Alaris Equity Partners Income Trust (ADUN) Earnings Call Transcript & Summary

Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Alaris Royalty Corp. Q4 2019 Earnings Conference Call. [Operator Instructions] And I would like to turn the conference over to Curtis Krawetz, VP Investments and Investor Relations. Please go ahead, sir.

Thank you, Sylvie. Good morning, ladies and gentlemen, and welcome to Alaris Royalty Corp's conference call and webcast to discuss the financial results for the 3 and 12 months ended December 31, 2019 as well as a brief corporate update. I am Curtis Krawetz, Vice President of Investments and Investor Relations, and I'm joined on this call today by Steve King, President and Chief Executive Officer of Alaris; as well as Darren Driscoll, Chief Financial Officer. After a short presentation from Steve and Darren, there will be a question-and-answer session. [Operator Instructions] Before I 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 as a result, actual results could differ materially. Additional information concerning the underlying factors, assumptions and risks are available in yesterday's press release and MD&A for the period under the headings Forward-looking Statements and Risk Factors, copies of which are available on SEDAR 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 the period for more clarification. I'll now pass the call over to Darren Driscoll.

Thanks, Curtis. I think I'll start out of the gate addressing Sandbox and the financial impact last Friday, on February 28, with the conclusion of the sale of a disappointing investment in Sandbox, where we recovered all of the senior debt, including interest owing, but recovered only USD 9.2 million on USD 40 million of preferred shares in the business. $4.1 million of those proceeds are being held in escrow for working capital adjustments and indemnity obligations and initial $2 million may be available through earn-out. But for our financial statements, we have only recorded what we received and will book further proceeds from escrow or earn-out as they come in. So on $40 million of prefs invested, we collected $18 million in distributions over time and that 9 -- plus the $9.2 million of consideration for a total return of between minus 28% and 42% depending on future collections. That's an IRR of between minus 9% and minus 16% over the 4-year investment period. The end result of USD 35 million loss on those preferred shares, all that's recorded in Q4 as we -- December 31 was our fair value recording date, and it made sense with the February 28 close to use that as an anchor. The only revenue we'll show in Q1 2020 for Sandbox is the interest on the secured debt, which will be an immaterial amount as no distribution income was recorded after December 31, 2019. A lesser concern to most, but a change in our financial statement presentation, once we used our step-in rights right late in 2019, the accounting treatment changed drastically for Alaris. You'll see assets and liabilities held for sale on both sides of our balance sheet, which are the assets and liabilities of Sandbox at December 31, 2019, the net of which is what we received last week. Further details describing accounting treatments are provided in a scintillating new note 11. Steve will also address Sandbox in his comments. Another subsequent event on January 7, the successful redemption of SBI at a USD 9.3 million premium to cost as well as additional USD 7 million of Make Whole Distributions to the third anniversary of the deal. Those revenues will show up in Q1 2020. On USD 85 million invested, a 50% total return and a 22% IRR and resulted in a significant paydown on our debt facility. As far as our 2019 results go, another year of record deployment of $193 million. 2 new partners in Amur and Stride and follow-on contributions to Planet Fitness, a significant one, Unify, Accscient and others. A second straight record year for revenue at $116 million. That's $3.17 a share, about 16% increase from the prior year. Q4 revenue was $30.9 million. That's up from $25.3 million in the Q4 of '18 and $30 million in just this most recent quarter, Q3. As far as partner updates, pleased to be showing some very positive news across the portfolio. LMS has completed a sensational year. And since the distribution from LMS has no color, it does move the needle. They're up over 30% year-over-year. We have used 30% on our fair value and run rate estimates and will confirm the final reset upon completion of the audit. SCR continues to steadily improve and the monthly distribution was just recently increased from $250 million a month to $350 million a month effective January 1, 2020, an incremental of $1.2 million over recently, but it started 2018 $2.5 million behind where it is today. On top of the collar, resets are expected from GWM, Heritage, Fleet, Planet Fitness, and also DNT after a big fourth quarter for DNT. BCC continues to impress with an estimated 5 -- plus 5% reset and an ECR that continues to improve faster than we had expected, that's approaching 1.5x. Federal Resources had its first negative reset after 3 straight plus 6% increases, but that one comes along, improving EBITDA, which translates into a nice jump in the ECR, making that an even better piece of paper overall. Amur performing as expected and paid its second straight common dividend in Q4, an annualized after-tax yield of 7% on those Amur common shares, and we do expect those quarterly dividends continue in 2020. We announced the temporary suspension of the ccComm distribution starting in February 2020 due to a required investment in working capital. We are managing the ccComm distribution month to month but have removed the full distribution from the estimated payout ratio, and we'll report back once more distributions were started. But the conclusion of the Sprint, T-Mobile merger will be a much welcome catalyst for the business. Overall, expected net positive resets of $3.7 million or $0.10 a share and a weighted average increase of just under 5% on the performance metrics. That doesn't include that extra $1.2 million annually coming from SCR. So the new CAD 4.8 million in revenues from the reset and SCR, a much larger impact than even a full year of ccComm distributions of around CAD 3 million. On the fair value front, aside from the Sandbox loss, there was a small decrease, less than 0.5% to the overall fair value of our investments, performance-related increases to LMS, Heritage, Fleet, BCC and GWM totaling just under $12 million and performance-related decreases to Kimco, ccComm and a small -- and Accscient totaling just under $15 million, all of that recorded in the fourth quarter. Transaction diligence costs for the year were $2.8 million compared to $4 million in 2018, which is a bit surprising given the record deployment. But a big portion of that deployment in 2019 was with current partners, Planet Fitness, Unify and Accscient, which requires considerably less external financial and legal resources. Our total cash G&A expenses were $10.7 million in the year, down 12% from 12.1% in the prior year. Each of the 3 line salary benefits, legal and accounting and corporate offices were down slightly year-over-year. Bank covenants, all in very good shape and currently about $250 million to deploy on our balance sheet. And so the outlook for 2020, Q1, we're actually going to have a revenue of $34.8 million. 25.5% is our run rate plus that CAD 9.3 million of Make Whole revenue received from SBI in early January. Our current annualized revenue without that extra SBI revenue, this is just going forward from here, is $102 million. And with an expected G&A of $11 million, that's over $90 million of EBITDA and a very manageable curve run rate payout ratio in the low 90s. I'll pass it over to Steve before going to questions and Q&A.

