Medley Management Inc.
Q3 2016 Earnings Call Transcript

Published: 15 Nov 2016

[Operator:]

Welcome and thank you for joining Medley Management Inc Third Quarter 2016 Conference call. I'd like to remind everyone that today's call is being recorded. Please note that this call is the property of Medley Management Inc 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. And now, I would like to hand the call over to Sam Anderson, Medley's Head of Capital Markets and Risk Management, who will host this morning's conference call. Mr. Anderson, you may begin.

[Sam Anderson:]

Thank you, operator. Good morning, everyone, and thank you for joining us today for Medley Management's third quarter 2016 conference call. I'm joined today by Brook and Seth Taube, our CEOs; and our Chief Financial Officer, Rick Allorto. Before we begin, I want to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information, as today's conference call may include forward-looking statements and projections, which are subject to risks and uncertainties. Any statement other than the 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 reasons such as those disclosed in our most recent filings with the SEC. We do not undertake to update our forward-looking statements unless required by law. And during this conference call, we 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. We use these as a 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 generally accepted accounting principles. In addition, these measures may not be comparable with similarly titled measures used by other companies. Please refer to our earnings press release and our Form 10-K for definitions and reconciliations of these measures to the most directly comparable GAAP measures. We have posted our third quarter 2016 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 Brook.

[Brook Taube:]

Thanks, Sam. And welcome everyone to our third quarter 2016 conference call. Last night, we announced our financial results for the quarter ended September 30. The Company's core net income per share for the quarter was $0.14. On November 10, our Board of Directors approved a dividend of $0.20 per share that will be paid on December 5 to shareholders of record on November 22. Our total AUM ended the quarter at $5 billion, which was up over $1 billion or 25% year-over-year. Fee earning AUM at quarter end was $3.1 billion. I am pleased to announce that since our quarter end, we've been selected to manage nearly $500 million of new capital for new institutional investors. In addition to existing dry powder, this new capital will help grow our fee earning AUM in 2017 and beyond. As we said on our prior call, during the third quarter, we issued $25 million of 10-year notes subsequent to the quarter end, we issued an additional $28.6 million, bring the total to $53.6 million of outstanding 10-year notes. The net proceeds were used to reduce the outstanding balance on our term loan. We expect to access the public debt market in the future to ladder our maturities and strengthening our balance sheet as we continue to scale the platform. Overall, we continue to remain focused on building our business around a combination of permanent capital, long-dated private funds and separately managed accounts. Combined, we expect these sources of capital will drive revenue and earnings growth over time. Seth can speak further about our new product initiatives, which combined with our existing dry powder, position us well for growth in both assets under management and fee earning assets under management going forward. First, however, I'd like to turn the call over to Rick to give you a quick update on our financials.

[Rick Allorto:]

Thank you, Brook. Our results from operations for the three months ended September 30, 2016 were as follows. Total revenues increased by $13.4 million to $18.9 million compared to $5.4 million for the same period in 2015. This increase was due primarily to an accrual of performance fees for the three months ended September 30, 2016, compared to a reversal of performance fees for the same period in 2015. Management fees decreased by 16% or $2.9 million to $15.3 million compared to the same period in 2015. Total expenses increased by $11.7 million to $15.6 million compared to $3.9 million for the same period in 2015. The increase was due primarily to increases in performance compensation and higher expenses under our expense support agreement with one of our funds. Pre-tax core net income increased by $6.8 million to $7.4 million, core net income per share was $0.14 compared to $0.01 in 2015. Core EBITDA increased by $7 million to $9.8 million, compared to $2.8 million in the same period in 2015. That concludes my financial review. I'll now turn the call over to Seth.

[Brook Taube:]

