Alaris Equity Partners Income Trust

Good day and thank you for standing by. Welcome to the Alaris Q4 2022 earnings release. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that this conference is being recorded. I would like to hand the conference over to your speaker today, Amanda Fraser, Chief Financial Officer. Please go ahead.

Thank you, Kevin. We appreciate everyone taking the time to join us this morning. We are excited to present our Q4 results. I'm joined on this call by Steve King, President and Chief Executive Officer of Alaris. After a short presentation from Steve and I, there will be a question and answer session. Before we begin, I would 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 therefore actual results could differ materially. Additional information concerning the underlying factors, assumptions, and risks is available in last night's press release and our MD&A under the headings Forward-Looking Statements and Risk Factors, copies of which are available on CDAR at cdar.com, 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 refer to last night's press release and our MD&A for more clarification regarding non-IFRS measures. Some of the Q4 highlights include Q4 revenue of $51.1 million with an increase of 36% over the prior period and exceeded previous guidance. due mainly to the receipt of 5.2 million U.S. in distributions owed by FNC upon redemption. As part of all of our investments, we have a three-year make-hold provision, and distributions up to the third anniversary are owing in the event of the transaction. Also, the catch-up payment of 3 million U.S. received in late 2022 from Planet Fitness in regards to amounts deferred during the COVID pandemic. During the year, Planet Fitness made a total of 5.4 million U.S. in cash-out payments and 4.2 million remains outstanding. For the year, revenue of 190 million was an increase of 28.7 over the prior period and driven by the redemption of Kimco and FMC during the year, each of which resulted in the collection of deferred and out-of-period distributions. Also, after the consideration of these out-of-period amounts, revenue of $165.7 million was 12.2% higher than in 2021, driven by the follow-on investments in BCC fleet and Axiant, as well as $13.1 million received in common distributions, an approximate 10% yield on our common equity portfolio, and a three-times increase over the prior year. Cash generated from operations prior to changes in working capital of $47.2 million for the quarter and $171 million for the year was an increase of 13% and 22% respectively over the prior period. During the year, Alaris generated basic earnings per unit of $2.89 and paid out $1.33 per unit in distributions, resulting in a $1.56 increase in book value. The actual payout ratio was 39%, thereby generating $93 million of excess cash flow from operations, which was used to pay down debt and for investing purposes. Earnings for both the quarter and year-end were impacted by the decrease in fair value gains as compared to the prior period, as net realized and unrealized fair value of investments was $20 million lower for the quarter and $55.2 million lower for the year. In the prior year, the portfolio was benefiting from the recovery of COVID declines and resulted in significant gains. In comparison, the portfolio in 2022 was impacted by the increasing interest rates effect on discount rates and multiples. Despite these factors, we saw an overall increase in fair value for Q4 of $4.4 million. FLEET's revenue and EBITDA have both improved as compared to the prior year, primarily due to an increase in syndication of new units. Also in Q4 2022, FLEET's backlog of syndication work for 2023 and into 2024 increased substantially with new contract wins. As a result of this growth in backlog and its impact to FLEET's outlook, coupled with the strong results during 2022, the fair value of FLEET's investment increased by $15.2 million in the quarter. As a result of the contemplated BCC transaction, as of year end, the fair value of the investment was increased by $67 million U.S. to bring the total up to the value realized in Q1. As discussed in previous quarters, GWM has not realized the growth expected at the time of our investment and a slowdown in early 2023 results has further impacted their growth expectations for the year. This shift in expectations coupled with continued discount rate increases and declining multiples have resulted in a decrease in fair value during the quarter of US$9.5 million. LMS's revenue has increased year-over-year. However, as a result of the increase in steel prices, LMS's margins have been compressed and gross profit has declined. Although LMS has worked to include steel price escalation features in new contracts, they still have to work through current lower rate contracts and on-hand higher priced steel in inventory, which is expected to occur during the first half of 2023, with the latter half of the year expected to bring improvements to gross margins. Based on the expected negative 25% reset for 2023, there was a decrease to the fair value of LMS during the quarter of $4.3 million. Based on the MERS unaudited financial results for the year, the reset in 2023 is expected to be a positive 6%. However, due to rising interest rates in late 2022 and the expected impact this will have on new loan origination demand, there was a net decrease to fair value of this investment of $7.2 million in the quarter. In FY22, redemptions during the year had a cost base of $130 million and attracted annual distributions of $17.2 million. The proceeds from these redemptions included $32 million in realized premiums for total proceeds of $162 million. This is a 25% premium over the investment cost base. Deployment in the year totaled approximately $156 million, which included initial annual contracted distributions of $19 million. As a result of this turnover in the portfolio, we generated increased book value, $0.71 per unit of realized gain, and increased our annual revenue by 10%. Subsequent to the quarter, we completed a strategic transaction involving BCC and co-sponsor Brookfield. We exchanged $145 million of our preferred equity for convertible preferred units and redeemed the remaining equity which resulted in a realized premium of $9.7 million US. The new convertible preferred units provide a minimum 8.5% yield, $12.3 million US annually on the convertible preferred paid quarterly. with the ability to participate in any common distributions in excess of 8.5%, as well as an annual $1.5 million transaction fee. As a result of the BCC redemption of $20 million US, as well as the smaller partial redemptions for Fleet and Unify received on December 30th, subsequent to the quarter we decreased our senior debt outstanding. We currently have $104 million US and an additional $10 million Canadian outstanding and have $300 million of available capacity on the facility. This is approximately a 1.4 times senior leverage ratio. Our portfolio has a weighted average ECR over 1.6 times. The only reason for the decline below 1.7 times was the revision to BCC based on the new transaction. 13 of our 18 partners continue to have an ECR over 1.5 with LMS the only partner below one, and as mentioned earlier, we expect them to be back above one in the later half of the year. Our anticipated aggregate partners resets totaled 1.2% in 2023, an increase of approximately $1.4 million, or $0.03 per unit. This estimate is reduced due to the redemption and subsequent conversion of BCC's preferred equity into convertible preferred Top of the collar resets are expected from 10 of our partners. Our current outlook calls for $47 million of revenue in Q1 and a 12-month run rate of $151 million. Our G&A expectations have increased from $17 million to $17.5 million to reflect the impact of higher FX rates on U.S. denominated expenses and continued elevated legal spending. I'll turn it over to Steve now for his further comments.

