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Edited Transcript of OCX.TO earnings conference call or presentation 24-Feb-17 4:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Onex Corp Earnings Call

Toronto Feb 24, 2017 (Thomson StreetEvents) -- Edited Transcript of Onex Corp earnings conference call or presentation Friday, February 24, 2017 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Laura Carrigan

Onex Corporation - Director, IR

* Bobby LeBlanc

Onex Corporation - Sr. Managing Director

* Chris Govan

Onex Corporation - CFO

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Conference Call Participants

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* Geoff Kwan

RBC Capital Markets - Analyst

* Paul Holden

CIBC World Markets - Analyst

* Scott Chan

Canaccord Genuity - Analyst

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Presentation

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Operator [1]

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Welcome to the ONEX fourth quarter and full year 2016 conference call. My name is Nicole, and I will be your operator today. During the presentation, all participants will be in a listen-only mode. (Operator Instructions). As a reminder, this conference is now being recorded. I would now turn the conference over to Ms. Laura Carrigan, Director of Investor Relations at ONEX. Please go ahead.

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Laura Carrigan, Onex Corporation - Director, IR [2]

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Thank you Nicole. Good morning everyone, and thank you for joining us. We are broadcasting this call live on our website. With me today are Bobby Le Blanc, Chris Govan, and a number of our managing directors. The 2016 MD&A and consolidated financial statements are available on our website, and have also been filed on SEDAR. Our supplement information package, which includes the how we are invested schedules, schedules of season expenses and additional information, is also available on our website. Before we get started, just a reminder that all references to dollar amounts on this call are in US, unless otherwise stated. I must also remind everyone of the usual forward-looking statements disclaimer, and point out that all information relating to the fair value of our private company is the view of ONEX.

In addition, later in this call we'll reference certain credit offers, including collateralized loan obligations, or CLO offerings. We're required to remind you that these offerings are made solely to qualified institutional investors, and to certain non-US investors in private transactions, not requiring registration under US securities laws. The securities are not and will not be registered under US securities laws, and cannot be offered or sold in the US without registration or exemption. Lastly, we'd like to let you know that our Annual Investor Day will take place in Toronto on June 15. Should you be interested in attending, please contact me for more details.

With that, I'll now turn the call over to Bobby.

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Bobby LeBlanc, Onex Corporation - Sr. Managing Director [3]

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Thanks Laura. Good morning, everyone. I'll spend some time this morning reflecting on our performance in 2016, and our activities so far this year. But first, let's take a look at what we're seeing in the market. This past year was anything but quiet for the equity and credit markets. Despite many political surprises, global equity markets improved over the course of the last year. The US, UK, and Canadian indices were all up more than 10%. This momentum has continued into 2017, and investors seem cautiously optimistic for the year ahead.

The credit markets also continue to function well, in spite of a rising rate environment, geopolitical uncertainty, and potential US tax changes under President Trump's leadership. The strength of both the equity and credit markets has caused acquisition multiples to creep higher. Private equity transaction multiples were nearly a turn higher last year relative to 2015. Not surprisingly global and US private equity activity was down meaningfully. The IPO markets also had a sluggish year. In the US IPO activity was down 25%, in fact the number of PE-backed IOs hasn't been this low since 2009. In spite of this we recently took Jeld-Wen public, more on that in a few minutes.

With that as a backdrop, let me take you through some of our highlights for 2016. We invested or committed to invest $2.9 billion in five new businesses, including the pending acquisition of Parkdean. ONEX's share of this amount is approximately $900 million. As you know, private equity is an episodic industry, and we had a number of opportunities come to fruition in the back half of last year. Our activity was the direct result of years of diligence, industry research, and relationship building.

The acquisition of Save-A-Lot is a great example. In 2010 we identified the retail segment as an area we wanted to cover, and have been tracking Save-A-Lot since 2013. Matt Ross and the team did a great job leading this complicated carve-out. We are also excited about Parkdean. The company, which is one of the largest caravan holiday park businesses in the UK, owns and operates 73 parks, and sells more than 500,000 holidays to 2 million customers a year. It offers a wide range of accommodations, from caravans and camping pitches, to chalets, apartments, and lodges.

I personally visited more than 25 Parkdean sites, and was very impressed with the locations and guest offerings. We like the business for several reasons. Parkdean's customer base is very loyal, and there is a high degree of repeat business. The holiday park market in the UK is quite resilient. In good economic times price conscious consumers trade up from staying with friends and families. In downturns, marginally better off consumers trade down, from oversea holidays to stay domestically. This is a nuance that we really like about the business.

