Medley Management Inc.
Q3 2015 Earnings Call Transcript

Published: 16 Nov 2015

[Operator:]

Welcome and thank you for joining Medley Management Inc.’s Third Quarter 2015 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 question-and-answer session following the prepared remarks. I’d now like to hand the call over to Sam Anderson, Medley’s Head of Capital Markets and Strategy, 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 2015 conference call. I’m joined today by Brook and Seth Taube, our Co-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 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. During this conference call, we will refer to certain non-GAAP financial measures including fee, earnings 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 2015 investor presentation, which is available on 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:]

Thank you, Sam and welcome everyone to Medley’s third quarter call. This morning, we announced our financial results for the quarter ending September 30. The company’s core net income per share for the quarter was $0.01. During the quarter, our fee earning assets under management increased from $3.35 billion to $3.40 billion, and total assets under management ended the quarter at $4 billion. On November 12, our Board of Directors approved a dividend of $0.20 per share that will be payable on December 4 to shareholders of record on November 25. Rick will review the financials in greater detail, but I would like to add a few comments here related to valuation adjustments and the corresponding impact to our non-cash performance fees, reported core net income, and core EBITDA during the third quarter. As a credit focused asset manager with private fund vehicles, we accrue for non-cash performance fees on a quarterly basis. In the third quarter, we reversed $0.15 per share of previously accrued net performance fees as a result of changes in asset values within our private funds. As we’ve discussed on previous calls, we are in the catch up window for some of our private funds where the returns are in excess of the funds’ hurdle rates, which means that net performance fee accruals are being credited to MDLY on an up to 100% basis during the catch up period. That is to say any movement up or down in the overall asset value of a fund may have as much as a dollar-to-dollar impact on our net performance fees. To put this perspective, the valuation adjustment on our private funds was approximately negative 1.9%, which while significant should be seen in the context of overall asset valuation changes in the broader market during the September quarter. In the third quarter, broad markets experienced significant declines with the S&P down 7%, oil down 24%, and the S&P high yield corporate bond index down 5% with certain sectors like high yield energy prices were down over 15%. In terms of the income statement impact at MDLY, further asset value declines in our private funds are remaining net accrued performance fees that couldn’t be subject to reversal is less than $0.16 per share. That being said, we continue to expect to accrue positive performance fees on average overtime. At the request of several shareholders and analysts, we added page 12 to our investor presentation. This page removes net performance fees from our financial results in order to demonstrate the stability of our financial performance when you exclude the volatility of mark-to-market asset valuation adjustments in any given quarter. Specifically, page 12 shows our trailing 12-month revenue, EBITDA, and core net income adjusted for net performance fees. And for context, our trailing revenue and core EBITDA for the period exclusive of these net performance fees was $82 million and $47.8 million respectively. Despite market volatility, we saw an increase quarter-over-quarter in fee earning AUM from $3.35 billion to $3.4 billion. The core rent number of $3.4 billion is up 12% from the prior year comparable period. Our total AUM which includes undeployed capital was flat quarter-over-quarter at $4 billion, which was up 10% versus prior year period. I am pleased to report that we’ve added over $0.5 billion of institutional capital since the 09/30 quarter end and continued to raise capital at Sierra [ph] on a daily basis. This growth in total AUM will help us to continue to drive growth in our fee earning AUM as we look to 2016 and beyond. I’d like to comment briefly now on the overall market environment. In general, credit spreads have widened. The more junior layers of the capital structure clearly experienced the most negative performance in the past quarter. Generally, secured loans outperformed although total returns were still negative. Among secured loans, there were significant widening between first lien and second lien assets. In the broadly syndicated loan market, we witnessed over 25 basis points widening for first lien while second lien loans widened by 100 basis points to 150 basis points on average. This performance is consistent with a typical risk-off environment. As a result, we are seeing increasingly attractive opportunities now in our core lending market, and expect that to continue for the balance of this year and into 2016. Our direct and fundamental driven approach positions us well for this type of market environment, and we expect to capitalize on this increasingly volatile backdrop by taking advantage of attractive new investment opportunities as we have during similar cycles in the past. I like now to turn the call over to Seth.

