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

Good morning, ladies and gentlemen. Welcome to the Flow Capital Corp.'s Earnings Call for the Q2 2023. [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 August 28, 2023, which is available on SEDAR. Today's call is being recorded on Tuesday, August 29, 2023. I would now like to turn the meeting over to Alex Baluta, Chief Executive Officer of Flow Capital. Please proceed.

Thank you, Cheryl. Good morning, and thank you all for participating in today's call or for listening in on the recording. I'm joined by Gaurav Singh, our current Chief Financial Officer. After the close of market yesterday, we released our financial results for the second quarter ended June 30, 2023. Details can be found on our website at flowcap.com or as filed on SEDAR. Similar to Q1, we had a relatively flat quarter that was in line with our expectations. I will not be going through the full financial statements on this call, but we'll focus on a few highlights. If you'd like more detail, I'd encourage you to read our full financial statements, again, there you can find on our website or on SEDAR. Recurring interest revenue was $1.45 million, down slightly from the prior year and essentially flat to the $1.5 million in recurring revenue for Q1 of this year. As I've mentioned several times in the past, our definition of recurring revenue is a non-IFRS metric. Our total revenue, as reported under IFRS for the quarter was actually $2.3 million. However, IFRS revenue can be slightly distorting and hard to follow under IFRS changes in the balance sheet, leading to a flow through the income statement, that could lead to things like negative revenue for the quarter, making it hard to track real performance of our core business. This is why we talk about recurring revenue and recurring free cash flow, which we believe are better metrics to track, and it's how we track ourselves. As we mentioned on our Q1 call, we expected our revenue to be flat because we had several early repayments last year and early this year, and our redeployment of capital was not keeping pace with those early repayments, although that is now changing as we deployed more than $6 million in capital in the last 2 months, but more on that in a moment. With respect to recurring revenue, we had, as I mentioned, the early repayments of Performio Hereto those last year, two of our [indiscernible] and in April of this year, we had the repayment of [indiscernible] all of which were early than the maturity date. However, over that same time period, we only had 1 new investment, and that was a relatively small investment at a company called Prolific, that was late last year. Since we generate recurring interest and revenue from senior secured loans into high-growth companies, when new deployments taking up with early repayments, we would expect the recurring revenue to be down, and that's what we're seeing now. Recurring cash flow, another non-IFRS metric -- I-F-R-S, metric, defined as recurring revenue, less cash expense and less interest costs with a positive $127,000 in the quarter and $725,000 over the past 4 quarters, again reasonable to banks lately compared to prior periods for primarily same reasons. Costs from our perspective were in line with our expectations. While slower redeployment is not optimal, it is primarily because we are being particularly selective in the job that we choose to do, and this is one of the reasons why our 5-year IRR is over 30%. And again, more on that in a moment. But we're finally starting to redeploy our cash, which, by the way, the cash at the end of the quarter was $8 million on our balance sheet. As in -- but late in the quarter, we closed on an investment made Wrisk, that is spelled W-R-I-S-K, Wrisk. It is a U.K.-based B2B2C SaaS company in the insurtech space. And a few weeks ago, we also closed on an investment in the B2C space in a company in the sleep wellness -- sorry, a B2C company in the sleep wellness space. In aggregate between these 2 companies, we deployed approximately $6 million in the last 2 months. Both of these investments carry an interest rate that is higher than our average rate from a few years ago, reflecting the change in the broader interest rate environment that we're seeing. And we expect to see more deployments in the coming weeks and months. I've been mentioning -- I have mentioned for several quarters now on how our pipeline has been incredibly strong and that strength continues. [indiscernible] conversions of the pipeline. The strength has been driven by broader changes in the investment landscape in particular, venture capitalists are still not investing in the companies that are either pure AI or they are growing at 100% or more. So if you're not pure AI or have a 100% plus growth rate, venture capitalists are not interested. And to be honest, those kind of companies are few and far between. They're also avoiding down runs in their existing companies in this current environment, which means they're not supporting their existing portfolio of investments. Add this to the fact that public markets are essentially closed and ultimately raising capital, a large amount of equity, for most companies is a challenge. Yet there's a huge universe of great companies out there that are generating anywhere from $3 million to $15 million in revenue, which is our target, that are at or near breakeven because all of them have cut costs in this current environment. And for whatever reason, they need capital and the VCs aren't there, and so it creates such fantastic opportunities for companies like Flow to make investments into those companies. So I'd like to give you a few stats to support what we're seeing in our pipeline. Stages in our pipeline starts at the top. We have a lead that progresses downward through market qualified leads, sales qualified lead, IC, investment committee, term sheet, due diligence and then portfolio. So to give you an idea, normally, we see about 900-plus leads at the top of the funnel every year, and we close on less than 1% of those. The key stages or key stage, I should say, in our pipeline is what we call the IC level or Investment Committee. This is where the company has been preliminarily fully qualified. I mean they will meet our standards. They understand our structure and our requirements. And so we both feel there's a fit, and we get -- start getting to know them better. This