OCSL - NASDAQ

Welcome, and thank you for joining Oaktree Specialty Lending Corporation's Third Fiscal Quarter 2025 Conference Call. Today's conference call is being recorded. Before we begin, I want to remind you that comments on today's call include forward-looking statements reflecting current views with respect to, among other things, future operating results and financial performance. Actual results could differ materially from those implied or expressed in the forward-looking statements. Please refer to the relevant SEC filings for a discussion of these factors in further detail. Oaktree undertakes no duty to update or revise any forward-looking statements. I'd also like to remind you that nothing on this call constitutes an offer to sell or a solicitation of an offer to purchase any interest in an Oaktree fund. Investors and others should note that OCSL uses the Investors section of its corporate website to announce material information. The company encourages investors, the media and others to review the information that it shares on its website. I'll now turn the call over to Clark Koury, OCSL's Head of Investor Relations. Please go ahead.

Thank you, operator. Our third quarter earnings release, which we issued this morning, along with the accompanying slide presentation, can be accessed on the Investors section of our website, oaktreespecialtylending.com. Joining me on the call today are Armen Panossian, CEO and Co-CIO; Raghav Khanna, Co-CIO; Matt Pendo, President; and Chris McKown, CFO and Treasurer. Now I'll turn over the call to Matt to provide an overview of our performance for the quarter. Matt?

Thanks, Clark, and thank you all for joining our call today. This quarter, NAV was up slightly, and we made progress restructuring or exiting certain challenged names within the portfolio and reducing nonaccruals, which declined as a percentage of both fair value and cost. Adjusted net investment income declined to $0.37 per share, primarily due to the impact of certain nonrecurring and noncash items related to refinancing activities. We also experienced a lower-than-usual amount of nonrecurring income. Chris will share more details on nonrecurring income a bit later in the presentation. Regarding our dividend, our Board approved a base dividend of $0.40 per share for the quarter. Turning to our balance sheet. There were several positive outcomes during the quarter. As mentioned on last quarter's call, we successfully amended and extended the maturity of our senior secured revolving facility, reducing the interest rate from SOFR plus 2% to a range of SOFR plus 1.75% to 1.875%. This enabled us to terminate a higher cost ABL facility with pricing of SOFR plus 2.35%. Taken together, these will reduce our overall interest expense, which will be accretive to earnings going forward. There were some onetime costs as a result of these developments as we wrote off unamortized deferred financing costs that impacted our NII. With a strong balance sheet, ample liquidity and leverage at its lowest level in 3 years, we have meaningful dry powder to further diversify the portfolio and position OCSL for sustained growth. Now I'll turn the call to Armen to provide an overview of the market environment.

Thanks, Matt. uncertainty surrounding the implementation of increased tariffs and their potential impact on inflation, the economy and monetary policy deterred M&A activity, which remain muted. Consequently, most lending in the marketplace pivoted to refinancing existing debt rather than de novo buyouts. Robust CLO issuance in recent months has created some competition for deal flow, pulling some deals out of the private market and into the broadly syndicated loan market. These dynamics, coupled with the continued strength of fundraising for private credit, pushed credit spreads tighter. Liquid credit markets also tightened, but it's important to note that private credit still offers an attractive premium. However, spreads on newly originated loans have reverted to the levels we saw at the start of the calendar year. Pricing for large cap sponsor loans is in the SOFR plus [ 4 25 to 4 75 ] basis points range, and spreads are 25 to 50 basis points higher in the core to upper middle market. OCSL has deep expertise in originating and structuring loans for middle market companies, and we are finding more value in this part of the market in the current environment. Beyond core middle market lending in the U.S., we are seeing pockets of opportunity in asset-backed financing and life sciences, areas where Oaktree has extensive capabilities. We are observing increased opportunities in Europe, supported by a strengthening economic outlook and favorable valuation metrics. Concurrently, we are seeking to expand our capabilities across the Asia Pacific region and within infrastructure debt. Against this backdrop, credit quality has remained stable, and most problems are tied to company-specific issues where management teams have not executed in line with expectations, creating financial pressure on their balance sheets and capital structure. We are also keeping a close eye on areas of potential risk within the portfolio, including the use of PIK income. In this regard, we have maintained a conservative stance and continue to rank near the low end of our peer set in PIK as a percentage of total income at 6.7%. Even as spreads have tightened, our focus remains on high-quality companies with strong credit profiles. We believe the long-term outlook for direct lending will remain favorable. Yields are compelling on a gross unlevered basis, including at the top of the capital structure. The absence of mark-to-market volatility and the historically tight band of returns across different market environments make this asset class appealing to investors seeking income and capital preservation. Now I'll pass the call to Raghav Khanna to give an update on our portfolio.

