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

Good day, and thank you for standing by. Welcome to the Alaris Q2 2021 Earnings Release Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Darren Driscoll, Chief Financial Officer. Please go ahead.

Thank you, Matti, and good morning, ladies and gentlemen, and welcome to Alaris Equity Partners conference call and webcast to discuss the financial results for the 3 and 6 months ended June 30, 2021, as well as a brief corporate update. I'm Darren Driscoll, Chief Financial Officer of Alaris. I'm joined on this call by Steve King, President and CEO. After a short presentation from Steve and I, there will be a question-and-answer session. [Operator Instructions] 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. These forward-looking information -- this forward-looking information is based on 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 for the period under the headings forward-looking statements and risk factors. Copies of which are available on SEDAR at sedar.com as well as our website. Non-IFRS data is also presented and may differ from the way other companies sent such data. And as with forward-looking statements, please refer to last night's press release and our MD&A for a period for more clarification regarding those non-IFRS measures. We certainly appreciate everybody taking time out of a sunny summer day to join us for our Q2 results. We were certainly very excited to get these numbers out. Some of the highlights I'll go through here. Q2 revenue of $34.9 million, a record for us, ahead of $33.8 million guidance. And that's despite some FX headwinds and due to some extra common dividends from FNC and Amur of total common dividends of $1 million in the quarter as well as the cash flow sweep accrual for SCR of $500,000 in addition to the monthly amounts that they're paying us. Well ahead of Q2 numbers last year as Q2 2020, you'll recall, had nothing in revenue from Planet Fitness and Body Contours and the total from those 2 partners was $4 million in the current quarter add to that, a bunch of new deployment revenue made for a record quarter of revenue in the current quarter. Q2 normalized EBITDA was $32.2 million, a regrettable typo in the press release said $31.2 million, but the MD&A has the correct number and the details behind it. That $32.2 million is well ahead of guidance, well ahead of the $17 million in the prior year, obviously, due to those new partner revenue and a soft Q2 2020 due to Planet Fitness and Body Contours. Our G&A of $1.9 million, again, well under prior year period as the trust conversion costs were significant last year. In our Q2 numbers, recent deployment and, of course, Planet Fitness returning to full distributions led to a decision to increase the annual distribution by 6.5% to $1.32 annually or $0.33 per quarter. Of note, our run rate payout ratio is still under 65% after this increase. And I'd like to add that if we do get the redemptions as we're expecting from Federal Resources and Kimco, back before any further deployment, our payout ratio will still be below our target of 70%. Also worth noting the cash we're generating quarterly is not insignificant. And for example, just yesterday, we paid down $7 -- sorry, USD7 million of debt out of cash flow we've generated. Our debt at September 30 was just under 2.6x. Since then, we paid down some, as noted above, as well as funds from the ccComm redemption on July 2. Our covenants shift back to normal at September 30. So if by chance, we're still over 2.5 at September. I will have until December 31 to get it back under 2.5x, but nothing we're expecting any problems there. From the finance statements on the balance sheet, quite a few fair value changes in Q2. In aggregate, including the common units, an increase of $16.2 million to our book value or $0.36 per unit. I'll hit some of the larger ones. [Technical Difficulty] And on July 2, we received USD11 million and have fully exited ccComm. Planet Fitness, a fair value increase of USD5 million. Full distributions restarted in July. Their bank covenants are in great shape, and TTM EBITDA is increasing monthly. And they've also seen membership levels get almost back to pre-COVID levels. Federal Resources fair value increase of USD5.4 million. They are continuing to close on redemption, and this write-up gets us closer to that redemption amount. And we're getting more clarity daily on this one. And I would note that if the transaction that they're working on does not get completed, they have -- they will have the balance sheet wherewithal to take us out. So we certainly expect this with a high degree of certainty in 2021. Accscient fair value increase of USD1.1 million. That one is certainly looking like a top of the call a reset in 2022, and business is performing extremely well. A couple of decreases to note LMS, CAD4.9 million reduction. That's our only uncolored partner. They've seen some margin pressure with the rising price of steel. So expecting a larger decrease than we were expecting last quarter. But LMS still with an excellent ECR and will always be our most volatile on the fair value line. For example, 4 years ago, the fair value was $36 million, 4 straight double-digit adjustments, with 2019 being close to a 40% increase, took it to $52 million and now today, we're sitting at $47 million, looking ahead to next year's reset. Brown & Settle had a fair value reduction of USD3.3 million. Brown & Settle performs large projects, the timing of which can impact monthly cash flows. The first 5 months of the 2021 year has seen some margin pressure due to project and customer mix as well as some of those large project delays, which results in a fair value decrease in the current quarter. These projects have since started. Their backlog is robust. They have an ECR over 1.2x and to the long-term business case is still well intact. For Kimco, we didn't touch the fair value this quarter as they continue to proceed toward a redemption, but we don't have as much certainty as we do with Federal Resources to increase the fair value to the redemption value just yet. The business continues to perform exceptionally, and a load if a redemption doesn't occur, Kimco would still have one of our highest ECRs with no debt. Worth noting, they've been generating so much cash in the last 6 months, they've repaid $4 million of previously unpaid distributions and $4 million of promissory notes. Our fair values for the common units were up approximately $2 million as Planet Fitness, Amur and Carey were up, offset by a small decrease to Brown & Settle. And we now have 5 months of financial results for all of our partners and are starting to anticipate what our total aggregate resets for '22 and currently expecting another increase north of $2 million or $0.04 or $0.05 per unit. Top of the collar resets from large revenue streams for Planet Fitness, GWM, Body Contours, Accscient, DNT and FMC with us -- even with uncollared decrease from LMS, it still looks like a real positive organic growth again in the portfolio. Deployment in Q2 did include a new investment in the D&M, a car leasing business out of Dallas, Fort Worth, Texas, $62.5 million in preferred units and $7.5 million in common. I should note in these -- for these common units, we certainly don't expect any common dividends in the near-term as there are lots of growth opportunities to focus on. Total capital deployed for the first 6 months is already a record year at $260 million. A couple of notes on our partners. The portfolio continues to perform extremely well. Our weighted average ECR is now over 1.75x and at an all-time high. We now have 16 out of 20 partners. That's 80% of them that have an ECR of over 1.5x. And 9 of those 15 are over 2x and no partners below 1.2x. Something Steve and I have talked about in 13 years of public company investor presentation. Our diversification goal is to have no partner greater than 10%. And today, I'm pleased to say our largest partner is now 10%. Our outlook for Q3 2021 calls for revenue of $37.5 million, and our G&A remains well inside of annual expectations. Before I hand it over to Steve, I would like to make a couple of comments on a certain section towards the end of the press release. Being the CFO of Alaris has quite simply been the best job I could have ever had, and I have certainly enjoyed every minute of it. I'm looking forward to assisting our new CFO, Amanda Fraser, during this transition period and having worked closely with her for the last 8 years at Alaris, I am certain she's going to do a tremendous job. She and I have talked about this the last year or so, and she shadowed me for this Q2 process. And I'll be here to assist her through Q3 results and whatever else she and Steve and the rest of the team need for me over the next few months. I want to thank my pal since the late 80s Steve for inviting me on this incredible journey. And also a huge thanks to the entire team at Alaris, our Board, all of our partners, our shareholders and our business partners for making this such an amazing experience. My wife, Sally and I are excited to head off on this new chapter of our lives, and I cannot wait to be on the end of this conference call for many years to come. So I'll pass it over to Steve for some more comments before moving to Q&A.

