Fifth Street Asset Management (NASDAQ:FSAM)
Q3 2016 Earnings Conference Call
November 22, 2016 10:00 ET
Robyn Friedman - Head, Investor Relations
Leonard Tannenbaum - Chief Executive Officer
Alexander Frank - Chief Operating Officer and Chief Financial Officer
Good day, ladies and gentlemen and welcome to the Fifth Street Asset Management Third Quarter 2016 Earnings Call. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to introduce your host for today’s conference, Robyn Friedman, Head of Investor Relations. Ma’am, please go ahead.
Thank you, Liz. Good morning and welcome to Fifth Street Asset Management Inc.’s third quarter 2016 earnings conference call. I am joined this morning by Leonard Tannenbaum, Chief Executive Officer and Alexander Frank, Chief Operating Officer and Chief Financial Officer.
Before we begin, I would like to note that this call is being recorded. Replay information is included in our November 21, 2016 press release and is posted on the Investor Relations section of Fifth Street Asset Management Inc.’s website which can be found at fsam.fifthstreetfinance.com. Please note that this call is the property of Fifth Street Asset Management Inc. 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 believe, expect, will, estimates, 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 it. 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 laws. In addition, this conference call will include certain non-GAAP financial measures such as adjusted net income and pro forma adjusted net income. A reconciliation of these measures to the most comparable GAAP measures can be found in our earnings release, which is available on the Investor Relations portion of our website and has been filed with the SEC.
I would also like to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase any interest in Fifth Street funds. Investors should note that the historical investment performance of our funds, including Fifth Street Finance Corp. and Fifth Street Senior Floating Rate Corp., are not indicative of future results. The format for today’s call is as follows. Len will provide introductory remarks, an overview of our results and strategic commentary, and Alex will summarize the financials. Then we will open the line for Q&A.
I will now turn the call over to our Chief Executive Officer, Len Tannenbaum.
Thank you, Robyn. Before turning to our quarterly results, I would like to discuss the strategic review that we recently initiated to streamline our operations and enhance long-term performance at FSC and FSFR. While we are proud of the middle-market direct lending platform we have built over the last 18 years, we recognized that changes need to be made and as I am not pleased with the historical NAV declines at our two publicly traded BDCs, FSC and FSFR. As a credit focused asset manager, we are dedicated to driving long-term shareholder value at FSAM in all of the vehicles we manage. To this end, we are committed to stabilizing each BDCs NAV and increasing the return on equity at Fifth Street Finance Corp. and Fifth Street Senior Floating Rate to be among the best of our peers.
Our review is focused on enhancing all aspects of our business processes and operations. I am committed to taking all necessary actions to improve our returns, including evaluating underwriting processes, team composition, strategic direction and investment philosophy. Additionally, we continue to seek ways to increase the alignment of interest between FSAM and the shareholders of the BDCs. Over the last year, both FSAM and I have purchased shares of FSC and FSFR. As a group today, we are the largest shareholders at both FSC and FSFR holding more than 15% and 26% respectively. As the manager and a significant owner of both BDCs, we continue to believe that it is important to drive sustainable results that increase value for all three entities.
Now, turning to our third quarter results. FSAM generated pro forma adjusted net income in line with last quarter. Similar to last quarter, the increased profitability of FSAM was primarily due to lower incremental professional expenses at FSC and FSFR as well as lower expenses at FSAM. Looking ahead, we expect to approach normalized levels of expenses at FSAM and therefore expect FSAM’s profitability to remain relatively steady. We are confident that our steady state earnings is substantially above our current dividend level. As a result, we have increased the dividend to $0.125 per share quarterly or $0.50 on an annualized basis. As the additional incremental expenses further declined or sees to exist at our funds and at FSAM the dividend level may increase further.
Turning to the middle-market environment, the September quarter was marked by continued sluggishness mainly due to a lack of M&A deals by private equity firms coupled with global growth concerns. We believe in this competitive environment, Fifth Street’s established relationships with our private equity sponsors are increasingly important. As an incumbent lender, the Fifth Street platform is operating with a competitive advantage and is well-positioned to choose select deals that we believe are mutually beneficial. In our view, the overabundance of liquidity chasing two few deals remains an ongoing factor exacerbating the supply demand imbalance as it has driven leverage levels higher and yields lower.
In an environment such as this, with large amounts of capital chasing fewer deals we believe it is important to be disciplined and employ a high degree of selectivity. As a result, we have not seen many deals in our pipeline that we believe will provide adequate risk adjusted returns despite projected refinancings. Importantly, we are contempt to sit on the sidelines for now as we are in the late innings of the credit cycle and do not believe this is the correct environment to be aggressive with capital deployment. Looking ahead, we expect there will be a time when the market becomes more attractive and we remain acutely focused on ensuring that the entities we manage are well-positioned to take advantage of opportunities with appropriate risk adjusted returns in the next cycle.