Thanks, Armen. I'll start with investment activity for the quarter. While our overall investment activity was tempered due to the slower market environment, we leaned into opportunities that squarely met our portfolio objectives and disciplined underwriting standards. The weighted average yield on our new debt investments was 9.1% comparable to 9.5% in the prior quarter, reflecting continued tight spreads in the marketplace. All our originations in the quarter were first lien loans, consistent with our strategy of investing at the top of the capital structure to provide greater downside protection. We are excited about our current pipeline and continue to see compelling investment opportunities even amid persistent inflation, elevated interest rates and tariff-related uncertainty. In this environment, we are selectively deploying capital into mature market- leading businesses with solid fundamentals and consistent cash flows. We are also maintaining a granular diversified approach to portfolio construction, avoiding an industry concentration risk and steering clear of more cyclical businesses. The strength of Oaktree's global platform is a competitive advantage for OCSL. As one of a handful of lenders that has the scale to lead or participate in larger financings, our platform gives us access to high-quality transactions that are often unavailable to smaller lenders. In addition, Oaktree's broad sourcing capabilities span both sponsored and non-sponsored deals, stress and rescue lending, high-yield public credit and asset-backed transactions. This breadth allows us to evaluate a wide range of attractive opportunities in any market environment, and allows us to lean into opportunities with the best risk-adjusted returns. As of June 30, the median EBITDA of our portfolio companies was approximately $161 million, a $3 million increase from the prior quarter. The weighted average leverage in our portfolio decreased slightly from 5.2 to 5.1x, and the weighted average interest coverage slightly increased from 2.1 to 2.2. Now I'll share the details on 2 recent investments during the quarter that demonstrate our focus on portfolio diversification and first lien lending. Both were sourced through the broader Oaktree platform and underscore how we are leveraging the firm's extensive sponsor relationships and broaden market access to co-invest in compelling opportunities. I'll begin with Draken International, a provider of operational training solutions to air forces around the world. The business has close relationships with both the U.S. and U.K. air forces. This investment expands our exposure in the countercyclical aerospace and defense industry, where demand for cost-effective pilot training continues to rise amid persistent global pilot shortages. With long- term government contracts in place, Draken generates recurring revenues by serving a critical market with predictable demand. This investment also aligns with our strategy to partner with institutional sponsors, Blackstone, in this instance, to originate senior secured loans for resilient businesses operating in sectors with long-term demand visibility. Oaktree was the sole lender in this new transaction, which Draken used to refinance existing debt. Oaktree committed to $217 million, of which $177 million was funded upfront. The deal was priced at SONIA plus [ 5 50 ] with 2 points of upfront fees. OCSL was allocated $31.9 million, of which $26 million was funded upfront. Turning to Lyons Magnus. Founded in 1851, Lyons Magnus is a leading food and beverage manufacturer of plant-based beverages and flavor ingredients, serving the food service, health care and dairy industries. Lyons Magnus maintains a top 3 market share position across its core product categories and has long-standing relationships with leading QSRs, food service distributors and health care providers, including the likes of Starbucks, McDonald's and Sysco, customers that generate stable recurring revenue for the business. This is a great example of our focus on investing in established businesses with long-standing customer relationships, diversified product offerings and strong margin profiles. Lyons Magnus used the proceeds of the transaction to refinance its existing capital structure. This investment was sourced directly by Oaktree through a long-standing relationship with the sponsor, Paine Schwartz Partners. Oaktree acted as joint lead arranger on the deal, providing $150 million commitment or 34% of the total transaction, and $133 million was funded upfront. OCSL was allocated $12.7 million, of which $11.2 million was funded upfront. Now turning to our existing portfolio, where we are seeing encouraging signs of progress in addressing nonaccruals. During the quarter, one company, BayMark, was added to the nonaccrual list, and one company, Telestream Holdings, was removed. BayMark is one of the largest substance abuse and recovery treatment providers in North America. It is experiencing operational issues with its revenue cycle management systems and underperformance in certain business segments, resulting in cash flow and liquidity pressures. The company is working with turnaround professionals, and we are actively engaged with management to help them achieve the best possible outcome for the company and our loan. These situations take time to resolve, but our team has the experience and the discipline to navigate them effectively and drive favorable resolutions. We're pleased to report that Telestream Holdings, a video software platform that provides on-demand digital video tools to broadcasters, media companies and content creators was removed from nonaccrual status after completing a comprehensive restructuring that helped reduce the company's debt burden and eased liquidity constraints. Additionally, we're beginning to realize meaningful exits and recoveries from previously challenged positions, which were contributing factors to the decline in nonaccruals as a percentage of the overall portfolio. One notable example is Mosaic, where we received cash paydowns totaling $25.7 million or just over 50% of our total position during the quarter. We remain focused on working through challenged positions and maximizing recoveries. Moving now to exit and repayment activity during the quarter. Investment exits decreased to $249 million, down from $279 million in the prior quarter. One exit worth mentioning is Alto, a digital pharmacy company which was merged into LetsGetChecked to create a comprehensive platform combining pharmacy, diagnostics and virtual care. The loan for Alto had been marked at 85 and 95 as of December 31, 2024, and March 31, 2025, respectively, and was taken out at par in connection with the merger. Looking to the second half of the year, we are very encouraged by the depth and diversity of the opportunities we are seeing across sectors, structures and sponsors. We are leaning hard into our strengths, our deep industry relationships, broad market access and due diligence and underwriting expertise to continue building a well-diversified portfolio that can deliver sustained long-term performance. And with that, I will now turn the call over to Chris.

