Medley Management Inc.
Q1 2015 Earnings Call Transcript

Published: 15 May 2015

[Operator:]

Welcome and thank you for joining Medley Management Inc. First Quarter 2015 Conference Call. I’d like to remind everyone that today’s call is being recorded. Please note that the 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 prompt for 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 Strategy, who 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 the Medley Management first quarter 2015 conference call. I’m joined today by Brook and Seth Taube, our Co-CEOs; and Rick Allorto, our Chief Financial Officer. Before we begin, I want to call your attention to the customary Safe Harbor disclosure in our 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 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 reason 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 earnings assets under management, pretax core net income and core net income per share. We use these as a measure of operating performance, not as a measure of liquidity and 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 release and our Form 10-K for definitions and reconciliations of those measures to the most recent directly comparable GAAP measures. We’ve posted our first quarter 2015 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 Brooks.

[Brook Taube:]

Thanks, Sam. And welcome everyone to Medley's first quarter conference call. We’re pleased to be here today and I like to thank everyone for taking the time to join us. Last night we announced the financial results for the quarter ended March 31. Core net income per share for the quarter was $0.25 that represents a 125% increase compared to the prior year period. Our fee earning assets under management were $3.2 billion, which represents a 45% increase compared to the prior year as well. The $0.20 dividend from the quarter ended March 31 was paid on May 6 and please refer to page 29 of the Investor presentation for our dividend schedule for the balance of the year. A brief agenda for the call this morning, first, a business update on Medley, we'll give you summary of the fee earning AUM growth, an overview of the current investment environment, a review of recent business developments, financial review of the first quarter from Rick, and then we’ll take questions We continue to build the business around a combination of permanent capital, our long-dated funds and separately managed accounts, combined they are going to continue to provide steady and cash rich earnings to shareholders of MDLY over time. In the first quarter, the fee earning assets under management continue to rise. We ended the quarter with permanent capital vehicles representing 67% of total fee earning assets with the remaining 33% in long dated funds or separately managed accounts. We remain focused on our core credit strategy, which drives attractive returns through direct origination, conservative underwriting, a focus on protecting capital, floating rate assets and active asset management. We are still well positioned to capitalize on the significant opportunity that exists in direct lending today in the middle market, two powerful trends remains in place that support this opportunity. First, assets continue to migrate off bank balance sheet; and second, investor demand for yield remained strong. The team in Medley is strong. We expect it will continue to grow. Today it is 80 people with 44 on the investment side. We’re excited about the opportunities presenting themselves in the market and we’ll continue to seek ways to enhance shareholder value in the quarters and years ahead. On a year-over-year basis, permanent capital and institutional capital of fee earning assets under management grew by 68% and 14% respectively. During the quarter, permanent capital, fee earning assets under management grew 4% while institutional capital fee earning assets under management by 3%, compared to their prior quarters. The quarter-over-quarter growth in permanent capital, fee earning assets under management was primarily driven by the continued capital raise in Sierra Income Corporation. We’re pleased to see the fund raising numbers for Sierra improving versus the fourth quarter and look forward to growth for the Sierra in the balance of this year. On February 9, we announced that Medley Capital Corporation had received Board approval to implement a $30 million share repurchase program and during the quarter we repurchased 825,677 shares that totaled just under $8 million and I think this demonstrates our commitment to the BDC shareholders which we believe will benefit MDLY shareholders over the long term. Two positive developments at Medley Capital Corp this quarter included an increase of $10 million in our regulatory capital at MCC's SBIC subsidiary which gives MCC access to an additional $20 million of SBIC leverage. And we also established the senior loan joint venture that Seth will describe in further detail. I'd like now to turn the call over to Seth.

[Seth Taube:]

Thanks Brook. As we mentioned on previous calls the two decade long trend of bank consolidation coupled with the increasing regulatory burdens has continued to drive traditional lenders out of the middle market in United States. In addition, the ongoing trend of commercial banks exiting, GE which was a major player has recently announced that it too is exiting the market. At Medley, we continue to benefit from this trend. We've -- at the same time we've maintained our disciplined underwriting approach, we've kept loan to value ratios on our originations at sensible levels and maintained strong covenant packages. We continue to focus on senior secured loans that are predominantly floating rate. We believe this provides downside for taxing for our capital and also allows us to benefit from the potential rise in interest rates. On balance, more competition has been increasing in the middle market. We continue to see attractive lending opportunities to our robust distribution channel. And we remain active in the market through our various investment vehicles. We continue to grow assets under management in Sierra and continue to expand our distribution network. During the first quarter we added nine new broker dealer selling agreements, bringing the total to 131 active selling agreements around the country for Sierra Income Corporation. Sales in have Sierra improved compared to the fourth quarter and we ended the month of April having raised total of $641 million in Sierra since inception. During the quarter, Sierra and MCC each announced the formation of separate senior loan joint ventures with Great American Life Insurance, they are premier US provider of property and casualty insurance; combined Sierra and MCC along with Great American Life have initially committed to provide $200 million of capital to the joint venture. We are in the process of securing a financing facility which combined with our capital contribution will add an additional $600 million of total investing capacity across Sierra and MCC. We expect that the joint venture will allow us to add to net investment income for both Sierra and MCC. And as a result will benefit the shareholders of MDLY. In addition, the joint venture broadens Medley's product offering and represents a natural extension of our lending franchise. Now I'd like to turn the call over to Rick, Chief Financial Officer to review first quarter financial results. Rick?

