Alaris Royalty Corp. (OTC:ALARF) Q4 2019 Results Conference Call March 6, 2020 11:00 AM ET
Curtis Krawetz - VP, Investments and IR
Darren Driscoll - CFO
Steve King - President and CEO
Conference Call Participants
Gary Ho - Desjardins Capital Markets
Jaeme Gloyn - National Bank Financial
Good morning. My name is Sylvie, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Alaris Royalty Corp. Q4 2019 Earnings Conference Call. [Operator Instructions]
And I would like to turn the conference over to Curtis Krawetz, VP, Investments and Investor Relations. Please go ahead.
Thank you, Sylvie. Good morning, ladies and gentlemen, and welcome to Alaris Royalty Corp.’s conference call and Webcast to discuss the financial results for the three and 12 months ended December 31, 2019, as well as a brief corporate update. I’m Curtis Krawetz, Vice President of Investments and Investor Relations, and I’m joined on this call today by Steve King, President and Chief Executive Officer of Alaris; as well as Darren Driscoll, Chief Financial Officer.
After a short presentation from Steve and Darren, there will be a question-and-answer session. The lines will be placed on mute until then to avoid background noise.
Before I begin, I’d like to remind our listeners that all amounts given are in Canadian dollars, unless otherwise noted. Listeners are cautioned that comments made today may contain forward-looking information. This forward-looking information is based upon a number of important factors and assumptions. And as a result, actual results could differ materially. Additional information concerning the underlying factors, assumptions and risks are available in yesterday's press release and MD&A for the period under the headings forward-looking statements and risk factors, copies of which are available on SEDAR as well as our website.
Non-IFRS data is also presented and may differ from the way other companies present such data. As with the forward-looking statements, please also refer to last night's press release and the MD&A for the period for more clarification.
I’ll now pass the call over to Darren Driscoll.
I think, I’ll start out of the gate, addressing Sandbox and the financial impact last Friday on February 28th, with the conclusion of sale of a disappointing investment in Sandbox where we recovered all the senior debt, including interest owing but recovered only US$9.2 million on the US$40 million of preferred shares in the business. US$4.1 million of those proceeds are being held in escrow for working capital adjustments and indemnity obligations and additional $2 million maybe available through an earnout. But for our financial statements, we have only recorded what we received, and we booked further proceeds from escrow or earnout as they come in.
So, on $40 million of prefs invested, we collected $18 million in distributions over time and that plus US$9.2 million in consideration for total return between minus 28% and 42%, depending on future collections. That's an IRR of between minus 9 and minus 16 over the four-year investment period. So, the end result of US$35 million loss on those preferred shares all was recorded in Q4 as we -- December 31st was our fair value recording date and it made sense with the February 20th close to use that as an anchor.
The only revenue we'll show in Q1 2020 for Sandbox is the interest on the secure data, which will be immaterial amount as no distribution income was recorded after December 31, 2019.
Of lesser concern to most, but a change in our financial statement presentation, once we used our step-in rights late in 2019, the accounting treatment changed drastically for Alaris. You'll see assets and liabilities held for sale on both sides of our balance sheet and which are the assets and liabilities of Sandbox at December 31, 2019, the net and which is what we received last week. Further details describing accounting treatments are provided in a scintillating new note 11. Steve will address Sandbox in his comments.
Another subsequent event on January 7th, the successful redemption of SBI at $9.3 million premium to cost as well as additional $7 million of make whole distribution to the third anniversary of the deal. Those revenues will show up in Q1 2020.
On US$85 million invested a 50% total return and a 22% IRR and resulted in a significant pay down on our debt facility.
As far as our 2019 results go, another year of record deployment of $193 million. Two new partners in Amur and Stride and following continued contributions to Planet Fitness, a significant one, Unify Accscient and others.
Second straight record year for revenue at $116 million, that's $3.17 a share, about 16% increase from a prior year. Q4 revenue was $30.9 million that's up from $25.3 million in the Q4 of ‘18 and $30 million in just the most recent quarter Q3.
