Flow Capital Corp.

Good morning, ladies and gentlemen. Welcome to Flow Capital Corp's earnings call for Q1 2024. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions. If anyone has difficulties hearing the conference, you may press star zero for operator assistance at any time. I would now like to remind everyone that today's discussions 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 Companies Management Discussion and Analysis, which is available on CEDAR. Today's call is being recorded on Thursday, May 23, 2024. I would now like to turn the meeting over to Alex Belluta, Chief Executive Officer of Flow Capital.

Thank you, Joelle. 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 CDAR. 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 as a record, assets are a record, portfolio is at a record, And this is going back as far back at least as far as December 2018, which is when we formally transitioned our strategy away from royalties and into growth debt or venture debt and 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 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 is 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. It doesn't include PIC. It 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 distorted 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 or 1.76. 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, where we were five quarters ago. I will note that the drop in book value over the last five 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 two years. Recurring free cash flow was $415,000, and that's up over $1.1 million over the past four 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, you know, we're getting to this stage where, I'll talk about it in a minute, we expect that number to grow substantially as we scale our business. A couple of minor points. Post-quarter, we did, and this was press released, we received a $4.5 million U.S. repayment of the successful investment in Pure. That was a four and a quarter year term, and that represents on repayment over a 20% ILR. We then quickly redeployed that money into a $4 million loan into a company called Tattle, a fantastic B2B SaaS software company focused on customer experience improvement. We did an additional small second tranche into Judy AI as well. So I thought I'd just quickly mention Looking back to our last negative free cash flow quarter, which was Q1 2020, so kind of a four-year progress. Recurring revenue over that time has gone from just below $1 million to almost $1.8. Our assets over that time have grown from $34 million to $65 million. Importantly, most importantly, our book value for share attributed to the common shareholders has gone from $0.46 a share to $1.23 a share. At the time, over 80% of our revenue was generated from royalties, which were much higher risk in our, from our opinion, and 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 in that, that is just over a million dollars. And that's in a fantastic company called true golf, which just recently in public, um, 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, there's multiple reasons, growth in revenue, growth in assets, but our costs actually from that time period are flat to down over a four-year period. Importantly, our gross IRR over that time period has been, last year we put out a press release, it was just over 30% on the trailing five 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 six-year track record on IRR shortly, so please pay attention for that. And that is really driven by the relentless focus on quality and And you'll see that in our closed 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 term sheet, we still only close about a third, below a third, or I should say between a third and a half of the deals we sign a term sheet on. And that's because we're just, we do an incredible level of due diligence. And, you know, internally, as I mentioned before, we focus on zero zeros. And as a manager, it's so hard for us to make back a million dollar 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 what I think is a fantastic growth IRR over the last six years. But you can see that we've grown, and what we've done, you might argue that You know, going from a million to recurring revenue to a million and eight over a good span of four years is great, but it's still small. And I would agree with you. But what we've done over the last four years is develop a consistent approach, a consistent focus. We've built our brand. We've built our processes. Importantly, very importantly, 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 four years, is to grow first to 100 million in assets, then 250, then 500, then a billion. It is a very, very achievable target in the market that we plan, which is venture debt and or growth debt. Peak originations in this market in the early 21, 22 timeframe were well over $30 billion per year in North America alone. We focus on both Canada on all three – 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, that's more of a short-term cyclicality given the rates and changing 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 to be 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 five, six years. Our progress has been sometimes a little lumpy given the nature of repayments and the nature of redeployments. As you saw with the pure repayment, we within seven to ten days redeployed that into TATL. We continue to have an exceptionally strong pipeline, three term sheets that are signed and incurring 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 a third 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. You know, if you want to, if you'd like to go back and listen to the comments that I, on the quarter that we just, the 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.

Thank you, ladies and gentlemen. We will now begin the question and answer session. Should you have a question, please press star, followed by the one on your touchtone phone. You will hear a three-tone prompt that your hand has been raised. Should you wish to decline from the polling process, please press star, followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. There are no questions at this time. I will now turn the call over to Alex.

Actually, I want to see Ed ask the question. Please let him. Please allow that question.

Okay. Ed Soba from Spartan. Your line is now open.

Good morning, Alex. Congrats on resuming growth again, as you predicted. That's an ace quarter. I had a bunch of questions, actually. I look at the website. It says you'll do loans up to $7 million. Is that correct? Have you done a little not big or is that what you would do?

