Q3 2022 Alaris Equity Partners Income Trust Earnings Call

Good day, and thank you for standing by.

Welcome to the <unk> third quarter 2022 earnings 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.

To ask a question during the session you will need to press star one one on your telephone.

Please be advised that today's conference is being recorded.

I would now like to hand, the conference over to your speaker today amid the Frazier Chief Financial Officer. Please go ahead.

Thank you Liz we appreciate everyone, taking the time to join US. This morning, we're excited to present, our Q3 results I'm joined on the call by Steve King President and Chief Executive Officer of alert.

Before we begin I would like to remind our listeners that all of the amounts given are in Canadian dollars unless otherwise noted listeners are cautioned that the comments made today may contain forward looking information.

This forward looking information is based upon a number of factors and assumptions and therefore actual results could differ materially additional information concerning the underlying factors assumptions and risks are available in last night's press release, and our MD&A under the heading forward looking statements and risk factors.

Speaking of which are available on SEDAR at SEDAR dot com as well as on our website <unk>.

<unk> data is also presented and may differ from the way other companies present such data.

With the forward looking statements. Please refer to last night's press release, and our MD&A for more clarification regarding non <unk> measures.

Now for the Q3 highlights.

Q3 revenue of $42 9 million was consistent with the prior period.

The current period benefited from common distributions from <unk> of $3 1 million and a 4% more favorable exchange rate while the prior period benefited from the receipt of $4 3 million of deferred kimco distributions.

Cash generated from operations prior to changes in working capital of $44 million with an increase of one 2% over the prior period and included in this amount is $5 8 million of realized gains.

Waiting to a common distributions paid by sleep.

The increase in the quarter was partially offset by increased G&A expenses of $1 5 million a $700000 decrease in salaries and wages driven by a change in the mechanics of the bonus accrual was offset by a $400000 increase.

Related to continued exploration of the AUM strategy and increased insurance costs as well as $1 9 million of increased legal spending in regards to the sandbox matter.

During the quarter <unk> entered into insurance contracts to mitigate.

The rest presented by the reassessment of the CRA.

Ability of alert to obtain insurance contracts show that underwriters are aligned with our views of ultimate ultimate success on this matter. However, the state of the law is influx and by obtaining insurance, we are able to protect against any adverse changes. Although there can be no assurance that all of the amounts for which allow us may become viable will be fully cover obtained.

Insurance provides increased certainty for alero and its shareholders. We continue to defend this matter vigorously.

Q3 earnings as compared to the prior quarter were impacted by a $22 5 million change in net realized and unrealized fair value of investments for $15 8 million gain in Q3 of 2021 as compared to our current net loss of $7 $1 million, primarily impacted by the increasing market interest rates affect on discount rates or multiples.

Okay.

Despite these factors we saw increasing fair values for SCR of $1 3 million BCC of 900000 U S fleet of 900000 U S.

Water of 800000 U S.

As discussed last quarter the results of SCR can be impacted by the timing of project related work throughout the year as expected activity picked up through the summer and has continued increasing our expected cash sweep for the last half of the year as a result, increasing fair value. <unk> are also rebounded and is now back in the range of one.

Five to two times range.

CCC has seen impressive year over year growth with record high activity, which has resulted in an upward revision to our recent metric same clinic sales.

In Q2, we realized a $4 4 million U S fair value increase on fleet as a result of significant improvement in their balance sheet in excess assets held in the business at the time. It wasn't anticipated that these assets would be distributed in the near term, but in Q3 fleet declared a common distribution of $5 nine.

9 million U S tool eris and distribute excess cash to common unitholders. This distribution represents a significant portion of the common equity invested in Q4 of 2021 of 8 million U S.

Due to the previous inclusion of these distributed assets in the fair value of fleet $4 4 million you asked if the distribution was included as a realized gain while $1 5 million U S was recorded as dividend revenue.

Net impact of these realized and unrealized gains with a 900000.

U S increase in the fair value of fleet in the quarter.

Edgewater has been able to generate an increase in revenue through growing head count in both new and existing long term contracts with strong spending expected to continue within the U S Department of energy the outlook for the remainder of 2022 and 2023 continues to be very positive.

Offsetting these increases were declines in gws of $6 7 million U S.

As discussed last quarter GW AUM has not achieved the growth expected at the time of our investment while they continue to see improving topline growth and the diversification of their customer base. We have further decreased our reset expectations for the full 8% color. We continue to believe in the long term trajectory of the business, but given the slower than expected.