[Seth Taube:]

Thanks, Brook. At Medley, we remain focused on a long term opportunity to provide innovative yield solutions to both institutional and retail investors globally. The growth opportunity ahead of us is significant. To give you perspective on our view of the opportunity, total investments globally are projected to exceed $100 trillion by 2020, that’s five years from now. Alternative investments are expected to expand from $7 trillion today to over $13 trillion during the same time period and as much as $4 trillion of this $6 trillion increase in alternatives is projected to come from retail investors. So the opportunity is enormous. From a product and distribution standpoint, we are well positioned to benefit from these strong fund flows from both the institutional and retail channels. Today, Medley is known as the trusted partner to our borrowers, private equity sponsors, shareholders, independent broker dealer partners, and institutional investors. We continue to increase our presence as the top tier manager in the retail channel to our existing Sierra products and in the institutional channel of gaining meaningful assets from top tier institutional investors. We believe that due to our team, platform, and track record that we will continue to grow meaningfully on both these fronts in the years ahead. We have communicated that our target growth rate for our institutional business is 20% annually with the addition to over half a billion dollar in institutional assets that we've added since the end of the third quarter. We’re well ahead of a targeted growth rate for this year. Given the ongoing dialogues with our institutional partners, we expect continued and meaningful growth in this segment of our business as we look forward into 2016 and beyond. In addition to our institutional business, we are focused on the growth of Sierra through the retail's channel. During the quarter, Sierra eclipsed over $1 billion in assets having raised $77 million in equity in the quarter. Let's comment briefly now on a new product pipeline. First in the regional channel, we have planned and placed to expand our products as we look out into 2016. On the institutional side, we’re focused on a CLO asset management platforms, as well as a they are risk retention vehicle. We expect to be able to report progress on all of these new initiatives in the next several quarters. Our planned retail initiatives are expected to be registered investment companies under the Investment Company Act of 1940. These offerings will broaden our relationships with financial advisors and importantly work well within the Proposed Department of Labor Fiduciary exceptions. Preliminary discussions with our broker dealer partners indicate strong interest in our planned products generally and specifically from our Sierra platform. Because the impact of the Department of Labor Proposal is unclear, we will remain flexible in our offerings and are working to create a strong mix of both new and traditionally structured products. We believe any potential change from the DOL will be an opportunity to further differentiate Sierra in our future products. While we’re experiencing attractive growth in capital equipments across our existing franchise and continue to develop new products, we remain extremely disciplined in our origination and underwriting. Our pipeline of opportunities remain strong and we’re selectively investing capital. During the quarter, across our platform we committed $165 million of total capital with 10 borrowers in 9 different industries. As Brook mentioned, the recent spread widening in the broadly syndicated loan market is already translated into interesting opportunities and report directly lending strategy in the fourth quarter. At medley, we are proud of the fact that we provide capital to U.S. middle market companies. These companies are critically important to growth in the U.S. economy and their management teams value their partnership with Medley. At the end of the quarter, our 176 borrowers employed over 320,000 people. At Medley, we’re also committed to attracting and retaining high caliber talents. We remain focused on adding key personnel that will help drive growth and maintain our investing discipline. Most recently David Indelicato joined our team from GE Antares as a managing director to oversee our asset management and underwriting functions. David is a seasoned investment professional with a successful track record of underwriting structuring and restructuring credit investments, and we look forward to his contribution going forward. And now I like to turn the call over to Rick Allorto, our Chief Financial Officer to review the third quarter financial results. Rick?

[Rick Allorto:]

Thank you, Seth. Our standalone results from operations for the three months ended September 30 were as follows. Management fees increased by 3% or $0.5 million to $18.1 million compared to the same period in 2014. This was primarily due to an increase in Sierra fee earning AUM. Performance fees for the quarter were negative $4.6 million, due to a decrease in the asset values of our private funds. As a result, total revenues decreased by 77% or $18.4 million to $5.4 million compared to $23.8 million for the same period in 2014. As Brook commented earlier, we are in the catch-up period in some of our private funds, therefore our accrual performance fees is more sensitive to positive or negative mark-to-market changes in any given period. Total expenses decreased by 53% or $4.3 million to $3.9 million, as compared to $8.2 million for the same period in 2014. The decrease was primarily the result of $4.1 million reduction in our performance fee compensation payable. Total other expenses net increased by $0.9 million to $2.8 million for the three months ended September 30 compared to $1.9 million for the same period in 2014. The increase was due primarily to an unrealized loss from one of our investments. Pretax core net income decreased by $12.8 million to $0.5 million compared to the same period in 2014, core EBITDA decreased by $12.6 million to $2.8 million compared to $15.4 million in the same period 2014. Core net income per share and core EBITDA, excluding the net reversal of performance fees would have been $0.16 per share and $10.5 million respectively for the three months ended September 30 2015, compared to $0.18 per share and $11.7 million respectively for the same period in 2014. That concludes my financial review. I will now turn the call back over to Brook.

