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

Good morning, ladies and gentlemen. Welcome to Flow Capital Corp.'s Earnings Call for Q1 2024. [Operator Instructions] I would now like to remind everyone that today's discussion 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 Q1 2024 company's Management Discussion and Analysis, which is available on SEDAR. Today's call is being recorded on Thursday, May 23, 2024. I would now like to turn the meeting over to Alex Baluta, Chief Executive Officer of Flow Capital.

Thank you, Joel. Good morning, and thank you all for participating in today's call. I am joined by Michael Denny, our Chief Financial Officer. After the close of market yesterday, we released our financial results for Q1 to March 31, 2024. Details can be found on our website at flowcap.com or as filed on SEDAR. This call is being recorded and will be available for replay on our website as all of our calls are. I am going to keep my comments relatively brief today and free form, unscripted, a little unusual for me. During Q4 -- I should say Q1, we did report another record quarter in terms of almost all metrics, recurring revenue at a record assets are at a record, portfolio is at a record. And this is going back as far back at least as 1st December 2018, which is when we formally transitioned our strategy away from royalties and into gross debt or venture debt, and we changed our name to Flow Capital. I'm not, as is usual, going to be going through the full financial statements on this call, but we'll provide a few highlights following along with the highlights that we put into our press release. If you'd like more detail, I encourage you to read the full financial statements that's filed or call us at any time. Recurring interest revenue was a record $1.76 million, up 16% compared to the prior year. As I mentioned on the last call, which was only a month ago, we're starting to see traction in the second half of 2023, and that traction in terms of new deployments continued into this year and looks to continue into the future. And as I mentioned, every call as a quick aside, and I've repeated this time and time again, it's worth making the point that our definition of recurring revenue is a non-IFRS metric. For us, recurring revenue means cash -- revenue generated from our investments, doesn't include [ PIK ]. Doesn't include bonuses, early exits, et cetera. Total reported revenue under IFRS is different. That revenue can be distorted and hard to follow based on the fact that changes in the balance sheet need to flow through the income statement. And so it can lead to distortive numbers that are hard to follow. So we like to talk about recurring revenue and recurring cash flow. And you'll note that we've consistently been talking about this now going back years. And we think that's a better way to track our business. So to review some of the highlights, recurring revenue was up to $1.8 million or $1.76 million, up 16.4%. I want to note that our cash yield on our current loan book, which is almost $44 million is over 16%. That's a cash -- current consistent cash yield. Our book value per share was back up to a recent record of $1.23 and where we were 5 quarters ago. I will note that the drop in book value over the last 5 quarters was primarily due to dilution from warrants and some auction exercises. The book value is up 2.9% over the prior quarter and over 49% over the past 2 years. The recurring free cash flow was $415,000 and that's up over $1.1 million over the past 4 quarters. That is up -- I should say, positive for the last 16 quarters in a row. In fact, the last negative free cash flow quarter, we had, was Q1 2020. And I'm going to give you a quick comparison to Q1 2020 in a moment. Total assets, $65.4 million, up almost 3% quarter-over-quarter and 10.6% year-over-year, another record. And here's an interesting metric, we've deployed over $28 million in the last 12 months. For us, that's a record, and we're getting to the stage, where I'll talk about in a minute, we expect that number to grow substantially as we scale our business. A couple of minor points, post quarter, we did -- in this press release. We received a $4.5 million US repayment with successful investment in Pyure, that was a 4.25 year term, and that represents on a repayment over a 20% IRR. We then quickly redeploy that money into a $4 million loan into a company called Tattle, a fantastic B2B SaaS software company focused on customer experience improvement. We get an additional small second tranche into JUDI.AI as well. So I thought I'd just quickly mention, looking back to our last negative free cash flow quarter, which is Q1 2020. So kind