Flow Capital Corp.

Good morning, ladies and gentlemen, and welcome to the Flow Capital's Q2 2022 earnings call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you need assistance, please press star zero for the operator. This call is being recorded on Wednesday, August 17, 2022. I would now like to turn the conference over to Mr. Alex Belluta. Please go ahead.

Thank you, Joanne. Good morning, everybody, and thank you for participating in today's call. I'm joined by Gaurav Singh, our Chief Financial Officer. After the close of market yesterday, we released our financial results for the second quarter, ended June 30th. Details can be found on our website or as filed on CDAR. We had another excellent quarter, continuing the progress that we made last year and, in fact, over the last three years. By almost all measures, we had a record quarter. Here are some of the financial highlights. Recurring revenue, just under $2.1 million in the quarter, was the highest quarterly revenue from investments over the past four years, and it was up over 23% year over year. Adjusted recurring cash flow of nearly $1 million in the quarter, $1.6 million year to date, and $2.1 million over the past four quarters marks a record in free cash flow generation for us. Total assets just crossed 50 million at $51 million, and that's compared to $44 million at the end of the year of 2021, another record. Cash on the balance sheet currently stands at $8.8 million, and that compares to $4.1 million at the end of 2021. And importantly, book value per share is up to $0.91 per share. That's up 22.4% year-to-date. And that's on top of the 33.7% increase that we saw in 2021. Please note that the numbers I just quoted are our adjusted numbers, which really focus on recurring revenue and operations related to recurring revenue. IFRS numbers, which as we file our financial statements, can be volatile due to the unpredictable timing of buyouts and unrealized fair value changes and FX adjustments. Given that, Our perspective as management is that recurring revenue is a much more informative metric to track. I will not be going through the financial statements in detail on this call, but I'm going to focus on the business highlights. If you'd like more details, I strongly urge you to download our financial statements, either from our website or from CDAR. And if you have any questions, feel free to call. If you've been following the flow for any length of time, you'll know that in 2021, it was a transition year for us. on the back of several years of preparation as we changed our focus. During 21, we experienced a very rapid transition in our business away from royalties, which is our legacy business investment structure, and firmly into venture debt. And we defined venture debt, or more appropriately, growth debt, as much lower risk, higher quality, senior, secured debt investments into high-growth companies primarily into SaaS software technology companies that represents well over 50% of our portfolio. And this is in contrast to the unsecured perpetual royalties or quasi equity that the company focused on from 2014 to 2018. This transition to higher quality investments with equity participation upside has been our strategy for well over three years now. In the quarter, As I mentioned, we reported $2.1 million of recurring revenues from royalties and interest income. Now, I only say royalties because that's the legacy stub of our business. The vast majority of our revenue now is from loans and interest income. For example, last year at this time in Q2, loan interest represented 36% of our recurring revenue, while royalties were 64% of our recurring revenue. This year, recurring revenue from loans was 83% of our total recurring revenue, while royalties represented just 17%. So, in fact, we really have only one significant royalty remaining, and we expect that by this time next year, our royalty revenues will likely be below 10% of our overall recurring revenues. To be clear, we offer royalties when we speak to clients, potential investing partners, if they need it, if it's the right fit. I mean, we do pride ourselves on providing a financing, minimally dilutive financing solution to our partners that fits their needs. But most times when we issue term sheets, it's for debt. In fact, I don't think we've issued a royalty term sheet for several years now. It just doesn't fit the risk return profile that we're looking for. And it tends not to fit the profile of the type of investment that the companies that come to us are looking for. So we firmly transitioned away from royalties. Turning to book value, honestly, I could not be more proud of our performance when it comes to book value, and by extension, shareholder value over the past four years. We've had another phenomenal quarter in terms of book value growth, as I mentioned, up 22% year to date. Book value now stands at 91 cents a share. That's up from 75 cents a share in December of 2021. But more importantly, it's up 22% year to date. It's up 63.6% from year end 2020. And it's up 101.8% from the year end 2019. That means in 10 quarters, we've increased book value per share by over 100%. I challenge you to find any other comparable company that's had the same increase in book value per share over the same period of time. As I said, the team's worked hard to achieve that. I'm very proud of our performance and I look forward to growing that going forward. Regarding free cash flow, in the quarter we generated almost a million dollars of adjusted free cash flow from recurring revenue. As I said, we manage our business based on recurring revenue and adjusted recurring revenue. And so just to help you understand what that means, Our adjusted free cash flow metric is simply recurring revenue, less cash expenses, less interest expense. That's it. Clean, simple, very easy to track, very easy to analyze, very easy to perform against. On that basis, we generated $2.1 million of adjusted free cash flow over the past four quarters. As I mentioned, that's