Thank you, Raghav. Let's review our financial results. In our third fiscal quarter ending June 30, 2025, we delivered adjusted net investment income of $32.5 million or $0.37 per share as compared to $38.7 million or $0.45 per share in the prior quarter. The decrease for the quarter was primarily driven by nonrecurring and noncash expenses related to refinancing activities as well as a decline in nonrecurring income, which we generally define as things like prepayment fees and OID acceleration. To drill into that a bit, our trailing 8-quarter median amount of nonrecurring income has been about $3.8 million or $0.043 per share based on current shares outstanding. Our June quarter nonrecurring income came in around $2.1 million less or a little over $0.02 less than this median level. Adjusted total investment income in the quarter declined $2.9 million compared to the prior quarter, primarily due to the reasons I just mentioned as well as a modestly smaller average portfolio, the impact of tightening spreads and lower dividend income from the Kemper JV. Net expenses increased $3.5 million from the prior quarter, driven by a $2.9 million increase in interest expense due to $3.9 million of nonrecurring and noncash expense related to the acceleration of certain deferred financing costs in connection with the termination of the Citibank SPV facility and the amendment of our revolving credit facility. This was partially offset by lower average borrowings outstanding during the quarter and reduced interest rates for the amended credit facility. Our weighted average interest rate at June 30 was 6.6% compared to 6.7% at the end of the prior quarter. Our net leverage ratio at quarter end was 0.93x, flat from last quarter, and total debt outstanding was $1.46 billion. Unsecured debt represented 65% of total debt at quarter end, consistent with last quarter. We have ample dry powder to fund investment commitments with liquidity of approximately $730 million, including $80 million of cash and $650 million of undrawn capacity on our credit facilities. Unfunded commitments, excluding those related to the joint ventures, were $278 million, approximately $264 million of which can be drawn immediately as the remaining amount is subject to portfolio companies meeting certain milestones before the funds can be drawn. Our target leverage ratio remains unchanged at 0.9x to 1.25x, and we are currently at the low end of that range due to a combination of successful investment exits in recent quarters and our prudent approach to deploying capital. Turning to our 2 joint ventures. Together, the JVs currently hold $442 million of investments, primarily in broadly syndicated loans spread across 54 portfolio companies. During the third fiscal quarter, the JVs generated ROEs of 10.5% in aggregate. Leverage at the JVs was 1.3x, unchanged from 1.3x last quarter. In addition, we received a $525,000 dividend from the Kemper JV. With that, I'll turn the call back to the operator to open the call for questions.

