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Edited Transcript of OHAI earnings conference call or presentation 15-Nov-18 3:00pm GMT

Q3 2018 OHA Investment Corp Earnings Call

Houston Feb 1, 2019 (Thomson StreetEvents) -- Edited Transcript of OHA Investment Corp earnings conference call or presentation Thursday, November 15, 2018 at 3:00:00pm GMT

TEXT version of Transcript


Corporate Participants


* Cory E. Gilbert

OHA Investment Corporation - CFO

* Steven T. Wayne

OHA Investment Corporation - CEO and President




Operator [1]


Before we begin, I would like to remind everyone that today's remarks may include comments which could be considered "forward-looking statements" and such statements are subject to many factors that can cause actual results to differ materially from our expectations as expressed in those forward-looking statements. Those factors are described in more detail in the Company's SEC filings, and I refer you to the Company's website or through SEC's website to read those filings. The Company undertakes no obligation to publicly update or revise any forward-looking statements, which speak only as of today's date.

As a reminder, this conference call is being recorded.

I will now turn the call over to Steven Wayne, the company's President and CEO.


Steven T. Wayne, OHA Investment Corporation - CEO and President [2]


Thank you, Romani. Good morning. I would like to welcome all of you to our Company's 3rd quarter 2018 earnings call. I am joined on the call today by Cory Gilbert, our Chief Financial Officer.

The presentation we are about to review was posted to our website earlier this morning under the Events and Presentations heading of the Investor Relations tab. We also refer you to our quarterly report on Form 10-Q that was filed yesterday.

Before I begin today, I want to remind you that OHAI is in the midst of a Strategic Review process that our Board of Directors initiated to provide more scale to OHAI. These options could include, among other things, raising additional capital, a merger or joint venture with another party, the acquisition of existing investment portfolios or other strategic transactions. We are actively working with our financial adviser, KBW, although there is no assurance that the Company will execute on any of these options. As we have said previously, we do not expect to comment further or periodically provide updates to the market with additional information unless and until the Company's Board of Directors has approved a specific transaction or otherwise deems disclosure appropriate or necessary, and I will not be commenting further or answering questions today regarding the Strategic Review process.

I will now turn to Page Four and provide a summary of the developments for OHAI for the 3rd Quarter ended September 30, 2018.

OHAI's NAV declined $0.31 per share in the 3rd Quarter of 2018, to $2.15 from $2.46 at the end of the 2nd Quarter of 2018. This decline largely stems from a net write-down of $6.3 million or $0.31 per share of our legacy investments. During the quarter, we wrote down our investment in OCI's subordinated note, a legacy non-energy portfolio investment, $0.39 per share, reducing our mark from $18.0 million last quarter to $10.9 million this quarter. This write-down was partially offset by a writeup of $1.5 million or $0.07 per share in our investment in ATP's overriding royalty interest.

From a financial standpoint, we finished the quarter with $56,000 of Net Investment Income or less than $0.01 per share on a GAAP basis and declared distributions of $0.02 per share. During the quarter, we reserved $828,000 of contractual PIK interest related to our investment in OCI, based on its September 30, 2018 fair value. Cory will provide more detail on the financial results later on in the presentation.

This quarter, we invested a total of $4.1 million in two new portfolio companies and an add-on to one portfolio company at an average price to par 98.9%. Also during the quarter, we had $1.9 million of realizations, including an $800,000 partial paydown on our Hayward 2nd lien term loan an OHA investment, which included a 1% call premium. Other realizations during the quarter included a $375,000 net paydown of the ClearChoice revolver and $707,000 of ATP production payments received during the quarter that were applied to our cost basis.

There were two other notable developments during the quarter.

First, we amended and extended our Credit Facility with MidCap through September 2019, with an option to extend for an additional six-months. This amendment lowered our borrowing rate and modified certain financial covenants. Second, we believe the ATP litigation matter is now resolved in our favor as the Statutory Lien Claimants has failed to file a petition for judicial review by the United States Supreme Court before the September 4, 2018 deadline. We consider the matter concluded and the Fifth Circuit's decision final.