a record for us. In terms of new deployments... We deployed $3 million U.S. in the quarter. This was a third tranche investment into one of our strongest portfolio companies, a company called EchoBox. EchoBox is MRR. This is a software-as-a-service company based in Europe. The company's monthly recurring revenue is up well over 200% since we made our first investment in the company. At U.S. $6 million, that is our largest investment to date. While I'm very glad of this investment in our track record with that company, I am a little disappointed that we did not make more investments in the quarters, but more on that a little bit later in my commentary. We had no exits booked in the quarter. However, Performio, which we spoke about a lot in the last conference call, was booked in the last quarter. That did contribute a residual $250,000 to our results in the current quarter. As I mentioned last quarter and it's worth reiterating now, Performio represents an example of a key part of our business model and strategy. In all of our loans, while we focus on recurring revenue and that's how we manage our business, we also take a small upside participation right, usually in the form of warrants or what's called a success on exit bonus, which is in lieu of warrants, if we've helped the company grow its equity value by using our capital, there's a small – when they exit our loan, there's a small bonus on that increase in equity value. And that's, in fact, the structure that we had with Performio. And Performio was so successful for us because of the gains that we crystallized on our bonus position. What's important, I think, for us is that we're not just a company that generates recurring revenues in senior secured loan positions in high-growth companies. But over time, each one of those investments provides a potential for a bonus on exit, either through warrants or a bonus success on exit type structure. And that represents, I think, significant upside to our book value and actually protection to our downside over time. As we reach 100 million in assets, we expect there should be over 25 to 30 of these positions. In fact, right now we have 13 warrant slash bonus positions plus three common equity positions. Sometimes our warrants, as you know, will convert into common equity. So we have 16 non-loan positions on our books, and I expect that this will continue to be an important part of our value generation strategy going forward. In fact, we don't generally do any loans without some form of bonus participation right. Turning to assets, a quick mention on our asset base, which is now over $51 million. It's a small, you know, passing $50 million is a small, meaningful milestone. Our objective is to get to $100 million, then $200 million, then $500 million over the next several years. Book value and asset gains in the quarter were driven by free cash flow, FX, and book value increases in our warrant portfolio, particularly in three of our companies, which saw a material increase in their valuations. As I mentioned, book value per share is 91 cents. Book value in terms of cash is over 28, almost $29 million. In terms of capital structure, at the end of the quarter, we had well over $8 million in cash. During the quarter, we did close our first tranche, which was $1.2 million of our preferred share offering. It's a six-year term preferred share that yields 9.2% in terms of eligible dividend yield. We will be raising an additional four and a half million dollars in that structure up to our limit of about five and a half. But we expect that we'll be raising that money over the several quarters as we need it. Currently, we're not capital constrained for the near term. However, we continue to work on long-term capital solution to help us scale from where we are now to that 100 to 250 to $500 million capital mark, as I mentioned earlier. In terms of our pipeline, It remains at very similar levels to last year. We've seen about 1,000 deals per year at the top of our funnel consistently for the last several years. And year-to-date, we've seen about 600 leads, very, very similar to the number last year. But I am disappointed with the number of deals that we've closed. We're not closing as many deals as we expected year-to-date. And, again, it's not for the lack of deals. I think we're tracking similar levels as last year. But I think it's... There's a lot of volatility in the markets right now. Equity markets, both public and private, are shut down. And we expect to see a significant inflow of deals related to that as companies bridge to their next round or bridge to cash flow break even. But I think a lot of companies prior to the bubble or the burst of the bubble that we've seen topped up their capital. And we are starting to see some of these deals come in that are related to equity. the lack of their ability to raise equity, but we're not seeing as many as I thought we would. This is a lumpy business by nature. And to be honest, from our perspective, the solution to that lumpiness is simply to see more deals, i.e. increase the number of deals at the top of the funnel. So this has been and continues to be a focus for us. So we're trying to grow that 1,000 per year to 2,000 to 3,000 which is, at the end of the day, the ultimate solution to this problem is see more deals and choose the best deals amongst those that you do see. And so stay tuned for that. We're working on more initiatives, ramping up our marketing, ramping up our referral networks, and I expect that that should continue. While it's shown great progress to date, there's more to do, and that is the focus that I have and the team has going forward. And with that, I'll end my prepared remarks and hand it back to the operator for questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging a request. If you are using a speakerphone, please lift the handset before pressing any keys. As a reminder, if you have any questions, please press star 1 now. First question comes from Ed Zolba at Spartan. Please go ahead.