FS KKR Capital Corp (FSK) 2017 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the FS Investment Corporation's Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note that this conference is being recorded.

At this time, Dominic Mammarella, Director of Investor Relations of FS Investments, will proceed with the introduction. Mr. Mammarella, you may begin.

Thank you, Lisa. Good morning, and welcome to FS Investment Corporation's Third Quarter 2017 Earnings Conference Call. Please note that FS Investment Corporation may be referred to as FSIC, the Fund or the Company throughout the call. Today's conference call is being recorded and an audio replay of the call will be available for 30 days. Replay information is included in the press release that FSIC issued on November 9, 2017.

In addition, FSIC has posted on its website a presentation containing supplemental financial information with respect to its portfolio and financial performance for the quarter ended September 30, 2017. A link to today's webcast and the presentation is available on the Investor Relations section of the company's website at www.fsinvestmentcorp.com under Presentations and Reports.

Please note that this call is the property of FSIC. Any unauthorized rebroadcast of this call in any form is strictly prohibited.

I would also like to call your attention to the customary disclosure in FSIC's filings with the SEC regarding forward-looking statements. Today's conference call includes forward-looking statements, and we ask that you refer to FSIC's most recent filings with the SEC for important factors that could cause actual results or outcomes to differ materially from these statements. FSIC does not undertake to update its forward-looking statements unless required to do so by law.

In addition, this call will include certain non-GAAP financial measures. For such measures, reconciliations to the most directly comparable GAAP measures can be found on FSIC's third quarter earnings release that was filed with the SEC on November 9, 2017. Non-GAAP information should be considered supplemental in nature and should not be considered in isolation or as a substitute for the latest financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be the same as similarly named measures reported by other companies. To obtain copies of the company's latest SEC filings, please visit FSIC's website.

Speaking on today's call will be Michael Forman, Chairman and Chief Executive Officer of FSIC; Brad Marshall, Senior Portfolio Manager of FSIC and the Senior Managing Director at GSO/Blackstone, FSIC's investment subadvisor; and Chris Condelles, Executive Vice President of FS Investments, who will be standing in for Jerry Stahlecker, who is traveling. Following the remarks, we will open the call for questions.

I will now turn the call over to Michael.

Thank you, Dom, and welcome, everyone, to FS Investment Corporation's Third Quarter 2017 Earnings Conference Call. We appreciate your interest in FSIC.

On today's call, I'll provide a summary of FSIC's key highlights and strategies. After which, Brad will provide an overview of our investment activity. Then Chris will discuss our financial results in greater detail.

I would like to begin by welcoming Brian Gerson to FS Investments. Brian joined the investment management team early this week as Head of Private Credit. He will oversee our expanding BDC platform and work closely with our current team and subadvisor, GSO. We're excited to have him on board and believe he will be a valuable part of the FSIC franchise. With that, I will begin my prepared remarks.

Net investment income for the third quarter of 2017 was $0.21 per share compared to $0.19 per share for the second quarter of 2017 and $0.20 per share for the quarter ended September 30, 2016. Adjusted net investment income for the third quarter of 2017 was $0.21 per share compared to $0.19 per share for the second quarter of 2017 and $0.20 per share for the quarter ended September 30, 2016. As of September 30, 2017, FSIC's total accumulated undistributed net income -- net investment income on a tax basis was approximately $0.54 per share.

FSIC's net asset value as of the end of the third quarter was $9.43 per share compared to $9.30 per share as of June 30, 2017. The rise in NAV was driven primarily by the net change in unrealized depreciation in certain of our equity and subordinated debt positions. It is important to note that we, along with our Board of Directors, work with independent third-party valuation service providers to mark 100% of the investment portfolio to market each quarter.

The market remained relatively aggressive during the third quarter as robust competition among lenders led to further spread compression and borrower-friendly terms. Given this competitive backdrop, we continue to focus on investing at the top of the capital structure and avoid it stretching for yield. In fact, first lien senior secured loans represented 98% of third quarter purchases. By comparison, first lien senior secured loans represented 80% and 89% of second quarter 2017 purchases and third quarter 2016 purchases, respectively.

While our defensive posture in a traditional unit-charged market is obvious, we believe there continues to be opportunities to enhance our distribution coverage. To help improve coverage, we remain committed to rotating out of nonincome-producing equity and identifying compelling opportunities.

With that, I will now turn the call over to Brad to discuss our investment activity during the quarter. Brad?

Thank you, Michael. The third quarter of 2017 closed on a strong economic note as U.S. GDP was estimated to have grown by 3% and second quarter GDP was revised upward to 3.1%. Moreover, synchronized economic growth appears to be continuing across major global regions. While we do expect to see some impact from the damaging hurricanes, we believe it will be contained geographically and within certain sectors and will not have a lasting effect on any of FSIC's portfolio companies.

