FSAM - Q Fifth Street Asset Management Inc Earnings Call EVENT DATE/TIME: NOVEMBER 24, 2015 / 9:30PM GMT

Transcription

1 THOMSON REUTERS STREETEVENTS EDITED TRANSCRIPT FSAM - Q Fifth Street Asset Management Inc Earnings Call EVENT DATE/TIME: NOVEMBER 24, 2015 / 9:30PM GMT

2 CORPORATE PARTICIPANTS Robyn Friedman Fifth Street Asset Management Inc. - SVP & Head of IR Leonard Tannenbaum Fifth Street Asset Management Inc. - CEO Alexander Frank Fifth Street Asset Management Inc. - COO & CFO CONFERENCE CALL PARTICIPANTS Ken Worthington JPMorgan - Analyst Christopher Nolan FBR & Company - Analyst Craig Siegenthaler Credit Suisse - Analyst Stephen Laws Deutsche Bank - Analyst PRESENTATION Good day ladies and gentlemen, and welcome to the Fifth Street Asset Management Inc. third-quarter 2015 earnings call. ( Instructions) As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Robyn Friedman, Senior Vice President, Head of Investor Relations. Please go ahead. Robyn Friedman - Fifth Street Asset Management Inc. - SVP & Head of IR Thank you, Jonathan. Good afternoon, and welcome to Fifth Street Asset Management Inc's third-quarter 2015 earnings conference call. I am joined this afternoon 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 23, 2015 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 believes, expects, will, estimates, plan, 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 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. In addition, an investment in Fifth Street Asset Management Inc. is not an investment in any of our funds. Investors should note that the historical 2

3 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 September quarterly results, I would like to briefly discuss the overall market environment. There are several new regulations that are reshaping the middle market landscape ranging from the SEC's liquidity management program, whereby funds will be mandated to keep a certain percentage of the portfolio assets that could be liquidated without materially impacting pricing within a three-day window, to new risk retention rules for CLOs. As CLOs seek to solve for risk retention, we have seen many players temporarily pull out of the market. We believe that both of these regulations provide opportunities for our platform to take advantage of additional supply in the market with potentially wider yields. Across the BDC industry in general, there's been some developments on the legislative front. On November 4, the House Financial Services Committee passed legislation that would increase debt to equity limitations on BDCs from 1 to 1, to 2 to 1, and allow preferred stock to count as a senior security. Given the past history of the bill, and the current Washington political environment, we continue to be skeptical about the prospects of this bill's passing. For the quarter ended September 30, 2015, FSAM generated $0.18 of pro forma adjusted net income per share, which excludes the results of a majority owned company, MMKT. This quarter, excluding MMKT, our earnings were relatively stable quarter over quarter, driven by modest increases in fee earning AUM. As we have stated on previous conference calls, we are in an operating environment for our two business development companies, which contribute a majority of our earnings, have been trading at a discount to book for an extended period of time. We expect that the BDCs will operate under a steady-state environment for the foreseeable future and recycled capital will be used to fund new originations. Subsequent to quarter end, a class-action lawsuit was filed against FSC by a class of FSC shareholders. FSC, as well as FSAM, believe the claims are completely without merit, and we intend to vigorously -- to defend ourselves vigorously. Additionally, FSC received a letter from a shareholder, River North Capital Partners, an investment firm that has recently purchased FSC shares. In its letter, River North called for the replacement of three FSC directors, and additional strategic changes, including replacing the investment advisor. We believe certain statements in River North's press release were inflammatory and misleading. However, we do agree with River North that FSC assets are significantly undervalued by the market. With that said, questions have been raised by River North and other shareholders. We encourage constructive and open dialogue with these constituents to better understand their recommendations and reasoning. As we previously announced in September, we closed Fifth Street SLF II, a $417 million CLO. This transaction was our second actively managed CLO, and the third debt securitization closed across the broader Fifth Street platform in The closing of this deal is significant given the widespread market volatility at the time, and served as a strong endorsement of our platform by global capital markets. The transaction was structured to comply with both US and European risk retention requirements, which serve to further differentiate our platform in the eyes of investors. As I discussed earlier, the new risk retention requirements present a variety of challenges to CLO managers, given the significant increase in the cost of capital associated with this business line. As we look to continue to grow this business line, we plan to evaluate a variety of options to ensure continued compliance with risk retention in future deals. 3

