FS KKR Capital Corp. (FSK) Q2 2026 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to FS KKR Capital Corp.'s Second Quarter 2026 Earnings Conference Call. [Operator Instructions] Please note that this conference call is being recorded. At this time, Anna Kleinhenn, Head of Investor Relations, will proceed with the introduction. Ms. Kleinhenn, you may begin.

Thank you. Good morning, and welcome to FS KKR Capital Corp.'s Second Quarter 2026 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 this morning. 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 June 30, 2026. A link to today's webcast and the presentation is available on the For Investors section of 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 that are not historical facts, including, without limitation, statements with regard to future events or future performance or financial conditions, statements regarding share repurchase activity, distribution levels and frequency, expectations for net investment income levels in future quarters and the financial position, business strategy and plans and objectives of management for FSK's future operations. Words such as anticipate, believe, expect, intend, project and future or similar expressions indicate a forward-looking statement, although not all forward-looking statements include these words. These forward-looking statements are not guarantees of performance or events and are subject to risks, uncertainties and other factors, some of which are beyond our control and difficult to predict and could cause our actual results or future events to differ materially from those expressed or forecasted in these forward-looking statements for any reason. 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 future events to differ materially from these statements. The forward-looking statements included on this call are based on information available to FSK today and current expectations, forecasts and assumptions and involve a number of judgments, risks and uncertainties. Except as required by the federal securities laws, FSK undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In addition, this call will include certain non-GAAP financial measures that have not been prepared in accordance with U.S. generally accepted accounting principles. These non-GAAP financial measures are not in accordance with or an alternative to measures prepared in accordance with GAAP and may be different from non-GAAP financial measures used by other companies. In addition, these non-GAAP financial measures are not based on any comprehensive set of accounting rules or principles. These measures should only be used to evaluate FSK's results of operations in conjunction with their corresponding GAAP measures. For such non-GAAP measures, reconciliations to the most directly comparable GAAP measures can be found in FSK's second quarter earnings release that was filed with the SEC on August 6, 2026. 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 President; and Steven Lilly, Chief Financial Officer. Also joining us on the call today are Co-Chief Operating Officers, Drew O'Toole and Ryan Wilson. I'll now turn the call over to Michael.

Thank you, Anna, and good morning, everyone. Thank you for joining FSK's Second Quarter 2026 Earnings Conference Call. During the second quarter, FSK generated net investment income totaling $0.44 per share and adjusted net investment income totaling $0.43 per share. Our net asset value per share declined 2.8% from $18.83 to $18.30 during the quarter. Our net investment income per share for the second quarter equates to an annualized yield of 9.6% based upon our June 30 net asset value per share and compared to our previously announced guidance of 8% to 9%. Our Board has declared a third quarter distribution of $0.44 per share for common shareholders, which is consistent with our dividend policy of paying out 100% of our prior quarter's GAAP net investment income on a per share basis. As we have indicated on prior earnings calls, we expect our quarterly distribution level will fluctuate as our net investment income fluctuates on a quarter-to-quarter basis. On our first quarter earnings call in May, we announced several strategic actions that the FS/KKR advisor is undertaking to help enhance the financial and trading profile of FSK. Since that announcement, we believe we have made meaningful progress executing these actions. Dan will provide a detailed update on our progress during his portion of this call. There continues to be strong collaboration across the FS/KKR partnership, and we believe these actions reflect our commitment to long-term value creation. At the same time, we recognize that there is work ahead as we continue stabilizing our investment portfolio and executing on our strategic actions. And with that, I'll turn the call over to Dan.