[Rick Allorto:]

Thank you, Seth. Our standalone results of operations for the three months ended March 31, 2015 were as follows. Management fees increased by 18%, or $2.6 million to $17.5 million, compared to $14.9 million for the same period in 2014. Performance fees increased to $6.3 million compared to $0.1 million for the same period in 2014. And total revenues increased by 49%, or $8.4 million, to $25.5 million, as compared to $17.1 million for the same period in 2014. The increase in management fees was due to a 45% increase in fee earning AUM for the quarter ended March 2015 compared to the quarter ended March 2014. Total expenses increased by 25%, $2.3 million, to $11.8 million as compared to $9.5 million for the same period in 2015. The increase was primarily the result of increases in compensation and benefits expense which was partially offset by a decrease in performance fee compensation. Total other expense net increased by $0.5 million, to $2.1 million compared to $1.6 million for the same period in 2014. The increase was due primarily to a $1.5 million increase in interest expense which was partially offset by a decrease in other expenses. Pretax core net income increased by $7.2 million to $13.3 million, compared to $6.1 million for the same period in 2014. Core net income per share increased to $0.25 per share for the three months ended March 31, 2015, compared to $0.11 per share for the same period in 2014. Core EBITDA increased by $8.7 million to $15.5 million compared to $6.8 million for the same period in 2014. That concludes my financial review. I'll now turn the call back over to Brook.

[Brook Taube:]

Thanks, Rick. We appreciate everyone's continued support and now operator we can open the call for questions.

[Operator:]

[Operator Instructions] Our first question comes from Craig Siegenthaler with Credit Suisse. Please proceed.

[Craig Siegenthaler:]

Thanks. Good morning, everyone. First just on the institutional business. MOF 3, I think just had its first close in the first quarter. Can you remind us what’s the total capital raising target is for MOF 3? And how much is included in fee earnings AUM as of March 31st?

[Seth Taube:]

Hi, Craig. This is Seth. We had a first close for MOF 3 in the fourth quarter driven by investor demand, during the first quarter we had additional capital commitments. So it has been I guess -- I forget the exact date of the closing but it was -- the first was in the fourth quarter. And we were targeting $800 million to $1 billion for that fund across the both the LT itself as well as separately managed account. So we think of it bit more as the institutional side of the business. And Rick as of 3/31, do you have the number for --

[Rick Allorto:]

Yes. The fee earning AUM, sure, Seth, the fee earning AUM was $103 million.

[Craig Siegenthaler:]

Thank you. And then as you are marketing MOF 3, I am wondering when you talk of MOF 2, do you have handy the inception to date net IRRs or the [indiscernible] invested capital ratios or any type of performance metric you guys look at as you are marketing and talking about MOF 2.

[Brook Taube:]

Yes. I will take that, Craig. It's Brook. We -- as you can see from the performance fee and we talked about this in the prior quarter. MOF 2 is now past the end of its investment period. And it is already through on a net basis the 8% hurdle. It is currently in the catch up phase so our accrued carry is -- we’re being accrued dollar for dollar above the 8% hurdle. So that partially explains performance fee volatility more than we would -- normally expect once we get to the hurdle plus the catch up it will be 1 - 20% is volatile if you will. So the sort of net return is over 8% and that's a pretty positive signal considering that we just finished the investment period. And that includes any effect of J curve early in the funds life. What -- there was a second part of the question.

[Craig Siegenthaler:]

I think you kind of covered both because then to our question was coming performance but if we take a step back now look at the entire institutional business so long dated and the SMAs, the $86 million of commitments in the quarter, that was down a lot from last two quarters and it would also seem it's kind of low given that I believe you diverted some resources away from MCC and refocused them on this business. But you know institutional business is inherently lumpy so maybe give us some color on new sales activity, frequency of meetings and then maybe also any lag between when fee earning AUM shows up when you are actually raising the capital.

[Brook Taube:]

Sure. During the quarter we have enormous number of meetings going on. It is interesting the demand for direct credit specifically with an origination capacity is extremely high. We are meeting and speaking about this on a daily basis. The interest range is from insurance to pension, it is domestic and international. I think what I said on the last call it bears repeating is that we would expect that the institutional which again Seth mention was a fund or a managed account, we look at them as the institutional that will grow at or above our historical average which is just under 20% as we look out in 2015 and beyond.

