New Mountain Finance Corporation 8.250% Notes due 2028 (NMFCZ) Q1 2015 Earnings Report, Transcript and Summary

Good morning and welcome to the New Mountain Finance Corporation First Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Rob Hamwee CEO and President. Please go ahead.

Thank you and good morning everyone and welcome to New Mountain Finance Corporation’s first quarter earnings call for 2015. On the line with me here today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital; and Dave Cordova, CFO of NMFC. Steve is going to make some introductory remarks. But before he does, I would like to ask Dave to make some important statements regarding today’s call.

Thank you, Rob. I would like to advise everyone that today’s call and webcast are being recorded. Please note that they are the property of New Mountain Finance Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available on our earnings press release. I would also like to call your attention to the customary Safe Harbor disclosure and our in our May 05, 2015 press release and on page two of the slide presentation regarding forward-looking statements. Today’s conference call and webcast may include forward-looking statements and projections, and 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 those statements and projections. We do not undertake to update our forward-looking statements or projections unless required to by law. Any references to New Mountain Capital or New Mountain are referring to New Mountain Capital, LLC or its affiliates and may be referring to our investment advisor, New Mountain Finance Advisors BDC, L.L.C. where appropriate. To obtain copies of our latest SEC filings and to access the slide presentation that we will be referencing throughout this call, please visit our website at www.newmountainfinance.com or call us at 212-720-0300. At this time, I’d like to turn the call over to Steve Klinsky who will give some highlights beginning on page four of the slide presentation. Steve?

Thanks David. Rob and Dave will go through the details in a moment but let me start by presenting the highlights of another strong quarter for New Mountain Finance. New Mountain Finance’s adjusted net investment income for the quarter ended March 31, 2015 was $0.34 per share. The middle of our guidance of $0.33 to $0.35 per share. This once again covers our Q1 dividend of $0.34 per share. The company’s book value on March 31 was $13.89 per share an increase of $0.06 from last quarter. We are also able to announce our regular dividend for the quarter ending June 30, 2015. The regular dividend will again be $0.34 per share, consistent with our previously communicated view that we have reached a fully ramped steady state dividend level. The overall credit quality of the company's loan portfolio continues to be strong beside Edmentum which we discussed on last quarter's call. No new loans placed on nonaccrual this quarter. Since the inception of our debt effort in 2008 we have had only two issues with a realized default loss representing less than 0.2% of cumulative investments made to date. The company invested $65 million in gross originations in Q1 and $15 million net of repayments maintaining leverage at the high end of our range. In summary, we are pleased with NMFC’s continued performance and progress. With that, let me turn the call back over to Rob Hamwee, NMFC’s CEO.

