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FS KKR Capital Corp. (NYSE:FSK) Q1 2024 Earnings Call Transcript

FS KKR Capital Corp. (NYSE:FSK) Q1 2024 Earnings Call Transcript May 9, 2024

FS KKR Capital Corp. isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, ladies and gentlemen. Welcome to FS KKR Capital Corp First Quarter 2024 Earnings Conference Call. Your lines will be in a listen-only mode during remarks by FSK's management. At the conclusion of the company's remarks, we will begin the question-and-answer session, at which time I will give you instructions on entering the queue. Please note that this conference is being recorded. At this time, Robert Paun, Head of Investor Relations, will proceed with the introduction. Mr. Paun, you may begin.

Robert Paun: Thank you. Good morning and welcome to FS KKR Capital Corp's first quarter 2024 earnings conference call. Please note that FS KKR Capital Corp may be referred to as FSK, the fund, or the company throughout the call. Today's conference call is being recorded and an audio replay of the call will be available for 30 days. Replay information is included in a press release that FSK issued yesterday. In addition, FSK has posted on its website a presentation containing supplemental financial information with respect to its portfolio and financial performance for the quarter-ended March 31, 2024. A link to today's webcast and the presentation is available on the Investor Relations section for the company's website under Events and Presentations.


Please note that this call is the property of FSK. Any unauthorized rebroadcast of this call in any form is strictly prohibited. Today's conference call includes forward-looking statements and are subject to risks and uncertainties that could affect FSK or the economy generally. We ask that you refer to FSK's most recent filings with the SEC for important factors and risks that could cause actual results or outcomes to differ materially from these statements. FSK does not undertake to update its forward-looking statements unless required to do so by law. In addition, this call will include certain non-GAAP financial measures. For such measures, reconciliations to the most directly comparable GAAP measures can be found in FSK's first quarter earnings release that was filed with the SEC on May 8, 2024.

Non-GAAP information should be considered supplemental in nature and should not be considered in isolation or as a substitute for the related financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be the same as similarly named measures reported by other companies. To obtain copies of the company's latest SEC filings, please visit FSK's website. Speaking on today's call will be Michael Forman, Chief Executive Officer and Chairman, Dan Pietrzak, Chief Investment Officer and Co-President, Brian Gerson, Co-President, and Stephen Lilly, Chief Financial Officer. Also joining us on the call are Co-Chief Operating Officers Drew O'Toole and Ryan Wilson. I will now turn the call over to Michael.

Michael Forman: Thank you, Robert, and good morning, everyone. Thank you all for joining us today for FSK's first quarter 2024 earnings conference call. FSK had a positive start to the year consisting of net investment income totaling $0.76 per share and adjusted net investment income totaling $0.73 per share. During the quarter, we also made significant progress with regard to three of the investments placed on non-approval during the fourth quarter of last year. We experienced increased origination volumes as our investment team originated with approximately $1.4 billion in investments. Our net asset value as of the end of the first quarter was $24.32. From a liquidity perspective, we ended the quarter with approximately $4.2 billion of available liquidity.

Finally, we delivered an annualized ROE of 10.1% for the quarter. Based on our positive operating results, our board has declared a second quarter distribution of $0.70 per share consisting of a base distribution of $0.64 per share and a supplemental distribution of $0.06 per share. As we mentioned on our third quarter 2023 earnings call, our Board previously declared a special distribution totaling $0.10 per share. The first $0.05 per share installment was paid this February and the second $0.05 per share installment will be paid later this month. Accounting for the special distribution, our total second quarter distribution will be $0.75 per share. As a result of achieving our operating targets, we believe investors will be able to receive a minimum of $2.90 per share of total distributions in 2024, which equates to an 11.9% yield on our March 31, 2024, net asset value and an annualized yield of approximately 15% based on our recent share price.

