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

Good morning, ladies and gentlemen, welcome to Flow Capital Corp.'s earnings call for the quarter ended March 31, 2021. [Operator Instructions] I would 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 Capital's risks and uncertainties related to these forward-looking statements please refer to the company's management discussion and analysis dated May 25, 2021, which is available on SEDAR. Today's call is being recorded on May 26, 2021. I would now like to turn the meeting over to Alex Baluta, Chief Executive Officer of Flow Capital.

Thank you, operator. Good morning, everybody, and thank you for participating in today's call. I'm joined by Gaurav Singh, our Chief Financial Officer. After the close of the market yesterday, we released our Q1 2021 financial results. Details can be found on our website at flowcap.com or on SEDAR. I'll briefly highlight the numbers. Flow Capital's total IFRS revenue for the quarter was $2.3 million, up over 114% from $1.1 million a year ago. I do note that IFRS numbers can be volatile due to the unpredictable timing of buyouts and/or unrealized fair value and foreign exchange adjustments. Given that, internally, we track revenue and adjusted -- I should say, recurring revenue and adjusted free cash flow to gauge performance of our business. Our recurring revenue for the quarter was a record $1.6 million, an increase of 73% over the $930,000 a year ago and up 5% sequentially from Q4. We're now at an annualized recurring revenue run rate of over $1.6 million. Adjusted EBITDA for Q1 was $1.3 million, that's an IFRS EBITDA number -- no, no, it's adjusted, sorry about that. And a year-over-year increase of 125% from $590,000 in Q1 2020. Q1 2021 net income as per IFRS was $1.3 million versus a net loss of about $370,000 in Q1 2021. These numbers were driven by the strength of our portfolio, even through the COVID crisis, several of our portfolio companies continued to experience record revenue growth validating our investment thesis and our business model to invest in high growth businesses. During the quarter, we generated IFRS free cash flow of $405,000 compared to a loss of $76,000 a year ago. Again, IFRS is somewhat skewed, and we track internally a number called adjusted free cash flow from recurring operations. Adjusted free cash flow from recurring operations was just under $600,000 compared to a negative $460,000 last year. Our adjusted free cash flow from recurring operations has now been positive for 4 quarters. We ended the quarter with a strong balance sheet with over $29.7 million in investments or settling in cash a total of assets of almost $38 million. And finally, book value was up again this quarter to $0.60 a share. That's up from $0.46 a share last year, a 30% increase, and it's a number that we're particularly proud of. The final financial number -- I don't usually mention this, but I want to highlight it on this call is our share count. You'll note that our share count is now below 32 million shares. And over the past 9 quarters, so just over 2 years, we've bought back 11.8 million shares with 27% reduction in the shares outstanding. All of these purchases were done at a substantial discount to book value and at a price substantially lower than where the stock is today. The reason is simple. It's because we believe in our business model and our opportunity. Given the discount to book that we're trading at, it makes perfect sense for us to buy back as many shares as we can. As one of our Board members says buying dollar bills with $0.50 always makes sense. As you know, we don't usually go into more detail about the financial results during the call, and we'll focus on a broader business update. The financial results are summarized in our press release and the full details can be found in our financial statements and the MD&A, either on our website or on SEDAR, I encourage you to review those and call or email if you have any additional questions. I want to highlight the amazing opportunity that lies ahead for the company, and I hope that some of you -- that some of the excitement that I feel for our prospects comes through in my comments. Q1 highlights again the recurring revenue from our portfolio of investments is now generating meaningful revenue growth and positive free cash flow. Moreover, we've increased the size and quality of the investments that we are considering and our efforts to grow our pipeline are working well. To the point where our near-term pipeline of deals is stronger than it has been in years, and equally, if not more important, the quality of these opportunities that we are seeing has increased substantially. We've intentionally come down the risk curve over the last 2 years in terms of the deals that we want to see and invest in. Add to that the warrant and equity positions that we've been building that are now worth over 20% of our book value and we expect that several of these warrant positions will see exits in the coming years. These warrants should add meaningful upside to our overall returns as they mature in the coming years. Finally, on the operations side, we've made a tremendous amount of progress in the last 2 years in terms of cleaning up our balance sheet, simplifying our corporate structure, streamlining our operations. And the net effect has been a simplification of our business, a reduction of costs and a freeing of management's time to focus on continued growth and continue increasing shareholder value by increasing recurring revenue. For those of you that are relatively new to the story, I'll quickly summarize that Flow Capital is a growth investor. We invest in revenue stage high-growth companies, and we're generally industry-agnostic. And sometimes -- as we sometimes say, once a company has nailed their value proposition, it's proven through sustained revenue growth and minimal -- certain minimum revenue traction, our minimally dilutive capital can help them scale. We're not a direct equity investor but rather we use cash flow generating structures like term loans, bullet loans, royalties, all with embedded equity upside, primarily through warrants. For a high growth company, a minimally dilutive structure, such as the one we provide can often be the most cost-effective funding structure that they can use. What's unique about Flow is we combine exposure to high-tech, high-growth companies through cash flow yielding investments and we get some equity exposure and upside through our growing warrant portfolio. Most -- for most investors, high-growth private companies is a very difficult asset class to get exposure to. I'm going to summarize the rest of my operational comments by answering 2 questions that I think