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

Good morning, ladies and gentlemen. Welcome to Flow Capital Corp.'s Earnings Call for Q4 and Year End 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 Q4 and year-end 2023 company's Management Discussion and Analysis, which is available on SEDAR. Today's call is being recorded on Tuesday, April 30, 2024. I would now like to turn the meeting over to Alex Baluta, Chief Executive Officer of Flow Capital.

Thank you, Joanna. Good morning, everybody, and thank you all for participating in today's call or for listening to the recording. I am joined by Michael Denny, our Chief Financial Officer. After the close of market yesterday, we released our financial results for the quarter and the year-ended December 31, 2023. Details can be found on our website at flowcap.com or as filed on SEDAR. I will try to keep my comments relatively brief today. During Q4, we reported a record quarter in terms of recurring revenue, going as far back as at least December 2018. That's when we transitioned our strategy away from royalties and into growth debt and we changed our name to Flow Capital. I will not be going through the full financial statements on this call, but rather we'll focus on a few of the relevant highlights. If you'd like more detail, I strongly encourage you to read the statements, as I said, that are on our website or filed on SEDAR. Recurring interest revenue for Q4 was CAD 1.65 million, up over 15% compared to the prior year. For the year as a whole, recurring revenue or recurring interest revenue was down slightly to CAD 6.1 million, driven by slow investment deployments in the first half of the year as well as early repayment of several deals late in the prior year. As a quick aside, I have repeatedly pointed out on every call, and it's worth noting again, that our definition of recurring revenue is a non-IFRS metric. For Flow, recurring revenue means cash revenue generated from our investments. Our total reported revenue under IFRS was actually CAD 1.1 million in the quarter and CAD 5.8 million for the year. However, IFRS revenue can be slightly distorting and hard to follow as under IFRS rules, changes in the balance sheet need to flow through the income statement, which can lead to things like negative revenue in a quarter, making it hard to track the real performance of our core business. That's why we talk about recurring revenue and recurring free cash flow, which we believe are better metrics to track. Our current recurring revenue growth in Q4, as an example, was a function of strong capital deployment in the second half of 2023. Recurring cash flow, another non-IFRS metric, which we define as recurring revenue less cash expenses and cash interest costs was a positive CAD 338,000 in Q4, up strongly from the Q4 last year. For the full year, recurring cash flow was down from CAD 1.3 million to CAD 1 million, driven primarily by increase in our cost of capital as we moved from paying to a floating rate interest -- sorry, we moved to a floating interest rate on our debenture, which was over 1% higher than what we were paying in 2022. We expect that as rates come down, our cost of capital and what we pay in our debenture will also come down as it's a floating rate. During the year, we had 2 loan repayments totaling approximately CAD 10 million. IRR on those deals was in the range of 21.5% on one deal and 36.2% on another. It's worth noting that we still have equity warrant positions in both companies. Usually our loans have a duration of 3 years, but our warrants have a term of 5 to 10 years. Total assets ended the year at CAD 63.6 million, another record going back at least 6 years, up from CAD 58.7 million last year. We ended the year with just over CAD 5 million in cash, but note that, that does not include roughly USD 6 million from one of the repayments that I prior just mentioned that actually hit our bank accounts on January 2, 2024. During the year, the portfolio performed well and we had no new non-performing loans. We do have a loan that we have been restructuring for some time and that ceased payments, which negatively impacted Q4 revenue, but this was not a new distressed situation, it's an ongoing workout. Book value was down a few pennies year-over-year to CAD 1.19 per share. This was due primarily to warrant revaluations. The warrant valuation decline was itself a reflection of the broad and material contraction in equity valuations that we've seen over the past 15 to 18 months. As you know, we regularly mark-to-market as best we can define the market our warrants. OpEx has remained consistent at approximately CAD 3 million per year plus or minus CAD 100,000 for the past 4 years. Over that time, going back to Q1 2020, we've grown quarterly revenue from CAD 1 million to almost CAD 1.7 million, up almost 70%, and we've grown book value per share by almost 160% to CAD 1.19. I think we've handily outperformed pretty much any relevant benchmark when it comes to book value per share growth. From a profitability perspective, Q4 marked the 15th sequential quarter that we've been free cash flow positive going all the way back to Q1 2020. We have been efficient operators and we will continue to improve our operational efficiency every quarter. As we scale our business, I fully expect it will remain profitable even as we grow our [ time ]. While we have continued to improve our insurance processes and efficiency over time, the primary reason for the strong track record of generating positive free cash flow has been a relentless focus on doing excellent high-quality deals. As we approach our 6th anniversary of transitioning from royalties to focusing on providing growth debt to high fast -- high-growth fast-scaling companies, our investment IRR to the end of Q4 remains in the high-20% range. Please keep a look out for an upcoming press release in the coming weeks where we will be releasing more detail on our 6-year IRR performance numbers. This IRR performance is also the result of a deeply ingrained focus on deal quality and risk mitigation. Philosophically, we target zero 0s, as in zero defaults, which is a short-hand way of reminding everybody on our team here that it is very hard to make up a capital loss based on the net spread of the rest of the portfolio, although warrants can help make up such losses. We