Oaktree Strategic Income Corporation
Q4 2015 Earnings Call Transcript

Published: 15 Dec 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the Fifth Street Senior Floating Rate Corporation Fourth Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Ms. Robyn Friedman, Senior Vice President and Head of Investor Relations. Ms. Friedman, you may begin.

[Robyn Friedman:]

Thank you, Andrea. Good morning and welcome to Fifth Street Senior Floating Rate Corp.’s fourth quarter and fiscal year end 2015 earnings call. I am joined this morning by Ivelin Dimitrov, Chief Executive Officer; Todd Owens, President; and Steve Noreika, Chief Financial Officer. Before we begin, I would like to note that this call is being recorded. Replay information is included in our December 14, 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, plans, projects, anticipates and future or similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to the inherent 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 will provide introductory remarks and overview of our results and market update and Steve will summarize the financials. Then, we will open the line for Q&A. I will now turn the call over to our CEO, Ivelin Dimitrov.

[Ivelin Dimitrov:]

Thank you, Robyn. For the quarter ended September 30, 2015, FSFR generated $0.25 of net investment income per share, covering our quarterly dividend of $0.225 per share. During the September quarter, FSFR closed originations of $104 million across 25 new and one existing portfolio companies. In addition, we operated at the upper end of our targeted leverage range of 0.8 to 0.9 debt-to-equity and continued to make progress funding the FSFR Glick joint venture. FSFR continues to leverage the Fifth Street origination platform and remains focused on maintaining a diverse portfolio of senior secured floating rate loans. Fifth Street’s distinction is a leading middle market lender and its strong relationships with private equity sponsors creates a wide funnel of investment opportunities. This allows FSFR to selectively invest in opportunities with strong risk adjusted returns. We maintain rigorous underwriting standards and employ a high degree of selectivity, investing in credits with strong fundamentals. As a result, we prefer to invest in high cash flow sectors and employ a conservative approach when selecting our positions. As of September 30, 2015, we’ve always seen our portfolio was spread across 64 companies in 27 industries with our largest investment accounting for 8.2% of total assets. Overall, the credit quality of the portfolio remains healthy as 100% of our investments remain current with their cash interest payments. On average, our portfolio companies experienced improving financial results during the quarter consistent with the modestly growing economy. Additionally, our exposure to cyclical sectors such as energy remains limited. In the current challenging environment, we are pleased that our energy exposure remains at only 0.7% of total investments at fair value in one portfolio company. The credit portfolio remains strong, however, Ameritox one of our Top 10 physicians has underperformed over the course of this year, primarily due to a significant reduction in Medicare reimbursement rates and to a lesser extent lower testing volumes. As a consequence, Ameritox has been marked down to 91% of power and we have moved it to a category three asset. Additionally, we placed an immaterial amount of income from the answers.com second lien on non-cash non-accrual. Given our mark on the answers.com second lien, we felt it was prudent to stop accruing $14,000 of OID for the quarter. The first and second lien loans do not have any thick interest associated with them and the company continues to pay its contractual cash interest on both tranches. FSFR Glick JV, FSFR’s joint-venture with the Glick family continues to ramp during the quarter. As of September 30, 2015, the joint venture had $190.4 million of assets invested across 29 portfolio companies. Fifth Street’s direct origination platform has been instrumental in driving the funding of the joint venture which we believe will be accretive to earnings and generate the low-teens return from FSFR’s investment. Last quarter, our Board of Directors set the dividend at a level that it believes will be consistent with our earnings, which creates additional operating flexibility. Earlier in December, the Board declared monthly dividend of $0.075 per share for December, January and February. We expect our Board of Directors to continue to declare monthly dividends on a quarterly basis. As we have discussed, we have been ramping FSFR’s portfolio over the course of this year, and over the last two quarters has been operating substantially within our target leverage range. Additionally, we have made steady progress funding the joint-venture and anticipate ramping the JV towards its targeted size of $300 million over the coming quarters, at which point our portfolio and its performance will be more reflective of steady state. I would now like to turn the call over to our Chief Financial Officer, Steve Noreika to discuss our financials.