From a forward-looking perspective, we remain confident in the long-term earnings power of FSK, which enables us to continue paying an attractive distribution to our shareholders. We are encouraged by the increased level of origination activity and the quality of the deal volume during the first quarter. The private credit markets continue to experience strong tailwinds and we believe we are well-positioned to take advantage of these opportunities. And with that, I'll turn the call over to Dan and the team to provide additional color on the market and the quarter.

Daniel Pietrzak: Thanks, Michael. For the past year, it has been our view that inflation would remain elevated, and the higher interest rate environment would last longer than some market observers expected. Our view has largely proven accurate, and should our views continue to play out, we believe floating rate asset structures coupled with investment strategies focused on large defensive portfolio companies and asset-based finance investments directly tied to financial and hard assets will remain attractive. Looking ahead, it is our expectation that the economy will experience stickier inflation in the near term, coupled with continue, albeit slowing overall economic growth. As Michael highlighted earlier, there are strong tailwinds to our business as sponsors continue to utilize private credit solutions to finance transactions.

Origination activity picked up meaningfully in the first quarter compared to the prior few quarters and we expect a material increase in private market transaction activity during 2024. Given significant private equity dry powder combined with pent-up demand from an M&A perspective and the desire for private equity fund LPs to see a higher level of return of capital. As we mentioned on our last call, the macro backdrop created challenges for a few of our portfolio companies during the fourth quarter of last year. Our workout team has been active on these names and as Brian will discuss, we are pleased to have achieved positive results quickly. And while there's still work to be done reducing our non-income and non-accrual investments, we clearly are pleased with the recent progress we have made.

Turning to investment activity, during the first quarter, we originated $1.4 billion of new investments. Approximately 75% of our new investments were focused on add-on financing to existing portfolio companies and long-term KKR relationships. Our new investments combined with $1.7 billion of net sales and repayments when factoring in sales to our joint venture equated to a net portfolio decrease of $221 million. New originations consisted of approximately 69% in first lien loans, 3% in second lien loans, 3% in other senior secured debt, 1% in subordinated debt and 24% in asset-based finance investments. As we mentioned on our last call, with regard to new investments, we are continuing to see tighter pricing in the upper end of the middle market.

The trade-off to the spread compression is still strong documentation and very solid credit profiles. We also continue to be pleased with the quality of the new deals. During the first quarter, our new direct lending investments had a weighted average EBITDA of approximately $243 million, 5.7x leverage through our security and a 47% equity contribution, all with the weighted average coupon of approximately SOFR plus 570 basis points. One example of a new deal in the quarter was our investment in Curia Global, a manufacturer of active pharmaceutical ingredients who provides contract pharmaceutical development, manufacturing, packaging and analytical services. KKR was the sole lender as we provided $125 million off-balance sheet SPV structured trade receivables facility secured by Curia's U.S. receivables.

Pricing was 625 basis points with a 2% upfront fee. FSK committed $83 million of the $125 million facility. Additionally, in the first quarter, KKR and its affiliates along with other partners purchased GreenSky, a point-of-sale finance company from Goldman Sachs as part of its divestiture from consumer related businesses. GreenSky was founded in 2006 and focuses on offering home improvement financing alternatives for prime borrowers. FSK committed $80 million to the transaction. I also wanted to highlight a sale of the music IP investment and KKR cord IP aggregator that occurred during the first quarter. In connection with this sale, FSK received an $89 million return of capital. FSK cord IP aggregator also received a well collateralized seller note that is expected to be repaid during 2024.

And FSK's respective share of the seller note is approximately $30 million. The transaction resulted in a $20 million gain to our net asset value. And we expect to realize an IRR of approximately 18% on our position. When we look at the aggregate trends across our portfolio companies, we have continued to see high single digit EBITDA growth with modest margin pressure due to the continued inflationary environment. Over the coming quarters, while we expect continued revenue growth in our portfolio companies, we would expect growth to slow modestly as macro trends could potentially lead to a slowdown in economic growth. The weighted average EBITDA of our portfolio companies was $218 million as of March 31, 2024. Additionally, our portfolio companies reported a weighted average year-over-year EBITDA growth rate of approximately 7% across companies in which we have invested in since April of 2018.

