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

Good morning, ladies and gentlemen, and welcome to the Alaris Equity Partners Income Trust Third Quarter 2020 Earnings Conference Call. [Operator Instructions]. Also note that the call is being recorded on Friday, November 6, 2020. And I would like to turn the conference over to Mr. Curtis Krawetz. Please go ahead, sir.

Thank you. Sylvie. Good morning, ladies and gentlemen, and welcome to Alaris Equity Partners conference call and webcast to discuss the financial results for 3 and 9 months ended to September 30, 2020 as well as a brief corporate update. I'm Curtis Krawetz, Vice President of Investments, Investor Relations, and I'm joined on the call by Steve King, President and Chief Executive Officer; 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 we begin, I'd like to remind our listeners that all amounts are given in Canadian dollars, unless otherwise noted. Listeners are cautioned the 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 on last night's press release and our MD&A for the period under 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 our MD&A for the period for more clarification. I'll now pass the call over to Darren Driscoll.

Thanks, Curtis, and thanks everyone for joining. Certainly happy to be reporting solid Q3 in the midst of a global pandemic that points the required services that the majority of our portfolios provide. More of our company's reporting year-to-date increases in revenue and profitability than aren't and the overall weighted average earnings coverage ratio for the portfolio has increased from historically rate around 1.5x to 1.7x, a significant move in 1 quarter. Now this is a significant status. We do cap our ECRs at 2x to avoid skewing the numbers. For example, Federal Resources has an ECR way over 2x but that would inflate the overall number if we use the actual ECR. And more importantly today, we have 12 of the 17 partners with an ECR of over 1.5x. Just over 18 months ago, that was 6 out of 16. Our businesses continue to perform in a very challenging environment. We issued an operational update a few weeks ago that suggested $23.5 million of revenue in the quarter produced just that, except for a small FX-induced variance to land at $23.4 million, a 16% increase on a per unit basis over our previous quarter. Also in the quarter, we achieved normalized EBITDA of $20.1 million compared to $17.3 million in the previous quarter, a 19% increase on a per unit basis. Those revenue and EBITDA results primarily a result of 2 of our partners. At BCC's, recovery has been much faster and better than expected after being required to close all of its clinics for over 2 months in Q2. Regular distributions restarted and were paid in full for Q3, and there's a plan to pay the $2.2 million of unpaid distributions from Q2 in the coming months. And nothing has been accrued in our books, so those will be increases to future revenue totals. Kimco, we're seeing significant tailwinds from the additional cleaning requirements that the pandemic has required. After no distributions for the first 6 months of 2020, they paid just under USD 1 million in Q3, with another USD 1.1 million expected in Q4, and now an expected annualized run rate of USD 4.4 million and the prospect of more in the way of distributions and loan repayments in the coming quarters. Of note this quarter was the conversion to an income trust and the name change to Alaris Equity Partners on September 1, which resulted in a number of accounting impacts that even the diehard accountants will be hard-pressed to get excited about. Bottom line is the trust is a different kind of a company that attracts different accounting rules. Specifically in Alaris' case, that impacts the accounting for RSU and PSU commitments to management directors as well as the method for presenting the convertible debentures. Note 13 in our financial statements sets out the various headline impacts, and we'll be happy to answer any questions on the call or follow up after the fact. The income statement impact was a $10.6 million increased to earnings in the quarter due to the change in accounting for the convertible debentures but that impact was fully backed out when we presented our normalized EBITDA result. The trust conversion allows us to retain more capital internally by reducing admin expenses related to operating subsidiaries overseas and most importantly, reducing our effective tax rate on US revenue, returning us to an overall rate comparable where we were pre-2019 and lowering our payout ratio. A couple of improvements to our disclosure worth mentioning. We've condensed the partner fair value table in Note 4 to show the base currency to take some of the FX noise out and then a significant change to our partner section in the MD&A, where we now summarize key points in a single table and then provide commentary on those partners where additional explanation is warranted. We