Flow Capital Corp. (FW) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to Flow Capital Corp.'s 2020 Second Quarter Earnings Call. [Operator Instructions] I'd like to remind everyone that today's discussions may contain forward-looking statements that reflect current views with respect to future events. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For more information on Flow's -- Flow Capital's risks and uncertainties related to these forward-looking statements, please refer to the company's management discussion and analysis dated August 20, 2020, which is available on SEDAR. Today's call is being recorded on August 21, 2020. I would now like to turn the meeting over to Alex Baluta, Chief Executive Officer of Flow Capital.

Thank you very much, operator. Good morning, and thank you all for participating in today's call. I am also joined by Gaurav Singh, our Chief Financial Officer. After the close of the market yesterday, we released our Q2 2020 financial results. The details can be found on our website at www.flowcap.com or on SEDAR. Our total IFRS revenues for the quarter were $1.83 million, up from a loss of $510,000 last year and up 68% from the $1.1 million in Q1 of this year. Our recurring revenues for the quarter were $1.3 million, down 12% from the $1.5 million in the second quarter of last year, so year-over-year and up 39% from the $930,000 in Q1 of this year. In the context of the ongoing COVID epidemic, we are quite pleased with our Q2 numbers. We had better-than-expected performance on both the revenue side and on our operating expenses. The improvement in our numbers was driven most notably by resilience in our -- the resilience to COVID-19 across most of our portfolio of companies. It's actually interesting to note that several of our portfolio companies are experiencing record revenue growth and record revenue EBITDA or record revenue, I should say. As we discussed on our last call, increasing our deal flow and investments in the high-growth, high-quality companies is our primary focus for 2020. Our year-over-year revenue slowdown is simply a function of us not redeploying enough capital fast enough to make up for the bias and the return of capital that we are seeing. This is largely due to us being selective and focusing on higher-quality investments, and we have several deals in diligence that did not close in the quarter. Adjusted EBITDA for the quarter was a positive $244,000, a year-over-year decline of 75%; and adjusted EBITDA year-to-date for the 6 months was a positive $836,000. Flow used cash in operations of $1.27 million in Q2 compared to $1.1 million in Q2 of the year ago, an increase in cash used was in operations to account for an investment that closed in April. Continuing the format adopted in the previous call, we will not be reviewing the financial details in any kind of detail, but we'll continue with the broader update. I encourage you to go to SEDAR or our website to download the numbers. As a reminder, we generate revenues from 3 sources: one, recurring revenue in the form of interest and/or royalties; two, buyout revenues, essentially a premium paid to us when an investee exits a royalty; and three, equity upside from the equity positions that we take as part of our investments, generally in warrants. The most important part of that, though, is the recurring revenue. That's how we manage our business is by chopping that recurring revenue. Buyout's an important part of how we generate returns. And while they can actually substantially grow our free cash flow, they do negatively impact near-term future revenue as we lose a revenue-generating investment until such time as we reinvest that capital into another investment. And that's the situation we're in now. We have a very strong balance sheet but declining revenue as we cautiously redeploy our capital. I'd like to take a few more minutes now to talk about the business highlights of the quarter and some of the ongoing initiatives that we're working on to continue to improve our performance to ultimately increase shareholder value. COVID is an obvious topic that we need to address. Internally, we adapted quickly. We've had several press releases and conference calls to this effect. And we've had everybody working from home or safe environments since March. We see no change in our productivity, and we expect we'll continue to -- with the remote work profile for the foreseeable future. Early in the pandemic, we initiated biweekly, proactive portfolio review calls with all of our investee companies. There was a lot of uncertainty early on. But as of today, almost all the companies in our portfolio performed surprisingly well throughout the crisis. Given the resilience and the strong performance of most of these companies, we've now moved to a more standard monthly review process. We nevertheless do remain cautious, and we will continue to monitor the situation. And we'll do what's best for both our investee partners and for our shareholders. In early Q2, we deployed $1 million in Novation Networks. Novation uses a highly trained and motivated workforce and former military personnel to deploy 5G