A portfolio manager typing away on a laptop, analyzing debt securities for private middle market U.S. companies.
A portfolio manager typing away on a laptop, analyzing debt securities for private middle market U.S. companies.

And with that, I'll turn the call over to Brian to discuss our portfolio in more detail.

Brian Gerson: Thanks, Dan. As of March 31, 2024, our investment portfolio had a fair value of $14.2 billion, consisting of 205 portfolio companies. This compares to a fair value of $14.6 billion and 204 portfolio companies as of December 31, 2023. At the end of the first quarter, our 10 largest portfolio companies represented approximately 20% of the fair value of our portfolio, which is in line with prior quarters. We continue to focus on senior secured investments as our portfolio consisted of approximately 57% first lien loans and 65% senior secured debt as of March 31. In addition, our joint venture represented 9.8% of the fair value of our portfolio. As a result, when investors consider our entire portfolio, looking through to the investments in our joint venture, then first lien loans total approximately 66% of our total portfolio and senior secured investments totaled approximately 74% of our portfolio as of March 31.

The weighted average yield on a current debt investments was 12.1% as of March 31, a decrease of 10 basis points compared to 12.2% as of December 31, 2023. The decrease was largely driven by spread compression on new deals. As a reminder, the calculation of weighted average yield is adjusted to exclude the accretion associated with the merger with FS KKR. From a non-accrual perspective, as of the end of the first quarter, our non-accruals represented 6.5% of our portfolio on a cost basis and 4.2% of our portfolio on a fair value basis. This compares to 8.9% of our portfolio on a cost basis and 5.5% of our portfolio on a fair value basis as of December 31, 2023. We believe it will also be helpful to provide the market with information based on the assets originated by KKR Credit.

As of the end of the first quarter, non-accruals relating to the 88% of our total portfolio, which has been originated by KKR Credit and the FS KKR Advisor were 2.3% on a cost basis and 1% on a fair value basis. During the first quarter, we placed one small investment on non-accrual with a cost and fair value of $21 million and $19 million, respectively. Additionally, we removed three investments from non-accrual status with a combined cost and fair value of $395 million and $224 million. [Witter] [ph] was one of the names removed from non-accrual during the quarter. As we've discussed on prior earnings calls, we placed our second lien loan on non-accrual during the first quarter of 2023 as it was facing persistent inflation headwinds as well as a slowdown in construction in China.

The restructuring resulted in our second lien loan being fully equitized and KKR taking control of the business. The first lien debt of the company was significantly reduced at the operating company and FSK's existing first lien loan was converted into a €52.2 million other senior secured debt position. FSK and other funds managed by KKR provided new capital to the company to fund operations. This recapitalization resulted in $122.5 million of cost and $31 million of fair value being removed from non-accrual status. Additionally, KBS completed its full consensual restructuring during the quarter, which resulted in equitization of a portion of the non-accruing second out loan and FSK and other lenders taking control of the company. FSK received $190.5 million of a new first lien loan, $82.8 million of a new second out first lien loan, $48.3 million of preferred equity and KKR managed funds now own 46% of the company.

This restructuring resulted in $197.6 million of cost and $135.3 million of fair value being removed from non-accrual status. Lastly, our first lien position in Sweeping Corp of America was restructured during the first quarter and the company received a $50 million cash injection from the equity sponsor. The first lien debt facility was restructured into a $15.7 million first lien first out cash paid term loan, a $28.1 million first lien first out pick tranche, a $8.3 million second lien first out and a $24 million second lien second out term loan. This restructuring resulted in 75.3 million of cost and 57.2 million of fair value being removed from non-accrual status. The progress we've achieved with regard to these portfolio companies is an example of the benefits of KKR Credit Investment Platform.