As far as partner updates, pleased to be showing some very positive news across the portfolio. LMS has completed sensational year and since distribution from LMS has no collar, it does move the needle there, up over 30% year-over-year. We have used 30% on our fair value and run rate estimates and we'll confirm the final reset upon completion of the audit. SCR continues to steadily improve and the monthly distribution was just recently increased from 250 a month to 350 a month, effective January 1, 2020, incremental of $1.2 million over recently, but it started 2018 $2.5 million behind where it is today.
Top of the collar, resets are expected from GWM, Heritage, Fleet, Planet Fitness, and also DNT after a big fourth quarter for DNT. BCC continues to impress with an estimated 5 -- plus 5% reset, and an ECR that continues to improve faster than we had expected that’s approaching 1.5 times. Federal Resources had its first negative reset after three straight plus 6% increases. So, that one comes along improving EBITDA, which translates into a nice jump in the ECR and making that an even better piece of paper overall.
Amur performing as expected and paid its second straight common dividend in Q4 and annualized after tax yield of 7% on those Amur common shares, and we do expect those quarterly dividends to continue in 2020. We announced a temporary suspension of ccComm distribution starting in February 2020, due to a required investment in working capital. We are managing the ccComm distribution month-to-month, but have removed the full distribution from the estimated payout ratio, and will report back once more distributions are started. But the conclusion of the Sprint T- Mobile team will merger will be a much welcome catalyst for the business.
Overall, expected net positive resets of $3.7 million or $0.10 a share and a weighted average increase of just under 5% on the performance metrics. That doesn't include that extra $1.2 million annually coming from SCR. So, the new C$4.8 million in revenues from the reset and SCR, a much larger impact than even a full year of ccComm distributions of around C$3 million.
On the fair value front, aside from the Sandbox loss, there was a small decrease of less than half or 1% to the overall fair value of our investments. Performance related increases to LMS, Heritage, Fleet BCC and GWM totaling just under $12, million and performance related decreases to Kimco, ccComm and SML and Accscient, totaling just under $15 million, all of that recorded in the fourth quarter.
Transaction diligence costs for the year were $2.8 million, compared to $4 million in 2018, which is a bit surprising given the record deployments, but a big portion of that deployment in 2019 was with current partners, Planet Fitness, Unify and Accscient which requires considerably less external financial and legal resources. Our total cash G&A expenses were $10.7 million in the year, down 12% from $12.1 million in the prior year. Each of the three lines, salary and benefits, legal and accounting, corporate and office were down slightly year-over-year.
Bank covenants are all very good standing and currently about $250 million to deploy in our balance sheet. And so, the outlook for 2020, Q1, we’re actually going to have revenue of $34.8 million, $25.5 million is our run rate, plus C$9.3 million of make-whole revenue received from SBI in early January. Our current annualized revenue without that extra SBI revenue, this is just going forward from here, is $102 million. And with expected G&A of $11 million, that's over $90 million of EBITDA and a very manageable current run rate payout ratio in the low-90s.
I’ll pass it over to Steve before going to questions, Q&A.
Obviously, aside from Sandbox, very, very pleased with our 2019 record deployment revenue and normalized EBITDA as Darren mentioned. But, our fourth quarter reflects a very dynamic nature of our business and the swings that can occur when you're dealing with private companies.
What I thought would be useful today is for shareholders to learn about what our process is, what we go through in terms of our due diligence and review process of investments, and the chain of events as it related to Sandbox.
So, we review roughly 500 investment opportunities every year of which we typically choose between 2 and 5. Each new investment starts with preliminary due diligence performed by our team of in-house and at Alaris. And out of our 15 employees, 11 of them are either CPAs, CFAs or lawyers, with -- all with extensive transaction experience. Once that early due diligence is complete and we're satisfied with what we found and have an agreement with the company and on the investment terms, we undergo a formal due diligence process that not only includes our own professionals, but the expertise of third-party that work for Alaris. Ernst & Young on the financial side, two law firms on the legal due diligence, and HR firms that look into the people side of the businesses. Over the course of two to three months, the final report is compiled based on the findings of all these groups and presented to our Board of Directors and our banking syndicate for final approvals.
