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

Good morning, ladies and gentlemen, and welcome to Flow Capital's Q1 2023 Earnings Conference Call. [Operator Instructions] This call is being recorded today Monday May 29, 2023. And it is now my pleasure to turn the conference over to Alex Baluta, Chief Executive Officer. Please go ahead, sir.

Thank you very much, Michelle. Thank you, everybody, for joining the call or listening in on the recording. Today, we're going to talk about our Q1 2023 Conference Call numbers. To be honest, very in line, quite nondescript quarter which is good news and bad news. It was -- our numbers -- as you know, we publish -- our numbers in our financial statements on our website and on SEDAR. So I'm not going to go through in detail, but recurring royalty revenue, which is an internal metric, not an IFRS metric was down slightly year-over-year that was primarily because we had several major buyouts last year and not as many deployments as we hoped. So we are performing a buyout. And in the end of the year, we're only invested in Prolifiq and so we had a -- we just haven't been able to deploy our capital as much. So you're going to start seeing a slight decline in revenue trend, although we do expect that should turn around. Nevertheless, IFRS revenues, which can be distorted, we don't use that as a metric. But last year, we had several buyouts in the 3-month period. Any change in the amount you have to flow through the income statement, so you had $3.8 million or $3.9 million revenue last year versus $1.7 million. That's honestly not a relevant figure. The more important one is looking at royalty revenue and loan revenue, which was basically down 4.4%. Book value was essentially flat quarter-to-quarter, and we continue to buy back shares in our NCIB. I think the big news for us isn't this quarter, which was, frankly, slightly better than our internal expectation and as expected, down because of buyouts last year was the opportunity that we're seeing in our pipeline. It's been -- we've seen improving volume of deals and more importantly, improving quality of deals. One of the metrics we have a fairly robust pipeline approach to managing our pipeline and one of the metrics that we look at is what we call the preliminary investment committee meeting where it's an all-hands meeting after we qualified the deal, qualified that they understand our structure, our rates and that we -- that they qualify from our perspective in terms of the revenue and capabilities of growth. Last year, we, in the entire year, we did 31 preliminary IC meetings. Year-to-date this year, already, we've done 25. And we're well -- we're over 100% up on preliminary IC meeting. We have at the current time 5 soon to be 6 signed term sheets. We expect a deal that is going to close in the next week or 2, followed by several others after that. There is instances that actually think last year, we declined on closing on 5 deals post-signing the term sheet because of the quality of the deal, we just wasn't -- we weren't comfortable in the diligence, which is a testament to the our real focus on quality. But nevertheless, very high-quality deals this year, a lot of term sheets signed, really, really deep pipeline in the orders -- on the order of hundreds of millions of dollars in our pipeline. And so I think you'll see us deploying capital fairly aggressively in the coming months. And so you'll start seeing resumption in growth in our revenue. The good news is, we continue to be profitable. We're continuing to generate adjusted free cash flow. We continue to generate positive EBITDA. Really, our business after the last 5 years of adjustments to get here is performing very well. I want to point out over the next couple of weeks, we're also going to -- we've done -- it's been 5 years since the merger of LOGiQ and Grenville. Grenville was the predecessor company of Flow Capital. We've decided to use that as a non-arbitrary time point to determine -- to evaluate our progress. And we'll publish a little bit of a preview press release coming out in a couple of days, showing our IRRs, and they're really quite good. In our business model, which is focusing on high-growth company, we really take debt-like risk into the best of our ability to shoot for equity-like returns. And we do that through 2 components really, it's the cash yield, but also bonuses related to those cash yields on early repayment or sometimes a bonus on exit. And then the second part comes from our equity exposure. Maybe one of our deals we take equity exposure unlike many of our competitors. It could be as small as a 0.5% of equity of the company, it could be large as 2% or 2.5% of equity. But if you think about it, most of the companies we invest in are all almost all of them are high-growth companies, primarily technology, 80-plus percent of our portfolio is tech, 80-plus percent is U.S. And so these are the kind of companies that -- not just the owners and the entrepreneurs, but also the equity investors are looking for an exit over time. And our relatively small portfolio of positions, but a relatively large portfolio of these positions is starting to generate very strong returns. And so you'll see our IRRs well above 20%, again pay attention to next coming weeks when we publish our sort of performance over the last 5 years. And if you think of net loss ratio in terms of losses in capital because of sale deals, we really haven't had any in the past year -- 5 years, I should say. But more importantly, the gains in our 1 portfolio more than make up for any write downs or losses we might have in our portfolio. So on a net basis, our IRR is a function of both our cash return plus our gain minus our losses and its -- are dramatically higher than the cash returns that we generate. So all in all, I mean, I'll stop there, a relatively benign quarter, slight revenue decline as expected as we've had several buyouts and less deployment. The pipeline has never been stronger. The number of deals in signed term sheets and due diligence now is at a record concurrent level, we've never had this many. We'll see how many get through the full due diligence process. And we've built the company, the infrastructure, the team to really scale this company from the $60 million in assets we've now to $100 million and to $200 million and to $500 million. So we think the future is bright. Our performance has been phenomenal over the past 5 years. And with that, I'll pause, turn it back to the operator and see if there's any questions.

[Operator Instructions] Your first question will come from Ed Sollbach at Spartan Fund Management. Please go ahead, sir.