All right. So this is Brook. I think there was a communication issue for us on the line. I'll take that from you Rick. During the third quarter of 2016, we continue to see consistent demand for our yield solutions from both institutional and retail investors. I am going to start on the retail side. Sierra Income Corporation raised capital on a daily basis and remains the top performer among its peer group. Following the quarter end, I am pleased to report that SEC declared Sierra Total Return Fund effective. We are actively engaged with our distribution partners and expect sales of Sierra Total Return Fund to begin in 2017. We value the growing opportunity within this Sierra channel and the brand recognition that we’ve built. Sierra Total Return Fund is the first interval fund for Medley and it's our second fund targeting the channel. We are currently developing our third Sierra branded product which we expect will launch in the latter half of 2017.These product expansions are important steps in our continued diversification of our alternative asset management platform. Turning now to the institutional side of the business. As I had mentioned earlier, we have been selected to manage nearly $500 million of new capital for new institutional investors, including this number our total capital raised on the institutional side of our business now exceeds $1.5 billion in the last 13 months. As we described on our prior call, we had a first closing in July of our CLO Opportunity Fund. We've already made several investments in partnership with top tier CLO managers and have an active pipeline of opportunities heading into 2017. At Medley, we are focused on diversifying our platform with an eye towards long-term growth. The broadening product platform combined with the continued strong demand for yield for both institutional and retail investors, positions us well as we focused on achieving our long-term goals of revenue and earnings growth. In summary, I'd like to thank everyone for joining today. As a high level recap, we grew assets under management over 25% year-over-year. Retail and institutional product offerings continue to expand and diversify. We are investing in our people and our infrastructure and remaining focused on growing revenues and earnings in the quarter and years ahead. Thank you all for your continued support. And we can open the call for questions.

[Operator:]

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

[Craig Siegenthaler:]

Thanks. Good morning. It was nice to see that the total return fund was approved by the SEC last week. Which groups will you be marketing this fund to? Which channels and should we expect Sierra, the non-trade BDC, to see a lower fund raising activity as total return ramps up?

[Brook Taube:]

Yes, thanks, Craig. It is Brook. At a high level we are going to the same channel. We have broker dealer relationship with 150 different partners. We have to sign new agreement for Sierra Total Return Fund, the channel is selling interval funds and Sierra Total Return Fund is an interval fund so we are optimistic. We do have plans in place with respect to Sierra Income Corporation both new fee -- new share structure as well as different distribution capability. It is early to tell how Sierra Total Return Fund sales will impact Sierra Income Corporation but we expect that we will be able to continue to sell both products in 2017 and beyond.

[Craig Siegenthaler:]

And then, just as my follow-up, can you give us an update on the CLO opportunity fund and how we should expect AUM here to ramp?

[Brook Taube:]

Yes. We had said on the prior call that we had a target first close of $100 million by year end, a portion of that nearly $500 million of new institutional capital was in support of the CLO Opportunity strategy. So as of this call, we are near what was the year end target of $100 million. And we've already begun investing as I said through [end half], and we have an active pipeline.

[Operator:]

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

[Casey Alexander:]

Good morning. I have several questions. First of all just in general .We've seen a pretty market rise in rates since the election last week. Can you give us a general sense of how that may or may not impact the products that Medley Management is the advisor on?

[Brook Taube:]

Sure. Look, it is clearly there has been a meaningful move, we don't know what the future holds. We do think a lot about how to position our portfolios and our product offerings. I would say to the extent that rising rates are a reflection of expected growth then that's a positive generally speaking for credit. On the front end, since the bulk of portfolios are LIBOR base and floating rate, rising LIBOR, all else equal is clearly a positive for the portfolio returns. So with rising investment return and a pro growth economic backdrop, I mean our performance is reasonably expected to be consistent if not better. In terms of the products, we positioned all the products now to focus on floating rate and substantially all the portfolio are floating. So we that as a positive and in the few cases on our publicly listed vehicles we have continued to term out our debt which we did before the rise. So I think we feel well positioned, we are watching it carefully and I think it’s a net positive on balance. If it is reflection again of the growth environment.

[Casey Alexander:]

Okay. Thank you. Secondly, obviously the election has thrown some curveballs, one which maybe a reduction in some of the restrictions in the Department of Labor guideline as to how products such as yours are distributed. Does that change how you might set up and distribute your products? Or are you okay pretty much either way this goes?

[Brook Taube:]

Thanks for the question. We don't anticipate changing what we are doing. It is too early to tell what impact that the election and views of the future may have. To the extent that the rules do change, we would expect to modify our products accordingly which we’ve done in anticipation of the current plan rule. So I think at a high level we are well positioned to continue to leverage the presence we have in the Sierra channel. We expect continued sales of the existing products, the newly introduced one and also for our third product which again was schedule for the latter half of 2017.

[Casey Alexander:]

Okay. Thank you. Now -- I think it's great that company has another $500 million of dry powder. This has some considerable dry powder for few quarters now. Tell me how we get some of that dry powder wet.

[Brook Taube:]

Invest the capital prudently which is what we are focused on.

[Casey Alexander:]

Okay. Acquisition of a significant number of shares of MCC by MDLY, Rick, where do we look for that additional dividend income on the Medley income statement? Does it come into other revenues above the revenue line or does it come in to dividend income below -- down in the other income line?