Thanks, Michael. The broader credit markets continue to be impacted by a combination of geopolitical uncertainty, inflationary pressures and rapid technological change. Ongoing tensions in the Middle East, along with a broader focus on energy security and supply chain resiliency contribute to elevated levels of macroeconomic volatility. As a reminder, FSK does not invest directly in oil or commodity-linked companies. Inflation remains higher than pre-pandemic norms, reinforcing the importance of disciplined underwriting and thoughtful capital structure selection. We continue to closely monitor inflation and the incremental risk associated with a sustained inflationary period as do our portfolio companies. That said, given the size and market position of many of our portfolio companies, they historically have demonstrated an ability to pass through higher operating costs to customers during inflationary periods. This dynamic reinforces our confidence in the resilience of the upper end of the middle market. While advances in AI and automation are driving meaningful productivity gains, they are also creating both opportunities and risks as industries adapt to evolving competitive dynamics. Against this backdrop, we believe scale, selectivity, strong portfolio construction and deep sponsor relationships remain critical differentiators in private credit. We also believe that the breadth and depth of the KKR Credit platform, along with our active approach to portfolio management, position us well as we navigate the current environment. As Michael mentioned, I'd like to provide an update on the strategic actions we announced on our first quarter earnings call, which we believe already are providing benefits to shareholders. The $150 million tender offer by KKR expired on June 11, 2026. As a result, a subsidiary of KKR purchased approximately $150 million of shares of FSK's common stock at a purchase price of $11 per share. On June 29, 2026, FSK closed the $150 million issuance of Cumulative Convertible Perpetual Preferred Stock, purchased by a subsidiary of KKR. As a reminder, the convertible preferred stock will pay dividends on a quarterly basis of 5% per annum in cash or at FSK's option, 7% per annum in PIK dividends, in either case, increasing annually by 1% beginning on the 5.5-year anniversary of the issue date. FSK's $300 million stock repurchase program commenced on June 29, 2026. During the second quarter, we repurchased approximately 377,800 shares of FSK's common stock through the program or approximately $4 million worth of shares. During the third quarter, we have continued repurchasing shares. Since the beginning of the third quarter, we have repurchased 3.3 million shares or approximately $36 million, bringing the cumulative value of shares repurchased to $40 million since June 29 at a weighted average purchase price of $10.73 per share. Beginning in the second quarter of 2026, KKR agreed to waive its portion of the subordinated income incentive fee for 4 consecutive quarters. This waiver had a positive $11 million impact on our Q2 net investment income. Turning to our investment activity. During the second quarter, we originated approximately $590 million of new investments. Almost all of these investments related to deals committed to prior to the second quarter or add-on financings to existing portfolio company names. As we have previously communicated, during the period when FSK is repurchasing shares, we will continue to reduce the fund's new investment originations. Our new investments, coupled with $1.3 billion of net sales and repayments when factoring in net sales to our joint venture, equated to a net portfolio decrease of $735 million during the second quarter. As we outlined on our first quarter earnings call, as part of our broader goal to increase the overall quality and diversification of our investment portfolio, we are focused on rotating certain assets. During the second quarter, Global Jet, a legacy investment, returned $50 million of capital to FSK, which was used to further reduce our position. In addition, FSK sold approximately $500 million of investments to third parties during the second quarter at a price in line with our first quarter valuations. We continue to believe in the strength of our investment strategy, which primarily focuses on upper middle market companies with EBITDAs in the $50 million to $150 million range across a diverse set of industries and sectors. As of June 30, the weighted average EBITDA of our portfolio companies was $241 million, and the median EBITDA was $130 million. Our portfolio companies reported a weighted average year-over-year EBITDA growth rate of approximately 6% across companies in which we have invested in since April 2018. Interest coverage levels remain healthy with median second quarter coverage at approximately 1.9x. During the second quarter, 2 investments were added to non-accrual status and 2 were removed. Heniff Transportation Systems and Alacrity Solutions Group, the 2 nonaccruals together totaled $104 million of costs and $91 million of fair value across our investment portfolio. Dental Care Alliance and Affordable Care were removed from non-accrual status as they were restructured during the second quarter. As of June 30, non-accruals represented 7.1% of our portfolio on a cost basis and 3.8% of our portfolio on a fair value basis. This compares to 8.1% of our portfolio on a cost basis and 4.2% of our portfolio on a fair value basis as of March 31. In summary, we are pleased with the strategic actions the FS/KKR Advisor has taken and is continuing to take. KKR's tender was successfully completed. FSK's liquidity position was enhanced by KKR's $150 million convertible preferred stock investment. Our gross and net leverage levels are lower and our portfolio rotation continues in earnest. As we execute on the remaining portion of our common stock buyback program and continue to improve the quality of our investment portfolio, we do acknowledge that FSK will become a smaller fund. On the other side of the equation, we anticipate it will be a higher-quality fund as well. And with that, I'll turn the call over to Steven to go through our financial results.