Post closing, our monitoring team is in regular contact with our partners, and receives details financial statements on a monthly basis and audited financials on an annual basis. All of this information is uploaded in real time to our web portal that every Alaris employee has access to on any device. On Sandbox and other situations, our monitoring staff became aware of problematic situations quickly, and in fact, much quicker than the banks involved in those files. And doing this for 16 years now, we feel that we've adopted best practices from the private equity industry. And more importantly, we feel that our diligence and monitoring practices have led directly to our above market returns over a very large sample size.
Over the 16 years, we've made a compound annual internal rate of return of 17%, which is outstanding in this incredibly competitive investment environment. This number was 17% at this time last year, and it's 17% now, even after giving the impact of Sandbox, because of the gains we've had on other investments, including SBI in January. That is the nature of our business.
As it relates to Sandbox, specifically our monitoring worked well and as well as it could have. That's why we're able to act quickly to use our rights and remedies to effect change. A top advisor was hired by the Company to conduct the process. The market for potential buyers is surveyed for interested parties and multiple bids were received. When we last updated our shareholders, we had every indication that the process would result in Alaris getting full value, but from that point until closing, the deal was repriced numerous times based on numerous factors. The number of stakeholders and claims outstanding and a very recent decline in the business were contributing factors in the final pricing, which is far less than what the original bits were.
We very much considered walking away from this transaction and staying in the investment, but it was deemed by our management team and Board that this company would have required a significant amount of capital to improve the situation to a point where we could have received a material amount more on a sale, and putting more money at risk in the challenged situation, which is not as attractive to us as redeploying that capital into new partnerships.
If our remaining amounts are paid out over the next two years, it will result in a 9% loss on our investment on an IRR basis. Not a good result, but in the scheme of our overall results from investments, it's also not a result that changes our track record quite a bit.
Moving forward, we have a group of partners that are operating at a very high level. We’ll be receiving, as Darren mentioned, $0.10 a share on new distributions from our partners, based on '19 results. And we have at this stage a very strong likelihood of again breaking our annual deployment records for 2020, based on the pipeline of opportunities that we have visibility on and that are in process right now.
Obviously, the coronavirus has weighed heavily on the markets and on our stock, and something we're taking extremely seriously. Looking at our portfolio and possible effects that a growing pandemic could have on our partners, there certainly are businesses that it will impact, if it spirals out of control. But I also think that our portfolio is extremely well set up in this kind of scenario.
Our partners have a weighted earnings coverage ratio of 1.6, meaning that there's a 60% cash flow cushion before they would not be making enough money to their distributions. And also many of our partners have no debt. So, they're well suited for prospering in difficult times.
So, thanks very much for your time today. I'll now open it up to questions. But please keep in mind that due to the dispute that we've launched against the founders of Sandbox, we will not be able to go into greater detail on the circumstances of that situation at this time. So, Sylvie, we will open it up to questions, please.
Thank you, Mr. King. [Operator Instructions] And your first question will be from Gary Ho at Desjardins Capital Markets.
Let me just start off with Sandbox, it’s quite topical. I know you're limited in what you can say, given the legal actions. But, can you -- maybe can you comment on whether you had similar situation with other companies, portfolio companies in the past where you're trying to solve it and maybe go back to the co-founders or with the owners of the business? And how that paid out. Is it similar to kind of SM a few years back or is it completely different?
I think, there's some similarities there. But, every case is very different. One of the things that made this situation quite a bit better than SM was our new ability to take over the debt and act faster than what we're able to do in SM’s case, which I think had a direct correlations are getting more value here than we did with SM, but very different fact set here.