of a 4-year progress. Recurring revenue over that time has gone from just below $1 million to almost $1.8 million. Our assets over that time have grown from $34 million to $65 million. Importantly -- most importantly, our book value per share attributable to common shareholders has gone from $0.46 a share to $1.23. At the time, over 80% of our revenue was generated from royalties, which were much higher risk in our -- from our opinion it was higher risk investment structures. And now it's less than 10% come from royalties. In fact, we only have one material royalty outstanding and that is just over $1 million, and that's a fantastic company called TruGolf, which just recently went public. Our free cash flow at the time in that quarter was below -- negative $200,000, it's now over $400,000 in the quarter. And part of the reason for that cash flow growth -- multiple reasons, growth in revenue, growth in assets, but our cost actually for that -- from that time period are flat to down over a 4-year period. And Importantly, our gross IRR over that time period has been -- last year, we put out a press release just over 30% on the trailing 5 years. It's still very close to 30%, a little bit lower in the high 20s. We'll be putting out another press release giving you our 6-year track record on IRR shortly, so please pay attention for that. And that is really driven by the relentless focus on quality, and you'll see that in our close numbers in our pipeline where we still see just below 1,000 leads per year. But even after we get all the way down to turn sheet, we still only closed about 1/3, below 1/3 or should say between 1/3 and 1/2 of the deals that we signed term sheet on. And that's because we're just -- we do an incredible level of due diligence and internally, as I mentioned before, we focus on 0 zeros and as a [indiscernible], it's so hard for us to make back $1 million capital loss on the net spread on the rest of our portfolio. So we're laser-focused on high-quality investments with appropriate risk adjustment. And that is what's generated that, what I think is a fantastic growth IRR over the last 6 years. But you can see that we've grown and what we've done, you might argue that going from $1 million in recurring revenue $1.8 million over -- over a good span of 4 years, it's great, but it's still small, and I would agree with you. But what we've done over the last 4 years is develop a consistent approach, a consistent focus. We've built our brand, we've built our processes importantly, very importantly, in fact most importantly, we've built a fantastic team and we've set the stage for what we think is going to be continued strong growth in all of our metrics, recurring revenue, recurring free cash flow assets, book value. And our goal after having built -- done a lot of the hard work over the last 4 years is to grow first to $100 million in assets, then $250 million, then $500 million, then $1 billion. It is a very, very achievable target in the market that we play in, which is venture debt and/or growth debt. Peak originations in this market in early '21, '22 time frame were well over $30 billion per year in North America alone. We focus on both Canada on all 3 -- I should say, Canada, the U.S. and the U.K. in terms of our loan origination deals. And while originations have come down a little bit in venture debt, it is -- that's more of a short-term cyclicality given the rates and change in the market and venture capital appetite. But it's still a multi-tens of billions of dollar origination market globally. And we're very excited we're part of that market, and we see the path to get to hundreds of millions of assets over the next several quarters and several years. And I'm very, very proud of the results that we've generated over the last 5, 6 years. Our progress has been sometimes a little lumpy given the nature of repayments and the nature of redeployments. As you saw with the Pyure repayment, we, within 7 to 10 days, redeployed that into Tattle. We continue to have an exceptionally strong pipeline, 3 term sheets that are signed and in current due diligence, several term sheets that are in negotiation behind that. And while I mentioned earlier, our close rate post term sheet signing was between 1/3 and a half, I do expect that, that's going to improve a little bit over time, but we're still going to be selective. But I'm going to end the comments there. If you want to -- if you would like to go back and listen to the comments today on the quarter that we just -- Q4 that we reported about a month ago, they're very similar. You can get a little bit more detail there. But I'll pause there and see if there's any questions.