[Rick Allorto:]

Down below Casey in other income expenses.

[Casey Alexander:]

Okay. Was there any contribution from the MCC dividend in Q3 or is that something we should be looking more towards Q4 in 2017 for?

[Rick Allorto:]

Q4 and 2017

[Casey Alexander:]

Okay. Lastly at Sierra the company has effectively fee waivered of about $16 million worth of management fees through the first nine months of this year. As Sierra has right sized the dividend, should we look for some recaptured into management fees of fees that have been previously waived.

[Rick Allorto:]

Casey, I do want to clarify you are referring to the ESA at Sierra?

[Casey Alexander:]

Correct.

[Rick Allorto:]

Correct. It is difficult for us to predict the reimbursement. There are mechanics within the agreement that allow for reimbursement. But at this point it is too early for us to forecast and project.

[Casey Alexander:]

But certainly right sizing the dividend at Sierra for Q4 would at least all other things being equal reduce some of the obligations of the ESA. Would it not?

[Rick Allorto:]

Yes, Casey, that's correct. We expect meaningful decline in any potential obligation to provide additional support in the future.

[Operator:]

And our next question comes from the line of Mickey Schleien with Ladenburg. Your line is now open.

[Mickey Schleien:]

Yes, good morning, Brook and Rick. A couple of top-down questions -- Brook, you have obviously been involved in investing in the credit markets for a long time before Dodd-Frank. And now there's talk about repealing Dodd-Frank or pieces of Dodd-Frank. I'm just curious what your thoughts are about how you think the commercial banks may approach the leveraged loan market if Dodd-Frank were repealed, which is what the new administration is thinking about?

[Brook Taube:]

Well, that would require seeing the future I guess now. I think, look, it is clearly out there, the banks need earnings asset. They have substantially reduced their presence in this business and have indicated a continued decline. If this repeal happens and it changes their perception of how to behave, it is possible they are back. There would be a meaningful need for human capital to rebuild those businesses. And I think we would expect they would focus on larger higher rated assets at the start. But clearly we will watch it, time will tell. So we'll see. I think on a net positive base is the capital needed in the system remains strong given our scale we expect to continue to grow meaningfully and we have great distribution and partnership and capital. So where we sit we are optimistic. And we'll watch it like you will in the years ahead.

[Mickey Schleien:]

Fair enough. My next question regards performance looking at the roll forward table. I see that the BDCs saw their funds appreciate, I am talking about mark-to-market about 0.8% and the other vehicle saw about 0.4%, but that was in a quarter where middle market loan spreads were contracted a lot with the first lien down 50 basis points, second lien down 120 basis points and you look at things like LSTA 100 which obviously more liquid loans up 3%. I am trying to understand what may have hindered the underlying performance of the funds during the quarter if anything?

[Brook Taube:]

Well, I am not going to get too specific. I think at a high level we saw as you said an aggregate performance was positive. We don't own liquid loans. So I think we don't tighten as much generally when they spread tightened we don't widen as much. Again, all of our valuations are based upon individual credit analysis. So we had many go up, we had some decline I think on a net basis performance as you said you got it about right. So I don't think looking at the market for an individual or quarter to quarter movements would be instructive every quarter.

[Mickey Schleien:]

All right. With respect to the two interval funds, Brook, I understand its early days but I am trying to get a sense of at least what expectations might be? When Sierra got started in the first couple of years as we've seen with other non listed BDCs took a while to get traction, it got to $50 million of AUM after a couple of years. But in year three it got to $250 million, I know the hockey stick that we've seen elsewhere. Do you expect the similar pattern for the two new internal funds?

[Seth Taube:]

Hi, Mickey. This is Seth. Good morning. Share -- the interval funds in many ways are -- those are easier to process to the broker dealer channel or what we call point, click and buy, it don't require subscription documents and other attributes of the non traded BDCs. So to some extent administratively the ability to purchase those securities is easier in the channel. So our expectation is structurally it is maybe a better fit in the channel. That's one reason why we are optimistic the sales will meet or exceed the historical trend of Sierra Income Corporation. The second is that we have today over 150 selling agreements in the channel and the channel knows us well. So we have an expectation that the ability to sign selling agreements which allow us to sell into that retail broker dealer channel will be -- will take less time for the interval funds. I think the third is that they are all -- the interval funds and you may have seen this in press, they are now being viewed as maybe the appropriate new technology in that channel to provide higher yield and liquid alternative but also give the manager flexibility to invest in slightly less liquid asset. So all us being equal we are optimistic that Sierra Total Return and the other interval fund will be -- sorry other fund at the channel will actually meet or exceed the historical growth rates.