Now turning to the leveraged credit markets, private equity activity, which generally drives new money financing opportunities in the below-investment-grade credit markets, continued its recent decline in the 3rd Quarter of 2018 as private equity deal count in the U.S. declined 44% and capital invested declined 52% compared to levels in the 3rd Quarter of 2017. Private equity activity also declined compared to the 2nd Quarter of 2018.

After a weak 1st quarter of 2018, the U.S. high-yield market bounced back in the 2nd Quarter, and this strength continued into the 3rd Quarter as it was up 2.4%. Post quarter end, we saw heightened volatility in markets throughout the U.S. and the world. The S&P 500 was down almost 7% in October, with the NASDAQ and Russell faring worse. The credit markets were not immune and the U.S. high-yield index was down -1.6%, its worst month since December 2015. Year-to-date through yesterday, the high-yield market has returned only [+0.84%] (corrected by company after the call) on the year. The recent high-yield market weakness has widened spreads approximately 50 basis points from recent levels, which were at post-financial crisis tights.

Moving on to the leveraged loan market, the record level of new issuance in the first half of 2018 slowed down considerably in the 3rd Quarter of 2018. Quarter-over-quarter, volume was down 35% and down 15% from the 3rd Quarter of 2017. The decline in new issuance volume resulted in an increased percentage of issuer friendly activity in the loan market as re-pricings and dividend deals took center stage with many loans pricing at the same tight levels seen earlier this year.

The loan index lagged the HY market in the 3rd Quarter of 2018, gaining +1.8%, and loans outperformed HY market in October, although at a negative three basis point return, it was the first negative month in bank debt since August of 2017. After remaining relatively steady over the past six months, LIBOR has moved up considerably, almost 30 basis points in the past two months. This rise will have an impact on both the yields of our floating rate assets the costs of our borrowing, which is LIBOR based. Three month LIBOR has gone from 1.33% at the end of the 3rd Quarter of 2017 to 2.62% today, up from 2.34% at June 30, 2018.

Activity in the middle market declined on a year-over-year basis but increased from the 2nd Quarter of 2018. Issuance by companies with EBITDA of $50 million or less decreased from $3.8 billion in the 3rd Quarter of 2017 to $2.4 billion in the 3rd Quarter of 2018. The 3rd Quarter 2018 activity was an increase from $2.3 billion in the 2nd Quarter.

In the middle market, spreads widened, driven by heightened M&A activity, which accounted for nearly 61% of syndicated middle market loan issuance, up from the 42% share in the 2nd Quarter of 2018. According to LCD, syndicated middle market spreads widened from 442 basis points in the 1st Quarter to 462 basis points in the second, where they remained throughout the 3rd Quarter. The increase in spread, coupled with rising LIBOR, has resulted in higher yields. Average first lien yields for syndicated middle market loans were 7.0% in the 2nd and 3rd Quarters of 2018, up from 6.58% in the 1st Quarter.

I will now turn the call over to Cory to discuss the financial results for the 3rd Quarter.


Cory E. Gilbert, OHA Investment Corporation - CFO [3]


Thank you, Steven. The financial summary for the 3rd Quarter can be found on Page five. Our investment income for the 3rd Quarter totaled $1.9 million or $0.09 per share, a 28% decrease from the prior quarter. Our portfolio yields 11.8% and 10.1% based on weighted average fair value and cost, respectively, at September 30, 2018. Base management fees were $397,000 or $0.02 per share, and there was a $6,000 capital gains incentive fee in the 3rd Quarter, which is subject to the incentive fee waiver. We finished the quarter with net investment income of $56,000, less than $0.01 per share. We recorded net realized and unrealized loss totaling $6.0 million or $0.30 per share during the quarter. All together, we reported a net decrease in net assets from operations of $0.29 per share. After our $0.02 per share distribution declared in September and paid in early October, our net asset value decreased 31% -- $0.31 per share to $2.15 per share, a 13% decrease from the end of the 2nd Quarter of this year.