I'm not sure there's too much left for me. Thanks, Darren. And yes, I mean, I'll start with the quarter. I'm not aware of a meaningful statistic for a company that isn't at an all-time high right now. Revenue, earnings, run rate, capital deployment pace with the return on our individual investments, coverage ratios, all at levels we've never seen before in our 17 years. So this is not a Q2 story, this is many years of work from our staff, behind the scenes stuff originating the deals, the diligence in the deals, structuring the deals, monitoring the companies once they're partners. So I want to thank all of our staff really for these incredible results that have come from a lot of hard work. Looking forward, the deal pipeline continues to be very robust. Coming out of COVID, we're seeing a larger than usual number of companies coming to the market. It's certainly a tricky time as an investor. The pandemic has had a significant impact on most companies, both good and bad. In fact, I would say, in general, we're probably seeing more positive bumps from COVID than negative. So determining what a normalized performance level is in this environment becomes a challenge. But with the experience that we have internally and with our third party experts, we think this is actually an outstanding opportunity for us. We have several new partnerships in discussions, and we also have a record amount of follow-on opportunities with our portfolio companies coming out of COVID that we'll be pursuing in the second half of this year. Our decision to raise the dividend at this time was based on several factors, including the health of our portfolio. As Darren mentioned, the expected positive resets that we're tracking and also the accretive capital deployment that we've already done over the last 12 months. All of these items contributed to our payout ratio dropping below 60% for the first time in our history. And with the anticipated redemptions of Kimco and Federal Resources, as Darren mentioned, we're still going to be at 70% payout ratio with this new higher dividend rate. But at that point, we'll also have $200 million -- over $200 million of available capital to deploy. So the deployment of that capital will again drive our payout ratio down significantly. So our goal is to continue to drive down that payout ratio, but we do want to give our shareholders a consistent dividend growth rate. And I can't leave without commenting on the decision of my buddy, Mr. Driscoll over here. As Darren said, we've been best friends since the Starter University here in Calgary. And as he likes to say, he joined me once Alaris is able to start paying salaries a few months after I opened the doors in January of 2004. So the things that we've seen, we can make a great book out of, and I thank him for all of it. He's leaving Alaris at the strongest days in our history, and he's also leaving the company in great hands with the successor at Amanda. So Amanda has been a key cog for us for 8 years. And even before then when we stole her from the diligence team at Ernst & Young, working on our files. And Amanda and the rest of our team that were able to advance because of Darren's departure are the present and the future of Alaris, and I can't wait to work with all of them for many years to come. So Matti, we'll open it up to questions.

