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

Thank you for standing by, and welcome to Alaris Equity Partners Income Trust Fourth Quarter 2021 Earnings Release Conference Call. [Operator Instructions] Please be advised that today's call is being recorded. [Operator Instructions] I would now like to hand the call over to Amanda Frazer, Chief Financial Officer. Please go ahead.

Thank you, Latif. Good morning, ladies and gentlemen, and welcome to Alaris Equity Partners conference call and webcast to discuss the financial results for the 3 and 12 months ended December 31, 2021, as well as a brief trust update. I am Amanda Frazer, Financial -- Chief Financial Officer of Alaris, and 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. 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 sedar.com as well as our website. Non-GAAP 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-GAAP measures. Appreciate everyone taking the time to join us this morning. We're excited to present our 2021 results. Some of the highlights include Q4 revenue of $37.6 million and cash generated from operations of $34.5 million, both boosted by higher-than-expected common dividends from FNC and the additional follow-on investments in November and December, including 3E, D&M and BCC, causing us to beat our recent guidance. 2021 revenue of $147.7 million and cash generated from operations of $124.7 million represents a 35% increase in revenue and a 44% increase in cash generated from operations. The increases were largely driven by the significant deployment that occurred at the end of 2020 and beginning of 2021 as well as the additional payments received from Kimco for unpaid and unaccrued distributions relating to the prior period. Deployment in the year totaled $357.8 million, including $93 million in Q4, resulting in 4 new partners, 6 follow-on investments, run rate revenue of $150.7 million or $3.34 per unit as compared to $136.7 million and $3.04 per unit in the prior year, run rate net cash from operating activities of $92.1 million or $2.04 per unit compared to $81.1 million and $1.80 per unit in the prior year. Our payout ratio remains at historically low levels between 60% and 65%. We are expecting net positive resets for 2022 of approximately 2.4% despite LMS' uncollared reset down of 18%, resulting in $2.6 million of additional revenue or $0.06 per unit. We are expecting -- there were significant increases in fair value at December 31, $23.8 million or $0.54 per unit, demonstrating both an almost complete recovery from the portfolio from the effects of COVID-driven write-downs as well as significant growth and strong performance of new partners such as FNC and D&M. Planet Fitness, up USD 6.7 million, both on preferred and common, restoring what was written down in 2020 and reflecting expected growth in 2022. FNC, up USD 4.8 million on both preferred and common reflects significant growth in the company over the short time of our investment. D&M, up USD 3.4 million on common as a result of strong performance over the last 6 months and expected in the coming year. Other preferred increases, including USD 1.6 million from DNT; Accscient, up USD 1.5 million; Amur and B&S, each up $1.8 million, reflect an outlook for 2022 that maintains and builds on the growth experienced in 2021. These increases were offset by cumulative decreases of $5 million in Edgewater fleet and SCR. During the year, net fair value increases by a total of $63.2 million, contributing to a 13% increase in book value per unit from $15.51 in 2020, up to $17.93 in 2021. Subsequent to year-end, we completed a $65 million bought deal offering of senior unsecured debentures that was used to reduce our senior debt outstanding to $265 million. This results in $135 million of available capacity. And we do also continue to expect the redemption of Kimco, which would add another USD 65 million to USD 70 million to the amount we have available for deployment. Our portfolio continues to perform extremely well and has a weighted average ECR now over 1.8x as compared to 1.7x in the prior year. This metric has continued to beat the all-time high of previous quarters for the last year. 15 of our 19 partners or 80% have an ECR over 1.5, and 12 of those are over 2x as compared to 6 over 2x a year ago. As previously mentioned, we are expecting net positive resets based on unaudited information, 11 up, 4 down and 1 flat. Planet Fitness has started additional catch-up payments for the deferred distributions associated with 2020 of USD 196,000 per month as of this January. Overall, we are extremely pleased with the performance of our partners. A couple of unique items from our release worth expanding on. Due to the changes in non-GAAP measures, we are no longer presenting normalized EBITDA. Replacing this metric is cash generated from operating activities. This metric does include the effects of unit-based compensation expense, current income tax and changes in working capital as compared to normalized EBITDA. In prior periods, the material normalizing items primarily related to unrealized gains and losses in foreign exchange as well as realized and unrealized gains and losses to investments at fair value, all of which are removed from the cash generated from operating activities, which is why we've determined it's the most comparable figure within our financial statements. Also worth mentioning, since converting to a trust, the tax profile of our distributions changed from being 100% eligible dividends to a combination of return of capital, eligible dividends, capital gains and interest income. The effective tax rate of Alaris' distribution for an Alberta individual in the top tax bracket for 2021 was 37.5%. If the same distribution was received from a corporation, the effective tax rate would be 34.3%. We also continue to work with our external advisers in producing our ESG report and target to release in Q2. We have paid close attention to these issues throughout our company's history, and we look forward to presenting our first report. Our outlook for 2022 based on recent deployment calls for $38.6 million of revenue in Q1 and a run rate for the year of $150.7 million. We do expect our G&A to increase in line with our growth in revenue to around $14 million. I'll pass it over to Steve to add a few comments before we continue with the Q&A.

