Oaktree Strategic Income Corporation
Q3 2015 Earnings Call Transcript

Published: 11 Aug 2015

[Operator:]

Good day ladies and gentlemen and welcome to the Fifth Street Senior Floating Rate Corp.’s Third Quarter 2015 Earnings Conference Call. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder this call is being recorded. And now I’d like to introduce your host for today's conference Robyn Friedman, Vice President of Investor Relations. Please go ahead.

[Robyn Friedman:]

Thank you, Daniel. Good morning and welcome to Fifth Street Senior Floating Rate Corp.’s fiscal Third Quarter 2015 earnings call. I am joined this morning by Ivelin Dimitrov, Chief Executive Officer; Todd Owens, President; 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 July 9, 2015 press release and is posted on the Investor Relations section of Fifth Street Senior Floating Rate Corp’s website, which can be found at fsfr.fifthstreetfinance.com. Please note that this call is the property of Fifth Street Senior Floating Rate 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, words such as beliefs, expect, will, estimate, projects, anticipates and future or similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to the inherit uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ materially from those projected 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 us. 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. We undertake no obligation to publicly 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

[Ivelin Dimitrov:]

Thank you, Robyn. Before we begin, I would like to introduce our investors analyst, Steven Noreika, FSFR's new Chief Financial Officer, prior to his promotion Steve was serving as the Chief Accounting Office, Fifth Street Asset Management, he was over 18 years of experience and he is been with Fifth Street since September 2008. Steve has filled various finance positions during his tenure including Chief Financial Officer of FSFR from November 2013 to July 2014. We are excited to have Steve back on the management team and are confident that his experience across Fifth Street platform and his depth of financial knowledge will prove beneficial for FSFR. We look forward to introducing our analysts and the investors to Steve over the coming month. For the quarter ended June 30, 2015 FSFR generated $0.25 of adjusted net investment income per share. During the June quarter we deployed capital into deals with strong risk-adjusted returns increasing our weighted average cash yield to 7.6% and reaching our target leverage of 0.85 times. Additionally, during the quarter we closed $337 million of investments across 26 new and eight existing portfolio companies. As part of our mission to deliver strong and sustainable performance for FSFR shareholders our management team regularly evaluate all aspect of our business. As we stated on past conference call. We wanted to ramp FSFR and determine of run rate profitability level prior to our board setting the next few month of dividend. Now that there is greater clarity around the steady states earrings of FSFR our Board of Directors have decided to set our dividend as a level that reflects the current operating environment. The goal of our Board of Directors was to set the dividend at a level that we could meet or exceed on a consistent basis which we believe is important as it both increases our operating flexibility and should help us to achieve greater consistency around future distribution. As a result our Board of Directors declared monthly dividend of $0.075 per share for September, October and November which translates into quarterly dividend of $0.225 per share and annual dividend of $0.90 per share. Going forward we expect our Board of Directors to continue declaring monthly dividends on a quality basis. Over the past few quarters we have been working hard to optimize FSFRs capital structure. We ended the quarter at a regulatory leverage ratio of 0.85 times, within our target range of 0.8 to 0.9 times debt-to-equity. During the quarter FSFR was able to take advantage of the attractive capital market environment closing a $309 million debt securitization transaction which allows FSFR to lower its cost of capital and long date our liabilities to better match our assets. This securitization carriers a blend of cost of capital of 2.4% in a tenure of 10 years. Additionally, the deal represents the tightest trend for a middle market CLO this year which we believe is a testament to FSFR and the Fifth Street platform. FSFR remains focused on building a diverse portfolio of senior secured floating rate loans and has invested in 62 portfolio companies across 25 industries. The credit quality of our portfolio remains healthy with no investments on non-accrual. We maintain rigorous underwriting standards focusing on high cash flow sectors and limiting our exposure to cyclical sector such as energy. As of June 30, 2015 we had one investment in the energy sector representing only 0.7% of total investment [indiscernible] value. I would now like to take a few moment to highlights the differences between FSFR and Fifth Street Finance Corp and other BDC managed by Fifth Street to asset management. Unlike FSC which invests across the entire capital structure, FSFR focusing on investing in senior secured volume rate loans. Additionally, while FSC investing the mid middle-market, FSFR investing the upper middle-market backing companies with larger EBITDA which has the tendency to resulting in more liquid assets. For example at FSFR the average portfolio company EBITDA was $58.4 million as of June 30, 2015 because FSFR focusing on senior secured loans that reside at the top of the capital structure and are perceived to be safer. These loans generate a lower yield then those in FSCs portfolio. Lastly, FSFR receives 100% cash pay interest in the portfolio has no fixed interest. I will now turn the call over to our Chief Financial Officer, Steven Noreika to discuss our financials.

[Steven Noreika:]

Thank you Ivelin. We generated total investment income of $13.7 million and adjusted net investment income of $7.4 million or $0.25 per share for the quarter ended June 30, 2015. We have represented adjusted net investment income per share and net of a onetime charge related to our debt securitization during the quarter, including this onetime charge GAAP net investment income was $6.3 million or $0.22 per share. Total investment income increased from $11.9 million and adjusted net investment income increased from $6.7 million or $0.23 per share in the prior quarter. Net asset value per share was $12.23 which was a $0.23 decrease from the prior quarter. The change in net asset value was comprised of $0.15 per share from the net effect of credit and yield movement in the portfolio. And $0.08 per share from paying a dividend in excess of our GAAP net investment income. Of the $0.08, $0.03 per share is from an acceleration of fees related to securitizing our Natixis credit facility. Although we believe the attractive cost of capital and increased tenure of the debt securitization will be beneficial for shareholders over the long term. We ended the June quarter with portfolio investments of $628 million at fair value. During the quarter we had gross origination of $337 million in 26 new and 8 existing portfolio companies and funded $283 million across the portfolio. We also received $235 million in connections with the full or partial payoffs and sales of 43 net investments. Our portfolio consists of investment in 62 companies with our largest exposures in the software and healthcare industries. We continue to build the well diversified portfolio and at June 30, 2015 the average size of a portfolio net investment were $10 million and average portfolio company EBITDA was $58.4 million. Credit quality was strong once again as one 100% of the portfolio remained on accrual status and over 99% of the portfolio was ranked in the highest one and two categories. FSFR's joint venture with the Glick family commenced operations in April and as of June 30, 2015 the joint venture has $148 million of assets including investments in a range of senior secured loans to 20 Portfolio Company. As we continue to ramp the JV we anticipate that this partnership will generate a low teens return on net equity going forward the weighted average cash yield on our debt investments including the return on the JV was 7.6% as of June 30, 2015 which increased from 7.4% as of March 31. Turning to our capital structure, during the June quarter we operated at or around our target leverage range and we ended the quarter at our target leverage of 0.85 times debt-to-equity. As of June 30 we had $180 million of notes payable outstanding related to our securitization and $127 million drawn on our Citi Bank Credit facility. I'll now turn it back over to Robyn.

[Robyn Friedman:]

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

[Operator:]

[Operator Instructions] And our first comes from Christopher Nolan, MLV & Company. Your line is now open. Please go ahead.

[Christopher Nolan:]

Ivelin with our new sale or I guess Steve, any sales into the SLF?

[Steven Noreika:]

During the June quarter?

[Christopher Nolan:]

Yes.

[Steven Noreika:]

Sequential or Subsequent?

[Christopher Nolan:]

No, no just during the June quarter.

[Steven Noreika:]

Yes FSFR did sell investment into the JV and the JV is ramped to about a 140 million of assets and those assets were transferred from FSFR.

[Christopher Nolan:]

So $140 million in sales from FSFR to the SLF?

[Steven Noreika:]

Yes.

[Christopher Nolan:]

And then the excluding the non-recurring securitization expense, operating expense is seem to increase relative to revenues on a linked quarter basis, what's driving that?

[Steven Noreika:]

I actually don’t think overall operating expense did increase. If you look down the P&L, professional fees were up but comp and G&A were down quarter-over-quarter. So I think it was pretty much of flat quarter in terms of expense growth.

[Ivelin Dimitrov:]

Nothing unusual there.

[Steven Noreika:]

No, no there is not driving any sort of business trend there.

[Christopher Nolan:]

And then was there a comment, I mean you mentioned low teen IRR for the SLF. As I recall, I might be wrong that you guys were targeting mid-teen returns before, is that correct?

[Steven Noreika:]

No, I think we’ve been pretty consistent saying low-teens and especially during the ramp period. We generated 9% in the June quarter, but keep in mind that was a partial quarter, we didn’t start investing until the end of April. So you should see a low-teen return going forward.

[Christopher Nolan:]

And then the final question would be, asset quality. I mean right down before starting CRS, starting to ramp up in 2015 or so, year-to-date fiscal year relative to priors. What's going on because I -- the home investor pieces for FSFR was investing in a high quality, lower yielding middle market investments and it seems like you've seen lot more in terms of depreciation charges?

[Ivelin Dimitrov:]

This is a fair point. It's a fairly well-diversified portfolio with a lot of assets on the books, the markdown this quarter was driven really by two investments, Sears Corporation and Smile Brands. Those are investments that we hold across the platform, those indicated deals and staying very close to those situations but we think there is a good outcome there and it's really driven by the company's reporting number that were down quarter-over-quarter, they’re still on budget and they’re still tracking to our underwritten case. But the market perceived those two names to be of lower quality and so they treaded down and so we've marked them down accordingly. In both of those cases were actively involved our partners in the deal and we remain confident we’ll get back to our partner [ph] value there, over time.