As usual this investment has a number of ONEX-like characteristics that create value, particularly related to operational improvements, and add-on acquisitions. Tony Morgan, who spearheaded the acquisition, has known this business and the CEO, John Waterworth for more than ten years. In fact Tony was a member of its Board when he worked for Alchemy Partners in the UK. We're really excited to be partnering with John and his management team, who have made a significant financial commitment alongside of us.

Turning to fund-raising, we successfully raised $1.1 billion for ONCAP IV, our latest middle market private equity fund, in a single close that took us only two months. ONEX as always, is the largest LP with a $480 million commitment. Moving on to 2016 highlights related to our credit platform. Assets under management increased by 15% to $7.5 billion. This growth was primarily driven by two new US CLOs, and this month our first CLO began its warehousing process, and we expect it to contribute to our AUM in 2017. We also now plan to launch a direct lending platform, and we plan to share more details about this product with you at Investor Day. On to realization.

On to realizations. Since the beginning of last year, ONEX and our partners received $1.7 billion from realizations and distributions, of which ONEX's share was about $460 million. This includes Jeld-Wen's IPO in which $661 million was raised at the $23 offering price. Since the IPO the shares have traded well closing at $30.79 yesterday. This share price employed a multiple of capital of 3 times. The strength of several our businesses combined with the open credit markets, allowed us to collectively raise or refinance a total of $4.3 billion in debt. This contributed to ONEX's partners receiving distributions of $505 million.

We also continue to invest in and build our team. Across the firm, we have promoted eight investor professionals, including Amir Motamedi to Managing Director. We developed most of our own talent at ONEX, and believe this is one of the secrets of our long-term success. Finally, our distinctive ownership culture, requires ONEX management to have a significant stake in ONEX shares, and to make meaningful personal investments in everything we do. Today our team has $1.9 billion invested in our shares, operating companies, and credit platform. This financial alignment is critical to our culture and overall success. We all share in the risk and rewards of everything we own. I will now hand it over to Chris.

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Chris Govan, Onex Corporation - CFO [4]

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Thanks Bobby. Good morning everyone. My comments this morning will provide an update on ONEX's Q4 performance relative to our shareholder value model. This model illustrates how we expect to meet our long-term target of 15% annual growth in capital per share. As a reminder our target is based on being above 75% invested, generating blended returns from private equity, and credit in the high teens, and benefiting from the positive operating leverage we expect our asset management platforms to provide.

Let's first look at the mix of our assets. The quarterly changes in our asset mix are driven by ONEX's net investment activity, both in private equity and credit. Q4 saw us close on two significant investments, Clarivate and Save-a-lot. The capital put to work in these businesses netted a little over $100 million of distributions primarily from Jeld-Wen and Hopkins, increased ONEX's private equity exposure by about $500 million. At credit, there was a $21 million net decrease in ONEX's investments, mainly as a result of the regular quarterly distributions from our CLOs.

Overall, ONEX's cash decreased from 34% to 25% of hard NAV during Q4, putting in line with our model. Bobby mentioned a couple of significant 2017 events that affect our asset mix. ONEX received $40 million as a result of the Jeld-Wen IPO in late January, and expects to invest $170 million when Parkdean closes later this quarter. If you pro forma the quarter end numbers for these two transactions, cash as a percentage of hard AV falls to 23%, bringing ONEX to 77% invested. We're happy to have made significant progress in getting ONEX's cash working, but that's only half the battle. The other very important half is generating attractive risk adjustment return.

Let's look at our Q4 investment returns by reviewing the quarter-over-quarter changes in the how we are invested schedule. Looking at that schedule, you'll see the year end investment in ONEX partner's private companies was $576 million greater, than at the end of Q3. This was primarily due to the investment activity I discussed earlier, but also includes over $46 million of value generated at our operating companies, or about a 2% quarterly return for ONEX. For all of 2016 private equity generated a 7% return for ONEX Corporation.

Our exposure to ONEX credit also contributed meaningfully to NAV growth in the quarter, a net return of $46 million. That includes $39 million of mark to market gains from our CLOs, as the leverage loan market continued to perform. We're happy to note that all of the CLO mark to market losses we experienced in the second half of 2015 have now reversed, but as you know we look at our CLOs from a cash flow perspective. Things continue to play out according to plan in that respect.

