Medley Management Inc.
Q3 2017 Earnings Call Transcript

Published: 14 Nov 2017

[Operator:]

Welcome and thank you for joining Medley Management Incorporated Third Quarter 2017 Earnings Conference Call. Today’s call is being recorded. Please note that this call is the property of Medley Management, Incorporated and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone numbers and PIN provided in the Company’s earnings press release. At this time, all participants are in a listen-only mode, but will be prompted for a question-and-answer session following the prepared remarks. On the call today is Brook Taube, CEO; Rick Allorto, CFO. Before the call begins, the Company would like to call to your attention the customary Safe Harbor disclosure in the Company’s press release regarding forward-looking information. And today’s conference call may include forward-looking statements and projections, which are subject to risks and uncertainties. Any statement other than a statement of historical fact may constitute a forward-looking statement. Please note that the Company’s actual results could differ materially from those expressed by any forward-looking statements for any reason such as those disclosed in the Company’s most recent filings with the SEC. The Company does not undertake to update its forward-looking statements unless required by law. During this conference call, the Company will refer to certain non-GAAP financial measures, including fee earning assets under management, pre-tax core net income and core net income per share. The Company uses these as measure of operating performance, not as a measure of liquidity. These measures should not be considered in isolation from or as a substitute for measures prepared in accordance with the Generally Accepted Accounting Principles. In addition, these measures may not be comparable to similarly titled measures used by other companies. Please refer to Medley Management, Incorporated earnings release and Form 10-K for definitions and reconciliations of these measures to the most directly comparable GAAP measures. The Company has posted its third quarter 2017 investor presentation, which is available in the Investor Relations section of the Company’s website at www.mdly.com. I would now like to turn the call over to Mr. Taube.

[Brook Taube:]

Thank you very much operator, and welcome everyone to Medley’s third quarter 2017 call. This morning, we announced our financial results for the quarter ending September 30. Our core net income per share for the quarter was $0.09. On November 8, our Board of Directors approved a dividend of $0.20 per share that will be paid on December 6, to shareholders of record on November 24. Total AUM ended the quarter at $5.3 billion, which was up over $300 million or 6% year-over-year. Our fee earning assets under management was $3.2 billion at the quarter-end. Overall, we remain focused on building the business around a combination of permanent capital, long-dated private funds and separately managed accounts across our five investing disciplines. We do continue to see significant demand for yield solutions and that’s coming both from institutional and retail investors. Over the last 12 months, we’ve received over $400 million of commitments from institutional investors, and today, we have a strong pipeline of institutional demand for managed accounts. We also expect to launch our next private fund targeting senior loans in the early part of 2018. Our Sierra brand remains a leader in the retail channel, and we continue to expand our Sierra product offerings. I’m pleased to report that yesterday, we filed our fourth Sierra branded product, Sierra Real Estate Fund. We expect this vehicle will launch in 2018. Sierra Real Estate Fund will provide retail investors with diversified exposure to real estate through public and private investments. It is structured as an interval fund and will provide investors the benefits of the interval fund structure from a liquidity and distribution perspective. Sierra Total Return Fund, our corporate credit- focused interval fund, continues to make inroads into the broker-dealer channel, and we continue to receive very favorable feedback on the interval fund structure generally. We do look forward to reporting on the growth in Sierra Total Return Fund in the quarters ahead. We continue to expand our structured finance team and are in active discussions on further capital raise for that business in both institutional and retail channels. The expansion of our investment capabilities and products are important steps as we continue to diversify and grow our alternative asset management platform. I’d like to turn the call over to Rick now to give you an update on the financial performance for the quarter.