To start have pushed out the forecast to achieving this level of growth.

This shifted expectations, coupled with the continued discount rate increases and declining multiples have resulted in a decrease in fair value.

Planet fitness and PNM, each had declines of $3 5 million U S and three 4 million respectively again, due mainly to the impact of rising interest rates have had on the respective discount rates used to value. These companies equity investments.

In addition to the follow on investment of 26 million U S into our existing partner oxy, and including $16 million of preferred and $10 million of common earlier. This quarter. This week, we closed an investment into new partner Sagamore for 24 million U S, including $20 million of preferred at a pre tax yield of 15%.

And $4 million of common these two investments bring our year to date deployment up to $152 8 million.

Subsequent to the quarter FNC fully redeemed their investment.

Marking the first common equity crystallization for Alero proceeds of $58 3 million U S consists of $51 7 million for the redemption of the preferred and common equity and $5 2 million of make whole distributions to the third year anniversary of the deal those revenues will be recorded in Q4, the total return on our $40 million.

Investment, including preferred and common equity distributions will be $29 9 million or 75% upon the collection of the $1 4 million of escrowed amounts.

Which represents an approximate 43% IRR.

For our preferred equity investment of 38% IRR for our common equity investment in FNC.

In Q3, we also completed an amendment to the credit facility, increasing the facility from $400 million to $450 million with an additional $50 million accordion. The amendment also extended the facility maturity date from November 2023 to September 2026.

Subsequent to the quarter, we decreased our senior debt outstanding by $47 million U S. As a result of the FMC redemption as well as cash flow, partially offset by the investment and take them or we currently have $231 million of senior debt outstanding resulting in $219 million of available capacity and are at approximately one six times senior law.

Average ratio.

In regards to our partners our portfolio continues to have a weighted average ECR over 175 times with 13% to 17 partners continuing to have an ECR above one five times.

We now have eight months of financial results for all of our partners and are anticipating total aggregate resets of 3% in 2023, an increase of approximately $4 5 million or <unk> 10 per unit top of the collar resets are expected from 10 partners.

Our current outlook calls for $47 million of revenue in Q4 inclusive of $7 1 million and make whole distributions received on the redemption of FMC in a 12 month run rate of $161 5 million up from $159 3 million last quarter or $168 6 million, including the FMC may call.

Our G&A expectations have increased from 16 million to $17 million. This is to reflect the amortization of the additional insurance contracts entered into in Q3.

Okay.

Yeah.

Although it should be considered that those are noncash in nature as all of those contracts were paid in cash.

I will now turn it over to Steve for his comments great. Thanks, My mom and thanks, everybody for tuning in.

And you know we're in an environment, where other companies are seeing increased cost volatility.

So I'll be able to have been able to stay incredibly stable our third quarter again highlights the strength and diversity of our diversity of our portfolio with another record high earnings coverage ratio reported by our partners.

Well so there were some negative adjustments in the quarter. The quarterly valuation is and I have to say those are simply just changes on the discount rate used by KPMG and did not reflect any long term impairment of the company's future prospects all.

All that said our book value per share did go up by around a dollar per share in the AR in the quarter. So that's a significant.

Oh, the best thing for me is the 17 out of our 18 companies.

In our portfolio are reporting stable to a mostly improved results compared to last year, which is really incredible performance.

A significant number and doctor showing more than 25% year over year growth in 2021, which was itself a good year.

We have a number of embedded factors intercompany that explains this unusually strong performance.

First is our portfolio is constructed with required service type businesses.

Either no or very low levels of the low capex, which can be negatively impacted by inflation or supply chain issues. We don't have to really deal with a with a lot of US had also customer demand that is not highly sensitive to the economy.

We're also very pleased to announce the closing of another new partnership yesterday with the addition of Sagamore to her family.

Sagamore is a highly profitable commercial plumbing and HVAC company.

With customers in many sectors of the economy and in the Boston area.

Furthermore, display has all the characteristics, we look for in a company, including highway motored highly motivated order management group a.

30 year, plus track record of profitability, no doubt and a coverage ratio of about one point Bob.

Our G&A was a little higher than expected.

I guess the good news is a large part of that is a very positive sign for the future.

Our travel and transaction expenses were higher than usual due to the fact that our deployment activity is very strong.

