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Flow Capital Corp.
5/31/2022
Good morning, ladies and gentlemen, and welcome to the Flow Capital's Q1 2022 earnings conference call. At this time, all lines are list and only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Tuesday, May 31st, 2022. I would now like to turn the conference over to Mr. Alex Belluta. Please go ahead, sir.
Thank you, operator. Good morning and thank you everybody for participating in this call. After the close of markets yesterday, we released our financial results for the quarter ended March 31st, 2022. Details can be found on our website or a website, by the way, at flowcap.com or on CDAR. We had an excellent quarter, continuing the progress we made last year. Book value grew by over 10% in the quarter. to 82 cents a share. That's on top of the 30, almost 34% increase that we saw in all of 2021. IFRS reported revenue was up to 3.9 million of 55% year over year. And net income, IFRS reported net income was 2.35 million of 79% year over year. Note that I say this on every conference call, IFRS numbers can be volatile. due to the unpredictable timing of buyouts and or unrealized fair market value changes and FX adjustments. Given that, what we really focus on is simple recurring revenue from ongoing operations, i.e. interest and royalty income. And that's a much more informative metric for us to track. Recurring revenue from royalties and interest income grew by 10% to approximately $1.77 million. I'm not going to go through the full financial statements on this call, but I want to focus again on a few of the highlights. If you'd like more details, I urge you to download our financial statements from the website or from CDR. And we're always open for questions if you have any questions after reviewing those statements. In terms of highlights, if you've been following Flow for any length of time, you'll know that 2021 represented a significant transition year for Flow, basically the culmination of three years' worth of more than three years with the transition efforts. During that year, last year, we experienced a very rapid transition in our business away from royalties, which was our legacy investment structure going back almost four years now, and firmly into venture debt. We define venture debt or growth debt as much lower risk, higher quality, senior secured debt investments into high growth companies. And primarily that's used into sectors of service or other technology companies. Well over 50% of our portfolio is skewed to technology. And this is in contrast to sort of the 2014 to 2018 time period where unsecured perpetual royalties were the primary focus of the company. This transition to higher quality investments with equity upside, I should add, has been part of our strategy, as I said, for the last four years now. And Q1, that $1.77 million of recurring revenue, sort of highlights an interesting transition. Last year, loan interest represented only, last year in Q1, that is, represented about 22% of our recurring revenue, while royalties represented about 7, 8% of our recurring revenue. If you recall, last year, we had five major buyouts of our very strong remaining royalty portfolio. And interestingly, this year, the percentages are reversed. Loans represented loan interest income revenue represented 78% of the revenue in the quarter, and royalties were down to 22%. And looking forward, you'll gradually see royalty revenue essentially fade away. We rarely issue a royalty term sheet these days as we focus on much higher quality investments, and the investee companies tend to self-select away from royalties and into loan structures. So it's not that we don't offer royalties, it's just that it's rare that the type of companies that we invest into those um, seek a royalty three book value. Um, it's pretty evident. We had a pretty phenomenal quarter in terms of the growth in book value of 10% in the quarter, uh, to 82 cents. That's up from 75 cents, um, in December. Um, the numbers are, they're, they're pretty striking. I'm actually, we're pretty excited about the performance over the last several years, uh, They were up almost 38% last year on a year-over-year basis. And if you look back to mid-2019, our book value is up over 85%. I don't know anybody else in our sector who's had that kind of performance in terms of book value growth. Growth in book value this quarter is driven primarily, although not exclusively, by the exit in Performio. There were no other material changes in our portfolio. I should add. I want to highlight Performio for a minute. It's a fantastic company, and it was a fantastic deal for us. And it actually is a perfect illustration of our ongoing strategy and what you really should come to expect from us over time. Performio is an investment that we closed last year. The exit was an early buyout, and they received a major equity infusion from a top-tier venture capitalists. They used that capital to buy. So that investment also triggered what we call a buyout on exit success fee. So as I mentioned, we run our business on recurring revenue. So on a day-to-day, month-to-month, year-to-year basis, our primary focus is on ensuring we have strong recurring cash-based interest and royalties. But in all of our loans, we take a small outside participation rate or a bonus, and it's either in the form of warrants or what we call a success on exit bonus, that's generally a non-dilutive small percentage of equity that is triggered on a change of control. Those success bonus on exits are generally smaller than warrants in terms of the representation, the size of the company that they present for us. So our warrant positions will average 1% to 4% of the equity of the company we invest in. Success on exit will be a little bit smaller. Over time... you know, we'll have a large portfolio of these bonus positions that are essentially tied to equity upside in our invested companies. As we reach forward to $100 million in assets, we expect that we'll have somewhere in the range of 25 to 30 positions. Right now, we're approaching almost 20 positions in terms of warrants, bonus on equity, or common equity positions. And these bonus, equity-related bonus positions represent not only the anti-protection for us, but as you saw in this quarter, a material upside to our book value over time. Now, as that portfolio of bonus positions grows, you'll see the cadence become a little bit more regular, but to