hope people found both of those changes useful. Q3 did see a handful of fair value increases. Obviously, most significantly, Kimco up USD 7.5 million to USD 20 million on the heels of materially improved results over the past number of months as well as our expectations for the months ahead. Unify was up USD 0.7 million based on continued success in 2020 as this U.S. IT consulting business has grown organically and through new opportunities in the current business environment and through the quarter it became apparent that a max reset would be happening for 2021. Similar to Fleet, up just under USD 1 million based on their 2020 financial results that will ensure maximum reset in 2021. Of note, no decreases at all in fair value of any of our partners this quarter. Other businesses like LMS and Federal Resources, for example, continue to perform well ahead of expectations but no fair value adjustments recommended at this time. Last quarter, we mentioned an opportunity to support Federal Resources on a PPE contract with the U.S. government. The supply chain as it was drawn up didn't materialize and instead, FR has recently secured a supply chain that will deliver the PPE but over a much longer time frame, which allows FR to use their own balance sheet to finance the project. So Alaris had previously paid USD 11.5 billion deposit, which has all since been repaid, so no financial impact to Alaris other than the benefit of having a high-performing partner like Federal Resources. Earlier in the year, fair to say we are expecting our first weighted average negative reset in over 10 years and as the years played out, our expectations have certainly improved and are now for a flat reset based on the following: an increase of greater than 10% for LMS as they continue to perform; a top of the call resets for Federal Resources, Unify and Fleet; BCC, which we thought would be down after 2 months of closure, we'd now expect that to be flat depending on their Q4; bottom of the call resets as expected from Planet Fitness, GWM, Heritage and Amur; and DNT, which will be down 6% this year but was up 6% last year, earlier this year, we flattened the payment on the 2020 reset, so that the current distribution will be maintained through the end of 2021. So you won't see a change to the DNT revenue amount until 2022. An overall flat reset during the economic fallout from COVID-19 displays the benefits of a diverse group of partners and industries and speaks to the high quality of our businesses and, more importantly, the management teams that are running them. Other items worth mentioning, our bank covenants continue to be easily met. And just recently, we extended the facility another 2 years to November 2023 on similar terms, and we'd certainly like to thank our bank syndicate for the significant show of support during these truly unique times. On our income statement, G&A was a little higher than normal current quarter with approximately $0.9 million spent on the end of the trust conversion, a noncash unit based formerly called stock-based comp expenses artificially decreased in the current quarter, based on the new accounting rules for the trust. But you'll see in the normalized EBITDA reconciliation MD&A that we have allowed for the $0.5 billion or so to normalized expense for the period. The ongoing legal issues with Sandbox will take time to work through, and Alaris will not be giving any updates on this topic unless required in relation to a material change in the suit, a resolution of the matters or a final judgment. As stated previously, Alaris will vigorously defend the claims made against the company and to date, obviously no accounting or financial impact on the financial statements. The longstanding dispute with the CRA continues but a second favorable tax ruling with a similar fact pattern to ours was decided in the tax payer's favor during the quarter, giving us further confidence in our position. In fact, the CRA has reached out and is interested in a settlement discussion, and we're currently putting together a proposal for their consideration. And with more visibility on our partner performance, we have returned to providing detailed guidance in the outlook section of the press release and the MD&A expecting revenue of $26 million for Q4, which I should add, does not include any recovery of the BCC, unpaid revenues or anything extra that may come from Kimco. It also does not include any distributions for Planet Fitness. And with all of its clubs now open for 3 months, we do expect some level of distributions to commence in early 2021, and we'll provide guidance as soon as the terms are finalized with Planet Fitness' senior lender. So with $120 million of dry powder and a payout ratio below 75%, which is our lowest in many years, that only gets lower with the restart of Planet Fitness distributions, we are well positioned heading into 2021. So with that, I'll turn it over to Steve before we go into Q&A.

