Transcripts
Alaris Royalty Corp. (ALARF) Q1 2023 Earnings Call Transcript
Operator
Good day, and thank you for standing by. Welcome to the Alaris First Quarter 2023 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded.
I would now like to hand the conference over to your speaker today, Amanda Frazer, CFO.
Amanda Frazer
Thank you, Josh. We appreciate everyone taking the time to join us this morning as we present our Q1 results. I’m joined on this call by Steve King, President and Chief Executive Officer of Alaris.
Before we 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 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 heading Forward-Looking Statements and Risk Factors, copies of which are available on SEDAR at sedar.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.
Our Q1 revenue of $36.7 million was just shy of our $37 million guidance and represents a 7% decrease over the prior year. In the quarter, LMS deferred $1.5 million of distributions, which contributed 3.5% to the year-over-year decrease. As discussed in previous quarters as a result of the increase in steel prices, LMS’ margins have been compressed and gross profit has declined.
Although LMS has worked to include steel price escalation features and new contracts, they still have to work through current lower rate contracts and on-hand higher-priced steel and inventory. The latter half of the year where projects will include lower-priced inventory and higher-priced contracts is expected to improve gross margins and return LMS to paying current distributions. Makeup payments on the deferred amounts are expected to begin in 2024.
Also contributing to the decrease was the previously announced strategic transaction involving BCC and Brookfield. The newly acquired convertible preferred units provide a minimum 8.5% yield, which is US$2.3 million on convertible preferred paid quarterly with the ability to participate in common distributions in excess of 8.5% if paid as well as an annual $1.5 million transaction fee.
Cash from operations prior to changes in working capital of $17.5 million decreased 50% as compared to the prior period primarily as a result of an accrual for the litigation relating to Sandbox transaction. While we continue to believe, we would have ultimately prevailed in the litigation given the inherent risks associated with the process its protracted nature and associated legal costs, which were approximately $4 million in the 12 months ended December 31, 2022 alone, the decision was made to proceed with settlement discussion.
After excluding all legal fees and costs associated to the Sandbox litigation in the respective quarters, cash from operations prior to changes in working capital decreased by 15% as compared to Q1 2022 as a result of lower revenue and higher G&A. Aside from the litigation related costs, the increase in G&A is primarily driven by the timing of expenses incurred with $900,000 of an increase in G&A due to a change in the mechanics of the bonus calculation. Bonus accruals are now being made quarterly and driven by a percentage of total cash flow available for distribution, as well as $160,000 related to the timing of travel and donation expenses. Another $350,000 of incremental costs related to the amortization of insurance premiums purchased in Q3 2022 drove up G&A in this particular quarter.
Q1 is generally a quiet quarter for fair value adjustments given the proximity to our year-end. The trust had a net unrealized and realized gain from investments in Q1 2023 of $0.8 million. The main driver is the increase of US$4 million in the fair value of Fleet. Fleet’s backlog of syndication work for 2023 and into 2024 continues to increase with new contract wins. This growth in backlog and its impact to Fleet’s outlook coupled with strong results during 2022 and Q1 2023 continue to increase fair value.
The increase was partially offset by less significant decreases to fair value of Planet Fitness as it remains the most sensitive of our partners to continued rate increases, as well as Accscient as they adjusted their outlook for a slower 2023 than previously forecast.
We deployed a further US$36.5 million in the quarter to new partner FMP, and currently have $ 203 million of senior debt outstanding, resulting in $247 million of available capacity for new transactions.
Our portfolio continues to perform well, and has maintained a weighted average ECR of over 1.6 times following the revision to BCC based on the new transaction. 11 out of 19 of our partners have an ECR over 1.5 times, and seven of those are over 2 times. LMS is the only partner below 1. And as mentioned earlier, we expect them to be back above one in the latter half of the year and expect payment of deferred distributions in 2024.
Our current outlook calls for $36.1 million of revenue in Q2, and a 12-month run rate of $156.7 million. Our G&A expectations have decreased from $17.5 million to $16.5 million, to reflect the expected reduction in ongoing legal fees. This amount is expected to continue to decrease as we wrap up the settlement agreement.
I’ll turn it over now to Steve, for his further comments.