Great. Thanks, Darren. Obviously, aside from Sandbox, very, very pleased with our 2019 record deployment revenue and normalized EBITDA, as Darren mentioned. But our fourth quarter reflects the very dynamic nature of our business and the swings that can occur when you're dealing with private companies. What I thought it would be -- would be useful today is for our shareholders to learn about what our process is and what we go to in terms of our due diligence and review process of investments and the chain of events as it related to Sandbox. So we review roughly 500 investment opportunities every year, of which we typically choose between 2 and 5. Each new investment starts with preliminary due diligence performed by our team of in-house at Alaris. And out of our 15 employees, 11 of them are either CPAs, CFAs or lawyers with -- all with extensive transaction experience. Once that early due diligence is complete and we're satisfied with what we found and have an agreement with the company on the investment terms, we undergo a formal due diligence process that not only includes our own professionals but the expertise of third parties that work for Alaris: Ernst & Young on the financial side, 2 law firms on the legal due diligence and HR firms that look into the people side of the businesses. Over the course of 2 to 3 months, the final report is compiled based on the findings of all these groups and presented to our Board of Directors and our banking syndicate for final approvals. Post closing, our monitoring team is in regular contact with our partners and receive detailed financial statements on a monthly basis and audited financials on an annual basis. All of this information is uploaded in real time through a web portal that every Alaris employee has access to on any device. On Sandbox and other situations, our monitoring staff became aware of problematic situations quickly and in fact, much quicker than the banks involved in those files. In doing this for 16 years now, we feel that we've adopted best practices from the private equity industry. And more importantly, we feel that our diligence and monitoring practices have led directly to our above-market returns over a very large sample size. Over the 16 years, we made a compound annual internal rate of return of 17%, which is outstanding in this incredibly competitive investment environment. This number was 17% at this time last year. And at 17% now, even after giving the effect of Sandbox, because of the gains we've had on other investments, including SBI in January, that is the nature of our business. As it relates to Sandbox, specifically our monitoring worked well and as well as it could have. That's why we were able to act quickly to use our rates and remedies to affect change. A top adviser was hired by the company to conduct the process, the market for potential buyers was surveyed for interested parties and multiple bids were received. When we last updated our shareholders, we had every indication that the process would result in Alaris getting full value. But from that point until closing, the deal was repriced numerous times based on numerous factors. The number of stakeholders and claims outstanding and a very recent decline in the business were contributing factors in the final pricing, which is far less than what the original bids were. We very much considered walking away from this transaction and staying in the investment, but it was deemed by our management team and Board that this company would have required a significant amount of capital to improve the situation to a point where we could have received a material amount more on a sale and putting more money at risk in the challenged situation, which is not as attractive to us as redeploying that capital into new partnerships. If our remaining amounts are paid out over the next 2 years, that will result in a 9% loss on our investment on an IRR basis, not a good result. But in the scheme of our overall results from investments, it's also not a result that changes our track record one bit. Moving forward, we have a group of partners that are operating at a very high level. We'll be receiving, as Darren mentioned, $0.10 a share on new distributions from our partners based on their '19 results. And we have, at this stage, a very strong likelihood of, again, breaking our annual deployment record for 2020 based on the pipeline of opportunities that we have visibility on and that are in process right now. Obviously, the coronavirus is weighed heavily on the markets and on our stock and something we're taking extremely seriously. Looking at our portfolio and possible effects that a growing pandemic could have on our partners, there certainly are businesses that it will impact if it spirals out of control, but I also think that our portfolio is extremely well set up in this kind of scenario. Our partners have a weighted earnings coverage ratio of 1.6%, meaning that there's a 60% cash flow cushion before they would not be making enough money to pay our distributions. And also, many of our partners have no debt, so they're well suited for prospering in difficult times. So thanks very much for your time today. I'll now open it up to questions, but please keep in mind that due to the dispute that we have launched against the founders of Sandbox, we will not be able to go into greater detail on the circumstances of that situation at this time. So Sylvie, we'll open it up to questions, please.