[Operator Instructions] And your first question today will come from Finian O'Shea with Wells Fargo.

First question on spreads this quarter. I think you were mid- to upper 5s, which is tracking better than most peers. Obviously, a very good thing, but the other side of the coin is we ask sort of how you were able to generate that? Maybe if it was nonsponsor, higher leverage? Or any color you could give us there.

Fin, it's Raghav. Thanks for the question. So you're right, both for the quarter and for the year, we have been able to achieve, on first lien spreads which are, call it, mid-500s, including OID. There's a few factors that have played into it. So one is that does include the lower spread deals that you are seeing in the market currently. So we do have some deals that we've done this year, which are that [ 4 50 to 4 75 ] in range. And then OID will take you to just around 500. But we also have some higher-yielding deals. There's been a couple of life science deals, which have been higher yielding. That's helped. Some of the non-U.S. deals we've done, such as the Draken deal, which we mentioned, which is SONIA plus [ 5 50 ] with 2 points of OID. That's helping as well. European spreads are slightly wider than what we're seeing in the U.S. And then the third thing I would say is that there is a premium for refinancing deals versus brand-new de novo [indiscernible]. It's not huge, but it could be 50 to 75 basis points. And on the margin, that's helping as well.

Okay. It's helpful. And then just sort of back of the napkin here with the moving parts that you hopefully outlined on earnings, the onetime, the facility fee and so forth. Those seem to roughly offset if that, the impact of the look back and you're still below the dividend. So I guess is the -- should we assume the main obvious lever to drive earnings that would be levering up? And then can you give color on how the discussions with rating agencies are in that regard given recent loss rates. Would they would they be comfortable with you going up to 1.25 or so if that is the plan?

Thanks, Fin, it's Matt. So the plan isn't to go to 1.25, just to kind of hit that number. But the plan is to kind of be at the midpoint of our range. Our range is 0.9 to 1.25. Right now, we're at 0.93. So which I think is the lowest we've been for quite a while. And I think if we continue -- we have active dialogue with the rating agencies. They're aware of our plans. But one of our plan, to your point, to take leverage up -- is to take leverage up to create more earnings to support the dividend. So that's one we feel comfortable with where we are with the agencies in doing that. Again, take it up to the midpoint of our range, not the top end of our range. I think as Raghav mentioned, our pipeline is pretty diverse and pretty robust. So we feel good about the ability to deploy. We also -- just kind of given where we are in the quarter, we have some visibility into repayment activity for the September quarter. We also -- and another lever is the JV. The JV is now really focused on broadly syndicated loans. So taking some leverage up slightly there. Our target there is 1.5x. We're at like [ 1.3 ] right now. So that's another lever. And then it's to take cash from the equity and the nonaccruals and put those into interest-earning assets. So we talked about this quarter about Alto and Mosaic, which are 2 examples. Another example in July, we got the cash for the EOS Fitness, and there was a nice gain there, so we can redeploy that. So those are -- that's the kind of the strategy. We're comfortable with the rating agencies in executing that. It won't necessarily happen in one quarter, but that's the plan. And again, given kind of the pipeline, visibility on repayments, some of the legacy nonearning assets, put that all together, that's kind of how we think about things.