[Operator Instructions] There are no questions at this time. I will now turn the call over to Alex.

Ed had asked a question, please let him -- please allow that question.

Okay. Ed Sollbach from Spartan.

Congrats on resuming growth again, as you predicted. That's this quarter. I had a bunch of questions actually. If I look at the website, it says you'll do loans up to $7 million. Is that -- have you done a loan that big? Or is that what you would do, I guess?

Yes. Thanks for your long-term support and thanks for joining the call. I will point out, I meant to mention that we will have a new website launching probably the next month. So keep your eyes up for that. Yes, it's probably now $2 million to $7 million. It's very rare that we would do a low-end deal below $2 million. As you know, you're doing the same due diligence on a $1 million deals as you're doing a $50 million deal, at least that's our perspective. And so you just get a much better return. I think our average sale size is closing in on USD 3 million, if not USD 4 million. We have not ever gone as high as USD 7 million in any deal to date. The largest one was Echobox which was repaid January 2 on a December 31 close of last year. We've got a couple in the $5 million range right now. But we had -- to answer your question specifically, we've not had a deal that's gone above USD 6 million. I'm not averse to it. We are growing our diversification and lowering our exposure to any particular deal. We have a couple of deals that are in the 12% to 15% range in terms of portfolio. I expect that all of those will be below 10% contribution to portfolio within the next quarter or 2, depending on the continued deployments but the answer is no, not yet. We'd happily get there for the quality company. You'll note that -- or I should highlight that all of our deals are non-amortizing. A couple of reasons for that. It's a bit of a differentiator in the market, but also gives us better exposure to long -- you're going to be exposed to a great company, you want to be exposed fully for a longer period of time. So while we limit our turns to 36 months, mostly, we do -- we haven't got a single amortizing loan, we don't -- we haven't really even done an amortizing loan in a term sheet for a long time. And the reason for that besides better exposure for us is if you think of it from the borrower's perspective, if you're amortizing, you're paying out an awful lot of money, you're not getting the full use of the money that you're borrowing from us. A lot of the money gets paid back quickly. Now I understand that it's a risk reduction from our perspective. But given the diligence that we do on our companies, we're very comfortable with the risk and it's been working for us. So the answer is no. No deal got $7 million, yes, we would do a deal there if -- and add one other thing we'd probably get these through multiple tranches. In other words, Echobox, we did a $1 million tranche, then a $2 million tranche, then a $3 million tranche all in succession based on the progress. Several other deals, Pyure was 2 tranches, JUDI, we just did 2 tranches. So our approach to getting $7 million is generally give them enough money see that they're -- on track with expectations within manageable variables or variants and then put in the second tranche and then put in the third tranche. So I hope that answers your question.

Yes. No, that gives a lot of good insight into the loan process. So it's really driven by your -- how comfortable you are with the risk profile and then I guess...

If we get a $10 million deal, we'll pass it on to the partners/ -- somebody we know that focuses on larger deals. People ask us to co-invest on deals with us. The problem there is that it's just not -- you never have certainty on close, right? So why would we negotiate a $10 million term sheet when we got to go get $4 million from somebody else and then we can't get it. And so partners say, we'd love to partner with you, it's really very, very subjective. So we don't do co-investments with -- we don't scale higher through co-investment partners because it's just very, very difficult to get there. And [indiscernible] sure, that you can fund the company, once you've made a commitment. What we don't want to do is make a commitment and then not be able to fulfill that commitment.

Right. Okay. So I just -- I've got a couple of questions on the -- like the balance of financial statements. If -- so in your news release, you said loan book of $44 million basically, right? And then if I look at -- so is that -- what date is that? Is that as of March 31 or -- pardon?

Sorry, as of March 31.

Okay. And you get 16% on that.

Yes. The loan book now is closer to $46 million at fair value. So -- and that includes ECLs and stuff. So those are -- those are the essential carried book value of the loans.

Okay. So -- but then if I look at the balance sheet, I see investments $34 million -- $35 million, I think. If we add that up and then an -- investment's current portion, $15 million. So if I add that up, we get closer to $50 million. Is that the correct data...

Yes, let me -- I don't actually have it...

There's 2 buckets for investment. There's current portion and noncurrent...

Yes. sorry, so our loan book, both current and long term, we have over $6 million in warrants. We have $7-ish million in the long-term cash asset -- tax assets.

Okay. So the investments would be bigger than -- the investments are bigger than the loan book because that includes points and stuff like that.

Correct.

Okay. Okay. Okay. Right. So that's different than the loan book, which is just the straight loans, okay. So that would kind of suggest that you have -- anyway, it's broken down, but you have -- a number of -- some [ gains ] in there too, right? Yes.

We have the deferred tax asset -- so there's -- it's pretty clear on the balance sheet. The other thing, IFRS while the income statement is challenging to sometimes decipher given the changes in balance sheet run through the income statement. The balance sheet's pretty simple and pretty clean and pretty easy. One of the things that you'll note, I would just -- now and compared to 2021, we had an accumulated deficit at the time of $338 million down to $14 million. It just shows how profitable we've been over the last 4 years. And I expect given our trajectory, given our costs, given everything we've done, we should continue to be profitable, barring some unforeseen major events.

Yes. Yes. No, that's -- yes, that's great that it's grown that way and especially the book value. So I noticed on the income statement, there was about $300,000 in tax. So I'm wondering how does -- you've got a tax asset of $8 million and you're showing tax. So how -- is that a tax [ practice ] or like a...

Yes, it shows that, that was taxable, but then that's netted out against the loss, and you don't pay any cash taxes. So it's an expense, but it's not a cash expense.