We continued our practice to seek positive assurance from a third-party valuation firm on all Level 3assets with fair values in excess of $10 million on a quarterly basis. We will also seek positive assurance on other Level 3 assets with any meaningful fair value on an annual basis. This quarter, we sought and received third-party positive assurance on 88% of our Level 3 assets with any fair value.

Moving on to Page six. Page six shows the net investment income section of our income statement for the third quarter of 2018 compared to our results for the 2nd Quarter of 2018 and for the 3rd Quarter of the prior year. Investment income decreased by approximately $741,000 and $865,000 from the 2nd Quarter of this year and the 3rd Quarter prior year, respectively. The decrease quarter-over-quarter and the same quarter prior year is primarily driven by a reduction of PIK interest income recognized in connection with our investment in OCI. During the 3rd Quarter of 2018, we limited OCI's PIK interest income recognition to 45% of the contractual PIK amount. This percentage is based on OCI's September 30, 2018 fair value mark. As a result, we reserved $828,000 of the $1.4 million of contractual PIK interest this quarter.

Interest expense for the quarter was $767,000 or $0.04 per share compared to $801,000 or $0.04 per share in the 2nd Quarter of this year and $1 million or $0.05 per share in the same quarter prior year. Quarter-over-quarter, the decrease in interest expense is due to a lower average amount outstanding on our credit facility as the result of a $7.0 million principal pay-down on our credit facility in September and the lower interest spread. Compared to the same quarter prior year, the decrease is primarily attributable to a lower amount outstanding on our credit facility as a result of $11.5 million of principal pay-downs over the last 11 months.

Management and incentive fees to our advisor were $20,000 higher in the 3rd Quarter of this year compared to the 2nd Quarter and $141,000 lower compared to the same quarter prior year. Other G&A expenses for the quarter were $659,000 or $0.03 per share compared to $743,000 or $0.04 per share in the 2nd Quarter of this year and $865,000 or $0.04 per share in the same quarter prior year. Quarter-over-quarter, other G&A expenses were $84,000 lower, primarily due to lower legal fees in connection with the ATP litigation and lower audit-related expenses. G&A expenses were $206,000 lower compared to the same quarter prior year, primarily due to lower legal fees and audit-related expenses.

As a result, our net investment income for the 3rd Quarter of 2018 totaled $56,000, less than $0.01 per share, compared to a net investment income of $667,000 or $0.03 per share for the same quarter of 2018. In comparison, net investment income for the third quarter of 2017 totaled $323,000 or $0.02 per share.

Turning to Page seven, you can see the summary of realized and unrealized gains and losses in the portfolio for the relevant quarters. There were no meaningful realized gains or losses recognized during the 3rd Quarter of 2018.

Now let's look at the net unrealized gains and losses on the lower portion of the page. For the third quarter of 2018, the total net unrealized loss was $6 million. Meaningful valuation changes in the quarter related to a $7.8 million write-down in our investment in OCI's subordinated note, which was offset by a $1.5 million writeup in our ATP royalty interests. The $7.8 million write-down of OCI was comprised of a $7.1 million reduction in fair value from $18.0 million at June 30, 2018, to $10.9 million at September 30, 2018, and the $700,000 of write-off of PIK income recognized during the quarter. Steven will provide further commentary on the portfolio valuation changes in a moment.

On Page eight, you will find a graphical presentation of the components of the quarterly results and their respective impact on our net asset value per share. Net asset value at the beginning of the quarter was $2.46 per share. Net investment income was less than $0.01 per share. Net Asset Value was reduced by the 3rd Quarter distribution of $0.02 per share and the net negative valuation adjustments in our investment portfolio totaling $0.30 per share. These all combined to decrease our net asset value per share to $2.15 for a quarter-over-quarter decrease of $0.31 per share or 13%.

Now to discuss recent portfolio activity, let me hand the call back over to Steven.