[Mickey Schleien:]

Okay. Appreciate that background. And just a couple of accounting questions maybe for Rick. There is a line in the cash flow statement labeled capital contributions from non controlling interest. It was $12 million. It wasn't present in the previous quarter. What is that line represent, Rick?

[Rick Allorto:]

Mickey, that's in conjunction with the joint venture partnership that was formed last quarter. We issued a capital call during the third quarter for $12 million.

[Mickey Schleien:]

Can you remind me to which joint venture you are referring?

[Rick Allorto:]

Sure, that's joint venture, a total of $50 million capital and intention is to use the proceeds to invest in Medley funds.

[Mickey Schleien:]

Okay. And my last question is just if you could give us your cash EPS number?

[Rick Allorto:]

Sure. Our cash core earnings for the quarter were $0.11

[Operator:]

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

[Ann Dai:]

Hi, good morning. Thanks. I wanted to follow up quickly on two questions asked earlier. So on the capital deployment front, it does feel like the climate's been relatively muted. And so I guessing kind of wondering what about the current market conditions has been challenging for you guys to put money to work at solid pace? And then really what conditions do you need to see change for that to change for you?

[Brook Taube:]

Sure, Ann. This is Brook. And thanks for the question. The Sierra AUM static to down was primary result of higher than normal repayment. So the big driver this quarter was getting capital back that's just part of the business, I'd say it is an outlier in terms of repayment. We do expect fee earnings assets to grow generally as we sort of indicated in the prepared remarks. We continue to add assets under management and dry powder. But at a high level we are remaining prudent and looking at deal so deal volumes were down in the first half of this year coming off of effectively, a hard end of 2015. Volumes have begun to pickup; we did get repaid that was part of the same deal volume pickup. We have observed that pipeline is filling. We expect the fourth quarter to be positive but we are focused on driving appropriate and sensible risk adjusted return. So we feel well positioned for what is looks like an increasingly volatile market and backdrop.

[Ann Dai:]

Okay. And just my second follow-up is on the CLO Opportunity Fund, I think you guys had mentioned last quarter that you were targeting the final close around $100 million. So now that this mandate has -- part of the mandate has been allocated towards the fund, is this your still a final close number, or has that changed in light of the mandate?

[Brook Taube:]

Sure. Let me clarify. I think let me restate what I think we said last time and hopefully reconfirm was we had a first closing target, that will be the initial close of $100 million. We do expect to continue to raise capital for the fund in 2017. So our final target would be meaningfully higher than $100 million. But we are well on our way to the initial first close target which was slated for year end of a $100 million and we are kind of approaching that now. And with a portion of the $500 million of new capital we referenced being allocated to the CLO Opportunity strategy. Is that answers your question?

[Operator:]

[Operator Instructions] And our next question comes from the line of Christopher Nolan with FBR & Company. Your line is now open.

[Christopher Nolan:]

Hi. Thanks for taking my questions. For the $500 million just raised, can you give us an idea as to what the fees are on that to MDLY?

[Brook Taube:]

From an asset management perspective it is approximately 1.25, a portion will be in CLO Opportunity Fund which is just have slightly higher fees but it's nearly $500 million, it is not quite that number and it's kind of pencil and 1.25 as a rack rate.

[Christopher Nolan:]

Okay. Turning to MCC, given that's still trading at a significant discount to NAV per share -- and I know last year you guys, to your credit, cut the management fees -- any thoughts in terms of what else you can do to actually get the stock trading to above NAV, beyond your share repurchases?

[Brook Taube:]

Look, I think we've -- I'll stick with what we've said in the past. We are focused on the portfolio there driving a sensible risk adjusted return. We obviously like the stock and are buying it. And I think we'll see with LIBOR rising in a different economic backdrop I think the sector might be under with some more tailwinds that would certainly help, but I think we are doing everything we said we would do. I think time will tell that.

[Operator:]

And I am showing no further questions at this time. I'd now like to turn the call back over to Mr. Brook Taube for closing remarks.

[Brook Taube:]

Thank you all very much. It's been a strong beginning of 2016; the pipeline is strong heading into the balance of the year. We are happy with some good results since quarter end on asset growth. And we expect to continue to look for solid development as we expand the platform here in Medley both from a product, people and performance perspective. So feel free to reach out if you have any further questions. Thanks again for your time. And we look forward to speaking with you on the next call.

[Operator:]

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