I guess yeah, hi Thanks for your long-term support and thanks for joining the call I will point out I meant I meant to mention that we will have a new website launching probably the next month. So Keep your eyes up for that. Yeah, it's a it's probably now two to seven million it's very rare that we would do a low-end deal below two million and you know, I You're doing the same due diligence on a $1 million deal as you're doing on a $50 million deal. At least that's our perspective. And so you just get much better return. I think our average deal size is closing in on $3 if not $4 million U.S. We have not ever gone as high as $7 million U.S. in any deal to date. The largest one was Echo Box, which was repaid January 2nd on a December 31st close last year. We've got a couple in the $5 million range right now. But to answer your question specifically, we've not had a deal that's gone above $6 million U.S. 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%, 15% range in terms of portfolio deals. I expect that all of those will be below 10% contribution to portfolio within the next quarter or two, depending on 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. If 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 terms to 36 months mostly, we haven't got a single amortizing loan. 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. 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 is at $7 million. Yes, we would do a deal there. And one other thing, we'd probably get there through multiple tranches. In other words, Echo Box, 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, Pure was two tranches. Judy, we just did two tranches. So our approach to getting to $7 million is generally give them enough money, see that they're on track with expectations within manageable variables or variance, and then put in the second tranche and then put in the third tranche. So I hope that answers your question.

Yeah, no, that gives a lot of good insight into the loan process. So it's really driven by how comfortable you are with uh, with the, with the risk profile. And then, yeah.

And then I guess wait time on, you know, if we get a $10 million deal, we'll pass it on to the partner slash, you know, somebody we know that focuses on larger deals. We've had people ask us to co-invest on deals with us. The problem there is, is that it's just, it's not, you never have certainty on clothes, right? So why would we negotiate a $10 term sheet when we've got to go get 4 million from somebody else and then you can't get it. And, And so partners do say, oh, we'd love to partner with you. It's really very, very subjective. So we don't do co-investments with – you know, we don't scale higher through co-investment partners because it's just very, very difficult to get there. And make 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 actually, you know, fulfill that commitment.

Right. Right. Okay. So – I just, I've got a couple of questions on the, like the balance of financial statements. If, so in your, in your news release, you said a loan book of 43, 44 million, basically. Right. And then if I look at, so is that, what date is that? Is that as of March 31st? Pardon? Sorry. As of March 31st. Okay. Okay. And you get 16% on that.

Yeah, the loan book now is closer to $46 million. Okay. And that includes ECLs and stuff. So those are the essential carried book value of the loans.

Okay. But then if I look at the balance sheet, I see investments 34, 5. Anyways, if I add that up and then investments current portion, 15. So if I add that up, we get closer to, 50 million. Am I, is that correct? Yeah. Hold on.

Let me, I don't actually have it.

There's two buckets for investments. There's current portion and non-current.

So. Yeah. Yeah. Sorry. So it's our loan book, both current and non-long-term. We have over $6 million in warrants. We have seven-ish million in a long-term cash assets. A tax asset. Oh, okay.

Okay. So the investments would be bigger than the loan book. The investments are bigger than the loan book because that includes warrants 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, anyways, it's broken down, but you have a number of games in there. Yeah.

We have the deferred tax asset. So 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 is pretty simple and pretty clean and pretty easy. One of the things you'll note, I was just knowing compared to 2021, we had an accumulated deficit at the time of, Yeah, $38 million or down to $14 million. It just shows how profitable we've been over the last four years. And, you know, I expect, given our trajectory, given our costs, given everything we've done, we should continue to be profitable, barring some unforeseen major events.

Yeah. Yeah, no, that's great that it's grown that way, and especially the book value. So I noticed on the income statement there was – but $300,000 in tax. I'm wondering how you've got a tax asset of $8 million, but you're showing tax. You've got a cash tax?

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

Okay. The final question is just you know, uh, tactically, um, so you've got about 8 million cash on the balance sheet, right? And you're also boring through, you know, preferreds and anyways, your, your cost of boring is 10, 10, 11%, I guess with the, the debt debitors and stuff like that. So, um, like, do you want to keep, keep like 8 million? given your 10% cost of capital for that, or does it make sense to run that to near zero and then maybe have a line of credit if you have needs? What's the philosophy? Like how much cash do you want on the balance sheet? What are you comfortable with? What are you wanting? Sure.