Thanks, Dan. As of June 30, 2026, FSK's investment portfolio had a fair value of $11.4 billion, consisting of 232 portfolio companies. At the end of the second quarter, our 10 largest portfolio companies represented approximately 21% of the fair value of our portfolio compared to 20% as of the end of the first quarter. We remain focused on senior secured investments as our portfolio consisted of approximately 59% first lien loans and 63% senior secured debt as of June 30. In addition, our joint venture represented approximately 14% of the fair value of our portfolio as of the end of the second quarter. As a result, when investors consider our entire portfolio, looking through to the investments in our joint venture, then first lien loans total approximately 69% of our total portfolio and senior secured investments total approximately 73% of our portfolio as of June 30. The weighted average yield on accruing debt investments was 9.8% as of June 30 as compared to 9.9% during the first quarter. Turning to our quarterly operating results. Our total investment income was $290 million for the second quarter, a decrease of $14 million compared to the first quarter. The primary components of our total quarterly investment income were as follows: Total interest income was $217 million, representing a decrease of $7 million quarter-over-quarter. The decline in interest income primarily was due to a reduction in the size of our investment portfolio and assets placed on non-accrual during the prior quarter. Dividend and fee income totaled $73 million, a decrease of $7 million quarter-over-quarter. Our total dividend and fee income is summarized as follows: $45 million of dividend income from our joint venture, other dividends from various portfolio companies totaling approximately $23 million during the quarter and fee income totaling approximately $5 million during the quarter. As a reminder, on February 23, 2026, our partner, South Carolina Retirement Systems Group Trust increased its equity ownership percentage in our joint venture from 12.5% to approximately 21%, and our ownership percentage changed from 87.5% to approximately 79%. This purchase was executed at the then-current net asset value of the joint venture. This change in ownership, therefore, was reflected partially in the dividend income from the joint venture during the first quarter and was reflected fully during the second quarter. Our net expenses were $168 million during the second quarter, a decrease of $19 million compared to the first quarter. The primary components of our net expenses were as follows: our interest expense totaled $101 million, a decrease of $4 million quarter-over-quarter. Our weighted average cost of debt was 5.5% as of June 30. Management fees totaled $44 million, a decrease of $4 million quarter-over-quarter. As Dan mentioned, beginning in the second quarter of 2026, KKR agreed to waive 100% of its portion of the subordinated income incentive fee for 4 consecutive quarters. This waiver applies to 50% of the subordinated income incentive fee that otherwise would be paid. Net of this waiver, income incentive fees totaled $12 million, a decrease of $13 million from the first quarter. Other expenses totaled $11 million, an increase of $2 million quarter-over-quarter. The detailed bridge in our net asset value per share on a quarter-over-quarter basis is as follows: our ending 1Q 2026 net asset value per share of $18.83 was increased by GAAP net investment income of $0.44 per share and was decreased by $0.56 per share due to a decrease in the overall value of our investment portfolio. Our net asset value per share was reduced by our $0.42 per share quarterly common stock dividend paid during the quarter and increased by $0.01 per share due to share repurchases, which began on June 29. The sum of these activities results in our June 30, 2026, net asset value per share of $18.30. From a forward-looking perspective, we expect net investment income to be in the range of 8% to 9% of net asset value on an annualized basis for the balance of 2026. This level of net investment income will depend on numerous future factors, including geopolitical risks, the overall U.S. economy and the overall health of our investment portfolio. Turning to our capital structure. In June, we issued $900 million of 7.5% unsecured notes due 2031, which subsequently were swapped to a floating rate of SOFR plus 3.488% via an interest rate swap agreement. As of June 30, our debt-to-equity and net debt-to-equity levels were 127% and 122%, respectively, compared to 138% and 131% at March 31. Consistent with the objectives outlined in our first quarter earnings call, we reduced leverage and returned net debt-to-equity to our target range of 1 to 1.25x. Looking ahead, we will seek to manage leverage and liquidity while maintaining flexibility to support our share repurchase program. At the end of the second quarter, our available liquidity was $3.5 billion and approximately 72% of our drawn balance sheet and 48% 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.

