Oaktree Specialty Lending Corp (OCSL) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2016 Fifth Street Finance Corp. earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Ms. Robyn Friedman, Head of Investor Relations. Ma'am, you may begin.

Thank you, Taraya. Good morning and welcome to Fifth Street Finance Corp's second-quarter 2016 earnings call. I am joined this morning by Todd Owens, Chief Executive Officer; Ivelin Dimitrov, President and Chief Investment Officer; and Steven Noreika, Chief Financial Officer.

Before we begin, I would like to note that this call is being recorded. Replay information is included in our May 10, 2016, press release and is posted on the investor relations section of Fifth Street Finance Corp's website, which can be found at fsc.fifthstreetfinance.com. Please note that this call is the property of Fifth Street Finance Corp.

Any unauthorized rebroadcast of this call in any form is strictly prohibited. Today's conference call may include forward-looking statements and projections that reflect the Company's current views with respect to, among other things, future events and financial performance.

Forward-looking statements may include statements as to the future operating results, dividends, and business prospects of Fifth Street Finance Corp. Words such as believes, expects, seeks, plans, should, will, estimates, projects, anticipates, intend, and future or similar expressions are intended to identify forward-looking statements, although not all forward-looking statements include these words.

These forward-looking statements are subject to the inherent risks and uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ materially from those projected or implied in these forward-looking statements.

New risks and uncertainties arise over time, and it is not possible for the Company to predict those events or how they may affect it. Therefore you should not place undue reliance on these forward-looking statements.

We ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. To obtain copies of our latest SEC filings, please visit our website or call investor relations at 203-681-3720.

FSC undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise except as required by law. The format for today's call is as follows.

Todd will provide an overview of our results and outlook, and Steve will summarize the financials. Then we will open the line for Q&A. I will now turn the call over to our CEO Todd Owens.

Thank you, Robyn, and good morning, everyone. For the quarter ended March 31, 2016, FSC generated $0.17 of net investment income per share, which is slightly below our quarterly dividend of $0.18 per share.

Our net investment income was impacted by low origination volumes, limited turnover in our portfolio, and substantially higher professional expenses, partially offset by the reduction in our base management fee. Despite lower than normal volumes during the quarter, our net investment income would have covered our dividend for the fifth consecutive quarter if adjusted to exclude incremental professional fees.

The quarter was also marked by greater credit stability in our proposal and a steady amount of loans on nonaccrual. Additionally, as part of our focus on delivering strong returns for our shareholders, we continued to repurchase our shares, and operated within our targeted leverage ratio of 0.6 to 0.8 times debt to equity.

Over the course of 2015 we took a number of actions to maximize shareholder value, and renewed our focus on driving a strong sustainable performance for our shareholders. That focus has continued in the March quarter, as we took additional steps to drive shareholder value.

In January we permanently reduced FSC's base management fee on total gross assets from 2% to 1.75%. As a result shareholders benefited through and over 10% decrease in management fees paid to our manager this quarter.

As we've previously mentioned, we do not pay management fees on cash, and we have an 8% hurdle rate on our incentive fees, both of which compare favorably to the fee structures in the industry. For the second quarter in a row the 8% hurdle rate benefited our shareholders immediately.

Additionally I am pleased to report that we repurchased approximately $15 million of common stock in the open market this quarter, which was $0.07 per share accretive to our NIV. Since the end of the March quarter we have repurchased an additional $10 million of common stock, bringing the total repurchase this calendar year to $25 million.

These repurchases, combined with the $20 million that we repurchased in the fourth fiscal quarter of last year, represent north of 5% of our public float at today's prices. Following the trend observed in 2015, the middle market experienced its weakest quarter for sponsored loan volume in six years.

Sponsored issuance was down 45% from the December quarter and 31% on a year-over-year basis. Deal volume during the quarter was mainly driven by LBOs and other M&A transactions as there were very few refinancings that occurred.

Several factors contributed to the slowdown in the March quarter, including volatility in the energy and commodity sectors as well as in the credit markets generally, slowing global growth and an uncertain economic outlook. Many of our private equity sponsors took a wait and see approach in the quarter given the lack of quality deals and lofty valuations.

Consistent with the broader market environment, we experienced muted origination volumes, closing $107 million of investments in four new and five existing portfolio companies. We also experienced substantially lower than normal turnover in our portfolio.

While January and February were particularly slow, we were encouraged by an increase in activity as the quarter drew to a close, and are optimistic for an uptick to in-deal flow in the quarters ahead. As we look at the credit profile of our portfolio, we feel confident about the overall quality of our loans and the performance of our portfolio companies.