Steve King
Great. Thanks, Amanda. The focus for Alaris remains on the health of our portfolio. And I’m very pleased to say, that we’re seeing still very good strength across the board. Some small themes, that investors may be interested in. We’ve seen some low-level weakness in our business services companies particularly, in our IT consulting businesses. Part of this may be a tightening of corporate budgets in America.
But I believe, that more of it is actually just the reflection of a record year, that they’re all coming off of for 2022. Current performance is still very strong, in comparison to previous years including before the pandemic. On the flip side, we’re seeing very strong performance from several of the companies in our portfolio, that were showing weaknesses a few years ago.
Brown & Settle, Edgewater, Fleet, Heritage all putting up excellent results. This is exactly why we, create a portfolio. You’re going to have different kinds of companies, doing better and worse at different times.
Two of our largest investments BCC and Planet Fitness, are still showing very strong results in the personal care space, likely powered by very strong employment data in the US and both of them being low priced point providers.
Having an ECR across the portfolio of 1.6 times, which is what we were last quarter as well and steady results coming in for early 2023, we feel very comfortable with where we’re sitting with our portfolio.
As Amanda mentioned, we made the move to voluntarily defer LMS’ distributions this quarter, to ease the burden for them while they work through their high-priced inventory. LMS has been a partner of ours for 16 years, and has an outstanding track record of working through the inevitable ebbs and flows of their business. We’re highly confident, that they are on a visible path to resuming and catching up on payments, and as we see record levels of daily volumes and a record backlog that goes out for many, many months.
We were very pleased to finally close the FMP transaction recently. We had actually closed this transaction in escrow in December, but it had to wait for a final US government approval, before making it official. The delay in receiving FMP distributions impacted our results in Q1, as we weren’t quite able to replace the lost revenue from redemptions from late last year. We’re still sitting on a large amount of capital in our debt facility that we expect to deploy over the coming months, which will have a positive impact on our go-forward results.
The private equity market remains relatively slow in the kind of deals that we’re looking for. There are many deals in the market, but most of them are PE companies looking to sell or refinance their holdings, because the inability to refinance the debt that they have put on these companies over the last five years, typically in very large amounts, which are no longer available. The US debt markets are extremely tight, which is absolutely a huge benefit to Alaris. I remain confident, that we’ll exceed last year’s deployment of $150 million.
So, we’re happy to open it up to questions at this point, Josh.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Zachary Evershed with National Bank Financial. You may procees
Zachary Evershed
Good morning. Thanks for taking my question.
Steve King
You bet
Zachary Evershed
So obviously the first question is on the Sandbox settlement. If you could give us more color about how your evaluation on the litigation risk evolved over the course of the past three years? And then tell us if the settlement is fully reflected or whether there’s more to come in terms of the financials?
Steve King
Yes. We can’t talk too much about the settlement. As we mentioned in our press release, the final documents have not been signed. And there’s nondisclosure agreements involved in this. So we can’t get into any detail.
The one thing in terms of color, I would say, to investors and yourself Zach, as to why this is very unique for us is that typically we’re a non-controlled passive investor. And we would not be subject to these types of situations. For Sandbox, we had actually taken control of the business. And there was — there were no — usually in sale transactions there’s something they call rep and warranty insurance, which covers off situations like this. In this particular case for a variety of reasons that was not available.
So those two things combined are very, very rare in our business over our 19 years. So this is very much in my mind a one-off and obviously immaterial to our business. But kind of the cost of doing business in the U.S. private equity market this is not unusual for that industry.
Zachary Evershed
Got you. And then on LMS, you’ve got line of sight on margins improving by Q3. Do you think distributions will resume in Q3, or should we think more about Q4? And then how should we think about catch-up payments?
Amanda Frazer
As we’ve reported – disclosed, we do anticipate catch-up payments to begin in 2024. We’re expecting margins to return to normal in Q3. And as cash flows resume to normal base, they’ll turn on payments. So we’ll continue just to monitor it and see when that tipping point occurs.
Zachary Evershed
That’s great. That’s all I had. I’ll turn it over.
Steve King
Great. Thank you.
Operator
[Operator Instructions] Our next question comes from Fernando Torrealba with Cormark Securities. You may proceed.