For FSIC, despite a fairly aggressive market, the third quarter saw a steady pace of deal activity as we continued to rotate over more junior depositions and into senior secured investment opportunities, reflecting our view that now is the time for caution. Apart from an upsize in some of our existing investments, all of our new investments during the quarter focused on first lien senior secured loans at yields that were comparable to those of the previous quarter.

As of September 30, 2017, the gross portfolio yield prior to leverage and excluding nonincome-producing assets was 10.3%, down from 10.4% for the prior quarter and up from 10.2% for the quarter ended March 31, 2017. The average leverage for our direct originations through the respective tranche in which we invested, excluding equity and collateralized securities, was 4.8x, up from 4.7x in the prior quarter.

Total purchases for the quarter were $183.4 million, 98% of which were first lien senior secured loans. Exits of $225.5 million during the third quarter were driven by the repayment of certain directly originated investments. Portfolio activity in the fourth quarter is likely to be in line with that of the third quarter of 2017.

As of September 30, 2017, we had 3 companies on nonaccrual, which, in aggregate, represented 0.3% of the portfolio based on fair value and 0.5% of the portfolio based on amortized cost. The majority of our nonaccrual exposure is held in one name, that subsequent to the end of the third quarter, announced a revision to its capital structure that we believe will support an increase in the valuation from the quarter end mark. In addition, we evaluate the accrual status of the investment once the deal is closed and finalized.

Our equity exposure during the third quarter increased modestly to 14% of the portfolio as of September 30, 2017, primarily as a result of improved marks. As we have highlighted in previous quarters, we work hard as an equity owner and have many tools at our disposal in order to maximize our recoveries in the event of default. In fact, since the inception of FSIC, we have had, on a cumulative basis, a positive recovery on assets that have experienced an event of default.

Although we did not realize any equity monetizations during the third quarter, we did make progress. Subsequent to the quarter end, we received a paydown of our equity position in Aquilex, which produced a 14% IRR for FSIC. We continue to progress towards realizations of several of our other nonincome-producing equity positions and expect to report positive development in the coming year.

Let me now return -- turn to our energy portfolio. Energy-related investments as of September 30, 2017, comprised approximately 7% of FSIC's investment portfolio based on fair value, unchanged from the prior quarter. The net change in unrealized depreciation on energy investments during the third quarter of 2017 totaled approximately $4.1 million or $0.02 a share. Our 2 largest energy names, Ascent Resources and FourPoint, continue to operate as planned and remain very well capitalized.

Going to the next quarter, we continue to believe that discipline and selectivity in a complacent market will be the foundation for future success.

I will now turn the call over to Chris to provide additional details on our results.

Thanks, Brian. Net investment income for the third quarter of 2017 was $0.21 per share compared to $0.19 per share for the second quarter of 2017. Adjusted net investment income for the third quarter of 2017 was $0.21 per share compared to $0.19 per share for the quarter ended June 30, 2017. The income during the third quarter was lower than the previous quarter, primarily due lower direct origination prepayments. Fee and dividend income totaled $6.3 million in the third quarter of 2017 compared to $9.5 million in the second quarter and $4.2 million in the quarter ended September 30, 2016.

In the third quarter of 2017, we declared a regular quarterly distribution of approximately $0.22 per share, which was paid on October 3, 2017. For the fourth quarter of 2017, we declared a regular quarterly distribution of $0.19 per share to be paid on or about January 3, 2018, to stockholders of record on December 20, 2017. NAV was $9.43 per share as of September 30, 2017, compared to $9.30 per share as of June 30, 2017.

Net change in unrealized depreciation on investments during the third quarter of 2017 totaled approximately $53 million or approximately $0.22 per share, which is primarily attributable to the depreciation in certain of our equity investments. Net realized losses during the first quarter were $18.2 million or approximately $0.07 per share, driven primarily by the restructuring of Paw Luxco, also known as Jack Wolfskin. At quarter end, FSIC's debt to equity ratio was 74.4% compared to 75.3% as of June 30, 2017.

I'll now turn the call back over to Michael.

Thanks, Chris, and thank you to everyone on the phones for your trust and investment in FSIC. We remain committed to our investors, and we'll work hard on their behalf over the coming quarters to position the portfolio to generate the best possible returns.

With that, we'll now open the call for questions.

(Operator Instructions) Your first question comes from the line of Terry Ma with Barclays.

Can you just talk about how you think about earnings growth going forward in this environment? You guys continue to experience net repayments and reinvestment spreads are also lower. So as we think about the dividend year out, do you think you guys can earn it or adequately maintain coverage for it?