[Brook Taube:]

Thank you, Rick, and thank you all for joining us today. Overall, we’re pleased with the progress we’ve made at MDLY over the past year. We continue to grow our retail platform and institutional businesses. Total AUM at the firm, over our five quarters as a public company has increased by over 36% to $4.5 billion. Consistent growth in our core AUM combined with our well-positioned and attractive new product initiatives gives us confidence as we look forward to 2016. The entire team is hard at work carefully investing our capital, growing our platform and focused on enhancing shareholder value at MDLY. We all appreciate your continued support and we can now open the call for questions.

[Operator:]

Thank you. [Operator Instructions] And your first question comes from Craig Siegenthaler from Credit Suisse. Please proceed.

[Craig Siegenthaler:]

Hey, thanks. Good morning. There is a large decline in the management fee rate from 2Q 2015, and I’m looking at total management fees of $18.1 million and then the average fee earning AUM in the $3.4 billion range, so I’m just wondering what drove the sequential decline in the [industry rate] there?

[Rick Allorto:]

Sure, Craig, included within management fees are the origination fees that we received within the private funds. There is a decline in Q3 relative to Q2 with regard to origination fees, so that’s the primary driver there in that decrease.

[Craig Siegenthaler:]

Got it. And then just as my follow-up, on the new $500 million that you raised in the fourth quarter, from a modeling standpoint, what is the fee structure there and also can you help us in terms of the plan duration of that capital raising in terms of maybe when there’d be monetizations at the end of this cycle?

[Seth Taube:]

Yes, Craig, I mean there are some various numbers there, I would use approximately 1%, as a running fee that would approximate the asset management fee as well as origination fees on average and may be slightly higher or lower depending on the pace of deployment of capital and I’m not sure, could you repeat the second part of the question.

[Craig Siegenthaler:]

So, I want to know is this a long dated account where you raise capital, you deployed in loans and then it pays down in maybe five, six or seven years or is this more of a perpetual type business where the client decides where the redemption is?

[Seth Taube:]

Well, our expectation is that it would match the average duration of the assets. So the way it would work on the bulk of these is we deploy the capital. We expect to do that over the year or 18 months, then it will be us standing for the average life of the loans which I would say is approximately four years. So that capital will be out for somewhere between four and five years, I would model it that way. Each of our existing managed account providers have continued to increase their capital. So, from a functional standpoint, we’ll continue to expect to grow that, but I would look at it in that context. Does that make sense?

[Craig Siegenthaler:]

It does. Very helpful. Thank you.

[Brook Taube:]

Craig, one final point I wanted to make, on some of these managed accounts not all we do have performance fees. So I did give you the asset management fee component, we would expect where there are performance fees to target more than doubling that over time.

[Craig Siegenthaler:]

Got it. Thank you.

[Operator:]

Okay, thank you. And our next question comes from the line of Alex Blostein from Goldman Sachs. Please proceed.

[Alex Blostein:]

Thanks. Good morning. Just a follow-up discussion on the management fee stream, so the $500 million, do you guys expect to earn management fees in this as deployed or do they all turn on at once.

[Brook Taube:]

As deployed Alex.

[Alex Blostein:]

Gotcha. And then I hear your points I guess on origination levels being a little bit lower in the course of the quarter. In today’s environment, what do you think that’s the more of a norm, too low, too high as we already think about the run rate management fee rate going forward, should we use the base from 3Q as a good run rate?

[Brook Taube:]

I think 3Q given the volatility was lower than we expected. Our average origination volume over the past several years has been well north of $1 billion per annum. I think you could use a slightly higher, modestly higher run rate assumption for the quarterly origination volume. Again, it can be lumpy and our experience is that typically when the markets are more volatile, deals tend to just get delayed. I think it’s just overall anxiety or that risk of backdrop tends to slow volumes, but it usually is short-lived and drives better structure, higher returns, and more opportunity coming out of it over time.

[Alex Blostein:]

All right. And then I guess just taking a step back just a bigger question for you guys, given underperformance of the stock really since the IPO and considerable dividend yield that you guys are spinning out right now, the lot of investors are asking how sustainable obviously is the dividend? So two-part question, A) Do you foresee anything in the future that would potentially lead you to lowering the dividend and B) How do you think about the capital return risk reward here given where the stock is trading and whether or not you consider buying some shares back. Thanks.

