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

Good day, and thank you for standing by. Welcome to the Aleris Q1 2025 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Amanda Frazer, Chief Financial Officer. Please go ahead.

Thank you, Tanya. Thanks, everyone, for joining us this morning. Here with me is Steve King, President and Chief Executive Officer. 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 therefore, 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 under the headings Forward-Looking Statements and Risk Factors, copies of which are available on SEDAR at sedarplus.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 more clarification regarding these non-IFRS measures. Now for the Q1 results. Net book value increased by $0.12 per unit to $24.34. This increase was driven by $0.50 per unit of earnings offset by a $0.34 per unit distribution to shareholders. Partner distributions and transaction fee revenue of $43.7 million was ahead of our previous guidance of $42.5 million and 13% higher than Q1 of 2024. The guidance beat was driven by higher-than-expected foreign exchange rates and common distributions. As compared to the prior year, the increase was driven by the new and follow-on investments made over the last 12 months and an overall 4% increase in preferred distributions due to our -- the reset metric. Net distributable cash flow for the quarter increased by 19.1% to $30.4 million or $0.67 per unit from $25.5 million or $0.56 per unit in the same period of 2024. In addition to the $0.34 per unit dividend as part of the NCIB, approximately 219,000 units were repurchased and canceled for an average price of $1,960. Inclusive of the NCIB repurchases, the actual payout ratio for the quarter was 59%. With regards to partner updates, as a result of recent third-party equity transaction entered into by Shipyard. The multiple of earnings used in our fair value calculation was adjusted to reflect this recent market data. The business, driven in part by their acquisition of [indiscernible] in 2024, has increased in size as well as expanded their service offerings and their customer base. This adjustment increased fair value of the common equity by USD 8.3 million. Sono Bello has been impacted by softening in consumer discretionary spending as well as continued higher customer acquisition costs. Given the current market uncertainty and recent trends, we have adjusted the forecast earnings for 2025 as well as the exit time line reflected in our fair value model. The impact of these adjustments was a decline in fair value of USD 13.7 million. For Ohana, growth in memberships at mature clubs as well as the membership ramp at their new locations has increased both revenue and EBITDA resulting in a fair value increase of USD 5.9 million. Subsequent to the quarter end, FMP was notified of the suspension of certain key contracts, primarily due to significant reductions in U.S. federal spending and the cancellation of numerous government contracts. The suspension is expected to have a material adverse impact on FMP's near-term financial performance and outlook. As a result, we do not expect them to maintain distribution payments for the remainder of the year. FMP's management is actively evaluating mitigation strategies, and we continue to assess the impact on the company's fair value based on its long-term business outlook. Despite the recent loss, FMP is expected to achieve positive EBITDA and cash flow on a pro forma basis, and the company's lack of debt is expected to support its recovery. Despite the adjustment to below 1 for FMP, the portfolio has maintained its weighted average ECR of approximately 1.5x, with 10 of 20 partners continuing to be above this threshold. Of our 20 partners, 12 either have no or less than 1 turn of debt as compared to EBITDA. Based on our current evaluation of the portfolio, no other companies have significant risks as a result of the changes in U.S. procurement policies or the U.S. tariffs. While Edgewater's business does have exposure to government contracts, this area has not been a primary target of DOGE, and they have not seen any negative impact to the business or their related contracts. Our current outlook calls for $41.4 million of revenue in Q2. After reflecting the expected deferral of the FMP distribution, our 12-month outlook for revenue is now $178 million and includes $19.1 million in expected common distribution. We anticipate this change to take our payout ratio up just slightly to between 60% and 65%. As a result of the accounting standards requirement to revalue the U.S. acquisition entity at the quarter-end foreign exchange rate, the portfolio is subject to swings caused by unrealized foreign exchange gains and losses. During the quarter, book value was impacted by a foreign exchange loss of $0.11 per unit as compared to a gain of $1.35 per unit in Q4 2024. The sharp decline in the Canadian dollar over the course of Q4 and is offsetting recovery to date in 2025, is expected to create unrealized fair value losses, which will impact net book value. In its source currency, we expect continued portfolio performance and net book value growth from the U.S. acquisition entity but are anticipating volatility in the U.S.-Canadian exchange rates will cause some noise in our financial reporting in the coming quarters. On a similar note, in April, the senior credit facility was amended to convert the facility from CAD 500 million to USD 450 million. This change allows for easier management of the facility by removing the FX impact of the recently rising and falling exchange rates on outstanding draws as well as providing incremental capacity of USD 95 million or CAD 130 million. We currently have USD 290 million drawn on the facility, leaving USD 160 million of undrawn capacity. And on that note, I will turn it over to Steve for his comments.