[Operator:]

[Operator Instructions] Our next question comes from Ann Dai from KBW. Please proceed

[Ann Dai:]

Hi, good morning. Thanks for taking my question. First question just around performance compensation. Can you run us through some of the nuances around that? It tends to bounce around and I understand there are some intricacies around a catch up but you know any color would be really helpful.

[Rick Allorto:]

Sure. In the fourth quarter 2014, we estimated a decrease in the total projected future performance fee liability. And that resulted in a reversal performance fee comp in that quarter. And then in the first quarter of 2015, we didn't have any change in our total projected performance fee liability. So the expense you see in the current quarter relates solely to additional employee vesting of the profit interests that have been granted.

[Ann Dai:]

Okay, great. And just looking further out, what do you think is kind of a good run rate for performance fee comp?

[Rick Allorto:]

Q1, 2015.

[Ann Dai:]

Okay. I guess continuing on expense, comp and benefit were a little bit elevated in the quarter. Were there any one time items or any seasonality that you would want point out or what drove the increase quarter-over-quarter?

[Rick Allorto:]

Nothing specific to point out. I mean the increase was primarily due to our accrual for variable cash bonuses.

[Ann Dai:]

Okay. And same question for G&A. Anything to note there?

[Rick Allorto:]

Sure. On G&A the increase was related to the reimbursable fund start-up expenses for Sierra Income Corporation.

[Ann Dai:]

Okay, great, thank so much. Oh actually one last thing. Just on performance fees, I understood that you are kind of getting through the catch up now but do you have a sense of when you would expect that to turn into realized performance fees, really taking the cash performance fees on those?

[Brook Taube:]

Yes, Ann, it is Brook. We just ended the investment period last year so the weighted average life for the portfolio is probably in the 3.5 to 4 years. We reasonably expect some activity in advance of that it is hard to predict but typically like any institutional fund that we see today, you first return the capital and preferred and then you split the fee. So it will be -- it is over time we are going to get this but it is several years down the road.

[Operator:]

We now have a follow up question from Craig Siegenthaler with Credit Suisse. Please proceed.

[Craig Siegenthaler:]

Thanks. So I was wondering if you could help us for 2Q, 2015 sort of guidance on three separate items. Severance expense, income tax add back and other non core item. So the items that get a strong GAAP to sort of non-GAAP. Of those three items please.

[Rick Allorto:]

Sure. The severance that you see in Q1, that's none, recurring as you think about Q2. Income tax add back, Q1, 2015 is a good proxy. And then the other non core is the amortization of the IPO RSU grant and again Q1 is a good proxy.

[Craig Siegenthaler:]

Got it. And then if you look at total compensation and benefits, there is this ramp up in the first quarter, lot of these initiatives you put in place probably 9 -12 months ago, maybe the revenue environment isn't as strong as you thought. Can you help us -- how should we expect really comp to ramp in the future or is the 1Q, 2015 run rate now sort of a good run rate to think about as we move forward in 2015.

[Seth Taube:]

Yes. Craig, this is Seth. As you could -- if you look back at headcount in last two quarters, you will see that it has been relatively stable quarter-over-quarter for the last two. And if you look forward in 2015 we expect that the current headcount 80 people will increase modestly but those are pretty good proxies. I think it is heavy stabilized with modest growth from here.

[Operator:]

Our next question comes from the line Christopher Nolan with MLV and Company. Please proceed.

[Christopher Nolan:]

Hi. On the SLS, are you guys waiving fees at all or sort of any sort of -- does like sort of become additional fees for the management company?

[Brook Taube:]

So the SLS that we have at BDC is, Chris, is really just a subsidiary partnership, that is not going to generate additional fees for MDLY. It does however allow us to be in the larger deal market. And we expect it will drive incremental net investment income to the respective BDCs and to the extent that NI rises at the BDC, it will have an impact on the profitability of the BDC platform for us. But again we see -- it is investment in a partnership, it will just look like a mid-teens return on capital for those respective vehicles.

[Christopher Nolan:]

Right. And just a quick follow up for the previous question. If I understand you correctly should we look at the compensation and benefits for the first quarter to be a good proxy for the rest of the year?

[Rick Allorto:]

Yes. With probably a little bit of increase throughout the year as we continue to grow.

[Operator:]

We have no additional questions. I will now turn the call back over to management for any closing remarks. Please proceed.

[Brook Taube:]

Well, thank you all the continued interest and support. We are off to a good start here in Q2 we will look forward to the next conference call. As usual, feel free to reach out directly if you have any follow up questions. Thanks a lot.

[Operator:]

This concludes today's conference. You may now disconnect. Have a great day everyone.