Okay. Okay. And then the final question is just tactically, so you've got about $8 million cash on the balance sheet, right? And you're also borrowing through preferreds and -- anyways, your cost of borrowings is 10% or 11%, I guess, with the debt, debentures and stuff like that. So like do you want to keep like $8 million cash given you're [indiscernible] a [ 10%, 11% ] cost of capital for that? Or does it make sense to run that to near 0 and then maybe have a line of credit, if you have the needs? Or what's the philosophy -- like how much cash do you want on the balance sheet? What are you comfortable with? Where do you want to...

Sure. So that's a great question, Ed. It's kind of a -- I do want to mention, I mentioned in our last call that our debenture pays a floating rate of 10.5% or up to 11%, if the investor is over $1 million in it. So we are -- if you look at our space, and I mean, in its entirety, there's a lot of players in this space, all focused on different segments, as I mentioned, over 30 billion originations in North America alone. That vast, vast, vast majority of the space is funded through LP GP structures and debt. So if you're in an LP GP structure, which means locked up 8-year limited partnership, you -- that limited partnership investor is first loss capital and on top of that, the -- so let's say there's $100 million in LP money, and then there's another $100 million in debt. That LP investor is the first loss. In our case, we're not an LP GP. We're a public company. But what we have is equity, $38.5 million of equity. And that equity, which, by the way, management board own over 25% of, so we're highly aligned. That equity is first loss. And so that debenture that we use and it's going to be our primary funding vehicle, not the only, but the primary funding vehicle for the foreseeable future, that debenture, which pays 10.5% to 11% is supported by almost $40 million of first loss capital. In other words, we've got to blow through and burn $40 million of loans which, by the way, our loss ratio was well below 5%, well below 2% currently, before those debentures are at risk. And that's very unusual and very, very, very much better than any of the LP GP models you'll see out there. You're an LP investor in a growth -- whether it's venture capital or venture debt, growth debt-oriented structure, your capital is at risk as the first loss. I can't stress that point enough. So we feel -- sorry, and for the first -- for investors, our debenture is redeemable on demand after a short period of hold. It's RRSP eligible, and its senior to $40 million in equity. So we feel that, that risk-adjusted return that we're paying is excellent. Now from a cost of capital perspective, our average yield is 16%, 16.5%. We don't go below 15% cash yield in our term sheets. It's just a hard line for us. That's always been the case. Our debentures are floating. So when rates come down, our cost of capital over the debentures come down. So we're -- we've managed that spread. And it's somewhere between 6% to 7% of growth, net interest margin that we earn on our spread -- on our investments. However, we also then have a portfolio of approximately 20 warrant positions. And while many of those will expire without being exercised and without creating value for us, we have in the past 5 years, had several excellent assets on the warrant positions that we hold. And broadly speaking, we own either equity or warrants or what's called the success fee, which is -- it's kind of like a warrant, but it's not -- it just slightly -- it's basically when the company exits in a change of control transaction, it triggers automatically. So that's -- as our Chairman likes to call kind of the hidden treasure chest of our business model, we're in a cash interest of 15% to 17%. That is when I talk about recurring revenue, that all we're looking at is the cash interest and cash expenses. On top of that, we have this growing warrant portfolio that's almost double size of our current loan -- our current number of investments because our warrants tend to be anywhere from 6 years to perpetual. We expect that some of those will help grow our asset value for our shareholders over time. In other words, if we happen to have a loss of $1 million on a loan at some point. I expect that over that same period of time, we'll make $2 million or $3 million back in terms of the warrant book. So it's a broadly diversified strategy. The investors have security in debenture and security in terms of first loss capital below them and management and the Board are exposed at that equity level. And from my perspective, if we're taking care of book value and shareholders and shareholder value by definition, we're taking care of a very, very good care of the redeemable debt holders.

Yes. No, let me -- and that instrument is great -- is good for both sides, right, especially the investors at over 10%. And -- but given the health of the balance sheet that you -- the $40 million equity that you talked about, would it be possible for Flow to like have a bank line in case you need a $5 million or -- like I'm just wondering about -- do you really want $10 million cash sitting on the balance sheet? Is that [indiscernible] capital or like I know you need it because you have loans in the pipeline and stuff at the moment.