4 During the third quarter, the hedge fund made a strategic hire, and we are pleased to announce that Brian Walter joined Fifth Street as the Assistant Portfolio Manager for our hedge fund, Fifth Street Opportunities Fund. Brian brings over 19 years of experience working with leveraged finance markets and was most recently a Managing Director at Stifel Financial where he was Co-Head of Fixed Income Cleared Product and Head of Leveraged Finance Trading. In addition to executing on the hedge fund's core strategy, Brian brings specific bond market knowledge and expertise to the platform, which the hedge fund expects to leverage. In addition to myself, Brian is responsible for the day-to-day management of the fund, and as such, maintains a significant economic interest in the fund. We believe Brian was an integral hire, as it was necessary to install a dedicated senior resource. Beyond our existing vehicles, we have continued to explore organic growth opportunities, with a focus on expanding into products that are adjacent to our core strategies, such as middle-markets separately managed accounts. As we discussed on our conference call, one initiative that we've been focused on is MMKT, a financial technology company that introduces efficiency, liquidity, and transparency to the outdated middle-market loan syndication process, while increasing accessibility to a broader base of purchasers. We are pleased to announce that during the September quarter, MMKT successfully launched its loan syndication platform, and has closed on a $5.9 million institutional round of funding, led by QED Investors. Since the end of the quarter, Fifth Street has lifted select deals on MMKT, and over 30 institutional purchasers are registered on the system. We are currently seeking to complete a larger financing round to accelerate the growth of MMKT's infrastructure, as well as the sales team, and expand its product offering. In May, we received approval from our Board of Directors for a one-year $20 million share buyback. During the September quarter, we purchased approximately $1.1 million, or 144,000 shares in the open market under our existing share buyback authorization. Under our current authorization, we have purchased $1.8 million in the aggregate, and have capacity to buy an additional $18.2 million worth of shares. This week, our Board of Directors declared a quarterly dividend of $0.17 per share, which is consistent with our dividend from last quarter. The dividend will be payable on January 15, 2016 to shareholders of record on December 31, I would now like to turn the call over to Alex Frank, our Chief Financial Officer, to discuss the financials in more detail. Thank you, Len. Total revenues were $25 million for the quarter ended September 30, 2015, a 3.3% increase compared to the unadjusted revenue for the quarter ended June 30, After adjusting for the premature fee payment the increase in revenue quarter over quarter is 1.1%. Management fees, which include base management fees and Part I fees, were $23.6 million for the quarter ended September 30, 2015, or 94.6% of total revenues. After adjusting for non-recurring and reimbursed items, expenses remained relatively flat sequentially, but increased for the year-over-year period, due to previous investments in talent, infrastructure, and growth initiatives. Fee-earning AUM at September 30, 2015 was $4.5 billion, which increased slightly from June 30, 2015, driven by the CLO securitization of Fifth Street Senior Loan Fund II. Excluding the results of MMKT, pro forma adjusted net income for the quarter ended September 30, 2015 was $8.8 million, or $0.18 per share. Including the results of MMKT, net of tax, pro forma adjusted net income for the quarter ended September 30, 2015 was $8.5 million, or $0.17 per share. The delay in filing FSAM's Form 10-Q resulted from delays in compiling certain necessary information to complete our quarterly review procedures, and to prepare a complete filing of FSAM's Form 10-Q in a timely manner. Specifically, FSAM required certain information from FSC and FSFR that was not available before FSAM's November 16 filing deadline. This is the first quarter since FSAM's IPO that FSAM was required to make quarterly filings before FSC and FSFR were required to make their quarterly filings. Subsequent to the end of the September quarter, we identified adjustments in the calculation of Part I management fees previously paid to FSAM by FSC and FSFR. 4