[Operator Instructions] And your next question today will come from Melissa Wedel with JPMorgan.

I wanted to start with some of the onetime items. You've touched on them both in the press release but also on this call. When we back those out from the quarter, it kind of gets to earnings power, a bit above the base dividend, but not by a ton. I just wanted to revisit the level at which you reset the base dividend at $0.40 a share. I just wanted to gauge your confidence in that level, especially with the forward curve sort of implying 100 bps of rate cuts in the next year or so.

Melissa, it's Matt. Thanks for the question. So I think -- I don't want to like project out the dividend, the dividend subject to the Board. So I don't want to do that. I think kind of the color a little bit kind of last question -- the onetime items that we outlined in terms of the...

Matt, I'm sorry, you've cut out of it. It's hard to hear you.

Being more normalized. And then if you add on top of that... [Technical Difficulty]

Ladies and gentlemen, it appears we have lost connection to our speaker line. Please standby while we reconnect. Thank you for your patience.

Melissa, can you hear us?

I can hear you.

Okay. Okay. Sorry, we had some technical difficulties. So I'm going to -- did I answer your -- we're unclear where we cut out. What -- did I answer any part of your question?

You cut out pretty early, actually. Sorry, if you could recap it.

Sure, sure. So I don't want to get into kind of the habit of projecting the dividend. The dividend is up to the Board and they approve it every quarter. So I want to just focus kind of on where we were for this quarter and the $0.40, which is our base dividend. If you look at the add-backs that Chris covered earlier, so you've got to adjust for that. If you walk through kind of the -- what I just did with Fin regarding deployments and our pipeline there, our visibility into the prepayment activity for the quarter, some of the progress we've made in turning noninterest-earning assets into interest-bearing assets. So you add all that together, that kind of got us comfortable with the base dividend of $0.40. As you look forward, and there's obviously things outside of our control, such as base rate and spreads, we're obviously -- we'll tackle those kind of quarter-by-quarter as they present themselves. But that's a little bit how we were kind of thinking about the $0.40 for this quarter.

Okay. I appreciate that. When you -- you mentioned seeing some attractive opportunities particularly in asset-backed and also maybe infrastructure and even outside the U.S. I was hoping you could give a little bit more color on what particular flavor of asset-backed opportunities you're looking at and infrastructure. Is there a certain kind of collateral that you're looking more carefully at and then others that you wouldn't consider. Anything you can share would be helpful.

Yes. So Melissa, it's Raghav. It's actually a very diversified pipeline of asset-backed deals we're looking at. It ranges really from everything, from the rental car leases to small loans that are used to by homeowners to finance HVAC systems. So there's really no one particular threat. The only kind of overarching threat here really is that the assets, unlike in the corporate loans that we make, the assets and these asset- backed deals are a pool of contractual assets such as loans or leases. The other area that we have spent time on, but this is a market that has tightened, is the SRT market. That is an area we have been spending some time on, but most of the SRT trades are either at levels which are inside [ 3 50 ] spread, so not particularly interesting or are higher up on the risk spectrum and not interesting from a risk perspective. But away from SRTs, we're still finding a pretty decent portfolio of pipeline of assets in -- asset-backed deals.

And Melissa, this is Armen. The only other thing I would add is what we're not doing, much or any of an asset-backed is really consumer unsecured debt. That's not something that we feel like we have an edge on. But where there is a corporate underlying borrower assets that are used in the corporate context, for example, equipment receivables or even in industries that we know very well, like telecom and fiber optics, there are asset-backed deals there that we are seeing across Oaktree platform and evaluating them for the BDC. Obviously, not all of them will fit. But generally, it's in categories and industries that we know well, and it's just asset- backed as a different wrapper, different structure for deployment into that same industry.

This concludes our question-and-answer session. I would like to turn the conference back over to Clark Koury for any closing remarks.

Thank you for everybody for joining the call today. Please feel free to reach out directly to us to the extent you have any questions. We appreciate all of your support. Have a great day.