Great. Thanks, Amanda, and thanks, everybody, for calling in. The last 12 months have brought a great deal of change for Alaris, both in terms of our own business as well as the world around us. Starting with our own portfolio, we continue to operate at near record levels of portfolio health despite challenging labour, supplies and borrowing conditions that have had large negative impacts on other companies. Having a portfolio of required service companies as opposed to manufacturing and companies with little or no debt was a huge contributor to this continued strength. 2022 brought us our 14th consecutive year of positive overall portfolio resets, something I'm extremely proud of as the manager of this company. Our track record shows a remarkable level of consistency of cash flow for our shareholders over our 19 year history. The steep increase in interest rates that we've seen over the last year has been a double-edged sword for us. On the negative side, the impact that higher rates and a tighter debt market has had on the private equity and the entire capital markets industry has reduced the number of quality assets that have come to market. We've seen a recent pickup in deal flow, which we hope continues and grows throughout the year. On the positive side, our structured equity model now looks far more attractive to most companies as compared to traditional private equity that relies on high debt levels or straight debt options that are now extremely expensive compared to where we were just months ago. This will allow us to win a higher percentage of transactions that we're bidding on, and it also means that we'll see a significant decrease in redemptions compared to the norm. As a result, I'm quite confident in a strong net deployment outcome for 2023. The other very exciting change during this past year was the introduction of our first asset management initiative. I believe that the recently announced transaction with BCC, ourselves, and Brookfield is a significant complementary piece to our business. Not only did the transaction allow us to keep US $145 million deployed in a world-class company, it allowed us to increase our upside participation dramatically by not only having an increased return profile on our own investments, but also an economic interest on the full US $400 million that Brookfield put in. The partnership not only underlines the quality of our portfolio, but also the value seen by Brookfield and Alaris on our team. Creating a return on third-party capital is something that we feel will have a very positive impact on our return on equity, while also improving our net deployment outlook. Future asset management initiatives are being considered down the road, but the focus remains on deploying capital into more great companies, like the ones that allowed us to post another record year of results, like we just announced. Kevin, I'm happy to open it up to questions from the crowd.

ladies and gentlemen if you have a question or a comment at this time please press star one one on your telephone if your question has been answered you should move yourself from the queue please press star one one again one moment for our first question our first question comes from jeff kwan with rbc your light is open hi good morning um just wanted to ask on the uh the brookfield transaction if

you're able to kind of say if there's been any discussions about additional transactions that you might work together on either within the existing portfolio or stuff you might be looking at going forward. And also just in general, too, just anything you can give in terms of an update in terms of expanding that third-party capital business.

Yeah, Jeff, there's not been any material discussions on any of our other portfolio companies. I think Suffice to say that several of the groups that we went marketing to on BCC have expressed interest in other parts of our portfolio, but that's not something that's on the front burner. Every company in our portfolio has its own story in terms of management and owner needs and also where they are in their growth cycle and whatnot. So we don't see anything imminent in terms of another continuation fund like we just did with BCC. I think one thing that we still are considering is a common equity fund with third-party capital that will take advantage of our proprietary deal flow caused by doing our preferred equity business. That's probably the next thing that you'll see from us, but again, that's not anything that's going to be short-term. We're going to roll this out relatively slowly, really still focusing on growing our business, expanding our portfolio with more prep deals.

Okay. And when you talk about the deal flow being better than last year, that makes a lot of sense. But I'm just kind of curious what you see in the deal flow right now. I mean, how you would characterize what you see today versus call it like a more normalized deal environment.

Yeah, it seems, I would say, compared to 2019. I think the number of deals would be very comparable. I still think the quality of the deals is maybe a little less than what it would have been in 2019, but certainly better than what it was at this time last year, as interest rates were really starting to pick up steam and people just really left the market. So we're seeing good deal flow now. We're seeing good quality. It's certainly not at record levels, but like I said in my notes, we are competing against very, very inexpensive capital, both on the equity and debt side. And as kind of a hybrid between the two, this is a really perfect environment for us where you know, the kind of cash returns that we're looking for on our preferred shares don't have the same sticker shock that they did in 2019 for entrepreneurs. We're seeing senior interest rates, senior debt interest rates in the U.S. now in the private debt market well into the double digits. So for us, you know, targeting a 14%, 15% cash return, that's actually not that much off of what senior rates are right now. So It's going to be a real positive for us and on traditional equity offers, those multiples are having to come down because they just can't get the debt in their structures that they could even a year ago. It's been a huge change for our competitors, much less so for us. I think we're going to see a much higher win rate and we are starting to see that in reality. We hope to be pretty active here with our deployment in the short term.

Okay, and if I can just maybe ask one last question. On LMS, is that investment going to be something that will be with you over the long term, or is there a scenario that would see that investment get redeemed at some point, and what kind of scenario might that sort of look like?

Yeah, every investment has its lifecycle. LMS, I don't see an exit in the near term, and I hope we don't, to be quite honest. It's a It's a wonderful company run by wonderful people. They've gone through a very strange environment here with the steel prices having gone through what they went through over the last year. Based on the forecast that we've built out just with their work on hand, we're going to be looking at a really significant gain on LMS in the next 12 months. Probably a bigger gain than we've ever had on any reset in our history. You know, we've been with LMS for about 16 years already, and like I say, we're certainly not looking to exit. I think there's some things that we can do going forward after we get this, you know, large positive reset that we'll be able to smooth it out into the future, but we're certainly not looking to exit it.

Okay, thank you. One moment for our next question.

Our next question comes from Gary Ho, Desjardins, your line is open.

Thanks, great, and good morning. Steve, just wondering with the higher interest rate environment, you know, does that change the way you look at capital deployment, you know, industries that you might want to avoid or how you underwrite the deal? Just want to pick your brain on that.

Yeah, I mean, we are very long-term in our horizon, Gary, as you know, so You know, we try not to be flavor of the day investors. We're looking for solid cash flow streams that exist in any kind of economic and interest rate environment. And so nothing is going to change there. And it's largely why we have been, you know, untouched, if you will, from things that have happened over the last few years because of that focus that we've always had. So, you know, there's not many companies in our portfolio that are impacted by it. If something that we see in terms of a new deal has a really big dependence on low interest rates, obviously we're going to evaluate that. Again, we keep an open mind. We've kept our same investment criteria for 19 years. We've got a lot of smart people within the company looking at these companies and a lot of third party advisors that help us out. So, you know, I really don't see too much change there and, you know, it isn't really an area that has or will impact us.

Got it. Okay, that's helpful. And then my next question, maybe for Amanda, just on the ECR change six times, I think you did mention in your prepared remarks, some of it is related to BCC. Can you kind of walk me through that piece? Was the Brookfields investment considered as debt or debt-like? I'm not sure if you can parse out how much of the ECR drop was BCC-related.

So the change in their ECR is really driven by having a larger amount of now, that prep attracting the 8.5%. And I should have added to my remarks that we do expect that, you know, with the growth trajectory that BCC has, you know, we will see that tick up over the course of the year. So, you know, I don't think it's going to be too many quarters before we see that BCC EECR move back above one and a half.

Okay, but was... that the biggest contributor from the drop from 1.7 down to 1.6 was was the bcc yes yes if bcc hadn't have moved that metric would have remained above 1.7 got it okay so that drop is entirely bcc yep okay and then just uh maybe on the discount rate increase you mentioned you know have have you now marked it up to market or is there going to be more gradual increases over time? Trying to see if, you know, there could be further fair value markdowns, just looking out.