I would now like to turn the call over to Alex Frank, our Chief Financial Officer to discuss the financials of our filing in more detail.
Thank you, Len. Before turning to our results for the quarter, I would like to take a moment to explain why our filing was postponed. During the course of 2015 and 2016, FSAM made substantial common stock purchases of FSC and FSFR owning 8.4 million shares and 1.4 million shares respectively as of September 30, 2016. As FSAM’s positions in these investments increased, we decided to re-evaluate whether the equity method of accounting was appropriate versus our current accounting for these investments as available-for-sale securities. At this time, we have determined that we should be accounting for these investments under the equity method of accounting. The result of the accounting change had no significant impact on our financial statements and no change to our pro forma adjusted net income both in the current quarter, or for any previous quarters and periods. Additionally, this change has no impact on either FSC or FSFR.
Turning to our earnings, total revenues were $22.5 million for the quarter ended September 30, 2016, consistent quarter-over-quarter, but down 11.9% from the previous year primarily due to the deduction in base management fee at FSC as well as lower asset levels at our managed funds. Management fees, which include base management fees and Part 1 fees were $19.7 million for the quarter ended September 30, 2016 or 87.6% of total revenues. Total expenses for the quarter ended September 30, 2016 was $17.3 million. After adjusting for non-recurring and reimbursed items, net expenses were $12.1 million, $1.6 million increase year-over-year mainly due to litigation related costs and other one-time compensation costs.
Total litigation related expenses, other non-recurring legal costs and one-time compensation charges at FSAM which we expect to roll-off over time were $5.2 million for the quarter ended September 30, 2016. Excluding these costs, net expenses decreased by $3.6 million or 34.7% compared to the prior year period primarily driven by lower employee related costs as we right sized our business to operate in a steady state environment. We believe that we are well staffed to provide a continued high level of service to our existing business lines.
Fee earnings AUM at September 30, 2016 was $4.1 billion, down slightly as compared to June 30, 2016. Pro forma adjusted net income for the quarter ended September 30, 2016 was $9.9 million or $0.20 per share. This represents $1.4 million or 16.2% increase as compared to $8.5 million or $0.17 per share for the quarter ended September 30, 2015. As calculated under GAAP, FSAM had a net loss of $0.2 million or $0.04 per share for the quarter ended September 30, 2016. The GAAP net loss included a non-cash tax expense of $0.18 per share related to recent changes in state tax law. During 2016, the State of Connecticut lowered its effective tax rate on the income that we allocate to our Connecticut activities. As a result of this decrease, we have reported a non-cash charge which reflects the change in the value of future tax benefits expected to be realized over 15 years that we captured through a deferred tax asset as part of the structural reorganization as a result of FSAM’s IPO in 2015.
Our Board of Directors declared a quarterly dividend of $0.125 per share or $0.50 annualized which represents a 25% increase quarter-over-quarter. The dividend is payable on January 13, 2017 to stockholders of record on December 30, 2016. We expect our Board of Directors to continue declaring quarterly dividends subject to various factors including company performance, capital availability, level and timing of share buybacks as well as general economic and market conditions. Going forward, as some of the incremental professional expenses and other litigation related costs continued to roll off and we approach normalized earnings, the dividend should continue to increase.
I will now turn it back over the Len.
I would like to wrap up today’s call by walking through the key takeaways. One, over the course of the past year, Fifth Street has faced significant headwinds that we believe we are almost through. Two, as discussed earlier earnings were in line quarter-over-quarter which led to an increase in our dividend level. Three, as incremental expenses roll-off we expect that our dividend level will increase. Turning to our investment philosophy, we believe the current market is too frothy and many deals do not offer an appropriate risk adjusted return. As a result, we are exhibiting a great deal of selectivity. We believe that stabilizing NAV and improving return on equity in both of our BDCs are of the upmost importance. Therefore, we are focused on deploying internal and external resources to complete a comprehensive evaluation of the firm. In doing so, we are committed to making any and all necessary adjustments to improve our underwriting and operations to drive incremental value for all of our shareholders. We look forward to providing further updates on the review process in the months ahead.
I will now turn it back over to Robyn.
Thank you for joining us on today’s call. Liz, please open the line for questions.
[Operator Instructions] I am showing no questions on the phone lines at this time. I would like to turn the call back to management for closing remarks.
I want to thank all of you for attending the call and we look to provide you further updates in the future. Thank you very much.
Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Everyone, have a great day.
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