Steven T. Wayne, OHA Investment Corporation - CEO and President [4]


Thanks, Cory. Let's go to Page 10. As shown here, OHA has been able to invest $167.3 million in 33 new portfolio companies since September 30, 2014, which we believe demonstrates OHA's origination capability for OHAI.

Turning to Page 11. During that same period, we have realized $165.9 million of investments, including $115 million through the full or partial realization of OHA investments. $99.6 million of this has come from the full realization of ten investments. At the end of the third quarter, the fair value of our portfolio investments totaled $69.1 million, excluding the $3.7 million of cash on our balance sheet. As noted at the bottom of the page, our investment portfolio is now split 86%-14% between floating rate and fixed rate investments. Also 71% of our portfolio investments based on fair value were classified as Level 2.

Moving to Page 12. This page presents the realized and unrealized returns for the portfolio company investments OHA has made through September 30, 2018, since becoming OHAI's investment adviser and further underscores OHA's ability to originate investments for OHAI. The 10 fully realized investments generated a dollar-weighted average gross IRR of 13.4% on an unlevered basis. And when you include the $8.0 million of TIBCO that we sold in the 3rd Quarter of 2017, this increases to 13.8%, as shown on the page. The remaining unrealized investments, excluding the recently made investments this quarter, based on prices as presented in our September 30, 2018 financial statements, have a dollar-weighted average gross IRR of 13.7% on an unlevered basis. Even though these investments are still classified as "Unrealized", as shown on the prior slide, several of these investments have had partial realizations to date. The returns shown in this presentation and discussed today are unaudited and provided for informational purposes, and these gross IRRs are presented before any fees or expenses. Please note that the explanatory footnotes related to this chart are now found on the following page.

Turning to Page 14. Despite investing over $169 million over the past 4 years, (which includes $1.7 million of additional investments in legacy portfolio companies) the size of our portfolio by fair value has decreased 60% since September 30, 2014, driven by over $121 million in net negative valuation changes and $166 million of realizations.

Let's now go to Page 15. This page better illustrates and explains the significant decline in NAV that OHAI has experienced since September 30, 2014, when OHA became the investment manager of OHAI. As shown here, on that date, the portfolio consisted of $171 million of investment assets in 10 portfolio companies, concentrated heavily in the energy industry. The price of WTI, West Texas Intermediate, in the crude oil was over $90 a barrel but almost immediately started dropping, falling to around $50 a barrel by the end of 2014. In early 2016, WTI was under $30 a barrel and today is below $60 after hitting a recent high of $76.

This commodity price movement took its toll on these legacy energy assets. Over the past four years, we have had to write-down or markdown approximately $111 million of the original $171 million of investment assets or approximately 65% of the fair value. Most of that $111.0 million of write-downs and markdowns, $101 million of it, has come from the seven legacy energy assets that totaled $127 million of the $171 million of investment portfolio. As noted below, the amounts written-off and marked down shown here do not take into account any additional investments, paid-in-kind interest/dividends or discount accretion subsequent to September 30, 2014.

Let's now go to page 16. While the portfolio may be smaller, this chart does show a material difference in the composition and diversification of today's portfolio. Although our energy exposure has now been reduced to 3% at September 30, 2018, up from 2% last quarter due to the write-up of our ATP royalty, too much of this reduction in energy exposure has come unfortunately from the losses in the legacy energy investments. Away from the energy positions, we have substantially diversified our portfolio into a wide range of industries. I will note that our legacy position in OCI, shown here as therapy services, does still constitute just over approximately 15% of our investment portfolio plus cash today.

Let's move on to Page 17. I will focus my comments on the meaningful changes in the portfolio during the quarter. During the quarter, we increased the fair value of our ATP ORRI to $2.2 million based on increased production volumes and higher energy prices. This quarter, we received production payments totaling $707,000 and subsequently received an additional $215,000 in October, relating primarily to September production. During the third quarter of 2018, the $707,000 of production payments has been applied to our cost basis. Our September 30th valuation of $2.2 million is based on recent production volumes that continue over a 15 month period, which have been probability-weighted using future commodities pricing curves and discounted back at a 15% discount rate.