5 The identified adjustments related to incorrect information used by FSC and FSFR's administrator, a wholly-owned subsidiary of FSAM. It was determined that in the case of certain transactions entered into by FSC and FSFR, origination fees that were received at the close of the transaction should have been recognized as income over time, rather than the period the transaction closed. As a result of that finding, the BDCs cumulatively paid $3.3 million of Part I management fees prematurely. The premature payment will be refunded by the limited partners of Fifth Street Holdings LP, the owner of the BDCs' investment advisor, and none of the expense will be borne by the Class A public shareholders of FSAM. Prior period financial impacts have been reflected, primarily as a revenue reduction in FSAM's September 30, 2015 Form 10-Q. I will now turn it back over to Robyn. Robyn Friedman - Fifth Street Asset Management Inc. - SVP & Head of IR Thank you for joining us on today's call. We will take questions during the Q&A session from analysts that cover FSAM. We will not be taking questions on either of our publicly traded BDCs, as FSC and FSFR have not yet reported results for their fiscal years ended September 30, Additionally, other than what has already been stated during the prepared remarks, we will not be making any further comments on the class-action lawsuit or River North's Schedule 13D filing. If any investor has questions, please call the investor relations line at Jonathan, please open the line for questions. QUESTIONS AND ANSWERS ( Instructions) Ken Worthington, JPMorgan. Ken Worthington - JPMorgan - Analyst First, can you talk about the hedge fund, how is it performing to date? And maybe talk about how the pipeline of future investors look? How is interest rate now, given the returns that you have been able to generate thus far this year? So the good news is, the return has been really good on a relative basis. Every single month, we seem to be fighting to be flat or up, and I hear flat or up is the new up 15 in this environment. The tough thing about raising capital, which I guess I could have anticipated a little bit earlier, is I really needed another senior resource to be able to watch the day-to-day operations with me. And having Brian focused on it with his terrific reputation, owning a large part of the incentive fee of the fund, and very motivated and terrifically analytical has been a big help. And so only recently have we reengaged the fund-raising effort. And again, the traction starts at the beginning, and we hope to raise AUM. But it is hard to raise AUM in an environment where many credit hedge funds have performed very badly. 5

6 Ken Worthington - JPMorgan - Analyst Great, okay, thank you. In terms of compensation, I know it's only $1 million, but compensation up $1 million from last quarter. There's been a lot of maybe headcount changes, some hiring and some departures. What, I guess, is the right outlook for compensation? Maybe not just for next quarter but as we go into next year as well? How should we model out the growth rate there? I think on a sequential basis, we're where we expect to be going forward. We did add resources, as you know, over the last couple of years. But right now, we're not doing that. We're in a flat environment. So I think you can model it out, based upon where our run rate has been for the last couple of quarters. Ken Worthington - JPMorgan - Analyst Okay. I'll try this one as a flyer, but on MMKT, any additional information you can share with us on what you are really investing in, and maybe what the endgame is? I think, we hope as we said in my prepared remarks that we are in the process of raising a larger institutional financing round. And I think once that gets completed, we'll hopefully meet with all the analysts and talk to you about that, because I think educating you on what we're doing in this market is really important. But I think it's important first to complete this round. Ken Worthington - JPMorgan - Analyst Okay. Great. Thanks very much. Christopher Nolan, FBR & Co. Alex, how much does FSC contribute to revenues for FSAM? What's the percent -- 98? Do we disclose that number? No. 6

7 We will get back to you. It's pretty easy to calculate from public filings. Okay, and then looking to the fourth quarter expenses, last year you had a bump up in fourth-quarter compensation expenses. Should we expect the same bump up this coming quarter? I don't think I really want to comment on -- we haven't -- the year is not over. The fourth quarter typically on the business side, is seasonally our strongest quarter. And obviously our compensation that we pay people is related to the performance. A lot of our compensation is variable and discretionary, and paid in the form of year-end bonuses. So we have to see how the fourth quarter pans out, before we can really tell where that will come out. Now on those incentive fees you just mentioned, are those tied to the performance of FSAM, or does it also tie into the underlying BDCs? Which incentive fees are you referring to? The ones on FSAM's income statement, in compensation and benefits. I'm not sure what incentive fees, there are no incentive fees in the comp and benefit. I'm not sure what the question is. Okay I was looking at the Q, and I thought I saw some incentive fees in there. Final question -- There are incentive fees paid to FSAM, based upon the performance, but that's nothing to do with the comp line, directly. Got you. Okay. 7