[Rick Allorto:]

Thank you, Brook. Our results from operations for the three months ended December 30 were as follows. Total revenues were $16.7 million compared to $18.9 million for the same period in 2016. Revenues consisted of $14.8 million of management fees, $2 million of other revenues and fees and negative $0.2 million of performance fees. The decrease in revenues was due primarily to a $1.6 million decrease in performance fees and a $1 million decrease in Part I incentive fees, which was partially offset by a $0.6 million increase in base management fees. Total expenses were $9.9 million compared to $15.6 million for the third quarter of 2016. This decrease was due primarily to a $5 million decrease in ESA expenses. Other expenses net was $1.6 million compared to other expenses net of $2 million in the third quarter of 2016. The favorable variance was due primarily to increase in dividend income, partially offset by an increase in interest expense. Pretax core net income was $4.7 million compared to $7.4 million for the same period in 2016. Core net income per share was $0.09 during the three months ended September 30, 2017 versus $0.14 for the three months ended September 30, 2016. Core EBITDA decreased by $2.2 million to $7.6 million compared to $9.8 million for the same period in 2016. That concludes my financial review. I’ll now turn the call over to Brook.

[Brook Taube:]

Thanks, Rick. Thank you all for joining today. Thank you all for the continued support. And operator, we can now open the call for questions.

[Operator:]

[Operator Instructions] And our first question comes from the line of Craig Siegenthaler from Credit Suisse. Your line is now open.

[Jordan Friedlander:]

Good morning, this is Jordan Friedlander filling in for Craig. First, thanks for the color on the product launches. Can you provide a little bit more color on the fund raising environment? How’s investor demand been shaping up for these new products?

[Brook Taube:]

Thanks, Jordan. This is Brook. We’re in the early phases of penetrating broker-dealer channel. What that means is we’re talking to the broker-dealer, signing selling agreements. And this process just takes time. If you look back on the launch of our prior Sierra Income Corporation, that’s just a ramp phase. As this year ends and 2018 picks up, we’ll have more color on the actual ticketing for Sierra Total Return Fund, but based upon the feedback from the channel, the interest in the interval fund structure and the continued demand for yield that we’re seeing, we would expect to get on that typical trend and have an increase in sales over the course of the quarters ahead.

[Jordan Friedlander:]

Thanks Brook. And just real quick to follow up. Given the relatively elevated refinance activity, where are you guys finding the most attractive opportunities to put good capital to work?

[Brook Taube:]

That’s a good question. We have seen a pickup in volume this year, both on the origination side and, obviously, on the prepay side. I’d say, year-over-year, our volumes in number and in total origination were up about 50%, but that’s – pickup in volume has been offset by the prepays. Our concentration has been and continues to be in first lien senior loans. These are floating rate and also largely sponsor backed. We’re able to find opportunities in our market segment that are attractive. Structures make sense, including covenants. We have seen pricing tightened like everyone but not as much as we’ve seen, both in terms of lower pricing and more permissive structures that seem to be happening more broadly in the liquid credit markets.

[Jordan Friedlander:]

Thanks Brook.

[Brook Taube:]

Thanks Jordan.

[Operator:]

And our next question comes from the line of Ann Dai from KBW. Your line is now open.

[Ann Dai:]

Hey, good morning. Thanks for taking my question. My first one is on the broader selloff in high-yield market over the past few weeks. I guess I was just wondering what your thoughts on that – are on that and what’s driving it. And then can you comment and any read across the conditions in the private middle market credit area, if there are any?

[Brook Taube:]

Thanks Ann. I don’t – we don’t have any particular insight into the short-term volatility of liquid markets. We’re not active in the high-yield market. At a high level, we saw a lot of demand pouring in. My guess is there’s just some outflows that will drive that. In terms of the private market, there continues to be an increase in competition and capital formation. The way that shows up is in terms of pricing and competition on a deal-by- deal basis. Our view sitting here today looking at the origination pipeline and volume that we’re seeing in the private markets are that we’ve seen stabilization. That is to say we don’t see pricing tightening substantially from here. We’re also seeing sensible structures, which include covenants. So we haven’t had as much pressure on the structure in the borrower’s favor that has been flowing through over the past 12 to 18 months. So on balance, we’re optimistic about the current dynamic, and we’ll see where the prepay market goes to offset that in the quarters ahead.

