast. We will see a continuous trend of improvement in the fair value.
In addition in this quarter, there was a change to the equity risk premium. There was a couple of changes just to those market-driven rates, but the net impact was an additional write-up. So about CAD 5 million is due to the performance of the business and about another CAD 3 million is due to just some change in the discount rate driven by external factors.
Steve King
And keep in mind Jeff that the fair value write-up was just on our own investment as principal. So that has nothing to do with the hurdles on the carry on the Brookfield Capital.
Amanda Frazer
But it is an indication that the business is trending towards meeting them in the future.
Jeff Fenwick
Thanks. That’s an important clarification. And I guess a follow-up, there is this obviously continues to be a bit of like a roll up or roll out story of new locations and money being invested in the platform. Was it structured — that deal structured where they were going to be drawn down on an existing funding package, or is there a potential in the future that more capital will be injected here and Aleris might play in something along those lines in terms of putting incremental investment into BCC.
Steve King
Yes. It’s interesting. It’s been a phenomenal model in that every one of their now 100 locations closing in on 100 locations has been funded out of free cash flow. They’ve never had CAD 0.01 of debt in this company until this transaction and that was just for some liquidity capital.
So their kind of CapEx budget for the year is all financed by free cash flow. And there’s going to be probably another strategy layered on to expand their offerings and that will include some acquisitions, but they’ll be small acquisitions and are expected to still be funded out of cash flow.
So if there was ever a larger acquisition and that’s not completely out of the question if they want to get into other areas of cosmetic surgery, I would anticipate that we probably would participate in that along with Brookfield as their kind of investment partners.
Jeff Fenwick
Thanks. That’s helpful. And then I heard your commentary there about the opportunities in front of you guys heading through the back half. But just given where the stock is trading today and the significant distribution associated with that have you given any thoughts on ramping up buyback activity? It seems like that might be maybe an accretive use of capital in the short-term?
Steve King
Yes. We certainly considered it and we’ll continue to consider it. But because of the opportunities that we have in front of us and the IRR is expected on those opportunities. We still feel that that is the best place for shareholders’ capital. So that’s where our focus is going to be. If we’re in a situation where that equation flip flops then we change. But yes, right now, we’re looking at very good opportunities with very high expected IRR. So that’s the focus.
Jeff Fenwick
Okay. And then maybe one quick one just in terms of Q3 partner revenue guidance. Does that include the assumption of the return to the LMS payment there? I’m just trying to get my numbers to square, because I think you got that that would come on and then the first full quarter of the FMP investment?
Amanda Frazer
Yes. That’s correct.
Jeff Fenwick
Great. Thank you very much.
Steve King
Yes.
Operator
Thank you. And our next question comes from Zachary Evershed from National Bank Financial. Your line is now open.
Zachary Evershed
Good morning everyone. Good quarter. Thanks for taking my questions.
Steve King
Hey, you bet
Zachary Evershed
So you mentioned that the quality of deals landing on your desk is higher. Can you go through the factors that differentiate a great opportunity for Alaris, in this type of macro environment?
Steve King
Yes. You’re really looking at better kind of quality of earnings-type companies. There’s always a company that’s in demand in private equity, and it’s the cash cow business. And so we’re looking at companies that meet our criteria, of low debt, low CapEx, industries that don’t have either obsolescence risk or high volatility, management teams that are confident enough in their business where they will do anything to stay in as opposed to wanting to exit.
So yes, it’s a good list of opportunities for us. And they tend to go in, I’m not going to say completely random cycles, but it’s opportunity based and there’s only so many companies out there that fit all of those criteria for us. So, we’re lucky enough to have a good list of them right now. And I would say, in this environment our win rate, when we are interested in the company I would say, our win rate is much higher than it has been historically, because of the increased cost of capital of those options around us. So, we’re having success and we just have to execute.
Zachary Evershed
Right color. Thanks. And then with the debenture maturity on the horizon, what are your plans thus far, for refinancing given where the stock price and interest rates are?
Steve King
No. We’ve got a lot of room on our balance sheet, to take those out just on our revolver, if we want to. So really, we’re going to keep on kind of judging our deployment opportunities, along with that takeout of our converts. And so, we can either just use our line or if we have so much opportunity on the deployment side, then we would probably replace the convert with another convert.
Amanda Frazer
Given the cost of that capital, it’s attractive to hold on to it probably, a little longer here.
Steve King
Yes, it’s at 5.5%. So, needless to say, we can’t replace it at 5.5%. So, we’ll keep it as long as we can.
Zachary Evershed
No doubt. And on the revolver right now, what’s the incremental cost borrowing? Is that on a grid?
Amanda Frazer
So incrementally I mean, it varies because if we were to move that on there, it would definitely change the rating and the premium we’re paying to SOFR on that line, but that would be about eight – seven 75 to 8.
Zachary Evershed
Perfect. Thank you very much. I’ll turn it over.
Steve King
Thanks, Zach.
Operator
And thank you. And I am showing no further questions. I would now like to turn the call back over to Steve King, for closing remarks.
Steve King
Great. Thanks very much, Justin and thanks everybody, for tuning in, right before a long weekend. So, pleased with the quarter. We expect more of the same next quarter, basically and we hope to be back with good deployment news and other things from Alaris. So, have a good rest of your summer. We’ll, talk to you next quarter.
Operator
This concludes today’s conference call. Thank you for participating. You may now disconnect.