prospective investors, such as you and hopefully others, should be asking themselves. It's kind of a 2-part question. Why? -- number one, why invest in Flow? And part 2, why invest in Flow now? So part 1, why invest in Flow first? As I already mentioned, we provided a lower risk way for investors to gain access to the high-growth businesses powering the modern economy, things like e-commerce, fintech, AI, et cetera, all in a diversified cash yielding portfolio. We give investors venture capital like exposure with debt-like security, lower risk and in cash-generating investments. The second reason -- the second part of the answer as to why Flow is our business model. We generate recurring revenue from these debt and royalty investments. And these investments are in high-growth businesses with a proven value proposition in the gap that exists between banks and VCs and public markets that are secured and generally at the top of the stack, at the appropriate risk return profile with equity upside and in a scalable and repeatable way. As I said earlier, for companies that have nailed their value proposition, we can help them scale it. I also think that investing in high-growth companies that somewhat counterintuitively reduces our risk profile and increases our upside. Growth provides more downside protection for us as the equity value increases disproportionately with growth, that being the equity value of our investee company. Growth also provides more exit alternatives for us and for our investee partners. And growth provides substantially more upside to our warrant position that [ are ] in high-growth companies than in low-growth companies. It's worth noting that the revenue generated by investee companies increased over 50% in 2020 and was even higher in Q1 of 2021, all while COVID raged. So part 1, why Flow because an investment [ in ] Flow provides access to high-growth companies by secure recurring revenue business model with equity upside. Part 2, why invest in Flow now? Okay. Well, first, we think we're undervalued. We continue to trade at a discount to book value, and we are cash flow positive, generating an adjusted free cash flow of $600,000 in the quarter, and this was at the end of Q1. What it doesn't include is the impact of Inner Spirit. Inner Spirit was one of our portfolio companies. We owned a significant piece of equity in it, and it was just acquired. For those of you that follow us closely, you will have seen, as disclosed in our public filings, that we have a meaningful position in Inner Spirit, almost 13 million shares. The company is in the midst of being acquired for $0.39 a share. So for Flow, this is great news for 2 reasons. One, the acquisition was at a significant premium to market. So it will bump our book value; and second, it will free up almost $5 million in cash from an equity holding that was yielding us 0 and allow us to reinvest that cash at 15% plus yield and earn more warrants in high-growth companies. All good news. So the second reason in response to why Flow now is that we reach an inflection point in our fixed cost operating leverage and asset growth and our asset growth is generating meaningful ongoing free cash flow. Q1 was a particularly strong quarter from a free cash flow perspective. But we do expect that free cash flow will be lumpy in the coming quarters as some of our high-yielding legacy investments roll off and are replaced by more moderately yielding but lower risk investments, at least lower risk at the time of investment. You saw the buyout announcement of Interiormark, for example, and I'll provide more color on that in a moment. What's important to note, is that we can scale our business dramatically from here with only a modest increase in operating costs. With $100 million portfolio of cash yielding investments and assuming a 50% leverage, our business model should be able to generate somewhere north of $7 million of free cash flow per year from recurring revenues alone. And that's before the impact of upside from our warrant and equity positions, which is admittedly very difficult to forecast, so we don't try. The third response to why Flow now is momentum. We're seeing excellent momentum in critical areas of pipeline growth and asset growth both of which ultimately lead to recurring revenue growth. Increasing our pipeline of high-quality growth investment opportunities has been our primary operational focus for many quarters as it will be the principal driver of our continued success. Our efforts in digital marketing, building our network relationships with deal sources, like investment bankers and DCs, referral partner platforms, et cetera, all of our efforts are paying off, and we continue to see more and better quality deals every quarter. And I think I mentioned this last quarter, but our pipeline is near-term and qualified deals is the best it's been in the last 2 years. I don't think we will ever be content with our pipeline as it's a continuous race to find the best companies. However, I feel that we are in the right space with respect to the balance between price, risk and return, as our pipeline fills with these high-quality deals. So I'm going to summarize why Flow and why now? Well, we provide unique, secure investment exposure to high-growth companies through a repeatable, scalable business model that generates recurring revenue and comes along with equity upside. We can scale our business dramatically from here with modest increase in costs. We're generating positive free cash flow today. We're seeing great momentum in core business areas and in our operations and we're undervalued. So all in all, we feel very good about our forward prospects. Before I go, 2 other points I want to mention. First, I want to welcome Joshua Axler and Ranbor Li to the Flow team. Both have recently joined, both have extensive investment experience, and we're very excited to have them join our team and for them to grow with us and for them to help our growth. Second, I want to congratulate the team at Interiormark. We announced in our press release this morning that -- or last night, that our investments in Interiormark was bought out on Monday. Over the life of the investment, Flow earned a cash-on-cash return of approximately 2.67x our initial investment. Interiormark used our capital to invest in its operations and to scale their business, exactly as it's intended for, culminating an impressive revenue growth over the last several years. In fact, they paid us out of free cash -- out of internally generated free cash flow. They've been fantastic partners, and we wish them well as they continue on their growth journey. And with that, I'll stop and hand it back to the operator for questions. Thank you very much.