infrastructure. While we only closed that one deal in the quarter, which is below our expectations, we are seeing good pipeline activity. And this is in spite of the government assistance of free money programs that were being deployed pretty much around the world. As those programs wind down, we expect our pipeline and our qualified opportunities should increase. Note that except for these salary replacement programs, which have been very successful, we have not seen any low-cost capital coming into the market in the form of co-loan guarantees. So that has not been a disruptive impact. As has been mentioned in our last call, while we applaud the effort of governments to do co-loans, the banks are simply not equipped to invest in high-growth, low-asset, mid-cap companies, even with an 80% co-loan guarantee from the likes of BDC. So this means that key segment of the market where we focus on that small- and medium-growth business segment, unaffected by government-sponsored COVID -- most government-sponsored COVID initiatives. On the pricing front, we've seen no major changes in pricing in the quarter, either up or down. As mentioned last quarter, we continue to see indications that the availability of equity capital is becoming increasingly constrained, and companies looking for money are increasingly looking to debt-type structures. Private equity -- private market equity valuation seem to be down, and BDCs seem to be slowing their deployments. That's something we noticed last quarter and it's something we continue to see -- I should say, we saw on Q1, and it's something we continued to see in Q2. Turning to operations. As I mentioned on our last call, we've been slowly rightsizing the operational side of our business. We have several ongoing initiatives in the area of reducing overhead and leaning out the business model, and we expect that our operational costs should be significantly lower going forward. We've already reduced them fairly significantly over the last 4 quarters. These adjustments will help us achieve sustained price variability sooner. As we discussed in the previous call, we've also been actively moving up on the quality scale and deal size scale. We are seeing substantially larger companies in our pipeline as part of that effort -- as an outcome of that effort. And I expect that over time, we'll start closing some larger deals in the coming quarters. Right now, we have been targeting deals in the $1 million to $2 million range. We look at deals as large as $5 million, and I think that you'll start seeing us closing deals potentially as high as $4 million or even $4.5 million over the coming quarters. And this is actually an important part of our business model, and it's going to help us scale. Even as we do move up market, what we will continue to do is offer creative and flexible debt structures, including our royalty structure because we are one of the few royalty players in this $2 million to $5 million deal size segment. With access to permanent capital, we can offer few long term or even perpetual royalty structures where appropriate. While we try to tailor the flexible debt solution to our investee companies' needs, having access to permanent capital from our perspective is actually a significant differentiator. Finally, I'd like to highlight the performance of our book value since the beginning of the year. I'm pleased to highlight that in the first 2 quarters, we've seen an 8% increase in book value per share. Post Q2, we continued to record gains with an over $600,000 recovery on our previously distressed investments, and we announced that in a press release earlier this morning. These improvements in book value are the result of the several initiatives that we have been undertaking over the last 18 months to clean up our portfolio, increase our deal quality, reduce our cost, clean up our cap table and deal with our distressed -- backlog of distressed deals and broaden our deal flow network. While we're working carefully to deploy more capital, all these initiatives have started to show a positive impact incrementally on our book value. And really, that's what this is all about. We're laser focused on continuing to do the right things, to continue to increase our book value and to improve shareholder returns over time. And with that, I appreciate your time. I'll hand it back to the operator to see if there's any questions.

[Operator Instructions] And we do not have any telephone questions at this time. I will turn the call over to Mr. Baluta.

Thank you, operator. So to end, I'll recap by saying that our portfolio has done quite well through these uncertain COVID-19 times. And with the deals we're seeing in our pipeline, we continue to expect that the rest of 2020 and all of 2021 will be a busy year -- busy time as we scale up to deploy our capital, grow revenue and ultimately increase our shareholder value. With that, I'll end the call. Thank you, everybody, for attending, and feel free to call or e-mail if you have any questions. And if not, we'll talk to you again in 3 months. Thank you very much.

This concludes today's conference call. You may now disconnect.