[Seth Taube:]

Yes, Alex. Let me take both questions, and I think we’ve covered this earlier in the call that the core net income was impacted by previously accrued performance fee reversals. But given the consistency of cash flow from our base revenues and our current growth in AUM, we remain comfortable with the dividend at this level. And I’ve said this in the past, our intention remains to grow earnings, grow AUM, and then over time grow the dividend. We haven’t changed our position on that and we have new products and a lot of folks focused on both asset growth, revenue growth, and performance across the platform specifically with respect to share repurchase which I think is what you’re referring to. As we said on the last call, our intention with the share repurchase will be to be in the market to offset RSU grants over time and in this quarter we did not utilized the share repurchase program.

[Alex Blostein:]

Okay, thanks.

[Operator:]

Okay, thank you. Our next question comes from the line of Mickey Schleien from Landenburg. Please go ahead.

[Mickey Schleien:]

Yes. Good morning everyone. One big picture question and one more of an accounting question. Brook, I appreciate your comments on the market backdrop, but the last numbers I saw was were that the spread between first and second lien continued to widen in October. I’m not sure how it’s progressed in November so far, but we did see first lien come in a little bit. So what I’m trying to ask is how are the funds performing in the fourth calendar quarter? And my second question maybe for Rick is, this I don’t know let’s call it adjusted core number of $0.16 per share, how close is that to a cash earnings per share number?

[Brook Taube:]

I’ll take the first part, Mickey. It’s hard for us to tell at this point all of our valuations are done by third parties. Based upon some of the overall performance in the market as well as specific monthly numbers that we see, it’s just difficult to tell where 12/31 would end up across the platform. I think generally speaking to sit here and this is just a general comment, we’ll have to get more specific if the quarter unfolds clearly is that the performance this period is not as volatile as last period. And I just make that as a general comment based upon what we’re experiencing real time and we’re all watching like you are and performance in the market and obviously we are looking at 176 borrowers carefully every day.

[Rick Allorto:]

Thanks. And Mickey, on your adjusted core earnings of $0.16 relative to that, a portion of that is cash. So our cash core earnings for the quarter were $0.17 and the delta is there is several non-cash expenses such as depreciation, amortization and stock-based compensation. However, there are no other non-cash revenues besides the performance fees that were adjusted in the calc.

[Mickey Schleien:]

Okay. And just one quick follow-up Brook, I understand your comments on less volatility in the market so far this quarter but some of the deals in the oil sector have weakened even further. Can we expect that to potentially impact the fourth quarter results for MDLY?

[Brook Taube:]

It’s hard to tell at this point. I will reiterate that our positions in oil service and other part to that complex are first lien. I think I believe you’re referring to the price action broadly speaking in the unsecured bonds.

[Mickey Schleien:]

Yes.

[Brook Taube:]

We obviously watch that carefully. We do not have unsecured bond position, so I would expect we’re not going to correlate highly with those prices you’re referring to. But on balance, there continues to be pressure quite clearly given the decline in oil and we have had some positive news in existing oil field and energy service companies and we have other folks that are focused - continue to focus on cost controls and other measures to stabilize their business.

[Mickey Schleien:]

Great. Thank you for your time this morning.

[Brook Taube:]

Thanks, Mickey.

[Operator:]

Thank you. Our next question comes from the line of Ann Dai from KBW. Please proceed.

[Ann Dai:]

Hi, good morning and thanks for taking my questions. So I just wanted to start with the deck in G&A quarter-over-quarter and I think maybe part of that is corresponding with the change quarter-over-quarter and reimbursable funds start-up expenses but could you just give some color on how that’s changing and why that decrease sequentially?

[Rick Allorto:]

Sure. Ann, you’re correct in the decrease quarter-over-quarter, it’s almost entirely related to those reimbursable fund start-up expenses associated with Sierra Income Corporation.

[Ann Dai:]

Okay. And is that a reflection of the fact that you’re no longer providing expense support or something related to Sierra’s ability to reimburse Medley? Just any color you can give on that.

[Rick Allorto:]

Sure. The expense support agreement is currently still in place. In Q3, Sierra Income Corporation was actually in a position where it was required to reimburse MDLY by $1.1 million versus Q2 it required expense support of $2 million, so the net delta $3 million is what’s driving that variance. So in the third quarter, Sierra actually performed and earned excess income to reimburse Medley for previously provided expense support.

[Ann Dai:]

Great. And understanding that Sierra’s earnings are not straight-line but going forward do you think that we should see that line tick down as a run rate or was that more of a one quarter one-off type thing?

