Barings BDC Inc (BBDC) 2017 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the Triangle Capital Corporation's Conference Call for the quarter and year ended December 31, 2017. (Operator Instructions) Today's call is being recorded and a replay will be available approximately 2 hours after the conclusion of the call on the company's website at www.tcap.com, under the Investor Relations section.

The host for today's call are Triangle Capital Corporation's Chairman and Chief Executive Officer, Ashton Poole; and Chief Financial Officer, Steven Lilly.

I will now turn the call over to Tommy Moses, Vice President and Treasurer, for the necessary Safe Harbor disclosures.

Thank you, Bridget, and good morning, everyone. Triangle Capital Corporation issued a press release yesterday with details of the company's fourth quarter and full year 2017 financial and operating results. A copy of the press release is available on our website.

Please note that this call contains forward-looking statements that provide other than historical information, including statements regarding our goals, beliefs, strategies, future operating results and cash flows. Although we believe these statements are reasonable, actual results could differ materially from those projected in the forward-looking statements.

These statements are based on various underlying assumptions and are subject to numerous uncertainties and risks, including those disclosed under the sections titled Risk Factors in forward-looking statements in our annual report on Form 10-K for the fiscal year ended December 31, 2017, as filed with the Securities and Exchange Commission. TCAP undertakes no obligation to update or revise any forward-looking statements.

At this time, I'd like to turn the call over to Ashton.

Thanks, Tommy. Good morning, everyone. Thank you for joining us on today's earnings call. Before Steven and I provide you with some color regarding our financial and operating results, let me first say that the evaluation of certain strategic alternatives, that our board is considering, is still ongoing. As a result, while we look forward to sharing with you the results of the process once it has concluded, for obvious reasons relating both, to preserving the integrity and confidentiality of the process, we will not be making any comments nor answering any questions regarding the strategic process on this earnings call.

With that introduction, let me turn to a few high-level comments regarding our fourth quarter and full year 2017 results, after which, I will provide some color on our investment portfolio. During the fourth quarter of 2017, we generated total investment income of $31.7 million, which was comprised of $27 million of revenue associated with recurring portfolio company interest in fee income and $4.7 million of revenue associated with nonrecurring fees and dividends. The majority of our non-recurring fee income, during the quarter, was associated with the prepayment of loans across our investment portfolio, which totaled $3.5 million. Our NAV on a per share basis increased by $0.23 from $13.20 to $13.43, relating primarily to unrealized depreciation on our current portfolio of $0.11 per share and over-earning our dividend by $0.08 per share. From an investment standpoint, during the fourth quarter, we originated $92.2 million of total investments, of which $74.2 million were new investments and $18 million were follow-on investments.

Consistent with our TCAP 2.0 investment strategy, our new investments were comprised of $42.5 million in unitranche investments, $29 million in second lien investments, $500,000 in mezzanine investments and $2.2 million in equity investments. During the fourth quarter, we experienced $171.9 million in repayments and sale proceeds, resulting in a net portfolio decline of $79.7 million. For the full year 2017, we originated for $483.7 million in total investments, of which $408.9 million were new investments. The weighted average interest rate associated with all our new debt investments was 9.9%. We experienced $403.7 million in repayments and sale proceeds, resulting a net portfolio growth of $80 million.

Turning to our investment portfolio, as of December 31, 2017, we had investments in 89 portfolio companies with an aggregate cost of $1.12 billion and total fair value of $1.02 billion. The weighted average yield on our outstanding debt investments was approximately 11%, compared to 11.7% as of December 31, 2016. The weighted average yield on all of our outstanding investments, excluding nonaccrual debt investments was approximately 9.6%, compared to 10.2% as of December 31, 2016.