Our portfolio remains conservatively positioned and well diversified, with approximately 80% of the portfolio consisting of senior secured loans, with investments in 127 portfolio companies. Our energy exposure remains low, with only 1.8% of our portfolio at fair value spread across three companies. In addition, we have no CLO exposure debt or equity.

As we had previously mentioned, we placed Ameritox on nonaccrual status in the December quarter. Our portfolio management team worked closely with the company and its sponsor owners to restructure the investment.

And subsequent to the end of the March quarter, we entered into an agreement whereby we took majority control of the company. We feel comfortable with our current valuation level, and anticipate moving it off nonaccrual in the June quarter.

On a more positive note, the fair market value of our investment in Yeti has increased meaningfully, as that company has continued to rapidly grow and execute on its business plan. Additionally, I would like to take a moment to highlight the recent exit of an investment that illustrates our team's ability to prudently manage assets and realize gains when a market opportunity presents itself.

Subsequent to the end of the quarter, FIrst Star Aviation, a wholly owned portfolio company of FSC, sold one of the plans in its portfolio. The sale price was higher than the original purchase price, and when you factor in the lease payments made over the life of the whole period we realized a high teens gross IRR.

This is just one example of the great work our team has done to deliver strong, tangible results for our shareholders. As I mentioned at the outset, and similar to the December quarter we incurred higher than professional expenses in the March quarter related to the pending litigation at FSC and preparation for our annual meeting.

Excluding the incremental professional expenses, we would have generated $0.18 of net investment income per share, which would have covered our quarterly dividend for the fifth consecutive quarter. As was the case when we set the quarterly dividend at $0.18 per share a year ago, the Management team and the Board of Directors remained confident that our net investment income can regularly meet or exceed our dividend.

Going forward we anticipate that our professional expenses will decrease, although such expenses could remain at elevated levels due to the pending litigation. Despite the recent challenges we have faced, we are today increasingly optimistic about FSC's future prospects and are pleased with our repositioning over the past year.

The strategic actions taken during the March quarter, combined with the prudent deployment of capital and investments with strong risk-adjusted returns and consistently earning our dividend, will drive value for our shareholders. We look forward to providing updates on our progress as we continue to focus on generating steady results and executing on strategic initiatives to enhance shareholder value. I would now like to turn the call over to our Chief Financial Officer, Steve Noreika, to discuss our financials in more detail.

Thank you, Todd. We ended the second quarter of 2016 with total assets of $2.4 billion, down from $2.6 billion at FY15 end. Portfolio investments totaled $2.3 billion at fair value, which were spread across 127 companies at March 31, 2016.

At the end of the March quarter, we had $134.5 million of cash and cash equivalents on our balance sheet. Net asset value per share was $8.33 as of March 31, 2016.

That's compared to the net asset value per share of $8.41 at the end of the December quarter. NAV was impacted this quarter by a few factors, including a credit and spread-related write down of $0.14 per share, of which over one-third was due to movements in quotes.

And that was offset by $0.07 per share of accretion from our share repurchases during the quarter. I would like to note that while the high yield market rallied prior to the close of the March quarter, the index that we utilize in our mark-to-market process, the LCD middle-market index, generally lags the broader market and therefore was down slightly for the quarter.

Subsequent to quarter end, we have seen the LTD index followed the broader market in a positive direction. We ended the December quarter at a 0.77 times debt to equity ratio within our target range.

Subsequent to the end of the March quarter, we successfully repaid our $115 million of unsecured convertible notes, using capacity under our ING revolving credit facility. We estimate that this will be $0.02 per share accretive to earnings on an annual basis.

For the three months ended March 31, 2016, we generated total investment income of $59.6 million. The quality of our income continues to be high, as net PIK, which is PIK accruals recorded in excess of PIK payments received, represented only 4.5% of total investment income.

Net investment income was $25.3 million for the quarter ended March 31. During the quarter, we closed $106.6 million of investments in four new and five existing portfolio companies, and we received $49.9 million in connection with the full repayments of four of our debt investments, all of which were exited at or above par.

We also received an additional $78.3 million in connection with paydowns, syndications, and sales of debt investments. The credit profile of the investment portfolio continues to be solid, as over 95% of the portfolio at fair value was ranked in the highest one and two rating categories.

As Todd previously stated, I would also like to point out that one of the loans in category four, Ameritox, was restructured subsequent to quarter end, and we expect that it will return to accrual status in the June quarter. Ameritox represented approximately 3% of our debt portfolio at fair value at March 31.

We believe that we are conservatively positioned relative to our peers, with 92.8% of the portfolio at fair value consisting of debt investments, 79.9% of the portfolio invested in senior secured loans, 80.4% of the debt portfolio consisting of floating rate securities with no CLO investments and limited energy exposure at quarter end. FSC's joint venture with an affiliate of Kemper Corporation continues to perform well, generating a 10.4% weighted average annualized return on FSC's investments during the quarter.