ONEX received distributions from its existing CLOs of $19 million in the quarter, bringing aggregate distributions to $73 million for the year. On a cash basis, that's a 16% yield on an original cost of about $460 million. Looking at the schedule as a whole, our hard NAV per share at quarter end was $58.56, or based on yesterday's exchange rate Canadian CAD76.74. Over the course of 2016, our US dollar hard NAV per share grew by 8%. My comments so far have focused on the $6 billion of capital we manage on behalf of ONEX shareholders.

But our shareholders also benefit from the $18 billion we manage on behalf of fund investors. We expect the management of this third-party capital to provide a positive contribution to hard NAV growth over time, or what I call operating leverage. The schedule of fees and expenses details the revenue and expense items for ONEX and its asset management platforms, and provides one way of measuring our operating leverage. On this basis, our PE asset management platforms were just about breakeven in 2016, while credit contributed $19 million, up from $15 million last year. The overall contribution including the parent company came in at negative $16 million.

I'll make a couple of comments around these results, with a view to providing you some color on what to expect going forward. As discussed on last quarter's call, we expect the $93 million of LTM private equity fees reported for Q3 to represent a short-term trough. With fees from ONCAP IV accruing since November, you see that starting to play out. LTM fees moved up to $96 million, and run rate PEs were $110 million at year end. And pro forma for the investment in Parkdean, ONEX partner IV is now over 75% invested in reserved, typically the level at which we start to focus on raising our next fund.

Before I move on, a few comments around carried interest. We report carry on this schedule on a cash basis, which is conservative but it also masks significant value that has been created. At quarter end ONEX's unrealized carried interest stood at $197 million, with $33 million of value generating during the year. When we choose to realize on investment, and its associated carry is not easy to predict, but it's also not something that should be surprising. A realizing event is typically tied to the progress we've made executing on our investment season. As it was with the IPO of Jeld-Wen.

This transaction resulted in ONEX receiving $6 million of the accrued carry, and with our fund investors still holding almost 40 million shares, there's about $55 million of additional carry at the IPO price that may be realized over time. The point of all of that is the net contribution from our asset management platforms will move up and down from year to year, depending on realization activity within PE. However, with run rate annual fees from PE and credit of $150 million, and $197 million of accrued carry, going forward we expect the contribution from the asset management platforms to be a positive. Operating leverage will contribute to our long-term NAV per share growth. We believe ONEX's share should reflect both the growth and the value in our investments, and the growing contribution from managing fund investor capital.

Over the past five years, our hard NAV per share has grown at 10% CAGR, while our fee generating AUMs has grown 15% per year. Happily these results have translated into returned for our shareholders over the same time frame, with the stock compounding at 16% per year in US dollar terms. That completes my comments, and we'd now be happy to take any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Your first question comes from the line of Geoff Kwan with RBC Capital Markets.

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Geoff Kwan, RBC Capital Markets - Analyst [2]

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Hi, good morning. Chris, can you just clarify, or I can't remember if it was maybe Bobby that mentioned it, but the OP IV you guys are at 75% invested is what you said; is that correct?

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Chris Govan, Onex Corporation - CFO [3]

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We're over 75% invested in reserve, Geoff.

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Geoff Kwan, RBC Capital Markets - Analyst [4]

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Okay, okay, perfect. And then on the kind of the deal pipeline, can you kind of talk about how you feel about it today, and if there's any sort of impact given what's going on in the US, kind of broadly speaking, if that's having any impact, positive or negative?

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Bobby LeBlanc, Onex Corporation - Sr. Managing Director [5]

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Yes. So last year, the deal flow on a number of things that we looked at basis was lower than in 2015, but our yield, in terms of how many we closed was actually quite good relative to historical norm. The pipeline is okay right now. The political environment in the US, particularly related to tax, and how it impacts our businesses is in flux. I think President Trump has made it clear he wants to lower the corporate tax rate, how we pay for that as a country has yet to be seen. He's supposed to come out with his plan in the next couple of weeks. There's been talk about capping or elimination of interest deductibility, there has been talk of taxing import and foreign labor providing services to domestic companies, and deductibility of CapEx, and a bunch of other things. We are aware of all of these things. We run sensitivity analysis, but we're just not quite sure where all of this shakes out. In a low rate environment like this as a matter of fact, if you have a business that is generating decent pretax income, depending on where the corporate tax rate shakes out, it may be a net positive, even if he takes away our tax issuance and deductibility. So it's all in flux and we're well aware of it, but it really hasn't impacted too much, the level of deal flow we're seeing out of the industry.