Great, thanks. Darren. So obviously Darren has done a great job of outlining the strength of our partners. So I don't have too much to add from a financial perspective. But obviously we have been very much awarded for our philosophy of partnering with well-run required service businesses. They tend to be more resilient in times of distress like we're in right now, so we're very happy with everything in our portfolio. Reporting an all-time high number of companies with more than a 50% cash flow buffer and an all-time high aggregate number of a 70% cash flow buffer, all while we're going through a pandemic proves that our model is working extremely well. And it certainly gives us and should give investors confidence that regardless of how long the pandemic persists, that our fundamentals are strong and that we will be able to keep providing our investors with a steady yield at the very least. An update on Planet Fitness. Darren mentioned that all of their clubs have been open as we do have now several months of actual numbers and trends to look at. So they're not paying us their monthly distribution right now. Their cash flow numbers are strong. Membership numbers have stabilized. And interestingly enough, actual gym usage at our locations have moved up over 80% compared to peak pre-COVID levels. So while we get paid whether members use the gyms or not, the usage number is actually very telling as it relates to the risk of future membership declines or perhaps growth. Having a payout ratio below 75% with an identifiable event in the near future, which is Planet Fitness restarting, that will bring it down into the low 60% payout ratio range should give investors a very strong sense of not just stability but also potential dividend growth. Combine the restarting of Planet Fitness with any material amount of capital deployment, and our payout ratio would actually be in the 50s, well below our stated objective of 65% to 70%. On the deployment front, we've had a great deal of success during this period in sourcing potential new partners that are obviously attracted to our capital because of the ability to retain control, retain the upside and also to do a transaction that doesn't involve lenders, who have shown to be very difficult to deal with for many companies during the pandemic. We expect to be quite active with new partnerships and follow-on deals over the next 4 months based on transactions that are in process today. We have begun traveling again to the U.S. as we've been deemed as essential workers. So we expect that we'll be able to move forward the transactions that are in progress now, now that we're able to be face to face with our potential partners again. I'd also like to take this chance to thank not just our employees but also the management teams and the tens of thousands of employees at are 17 partners. This has been a really difficult time for everybody, obviously, and managing working remotely, working well trying to protect the health of your families, it's obviously been a tough time for everybody. And we do expect this environment to last for some time but we feel that we're very well positioned to prosper regardless of how long it takes. So Sylvie, I'll throw it back to you and open it up to questions.

[Operator Instructions] Please stand by for your first question, which will be from Scott Robertson at RBC Capital Markets.

So you guys have been deferring distributions from Planet Fitness now for a couple of quarters but it sounds like you guys are closer to a solution that will get distributions restarted. My question is what would have to happen to the distributions in terms of a level of initial restart or timing of restart to trigger a meaningful revaluation of the investment from an auditor perspective just thinking as we're heading into the Q4 auditing process?

Scott, we right now are in our fair value modeling fairly considerably for Planet Fitness. We did that back in Q1, which resulted in that fairly significant write-down of Planet Fitness. And so we would have to be well below our, I think, we've got probably somewhere between 50% and 75% of distributions collecting in 2021 right now. So worse than that would result in a decline, and we certainly don't expect that. So we expect better than that. We expect some level of distributions. We expect some level of recovery of unpaid distributions. But obviously that this is one that is with the most sensitive to what's going on right now, and we'll continue to work with them on the go forward. But as far as Q4 valuation, they would have to be a fairly significant change in our expectations.

Got it. And I guess my next question is around Kimco. How much upside do you guys think there is there? Theoretically, you guys have the ability to force the sale of the company and receive some proceeds from there. But you think there's potentially more upside if you were to hold the investment rather than monetize and deploy into something new? Just to get your thoughts on that. And I guess could you remind us, excluding the changes to the operating environment right now where there is an increased amount of focus being put on sanitization, have there been any fundamental changes to the company that would suggest the financial performance would improve under normal operating environment?