[Operator Instructions] Your first question is from Akiva Dubrofsky of Akiva Capital.

I'm wondering is the ability to participate in the subordinated units of the fund, is that exclusive to the company? Or do you let other people participate in the same units?

Yes. Thanks very much for the question. So let me provide a bit of background. What you're referring to is, we have a securitization vehicle that we call the Priority Return Fund, the PRF. What we do is that vehicle allows us to roll in existing investments that are on our balance sheet into the vehicle and basically use our equity capital. We increase the velocity; use it twice, for example. The priority return fund, the structure is -- it's not a greenfield fund. We only put in assets that are from our balance sheet, i.e., existing investments. And we fund it in 2 ways. One is a preferred unit that now pays a yield of 9.25% and a subordinated unit. Flow exclusively subscribes the subordinated unit to provide downside protection to the senior preferred unit. So if you think about it, we roll in $100; $80 comes in, in a preferred unit; $20 is subscribed to by Flow in a subordinated unit. That subordinated unit takes first loss on -- if there is any, first loss on interest, first loss on payback, et cetera. And then it's a self-liquidating structure. So when there's a -- imagine you had 10 existing investments in there, when an investment matures, just like Interiormark just matured, it actually is in our priority return fund, the proceeds from that maturity must go to pay down preferred unitholders in priority. So 100% of the maturity value goes to preferred unitholders. So what happens over time is the subordinated position as a percentage of the preferred position increases. All that to say that we provide that -- Flow subscribes that subordinated position to provide extra downside protection for the preferred unit. We've not thought about offering the subordinated unit to any investors, and to be honest, we probably won't. But I appreciate the question. Gaurav, do you want to -- is there something you want to add?

Thank you. I'd just add to that, that the opportunity to invest in the [ ceding ] unit is certainly open, and if there is interest in that, please feel free to e-mail either Alex or me, and we'd be happy to walk through the details.

Thanks for the question.

Yes, I have one more question. Would you say -- I mean, it kind of seems to me that some of the upside on the -- like, for Flow equity is in your position as an adviser to the SPE. Is that correct?

Yes. I mean it's not -- it's -- the structure is one. Think of it almost like a debenture. It's not quite, but think of it that way, where debenture investors don't get upside in the entire company. So yes, the equity position, the subordinated position -- I'll add -- so the other thing -- yes, it is -- it's just -- Gaurav, go ahead.

Thank you. Maybe just to clarify, what we try to do is structure 2 ways of 2 alternate structures of return that we can provide to investors. The PRF structures provide a yield, and they are not meant for equity upside participation. The equity upside participation is available through purchasing the stock. And so this allows us to cater to different segments of the investors in a more balanced manner without mixing the 2. And so to answer your question, the equity upside participation is certainly available through the stock itself, which, as Alex mentioned earlier, is still trading at a bit of a discount. I think the -- discount to book value has closed a fair bit over the last 12 months, but I think there's still an opportunity there, and we believe that there has been, which is why we continue to repurchase our stock. I do believe that from a yield perspective, we offer a compelling proposition, which reflects in the fact that every time we go out to raise a tranche in the PRF unit, we are usually oversubscribed and have to push some of the people onto the next tranche. I hope that helps. Again, happy to have a more detailed one-on-one conversation if needed.

[Operator Instructions] And at this time, we have no other questions in queue. Mr. Alex Baluta, do you have any closing remarks?

Thank you very much, operator. Thank you, everybody, for participating. And if you have any questions, please call or e-mail either myself of Gaurav, and we look forward to speaking to you next quarter. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.