Great. Thanks, Amanda. Obviously, the key metrics for our company continue to be very strong in Q1, payout ratio below 60%, including the capital spent on share buybacks, strong overall portfolio health with weighted average ratio is still at 1.5, even taking FMP into effect and growth in distributable cash of 19% year-over-year, very strong numbers. Our defensive strategy as well as our diversified portfolio, very little debt in our operating companies, the required service nature of the industries that we're in and the highly aligned owner-operator model continues to shield us from a volatile economic environment. Within that strong portfolio, there were 2 areas of softness that I'll highlight. The first being body contours who operate in the cosmetic surgery industry. BCC has experienced a soft consumer market over the last several months that has impacted both the rate of revenue growth and their margins. The company is extremely well run and are operating well above industry metrics. The current soft market will likely create a delay in the eventual exit because of a measured reduction in new location and product offering growth. Eventual value is very much still intact, but likely pushed out a year, which is why the present value calculation resulted in a decline. As discussed on our last call, FMP in Washington was 1 of -- was the 1 company in our portfolio that had risk of DOGE cuts. After feeling like they had weathered the storm, the company was hit by these cuts literally just a couple of days ago. It's far too early to speculate on the quantum and timing of replacing those lost contracts, but all of these following facts give us significant optimism for a full recovery. The company is exceptionally well run with industry-leading professionals and decades-long track record. FMP has 0 debt and has cash on the balance sheet that will give them ample time to pick up new work. At current revenue levels, the company is still profitable and has a solid platform to build off of. DOGE cuts are also creating opportunities for FMP with affected government contractors that need the exact human capital expertise that FMP provides to navigate through this volatile period. Letting go of an extraneous staff while retaining the right people is right in FMP's core competency, and they've already put out large bids on contracts that would go a long way to building back their book of business. History has also shown that cuts of this magnitude are typically followed by smaller amounts being added back by the government as they realize that some of the things that they cut are actually needed. Also, I would say that the beauty of our model is that while the hit to FMP is short term and not material, it is everything to the people that own and operate FMP, needless to say, they are on it. Just as we did with BCC, Ohana and LMS, when those businesses were hit with temporary external shocks. Alaris will do the right things by FMP and preserve long-term value by giving them the flexibility that's needed. We have full confidence that this asset will have a full recovery. Extremely important to note that the weighted average coverage ratio and our corporate payout ratio include the impacts of FMP situation and because of the well-diversified nature of our business, there's very little impact on our overall portfolio and particularly on our dividend stream. On the positive side, the benefit of the current environment is really a plethora of opportunities for Alaris in high-quality assets. Just as was the case coming out of COVID, our structured equity, which does not dilute business owners as much as traditional private equity becomes highly sought after. Acquisition opportunities for our partners become more available and potential new deals are plentiful. We have bids outstanding that involve just Alaris as principal and also bids that include third-party capital co-investing with us. So, Tanya, I'll turn it over to you for any questions that there may be.

[Operator Instructions] And our first question will be coming from Gary Ho of Desjardins Capital Markets.

Maybe just a first question on -- just going back to FMP here. So interesting to hear that even without the government contract, the company is still EBITDA and free cash flow positive. And sorry if I missed that, I think there's still no debt in the company. And maybe can you talk about and elaborate what other works that they can bid on?

Yes. At the end of the day, Ho, when we had a big conversation with the owners of FMP the day after they got the news, I mentioned that this is the kind of fork in the road where you're forced into decisions that 5 years from now, you look back and say, you know what, this is probably the best thing that ever happened to our company. Because they've had more work than they get handled just from government agencies over the last several years, they've never diversified into other areas. This is going to force that. And the easiest one right off the bat, as I mentioned, our government contractors in Washington that most of them have been hit even harder than what FMP has. All of those people are going through their rosters of staff, laying people off, making sure that who they lay off doesn't cut into muscle in their companies and just get rid of fat, and that's exactly what FMP does. So they've got some large contracts that have already come up through this process, and that's going to help them diversify as they build that out and also build back out the government contracts as well. So they will be just fine. They're going to make a full recovery. And as I mentioned, just like we did with BCC and Ohana in COVID with LMS coming out of COVID when you have some external shocks that a really good management team could not have foreseen, you want to be a good partner because the value is still there. It's still a great company, and they will be back in a very short period of time.

Perfect. That makes sense. Second question I have, it sounds like there was an increase to your credit facility. So I think you mentioned the dry powder already, but just wondering if you can comment on the capital deployment pipeline that you have currently, the size, and it sounds like it's still mostly in the U.S.

Yes. Yes, everything in our pipeline is U.S. at this time. And we've got probably more in our pipeline now than is normal. A huge amount of acquisition opportunities for our partners. I think we've got 5 or 6 that are working on acquisitions that would need our assistance in that. And then we've got a good roster of potential new deals that are in process as well. So we do expect a very busy second half.