So thanks for talking about your pipeline. So if you think about future loans, would you basically be with the same as historically? Or would they be bigger or smaller in terms of deal size?

Good question, Ed, thanks again for supporting us and calling in and being with us for this whole journey. I think what we are telling like right now, our average -- our largest deal is USD 6 million, have several in the pipeline in the recourse to that. Probably your average is going to be in the 3%, 3.5% range U.S. And I do think that as we scale, the scaling above $100 million to $200 million plus deals see us go slightly higher in terms of the deal size, maybe to 5% on average. So our sweet spot will be in the 3 to 10, let's say, 5, 6 on average. But what's interesting is -- I meant to say this on the call, so thanks for asking this question. Let me get back to this. If you think about what's going on in venture capital right now, I think the reason we have such a strong pipeline is 2 things. One, you had the equity markets potential recession and everybody knows venture capital dried up or venture capital deployment dried up in spite of a lot of apparent dry powder on the sidelines. But then what you've had is the explosion of AI. And really high, not just people putting an AI spin on what it is they're doing. And for most venture capitalists, when they invest 20% or 30% of their portfolio that makes up 100% of their returns. And we're seeing that the VCs are not interested in funding D-rounds and C-rounds in reasonable growth companies doing 30% growth. What they are really interested in is the companies that are growing at 100% or 200% and on the new, new thing, which is AI. And so I don't want to say that there's no investment going on. It's very -- I think it's sparse. But I think the companies that we focus on have -- they've gotten down on the hatches, they reduced their burn, they continue to grow, but they're finding that more equity isn't there for them to continue the growth. So they're turning to alternatives like us. And it's -- honestly, it's quite phenomenal, the number of deals that we're seeing that are companies with $5 million, $6 million, $7 million, $10 million in revenue, maybe have had $30 million, $40 million of equity invested. And just don't seem to have any interest in the equity markets or for that matter with the private equity markets, primarily because there's still -- those investors are still nervous but also because there's a new shiny object out there called AI that they're focused on investing in. So for us, it's a confluence of events that I think it's creating a really, really good opportunity where companies with $5 million and $10 million of revenue who got their costs under control, but want capital. They're already breakeven or close to it and they want money to continue to grow, which is not unreasonable, they're coming to players like us. So I'm quite excited about the future and yes, back to your question. I do think the deal size will increase over time, but it will be modest and it won't be for -- maybe at this time next year, we'll be talking about an average deal size, it's $1 million or $1.5 million more than what we are doing now, but it'll probably take us some time to get there. I don't see us -- until we get to be much, much larger getting into the 20s and 30s million dollars in terms of average deal size. That will take some time.

So from a risk management point of view, do you have like a hard limit in terms of how big you'll go?

Yes. Right now, it's no greater than USD 7 million, and we've never hit that limit. Right now we're at $6 million. So for sure, we're trying to manage concentration risk and exposure responsibly when we look at the overall portfolio. But as we grow our total asset base you can see that.

It will grow. Yes. So it's about 10% of your assets, I guess for a maximum deal size, yes, okay. And so thanks for talking about AI. So I was just wondering, given the trendy topic, if any of your portfolio companies are kind of would be considered AI beneficiaries or AI companies?

Wait a second. I don't think anybody -- there's no pure play AI that we have. Some of them have machine learning as part of their efforts in analysis. Yes, for sure. But I don't -- we don't have a pure play. I don't think we -- one of our companies, a smaller company, I'll give a bit of a shutout a company called AskVet had -- did conversations between veterinarians and pet owners, and they were live vets and live pet owners, and they accumulated almost -- almost 2 million in actual live chat. What I'm thinking about AI because I've been spending a lot of time trying to learn it, not from a technical perspective, but sort of implementation perspective is the uniqueness of the data set. Well, if you got 2 million conversations with pet owners and live vets you have it really interesting. It's not huge, but you have a really interesting data set on which to train sort of an automated assistant on. And so the -- they're continuing to be in that pet space and they do some various online things when it comes to veterinarian access. But they used that data set to train some of the AI platforms and now they're building automated assistance. And I think it's a brilliant pivot and I'm excited about the future. But that's one, that's really -- that makes the most sense from a unique data set perspective. If I look at the rest of the portfolio, no, nobody really has that level of AI exposure. And we'll see where it goes, but I'm more thinking about the companies that had great runs whether there were any kind of platform that was non-AI, but they've got $10 million or $15 million in revenue or try to get to $10 million or $15 million and the equity markets have just turned absolutely cold on them, and that's the opportunity for us. So I'd be surprised if we had a pure-play AI play in our portfolio other than like AskVet pivoting into that because they had some unique data.

Yes. I mean I think the second order opportunities are more interesting right down the road where people become more efficient or kind of into processes, but that takes time to develop. Well, thanks for that, Alex.

Thanks, Ed. Really appreciate your time and support. And again call any time if you have any questions.

We'll do, for sure. Take care.

Mr. Baluta, there are no further questions from the phone lines, sir. Please proceed.

Thank you very much, Michelle. Again, very nondescript in line quarter, lots of really good things happening in industry and in our pipeline. I'm very excited for the future. Really appreciate everybody's time, and we'll talk to you again in 3 months. Thank you very much.

Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask you to please disconnect your lines.