Yes, for sure, Scott. The management team at Kimco has done a great job, and they were seeing gains before COVID and expect that to continue going forward, with or without COVID. So yes there have been material changes, especially on the sales side. The first few years under this management team were really focused on rightsizing the company in the cost line. And now the next phase was increasing sales. So they've kind of rebuilt the sales department. We're seeing some really good traction from that pre-COVID. And then of course, we've had a significant rising tide with COVID. And I think most people expect higher cleaning rates going forward even after a vaccine is developed so -- but that's kind of the million-dollar question on that industry and that company is what is a normalized state. There are many multiples ahead of where they were from an EBITDA perspective just last year. So how much -- if you did sell the company, how much credit are you going to get for the current run rate, that's up for debate. So that's what we're evaluating right now and working with some advisers to get as much good intelligence as we can and make that decision in concert with the management team who we wouldn't force anything here. But if between us and the Kimco managers, we think it makes sense, then we'll move forward with the sale. And if we think there's just a really long pattern of growth here and even doing some tuck-in acquisitions, then that's a possibility as well. But right now, I would suggest our slight preference would be to selling and recouping some cash out of this one that would be far and above what we've got listed out on our balance sheet.

Your next question will be from Scott Fromson at CIBC.

Just following on the Kimco. Can you give us an idea of Kimco's exposure in terms of real estate asset class and geography? Just thinking about in terms of marketability for sales in terms of outlook on business sort of post COVID.

Yes. Scott, they have a massive footprint 48 states they operate in. Certainly heavier footprints in some around the Chicago area and Atlanta area but really diverse across the country and a reasonable amount of variability around the types of business, lots of office towers, lots of manufacturing spaces, some front line retail like telecom retail but a really good diverse customer base and a big geographic mix as well.

And importantly, they kind of removed themselves from malls over the last couple of years as mall business was not profitable. And given the pandemic, I think that was a very savvy move getting out of malls because that's probably not a place you want to be right now.

Okay. It's very helpful. Just going back to the M&A pipeline. Are you were revisiting many deal files that started before the pandemic? And how have the negotiations in proposed terms changed for these warm files, if you want to call it?

Yes. We do have -- one of the deals we're working on was started pre-pandemic. The rest have come about over the last couple of months. And we really don't foresee much of a change in our typical terms. I would say the vast majority of what we're doing is that kind of a standard 14% initial dividend yield from the company. So -- but a really tremendous group of companies, again, low debt levels and companies that have performed extremely well during the pandemic. So we're excited about hopefully getting some of these to the finish line.

And are you seeing sort of revived interest on cold deal files? And are you are seeing a lot of new inbounds?

Yes. Our new inbounds have returned to basically pre-COVID levels. They did come down for the first few months of the lockdown. But no, we haven't seen kind of a return of cold files. The ones that we're seeing are new opportunities.

Next question will be from Gary Ho at Desjardins Capital Markets.

This first one on the BCC here. It sounds like they've turned -- really turned around the corner here and they are mentioning -- you guys are mentioning a deployment of the second and third tranche, I think it was the USD 45 million or so. Any more specific in terms of timing you can share with us and what improvement to the payout ratio would that look like?

In terms of timing, we wouldn't do anything with BCC until we're caught up on all the deferred distributions. So it was 3 months of distributions that we deferred in Q2 would need to be caught up before we did a follow-on investment with BCC. But certainly their EBITDA numbers are sufficient to do a follow-on transaction and we would be ecstatic to put more money into that company. Talk about somebody that's proven themselves during the most difficult times, the management team is absolutely top-notch. And one of the interesting things is we actually think there is a little bit of a COVID tailwind behind their numbers right now as people that are staying home more and not traveling, not going out for as many dinners, things like that. Some of the more -- they've got more disposable income, and we think some of that is contributing to BCC's numbers. So we want to be cautious. We want to make sure that we know exactly what part of their numbers may be a tailwind, do they still have some headwind with some people not being comfortable going in. We will want to see the next couple of months play out. And as I say, we want those deferred distributions to be caught back up first. So those are the kind of the key things we're looking at on that one.

And then as far as the financial impact to us in the payout ratio. Right in our outlook, we talk about kind of every CAD 50 million of new deployment would knock the payout ratio down sort of 3%, 3.5%. So that would be kind of right in that range.

Okay. Perfect. And then, Steve, I know it's hard to predict but I just wanted your thought on the net capital deployment side. I think the other questions were kind of more on the gross capital deployment side. But just looking out over the next 12 months and also good to see the Carey Electric and GWM follow on in this environment. So I just wanted to pick your brain on that in terms of the net side looking out over the next 12 months.