therefore do extensive due diligence and we are very picky in our investments. What pickiness really means that our close rate remains at less than 1% from top to bottom. So for every 100 deals that come into the top of the funnel, we close on less than one of it. And if you look even deeper into the funnel, we only closed on approximately 1/3 of the deals that we signed a term sheet for. So if we sign 3 term sheets, we'll close one of those. So in spite of this pickiness, we have seen strong capital deployment over the last 12 months. Specifically, over the past 12 months through April 2024, we've deployed over CAD 22 million into new investments. And this is one of our core focuses going forward to continue to grow our investments and to well manage high-growth and occasionally venture-backed companies. Another highlight during 2023 was the conversion of our Priority Return Fund into a high-yield retractable, redeemable debenture. This is an on-balance sheet debenture that provides our debenture investors with a floating rate of interest currently at 10.5%, redeemability, RRSP eligibility and seniority of almost CAD 38 million in equity. The market reaction to this debenture has been very positive and we expect this structure will help us grow our asset base for the foreseeable future. From a pipeline perspective, we continue to see many high-quality opportunities. I've mentioned before, this is a trend that start -- that we started to see in late 2022 and it continued into '23 and into early '24. This has been driven by a few factors, including the equity markets drying up, and that's both public equity and private equity; venture capitals wanting to avoid a down round; companies focusing less on burn and higher -- more focus on profitability, which offers them slightly lower growth; and we can kind of add a fourth driver more recently, which is VCs focusing on investing billions and looking for AI unicorns. All this means that company might be strapped for capital and don't have equity auctions. And that leaves good small and mid-sized companies who really need the money turning to growth debt providers such as ourselves. To be a bit more specific in terms of high-quality leads, we saw 55 such companies in 2023, up from 36 such companies in 2022. Finding new ways to continue to grow our pipeline, both at the top of the pipeline and in terms of high-quality leads is a key strategic focus for us going into 2024. Quick mention on the warrant side. We now hold 23 warrants, equity or bonus on equity type positions, and this portfolio will continue to grow as we make more deployments. As I said, the average duration of these warrants is between 5 to 10 years, averaging on 6. These warrants and equity positions have been meaningful contributors to our IRR performance over the last 5 years. It's worth noting that our deal structure generally leads us to owning somewhere between 1% and 3% of these high-growth companies. And I'll remind you, we focus primarily on SaaS, tech software companies. And some of these companies will eventually become large, excellent, well-performing companies, and hopefully, we continue to own 1% to 3% of each of those companies. On the slightly disappointing side, it's worth mentioning that we lost our legal battle against the former royalty investment. Without going into too much detail, if this deal was in front of the courts today, we would have won a judgment for well over CAD 4 million based on new laws recently put into place in Canada. While it's disappointing that we did not win, the good news is that we were carrying this investment at a very conservative valuation and there will be no negative book value impact even as we collect almost CAD 1.5 million in the coming weeks. Next, a quick update on our NCIB. In our Normal course Issuer Bid ending in October 2023, we purchased almost 2 million shares for approximately CAD 1.1 million, so an average price of approximately CAD 0.56. I want to point out that over the last 5 years, we've continued to repurchase shares, and in aggregate, purchased somewhere in the range of 15 million shares, spending approximately CAD 8 million to do so. And as I've said in the past, given the market discount of the share price relative to our book value, we will continue to buy back our stock, essentially buying dollars for CAD 0.50, primarily because we're exceptionally strong believers in our future. Finally, I want to give a quick nod to our team. The team we have assembled in which we continue to grow is amazing. It's their hard work and relentless focus on quality and on generating meaningful shareholder returns which has gotten us to this point. And with their help and with the use of new star players, we will stay laser-focused on continuing to grow both our top and bottom line and on generating an excellent risk-adjusted return for all of our stakeholders. And with that, I'll end my prepared statements, and I will turn it back to the operator, Joanna. Thank you.

[Operator Instructions] We do have a question from Ed Sollbach from Spartan.

Alex, congrats on all the new business you've won. I look forward to that in coming quarters. Any thoughts about putting out like an adjusted earnings number or something? Because if I look like just -- like at the annual numbers, I see 322...

Ed, we've lost you there. Operator?

It seems like Ed's line had disconnected. And we have no further questions.

Okay. So I think I know what he was asking. We do focus on recurring revenue, recurring free cash flow, but the earnings that we put out do confirm to IFRS. And Ed, if you're asking for an adjusted earnings, we can do that as well. Really comes down to the cash flow that we're generating. We don't have a lot of non-operating expenses, meaning amortization type expenses. So I think if you just look at that cash flow number, that will give you a very good idea of our adjusted earnings. Look, we can always discuss this in more detail. Feel free to call me or Michael, our CFO, at any time. That's it, Joanna.

Thank you. We have no further questions.

Thank you, Joanna, and thank you everybody else for listening and look forward to talking to you again in a couple of weeks for Q1. Thank you.

Ladies and gentlemen, this concludes your conference for today. We thank you for participating and we ask that you please disconnect your lines.