Okay. And were there other examples that you can point to other than SM?
No. I think, those would be kind of the only two that would be similar.
Okay. And then, switching gear obviously, as you commented, the coronavirus, top of mind for investors, and your portfolio companies operated across a span of sectors. I guess, have you gone to your partners and assessed what the potential impact would be and maybe stress that ECR or other metrics on their ability to pay distribution if this situation worsens from here?
Yes, we have and will continue to. It was contributing factor in ccComm, they're having a tough time getting inventory, right now, in terms of handsets and tablets to sell out their stores. So, that was certainly a factor in deciding to not take a dividend from them for -- in the near future here as well as the Sprint T-Mobile, merger kind of letting the dust settle on the impacts of that as well. But other than that, I actually think most of our portfolio companies are in good shape.
I don't think too many of them are dependent on travel or anything like that. Talking to some of our consulting companies, like Unify,, some of their -- because they're based in Seattle, which is a bit of a hot spot, most of their consultants are working from home now. So, still generating revenue, even though they're -- they have changed their business practices. So, we don't see a lot at this point. So, we're speaking with Planet Fitness in a couple of hours. I know they're probably going to be doing some things that will help with current situation. But, obviously, it's kind of ever-evolving on -- it seems like on an hourly basis. So, we're certainly monitoring closely.
And maybe a take at the other angle, maybe on the positive side, are you seeing businesses that might benefit from this -- things that come to mind are maybe Kimco or maybe Federal Resources?
Yes. Kimco makes sense. People are going to want to really clean office but we haven't seen that. I don't think that one will be affected. Providence I think is the one that has seen a recent uptick -- where they have some South American manufacturing facilities and they have had many inbound calls because their competitors with their Asian facilities aren't able to deliver. So, a small benefit, but that's probably the only bright side of what's going on with that right now.
Yes. Federal Resources is I think is a good point there too. They provide all different kinds of products and training for first responders. So, whether that's EMS municipally, or war fighters, internationally. So, these are the types of things that they do supply, whether there's masks or anything else that can help, first responders and in a situation like this, it will certainly help Federal Resources as well.
And then, just maybe last question on capital deployment. The market conditions are quite volatile. Can you provide some color kind of behind the scenes on the activity level? Has it slowed recently, has valuation come off? Any comments on that would be helpful.
Yes. It's too early to say on that, Gary. So, a process -- processes that we've already won, we're working towards I would say one thing on this whole situation that it's nice to be in a situation to have balance sheet as strong as ours is right now with access to as much capital as we have. So, having the SBI and Sandbox sales go through already is a great thing. Those deals may have been in jeopardy, if they were delayed any further, we're seeing some transactions getting delayed or cancelled because of nervous banks. And so, we're pretty happy to have as much dry power as we have on our balance sheet, that's for sure.
[Operator Instructions] And your next question will be from Jaeme Gloyn of National Bank Financial.
I just want to go back to the Sandbox, or can you describe some of the declines and performance in revenue, anything specific around clients or products or anything on that front?
Yes. Unfortunately we can’t, Jaeme. We've been told by our lawyers not to get into any of those kind of details, unfortunately. I apologize.
Okay. I wasn't sure if that maybe related just to the management team at Sandbox and not the actual underlying performance. Okay. Shifting to SCR. If I look at the disclosures in the MD&A, kind of sounds like -- the likelihood of further upside on the SCR distributions or payments seems a little bit limited, given that statement around revenue increases is requiring to invest a portion of that free cash flow and net working capital. So, can you just sort of describe what's going on there that might prevent further upside or other puts and takes?
I mean, if the business continues on its current trend, we absolutely expect further growth. We have been extremely conservative with SCR, they've been tremendous partners to work with. We have left behind a lot of cash in the business to allow for working capital, as they continue to grow. So, that is not a significant concern. Again, we've bumped it from 250 to 350. I think the top end is around 5 and we're working towards that. So, I expect future increases in SCR.
