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 discussion 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 company's management discussion and analysis, which is available on SEDAR+.
Today's call is being recorded on Thursday, May 23, 2024. I would now like to turn the meeting over to Alex Baluta, Chief Executive Officer of Flow Capital.
Thank you, Joel. 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 SEDAR+. This call is being recorded and will be available for replay on our website, as all of our calls are. I am gonna keep my comments relatively brief today and free form, unscripted, a little unusual for me. During Q4, sorry, I should say Q1, we did report another record quarter in terms of almost all metrics.
Recurring revenue at 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 we changed our name to Flow Capital. I'm not, as is usual, gonna 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 statement 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. As I mention every call, as 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. Doesn't include PIK, 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, as 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 wanna note that our cash yield on our current loan book, which is almost CAD 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 CAD 1.23 on 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 option exercises. But book value is up 2.9% over the prior quarter and over 49% over the past two years. Recurring free cash flow was CAD 415,000 and that's up over CAD 1.1 million over the past four quarters. That is up to quite, 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 gonna give you a quick comparison to Q1 2020 in a moment. Total assets, CAD 65.4 million, up almost 3% quarter-over-quarter and 10.6% year-over-year, another record. Here's an interesting metric: We've deployed over CAD 28 million in the last twelve months. For us, that's a record, and, and, you know, we're getting to the stage where I'll talk about in a minute, we expect that number to grow substantially as we scale our business. A couple of minor points. Post-quarter, we received a $4.5 million repayment of a successful investment in Pyure, and this was press released.
That was a 4.25-year term, and that represents on a repayment over a 20% IRR. We then quickly redeployed that money into a CAD 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 JUDI.AI as well. So I thought I'd just quickly mention. Yeah, 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 CAD 1 million to almost CAD 1.8 million. Our assets over that time have grown from CAD 34 million to CAD 65 million. Importantly, most importantly, our book value per share attributable to the common shareholders has gone from CAD 0.46 per share to CAD 1.23.
At the time, over 80% of our revenue was generated from royalties, which were much higher risk, in our opinion, anyways, higher risk investment structures, and now it's less than 10% come from royalties. In fact, we only have one material royalty outstanding, and that is just over CAD 1 million, and that's in a fantastic company called TruGolf, which just recently went public. Our free cash flow at the time in that quarter was below -CAD 200,000. It's now over CAD 400,000 in the quarter. And part of the reason for that cash flow growth, well, there's multiple reasons, you know, growth in revenue, growth in assets, but our costs, actually, for that, from that time period, are flat to down over a 4-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 5 years. It's still very close to 30, a little bit lower, at in the high twenties. We'll be putting out another press release, giving you our 6-year track record on IRR, shortly, so please pay attention for that. And that is really driven by the relentless focus on quality, and you'll see that in our close numbers in our pipeline, where we still see, just below 1,000 leads per year. But even after we get all the way down the 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.
That's because we do an incredible level of due diligence. You know, internally, as I mentioned before, we focus on zero zeros, and as a mantra, it's so hard for us to make back a CAD 1 million 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 that what I think is a fantastic gross IRR over the last six years. So you can see that we've grown and what we've done, you might argue that, you know, going from CAD 1 million in recurring revenue to CAD 1.8 million over the 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, in fact, most importantly, we've built a fantastic team. And we've set the stage for what we think is gonna 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 CAD 100 million in assets, then CAD 250 million, then CAD 500 million, then CAD 1 billion. It is a very, very achievable target in the market that we play in, which is venture debt and/or growth debt.
Peak originations in this market in early 2021, 2022 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 and deals. And while originations have come down a little bit in venture debt, it is, that's more of a short-term cyclicality given the rates and changes in the market and venture capital appetite. But it's still a multi-tens of billions of dollars 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.
I'm very, very proud of the results that we've generated over the last 5-6 years. Our progress has been sometimes a little lumpy, given the nature of repayments and the nature of redeployments. As you saw with the Pyure repayment, we, within 7-10 days, redeployed that into Tattle. We continue to have an exceptionally strong pipeline, 3 term sheets that are signed and in current 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 gonna improve a little bit over time, but we're still gonna be selective. But I'm gonna end the comments there.
You know, if you wanna, 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, 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'll-
One more.
I see Ed's asked a question. Can you let him? Please allow that question.
Okay. Ed Sollbach from Spartan, your line is now open.
... Good morning, Alex. Congrats on resuming growth again, as you predicted. That's, it's in this quarter. I had a bunch of questions, actually. I look at the website, it says you'll do loans up to CAD 7 million. Is that... Have you done a loan that big, or is that what you would do, I guess?
Yeah. Hi, Ed. Thanks for your long-term support, and thanks for joining the call. I will point out, I meant to mention that we will have a new website launching probably the next month, so, keep your eyes out for that. Yeah, it's probably now $2 million-$7 million. It's very rare that we would do a low-end deal below $2 million. As you know, you know, when 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 million, if not $4 million US. We have not ever gone as high as $7 million US in any deal to date.