[Rick Allorto:]

Your instinct is correct. It’s hard to tell specifically, there are a lot of factors at the Sierra Income Corporation that do drive the end result of the expense support. Hard to give you guidance right now with regard to Q4.

[Ann Dai:]

Okay. Understood and I just wanted to clarify something, I’m not sure if I misheard that I thought you guys said that the pickup in other expenses quarter-over-quarter was related to an unrealized loss from an investment, is that right or I’m sorry did I mishear?

[Rick Allorto:]

Yes, that’s correct.

[Ann Dai:]

So, that’s kind of a balance sheet investment, not a fund investment then?

[Rick Allorto:]

Yes, that’s a balance sheet investment that we have. It was associated with our investment in the shares of Sierra Income Corp.

[Ann Dai:]

Okay, great. And are there any specifics you can provide on the performance fee accrual just understanding that the actual valuation adjustment in the private funds was relatively small, were there any specific investments that drove most of it or were a really big factor in the quarter?

[Rick Allorto:]

No, there were no specific investments that drove a significant portion of that decline. A decline in the credit quality of a particular investment does obviously decrease the valuation, but broadly speaking, the valuation adjustment or the change in the asset values were driven just by our fair value mark-to-market process or accounting.

[Ann Dai:]

Understood, and one more if I may just around the new product development and I appreciate the color you’re giving us on what you’re thinking for the retail and institutional platforms, but is there any timing you can give us around those, what stage are those retail products and is it more just a thought at this point or have you proceeded down the path of filing for different things?

[Brook Taube:]

Ann, it’s Brook. I would just say that we expect to have some or all of these initiatives online in 2016.

[Ann Dai:]

Okay. Thanks Brook, and thank you all.

[Brook Taube:]

Thanks, Ann.

[Operator:]

Thank you. Your next question comes from the line of Christopher Nolan from FBR & Co. Please proceed.

[Christopher Nolan:]

Hi, thanks for taking my questions. The decline in AUM for MCC, what was it driving that please.

[Brook Taube:]

I think Chris if you’re not aware, we have a share repurchase program in place at MCC that we’ve been very public about that we intend to do, so I think the bulk of it would be that and we do have some repayments every quarter but I think the bulk of it was driven by the fact they we’re repurchasing shares there.

[Christopher Nolan:]

Absolutely, thank you. And then on for these new initiatives, what fee structure would it be - would it be less if we get on the BDC’s or comparable?

[Brook Taube:]

I’ll just take a quick comment on that one Chris, thanks for asking. It’s hard to see fees being higher than the current BDC complex. We’ve been very clear publicly that our expectation as this sector grows and I think Seth made reference that we’re looking at a $4 trillion demand that number is being communicated to us by the channel in aggregate. The products are likely to range from lower yielding, more liquid assets up to and including BDC like assets, so I would say on average we would look at fees lower on average and volumes increasing and that’s a specific comment on a broad range of new product initiatives as we look forward, so the average would be lower. However, that volume we expect will overwhelm the scalability. So, we’re looking at balancing that volume with returns. The second point which we’ve said also, which I think you guys repeating is that as this overall institutional business and retail business continues to scale and become more institutional across the platform, we would expect pressure on fees and that’s going to come across the industry and we would expect over time this is a multi-year process that they would unbalance fee pressure as we scale the platform.

[Christopher Nolan:]

Great. And what is your growth outlook for Sierra in 2016 given the DOL possible changes?

[Seth Taube:]

Hi Chris, this is Seth. We’re monitoring closely our - we’re comfortable that we can maintain the same pace that we’re at now. We’re optimistic that it could increase, but as you just see our quarterly pace the fund rising has been relatively constant in the face of the DOL conversation. So, our hope is that with the completion or nearing completion of the elaboration of the DOL initiatives that we will have more clarity and that should lead ultimately to high quality institutional products like Sierra, [indiscernible] from that going forward. So, I would hold it constant for now, but if we have activity with the DOL, our assessment is that we’ll be able to increase in the wake of that.

[Christopher Nolan:]

Okay. Thank you for taking my questions.

[Operator:]

Okay, thank you. So, now I would like to turn the call back over to the CEO, Brook Taube for closing remarks.

[Brook Taube:]

Thank you all very much for taking the time today. It was a good first year. We’ve grown our AUM by over 30%, we have good visibility on continued growth, and we are hard at work as we said growing the product, the team, and the platform. So, we look forward to speaking to you next quarter. Thanks very much.

[Operator:]

Thank you for participating in today’s conference. This concludes the presentation. You may now disconnect and have a good day.