Moving on to our largest decline in fair value for the quarter, OCI, our last non-energy legacy portfolio company investment. We wrote down the fair value of OCI subordinated note to $10.9 million from $18.0 million at June 30, 2018.

OCI, a home health provider of pediatric therapy services to Medicaid patients in Texas, has been negatively impacted by Medicaid reimbursement rate reductions that were initially proposed in June of 2015 and were officially implemented by the state of Texas effective December 15, 2016. Although approximately 25% of the rate cuts subject to a number of specific provisions relating to pediatric therapy reimbursement were restored in September 2017, operating performance and cash flow have suffered. As part of the effort to navigate the challenging rate environment, on March 1, 2018, OCI entered into a preferred provider arrangement with Superior HealthPlan, covering approximately 167,000 member lives in the Texas Travis service delivery area and Central Medicaid Rural Service Area. OCI now provides speech, physical and occupational therapy in all practice venues for Superior's pediatric members aged three years and older. This value based care program is the first of its kind in the Texas Medicaid pediatric therapy services market. The program is still in its initial operating period, but we believe it could help mitigate the Medicaid rate reimbursement reductions and other industry issues OCI has faced over the past few years.

In September 2018, we executed an amendment to our OCI note purchase and security agreement, whereby we exchanged approximately $217,000 of cash default interest previously paid to us by the company in 2018 for PIK interest, which was added to the principal outstanding balance of the note on and as of the date the default interest payment was originally made. This amendment also allows the company to PIK its default interest through December 31, 2018.

There were no other meaningful valuation changes during the quarter across the rest of the portfolio, but as you see on our Schedule of Investments and as I mentioned earlier, in July, we added $1.7 million of second lien term loan in Hayward, an OHA investment, at a price of 100.625%. In September, Hayward repaid $800,000 of our second lien term loan, along with a 1% call premium, bringing our total position to $2.2 million at quarter end.

We also added $2.4 million par amount in two new portfolio company investments during the quarter, CentralSquare Technologies and NAVEX.

In August, OHAI purchased $2.0 million of second lien term loan in CentralSquare Technologies at 97.435% of par, which pays cash interest at the rate of Libor +7.5 and matures in August 2026. CentralSquare Technologies is a leading provider of software and services to public government and nonprofit agencies.

Also in August, we purchased $400,000 of second lien term loan in NAVEX at 99.0% of par, which pays cash interest at a rate of Libor + 7.00 and matures in September 2026. NAVEX is a provider of an ethics and compliance software platform.

So, let's move on to another snapshot of our investment portfolio, the yield comparison, on Page 18. This table focuses on the yield of our portfolio, both as it relates to fair value and cost. Based on our current yielding investments, which includes any PIK component from performing investments, our portfolio yields 11.8% and 10.1% based on weighted average fair value and cost, respectively, at September 30, 2018. This compares to 14.3% and 13.6%, respectively, at June 30, 2018. Our portfolio yields at September 30, 2018, excluding our investment in OCI, were 10.0% and 10.3% based on weighted average fair value and cost basis, respectively, an increase from 9.9% and 10.1% at June 30, 2018, respectively.

As shown on Page 19, we have 25 active portfolio company investments as of September 30, 2018, as compared to 10 investments at September 30, 2014. 23 of these are new investments made by OHA, and they now constitute 81% of the investment portfolio on a fair value basis.

This ends our formal presentation for today. I will now turn it over to the operator to coordinate the Q and A process.


Questions and Answers


Operator [1]


(Operator Instructions) And at this time, I'm showing no questions in queue. This concludes today's Q&A session. I would now like to turn the call back over to Steven Wayne for closing remarks.


Steven T. Wayne, OHA Investment Corporation - CEO and President [2]


Thank you, operator. I want to thank everybody for their time today, and I look forward to speaking with you next year.


Operator [3]


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