The largest one was Echobox, which was repaid. It repaid January 2 on a December 31 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. 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. I expect that all of those will be below 10% contribution to portfolio within the next quarter or two, depending on the 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 loans. If you're gonna be exposed to a great company, you wanna be exposed fully for a longer period of time. So while we, we limit our terms to 36 months, mostly, we do... We haven't got a single amortizing loan. We don't, we haven't really even done an amortizing loan on a, in a term sheet for a long time. And, 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 us.
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 at that $7 million. Yes, we would do a deal there if one other thing, we'd probably get there through multiple tranches. In other words, Echobox, 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, Pyure was two tranches. JUDI, we just did two tranches.
So our approach to getting to CAD 7 million is generally give them enough money, see that they're looking, you know, on track with expectations within manageable variables or variants, and then put in the second tranche and then put in the third tranche. So hope that answers your question.
Yeah, no, that gives a lot of, good, good insight into the loan process. So it's really driven by your, your, how comfortable you are with, with the, with the risk profile-
Yeah.
- and then, yeah, and then again-
We try not to waste 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.
Okay.
We've had people ask us to co-invest on deals with us. The problem there is that it's just, you never have certainty on close, right? So why would we negotiate-
Yeah
... $10 million term sheet when we've got to go get $4 million from somebody else, and then we can't get it? And so partners, you 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-
Right
It's very, very difficult to get there.
Right, I guess-
Ensure 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 exercise, you know, fulfill that commitment.
Right. Right. Okay, so, I just... I've, I've got a couple questions on the, the, like, the balance of financial statements. If, so... So in your, in your, news release, you said, loan book of CAD 43-CAD 44 million, basically, right?
Yep.
And then if I look at... So is that, what date is that? Is that as of March thirty-first?
As of March.
Pardon?
Sorry, as of March 31st.
Okay, and you get 16% on that?
Yeah, the loan book now is closer to CAD 46 million-
Okay
... at fair value. So, and that includes ECLs and stuff, so those are, you know, 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 CAD 50 million. Am I, is that correct?
Yeah. Hold on, let me... I don't actually have it.
There's two buckets for investment.
Yeah.
There's current portion and non-current, so.
Yeah. Yeah, so sorry, Ed. So our loan book, both current and long-term, we have-
Sure
... over $6 million in warrants. We have $7-ish million in a long-term cash asset, tax asset, I should say.
Oh, okay. Okay.
Yeah.
So 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, though, that would, that would kind of suggest that you have anyways, it's all, it's broken down, but-
Yeah.
You have a number of, some gains in there too, right?
Order.
Yeah.
We have the deferred tax asset.
Yeah.
You know, so there's
Right.
It's pretty clear on the balance sheet. It's, you know, the other thing, you know, IFRS while the income statement is challenging to sometimes decipher, given the changes in balance sheet run through the income statement.
Right.
The balance sheet's pretty simple and pretty clean and pretty easy. You know, one of the things that you'll note, I was just noting compared to 2021, we had an accumulated deficit at the time of CAD 38 million. It's down to CAD 14 million. 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 about CAD 300 thousand in tax. So I'm wondering, how does the tax—you've got a tax asset of CAD 8 million.
Yeah.
But you're paying, you're showing tax, so how, how, how-
Yeah, so, so you-
Is that a cash tax or just the, like?
Yeah, it just shows that that was taxable, but then that's netted out against the loss, and so you don't pay any cash taxes. So it's an expense, but it's not a cash expense.
Oh, okay. Okay. And then, yeah, the final question is just, you know, tactically, so you've got about CAD 8 million cash on the balance sheet, right?
Yeah.
And you're also borrowing through, you know, preferreds and anyways, your, your cost of borrowing is 10, 10, 11%, I guess, with the, the debt, debentures and stuff like that. So, like, do you wanna keep, keep, like, the CAD 8 million cash, given your pay 10%, you know, cost of capital for that? Or-
Yeah.
Does it make sense to run that to near zero and then maybe have a line of credit if you have needs or...?
Yeah.
What's your philosophy? Like, how much cash do you want on the balance sheet? What are you comfortable with? Where do you want to... Yeah.
Sure. So that's a great question, Ed. It's kind of a, you know, I do want to mention. I mentioned our last call that our debenture pays a floating rate of 10.5 or up to 11, if the investor has over $1 million 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 the space is funded through LP GP structures and debt. So if you're in an LP GP structure, which means, you know, a locked up 8-year limited partnership, you... That limited partnership investor is first loss capital.