Great. Thanks very much, Amanda. Thank you all for tuning in. Simply, it's an extraordinary year for our company, showing 35% revenue growth, 44% cash flow growth not including the fair value increases is something that everyone at Alaris is very proud of. There's no question that the small change initiated 2 years ago to add a portion of common equity to our traditional preferred shares has had the exact benefit that we had hoped for. We're already seeing the prospect of increased overall returns. And the fact that we've deployed over $500 million within the last 18 months has undoubtedly been helped by the addition of common equity and allowed us to offer a more flexible solution for partners, new and old. Amanda has already talked about the unprecedented performance within our portfolio, but I'll speak a little bit on the specific risks that are out there in the economy right now. First of all, we have no company that has any exposure whatsoever to Russia. Given the service nature of our entire portfolio, we also have very little exposure to the increase in commodity prices. LMS is one out of Vancouver that relies on imported steel for their rebar installation. So the current environment has certainly negatively impacted their gross margins as you saw in their negative reset as steel has spiked. But they've also been experiencing record volumes. So that has buffered some of the hardship. The only other partner that's experiencing anything negative fundamentally is Edgewater, where it has been a difficult labor environment. The company has done an excellent job recruiting new nuclear engineers, but the scarce labor market has certainly inhibited their results. It's unusual to have only 2 out of our 19 partners where there's anything negative to say. Our portfolio continued to show record results and average earnings coverage ratios and growing distributions to Alaris, both preferred distributions and common. Adding over $63 million of book value in the year from fair value increases in our partners is another all-time record. Looking forward, we expect 2022 to be another year of record results for our company. Deal flow remains strong. Both new partner and follow-on opportunities have near-term visibility. Rising interest rates for Alaris is actually mostly a positive thing as our primary competitors, traditional private equity firms for the most part, use extremely high levels of debt to produce the returns that they look for. Even a small change in interest rates materially affects their economics of those leveraged buyouts. Conversely, half of our portfolio doesn't have a cent of term debt in them. And even our most highly levered partners would be considered underlevered within the PE industry. In general, we feel that this is a very favorable environment for Alaris to continue to deploy capital as we've shown for the last many years despite the highly competitive landscape. So Latif, I'll turn it over to you and open the floor for any questions.

[Operator Instructions] Our first question comes from the line of Nik Priebe of CIBC.

So last quarter, you indicated that you might explore the management of third-party limited partner capital to generate a fee-based earnings stream. I was wondering if you could tell us a little bit more about that opportunity? How seriously you've considered it and whether you have an indication of institutional interest yet?