Yes. Base based on their last monthly report that we got there on a great track right now.
Okay. And the normalized run rate distributions at SCR, I think you just said, it was 500K monthly or I guess 6 million on an annual basis. Is that where it tops out and then you get back into the collar, or is that how I should understand the distribution mechanics work?
Yes. Generally, yes.
Okay, good. As it relates to ccComm, can you just walk me through in a little bit more detail how the Sprint, T-Mobile merger is impacting the networking capital there? And other than, I guess coronavirus impacts on supply of handsets and tablets, what other factors are driving the reduced performance?
The Sprint volumes are down 25% across their system over the last year. So, that's the number one factor. I think, Sprint working on that merger with T-Mobile has been a big disruption to their entire system. So, I would say, as one of their larger dealers, ccComm was not immune to that. So, then, you add in the inventory issues with coronavirus and now with the merger seemingly going ahead, there's just some uncertainty there. There's going to need to be some doors closed as they kind of integrate the 2 different dealer networks. And so, no one's quite sure how that's going to work out.
The T-Mobile economics for dealers is significantly better than what it's been for Sprint. So, there's some upside there. But first, we need to get through the uncertainty. So, we'll kind of suspend this -- their dividend to us temporarily and then hopefully restart it, once the dust is settled.
And Jaeme, specifically the working, the T-Mobile structure is more of a consignment model. So, the net working capital isn’t required. So, today, they have to buy their own inventory and have that working capital. So, it is a significant difference. So, getting that done will be -- as we mentioned a significant catalyst for ccComm.
Okay. And then, by the sounds of it, if that merger goes through, no reason to think we can't -- we wouldn't expect ccComm to restart the distributions almost immediately or are there other factors that play that would prevent that?
Yes. It would take a couple of months to work that working capital change through. But certainly, our expectation is among all of us others, issues obviously need to be resolved. But, the Company is still making money and we would expect distribution to restart. And important to note there, no debt in that Company. And ownership management team that is all in with us there, but their own personal capital into this business very recently, and couldn't be happier with their partnership.
Moving to Providence, just a clarification question here around the fair value calculation. In the disclosures there, it was mentioning that forbearance agreement extended till March 2021 and the assumption in the fair value calculation includes distributions beyond that point. Are those distributions at the current level or at the normal level? What is baked into the assumptions?
We bake in a gradual increase from the current level over time. So, not an immediate restart but just a gradual increase.
And a gradual increase back to the previous, I guess, what, $4.6 million U.S. distribution? Is that right?
Okay. Last one for me then is just around the U.S. tax reforms, could have a significant impact on 2019 if it's for retroactive. Can you talk about what the reforms could mean for 2020? And how that could impact tax and how that affects potentially your view of dividend increases and payout ratio?
Yes. We are actively working on a workaround, should they come back and not be favorable towards us. So, for prior years, if it goes retroactive, that's an amount we just have to borrow for a small -- with a 0.1% or 0.2% to our payout ratio going forward. Again, it would be a -- I guess our tax profile would be similar to 2020. But, we are hoping by the end of 2022, to have reduced -- or to have basically found a new plan going forward, which would leave us in the same place we are today.
Are you able to elaborate a little bit more on what those plans are?
Not at this point, but it will -- the plan we have in the works is -- again, will leave us in a very similar place, shareholders, business all the way through.
And at this time, Mr. King, we have no further questions. Please proceed.
Great. Thank you, Sylvie. And thanks, everybody,, for attending today. And I'm actually -- believe it or not, regardless of the stock market, I'm actually extremely excited about 2020. We've got a manageable payout ratio today with a huge amount of cash to spend. And so, every deal that you see in the future from us will reduce our payout ratio and into that -- at least into our target range if not better. So, looking forward to exciting year. Our deal flow is as good as it’s been and deals are in process. So, thank you again. And please feel free to reach out to us directly if you have any more questions. Thank you.
Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.