On top of that, so let's say there's CAD 100 million in LP money, and then there's another CAD 100 million in debt. That LP investor is the first loss. In our case, we're not an LP GP, we're a public company. But what we have is equity, CAD 38.5 million of equity. 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 debenture that we use, and it's gonna be our primary funding vehicle, not the only, but the primary funding vehicle for the foreseeable future. That debenture, which pays 10.5%-11%, is supported by almost CAD 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 debentures are at risk. And that's very unusual and very, very, very much better than any of the LP GP models you'll see out there. If you're an LP investor in a, in a, you know, growth, whether it's venture capital or venture debt or 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-
Right. Right.
Sorry, just for investors, our debenture is redeemable on demand after a short period of hold. It's RSP eligible, and it's senior to CAD 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 on the debentures come down. So we've managed that spread, and it's somewhere between 6%-7% of growth's 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, it's 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%-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 loan, our current number of investments, 'cause 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 CAD 1 million on a loan at some point, I expect that over that same period of time, we'll make CAD 2 million or CAD 3 million back in terms of the warrant book. So it's a broadly diversified strategy. The investors have security in terms of debenture and security in terms of first loss capital below them, and management and the board are exposed at that equity level.
From my perspective, if we're taking care of book value and shareholders and shareholder value, by definition, we're taking very, very good care of the redeemable debt holders.
Yeah, no. And that instrument is great, is good for both sides, right? Especially the investors at over 10%. And, but, given the health of the balance sheet that you know, the CAD 40 million equity that you talked about, would it be possible for Flow to, like, have a bank line in case, you know, they need, you need, say, CAD 5 million for something? Like, just- I'm just wondering about-
Sure.
Do you really want, do you really want CAD 10 million cash sitting on the balance sheet?
Yeah.
Is that a good use of capital? Or, like, I know you need it because you have loans in the pipeline and stuff at the moment, but,
No, 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 and even higher free cash flow, right? Because it automatically-
Right.
fall into 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.
Right.
So that's gonna, over time, isolate some profitability and gains to our warrant book. 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 $2 million. 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.
Yeah.
And, you 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 stack are well protected. So, I wanna keep... I'm gonna keep hammering that point, that our redeemable debenture 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 have taken comfort in, and that for probably the last four years, we've carried an average cash balance of somewhere between CAD 8 million and CAD 10 million. That will decline over time, and we will become more cash efficient with a more senior line to help us.
Yeah. No, that makes a lot of sense as you, as you mature as the company, right? So,
Yeah.
And then I guess the final... And just, this is the point you were making, like you were saying, your loans are non-amortizing, right?
Yeah.
Is that because your borrowers, you know, typically, they're looking for an exit in three or five or whatever years. They have-
Yeah.
And so from, from that point of view, if you're looking at that exit as the company, 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, is that the way they look at it?
Yeah. 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 like... 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.
Okay.
But look, think of it from this way, as I mentioned, if you... Let's say we give somebody a $3.6 million loan, and that's amortizable, it's a three-year loan.
Yeah.
They're gonna be paying interest and then $100,000 per month of amortizing down the principal. So instead of just paying, I don't know, 20, whatever, you know, $10,000, $20,000, $30,000 a month in interest, whatever the number is.
Sure.
They're paying $130,000.
Yeah.
From their perspective, they get CAD 3.5 million, but they don't actually have the use of it, and they have this massive amortization charge every month.
Yeah.
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, it's 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 CAD 125,000 a month, and for us, you're paying out CAD 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 you're trying to achieve with our capital. So that's how, from both parties, a 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 6-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. Makes a lot of sense. So-
Yeah, because a lot of the-
Sorry, did that answer your question?
No, exactly. You know, because I think a lot of those growth companies, like, kind of the hurdle, you know, target the growth target for all these companies is break even. Like, they don't really... You know what I mean? They want growth, and they want break even, right, in terms of cash flows. So an amortizing loan is really a pain because, you know, as long as they're break even, they're very attractive, in terms of an exit or, or going public or whatever, right?
Yes.
You know, but the amortizing loan, like you said, it really pinches them in terms of cash flows, so.
Yeah, exactly.
You know, thanks. That's great. I learned a lot about the business today, and congrats again on a great quarter, and look forward to more news ahead.
Ed, thanks just for your long-term support. Love having you on board and, yeah, we look forward to stronger numbers and continued growth over the coming future. So thanks very much.
Given the discount with book value, about 50%, is the share buyback, is that, that's-
Yeah.
Is that extra cash? Yeah.
Yeah, we continue to use. We've had an issue. I think I mentioned last call, we probably bought back 16 or 15 or 16 or 17 million dollars, shares, kind of 8 million dollars worth of shares over the last 4 years. We'll continue to do that. From our perspective, if we can buy shares here at 50, 55, 60, you know, 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 gonna continue to be buyers of our shares. So yeah.
Yeah. I'm in. I like, I love that. So, okay, great. We'll talk in the future again. Congrats on a great quarter.
Thanks.
Okay. See you all.
Operator, I think that's it.
Yes, there are no questions. 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.