Thank you, Steve. Before diving into the details of the quarter, as always, I’d like to give everyone a brief review of NMFC and our strategy. As outlined on page 6 of our presentation NMFC is externally managed by New Mountain Capital, a leading private equity firm with over $15 billion of assets under management and 100 staff members, including 60 investment professionals. Since the inception of our debt investment program in 2008, we have taken New Mountain’s approach to private equity and applied it to corporate credit with a consistent focus on defensive growth business models and extensive fundamental research within industries that are already well-known to New Mountain. Or, more simply put, we invest in recession resistant businesses that we really know and that we really like. We believe this approach results in a differentiated and sustainable model that allows us to generate attractive risk-adjusted rates of return across changing cycles and market conditions. To achieve our mandate, we utilize the existing New Mountain investment team as our primary underwriting resource. Turning to page 7 you can see our total return performance from our IPO and May 2011 to May 1, 2015. In the four since our IPO we have generated a compounded annual return to our investors of 13.2%, significantly above our regular dividend yield and dramatically higher than our peers. Page 8 goes into a little more detail around relative performance against our peer set benchmarking against the 10 largest externally managed BDCs that have been public at least as long as we have. We attribute the success to, one, our differentiated underwriting platform two our ability to consistently generate the vast majority of our NII from stable cash interest income and an amount that covers our dividend; three, our focus on running the business with an efficient balance sheet and always fully utilizing inexpensive appropriately structured leverage before accessing more expensive equity; and four, our alignment of shareholder and management interest. As outlined on page 10, credit spreads have begun to narrow since our last call driven largely by reduced supply in the market and to a lesser degree of stabilization in retail fund flows. Risks premiums still remains somewhat elevated but base rate remain historical low creating a neutral environment for capital deployment. We continue to see significantly elevated credit spread and smaller less liquid credits. Given the continued focus in the market on the possibility of future short term and long term rate increases we wanted to highlight NMFC’s defensive positioning relative to this potential issue. As you can see on page 11, 84% of our portfolio is invested in floating rate debt. Therefore even in the face of a material rise in interest rates, assuming of consistently shape yield curved we would not expect to see a significant change in our book value. Furthermore at the table of the bottom of the page demonstrate a meaningful rise in short term rate will generally increase our NII per share with the only exception being a modest rise having a slightly negative impact as the cost of the majority of our borrowings rise, while our interest income does not initially go up given the presence of LIBOR floors on our assets. Our highest priority continues to be our focus on risk control and credit performance, which we believe over time, is the single biggest differentiator of total return in the BDC space. If you refer to page 12, we once again lay out the cost basis of our investments with the current 03/31/15 portfolio and our cumulative investments since the inception of our credit business in 2008 and then show what has migrated down the performance ladder. Since inception, we have made investments of over $3.2 billion in 155 portfolio companies, of which only four representing just $36 million of cost have migrated to non-accrual and only two representing $6 million of cost has resulted in a realized default [loss]. Over 96% of our portfolio at fair market value is currently rated 1 or 2 on our internal scale. Page 13 shows leverage multiples for all of our holdings above $7.5 million when we entered into an investment and leverage levels for the same investment as of the end of the current quarter. Well not a perfect metric to be asset by asset trend and leverage multiple is a good snapshot of credit performance and helps provide some degree of empirical, fundamental support for our internal ratings and marks. As you can see by looking at the two tables, leverage multiples are roughly flat or trending in the right direction with the only a few exception. Page 14 gives a current update on Edmentum. The balance sheet restructuring has played out consistent with our expectations outlined on last quarter's call and is expected to close this month. You will receive a combination of new notes and equity and along with the three other large second lean holders will own and control the company. We are providing a modest amount of incremental liquidity to the company which our funded share will approximately $5 million. Operating results for the business are in line with the budget so far this year and we are cautiously optimistic that the company's performance has stabilized. The chart on page 15 helps track the company’s overall economic performance in since IPO. At the top of the page we show how the regular quarterly dividend is been covered out of net investment income. As you can see we continue to more than cover 100% of our cumulative regular dividend out of NII on the bottom of the page we focus on below the line item. First we look at realize gains and realize credit in other losses. As you can see look at the row highlighted in green we've had success generating real economic gains every year through a combination of equity gains, portfolio company dividend and trading profit. A significant realized gain of $14.6 million in Q1 reflects the very profitable monetization of our equity interest in global knowledge and parts as previously discussed. Conversely realize losses highlighted in orange have been significantly smaller and less frequent and show that we are not avoiding non-accrual by Southern port segment material loss prior to actual default. The net cumulative impact of this success to date is highlighted in blue which was accumulative net realized gains of $41.9 million since our IPO. Next we look at unrealized appreciation and deprecation. The decline in the cumulative net unrealized depreciation this quarter primarily reflects the $10 million impact of the reclassification of global knowledge from unrealized to realize, otherwise small mark to market gains on underlying assets were broadly offset by similarly sized mark to market losses. As you can see highlighted in gray we have cumulative net unrealized depreciation of $30 million. Finally, we combined net realized with unrealized depreciation to drive the final line on the table which in the yellow box shows a current cumulative net realized and unrealized depreciation of $12 million. The point here is to show that on both the realized and combined, realized and unrealized basis we have consistently and methodically more than offset any credit losses for impairment is below the line gain elsewhere in the portfolio. Our market driven volatility around unrealized appreciation and depreciation may cause a bottom line number to vary overtime true economic gains and losses will accumulate in the realize bucket where we will strive to retain a positive balance. Moving on to portfolio activity as seen on pages 16 and 17, origination have been moderate as we entered the quarter at the high end of our leverage range and only needed to deploy limited capital to stay fully leverage in light of modest repayment. We made significant investments in four portfolio companies and a total growth origination of $65 million. Payments in Q1 were also modest totaling $50 we exited Q1 fully level in Q2 so far has been similar to Q1 with limited repayment and origination to date, although our medium term pipeline of both is somewhat higher than it has been. Pages 18 and 19 show the impact of Q1 investment and disposition activity on asset pipe and yield respectively. Both assets origination and repayment were heavily weighted towards secondly lean investment, yield on origination were meaning pre-hired in those on disposal and higher than the portfolio as a whole. However the changes in the LIBOR curve more than offset. The net impact is that portfolio yield overall is slightly down to 10.6% in terms of the portfolio review on page 20 the key statics as of 3/31 was very similar to 12/31. The asset mix has shifted slightly towards non-first lean, as always we maintain our portfolio comprise with the companies in the defense growth industries like software, education, business services and healthcare that we believe are outperformed in an uncertain economic environment. Finally as illustrated on page 21 we have a broadly diversified portfolio with our largest investment in 3.3% of fair value and the top 15 investment accounting for 40% of fair value. With that I will now turn it over to our CFO Dave Cordova to discuss the financial statements and key financial metrics. David?