[Operator Instructions] And your first question will be from Gary Ho at Desjardins Capital Markets.

Let me just start off with Sandbox, it's quite topical. Yes, I know you're limited in what you can say given the legal actions. But can you -- maybe can you comment on whether you had a kind of similar situation with other companies, portfolio companies in the past where you're trying to solve with and maybe go back to the co-founders or the owners of the business and how that played out? Is this similar to kind of SM a few years back or is it completely different?

I think there's some similarities there. But every case is very different. One of the things that made this situation quite a bit better than SM was our new ability to take over the debt and act faster than what we were able to do in SM's case, which I think had a direct -- correlations are getting more value here than we did with SM, but very different fact set here.

Okay. And were there other examples that you can point to other than SM?

No, I think those will be kind of the only 2 that would be similar.

Okay. And then we -- switching gear. Obviously, as you commented, the coronavirus is top of mind for investors. And your portfolio of companies operate across, I guess, a span of sectors. I guess have you gone to your partners and assess what the potential impact could be and maybe stress test the ECR or other metrics on the ability to pay distribution if the situation worsens from here?

Yes, we have and we'll continue to. It was a contributing factor in ccComm, they're having a tough time getting inventory right now in terms of handsets and tablets to sell out their stores. So that was certainly a factor in deciding to not take a dividend from them for -- in the near future here as well as the Sprint, T-Mobile merger kind of letting the debt settle on the impacts of that as well. But other than that, I actually think most of our portfolio companies are in good shape. I don't think too many of them are dependent on travel or anything like that. I mean talking to some of our consulting companies like Unify, some of their -- I guess they're based in Seattle, which is a bit of a hotspot. Most of their consultants are working from home now, so still generating revenue, even though their -- they have changed their business practices. So we don't see a lot at this point. We're speaking with Planet Fitness in a couple of hours. I know they're probably going to be doing some things that will help with the current situation. But obviously, it's kind of ever-evolving on a, it seems like, on an hourly basis. So we're certainly monitoring that closely.

And maybe to get the other angle, maybe on the positive side, are you seeing businesses that might benefit from this? Things that come to mind are maybe Kimco or maybe Federal Resources.

Yes. Look, Kimco makes sense. People are going to want a really clean office, but we haven't seen -- and I don't think that one will be affected. Providence, I think, is the one that has seen a recent uptick in -- well, they have some South American manufacturing facilities. And they have had many inbound calls because their competitors with their Asian facilities aren't able to deliver. So a small benefit, but that's probably the only bright side of what's going on with that right now.

Yes. Federal Resources, I think, is a good point there, too. They provide all different kinds of products and training for first responders, so whether that's EMS municipally or war fighters internationally. So these are the types of things that they do supply, whether there's masks or anything else that can help the first responders in a situation like this, it would certainly help Federal Resources as well.

Got it. And then just very last question on capital deployment. The market conditions are quite volatile. Can you provide some color kind of behind the scenes on the activity level? Has it slowed recently? Has valuation come off? Any comments on that would be helpful.

Yes, it's too early to say on that, Gary. So a process -- processes that we've already won, we're working towards. I would say one thing on this whole situation, it's nice to be in a situation to have a balance sheet as strong as ours is right now with access to as much capital as we have. So having the SBI and Sandbox sales go through already is a great thing. Those deals may have been in jeopardy if they were delayed any further. We're seeing some transactions getting delayed or canceled because of nervous banks. And so we're pretty happy to have as much dry powder as we have on our balance sheet, that's for sure.

[Operator Instructions] And your next question will be from Jaeme Gloyn of National Bank Financial.

I just want to go back to the Sandbox. Can you describe some of the declines in performance in revenue, anything specific around clients or products or anything on that front?

Yes, unfortunately, we can't, Jaeme. We're -- we've been told by our lawyers not to get into any of those kind of details, unfortunately, I apologize.