[Operator Instructions] And your first question comes from Scott Robertson of RBC Capital Markets. Scott.

The first question I'd like to start with is on your sources of capital. So right now, you have about $30 million of credit capacity. And as you mentioned, you expect you could get up to $200 million of additional proceeds if Federal and Kimco redeem their investments. But looking past these events, how do you guys increase the scale of your available capital? Is it meeting with new banks to join the syndicate? Is there appetite for the existing members to increase their share? How do you guys think about your sources of funds over the next years as you try to deploy more capital?

I think it's a real blend of opportunities, Scott, especially with the performance that we've had. There's no shortage of capital out there looking for a home. So I think it would be a blend as our EBITDA continues to grow, our debt facility can grow. There's other banks that are looking to join that syndicate. There's the high-yield market, which we've been approached on quite a bit here. There's also, I think, an opportunity to have co-investors if we really needed that if we had large opportunities and maybe some things outside of the norm, having almost aside to our co-invest type of transaction might make some sense. And then, of course, the equity markets as well. But I would say at these prices, the equity markets would be our last choice out of those.

Got it. And I guess, is there any line of sight on those additional source of capital? Like if you guys had a $100 million deal come through the door tomorrow, is there availability in the market to be able to fund it without going to the equity markets?

We believe so, yes. Yes, Scott, we've got the last bank that joined us has stretch room, each of the banks probably has a little bit of stretch. We have another new bank that's currently diligencing and looked out because our EBITDA now, our EBITDA run rate is over $140 million. So we have room to stretch that $400 million. So we also -- if you get a little bit further along on our Federal Resources redemption, if a new deployment opportunity came in before that, we've had full cooperation from our lenders, and certainly can bridge that if that was required. So lots of options there. So we're not done by any means. We've got lots of deals we're looking at, and nothing has changed as far as our sort of traditional path here.

And I would say that there's nothing in our pipeline that we believe will need to close before we'll get proceeds from one of those 2 transactions.

Got it. And I guess, have you given them like a drop to-date to decide whether or not they want to pursue a transaction with you guys because the uncertainty can be tough, but obviously now you guys like to work with your partners. So I'm just wondering how to think about that.

Yes. They certainly are pursuing the transactions is just -- obviously, these types of things don't happen quickly. So we're just going through the process. It's not a matter of saying, should we do something, they are doing something and it's just closing it.

Got it. And I guess, do you guys have any updates on the Sandbox or the CRA files from the past year?

Nothing new on the Sandbox front and the CRA, really nothing new either. We're continuing to wait on a decision that was appealed by the CRA that if the CRA is unsuccessful, we're -- we think that will be very good for our physician. But again, nothing -- no further conversations on settlement. We're sort of quietly waiting. We still think we've got a real good position here, and we'll update people if anything happens. But as I've learned over the last 17 years, nothing at the CRA goes very quickly.

Your next question comes from of Nik Priebe with CIBC Capital markets.

Yes. So the private company partner trends look overwhelmingly positive with respect to earnings and revenue growth on a year-to-date basis. There were only 2 stood out to me that I wanted to ask about. So revenue at LMS looks like it's down on a year-to-date basis. I think you alluded to this earlier, but that's your only uncapped investment. I recognize it had a big positive reset last year. But I was wondering if you could just give us a sense for the scale of the year-over-year decline. Just trying to gauge how next year's reset might be shaping up?