[Ann Dai:]

Okay, good color thanks. Second question is, I was hoping to get your thoughts on the tax reform proposals. Obviously, there’s still a lot of uncertainty out there, but I guess, based on the current proposals, I was just curious how you’re thinking about the limits to interest deductibility that have been proposed and how you think they could have an impact on the demand for loans for small businesses or how they might impact financial funds or behavior and the demand for financing from those channels.

[Brook Taube:]

Good question. We’re watching it like others. At a high level, our view is that the demand for capital in the form of loans in our market is likely to persist independent of the potential changes. On the margin, will it have an impact both in terms of behavior and how it’s treated? I think the answer is most likely it will have some impact. But our capital is an important piece of the capital structure in corporate America, both small and large. It remains attractive financing source, and we expect it will continue to be a big part of the balance sheet under any future state.

[Ann Dai:]

Okay. Great. Thank you. Last quick numbers questions for Nick – sorry, for Rick. On the fund reimbursement expenses, they just came in a bit higher than the guidance from last quarter. I was wondering if there’s anything onetime about this quarter’s number. Or is this a good run rate to think about for Total Return Fund?

[Rick Allorto:]

There was nothing unique in the current quarter. Looking forward, yes, I would use the Q3 number as a forward run rate.

[Ann Dai:]

Okay. Great. That’s it from me. Thanks.

[Operator:]

And our next question comes from the line of Casey Alexander from Compass Point. Your line is now open.

[Casey Alexander:]

I’m sorry, I may have just missed that last question. There was a sequential increase in the operating expense, which normally is associated with some comp related to performance fees, but there weren’t really any performance fees in this quarter. So do you have some color on the sequential increase in operating expense?

[Rick Allorto:]

Casey, could you clarify your question, please?

[Casey Alexander:]

Yes. I mean, the – from quarter-to-quarter, the operating expense went from $8.5 million altogether to almost $10 million. And so I’m curious as to what the sequential increase in operating expenses might have related to.

[Rick Allorto:]

Sure. From an operating expense point of view, included in those numbers are about $700,000 of ESA related to Sierra Total Return Fund, which is a core add-back, and then the incremental component of variance is about $200,000 increase in professional fees.

[Casey Alexander:]

Can you explain that ESA from the Total Return Fund a little better for me, please?

[Rick Allorto:]

Sure. We have a structure in place where we provide expense support subject to an expense cap, which is just a fixed ratio of Sierra Total Return Fund’s net assets. That’s the high level.

[Casey Alexander:]

Okay. Would we expect this number to decrease going forward?

[Rick Allorto:]

Yes, we would.

[Casey Alexander:]

As the assets increase. At what pace?

[Rick Allorto:]

It should decrease pretty sharply as the assets increase, given that the current fixed cost structure is already in place for the fund and the variable cost structure is relatively limited. And I do want to highlight, Casey, that, again, we have a similar structure, in which case there’s reimbursement provision and we expect to get this expense support back as Sierra Total Return Fund achieves greater scale.

[Casey Alexander:]

Okay. So some of that, hopefully, will come back in future quarters.

[Rick Allorto:]

Correct.

[Casey Alexander:]

And where would you say that the public vehicles are in terms of sort of resuming incentive fees paid to the manager?

[Rick Allorto:]

During this quarter, we received $1.3 million of incentive fees from Sierra Income Corporation, and we are in the catch-up phase of that formula. So there’s substantial room for that to continue to increase as Sierra Income Corp. generates additional net investment income. For MCC, there was no incentive fee during the quarter, and we are still being limited based upon the incentive – the cap that was put in place at the beginning of last year.

[Casey Alexander:]

Okay. Great. Thank you for taking my questions.

[Rick Allorto:]

You’re welcome.

[Operator:]

And at this time, I’m showing no further questions.

[Brook Taube:]

Great. Well, thanks, everybody, for your time. We appreciate the support. All of us wish you a happy holiday season and look forward to speaking again in early 2018. Thanks very much.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.