Okay, okay. I wasn't sure if that may be related just to the management team at Sandbox and not the actual underlying performance. Okay, shifting to SCR. If I look at the disclosures in the MD&A, it kind of sounds like the likelihood of further upside on the SCR distributions or payments seems a little bit limited given that statement around revenue increases is requiring to invest a portion of that free cash flow and net working capital. So can you just sort of describe what's going on there that might prevent further upside or other puts and takes?

I mean if the business continues on its current trend, we absolutely expect further growth. We have been extremely conservative with SCR. They've been tremendous partners to work with. We have left behind a lot of cash in the business to allow for working capital as they continue to grow. So that is not a significant concern. Again, we bumped it from $250 million to $350 million. I think the top end is around 5%, and we're working towards that. So I expect future increases in SCR.

Yes. Based on their last monthly report that we got, they are on a great track right now.

Okay. And the normalized run rate distributions at SCR, I think you just said it was $500,000 monthly or I guess, $6 million on an annual basis. Is that where it tops out and then you get back into the collar? Or is that how I should understand the distribution mechanics work?

Yes. Generally, yes.

Okay. Good. As it relates to ccComm, can you just walk me through in a little bit more detail how the Sprint, T-Mobile merger is impacting the net working capital there? And other than, I guess, coronavirus impacts on supply of handsets and tablets, what other factors are driving the reduced performance?

The Sprint volumes are down 25% across their system over the last year. So that's the #1 factor. I think Sprint working on that merger with T-Mobile has been a big disruption to their entire system. So obviously, as one of their larger dealers, ccComm was not immune to that. So then you add in the inventory issues with the coronavirus. And now with the merger seemingly going ahead, there's just some uncertainty there. There's going to need to be some doors closed as they kind of integrate the 2 different dealer networks. And so no one's quite sure how that's going to work out. The T-Mobile economics for dealers is significantly better than what it's been for Sprint. So there's some upside there. But first, we need to get through the uncertainty, so we'll kind of suspend this -- their dividend to us temporarily and then hopefully restart it once the dust has settled.

And Jaeme, specifically to working capital, the T-Mobile structure is more of a consignment. Also, net working capital isn't required. So today, they have to buy their own inventory and have that working capital. So it is a significant difference. So getting that done will be, as we mentioned in the M&A, significant catalyst for ccComm.

Okay. And then, by the sounds of it, like if that merger goes through, no reason to think we can't -- we wouldn't expect ccComm to restart the distributions almost immediately. Or are there other factors at play that would prevent that?

Yes, it would take a couple of months to work that working capital change through. But certainly, our expectation is among all of those other issues, obviously, need to be resolved, but the company is still making money, and we would expect distribution to restart.

And important to note, there are no debt in that company. And ownership management team, that is all in with us. They put their own personal capitals into this business very recently and couldn't be happier with their partnership.

Okay. Moving to Providence. Just a clarification question here around the fair value calculation. In the disclosures there, it was mentioning that forbearance agreement extends until March 2021, and the assumption in the fair value calculation includes distributions beyond that point. Are those distributions at the current level or at the normal level. What is baked into the assumption?

We bake in a gradual increase from the current level over time. So not an immediate restart, but just a gradual increase.

And a gradual increase back to the previous, I guess, what, USD 4.6 million distribution? Is that about right?

Yes, yes, yes.

Okay, okay. Last one for me then is just around -- the U.S. tax reforms could have a significant impact on 2019 if it's retroactive. Can you talk about what the reforms could mean for 2020 and how that could impact tax and how that affects potentially your view of dividend increases and payout ratio?

Yes. We are actively working on a workaround should they come back and not be favorable towards us. So for prior years, if it goes retroactive, that's an amount we just have to have to borrow for a small -- with that 0.1% or 0.2% to our payout ratio going forward. Again, it would be -- I guess our tax profile would be similar to 2020, but we are hoping by the end of 2020 to have reduced or to have basically found a new plan going forward, which would leave us in the same place we are today.

Are you able to elaborate a little bit more on what those plans are?

Not at this point, but it will -- the plan we have in the works is, again, will leave us in a very similar place, shareholders' business all the way through.

And at this time, Mr. King, we have no further questions. Please proceed.

Great. Thank you, Sylvie, and thanks, everybody, for attending today. And I'm actually -- believe it or not, regardless of the stock market, I'm actually extremely excited about 2020. We've got a manageable payout ratio today with a huge amount of cash to spend. And so every deal that you see in the future from us will reduce our payout ratio and into that -- at least into our target range, if not better. So looking forward to exciting year. Our deal flow is as good as it's been and deals are in process. So thank you, again, and feels -- please feel free to reach out to us directly if you have any more questions. Thank you.

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.