Okay. And then just lastly, maybe just going back to BCC, there was that fair value write-down. Maybe can you walk us through kind of pushing out the potential monetization date and also the higher acquisition costs that they're seeing within the business?

Yes. It really is. It's been an interesting year for BCC. The acceleration of GLP-1 weight loss drugs has been an interesting thing to monitor for the company. And this company is very heavy into data analytics and has broken things down and is extremely well managed. And I would have to say, too, that Brookfield has been a very supportive and constructive partner with us on BCC. And it now is very evident that the GLP-1s have not been a material negative drag. In fact, there's probably a slight positive from them in terms of bringing people into the liposuction market after they've lost a large amount of weight. It's also introduced a new service offering of skin tightening which didn't really exist before, but now with so many people having lost enormous amounts of weight. That's now a pretty large market, which didn't exist even 2 years ago. But what really evident is the consumer discretionary spending in the U.S. has been in a recession for a number of months, probably a full year. And that has been what has made their acquisition costs higher and revenue, I would call it stagnant. CareCredit is one of the companies that provides credit to health care patients in the U.S. They're the biggest one, including Sono Bello patients. And comments from them anecdotally are that all of their client companies that they provide third-party financing for the whole industry, including even things as easy as med spas are down around 20%. BCC is not down 20%, just their growth rate has been paused. So we're feeling very good about where we stand and gaining market share during this period of time. But it's there. The consumer spending is definitely down, and it will come back. So the only thing that it really impacts in terms of our value of that investment is the timing, as you pointed out. So it's probably going to be a year later, probably 2028. And things like expanding the breast augmentation division, we've kind of put that not on hold, but it just slowed that down. But on the flip side, we have skin tightening coming in, which wasn't expected. So still a wonderful company, highly, highly profitable, under-levered. And they'll -- I don't have any change in my exit valuation expectations for BCC.

And our next question will be coming from Jeff Fenwick of Cormark Securities.

So, Steve, I wanted to follow up on Sono Bello there. One of the other points listed there was they exercise the PIK option on their payments, I think, for the quarter. Can you just remind us on the terms around that? Is it just a portion they can pay PIK? Is it all? What are the expectations going forward there on that?

Yes. It's a portion of the payment. They -- a lot of our PIK are deferrals, cash deferrals, and we collect the cash at a later point in time. It's a bit different for BCC. They truly are paying in kind. So we're being issued incremental equity. It's increasing our investment, and it immediately increases the cash pay for the next quarter. So that is reflected in revenue, and then it does go through into our investment in BCC. They don't expect, I think they can pick up to 50% above?

Think so.

Yes.

Yes. And we don't expect them to use that for long. It's a very conservative management team. They actually have a large cash position on their balance sheet. But in an environment like this, they like to use all the levers that are at their disposal and act with ultimate caution. So it does, at the end of the day, increase our expected returns on this investment by them using the PIK because we're getting more equity units issued to us.

Okay. That's helpful. And then I guess, back to FMP, probably challenging to come up with a fair value on that particular investment at this point in time doesn't sound like you're expecting it to be too greatly impaired. But again, how do you sort of handicap that? Like what are you going to look at under your accounting model when you go to approach that for the end of this coming quarter?

Yes. We've been -- their fair value. Our current fair value model has been based on a multiple of cash flow, which obviously we're probably shifting that to more of a DCF model. And part of that shift is really building out what that outlook looks like. And that's really what management is focused on right now, what contracts are in the near-term backlog that won't be impacted -- affected. What are the opportunities for new things to bid? So as we work through -- sorry, over the next few weeks, we'll be building out sort of what does the remainder of the year look like. And then going forward, how do we think that will play out so that we can sort of come up with that valuation? It's not 0. We -- there's EBITDA and cash flow to the business. So there is value here. It's just a matter. It was very difficult to put a range together without this information and having it happen so recently, the management team is obviously focused on more immediate concerns within the business and sitting down with us to sort of build out that forward-looking model for the next couple of years.

Yes. But we do know that they have some large bids already out there for these government contractors. So by the time we report our next quarter, I'm hoping we have some results on some of those bids, and that will really help Amanda and her team kind of formulate that valuation. .

Okay. And then maybe from a tax perspective, under your investment structure that you operate now when you experience a fair value loss like that, what's the impact of cash taxes? Is it deductible? Or I'm just wondering from a it will matter from a free cash flow or distributable cash perspective?

Yes. Because it's an unrealized loss, it doesn't create any current tax impact where that impact is really in our deferred tax number. So as we have increases in fair value, you'll see that deferred tax number push up. And then as we have declines in fair value, it just turns around some of that deferred tax liability.