[Christopher Nolan:]

Okay but in fact from this quarter, Ivelin I mean last quarter you guys had a $1 million realized loss then the quarter before that you had about $5 million of net depreciation charges and before that it wasn’t really much in way in depreciation charges and everything seems so ramped up in fiscal year 2015 in terms of depreciation charges and sort of knocking NAV per share even more. I mean, are you going stretching for deals? I mean you goes after the sponsored stuff but this was a type of thing that I thought FSFR was designed specifically to avoid lower yields but lower risk.

[Ivelin Dimitrov:]

You know, it is. And we are trying to stay close to that discipline. It all sponsor business in those companies as you know are going through volatile times and not everyone is always going up, across 65 companies we have some that are doing sectionally well and some that were working closely with. And I think that’s the point of investing in a platform we have a fully build out investment team that has underwriting resources, has portfolio management resources, so situations like this will happen and we’ll work through them and I think that’s something that’s we’ll -- our track record will show over time, how we’ve done?

[Christopher Nolan:]

Okay, okay. I'll get back in a queue. Thank you.

[Operator:]

[Operator Instructions] And we do have a follow-up from Christopher Nolan from MLV & Company. Your line is now open. Please go ahead.

[Christopher Nolan:]

The dividend cut what's driving that? Obviously that seems like you guys are starting to dial back expectations in terms of earnings for that relative to with the initial expectations were for the SLF. Is that a fair way you looking at it?

[Todd Owens:]

It’s Todd Owens, I think what we have done with this reduction in the dividend is we have gotten to the point now where we are closer to fully ramped. And fully enough ramped that we have a good sense for what we would describe as a steady state or run rate profitability of the enterprise. And as consequence of that we have revisited the dividend and decided to lower it to a level that we would expect to meet or exceed from steady state earnings. And so in many ways consistent with what we did at FSC, so to with FSFR is setting it at a little level that reflects what we now know to be within the ball part of our steady state earnings number.

[Christopher Nolan:]

Todd what was the short coming in terms of the -- relative to your expectations? Because obviously when you set the dividend and you did the diluted raise or FSFR did the dilutive raise last year. There is expectations in terms of forward earnings that the company had and from that goes the dividend. And obviously what came up short in terms of -- what your internal projections were relative to reality and driving the cut? Was it higher expenses lower revenues, what was the driver their?

[Todd Owens:]

That’s a good question, it is really two big components of the difference. Number one is the overall spread that we were expecting when we did the re-IPO of FSFR last fall, it has come in lower and that’s put pressure on the overall operating performance. And the second point really is the assumption.

[Christopher Nolan:]

When you say spread you mean difference between yield and cost of funds?

[Todd Owens:]

Yes, or overall yield on the portfolio is another way of thinking about it, is lower than we thought was achievable a year or a little bit less on the year ago, so that’s one thing. And the second point is, given where the stock is trading and again this is similar to FSC, we can't assume that there is going to be growth in the portfolio and as you know when there is growth that drives incremental operating income into the vehicle. And so when we talk about steady states that reflects that operated performance on the vehicle with no growth. And obviously if we get back into a position where we're able to grow at some point in the future than that provides the opportunity actually to prove the operated performance. But if you think about where we expected to be at the re-IPO and where we are now it really comes down to those two issues.

[Christopher Nolan:]

As that recall the earnings from FSAM is projections for growth or capital raises by FSFR were dialed back roughly six months ago to basically zero. I'm just working from memory here, so roughly six months ago the publically treated manager for FSFR dialed back its own expectations for growth. And what's the thinking about management where you do an equity raise for you basically dilute book value per share by 15% to 20% and the market will actually start rewarding you with above NAV evaluation. Was that real expectations?

[Todd Owens:]

I guess what I would say is we have sent to last several quarters ramping this vehicle and deploying the capital. And we have now done that and how a snapshot of what the operating performance is going to be, I think that it maybe -- you can make the argument that we sort of taken a dividend action last quarter. But we really wanted to make sure we had all of the facts in front of us in terms of the overall operating performance in terms of where we set the dividend level. We feel like we have that now and so we’ve taken the action that we’ve taken to reset the dividend.

[Operator:]

Thank you. That concludes today's question and answer session. I will now like to turn the call back to management for any closing remarks.

[Ivelin Dimitrov:]

Thanks everyone for joining the call, we look forward to keep updating you on our progress. Thank you.

[Operator:]

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