be clear, it's very hard to forecast when, you know, usually these, if our average loan duration is in the range of 30 months, and every time we redeploy capital, we earn more warrants. We don't know the timing of those exits, Um, generally they will outlive the warrant positions, uh, if our, our at least two times the duration of our investment positions. Um, and so it's hard to forecast, but as we grow that portfolio, we will over time expect to see a more regular cadence of exits, um, uh, and, and upside. And as I said, these are a meaningful contributor, both to our downside protection, but also to our upside in terms of new deployments. Um, We deployed only a modest $500,000 in the quarter. It's a little disappointing, but the pipeline activity remained very strong. Shortly after the end of the quarter, we did close a third tranche into EchoBox. It's now our largest investment. It's one of our longest-term investments now. Another excellent company. And again, it's part of our strategy that as we continue to invest in strong, performing companies, we like to stay invested in those companies for as long as we can. EchoBox is an example of Their MRR to software and service company, their MRR is up well over 200% since we first invested our first $1 million tranche in that company several years ago. At the end of the quarter, the portfolio in aggregate was 41.9 million up from 29.8 million a year ago. We have 16 active investments, 13, one bonus on exit positions and four common equity positions right now in terms of the pipeline. We continue to see good progress in our pipeline as our referral network continues to grow and our internal efforts keep generating good deal flow. We're very encouraged about the future right now, though, for a different reason, which is that the recent volatility that you're seeing in public markets, two things have happened. One, technology valuations have come down, in some instances collapsed. More importantly, though, so public equity markets are closed. The VCs, venture capitalists are also closed. And we tend to piggyback over 50% of our portfolio is in venture-sponsored, venture-invested companies. What VCs, there's lots of news stories out there. What VCs are saying to their investing companies is, we're not funding anymore. You need to get the cash flow break even on the existing cash that you have. Some companies will make that, some won't. But what we feel is this is going to represent an excellent opportunity for us to see companies that we might not otherwise have seen as they would have used equity to fund themselves. Now, we still have to make good investments, and we still have to focus on due diligence, but we're excited about the increase in opportunities that we expect that we're going to see over the next three quarters for the rest of the year. From an available cash perspective, we have over $4 million on our balance sheet available to invest, and we expect that's going to grow as we continue to work on strategic initiatives to increase access to capital. In terms of recurring cash flow, again, it's a non-IFRS metric that we use to manage our business. It's defined as simply recurring revenue, less OPEX, less interest expense. It's just a cash OPEX generally. Free cash flow in the quarter was over $630,000. That is the highest that it's been in at least the last four years. It's been now positive for the past eight quarters in a row. Very proud of that number. We continue to to focus on generating not only revenue growth and a strong portfolio with equity upside, but strong free cash flow and positive EBITDA. So with that, I'll pause and just summarize that we continue to see good dealer origination and improving pipeline metrics. You know, we have spent several years reducing our costs and streamlining our operations together to start growing our free cash flow. We're seeing improvements a strong and reasonable performance in our portfolio. We expect to see more performio-like exits over time as our equity-related bonus positions grow. And we look forward to the rest of the year. With that, I'll pause and hand it back to the operator for questions.
Thank you, sir. Ladies and gentlemen, we will now conduct the question and answer session. If you'd like to ask a question, press start on the number one on your telephone keypad. If you'd like to withdraw your question, press start to If you're using a speakerphone, please lift your hands up before pressing any keys. One moment, please, for your first question. Your first question comes from Ed Solba with Spartan. Please go ahead.
Good morning, Alex. Congrats on another great quarter.
Thank you.
So when you think about redeploying capital, it seems... one of the best opportunities for flow is your own shares, which are almost at half the book value, and that book value has grown so nicely over the last year. So how do you and the board feel about share buybacks and what's the position?
Ed, thank you very much for that. I love that question. It's a bit of softball. We, as you know, love buying dollar bills for 50 cents. or $0.60, which is what we're effectively doing when we buy back on our shares, and in particular because we're very confident in our strategy and it's proving to be working. We have, in aggregate, over the last couple of years, reduced our share count from about $44-ish million down to about $31 million. That's a meaningful reduction in the share count. We haven't bought as much back in the last couple of quarters as we have in the past, So that's simply a function of preferring to deploy capital into new investments, and then we had some restrictions. But we intend to have our normal course history a bit open and buying shares as we can. You know, I want to set expectations. It might not be as dramatic a reduction as you've seen in the past, but Yeah, we're strong believers in our own equity and have and will continue to buy shares back in the future.
Well, that's great. It's nice to have management, the company aligned and also because of the liquidity, it's nice to have a bidder in there sometimes, I think. The other question I had is, and I didn't realize that it had been such a dramatic reduction in the share count, which is... Totally the opposite of most TSX companies who are always diluting, diluting, diluting. So it seems to me that you're doing a lot of second and third tranches with companies that you're really familiar with and like. Is that a valid observation?