Our fundamental de-risking approach to these credits was evident in our resolution of non-accruals this quarter. While we prefer sponsors to continue supporting their portfolio companies with additional equity, we have the resources and capabilities to support companies ourselves when necessary. By taking action quickly, we believe we will significantly improve our chances of receiving a meaningful or even full recovery of our investment capital over time. And with that, I'll turn the call over to Steven to go through our financial results.

Steven Lilly: Thanks, Brian. Our total investment income decreased by $13 million quarter-over-quarter to $434 million, primarily due to repayments of higher yielding positions and the impact of investments placed on non-accrual during the fourth quarter of last year. The primary components of our total investment income during the quarter were as follows. Total interest income was $350 million, a decrease of $18 million quarter-over-quarter. Dividend and fee income totaled $84 million, an increase of $5 million quarter-over-quarter. Our total dividend and fee income during the quarter is summarized as follows. $53 million of recurring dividend income from our joint venture, other dividends from various portfolio companies totaling approximately $14 million during the quarter, and fee income totaling approximately $17 million during the quarter.

Our interest expense totaled $116 million, a decrease of $2 million quarter-over-quarter, and our weighted average cost of debt was 5.4% as of March 31. Management fees totaled $55 million, a decrease of $1 million, and incentive fees totaled $43 million, an increase of $2 million quarter-over-quarter. Other expenses totaled $8 million, a decrease of $2 million quarter-over-quarter. The detailed bridge and our net asset value per share on a quarter-over-quarter basis is as follows. Our ending 4Q 2023 net asset value per share of $24.46 was increased by GAAP net investment income of $0.76 per share and was decreased by $0.14 per share due to a decrease in the overall value of our investment portfolio. Our net asset value per share was reduced by our $0.70 per share quarterly distribution, and the $0.05 per share special distribution.

These activities result in our March 31, 2024 net asset value per share of $24.32. From a forward-looking guidance perspective, we expect second quarter 2024 GAAP net investment income to approximate $0.74 per share, and we expect our adjusted net investment income to approximate $0.71 per share. Detailed second quarter guidance is as follows. Our recurring interest income on a GAAP basis is expected to approximate $341 million. We expect recurring dividend income associated with our joint venture to approximate $52 million. We expect other fee and dividend income to approximate $34 million during the second quarter. From an expense standpoint, we expect our management fees to approximate $55 million. We expect incentive fees to approximate $42 million.

We expect our interest expense to approximate $114 million, and we expect other G&A expenses to approximate $10 million. As Michael indicated during his remarks, we currently expect our distributions during the year will total at least $2.90 per share, comprised of $2.80 per share of quarterly distributions and $0.10 per share of special distributions. Our gross and net debt to equity levels were 117% and 109% respectively at March 31, 2024, compared to 120% and 113% at December 31, 2023. As of March 31, our available liquidity was $4.2 billion, and approximately 65% of our drawn balance sheet and 44% of our committed balance sheet was comprised of unsecured debt. And with that, I'll turn the call back to Michael for a few closing remarks before we open the call for questions.

Michael Forman: Thanks, Steven. In closing, we're pleased with a positive start to 2024. As our origination activity picked up, we made significant progress on certain portfolio names, and we continue to fully earn both our base and supplemental distributions on a per share basis. The long-term earnings power of FSK continues to be strong, and we have confidence in our ability to continue to award shareholders with these attractive distributions. And with that, operator, we would like to open the call for questions.

Operator: Thank you. At this time, we will conduct the question-and-answer session. [Operator Instructions] Our first question comes from John Hecht with Jefferies. John, please go ahead with your question.

John Hecht: Thanks for all the detail on the quarter, and thanks for taking my questions. First one is you had a very active deployment quarter, but then also it was very active in repayments as well. Dan, I'm wondering kind of your outlook for both sides of that picture. I know you've talked about an increasing deal market over the course of this year because of private equity fund needs. And maybe give us an update on your perspective there. And then in addition, what kind of signals should we look for the repayment activity to either stabilize or start to drop? And is that a function of, call it the liquid loan markets, and different levels of competition in the space?

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