Yes, it's one of the benefits of the pandemic is that the M&A market isn't as hot and frothy as it would have been in the past from private equity firms, particularly because banks are more cautious and private equity requires on high leverage levels to do their deals. So I think it's going to reduce the number of redemptions that we get. As you've seen, it already has in this calendar year. And so there's a couple of our partners. Obviously, Kimco is one that could be a possibility for redemption, as we've already discussed. But in terms of material redemptions, we don't see much right now that would be on the radar screen, but things can change. I always like to think there's probably 1 or 2 companies each year. If you just do the math on the size of our portfolio, you should get 1 or 2 each year based on our average hold period that sell, but might be a little less over the next 12 months. But it will really depend on how quickly things get back to normal, which if I was a betting man, I would say it's going to take a while.

Okay. Okay. That's great. And then my last question speaking about your -- I know you're in a much better payout position now in the mid-70% range. You talked about Planet Fitness that could bring that down further, and you also mentioned that, I think, your comfort range is in the 65% to 70% range. So -- but when I think about historically you've operated in the 90% range and the stock has traded quite volatile given kind of redemption and capital deployment news, now does that change your way and how you think about raising dividends? And could you bring that payout ratio down further before you think about increasing dividends here?

So I think you nailed it. 65% to 70% is kind of our target. That gives us a huge amount of buffer, and I think should really reduce the volatility of the way our stock trades. But there's really no reason. Look, if the market doesn't want to pay us for our dividend, I guess that would be a different equation and we would just retain more and more capital for growth. But I think we will get rewarded for our growth and increasing the dividend to keeping that payout ratio in the 65% range. I think that's -- from what we've seen right now, I think that's going to be our strategy, which as I mentioned in my little talk, if you get Planet Fitness on and you get some deployment would certainly put us in a position to increase the dividend and stay at that 65% range.

Well, that's exactly where I was trying to go because the -- your dividend yield is quite high. And I think you guys have talked about Planet Fitness coming back on. But if the stock doesn't move back into kind of more higher territory even though Planet Fitness might come on, would you perhaps retain more of that for capital deployment or organic growth?

It's a consideration. I think with the catalysts of Planet Fitness and deployment. I really don't think we'll stay at this kind of a yield. Maybe that's wishful thinking, but if it does, then that would be a consideration to just retain that excess cash flow internally and redeploy it into 14% opportunity. So yes, it's a consideration. We've talked about that over this period of time but I do think that we'll get rewarded for those catalysts and then for increasing the dividend.

And next question will be from Abhilash Shabaham (sic) [ Abhilash Shashidharan ] at Stifel.

I just had a quick question. Have you all been seeing any indications of further lockdowns in any of the states where Planet Fitness operates? And is that kind of a consideration that's coming up when you all have your discussions with the senior lender there?

So we think that we're in a pretty good place of Planet Fitness. They are -- as you know, closures of businesses are really done at the state and county level, not federally, and Planet Fitness has worked a lot with the governors in the states that they operate in and really don't see any desire to close any clubs. But never say never. Like no one has a crystal ball on this pandemic and if things go completely out of control, then there is a possibility. But as it stands today at these levels and at this time, closures aren't being considered. So that's key to working with their lenders. The cash flow stream is strong as I mentioned. The kind of the underlying numbers and trends seem to be all moving in the right direction. So we think there is a good path there, and the lenders seem to be working well right now. So we'll be sitting down with the lenders in the company over the next 2 weeks and hopefully coming out with a plan on how to get our distributions restarted and kind of how any potential phasing might look like based on kind of operational targets that they'll set for the company.

And at this time, Mr. King, we have no further questions, so I would like to turn the call back over to you.

Great. Well, thank you very much everybody for tuning in. And as always, Curtis, Darren and myself are always available for follow-up calls and conversation. So I encourage you to do that. And in the meantime, we look forward to coming out with new news and hopefully a solid fourth quarter. So thank you very much.

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. Have a good weekend.