[Steve Noreika:]

Thank you, Ivelin. We ended the fourth quarter of fiscal 2015, with total assets of $697.7 million, an increase of $285.2 million from 2014 fiscal year-end. Portfolio investments totaled $623.6 million at fair value and was spread across 64 companies as of September 30, 2015. At the end of the September quarter, we had $53 million of cash on our balance sheet. Net asset value per share was $12.11 as compared to the revised NAV per share of $12.28 at the end of June quarter. For the three months ended September 30, 2015, we generated total investment income of $14.1 million and net investment income of $7.4 million or $0.25 per share. Net investment income increased 4.5% from $7.1 million in the prior quarter. During the quarter ended September 30, 2015 we closed $103.7 million of investments in 25 new and one existing portfolio companies and funded $108.7 million across new and existing portfolio companies. We also received $106.5 million in connection with full or partial repayments of debt investments, all of which were exited at or above par as well as open markets sales of debt investments. As of September 30, 2015, 98.7% of the portfolio consisted of senior secured floating rate loans, and 9.2% of the portfolio consisted of investments in the subordinated notes and equity interests of FSFR Glick JV. Our portfolio consisted of investments in 64 companies with our largest exposures in the software and healthcare industries. We continue to build a well-diversified portfolio and at September 30, 2015, the average size of a portfolio debt investment was $9.7 million and average portfolio company EBITDA was $62.5 million. Credit quality was strong once again as 100% of the portfolio remained on cash equivalent status. The weighted average cash yield on our debt investments, including the return on the JV, was 8.1% as of September 30, which increased from 7.6% as of June 30. Turning to our capital structure, during the September quarter, we operated within our target leverage range and we ended the quarter at 0.91 times debt to equity, slightly above our target range. As of September 30, we had $186.4 million of notes payable outstanding related our securitization and $136.7 million drawn on our Citibank credit facility. During our September 30, 2015 fiscal yearend audit work, in conjunction with our independent accountants, we identified errors in the recognition of fee income since inception through 2015. These errors primarily affected the timing of fee income recognition and were partially offset by the net overpayment of Part I and Part II fees to our investment adviser. In the aggregate, over the two year period, we prematurely recognized $8.1 million in revenue and prematurely paid $1.5 million in Part I and Part II fees, which resulted in a cumulative overstatement to net investment income of $6.6 million. In addition, we understated our net assets by $1.5 million as of June 30, 2015. We assessed the materiality of the errors on our prior quarterly and annual financial statements, both quantitatively and qualitatively, in accordance with the SEC guidance in SAB Number 99 and 108 and concluded that the errors were not material to any of our previously issued financial statements. Accordingly, we have revised our prior period financials to reflect the adjustments related to the fiscal years of 2013 and 2014, as well as the first three quarters of 2015. The $1.5 million of cumulative premature payments of Part I and Part II fees will be fully refunded by the limited partners of Fifth Street Holdings LP, the owner of our investment adviser, by December 31, 2015. The prior period financial impacts due to revision have been reflected in FSFR's September 30, 2015 Form 10-K and going forward, we expect that the reversed income will be accretive into our P&L over time. I will now turn it back over to Robyn

[Robyn Friedman:]

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

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Christopher Nolan with FBR Capital Markets. Your line is open.

[Christopher Nolan:]

Hi, thanks for taking my questions. Steve, is the restatement related to the same issues affecting FSC?

[Steve Noreika:]

Hi, Chris. Well, first, I just want to reiterate that this is a revision and not a restatement similar to FSC. Yes, very similar situation, same types of loans at the FSFR Fund as was at the FSC Fund.