Yes. Our fair value is based on a 20% decrease. This one is based on gross profit because of the commodity price impact. So their volume and sales line is intact. They're still doing lots of work. But again, the price of steel does impact how much money they make. They're still very, very profitable. And again, their last 4 increases were all in the teens, including a 30-something percent a couple of years ago. So giving a little bit of that back is certainly nothing we're concerned about. But this is one of the first investments we did. It was uncollared, and we learned the hard way that we should have a caller on our investments. That one went down in 2010 by a significant amount. And every deal we've done since then has had a collar.

Yes, they're doing extremely well. Activity in Western Canada and California is extremely high. But as Darren mentioned, we've seen -- everybody has seen a huge spike in commodity prices, lumber, steel, et cetera. So it certainly impacted them. We don't expect that to be a long-term phenomenon.

Yes. Fair enough. Okay. And then the only other one I wanted to ask about was, I noticed the ECR range declined on a sequential basis for Brown & Settle. I think it was the only one in the entire portfolio. But just given that that's a new partner and revenue and EBITDA are down on a year-to-date basis. So wonder if you could just provide a little bit of color on what you're seeing there?

Yes, you bet. So Brown & Settle is a site remediation, site preparation company, mostly for the data center industry in Northern Virginia, which is the data center capital of the world. And so most of these projects are done through companies like Amazon and Microsoft and Google. There was -- and they are very large projects. So you can have some short-term volatility when projects get delayed. And they have 2 very large projects that were both delayed in Q1, partly because of just internal decisions at the end user, which was Amazon. And partly because of the severe weather storms that were in the East Coast in Q1, if you recall. So it can have a material impact on a company like this that is kind of more project related. And so we just had a 1 quarter dip. As Darren mentioned, the projects are active today, and the company is making very good money on a quarterly basis now. But we'll -- in terms of the trailing 12 months results, it will take a year or 2 to get rid of that Q1 out of the TTM numbers. So no concern there, but just something you have to leave to in a company like that.

Nick, I'd add for those that have followed us a long time, Federal Resources is a company that did experience some fairly significant lumpiness depending on the project, the contract they were doing quarter-over-quarter volatility was pretty significant. So there was lots of bouncing around in ECR ranges. And so this one will be one of our bouncier ones from an ECR standpoint. So just something to keep an eye.

Yes. We're very long-term in our focus. A quarter of delays really has no impact on our investment thesis on this one. Their backlog is double what it was last year. So this is a very good company.

[Operator Instructions] Our next question comes from the line of Zachary Evershed with National Bank Financial.

Congrats on a great quarter. So a follow-up on Scott's question, what types of co-investors would you be open to work with?

That kind of stuff is nothing that I've gone down the road on, because, quite frankly, we just haven't needed it, and I don't anticipate that we will anytime soon. But I would say the types of co-investors would be -- would likely be pension funds.

Makes sense. And then a bit of a housekeeping one for you. Operating expenses are about $12.5 million on a run rate, but how will that look in a post-COVID environment when your travel expenses and partner events ramp back up?

Yes. I think it will still be around 12.5%. I think we'll probably be under 12.5% this year. But we do have -- like last year, we had some spikes from the trust conversion and our legal team had a lot to do with working through the PPP loans with each of our partners. So it is a little bit hard to pin down, but on a $150 some odd million of revenue, if our $12.5 million goes to $13 million or $13.5 million, we're not too concerned about that. But our regular travel -- I think our travel will be less going forward. We're going to do a lot of our marketing by Zoom and Team's meetings, but you'll never stop doing the travel to the U.S., the Steve and the group went down there last week for a 4 city tour or a wind tour, and that stuff will certainly ramp up now that we're allowed to go and come back without having to hunker down in our basement for a couple of weeks.

Got you. And given the ongoing slog with the CRA and Sandbox, do you guys have a bit of padding in that budget for a ramp-up in legal fees if it comes to that?

You bet. Yes. No, I mean we're padding, there would be a little bit. We have a reasonable amount for legal expenses each year. If anything, really jumped in, it would -- we'd probably have to add to that 12.5%.

Your next question comes from the line of Lee Pettigrew with Macquarie Capital.

So Darren, congratulations on your retirement and congratulations to everyone on a great quarter. I meant to ask an original question, but it's actually going to be more of a follow-up because I've gone through the press release and some detail and gone back to some of the other filing statements and so forth. And with regards to the $12.5 million, it's tough for me to kind of build that number up from executive compensation and so forth. And I've been an investment banker for better part of 25 years, I kind of know what travel costs and so forth are. And I know there's kind of some onetime costs with the conversions and so forth. But for those of us who are maybe 2 or 3 steps behind some of the analysts have been following it for quite a while, if you don't mind being a little bit pedestrian for the likes of me, if you could kind of walk me through that number, just on the face of it just seems the sticker shock is a little bit there.