Fernando Torrealba
Yes. Hi. Thank you for taking my question. I was hoping to ask about fair value changes. If I look at the MD&A on Page 11 the changes on fair value if I add them all up they worked to about an increase of US$600,000. Can you help me square that with what I see on the income statement a loss of 11.7 million that’s recorded there? Thank you.
Amanda Frazer
So that’s just actually the movement from BCC. In Q4 2022, we had an unrealized gain of about US$9.3 million. In Q1 that was realized when we converted BCC through the special transaction. So there was an unrecorded loss, but that’s offset by the realized gain of about 12.5 you see there. So you really have to look at them in that. It’s just a bit of accounting noise that’s created.
Fernando Torrealba
Got it. Thank you. That was perfect.
Operator
Thank you. Our next question comes from Trevor Reynolds with Acumen. You may proceed.
Trevor Reynolds
Hey, guys, I’m just wondering if you’ve ever seen a similar situation with LMS in kind of your 16-year history with the change in steel price like this?
Steve King
We did see something in 2008. So 15 years ago, they had almost the opposite issue where in the Great Recession steel prices plummeted. And they had quite a few projects that were backed by Lehman Brothers in the Vancouver area Lehman.
And so when Lehman went down, those projects actually got padlocked. And the steel that they had already purchased got — given back to them. So they actually had to work through steel that they had bought at a higher price and thought was already in a project and they got it back and now projects are being bid at much lower levels. So it was a similar kind `of phenomena for very different reasons, obviously. But yeah, they have worked through that. This company has been around for more than 30 years, very experienced team. They know how to get through these things. They’ve put more money in themselves to help with this situation.
So everything that you could ask for a partner, that’s why, we’ve been with them for so long. And I hope, we’re with them for a lot longer. We are going to see a really nice whip back here. This is our only investment that doesn’t have a collar on it.
So we are going to get a slightly less of a decrease than we expected this year from LMS which is a good thing. But we still expect a very nice bounce back for next year and collar. So it will be a fairly material increase to our overall distribution next year.
Trevor Reynolds
And are there any senior lenders in front of you on that name?
Steve King
The only — they don’t have any term debt. They do have basically…
Amanda Frazer
Working capital.
Steve King
Yes. Inventory yeah attached to specific steel inventory. So, there no term debt at all.
Trevor Reynolds
Okay. Great. On the weakness in the — some of your IT names, just maybe a little more color. Like, do you think those have kind of bottomed out in your view, or do you think there’s what’s the trend there do you think?
Steve King
Yeah. We are seeing, like I mentioned some softness. It’s too early to tell, whether it will continue or not. All of those companies have significant buffers on our cash flow and almost all of them have no debt.
So we’re certainly not worried about them. But just I thought an interesting trend. A lot of people ask me if we’re seeing things that they can use in their own investment, their own economic thesis. And they’re still at historically very high-levels just not quite as high as they were in 2022, so, yeah, too early to see, if things will continue down for them.
These are typically services that are very much required by companies regardless of what the economy is doing. So yeah, we don’t expect — and again, these are companies. If you look at other cycles in their past, all of these companies have been around for a long time. None of them have had significant troughs at all which is why we invested in them.
Trevor Reynolds
Great. And then, just on the Sandbox. Like, there’s no other companies that you’ve taken over I don’t think in my recollection. But I just want to confirm, that’s the case and there’s, no other outstanding potential cases like this in the portfolio?
Steve King
That’s correct. Yeah. That’s correct.
Trevor Reynolds
Okay. That’s it for me. Thanks.
Steve King
Thanks, Trevor.
Operator
Thank you. And this concludes the Q&A session. I’d now like to turn the call back over to Steve King, for any closing remarks.
Steve King
Great. Thank you very much Josh. And thank you all for tuning in. We look forward to Q2. Obviously, it’s — for me, it’s a very good thing to have gotten rid of that Sandbox situation. We’re tired of paying $4 million in legal fees and having our people tied up for so many hours on something like that.
So it’s good to have that behind us. You’ll see, good improvements in our G&A as Amanda mentioned and on to another hopefully successful quarter of showing the strength of our portfolio and hopefully having more fair value write-ups in the next quarter. So please call us, if you have any questions. And thanks again.
Operator
Thank you. This concludes today’s conference call. Thank you for participating. You may now disconnect.