Thank you, Rob. For more details on the financial results in today's commentary please refer to the Form 10-Q that was filed last evening with the SEC. Now, I would like to turn your attention to slide 22. The portfolio had just over $1.4 billion in investment to fair value at March 31, 2015 and total assets of just over 1.5 billion. We had total liabilities of 681.1 million of which, total statutory debt outstanding was 626.4 million, excluding 37.5 million of drawn SBA-guaranteed debentures. Net asset value of 806.5 million or $13.89 per share was up $0.06 from the prior quarter. As of March 31, our statutory debt-to-equity ratio was 0.78 to 1. On Slide 23, we show the historical NAV per share and leverage ratios, which are broadly consistent with our current target leverage of between 0.7 to 0.8 to 1. We also show the NAV adjusted for the cumulative impact of special dividends, which portrays a more accurate reflection of true economic value creation. On Slide 24, we show our quarterly income statement results. We believe that our adjusted NII, is the most appropriate measure of our quarterly performance. This slide highlights that while realizations and unrealized appreciation/depreciation can be volatile below the line, we continue to generate stable net investment income above the line. Focusing on the quarter ended March 31, 2015, we earned total investment income of approximately $36.5 million in line with the prior quarter. Total net expenses of $17 million decreased $0.5 million from the prior quarter primarily due to lower G&A expense. As mentioned on the last call due to the merger of our Wells Fargo credit facilities in the prior quarter and consistent with the methodology since IPO the investment advisory will wage management fees on the leverage associated with those assets that share the same underlying yield characteristics with investment leverage under the legacy SLF credit facility. This results in an effective management fee of 1.4% for the first quarter which is broadly in line with the prior quarters. It is expected based on our current portfolio construct that the 2015 effective management fee will broadly consistent with the prior year and it is important to note that the investment advisor cannot recoup management fees previously way. In total this resulted first quarter adjusted NII of 19.5 million or $0.34 per weighted average share which is in the middle of our guidance provided on March 3, 2015 of $0.33 to $0.35 per share and covers our Q1 regular dividend of $0.34 per share. In total for the quarter ended March 31, 2015 we had an increase in net assets resulting from operations of 22.9 million. Slide 25 demonstrates our total investment income is predominantly paid in cash though the amount of pre-payment fees vary from quarter to quarter based on repayment our historical earnings has consistent shown some material pre-payment fee income. Therefore we showed total interest income out of percentage of total investment income both with and without pre-payment fees which is one measurement of the stability and predictability of our investment income. Turning to slide 26 as briefly discussed earlier our adjusted NII for the first quarter covered our Q1 dividend, given our belief that our Q2, 2015 net investment income will fall in the previously declared expected range of $0.33 to $0.35 per share our Board of Directors has declared Q2, 2015 dividend of $0.34 per share in line with the past 12 quarters. The Q2, 2015 quarterly dividend of $0.34 per share will be paid on June 30, 2015 to holders of record on June 16, 2015. Finally, on slide 27 we highlight our various financing sources taking into account SBA-guaranteed debentures related to our SBIC license, we now have $840 million of total pro forma borrowing capacity. As a reminder, our Wells Fargo credit facility covenants are generally tied to the operating performance of the underlying businesses that we lend to rather than the marks of our investments at any given time. At this time, I would like to turn the call back over to Rob.