Well, I'm happy to answer that. I mean, we were -- when we were a $22 million company of revenue, we had -- our G&A was probably $8.5 million or $9 million there's just certain amount of costs that are required to run a public company. We have 16 staff. This includes base salaries. This includes an estimate for an annual bonus that's been around $1.5 million. So probably $3.5 million of that is people power. Then we would have our office rents, travel, legal and accounting for a public company is expensive. We also spend money on our transactions. Legal at alone would probably be a couple of million a year. So that doesn't take too long to get to -- I don't have the exact numbers in front of me, but that would be the mix of legal and accounting salaries benefits, including a bonus and then all corporate and office. So travel, we host a conference once a year with all of our partners that come in and we get together and network and get updates and build relationships with each of them. And so I'm quite proud of how low our G&A is, and especially as it's held the line, while our revenue has gone up significantly. If we add a couple of more people, which we will need to do if we add 3 or 4 more partners, we're adding a few hundred thousand to that. And we're adding $10 million or $20 million of revenue to the top line. We've got a really neat graph in our -- at the back end of our slide deck that shows the scalability and how our revenue has dramatically outpaced our G&A.

Lee, another way of looking at it is we've got about $1.3 billion in investments right now. And as you would know, most fund managers, especially private equity fund managers, would get about 2% of assets under administration as their G&A amount. That would equate to $26 million. So we're at $12.5 million, including public company costs. So we're keeping a very lean operation here comparatively.

Your next question comes from the line of Gary Ho with Dejardins Capital Market.

Just the first question, just on the distribution increase. Can you, Steve, maybe comment on your comfort in the payout ratio and looking out next year, you're successful in your capital deployment strategy again, and payout ratio drops, are you comfortable in raising that and moving back to a dividend growth story again.

Yes. So as I mentioned in my little piece, our goal is to still drive down that payout ratio lower and lower. I don't want to have 100% of our growth go to that, though, I think it will be the majority. I think it's important for our cost of capital to have a valuation that's based on growing dividend stream. So we did a very modest increase. And as I mentioned, even with the loss of Kimco and Federal Resources, we will still be at 70% payout ratio. So within our target, but then we'll have $200 million to deploy, which will be funded just with our senior debt facility at less than 4%. So very accretive deployment at that stage, which would drastically reduce that 70% number and keep us on the path towards a lower and lower payout ratio. So yes, we're -- obviously, we're very comfortable with that dividend increase.

Got it. Okay. And then second question, sorry to go back to the G&A. Isn't there typical -- typically in Q4, the bonus payment, I think there was something in Q4 last year. Any thoughts on what that number could be as we're kind of halfway through the year?

Starting to see it. I mean, I think last year, it was $1.5 million. It's based on a formula-based on an increase in distributable cash per share. It will probably be -- it will be a little higher than last year just because of our growth numbers. But I don't have too much clarity, but I would say somewhere in the $2.5 million is probably a reasonable guess at the moment. But it really depends. The redemptions actually hurt that number. So depending on when those happen, there's a number of things that can change that future deployment helps it. So a little too early. At Q3, you'll have a much better idea.

And your last question comes from the line of Trevor Reynolds with Acumen Capital.

Just curious about the market competition on deals, any change since last quarter?

Not since last quarter, no. It's still extremely competitive. We're going through a couple of bids right now, where we're in the finals. In one of them at least, we're in against certainly more than a dozen bidders. So that -- we've seen that for years, to be honest. There's still a lot of capital out there. All of these funds have been successful in raising new capital as well over the last quarter or 2. But our story is the same. If an entrepreneur wants to keep their business and enjoy more of the upside. Our preferred shares are going to be a better fit for them than common equity. And so we still don't have a head-to-head competitor, I would say, in that marketplace. And we're seeing that story resonate seemingly much more now than in the past. Business development guys have done an incredible job in getting our message out there and finding kind of the right situations for us to get into.

That's helpful. And then just on the minor decrease in the Kimco expected proceeds. Can you just touch on that?

That's just simply because we've collected $8 million of it in the last few months, they paid prom notes, they've paid unpaid distribution. So the total value that we would have said a while ago still holds, but we've collected $8 million is already in our jeans.

And there are no more questions at this time. Mr. King, do you have any closing remarks?

Yes, I just want to thank everybody again for tuning in. And as usual, if you have any further questions, to both Darren and I and Amanda are here to answer any of them. And we look forward to seeing you in Q3. Thanks very much.

This concludes today's conference call. Thank you for participating. You may now disconnect.