Yes. Thanks, Nik. We have been going down that road. We've been learning a lot over the last 3 months since we started talking about that. And we do feel that there is interest out there in having us manage third-party capital in addition to our public investors' capital as well. So we've got an 18-year track record that -- with very high returns for the industry, especially on a risk-adjusted basis. So that has certainly raised a lot of eyebrows, and we think that, that is a realistic opportunity for us. The exact form of it still needs to be figured out. There's corporate governance, conflict of interest issues, and just structurally how it happens remains to be seen. But yes, suffice to say that we are still very interested in adding that to our company. And based on preliminary results, we think there's a good chance of that happening.

Understood. Okay. And then on Kimco, Kimco has been contemplating a redemption for some time. I understand there's a pretty healthy level of unpaid distributions as well. Can you just update us on the status of that investment, why that redemption hasn't occurred quite yet? And just whether you have any visibility on potential timing there?

I'm sounding like a broken record on this topic, but we continue to expect it in the very near term. Nothing has changed in the last 3 quarters in the situation or our expectations on anything closing. And we hope that we'll be able to announce that in the near term.

Okay. And then just one last one. Brown & Settle deferred a portion of their contractual payment last quarter. Can you just give us an update there? Have they caught up on that? And if not, are there plans to collect over the next 12 months?

They did pay their Q4 distribution a bit late. We collected 90% of that, I'm going to say, distribution in Q1. We expect that there'll probably be a bit of a deferral for Q1 into Q2. As you recall from I believe our last conference call, we had a bit of a discussion that Brown & Settle had some challenges in Q1 of 2020, and it's putting some pressure just on their TTM covenant. And as soon as we can roll that period out of their results, we fully expect to be paid on as contracted. So probably 1 more month with our Q1 results there will be a bit of a delay in the B&S payment, and then we expect for them to be back on track. They are currently -- they have the highest backlog in the company's history. We have their 1-month results, and they're performing extremely well. So we really have no concerns on the B&S front. And we're nearing the end of that Q1 period, and we should see both of the ECR on B&S rebound back up and our payments to continue to be in full and on time.

Our next question comes from Geoff Kwan of RBC.

Steve, you talked about it, I guess, a little bit just talking about what some of the companies with LMS and Edgewater. But just maybe thinking about it from another perspective and also taking into account how big an individual company investment is to your overall portfolio, but which companies within your book would you say are best positioned for a higher inflation environment and which ones might be more vulnerable?

Yes. One of our largest investments is Planet Fitness. And Planet Fitness has been known as very much -- I'd call it a recession-resistant program because they are on the budget end of the fitness industry, where they're charging between $10 and $20 a month compared to multiples of that for other clubs. So that is one where if interest rates go up and discretionary income declines because of inflation and debt costs, that's one that I think will actually benefit from that and succeed very well. They've shown that historically. Other than that, gosh, there's very few that would have much correlation with inflation and interest rates, to tell you the truth. As I mentioned before, they are very much kind of required service type of businesses. And the whole reason we invested in them in the first place is we do have oftentimes a 20- to 40-year track record put up by these companies. So that's something that we look at is historical fluctuations based on different economic and interest rate environments. So we feel pretty good about where we're going to be here over the medium term.

Okay. And just my second question, just given some of the volatility we've seen in credit markets and the overall markets, what impact, if any, is this having on the competitive environment for you making new investments?

Yes. We haven't seen that much to be honest, Geoff. It's still a highly competitive industry. There's still over $1 trillion of private equity capital that is uninvested right now. And then to the previous question about forming an asset management business and raising a new fund, we've gotten to know even more about that industry. And there's still just a huge amount of capital coming into private equity. At the end of the day, only 2% of the middle market companies in the U.S. are public. So the private equity industry is covering a huge amount, and people need to be in that sector. And so there's still a huge amount of capital coming in. So regardless of the kind of the day-to-day, week-to-week instability that we're seeing, the liquidity in the market is overriding that.

Our next question comes from Jeff Fenwick of Cormark Securities.

So just one follow-up guys, on the Brown & Settle amounts owing to Alaris. Are those accrued as revenue in the period? Or are you going to capture that revenue later on? Like is it a receivable? Or is this something that's going to roll in the beginning of this year?

The amount of the payment that we received in Q1 related to Q4 was accrued, and you can see that in our accounts receivable. We did not accrue any amounts beyond what was received in that Q1.

Okay. And I'm just trying to square the revenue guidance for the beginning of the year and some of the factors that might be at play there. So it's a bit above where my modeling might suggest it might be. And maybe it's common dividends or other items like that, that might be there kind of with Brown & Settle.

No. Brown & Settle, how it's laid out within that guidance would -- is sort of as expected, payments as expected. I think there's a $250,000 unaccrued amount right now, but it wouldn't have a material impact on.

Okay. And then I did want to ask about the common dividends. You gave us some guidance on the 2022 outlook. I think $3.1 million is the number that you're guiding to here. So just could you speak to how that's coming together for you? I know a lot of them might pay you periodically, some of them don't pay at all because they're investing for growth. So how do you get a sense of that number? And is it tilted towards the beginning of the year?

We do have some visibility. There are certain -- FNC pays a very regular distribution. Amur generally pays a very set distribution. So we have visibility on those. History with companies like Carey, whereas the other ones, the newer ones, D&M, Planet Fitness, those will be sort of just as declared. We don't have a ton of visibility on those ones. And I think if you look to our MD&A, we've sort of given guidance on who we see as being regular payers and who we see as being in that category of investing for growth, Planet Fitness, D&M, et cetera.

Okay. And then one more on the common dividend investments. It was interesting at the end of the year when you did the GWM investment there. You effectively swapped out pref for common. What drove that decision between you and them? And how does that change your position in terms of your ability to sort of influence what's going on there?

Yes. GWM is a company that we've been trying to become common investors in really since the day we met them. This is a very high-performing company in a very high-performing industry. Like the industry growth rate for them and the programmatic media space is well into the double digits annually, just from an industry perspective. So this is something that we wanted for a long time as with a lot of situations that, after we've been partners for a few years, people enjoy being our partners, to be frank. And so even people that were very reluctant to bring us in as common equity holders, we can hopefully soften up over time. And that's what happened with GWM. At the same time, they had quite a bit of senior debt capability because of their growth and underlevered balance sheet. And so from a cost of capital point of view, replacing some of our prefs with a little bit of debt is something that was prudent for the company to do and we wanted to help facilitate for them. But in exchange for that because we do have full veto rights over any increased debt. We did say, "Hey, like it's time to bring us in as common shareholders, so that we both benefit from doing that." So that's kind of how it came to be, and we do expect to get common dividends from GWM and also experience in their high growth.

Okay. That's good color. And there was one more I wanted to ask you here. Just in terms of a pipeline, Steve, maybe just a comment there. You've given yourself some added capacity with the hybrid debenture offering that you did. How does the pipeline line up right now versus funding capacity? And I know you're trying to handicap the timing on the Kimco redemption as well.

Yes. It's been a challenge, obviously, with how long Kimco has dragged on. So we -- as Amanda said, we do expect to have that done in the very near term. So that obviously helped our balance sheet quite a bit. And we do expect to have that reinvested almost immediately. And the nice thing about that swap is that a good chunk of the capital coming in from Kimco is for previous unpaid distribution. So we'll be able to deploy that capital into a new situation and increase our revenue considerably by losing the Kimco revenue, adding the new one. We should be up several million dollars of revenue, and actually still have more money on our balance sheet. So it's a rare opportunity for us, and we do expect that to happen in the very near term.

Our next question comes from Zachary Evershed of National Bank Financial.

Congrats on the quarter.

Thank you.

So with the strong investment pipeline ahead, it likely won't take you long to deploy your available dry powder. It sounds like Kimco will be out as soon as it's in. So excluding organic cash flows and the funds from Kimco, what's your pecking order for incremental sources of funding?

Yes. I think at the last round of funding that we just did was a debt offering. So we want to keep a conservative and balanced approach to our balance sheet. So I would expect the next offering after that would be common equity, but we don't expect to need that for a decent period of time. Things may be alleviated as well if we can set up an asset management business and have outside institutional capital as well. That may allow us to grow for longer without adding common equity.

[Operator Instructions] Our next question comes from the line of Gary Ho of Desjardins.

Steve, when I think about your payout ratio in the low 60s and you probably have the Kimco redemption coming first half of this year, so that might increase it just marginally. But historically, the company has been known to be a dividend grower, and you raised it last year, obviously. So Steve, what are your thoughts around kind of excess capital and potential dividend to be increased this year?

Yes. As I just went through, like we should be able to decrease our payout ratio with a swap of Kimco proceeds for new opportunities. So that will drive our payout ratio down even further. We'll still have a decent amount of deployable capital. So as you get even halfway through that, excess deployable capital will be well below 60%. And I think that is as I've, I think, indicated in the past, I think that's probably the tipping point on increasing the dividend. So we're pretty close. There's definitely things on the front burner that would trigger that. But we're not going to get ahead of ourselves. We'll wait for those events to happen.

Okay. Great. And then my second one, just going back to Geoff's question on inflation. So when I look at your pref equity structure, the collar are based for the most part on revenue as opposed to kind of bottom line. Am I reading this correctly that if your portfolio companies could pass through higher cost inflation and whatnot on the top line, could you perhaps benefit disproportionately from elevated inflation in this current environment?

You're absolutely correct. Yes. No, that's one of the nice features of our setup. And that was one of the things that I really wanted to ensure when we started over a decade ago with this collar concept of capping the volatility of our distribution changes. I wanted to make sure that in all cases that the top end of the collar would be within the bounds of what typical inflation would be. So we're not losing out to inflation. But you're absolutely right. We actually do benefit from that if company's revenue and costs both go up at the same amount, a bottom line investor would not benefit from that, but we do.

Our next question comes from Trevor Reynolds of Acumen Capital.

Just curious on the deployment levels that you guys expect coming off of the records that we've seen over the last kind of 12 and 18 months that are well highlighted.

Yes. It's impossible to tell, Trevor. All I can tell you is that our deal flow would be comparable to last year. But we are a very opportunity-based company. So you can't put a forecast out there, an expectation on capital deployment other than kind of the overall health of the market and the number of deals that we're seeing. So I would say that on that front, it's at least as good as what we've ever seen. Our kind of reputation and credibility within the advisory market, I don't think has ever been higher. But you've got to go out and you've got to win those deals, and you got to close them. So yes, I feel very good about it, but I can't kind of go into any specifics.

Got it. And then in terms of -- as we've seen restrictions rolling off across North America, COVID restrictions rolling off, how has that impacted the deal flow? Have you see an increase or decrease?

No, it's been -- we're a U.S. business. So I would say that things have been pretty normal for some time already in the U.S. in terms of conferences and face-to-face meetings with management, et cetera. So yes, we've been backing that. Our business development guys, they're on the road right now. They've been on the road most weeks for the last several. And so yes, we haven't seen much of an impact from COVID in some time.

Got it. And then last one, just in terms of new deals or follow-ons. Is there a balance there? Or is it mostly new deals at this point that you're looking at?

No, a good mix. We'll have -- the next thing that we'll do will be a follow-on and a current partner to fund an acquisition that they are closing. But we've got a few new opportunities as well. So yes, we -- I think you -- just like last year, I think it will be a really good mix of the 2, which is kind of perfect for us.

At this time, I'd like to turn the call back over to Steve King for closing remarks. Sir?

Thank you, Latif, and thank you for everybody that's tuned in and for your support through this past year. We -- as I mentioned, we're really excited about what happened over the last 12 months and also where we're going over the next 12. So as usual, please feel free to reach out to myself and/or Amanda if you have any follow-up questions. And thanks again for tuning in.

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