Thanks, Dave. Once again we do not plan to give exquisite forward guidance. We continue to remain our intention to consistently pay at $0.34 per share on a quarterly basis for future quarters so long as the adjusted NII covers the dividend in line with our current expectations. In closing I would just like to say that we continue to be extremely pleased with our performance to date. Most importantly from a credit perspective our portfolio continues to be very healthy once again we like to thank you for your support and interest and at this point turns things back to the operator to begin Q&A. Operator?

[Operator Instruction] Our first question comes from Greg Nelson with Wells Fargo Securities. Please go ahead.

So just a few questions, first of on UniTek. Obviously you had a big portion of that convert to equity and then the equity was written up back towards the original cost base after the debt was written off. So it's about $25 of equity and just kind turn to get out how you're thinking about that position whether you're looking or eventually look roll out to equity into interesting assets just what your plans are there?

I think if you take a step back on UniTek its very cash generated business -- will be once we are finish doing the things we’re doing as we talked about in the past. So whether that position generates cash through cash extraction in the form of dividend or just us restructuring our position into interest bearing securities or whether we just monetize it and redeploy. I think one way or the other we're going to see so along as the business perform with our expectations we're going to see cash coming off with that position. Maybe not in the next one or two quarters but looking beyond that.

And then obviously there are couples of write downs in the energy portfolio. These are order investments, so I'm just trying to get sense what's going on, and what the progress is been with the five stage alliance and is there any opportunity to help leverage the expertise with five states with assets have been written down?

I don’t think in a material because there is still passive debt positions. We don’t have influence over what goes on when we do active dialogue with the companies, that being said you're really referring to Permian and to [CR] Hamilton. We continue to feel pretty good about those we're obviously taking because they're both bond positions that are quoted although they don’t trade very often. We are taking those quotes we don’t necessarily -- let me just put it this way; I feel that those are very conservative although appropriate mark and as I said in the past we don’t see any near term risk or even medium term risk of non-accrual on those positions despite the market.

And just one last one. So obviously when you talked last quarter on the call about the senior loan program and how -- as you see it's unlikely to continue building that out. So I just want to hear thoughts around pursuing more traditional senior loans on JV like other BDCs have.

In progress, I believe lot more to talk about or not next call.

The next question comes from Greg Mason with KBW. Please go ahead.

The follow up on Greg Nelson's on UniTek, the right up and fair value of $12 million in the equity; can you just walk us through kind of why you do that? I mean it just came out of bankruptcy, you converted your debt to equity at certain cost basis and then it get written up pretty significant this seems kind of surprising directly after coming out of bankruptcy.

I think what it primary reflects is prior to the 12/31 having not implementing the restructuring, there was risk around the company’s major customer which is [DirecTV], which accounts for 100% of the cash flow and in the first quarter we really materially de-risked it with the emergence and the signing of the affirmation of the new four year contract with [DirecTV]. So we do our internal valuation we look at comparable and have multiples and just to put it into context even of the current 3/31 valuation the enterprise value multiple is -- 5.5 times which in this market are pretty low multiple, and that’s before taking into account tax -- material tax attribute that the business has. So just mechanically there was meaningful risk factor discount applies to the 12/31 valuation and I think appropriately but that get remove when you signed the new contract and take away what was driving the risk factor which was big companies like [DirecTV] don’t necessarily want to deal with companies that are going through restructuring but we were able to preserve that relationship and that was the key to value enhancement. So that makes sense?

Yes perfect sense. Thanks for that color and then on Edmentum, in your slide deck you said that a portion of that’s going be converted a pick that security and then a portion to equity of $30 million. How much of that’s going to be on now performing debt going forward? Do have a dollar amount your [showing] in the share?

Yes half and half, so 15 and 15.

And then one last question just on expectations of continued draw of SBIC debentures, there is no additional draw this quarter, anything technical slowing that down or any expectations for drawing more debentures?

Nothing technical slowing down and we do have a number of things in the pipeline that could result in near term draws. But as always until deals cross the finish line there is no assurance about that. But in the long view I think we still believe consistent with past discussion that over the next four to six quarters we will materially drive the SBA facility.

As there are no further questions this concludes our question and answer session. I would like to turn the conference back over to Robert Hamwee for any closing remark.

I just want to thank everyone continued interest and support and look forward to speaking again next quarter and as always in the interim feel free to contact us with any questions or thought. Thank you.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.