So that's a great question, Ed. It's kind of a, you know, I do want to mention, I mentioned in our last call that our debenture, It pays a floating rate of 10.5 or up to 11 if the investor has over a million dollars in it. So, you know, 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. The vast, vast, vast majority of this space is funded through LPGP structures and debt. So if you're in an LPGP structure, which means, you know, locked up eight-year limited partnership, that limited partnership investor is first loss capital. And on top of that, 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 LPGP. We're a public company. But what we have is equity, $38.5 million of equities. And that equity, which, by the way, management and board own over 25% of, so we're highly aligned, that equity is first loss. And so that's a venture 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's a venture 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 is well below 5%, well below 2% currently, before those ventures are at risk. And that's very unusual and very, very, very much better than any of the LPGP models you'll see out there. If you're an LP investor in a growth, whether it's venture capital or venture debt, growth-oriented, growth debt-oriented structure, your capital is at risk as the first loss. I can't stress that point enough. So we feel that for, sorry, and for the first, for investors, our debenture is redeemable on demand after a short period of hold. It's RRSP eligible, and it's 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 of the debentures come down. So 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, you know, while many of those will expire without being exercised and without creating value for us, we have in the past five years had several excellent exits on the warrant positions that we hold. And broadly speaking, we own either equity or warrants or what's called a success fee, which is kind of like a warrant, but it's not – It's just slightly, it's basically when the company exits in a change of control transaction, it triggers automatically. So that's, you know, as our chairman likes to call kind of the hidden treasure chest of our business model, we earn a cash interest of 15% to 17%. That is, when I talk about recurring revenue, that's 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 the size of our current number of investments because our warrants tend to be anywhere from six 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 a million dollars on a loan at some point, I expect that over that same period of time, we'll make two or three million back in terms of the Warren book. So it's a broadly diversified strategy. The investors have security in the venture 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 the, of a very, very good care of the redeemable debt holders.

Yeah, no, let me, and that, that instrument is great. It's good for both sides, right? And especially the investors that over 10%. And, but, but, given the health of the balance sheet, the $40 million equity that you talked about, would it be possible for Flo to have a bank line in case they need $5 million? I'm just wondering about do you really want $10 million cash sitting on the balance sheet? I know you need it because you have loans in the pipeline and stuff at the moment.

It's a perfect question. I would At the stage we're at now, you're 100%. If all that capital was deployed, I would have had even higher revenue, even higher free cash flow, right, because it's automatic rent. They're all on the bottom line. But, no, you're bang on. I do see longer-term a three-tiered capital structure, which would be our equity at the bottom, at first loss. That's going to grow over time. I see profitability and gains are a warm plug. 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 million bucks. I need to close a deal. I draw it on the warehouse line. I then backfill it with debentures. That's kind of the strategy that we have. And 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 three layers of our cash back are well protected. So I'm going to keep hammering that point that our redeemable to venture holders, unlike most other structures in this space, have security below them, which is unavailable in other structures. So, yeah, you're right, Ed. We've got to be more cash efficient. I know it's been something that people are taking comfort in, and for probably the last four years we've carried an average cash balance of somewhere between $8 million and $10 million. That will decline over time, and we will become more cash-sufficient with a more senior line to help us.

Yeah, no, that makes a lot of sense as you mature as a company, right? Yeah. And then I guess the final – and just the point you were making, like you were saying, your loans are non-amortized, right? Yeah. And is that because your borrowers, they – Typically, they have an exit in three or five or whatever years. From that point of view, if you're looking at that exit as they mature their business, then when that exit happens, then everything's paid off. You don't need an amortizing loan like with a traditional business. Is that the way they look at it?

Yeah, absolutely. 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 often take a co-investment. Almost probably 60% of our loans, the existing equity investors do a co-investment alongside of us in subordinated equity. Think of it from this way. As I mentioned, let's say we give somebody a $3.6 million loan, and that's amortizable. It's a three-year loan. They're going to be paying interest, and then $100,000 per month of amortizing down the principal. So instead of just paying, I don't know, $20,000, whatever, $10,000, $20,000, $30,000 a month in interest, whatever the number is, they're paying $130,000. And so 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 We'll just say, yeah, 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. Yeah, you're paying 16% 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 six-month period of non-amortization and then amortization starts. So we've seen term sheets. We've issued term sheets to players, you know, 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 loan. Okay, we'll do that as long as the due diligence checks out. It makes a lot of sense.

No, exactly. I think a lot of those growth companies, kind of the hurdle, the target for all these companies is break-even. They don't really... you know what I mean? They want growth and they want break even right. And in terms of cash flows. So an amortizing loan is really a pain because you know, if, as long as a break even, they're very attractive, uh, in terms of an exit or, or, or going public or whatever. Right. Um, but, um, you know, but the amortizing loan, like you said, it really pinches them in terms of cash flows. So, um, uh, you know, thanks. Uh, that's great. I learned a lot about the business today and, uh, Congrats again on a great quarter and look forward to more news ahead.

Ed, thanks for your long-term support. A lot of him is new on board. And, yeah, we look forward to stronger numbers and continued growth over the coming future. So thanks very much.

And given the discount with book value, about 50%, is the share buyback, is that an easy catch?

Yeah, we continue to use – I think I mentioned last call, we've probably bought back 15 or 16 or 17 million shares, kind of $8 million worth of shares over the last four years. We'll continue to do that from our perspective. If we can buy shares here at 50, 55, 60 cents, we're buying back dollars for 50 cents. 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, you know, until we get above book value, we're going to continue to be buyers of our shares.

So, yeah. Yeah, I'm in. I love that. So, okay, great. We'll talk in the future.

Thanks.

Okay.

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 three months.

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