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Geoff Kwan, RBC Capital Markets - Analyst [6]

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That's what I was kind of getting at, whether or not the tax issue was maybe stalling overall activity, and once you get clarity things may start to pick up, or from what you're saying it's having a bit of an impact, but maybe not too, too much? If that a fair characterization?

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Bobby LeBlanc, Onex Corporation - Sr. Managing Director [7]

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It's pretty much a minimal impact right now. We really haven't noticed a meaningful change in behavior.

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Geoff Kwan, RBC Capital Markets - Analyst [8]

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Okay. The cash as a percentage of NAV right now as you mentioned it's a little under 25%. What's kind of, can you remind me what level of comfort that you guys have as to where you think is kind of the sweet spot? And then the other question I had, is how do you guys think about, or what's the right way to think about the return on that cash? Because I think it's cash as well as what you have in ONEX credit partners, I recall I think from an old, old presentation back in 2010 you guys had made assumptions around 3%, and obviously interest rates are much lower so if you can maybe provide some comment?

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Chris Govan, Onex Corporation - CFO [9]

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Yes, sure, Geoff. I think in terms of a sweet spot, our cash balance is going to move up and down with what I think of as sort of our investment in realization cycles. I think that 25% feels like a pretty good number to try to target through the cycle. So we certainly are comfortable being below that, and we know that we'll go through another cycle, where we hopefully have a lot of successful realization, and we'll find ourselves with cash above that. That's just part of being a private equity investor. So it's really hard to give you a definitive answer, in terms of how low we can go, but certainly we're not at a point where we're uncomfortable with our cash balance today.

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Geoff Kwan, RBC Capital Markets - Analyst [10]

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Okay. And then on the return on cash?

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Chris Govan, Onex Corporation - CFO [11]

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Yes. So as the cash balance has gone down, we have tweaked how we've allocated that cash, but for the most part, the cash today is in very low yielding investments earning, double, low double digits in terms of basis points of return. Historically we have had some meaningful exposure to some long only senior credit loans at ONEX credit, that we're providing more return, around 3.5%, but today it's fairly low yielding. Maybe on a combined basis in the 50 basis point range.

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Geoff Kwan, RBC Capital Markets - Analyst [12]

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Okay. If I can maybe sneak in one last question. The stock is going gradually make its way up to $100. Do you have any kind of consideration that are all preferences to whether or not you would ever split the stock? I think the last one if I remember correctly was probably around 2000?

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Bobby LeBlanc, Onex Corporation - Sr. Managing Director [13]

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Yes, Geoff, we haven't had any conversations around a stock split, so that's not something we'll comment on.

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Geoff Kwan, RBC Capital Markets - Analyst [14]

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Okay, great. Thank you.

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Operator [15]

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Your next question comes from the line of Paul Holden with CIBC.

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Paul Holden, CIBC World Markets - Analyst [16]

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Thank you. Good morning. First question is for Chris. So we've seen the company invest in the size of its team over the last couple years, which has resulted in some higher expenses for the private equity side of the business, when we look at the schedule fees and expenses. So just wondering how we should think about that level of investment going forward, if we'll continue to see the same rate of increase, or if it's going to sort of level off here?

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Chris Govan, Onex Corporation - CFO [17]

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That is always a little hard to predict, in terms of exactly how we're going to grow the team. It actually has a lot to do with how our team performs. As you know we grow the team internally, for the most part. And so the size of the team ultimately ends up being a function of our ability to retain, train, and really kind of create, if you will, deal-generating investors for our private equity platform. But you're right, we have invested in the team, both at ONEX partners and ONCAP over the last little while and you're seeing that result in the SOFE.

Just in terms of pure head count in the private equity platforms, there are 20% more investment professionals than there were ten years ago. That's sheer head count. As I alluded to the other thing that has happened is the team has grown if you will from an experience perspective, and we now have materially more deal-generating investment professionals on that team. And as you said, that's manifested itself, both in putting a lot of money to work over the last couple of years, but also, quite frankly, in our ability to raise a larger ONCAP fund. So we think the investment is paying dividends, and we actually, again we hope we can continue to invest in the team, because it's actually a sign of success.

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Paul Holden, CIBC World Markets - Analyst [18]

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Okay, okay. And any commentary you can provide around share repurchases, and any particular reasons why no stock repurchased in Q4 versus your historical track record?