8 Also, should we expect operating expenses to increase, as a result of the lawsuit and the activist shareholder? I think it's too early for us to make any predictions on that. I don't think we are prepared to do that at this point. Okay. I'll get back in the queue. Thank you. Craig Siegenthaler, Credit Suisse. Craig Siegenthaler - Credit Suisse - Analyst Just one more quick follow up here on the MMKT business. Can you give us a little more color on the one-time items that were evident this quarter, and any more color on those going forward that we should expect? Thank you. So color on the -- we disclosed the earnings with and without MMKT, so the delta you could see there. And that's primarily expenses associated with the investments that we are making in people that are working on the platform. You have to understand from a GAAP purposes, this is Len speaking, we clearly have MMKT expense running through our income statement, because it's a majority-owned subsidiary and a controlled subsidiary. My intention is that not to be the case at some point next year, so it would be not put into our financial statements. And from a cash standpoint, our total investment in MMKT, besides a lot of time, energy, effort, and not including all of the soft costs, and supporting the early growth, it's been about $1.5 million or so. And we don't expect that to materially increase, as most of the funding is now coming from institutional outside sources. So while clearly our losses will increase going forward on MMKT as it ramps up and spends money, and expands in the market, from a cash standpoint or investment standpoint, MMKT, we don't expect to materially invest that much more money. Craig Siegenthaler - Credit Suisse - Analyst Thank you. Stephen Laws, Deutsche Bank. 8

9 Stephen Laws - Deutsche Bank - Analyst Two questions, I think I'd like to hit on, that haven't been asked yet. The first is on the stock buyback. It looks like you've only done a small portion of the $20 million authorization. Can you talk about your appetite to repurchase shares here, and any willingness to increase that authorization, as you use up the entire $20 million? As to increasing authorization, we still have a lot left. Remember that we're -- yes, I anticipate since the stock is even lower than the last time we bought shares, I'd still be interested in buying them back, if I could, if the windows are open to do so, and windows are up to the lawyers. So I can't really comment whether my window is opened or closed at any given time, because I consult my legal counsel at any given time. And we are -- just so you know, when anyone buys back shares, there is severe restrictions, limitations on volume. And the amount you can buy back given volume, I'm not going to give a lecture on it, but I'm sure you can find that out from your trading desk, et cetera. Just so you know, it's not necessarily a reflection that I wouldn't have bought back more, it's often volume restricted. Stephen Laws - Deutsche Bank - Analyst Okay, thanks Len. And I guess to talk about the management fee reimbursement on the Part I fees, trying to get our model straightened out to think about what fees look like going forward. In order to back into that, can you give us the timeframe over what period of time those fees were paid for? Was it just fees associated with the third quarter? Is it this calendar year? Can you give us any more color on that, so we can get our model straightened out? The $3.3 million you are referring to? Stephen Laws - Deutsche Bank - Analyst That's right. That is the cumulative amount going back to any transactions that are currently on our books. And as you know, most of the loans that the BDCs make generally have a maturity -- a stated maturity of about 5 years, 5.5 years on average for the portfolio. Some of those we pay early, which is nice sometimes. And so if you think about that, it may be a 3 to 3.5 year actual average life. The difference between the accounting methodology is spreading it over 3 to 4 years, versus one year. It's only about a one-third difference. Stephen Laws - Deutsche Bank - Analyst Okay. We'll keep working on that. I appreciate the comments. Thank you. 9

10 This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Management for any further remarks. I just want to say that I'm extremely proud of the team that we have assembled at Fifth Street, and the hard work that everyone has put in. Although there was some initial uncertainty, morale continues to improve. In reaction to the challenges that we have faced, I am proud of the resiliency that our team has shown, day in and day out, far exceeding my expectations. You can tell that Fifth Street employees are extremely passionate, and have a personal stake in what we have built together. The long days and nights spent working towards a common goal have only solidified our team's cohesiveness and alignment. I could not be prouder of the team we have here at Fifth Street, or more optimistic about what we will all achieve together. Thank you all for attending the call. Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day. DISCLAIMER Thomson Reuters reserves the right to make changes to documents, content, or other information on this web site without obligation to notify any person of such changes. In the conference calls upon which Event Transcripts are based, companies may make projections or other forward-looking statements regarding a variety of items. Such forward-looking statements are based upon current expectations and involve risks and uncertainties. Actual results may differ materially from those stated in any forward-looking statement based on a number of important factors and risks, which are more specifically identified in the companies' most recent SEC filings. Although the companies may indicate and believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate or incorrect and, therefore, there can be no assurance that the results contemplated in the forward-looking statements will be realized. THE INFORMATION CONTAINED IN EVENT TRANSCRIPTS IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES THOMSON REUTERS OR THE APPLICABLE COMPANY ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY EVENT TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. 2015, Thomson Reuters. All Rights Reserved T00:42: