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

Good day. Thank you for standing by, and welcome to the Alaris Third Quarter 2021 Earnings Release Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Amanda Frazer, Chief Financial Officer. Thank you. Please go ahead.

Thank you, Gail. Good morning, ladies and gentlemen, and welcome to the Alaris Equity Partners conference call and webcast to discuss the financial results for the 3 and 9 months ended September 30, 2021, as well as a brief corporate update. I'm Amanda Frazer, Chief Financial Officer of Alaris. I am joined on this call by Steve King, President and Chief Executive Officer of Alaris. [Operator Instructions] 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 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 www.sedar.com 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 regarding non-IFRS measures. Q3 revenue of $42 million was ahead of $37.5 million of guidance, primarily due to USD 3.4 million of unaccrued distributions received from Kimco relating to prior periods. Q3 normalized EBITDA of $33.3 million was well ahead of our Q3 2020, $20.1 million and an increase of 32.5% per unit. Record deployment in the last 12 months of $400 million has resulted in this increase. During Q3, finance has returned to paying us full distributions of USD 800 million per month after deferring distributions in Q3 2020 due to the pandemic. In the quarter, we also received USD 526,000 of common distributions and year-to-date, we have received over USD 1.8 million. During the quarter, Alaris booked a $4.6 million tax recovery due to more favorable interest treatment than initially anticipated by the U.S. CARES Act legislation. We were able to carry back losses to prior periods and as a result, are expecting refunds on previous amounts paid. We also had some fair value changes in Q3, in aggregate, including the common units, an increase of $15.9 million to our book value or $0.35 per unit. Kimco was increased in the period USD 6.5 million as they continue to proceed toward a redemption at -- this as well as the business' continued exceptional performance has led to an increase. It's worth noting that in the last 9 months, Kimco has repaid USD 7 million of previously unpaid distributions and USD 4 million of prom notes. FNC's preferred and common was also increased by USD 2.7 million, looking like a top of the caller reset in 2022, the business is performing extremely well. Unify was increased by USD 1.8 million as the business is growing and expecting a maximum positive reset in 2022. Brown & Settle was increased by USD 1.5 million. During Q2, the preferred units of Brown & Settle were reduced by USD 3.3 million. The first 5 months of 2021 have seen their margin -- has seen some margin pressure due to the projects and customer mix as well as project delays, which reduced our expectations on the FY '22 reset to negative. B&S performs large projects and the timing of which can impact monthly cash flows. Since that time, Brown & Settle has delivered 2 quarters with double the revenue earned in Q1 and a significant amount of work on hand for Q4 and the following year. We now expect our reset to be at least flat as a result and net impact to the preferred valuation as a decrease of USD 1.8 million year-to-date, up from the USD 3.3 million previously reported. Other increases in the period included 3E offset by a small increase in Edgewater. We now have 8 months of financial results for all of our partners and are anticipating total aggregate resets in 2022 to be an increase of approximately $2.6 million or $0.06 per unit. Top of the collar resets are expected from 10 of our partners, including Planet Fitness, Body Contours, Accscient, DNT and new partners 3E and FNC, just to name a few, while an expected decrease from LMS will be uncolored. And much anticipated Federal Resources redemption took place on October 26. The successful redemption of Fed at USD 13.9 million premium on $67 million invested. The redemption resulted in a 113% total return and an IRR of 19%. Of note, our payout ratio remains in our targeted range of 65% to 75% after the transaction. The proceeds of the Fed transaction were used to pay down outstanding senior debt. And while we had pre deployed the capital with our investment into D&M at the end of Q2. This leaves us with $140 million of available room on our facility, and we are at roughly 2x leverage. We've been busy working through a number of potential follow-on transactions with existing partners. Follow-on transactions generally require less third-party diligence support and more upfront work performed by our own team. And as a result, our transaction costs for Q3 were down compared to prior periods, but we will be returning to more historical levels for Q4. Total capital deployed for the first 9 months has been a record year at $260 million. The portfolio continues to perform well. Weighted average ECRs continue to be over 1.7x at an all-time high. 15 of our 19 partners continue to have ECRs of over 1.5x, and now 10 of those 15 are over 2x. Last quarter was 16% and 9%, inclusive of Fed. During the quarter, we did have 2 partners move into the 1 to 1.2 range, being B&S and Edgewater. B&S as previously discussed, the project delays and margin pressure in the beginning of the year have resulted in a slight decline in the TTM ECR into the 1.2 range -- 1 to 1.2 range. If you were to look at that based on the last 6 months, the ECR would be back in the 1.2 to 1.5 range, and we expect them to move into this range or higher once the Q1 '20 results are out of the TTM period. B&S is also deferring a small portion of their payment to better align with the free cash flows generated from projects. B&S paid $1.3 million of the $1.9 million contractually owed in the quarter, and we expect any amounts deferred to be collected in the next 6 to 12 months, and our long-term outlook for the company remains unchanged. Edgewater's results have been impacted as COVID restrictions remain at most of the large DOE facilities in which Edgewater operates in addition to a tight labor market and sourcing and staffing new engineers. Edgewater has low levels of debt and the outlook for 2022 is positive, and we anticipate Edgewater to trend back up over the coming year. Our outlook for Q4 2021 calls for revenue of $36.2 million. Our G&A remains consistent with annual expectations of $12.5 million to $13 million, driven slightly higher by an increase in the management bonus accruals as a result of hitting bonus targets and continued growth in distributable cash flow per share for Q4.

Okay. Thanks, Amanda, and thanks, everybody, for dialing in. Obviously, I'm thrilled with the results that we were able to share yesterday in our Q3 release. In addition to being well ahead of guidance, the amount of growth that we've been able to show in our actual results is an overlooked feature of our business model, I think, given that our focus has been and always will be delivering a healthy cash flow yield to our shareholders. Increasing EBITDA by 32% on a per unit basis for the 3 and 9 months ended September is a large number for any company and reflects the accretive nature of our investments given that we had 2 equity offerings in the previous 12 months. One question that I've been getting a fair bit of recently, which for good reason, is the impact of supply chain and labor shortages within our portfolio, just as we were extremely fortunate to be in required service type businesses for the COVID shutdown last year. The same kind of companies are weathering the supply chain issues very well in 2021; the majority of our partners don't rely on products or materials to generate revenue and those that have been -- that have some element of that have been able to manage their businesses around that and stay within a pretty tight range on their budgets. The only one having significant declines from this feature is LMS, which relies on bringing steel in from foreign countries. The price of steel has spiked causing the impact on the gross margins. We do expect that impact to stabilize and possibly reverse at some point. Several of our companies are definitely having challenges with labor. Amanda already noted Edgewater, DNT would be another one, huge customer demand that they have not been able to take full advantage of because of just a shortage of labor across the U.S. All that being said, our portfolio, as a whole, continues to trend up from a distribution reset, fair value and an earnings coverage perspective. Given the issues that COVID has created, we couldn't be happier with that performance. As Amanda also mentioned, we have several follow-on investments that are scheduled between now and year-end. We don't anticipate being able to add another new partner in the next 7 weeks but the volume of follow-ons on top of the new partners we already added this year will make for another record year of deployment. 2022 is already looking like another very exciting year for our company. Our team is as good as it's ever been. Our reputation in the industry is helping us attract more great partners, and we're evaluating initiatives that will take greater advantage of those assets and provide more opportunities for growth for our shareholders. So Gail, I'll turn it over to you and for questions from the field.

[Operator Instructions] Your first question comes from the line of Nick Priebe from CIBC Capital Markets.

Yes. Okay. Just wondering if I could ask you to elaborate a little bit on what triggered the bonus accrual in the third quarter and whether we should expect Q4 now to look like a more traditional Q3 from that perspective?

Our bonus accrual is triggered by the growth in distributable cash per share. So as we achieved, we beat the prior period in Q3, we accrued a portion. There would be an additional accrual in Q4 if we sustain or exceed the Q4 growth per share. So I would expect to see some amount of additional management bonus accrual coming for the Q4 period as well.

Understood. Okay. And then just wondering if I could ask you to comment on how the pipeline looks for redeployment of the proceeds from the Federal Resources redemption?

Yes. It's a strange time of the year. So in August, early September, there's always a rush of new deals, companies looking to close deals before year-end. Once that period ends, the rest of the year is very, very lean because every PE firm is head down trying to get everything that they've signed up closed as we are right now. So typically, you don't see a lot of new deals until January once the end of September end. So yes, we don't -- as I mentioned, we don't expect any new partners to be added between now and year-end, but we've got a -- probably a record level of follow-on deals to close in the next 7 weeks, which we're looking forward to doing. And the deal flow -- we've just had our BD guys at several conferences in the U.S. and the advisers are expecting another great year of deals for 2022.

Okay. That makes sense. And then last one for me. I know the payout ratio may bounce around a little bit with the natural ebb and flow of investment activity. You did announce an increase in the distribution to unitholders last quarter. Just wondering at what payout ratio you would be comfortable contemplating another rate? Like should we be thinking about that 70% as being the general threshold for what you would target long term? And if you're able to drive it lower than that, then we might start to think about another distribution rate? Just trying to get your thoughts around that.

Yes, I certainly wouldn't recommend to our Board. Obviously, it's their decision, but I wouldn't recommend the dividend increase anywhere above 65% payout ratio. Personally, I'd like to see it below 60% before we raise it again so that after a raise, we're back in the low 60s. So that's kind of my target for it.

Your next question comes from the line of Gary Ho from Desjardins.

Steve, just maybe just a follow-on, on that last question on capital deployment. Can you maybe elaborate on those follow-ons, maybe the magnitude? I know there's the BCC one. I'm not sure if that's the one that you're referring to and/or others that's in the pipeline. And also you talked about potential larger kind of chunkier ones maybe in 2022. Are there stuff that's driving that maybe U.S. capital tax issues and whatnot. Maybe just talk about the environment in the U.S. as well?

Yes. So I won't give any specifics on follow-ons for this year. You mentioned BCC at USD 25 million. That's one that we've had contractually in place that is expected to close before year-end. There are several others on top of that, that would be -- that would add up to more than BCC. So we're excited about that. And in terms of kind of the deal flow environment, one of the things that has made us better deployer of capital that has been the addition of some common equity, along with our preps. That continues to be a major selling point where we can reach deals where they need more of the capital stack replaced. Up until 2 years ago, we were kind of limited to companies that needed only 50% to 60% at a maximum percent of their cap stack replaced. Now we can compete on deals up to 80% which is the vast majority of deals. Most private equity-owned businesses are 80% owned by PE, 20% owned by management. As long as management is willing to roll their 20% in with us, we can now bid on those deals. So we've seen that dramatically increase the number of deals we can contend on and people continue to love our preps and the financial leverage that, that gives them on success because their preps are capped in their growth. So that gives us a huge competitive advantage in the market. So we're still seeing really good interest in the same kind of deal terms that we've always had, averaging 14% kind of current yield on our preps and still with the vast majority that we'd be looking at being able to pay common dividends to us as well.

Okay. Great. And then maybe just a bigger picture question. Just in terms of the rising rates that we're seeing, how does that impact your business model? I think in the past, you've talked about maybe some competition from the net debt side. Just wondering like if you look out over the next couple of years, if we are still in this rising rate environment, how that might impact your offering? I know previously, you've offered something in the 15%, like would you potentially move back in that, in a higher rate environment?

Yes. I think there would be room to move it in a higher rate environment to a point -- we've been doing this for 18 years. So we've seen different interest rate environments. Although with that being said, it's been pretty low for the vast majority of that period. But when we first started 18 years ago, we were starting at 16%. As interest rates move down, multiples went up, we came down to an average of 14%. So I think there would be room to move back up to that 16% range if interest rates go up significantly. But too much past that. I don't think it's viable. It certainly wouldn't be regardless of where rates go, I think starting with something -- starting with the [ 2 ] , I think 20% and above, I think it's really difficult just from an optics point of view. So -- but we will certainly be able to move 200, 300 basis points.

Okay. And then maybe just my last question. Steve, you mentioned some labor shortage issues at Edgewater and DNT. How do you think they'll -- that will play out? Will we see potentially a decline in the ECR a little bit when we look out to 2022? Just wondering, like over the next 12 months, what we should expect from some of these companies.

Yes. I think we've already seen the impact in Edgewater. That's why you've seen the ECR move down. I don't anticipate and I may don't anticipate that moving down any further. Part of it is labor shortage, part of it is still workers not being allowed on site at some of the Department of Energy sites. So we do expect that to change positively in the next few months, knock on wood. And with DNT, they have hit records this year. So even though there's a labor shortage, it's really a matter of probably not being able to fill as many of the potential orders as they could have, but they're still hitting records. So it would be nice to have more labor, but it's not causing them a decline. That makes sense?

Yes. Okay. Perfect.

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

With the cash injection from Fed putting you very comfortably on side of covenants after running a little bit tight, how high are you willing to take leverage before tapping equity markets again?

I've always said that in order for us to bid on large new deals, I need to show that company and their adviser, I want to have $100 million of deployable capital on our balance sheet at all times. So we're at $140 million right now. We do expect for the proceeds coming in from Kimco. So we've got a little bit of room. With that being said, and I think I mentioned this in the last quarter, there are other options for us other than coming back to the equity markets. The high-yield debt market, I think, is a viable option for us as well, which would be lower cost of capital for our shareholders. So yes, I think we're in good shape. But if we got everything from Kimco, that would be another CAD 80 million, CAD 90 million. So that obviously makes a big difference and would certainly give us many months of leeway.

And on the topic of Kimco, any updates on timing or likelihood of redemption?

No updates on timing. I would say that the likelihood has increased since we last spoke. Things seem to be progressing well, but we're not quite at the point where we can call a date on it, yet.

Your next question comes from the line of [ Lloyd Yankee ].

I listened to a couple of presentations from U.S. firms in the same line of business. Carlyle is one. And on the universe of potential companies going forward in a higher interest rate and inflation environment, as you touched on, you've mostly operated in lower inflation, lower interest. Do you see that universe increasing? Or how do you see that? And also on the Federal deal, what really caught my eye was the endorsement by management of how satisfied they were and with those kind of endorsements from partners, are you getting a lot of referral business?

Yes. No, appreciate it, good questions. We are -- and always have -- once we've done a deal with somebody and I would include their advisers that advise them through their processes, we tend to get a lot of repeat business with people that we've already done deals with. We're a pretty unique structure. There's a lot of advisers that just don't take the time to really understand the benefits to their clients. So the more case studies we have like Fed and many, many others that we've had over 18 years, the more of those that we have, the better it is for us from a marketing tool. We've been really blessed that almost all of our current and former partners have been more than willing to talk to prospective new partners when we are bidding on those deals. And as I mentioned, the guys that will be no different. They would love to talk to people and kind of reiterate what they talked about in that press release. So -- and it's another great example of also why we have started putting common shares in -- as a small piece of the pie here. We got a 19% IRR, the common shareholders onset got significantly more than that because of the muted growth in our preps, they had an extreme amount of growth, especially over the last couple of years. So they benefited greatly from our structure. As it relates to your first question on interest rate environment, to a certain extent, a higher interest rate environment helps us from a competitive standpoint. We use very little debt in our transactions in their structures. So most of our companies have no term debt. The ones that do would have less than 3x EBITDA of debt. So in the U.S. marketplace that is considered underlevered, most PE firms are bidding with 4 to 7x leverage on average. And so higher interest rates for them really impacts their economic model much more than it does us. So we've seen that in the past when credit markets have either tightened or gotten more expensive, I think it's actually better for us from a competitive point of view.

Your next question comes from the line of Scott Robertson from RBC.

Steve, the first question I have is going back to the comments you made at the end of your opening remarks. Just regarding -- I believe you said something to the effect of you're going to try and take better advantage of opportunities next year for growth. Just wondering if you could speak a bit about that, if that's more from the capital structure perspective. Like I know you mentioned you're looking at high-yield debt. Like do you think you're going to try and change the capital structure that way or perhaps were you speaking more towards a change in the new product offering like the way you guys introduced common equity? If you could just provide a little bit more color around that?

Yes. No. Thanks for that, Scott. We've got a really great team here. And we've also got kind of a pseudo proprietary structure that no one else in the world does. So we get fantastic deal flow. We're getting between 600 and 1,000 deals in per year now because of our reputation and because of our unique structure, I think we can take better advantage of our team and our reputation and grow outside of the confines of our own balance sheet. And by that, I mean, I think we can raise outside capital and get fees on managing that capital for others within our team here and for our Alaris shareholders. So both on the senior debt side, and going further into the common equity side, I think there's opportunities for us there to make money on other people's money, not just our shareholders.

Interesting. Okay. And would you envision a -- like you're able to use the existing team you have? Or do you think you would need to also then build out call it, an asset management team that does more fundraising marketing kind of thing? Or are you guys able to do that with your in-house capabilities today?

I think we'd need some add, Scott, especially on the common equity side. We need to work through some of the corporate governance issues, but certainly, we'd be able to kind of piggyback on the work that our business development team does or due diligence and monitoring teams. But I think from a corporate governance point of view, we'd have to build out the team more. So there's a different group kind of solely evaluating common equity and whatnot. So those are the things we're evaluating. It's early stages right now, but I'm quite excited about it. And I think it's the right thing to do. We -- in my mind, we've got one of the best teams in the industry.

Great. And the second question I have is on Planet Fitness. So the franchisor is reporting improving fundamentals within the system in general. Just wondering how that may pull out for PFGP and ultimately, Alaris. And I guess, specifically, do you think the cash flow generation there. If it continues to increase, could result in advanced payments of those deferred distributions rather than over the 36-month time horizon? Or alternatively, do you think that there could be increased follow-on capital deployment with that partner given the environment that they're starting to see?

Yes, they're doing really, really well. So obviously, the results that you're seeing at the parent company are on the back of the franchisees like our partners at PFGP. So numbers have been continually getting better and better. They've also had the benefit, I think, of some people migrating from some of the smaller footprint, more expensive type systems to the Planet system. And in terms of getting our deferred distributions back quicker, I think that is likely, although it will be balanced with the fact that they have quite a few growth opportunities as well. So we don't want to diminish their growth possibilities by stripping them with too much cash. So we'll balance that. We want to be patient, good long-term partners for them, which we have been. And they've greatly appreciated that -- the question about having endorsements from our partners, you should talk to Victor and Lynne Brick at Planet Fitness. They will talk endlessly about how great we've been as partners. So yes, I think there probably is more capital deployment opportunities with Planet. I think there's some acquisition opportunities that they're looking at, and it is such a stable system that we'd be happy to put more money in that.

Your next question comes from the line of Jeff Fenwick from Cormark Securities.

So Steve, I think most of my questions have been answered, but I did want to touch at least briefly on the common dividend picture here heading through the end of the year. FNC has been a great, nice payer for you over the course of the year pretty consistently. And I know the other ones can be a little more sporadic. So can you just remind us, is there -- Is it through the fourth quarter that you might see a couple of them true up like more, I'm sure, has had a decent year. Any color there you can offer up on that?

So we do expect -- Amur has been paying twice a year dividend, and we would expect to be receiving another one this December as well Carey pays an annual distribution. And then on top of our more regular payers being FNC.

So yes, I was just at a Board meeting with Amur a couple of weeks ago, they're doing extremely well. So I'm expecting that dividend to continue to grow and same with FNC, we're putting up just huge results as is Carey for that matter. So Planet Fitness that I just touched on, I don't anticipate any common dividends from them, still. I think their focus will be on growth and debt repayment. Needless to say, when COVID hit, they weren't real pleased with their lenders and having the debt. So I think they're going to be in repayment mode, which is fine by us. For every dollar they pay off that adds a dollar to the common equity value. So yes, we're seeing some good things for sure with our common equity distribution.

Okay. And then maybe just one more on Kimco. And sorry, this has been asked already, but they topped up the quarter for you with some sort of deferred payments owing and I know there's a fairly sizable balance still outstanding there. So do you expect that, regardless of the transaction picture on them, do you see a few more of these payments coming in the coming quarters?

It looks like probably a redemption of some sort is more likely than just continued payments. So we're -- hopefully, we're closing in on it.

And I would say that if there are additional payments during Q4, they will likely just could be for the next quarter paying down the prom notes. So they've sort of been going back and forth between prom notes and accrued distribution. So I do know that if they have some additional cash and nothing gets done before the end of the year, we could probably expect another prom note payment.

[Operator Instructions] We have no further questions at this time. I would now like to turn the call back to Steve King, Chief Executive Officer for any closing remarks.

Great. Thanks again, everybody, for tuning in. As always, please don't hesitate to give us a call directly if you have any follow-on questions, and look forward to talking to you, I guess, in March after Q4 is out. Thanks very much.

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