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Chris Govan, Onex Corporation - CFO [19]

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Sure yes. I think you probably heard us say before, that we think about the normal course issuer bid, as I'm sure a lot of companies do, as sort of a capital allocation decision. When we think about buying back stock, one of the biggest factors for us is what other investment opportunities do we have in front of us. And if you look back at the activity late last year, particularly in Q4, we obviously had a lot in the pipeline, and a lot of opportunities to invest, and as you know we're always working on other opportunities that you all don't see, including we had a late-stage opportunity that we ultimately passed on. On top of that, going back to some of our earlier comments, ONEX is going to be in a position where it's likely going to have to make a commitment to ONEX Partners V at some point in the not too distant future, and so all of that just sort of led us to really slow down the normal course issuer bids in the near term.

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Paul Holden, CIBC World Markets - Analyst [20]

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Understood. Okay. That's helpful. And then is there any kind of update you can provide us on the returns you are seeing from the CLO portfolio, given 2016 was a much improved year versus 2015? Are you kind of running around that 12% to 13%-ish target?

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Chris Govan, Onex Corporation - CFO [21]

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That's a difficult question. The CLOs are performing as we expect in terms of distributions, probably performing better than we expect in terms of, they are performing better than we expect in terms of underlying credit issues, but the way a CLO really works, is you kind of don't know your actual return from a CLO until you ultimately realize and close out that CLO at the back end. But suffice to say, given that the credit quality is performing in line with our model, we continue to expect that the ultimate returns from our portfolio of CLOs will play out consistent with sort of those low double digit returns.

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Paul Holden, CIBC World Markets - Analyst [22]

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Okay, fair enough. And then one last question. Wondering if someone can provide some commentary around Carestream, and sort of the strategy going forward with that business, gross profit, even adjusting for FX is kind of trending lower, not significantly, but lower versus higher. So just wondering if there's some thoughts around that business?

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Bobby LeBlanc, Onex Corporation - Sr. Managing Director [23]

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Yes, foreign exchange has been a head wind for Carestream. And we are constantly thinking about the best way to monetize our remaining value within Carestream, and whether that's breaking up the business into pieces, or other methods. But the digital side is performing well, the film business is performing reasonably well, and foreign exchange in particular had a particular impact on the medical business side last year.

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Paul Holden, CIBC World Markets - Analyst [24]

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Okay. That is all of the questions I had. Thank you.

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Operator [25]

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(Operator Instructions). Your next question comes from the line of Scott Chan with Cannacord Genuity.

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Scott Chan, Canaccord Genuity - Analyst [26]

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Good morning guys. Just on OP IV, so the in fact it's over 75% invested right now, does that mean no fund-raising can start for OP V, and has it started for OP V?

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Chris Govan, Onex Corporation - CFO [27]

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So I can answer the technical question. Under the terms of our LPA, we can close on a subsequent fund, once the prior fund is 75% invested or committed. But private equity funds are private placements. And I'm probably not using the right technical term, and we're really not in a position to speak any more about it.

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Scott Chan, Canaccord Genuity - Analyst [28]

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Okay. Just switching over to credit, the European CLO I, is there an update on that fund? It seems like it's been kind of warehoused for a while from what I can see?

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Bobby LeBlanc, Onex Corporation - Sr. Managing Director [29]

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There's no hard and fast update, other than to say we continue to grow our warehouse position, and we're getting closer, so that's about all I can add to that, or add to what we've said before, and hopefully we'll have something more tangible for you in the not too terribly distant future.

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Scott Chan, Canaccord Genuity - Analyst [30]

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Okay. And, Chris, just on how we're invested in terms of the ONCAP portion for ONEX position, I saw it dropped down to $402 million, down 7% quarter-over-quarter, and I saw distribution as well during the quarter. What cased the drop? I may have missed it, but if you can maybe just comment on that drop sequentially it would be really helpful?

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Chris Govan, Onex Corporation - CFO [31]

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Oh, yes. That really is just the result of the final closing I'll say of the Tecta investment, where there was a co-invest that was warehoused for a short period of time on the ONEX balance sheet.

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Scott Chan, Canaccord Genuity - Analyst [32]

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Okay. Thank you.

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Operator [33]

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Thank you. And there are no further audio questions. I would now like to hand the conference back to Mr. Bobby Le Blanc for closing remarks.

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Bobby LeBlanc, Onex Corporation - Sr. Managing Director [34]

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Thanks everyone for the time. If you have any questions, please feel free to reach out to Emma or Laura, and we hope you all have a nice weekend. Thanks a lot.

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Operator [35]

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This does conclude today's conference call. Thank you for your participation, and we ask that you please disconnect your line.