A perfect question. I would -- at the stage we're at now, you're 100% -- if all that capital is deployed, I would have had even higher revenue, even higher free cash flow, right? Because it's automatically then [ fall ] into the bottom line. But no, you're bang on. I do see longer term a 3-tiered capital structure, which would be our equity at the bottom at first loss. So that's going to grow over time, [indiscernible] profitability and gains on our loan book. Second would be the debenture, which again is senior to that equity. And third would be what I would probably consider to be more of a senior warehouse line. So I keep my cash at a couple of million bucks. I need to close a deal, I draw it on the warehouse line and then backfill it with debentures. That's kind of the strategy that we have. And you don't be surprised if you see us signing some form of an agreement with a more senior lender but it strategically makes total sense for us to do so and all 3 layers of our cap stack are well protected. So I want to -- I'm going to keep hammering that point that our redeemable debenture holders, unlike most other structures in the space, has security below them, which is unavailable in the other structures. So yes, you're right Ed, we've got to be more cash efficient. I know it's been something that people are taking comfort in for probably the last 4 years, we carried an average cash balance of somewhere between $8 million and $10 million. That will decline over time and we will become more cash efficient with a more senior line to help us.

Yes. No, that makes a lot of sense as you mature as a company, right? So -- and then I guess the final -- and just this is the point you were making -- like you were saying your loans are non-amortized right? And is that because your borrowers, they -- typically, they're looking for an -- they have an exit in 3 or 5 or whatever years -- and so from that point of view, if you're looking at that exit as the company -- as they mature their business, then when that exit happens, then everything is paid off, you don't need an amortizing loan like with the traditional business. Is that the way they look at it?

So all of our investors take our money for a couple of reasons. One, bridge to a new round, bridge to an exit acquisition, rarely taking money off the table. We're just not comfortable with that. In fact, we like -- we often take a co-investment almost probably 60% of our loans, the existing equity investors do a co-investment alongside of us and subordinated [ equity ]. Look, from -- think of it from this way, as I mentioned, if you -- let's say, we give somebody a $3.6 million loan, and that's amortizable, it's a 3-year loan. We're going to be paying interest and then $100,000 per month of amortizing down the principal. So instead of just paying 20, whatever $10,000, $20,000, $30,000 a month in interest, whatever the number is, they're paying $130,000. And from their perspective, they get $3.5 million, but they don't actually have the use of it, and they have this massive amortization charge every month. From my perspective, you might think it's a bit less risky. And sure I get a little bit of my principal back. But I'm now less exposed to what is a good high-growth company. So one of the ways that we'll compete against an amortizing venture debt loan provided by a competitor that maybe has a lower headline rate. Look and say, yes, but you're paying out $125,000 a month. And for us, you're paying out $25,000 a month. In other words, you get to use the capital we give you for longer. And it's rational. Yes, you're paying 15% with us and maybe you're paying 14% with them. But it's just way better on your cash flow and you end up having to take less money to achieve your growth, or bridge or whatever it is that you're trying to achieve with our capital. So that's how from both parties, the non-amortizing loan works very well. There are some others that provide it, but most of the competitors that we come across have maybe a 6-month period of non-amortization and then amortization starts. So we've seen terms -- we've issued term sheets to players -- companies out there that are really, really good companies, 30%, 40% growth rate, but they have an amortizing loan and they want to change that to a non-amortizing one. We'll do that as long as those due deal checks out, makes a lot of sense.

No, exactly. I think a lot of those growth companies like -- kind of the hurdle target -- the growth -- the target for all these companies is breakeven, like they don't really -- they want growth, and they want breakeven, right, in terms of cash flows. So an amortizing loan is really a pain because as long as they're breakeven, they're very attractive in terms of an exit or going public or whatever, right? But the amortizing loan, like you said, is really -- pinches them in terms of cash flow. So that's great. I learned a lot about the business today and congrats again on a great quarter and look forward to more news ahead.

Ed, thanks just for your long-term support. Love having you on board. And yes, we look forward to stronger numbers and continued growth over the coming future. So thanks very much.

And given the discount to book value, about 50%, is the share buyback, is that -- that's a cash?

Yes, we continue to use -- we've had -- I think I mentioned last call, we probably bought back 16 million or 15 million or 17 million shares, kind of $8 million for the shares over the last 4 years. We'll continue to do that from our perspective, if we can buy shares here at $0.50, $0.55, $0.60 we're buying back dollars (sic) [ shares ] for $0.50. That's our strategic position on our share buyback, and we will continue to do that. We're getting excellent return on that buyback based on our IRR. It helps our shareholders. So until we get above book value, we're going to continue to be buyers of our shares. So yes.

Yes, I love that. So Okay. Great. We'll talk in the future. Again, congrats on great quarter.

Operator, I think that's it.

Yes. There are no more questions.

Great. Thank you very much for your help, operator. Thank you, everybody, for tuning in either live or on the recording and we'll speak to you again in 3 months.

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