Thanks, Steven. We are encouraged by the results of the strategic actions taken by the FS/KKR Advisor and the progress we are making with regard to portfolio rotation. We recognize, however, that there still is important work ahead. Improving portfolio performance, delivering greater consistency in our results and regaining market confidence remain key areas of focus. We are committed to executing on the initiatives we have outlined, and we believe the strength of our platform and our commitment to shareholders will enable us to be successful in our efforts. As always, we appreciate your participation on the call today and for your interest in FSK. Operator, we'd like to now open the line for questions.

[Operator Instructions] Our first question comes from the line of Arren Cyganovich of Truist Securities.

The loan sales that you did, the $500 million that you referenced, maybe you just provide some color on what were these? How did you go about doing this? And is this going to be something that we would expect kind of ongoing as we look forward?

I'd put it a little bit more in probably just ordinary course of business, right? We talked about this on our last call, looking at some of the tall trees, some of the larger exposures we might have had or some, we'll call it, very high-quality assets, but maybe just at a different kind of margin than what the market was affording. So I think net-net, we look at the overall new investments we made, but with that $1.3 billion plus of repayments, I think we're happy with that result and happy to get back down into our target leverage area.

Okay. And the marks that you took this quarter, were those more related to existing non-accrual restructurings or exits? Or were these a result of new marks from other companies this quarter?

If you do look at it, Arren, really driven off of a handful of names that we would have talked about before. The big drivers were PRG, ATX, Wittur, Peraton, Lionbridge and Medallia that pretty much made up the entire amount or at least a supermajority of the amount.

Our next question comes from the line of Finian O'Shea of WFS.

Can you remind us or update on the sort of destination portfolio composition with your sort of strategic repositioning? Is it going to look something like, say, 80% performing unitranche and 20% ABF JV? Or are there sort of inputs or other tilts around the edges?

Fin, we talked about this a bit last quarter. I think we're kind of on the same, I would call it, path that over time, we would look to get the 1L percentage up. I think we've been happy with our asset-based finance business and effort as it relates with inside FSK. I'd say the same thing about the JV. So I think you should expect those to be in the same kind of ranges of, let's call it, 10-plus percent, 10% to 15%, but probably a little bit less focus on second lien and sort of junior debt.

Okay. That's helpful. And then with the JV opening up more to the partner, was that sort of a one-off? Or might you downsize your position more, expand it more or anything like that?

I think time could tell there. We've had a great relationship with our partner there. A little bit, I think, constant conversations about what we want that to look like, how we want it to evolve, what's good for FSK, what's good for them. But I think where it sits today, we feel like we're in a pretty good spot.

Our next question comes from the line of Jason Stewart of Compass Point.

In terms of the loan sales and prepayment activity, what's the line of sight going forward in the next maybe 3Q, 4Q for that activity?

Yes. I mean prepayments or repayments have definitely been slower than I think we would have expected. I think that goes in line with what you would have heard on other calls where new deal activity or just kind of broad M&A feels light versus, I think, everybody's expectations from the start of the year. I think you can attribute that a lot to what's happening with Iran, geopolitical sort of tight points. That said, the team has definitely been busier on the other side of June 30, but I think it's still kind of muted sort of levels. So I would probably expect a light number in Q3. But at some point, I think it's fair to assume that, that ramps back up to more traditional levels.

Okay. I mean rough math, even if we assume that number is light or it gives you plenty of liquidity and room on leverage to continue on the share repurchase. I mean if you are done with that and the fee waiver is done in the next couple of quarters, what's the next step here?