We've also continued to progress on our third party asset management initiative. So there is significant startup costs are required for that concept, but we feel very strongly about the future success of it for our shareholders.

All of those factors were key elements in our decision to increase our dividend to $1 36 per share annually.

For the majority of our time as a public company, we have established a track record of consistent dividend increases.

Our third dividend increase since the start of the pandemic in 2020.

And then keeping with our objectives, we are maintaining our payout ratio between 65 and 70% after giving effect of the dividend increase.

So it was roughly $220 million of capital available, we expect to keep driving down our payout ratio was accretive new transactions like we've just done with sagamore.

Current environment really is ideal for <unk>.

And we have a very robust deployment pipeline.

We've essentially been competing against free money for the better part of a decade.

The cost of both debt and equity increase over the last few months makes our operating to entrepreneurs even stronger than it has been.

While it's still highly competitive out there with a massive amount of capital chasing do quality deals traditional private equity is facing a challenge the type of investment that type of investment is typically predicated on high leverage levels within their portfolio of companies.

Not only that now very difficult to find it's also considerably more expensive.

Then it has been in many years, so a private equity firm either needs to adjust the multiple that they pay for an asset or they have to accept lower economic returns.

<unk> model does not rely on any leverage in our deal. So our returns can stay consistent or move up slightly.

This environment, we were able to price deals slightly higher as seen in this AGM more transaction, starting dividend yield of 15% compared to 14% in most deals done over the last several years.

We also have the advantage of resetting our dividend from our partners based on their top line performance, which is a very nice feature in an inflationary environment given the top line should grow faster, but we are insulated from the increase in costs.

So putting it all together with 90% of our revenue in U S dollars low debt topline orientation and non cyclical investments.

We're really ideally suited for the uncertain world we're in today.

So Liz I'll turn it back to you and open the floor up for questions.

If you'd like to ask a question at this time. Please press star one one on your telephone again that is star one one if you'd like to ask a question.

Our first question comes from the line of Nick <unk> with CIBC.

Okay.

Yes Liana.

Just one moment, yes can you hear me.

Now again.

Okay.

I wanted to start with a question on the dividend or the distribution.

In the past you've talked about a comfort level for a dividend raise being appear.

Our payout ratio below 60%, whereas it seems now youre anchoring on a range of 65% to 75% I'm just wondering what what prompted the change in thinking there is that is that partly a product of the deployment pipeline you see in front of you.

It is.

It's always a balance between our payout ratio.

The amount of capital that we have available for deployment.

The prospects for deployment of that capital. So yes, we felt very comfortable we've we've targeted a 65% to 70 to stay within that range, we did that.

Yes, we see some some good activity coming in the near term.

Okay Fair enough and then with borrowing costs rising does that impact pricing at all on new investments in preferred equity historically your entry yield has been in a relatively tight range.

The latest one was kind of towards the high end of that range does that start to move upwards at all or do you feel that the pricing is probably going to be pretty pretty static.

I think it's moved up a little bit Nick.

As evidenced but.

It will never be like.

We're never going to be able to get to 20% or anything like that so it's always been in a pretty tight range for our full 19 years. So early days in a different interest rate environment I was able to do some some deals at 16.

No.

We see over the last several years, it's been an extremely low interest rate environment. So.

For follow on deals, we went to 13% to be competitive.

No.

We're seeing some senior debt Reeves.

Certain companies.

Broaching double digits, so for us having a.

And equity option for a company, where you are eliminating refinance risk.

You're only paying 14% 15%.

Compared to 10% on senior debt with a large amortization schedule.

It now becomes very very competitive and as I mentioned, we don't compete against that we do compete against private equity, but they're.

All of those people are facing the same issues without expensive debt and the higher amortization rates, though it's early.

Is there really a tremendous environment for us.

Yes, Okay, alright, that's it for me thank you.

Thanks, Nick.

Okay.

Our next question comes from the line of Gary Ho with Chardan. Your line is now open.

Great Thanks, and good morning, Steve.

You can see another investment analysis.

Just wondering if you can provide a bit more color and update on the capital deployment activity in the pipeline and maybe elaborate on kind of.

Touched on in your prepared remarks, but how the higher rates has really benefited the alere royalty structure there.

Yes so.

I think I mentioned in previous calls this year that the.

It wasn't so much the number of deals.

As an issue earlier in the year. It was the quality of those deals and we have seen a rebound in that where some of the higher quality companies are kind of coming back to the market and looking to raise capital.