It is. It's actually part of the strategy. So what happens when we do a follow-on tranche is we generally – Okay, take a step back. We invest, if we invest a million dollars, we expect that million dollars to be invested for an average term of about 30 months, might be as low as 24, might be as high as 36, but call it on average of 30. And then we earn, as I discussed in the call, warrants or just call it warrants along with that. So if we recycle, every time we get paid back, we recycle that money, we earn more warrants. So every 30 months or so for every dollar we invest, we should be earning some warrants. If one of our investing companies needs more money and they're performing strongly, as is usually when we make a follow-on investment, we're happy to reinvest in that company, increase our investment. But what we do is we earn more warrants when we make that reinvestment. So from our perspective, we view it as a new deployment of capital. So a couple of things happen.
Because you're paid back from the original tranche.
Yeah. And we just, our strategies turn warrants every time we invest on a certain time scale. So therefore we ask for warrants. But what we get is it's a high quality company where we've got a multiple year track record to see how they report and how they perform, where we feel strongly that as an example, you know, companies are up in their, in their revenue, sometimes hundreds of percent. It's about, and generally our rates or terms don't change. So it's a perfect scenario for making lower risk investments in companies that we're very, very familiar with. So we'd love to do that. We try to manage exposure risk and concentration risk, but I do expect that over time, I hope actually over time in our best companies, we get to see multiple opportunities to invest. Having said that, we do need to continue to build our portfolio with new investments. And as a last year, I don't have the exact number yet for this quarter, but last year we saw just under a thousand new opportunities and closed on, uh, less than 1% of them. Um, which sounds like a low close rate. Uh, but as our, our objective with the team that we have in place is to increase the number of deals that we see, uh, but keep the close rate relatively modest, implying that we're investing in the best deals that we can find. So we continue to focus on finding new deals. That is always a challenge in this business. But, you know, I think it's kind of like you as an equity investor. Once you've got that great company, you try to stay with it for as long as you can.
Oh, exactly. You want to stay with people you're – you know, really people that have a track record of delivering, right? Because so many people don't, so.
Right.
Okay. And just I think a new topic is – is in terms of concentration exposure risk, what, what kind of parameters does, does flow have in terms of, uh, those kinds of, the one that's most meaningful for us.
Yeah. The one that's most meaningful for us is kind of an LTV ratio loan to value. Um, and we look at loan to value to what is the equity value in a company. that is effectively subordinated to us as we're the senior lender on the balance sheet in most instances. And so we won't, on average, our loan-to-value, so if you think of a company that, I don't want to use specific examples, but let's say a company has $120 million market cap. It's a private company. It's got an equity value of $20 million. We won't go higher than $4 million in terms of the amount of debt relative to the equity value. And even then, the average across our entire portfolio is in the single digits. Probably 8%, 9% of our loan represents, let's say, 8% or 9% of the total equity value in the company. Now, that will change. Those are private equity valuations. If we have a public investment, a public company, that's subject to volatility of a small-cap company, let's say, on public markets. But in general, from a loan-to-value perspective, we're in the single-digit perspective from a risk of any individual investment relative to that company's equity value. From a diversification perspective ourselves, we have some concentration risk, but we make those investments. The largest deals we have tend to be the companies that we know the best. And as we grow our portfolio, and I mentioned to you and on this call before, we're trying to get to over 100 million assets and then over 250, the concentration risk will naturally decline over time.
All right. but, but right now, if you, if you think of the largest investment on what, what does that represent in terms of roughly 16, 17%.
Okay.
So it's, it's, so it's, um, you know, it's, I guess, I guess it's kind of like you're, you're, it's, it's because the company's done well, right. That it's grown to that size. So it's kind of like when you buy, it's kind of like when you buy Microsoft and it grows to 20, 20% of your portfolio, That's actually a good thing.
The largest company in our portfolio today is a company that we've got three tranches in, and therefore it is large. Most new investments are not that large.
Okay. But I guess to your first point, these companies aren't very levered, right, because they have pretty little debt on their balance sheet, so that makes it safer too.
Yeah, and that's, again, where we play is between venture capital or piggybacking on venture capital and between bank debts. So it's in a market where these are high-growth, low-asset companies, generally speaking. We don't do real estate. We don't do asset-backed loans. And we're the senior secure lender on the balance sheet where they want to extend an equity round and not suffer the dilution or loss of control through an equity investment. And banks just aren't interested. And so that's the space that we play in.
Okay, well, thanks for the update, and congrats on another great quarter.
Thanks, Ed. Thanks for your support over time.
Thank you. Ladies and gentlemen, as a reminder, if you have any questions, please press star 1. If there are no further questions at this time, Mr. Belluta, you may proceed.
Great. Thank you very much, everybody. We appreciate your support and look forward to speaking to you in about three months' time with our Q2 numbers. That's it, operators. Thank you.
Ladies and gentlemen, this concludes your conference call for today. We thank your participating and ask that you please disconnect your lines. Have a great day.