Yes. No, I appreciate that question. I think we are happy that we kicked off the share repurchase. I think we've been guiding the market that we will be mindful about liquidity and leverage as we think about the share repurchase, but we do have an intention to fulfill that. You're right about the fee waiver extending for another 3 quarters past the quarter that we just reported on. I think it remains our intention to get through, I'd say, a lot of heavy lifting on some of these non-income-producing assets. I would like leverage to get down to the middle of that target range over time. It could bounce around the upper end of that target range for a couple of quarters. But I think the longer-term piece is the middle of that range. So I would frame the quarter. I think we've had some good progress with things that we said we were going to do on the last call. You heard the comments in the script. We know there's some still heavy lifting to do and we're going to be focused on that as we finish out '26 and go into '27.

[Operator Instructions] Our next question comes from the line of Kenneth Lee of RBC Capital Markets.

Just one more on the loan sales there. Any details in terms of the types of loans across the industries or any other details around the specifics around what kind of loans were sold there?

Yes, Ken, no kind of real target beyond what I said. I don't view kind of what we did as much different than some of the ordinary course business stuff. I think we're always mindful about some of the -- these larger positions and can we bring those down I think it's good to see a certain amount of liquidity in the book. When we're underwriting a loan, we're not assuming that we're looking to kind of move on from it or sort of sell some of it, but we have the opportunity to do so. And I think it was good for the entity as we're talking about reducing leverage and getting inside that target range. But there was really no specific theme besides that.

Got you. Very helpful there. And just one more follow-up here. In terms of the share repurchases go-forward, and I realize you're going to be mindful of the leverage targets as well. How active could you be? And what factors are you going to be looking at closely to judge the activity of repurchases there?

Yes. And I mean I think it's a couple of things, right? I mean, obviously, it's going to be -- we've historically done these things under a 10b5-1 program. You're going to be mindful about market volumes, and there's a bunch of rules as it relates around that. I think we're still, I think, quite mindful about, on the one hand, just managing kind of that leverage ratio. But with where the stock has been trading, it's quite an attractive time to buy back the stock. But like I said, I think we've been trying to guide folks, and I think we talked about this on the last call that we have every intention of filling this, but it's going to be mindful of those sort of points and probably occurs over the course of '26 and '27.

Our next question comes from the line of Heli Sheth of Raymond James.

You mentioned activity is seeing somewhat of a pickup after 2Q. Are you seeing anything different there in terms of spreads or pricing? Or is it kind of steady on that front?

Yes. Thanks for the question. I'd put it in a couple of buckets. I think the activity level is picking up as there was some, we'll call it, sense of belief in the market that the Iran situation was either under control or at least the sides were working towards a deal. I think we did see spreads widen and terms and conditions get better really on the back of the redemption activity in the nontraded space. That's not really different than what we saw in 2022. I think -- and that we'll call that could have been up to 75 basis points plus of sort of spread move as you kind of work through the quarter for the new deals that were getting done. It's probably come back a little bit since then on the spread side, just as I think the redemption, we'll call it, noise has calmed down a little bit, even though the numbers remain elevated. There has been continued interest in the space from an institutional perspective. My guess is that will probably widen back out a little bit if M&A picks up to a normal volume. But I think net-net, we have seen the environment toggle to what I call more of a lender-friendly environment versus a borrower-friendly environment. We're happy to see that.

Got it. That makes sense. And then on repayments, I think you had pretty elevated repayments this past quarter. How are you weighing reinvesting back into assets into the portfolio versus share repurchases? Any specific strategy there?

I'm not sure it's a specific strategy beyond what we talked about, right? We want to get the share repurchase plan done. We want to be mindful about our leverage number. We want to see the repayments come through. We want actually that leverage to get back to probably more the middle of that range. So we're going to try to balance all those together. The majority of our new investments for the quarter really related to fundings on delayed draw term loans or revolvers. We'll be mindful about new investments as well. We're trying to just factor that all together to achieve the goals that we laid out.

This does conclude the question-and-answer session. I would now like to turn it back to Dan Pietrzak for closing remarks.

Great. Thank you. And thank you all for your time today. If there are any other additional questions, please do not hesitate to reach out to us. Enjoy the rest of the summer. We'll talk to you again next quarter. Thank you.

Thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.