Sure, Terry. It's Chris. I'll start with that one. Yes, I think what we said on prior calls was that part of repositioning our dividend rate was because we felt that $0.76 per annum was a sustainable rate. If you look at the portfolio yield over this quarter, we only had 10 basis points of degradation in that number, so we've had pretty healthy yields in the portfolio. We also believe that there's significant growth in distribution coverage as we rotated our equity portfolio, and we believe that there's a good portion of that portfolio that will get monetized in the next 12 months and then in the preceding 12 months. So we think there's some income growth there. We're also probably slightly underutilized in our non-eligible asset bucket, so there's ways to further generate value. And I don't know, Brad, if you want to add to that.

Yes.

Can you maybe just quantify the monetization of equity in the next 12 months? And can you maybe just put a number under an estimate? And how we should maybe think about that going forward?

Sure. I can take a stab at that. Terry, it's Brad. We have about 7 companies that are for sale or we'll be launching a sales process in the next 3 months. We think that, that makes up probably about half the portfolio going into next year. Timing is always tricky, but those would be the rough kind of parameters that we're seeing anyways in the portfolio. We pulled one process recently because we had a positive announcement in the portfolio of companies that will materially change the company's earnings to the upside. But apart from that, everything's kind of on schedule, and we just can't pinpoint the exact timing.

Your next question comes from the line of Rick Shane with JPMorgan.

A pretty straightforward quarter, so not a lot of questions here. You did mention that there was an equity realization, Brad had mentioned, at the -- during this quarter. 14% IRR, I am curious where that realization came versus the most recent quarter mark just so we can think about how to adjust our NAV?

The company was Aquilex, as I mentioned on the prepared remarks. And where it came out to the market, I think it's pretty close and it's a fairly small part of the overall portfolio, so it shouldn't change your model that much.

Your next question comes from the line of Jonathan Bock with Wells Fargo.

Joe Mazzoli filling in for Jonathan Bock. Just a follow-up on Terry's question about equity rotation. So broad valuation multiples are higher everywhere, and it's kind of late cycle and BDC investors, in general, prefer senior secured exposure. And of course, FSIC has been focusing more on senior secured assets. So the question relates to your ability to kind of drive the process here. Given that you're a minority owner in most of these situations, can you provide a little bit more information about your ability to put these companies for sale as ASG, PSAV or Mood Media?

I'll try and take that, Joe. I think, as I said with Terry's question, what we do have is a decent visibility on the process that certain companies are taking to sell themselves. And whether or not we have influence on that is a little bit less relevant. I think what's more relevant is the timing that we see on those existing companies and it's the schedule, which I laid out in respect to answering Terry's question. The good news is, as we've said before, 90% of the companies where we own equity are performing at or exceeding their plan. So everything is, for the most part, heading in the right direction.

Okay. That's very helpful. The next question relates to Spencer Gifts. So this is the second lien loan that was marked down or was previously marked down moderately, but it was further marked down from $19 million to $15 million, so not a large investment. But I'm curious, I know this -- especially with the Spirit pop-up stores, I think October is a very big month for this company historically, even in relation to the total earnings. So what kind of drove the markdown? Was this related to October results?

Spencer is a publicly-traded security, and the mark reflects where that loan was trading at the end of the quarter. And just to point out the obvious, Halloween falls after the end of the third quarter.

Okay, sure. And then just as a final question, with the stock still trading at a pretty sizable discount to net asset value, what are your thoughts about implementing a stock repurchase program, given that buying the stock at these levels is highly accretive to net asset value? Of course, this would be a complementary to new origination activity.

Sure. Thanks, Joe. It's Chris here. Yes, we recognize that given the discount to NAV, there could be compelling opportunities to purchase our stock back. We continue to evaluate putting in a share repurchase program, but we have to weigh that against where we are within the leverages of fund, our pipeline and continuing to deliver capital to long-term sponsors of ours and also managing our rating. So it's something we continue to look at. Today, on an NAV basis, it's about a 9.4% yield. We've been able to originate a little bit north of that. So it's on our minds, but nothing definitive at the moment.

(Operator Instructions) Your next question comes from the line of Ryan Lynch with KBW.

I just have one this morning. When I look at your interest income lines, so forgetting about fee income, which is pure interest income, it jumps substantially quarter-over-quarter, meanwhile the portfolio growth that you guys have had a little bit net repayments in the quarter. So can you talk about what drove the big increase in net interest income from around $89 million in the prior quarter to about $97 million this quarter? And what should that kind of run rate look like going forward, assuming the portfolio stays relatively flat from here?

Sure, Ryan. It's Chris. Thanks for the question. The increase in interest income is a result of a prepayment on our ASG debt, so that's an acceleration of our OID. And I think you can expect our interest income to be in line with prior quarter, so it's about $66-ish million there from ASG.

Thank you all for your participation on the call this morning. We appreciate the support and the loyalty and look forward to talking to you all on the next quarterly call. Thank you, operator.

This concludes today's conference. You may now disconnect.