But I also think that it's been a change in what we're expecting to see even more of this change in the fewer companies will be looking for complete sales transactions because.

Multiples are coming down it's not a great environment to be to be selling your company.

So people are going to want to keep more skin in the game.

Live to see a better day again in terms of multiples and the access to capital and cost of capital.

So I think we're going to see more kind of.

Partial liquidity events dividend recaps and those are all things that we really do well with our structure. So.

We expect a very robust 2023 in terms of capital deployment, both from the access to capital being constrained in other cases and also just the cost of capital as I mentioned, when Youre seeing senior debt at 10%.

Youre seeing mezz debt in the mid teens, we are.

Seeing equity multiples come down.

That is really a perfect environment for us and.

With the.

The lack of downside in terms of that within our portfolio, we're really not getting hit by that.

Other edge of that sword so.

We're pretty excited I think.

An average I think theres still will be some 14% deals out there for some larger ones that are very hotly contested.

But I think for smaller deals 15 would be kind of a new norm.

Okay.

Great and then maybe on the flip side.

We call it the S&P redemption.

Are there any other partners potentially indicating they may look to redeem over the next 12 months.

Nothing.

Nothing thats evident right now, but as I've always said, we always expect at least one or two a year.

So I don't think that will change that is one slight advantage of of a bad market as well is that it's not us.

Conducive for for someone wanting to sell so I think we'll probably see people going to stay with us for longer on average, but it's different it's different in every case.

A lot of the times it's.

The exterior forces that cause.

Cause a sale or whether its a medical issue or.

Or just a.

Hey, Julien.

Whatever it is.

There is always just kind of different circumstances on every deal but in general.

I would still expect another one or two redemptions and there could be some some ones that.

Excess cash where they can even just.

Pay down or our preferred investment a little bit.

As opposed to taking us right out so I think you could see some of those as well.

Okay, and then while I have you Steve can you give us an update on the managing third party capital strategy.

<unk> had and perhaps maybe some timeline guideposts you are targeting.

Yes, we've made some very good progress since we talked to you last quarter. So we're we're certainly more confident in.

Our ability to announce something.

In the relatively near future compared to what we were three months ago. So I can't give any timeframe on it but.

Yes, it's gone very well and thats evidenced in our actual costs that we've had that.

We wouldn't have had those costs if there wasn't a concrete transaction on the table.

Okay, great. If I can just sneak one more in maybe for Amanda given the higher FX.

We've benefited.

Quite a bit and I know Steve you.

You also mentioned the 6% increase in book value per share.

Thoughts on hedging more distribution at these levels I know you have a rolling 12, and 24 months hedge in place I'm just wondering if you could.

Peter Moore.

We actually don't bring a lot of cash back to Canada, So while we do benefit from.

The FX in our financial reporting as far as converting U S dollars into Canadian on a regular basis, we are fairly well hedged on that standpoint, so to hedge any further we would be bringing Canadian dollars back to Canada.

Kind of unnecessarily or most of our debt is also held in U S. Dollars. So we don't have as much of an advantage.

To that conversion.

Okay.

Okay.

Through the call.

Thanks, Eric.

As a reminder, if you'd like to ask a question at this time that star one one.

Our next question comes from the line of Zachary <unk> with National Bank Financial Your line is now open.

Good morning, everyone congrats on the quarter.

Thanks, Matt.

Most of my questions have been tackled so maybe just a quick one on the insurance for the negative outcome on the tax issue.

With that in place with your potential in that exposure now.

It really depends on the circumstances I mean as we.

We continue to believe that there is no exposure.

And we will be successful in the case.

It is currently.

A number of cases going through the courts and those decisions can always impact the.

View on our case and because we are uncertain on what those.

Other cases may hold for hours, we just thought it prudent to protect ourselves as much as possible but.

We continue to believe that we'd be successful.

Sounds good I'll leave it there.

Okay. Thanks.

I'm showing no further questions in queue at this time I would like to turn the call back to Steve King.

Great. Thank you Liz and thanks, everybody for tuning in and asking questions and as always if there is any follow up questions. Both Matt and I are always available to take those anytime. So thanks very much again, and we look forward to reporting back to you with our with our year end results. Thanks very much.

This concludes today's conference call. Thank you for participating you may now disconnect.

Okay.

The conference will begin shortly to raise your hand during Q&A you can dial one one.

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