year-to-date, we've had over 40 companies progress to the IC level in our pipeline. That compares with only 31 in all of 2022. I would not be surprised if we see more than 60 companies progress at the IC level in a pipeline this year. Furthermore, so far this year, we've received 25 term sheets. Of those 25, we signed 9. We closed on 2, as I mentioned for approximately $6 million. We rejected 3 in due diligence and 4 are currently in due diligence. Of these 4, we expect to close on most of all before the end of the year. And if we do, as we do, revenue and free cash flow growth should resume. For example, for the $6 million deployed earlier this year, that would generate over $1 million -- roughly $1 million revenue for us on yearly basis. I also mentioned that in our pipeline stats, we rejected 3 deals this year after signing term sheet, after doing detailed due diligence. This selectivity and focus on quality is a good lead-in to the discussion about our 5-year performance. On June 27, we issued a press release that summarized our 5-year investment performance. Specifically, we've invested $46 million into 16 portfolio companies. Our gross top level IRR was 30.5% on capital deployed. Our loss ratio was less than 1% on 0.7%, which represented about a $300,000 cash loss. We increased book value per share from a low of $0.45 a share in Q4 2019 to high of $1.23 per share in Q1 2023. That's an increase of 172%. I will mention that for the quarter we just booked, book value is down a couple of pennies to 118 primarily because of the issuance of shares and were issued the shares on the conversion of warrants and option exercise. Over the investment period that we mentioned for the past 3 years, we've been generating positive FDA and positive free cash flow, and continuing again in this quarter. And we repurchased 14 million shares, about 31% of the outstanding common shares at a weighted average price of 48% discount to book value. So essentially, we're buying [indiscernible] when we buy [indiscernible]. I'd also point out that we continue to be active in our NCIB and in the past 9 months, we've purchased almost 1.7 million shares for $930,000, and again, [indiscernible]. I expect it will continue our NCIB given our cash flow positive and expect to be cash flow positive, we'll continue our NCIB into the future. While the 30.5% IRR is remarkable, and it's a testament to the team, to our process and to our investment strategy and focus. For us -- I would say that maintaining that 30% is probably not realistic over the long term. But as a recap, we invest in high-grade companies, primarily in tech. These are asset-light companies that are a perfect fit for our capital. And I will say that we do sometimes look outside of tech, what we primarily look for is good companies with great management that have high growth. And for us, high growth is generally defined to be 20% to 50% plus growth, which, as I mentioned earlier in my statement, is below the threshold where most major capital is get interested. We focus on high growth because these -- because in these high-growth companies, in addition to paying us a cash interest, we can generate disproportionate large returns in equity upside. And -- what we're really looking for is senior -- the security of senior debt with equity upside, and we find our best banks in the markets and growth companies. As a reminder, we're additionally taking mid-teens cash interest rate, we also end up owning through warrants or other bonus structures, somewhere between 1% to 3% of the companies that we invest in. And through those bonus, the cash interest -- it's both through the cash interest payments as well as from the gains in our warrants in our portfolio -- bonus portfolio that we have generated that 30% IRR. I would encourage you to read that June 27 press release because if you haven't seen it, it's got some great details in it. While we're proud of our 5-year performance, we're also realistic, our long-term IRR target is in a low to mid-20s, which is still a fantastic long-term return. And if we hit that return, it will generate a meaningful return on equity and book value growth for our stockholders. Next, to help us capitalize on the quality and the volume of deals that we're seeing and to help us continue to scale the business, we recently launched a new redeemable debenture. The debenture carries a floating rate of interest. The F-Series currently pays 10.5% with a floor of 8 with a cap of 12 for holders of greater than $1 million. It currently pays 50 basis points plus, meaning 11% interest or 8.5% on a capital of 12.5%. It's RRSP eligible. It's redeemable by the holder on 90 days' notice, and it took senior to almost $40 million of equity that's on our balance sheet. We're hopeful that this structure will appeal to investors as we plan on using this vehicle to raise capital to scale our business and continue to grow our portfolio. Finally, we're also enacting a CFO transition. Michael Danny will be joining us on September 5. Michael has over 25 years of experience in investment banking and most recently he is a managing director with private equity manager, Linx Equity, where he manages the Linx Equity Income Trust. He brings a mix of investment, financial and capital raising scales that will help us continue to scale our business. Gaurav Singh, our current CFO will be leaving at the end of September. He will be here for several weeks to help with the transition. Gaurav has made a significant contribution to our business as is evidenced in our book value growth and our profitability and return to sustainable profitability and free cash flow growth, all during his tenure. He left us well positioned for growth. I'd like to thank him for his hard work and his dedication and wish him every success in the future. And with that, I'll stop with my remarks and turn it back to the operator.

[Operator Instructions] Presenters, at this time, I show no questions in queue.

Thank you, Cheryl. I appreciate that. Thank you, everybody, for joining the call and for listening. I would encourage you to download our financial statements or press release. And we've been -- as usual, if you have any questions at any time, please feel free to call us if you will. We appreciate your support and feedback, and we will talk to you next quarter. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's conference. Please disconnect your line at this time.