Okay. Great. And then you were -- you did a little bit of share buyback in the quarter there, Steve. So what's the thinking, it sounds like you've got quite a full pipeline. So I can't imagine that the buybacks are a priority for you. Is this just sort of absorbing, I guess, there's some share-based comp out there and you want to sort of counterbalance that? Or what's the thinking on that front?

Yes. I mean we'd like to buy back as much as possible, obviously, when we're trading below book value. But you're right. I mean we have some really great investment opportunities out there that have high IRRs attached to them. So but so does our current portfolio, which if you can buy our current portfolio at below book value, you're going to win. So the dollar values that we've attributed to our NCIB aren't ones that are going to move the needle on our deployment spending. If we're looking to spend $200 million over the next year, spending an extra $5 million to $10 million on NCIB isn't going to really going to change much. So we'll continue to do that. I think we've spent $5 million or $6 million to date this year. And the last batch was at 1,750-ish. So we think that was a heck of a buy, and we'll continue to do so.

[Operator Instructions] Our next question will be coming from Zachary Evershed of National Bank Financial.

Could you give us an update on your expectations for LMS given the steel tariff supply?

Yes. So LMS right now are unaffected. They get their steel from actually various countries, they're quite well diversified, none from U.S. other than for their own U.S. operations. So there is some risk that Canada might impose some tariffs on steel being imported from Asian countries and all other foreign countries. There is language in their contracts that all of that gets passed on to their customers. So they don't -- they won't be affected on current contracts. The only risk longer term would be if real estate developers just find it too expensive and mothball projects. So right now, no impact, still a huge backlog of business and high margins. They're doing extremely well as you've seen in the numbers, but that's something that we're -- that we and obviously management are keeping an eye on.

Got you. And then we had FMP talked about LMS steel tariffs, BCC evaluating GLP-1 risks. Any other kind of tail risks to partners that could have an outsized impact?

A lot of people have been asking about Edgewater, our nuclear engineering company out of Tennessee. They have several hundred nuclear engineers that work for mostly Department of Defense and Department of Energy, in the U.S. So those areas at this date have been unaffected. And in fact, they've got the biggest backlog of bids outstanding in those 2 areas that they've ever had. So there is acknowledgment an by the Trump government on the increase in spending on DoD and the nice thing about that business is whether you're dismantling nuclear arms or expanding them, it requires just as much work from nuclear engineers. And then I think it's fairly obvious as well that the use of nuclear energy for the DOE is expanding as well. So wonderful company. They are 1 of the ones that are looking at an acquisition right now. They are a high-growth company for us, and we haven't seen anything negative from them at all, just positive.

And our next question will be coming from Trevor Reynolds of Acumen Capital.

I was just wondering if there's any update on where heritage is that?

Heritage has made some very good improvements actually. They've worked through all of the negative margin contracts from the last 2 years that were entered into our management team that we brought in has really improved the back office and bidding kind of processes. So, yes, we see some good improvements there still work to do. But yes, they've got a good building backlog, and we expect that 1 to start showing some good progress throughout this year. So we're quite pleased there.

Is there any expectations around them returning to distribution?

Probably not within the year. They're in the heart of their busy season coming out of spring and going into summer. So they have a lot of capital investing into working capital. They're in the process of bringing on a new bank and revolver to sort of fund that ebb and flow of working capital. So we probably -- we'll see them invest in working capital back onto the balance sheet from the effects of last year. And so we'd probably look to see a return to distributions sometime in 2026.

Great. And then just to clarify on FMP, have they officially cut distributions? Or just maybe just kind of how best to model that out?

Yes, we got them. So just like with during COVID, when a shop like this happens, there's no point in trying to drain cash out of a company. We're going to want to preserve long-term value and keep working capital on their balance sheet, so they can actually grow out of this. So yes, we told them to stop paying us, and we'll pick that back up when they've replaced those contracts and are ready. So exact same thing we did with Sono Bello with Ohana and with LMS. All of those companies have repaid every single penny that we deferred, and we expect the exact same with FMP. So, I mean, that is the beauty of what we've built here is that over time, you're going to have some of these external shocks. We've got a really well-diversified portfolio. We're managing over $2.3 billion of capital here. So having a small company like FMP go through this really is not a material event for us. As I mentioned to somebody yesterday, we get so much mileage out of situations like this where we're bidding on 5, 6 new companies at any given time. I'm going to have every single 1 of them call Aaron at FMP to talk about how Aleris was when it hit the fan and how we were as partners. So this to us will have more value than what anybody knows.

And I'm showing no further questions at this time. I would now like to hand the call back to Steve for closing remarks.

Great. Thanks, Tanya, and thanks, everybody, for tuning in. As always, if there's any follow-up questions for myself or for Amanda, please give us a call any time. But until then, we'll talk to you in July.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.