As of March 31, 2016, the joint venture had $429.2 million of assets, including investments in a range of one-stop and senior secured loans to 38 portfolio companies. For the March quarter, the weighted average yield on FSC's debt investments, including the joint-venture return, was 10.3%, with the cash component of the yield making up 9.8%.

At March 31, the average size of the portfolio debt investment was $20.3 million, the average portfolio company EBITDA was $39.5 million, and our top 10 portfolio company investments represented 29.5% of total assets. Last week our Board of Directors declared monthly dividends of $0.06 per share for June, July, and August, consistent with the last four quarterly dividends.

We expect our Board of Directors to continue declaring monthly dividends on a quarterly basis subject to various factors, including Company performance, capital availability, level and timing of share buybacks, as well as general economic and market conditions. I will now turn it back over to Robyn.

Thank you for joining us on today's call. Taraya, please open the line for questions.

(Operator Instructions)

Leslie Vandegrift, Raymond James.

Good morning.

Good morning, Leslie.

So just first question, just quick color on originations and repayments in the quarter. I know they were low for you, it seems to be a trend going on in the market right now. Can you talk a little bit about what you saw this quarter and if you're seeing a bit of front load fill in the second quarter after that?

Happy to take the question. The March quarter was very slow. Interestingly it was slow in terms of portfolio turnover as well as slow on the originations side.

And the consequence of that was that we stayed pretty close from a debt to equity perspective. And as I said in the prepared remarks, we saw a meaningful uptick in activity as we headed into the end of the quarter, and that has continued into the now June quarter.

And so we are expecting a higher level of activity in both regards, originations and portfolio turnover, refinancings, and so forth. And we think that -- we think we're going to rebound from very, very low levels in the March quarter to more normal levels in the June quarter.

Thank you. And on the professional fees, I know you mentioned in your prepared remarks that they were higher on some of the legal actions right now. Is that the entirety of that increase, or can you give some color on that breakdown?

The incremental professional fees are related really to two things; principally the litigation, the class-action lawsuit that is still pending, but as well related to preparation for our annual meeting.

So just the one quarter [thing more].

As it relates to the shareholder -- the shareholder meeting for FSC is behind us, and so we don't expect any incremental costs there. And so we -- that's at least part of the basis for us saying that we expect those professional costs to decline, although the class-action litigation is still pending.

And then last question for me this morning. I know you were at $225 million on the SBA debentures, and while there may not be a large proportion for you, looking into getting up to $300 million on that second license. Any color there?

I'm going to let Steve take that one, Leslie.

It is an interesting opportunity. Currently we do have a meaningful cash balance in our SBA entities due to some repayments that we've had that we would like to deploy before we look any further into increasing the license.

Okay. Thank you for the color.

Thanks very much.

Doug Mewhirter, SunTrust.

Good morning. Just a couple of questions. First, for your adjusted income number, just a clarification.

I saw you report that on a basic share basis. Is there a reason why you did not report on a diluted share basis?

We generally view the P&L on a non-diluted basis. Doug, if you want to take it offline we can certainly recalc that for you. But there is no particular reason we didn't. That is just not the way we analyze our P&L.

Okay. Thanks. Moving on to Ameritox, I guess it was already on accrual this quarter.

If I read it correctly it sounds like was there a mix of debt and equity in the new restructuring? And would there be any incremental I guess interest that would come back onto the P&L in the next quarter from Ameritox, the new structure?

I can give you a little color on that. Yes, we exchanged our debt investment for a debt and equity component, and there will be a cash interest earning portion of debt along with that.

Okay. And also the share repurchase, I know you're up maybe toward -- you are still within the debt to equity range, and there's some more activity. But is there any room for more additional share repurchases beyond what you did subsequent to the end of the quarter?

I think there is room for additional repurchases as and when we decide to pursue that with our Board. But as we get nearer the top end of our range, it does reduce somewhat our flexibility there.

Or maybe another way to put it, it does become a factor that we think about. As we mentioned, we have already completed $10 million of repurchases in this quarter.

That is to say the June quarter, notwithstanding where we were from a leverage perspective. So obviously the 77% debt to equity ratio does not preclude us from doing buybacks, which we've actually already completed meaningfully in this quarter.

Thanks, that is all my questions.

Thank you, Doug.

(Operator Instructions)

At this time I am showing there are no further participants in the queue. I would like to turn the call to Management for any closing remarks.

Thanks to everyone for joining us this morning.

Ladies and gentlemen, thank you for your participation on today's conference. This concludes your program. You may now disconnect. Everyone have a great day.