So, yeah, our discount rates are currently marked to current, the interest rates as of December. You know, Canada is holding flat, it seems now, so that should cease to be pressure on our Canadian portfolio. You know, we'll have to see what the U.S. continues to do because as they continue to change rates, that will impact further the U.S. portion of our portfolio.

Okay. Got it. Okay. Those are my questions. Thank you.

One more for our next question.

Our next question comes from Zachary Evershed with National Bank Financial. Your line is open. Thank you. Good morning, everyone.

Congrats on the quarter.

Thanks, Zach.

So we've got some good color on the deal pipeline from an earlier question. Maybe you can give us a little bit of color around the redemption outlook for 2023. It does seem to be lower, but is there anything that's headed that way?

We actually don't see anything on the horizon this year, Zach. Obviously, things can change, but just in speaking individually with each of our partners and knowing that for the companies that maybe would have been interested in selling in the normal environment, they're certainly not interested in selling in this environment. The same reason that we are seeing fewer high-quality deals is the exact same reason that our high-quality companies are not interested in doing anything in terms of selling. So, yeah, I think it will be a very light year, an unusually light year for redemptions, which obviously we're fine with, especially given how well our companies are performing.

Makes sense. Thanks. And then we noted some fixed rate hedging disclosures. Are you going to continue to hedge interest rates or let that expire?

We do have another hedge rolling on, so we've got two interest swaps that roll off in June and another one that rolls on. I think with the level of debt that we currently have outstanding, we're still pretty well covered even once that switch happens. I think it's a $50 million U.S. swap, so that would be 50% of our debt. I don't think that we would do anything near term. I think the longer view Swaps are lower. You're looking at around 3%. We might book something further out beyond when that current 2023 swap rolls off. But yeah, I don't think we would layer on anything additionally at this point.

That's helpful. Thanks. I'll turn it over. And I'm not showing any further questions at this time. I'd like to turn the call back over to Steve for any closing remarks.

Great. Thank you very much, everybody. And I will just make a brief comment on the on the rates that are used to value our fair values. And obviously, especially in an environment like this, like I just talked about where redemptions are going to be very unlikely, I don't, to be honest, pay too much attention to the decline in fair values that are based on the rates that are used by KPMG and the valuations. Pardon me, Steve.

I didn't mean to interrupt. We just thought I've had another person queue up to see me one moment to promote their line, okay?

Okay, that's fine. Our next question comes from Trevor Reynolds with Acumen Capital. Your line is open. Hey, guys.

Just on that deal pipeline, is there any related to kind of add-on deals? Are you seeing any potential there from the partners? We're actually seeing significant potential there, Trevor. And again, another offshoot from a difficult market for a lot of people. If you think about it, there's going to be more companies that find themselves in a position where they need to sell. If they need to refinance their balance sheet, for example, this is now an extremely difficult environment to do that in. So we're seeing more acquisition opportunities for our partners. We're working on several of them as we speak and could be a fairly significant part of our deployment strategy. budget for this year. Are you able to provide any more color on GWM and what's driving that, maybe just when you start to see that turning around potentially? The management team at GWM is still extremely bullish. It's one of those things that I almost find is misleading on these fair values. This is still a very good company and we're not looking at a company that's in a huge state of decline. This is just using a fairly conservative, flat outlook for them for the next year as opposed to the traditional growth curve that they had. Still a very good company. They did have some some of their end users, you know, large advertisers that cut back their budget, you know, trying to be conservative, leading into potentially a recession in the US. So that was fairly standard throughout the advertising industry throughout the US. So they kind of just went along with the industry. We do expect them to get back on that growth trajectory and They've got several initiatives that they're extremely excited about. So I think still a very good holding for us. Great. Thanks for taking that question. Yeah, no problem.

And I'm not showing any other questions at this time.

Okay. So just to finish my comment, and GWM is a good segue into that, you know, being a public company in the private equity space, having to, fair value, these types of assets on a quarterly basis is not overly relevant. We're happy to do it and we keep on showing growth in that number. But, you know, with discount rates rising, it makes a really material impact on valuations. So, you know, it's not something that I get too fussed about. I am, you know, very much still a cash flow based investor at Alaris and, you know, To have a 39% payout ratio and the kind of coverage ratios that we have in all of our investments leaves us in a really tremendous place to grow and to keep on deploying capital. So happy to chat with anybody offline if you have any more questions. But in the meantime, thank you very much for tuning in. We'll talk to you next quarter.

Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day.