[Christopher Nolan:]

Great. And because FSC is the subject of class action lawsuits or at least lawyers talking about it and has guided for higher legal costs in 2016 calendar, should we expect higher legal costs for FSFR in calendar 2016.

[Steve Noreika:]

Chris, this is Steven. I will ask Todd to answer this question.

[Todd Owens:]

We don't have any reason to expect that there will be higher legal costs at FSFR.

[Christopher Nolan:]

Great. Todd, the board meets every January to review and renew the management contract. Given that the current manager has eroded NAV per share by 20% since the June 2014 quarter, has cut the dividend and supposedly for FSFR, it’s supposed to be a pretty liquid, low risk portfolio. Do you think that the current fee structure is appropriate right now for FSFR given that performance?

[Todd Owens:]

Yes, we do. Well, you really have asked a couple of questions on the topic of the fee structure at FSFR. We have among the lowest fee structures in the industry and we think that’s an appropriate place to be for this type of a vehicle, and we also believe that Fifth Street Asset Manager is the right manager for this vehicle with its – it is a manager that has a 17-year record, has invested over $7 million in assets and has an intimate understanding of the assets that we originate and the assets that are in the portfolio. So as we sit here today, we feel very, very comfortable that that is the right manager for the portfolio.

[Christopher Nolan:]

Should we expect any modification to the management contracts such as a look back or netting of incentive fees?

[Todd Owens:]

I am not going to speculate on what the Board will do. Every year, the Board will do investment agreement, the contract and that will happen in due course for both of our vehicles, so I don’t want to go ahead of the Board.

[Christopher Nolan:]

Got you. Do you see a loss of the management contract, the possibility for FSFR?

[Todd Owens:]

No, I think that that’s a remote – I mean, it’s a theoretical possibility, but we think that that’s a remote possibility.

[Christopher Nolan:]

Okay, final one, and I will get back in the queue. The shares are trading at roughly 40% at discount and that shares yielding 12%. How about buybacks, share buybacks?

[Todd Owens:]

It’s good question. Look, we – and as I have said, I think on earlier calls, we have been ramping this portfolio pretty significantly over the course of the year. We have been deploying the capital that we raised earlier in the year into a portfolio. You heard Ivelin describe that we have now operated for a couple of quarters within the target range of leverage and we are in the process of completing the ramp of the joint venture. I think as a consequence of that, we believe that we are now getting to a point where the steady state profitability of this business can be understood by the market and we have not thought it made sense to buy back stock up until now as we continue into 2006, we will revisit that. Then I would note at FSC, we bought $20 million in shares last quarter and I would also note that our manager FSAM bought shares in FSFR in the last quarter as well. And so that is something that we would consider in the future.

[Christopher Nolan:]

Ivelin’s comment, and Ivelin, I mean, you mentioned the way FSFR leverages the origination platform of Fifth Street. What happens in the event that Fifth Street is replaced as the manager for FSC, because I estimate FSC accounts were roughly 80% of the manger’s revenues. How does that affect FSFR -- if the manager loses roughly 80% of the revenue flow, how does that affect the origination platform, which FSFR relies on?

[Ivelin Dimitrov:]

Chris, I’ll ask Todd to answer that question.

[Todd Owens:]

Yes, Chris, look, it’s a big question, but I would default to what I have said before, a minute ago, and also what we said on the FSC, we think that probability is a remote probability.

[Christopher Nolan:]

Okay. And have you guys actually had discussions with RiverNorth since that call?

[Todd Owens:]

We are going to keep this conversation focused on FSFR and refer you to the public comments that we’ve made from FSC on that topic.

[Christopher Nolan:]

Okay. Thanks for taking my questions Todd.

[Todd Owens:]

Thank you.

[Operator:]

[Operator Instructions] And I am not showing any further questions at this time. I would now like to turn the call back over to management for any further remarks.

[Ivelin Dimitrov:]

Thanks, everyone, for joining the call today.

[Operator:]

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