During 2017, we had 21 portfolio company loans repaid, at par, totaling $332.5 million, and we received normal principal repayments, partial loan prepayments and thick interest repayments totaling $54.5 million. We received proceeds related to the sales of certain equity securities totaling $29.6 million and recognized net realized gains on such sales totaling $20.9 million. We recognized $72.3 million of realized losses related to the restructuring, right off or sale of our investments in certain portfolio companies, including CRS Reprocessing, Capital Contractors, DCWV Acquisition Corporation, DialogDirect and Waste Recyclers Holdings. As of December 31, 2017, the cost basis of our nonaccrual assets was $121.1 million and totaled 10.7% of our investment portfolio, and the fair value of our nonaccrual assets was $15.8 million and totaled 1.6% of our portfolio on a fair value basis. From a credit quality standpoint, we did not place any additional accounts on nonaccrual status during the fourth quarter of 2017. During the fourth quarter, we exited our investments in DialogDirect and DPII Holdings, and we also restructured our investment in CRS Reprocessing. Of the 8 remaining nonaccruals, 4 are currently valued at 0 and 1 investment, GST AutoLeather, Inc., has a nominal value based on recovery expectations. 4 of these accounts experienced meaningful depreciation during the fourth quarter from a valuation standpoint. In each case, the decline related specifically to company performance. Finally, as we take steps to reinvest the $171.9 million in portfolio company repayments and sale proceeds, we experienced during the fourth quarter, we expect our first quarter of 2018 NII per share will be slightly below our $0.30 per share dividend.

And with that, I'll turn the call over to Steven.

Thanks, Ashton. As Ashton previously mentioned, during the fourth quarter, we generated total investment income of $31.7 million. This level of investment income compares to total investment income of $29.9 million during the third quarter. The increase in our quarter-over-quarter total investment income resulted primarily from $4.7 million of nonrecurring dividend and fee income during the fourth quarter as compared to nonrecurring dividend and fee income during the third quarter of 2017 of $2.1 million, representing an increase of $2.6 million during the fourth quarter. This increase was offset by a decrease in portfolio debt investments from the third quarter to the fourth quarter. During the fourth quarter, interest expense and other financing fees totaled $7.8 million as compared to $7.4 million during the third quarter. Our compensation expenses totaled $4 million during the fourth quarter as compared to $4.3 million during the third quarter of 2017. The quarter-to-quarter decrease in compensation expenses is primarily related to a decrease in discretionary compensation expenses. G&A expenses totaled $2 million during the fourth quarter of 2017 as compared to $1 million during the third quarter of 2017. The increase primarily related to increased legal and other professional service fees, including public company expenses. From an efficiency ratio standpoint with efficiency ratio being defined as total compensation and G&A expenses divided by total investment income, our fourth quarter efficiency ratio was 18.8% compared to 17.9% during the third quarter. Net investment income during the fourth quarter was $17.9 million or $0.38 per share as compared to $17.2 million or $0.36 per share during the third quarter. During the fourth quarter, we recognized net realized losses totaling $34.6 million, relating primarily to $25.3 million of losses on the restructuring of our investments in CRS Reprocessing LLC and $10.9 million of losses on the sales for investments in DialogDirect, Inc. and DPII Holdings LLC. From a valuation perspective, we recorded net pretax unrealized appreciation on our current investment portfolio totaling $5.3 million for the quarter, largely driven by $21.5 million of write-ups in 11 strong performing equity investments, including write-ups in NB Products, Inc., Rotolo Consultant Inc., United Biologics, LLC and Nomacorc, LLC. In addition, we had debt write-ups of $5.1 million associated with the 2018 repayments of All Metals Holding, LLC, Nomacorc LLC and United Biologics LLC. These write-ups were partially offset by $15.6 million in write-downs, associated with our nonaccrual debt investments and $5.7 million in write-downs associated with certain debt investments, including PCX Aerostructures, LLC,

Passport Food Group, Technology Crops LLC, HTC Borrower LLC and Lakeview Health Holdings, Inc. As a result of these events, our net increase and net assets resulting from operations during the fourth quarter totaled $23.7 million and on a per share basis our net increase and net assets, resulting from operations during the fourth quarter, was $0.50 per share.

Our total net assets were $641.3 million as of December 31, 2017, and our net asset value per share at December 31, 2017, was $13.43 as compared to $13.20 as of September 30, 2017, and $15.13 as of December 31, 2016. For the full year ended December 31, 2017, total investment income was $123 million as compared to $113.7 million of total investment income for the year ended December 31, 2016. A change in investment income is primarily attributed to an increase in our overall investment portfolio and a $2.8 million increase in non-recurring fee and dividend income. These events were partially offset by a decrease in the weighted average yield on our debt investments from 2016 to 2017 and a decrease in investment income relating to nonaccrual assets. During 2017, interest expense and other debt financing fees totaled $29.3 million as compared to $26.7 million for 2016. With the increase relating to additional borrowings under our senior secured credit facility, a higher overall interest rate associated with the increase in LIBOR during the year, and an amendment to our senior secured credit facility, which extended the maturity to April 30, 2022.

For the year ended December 31, 2017, compensation expenses totaled $16.1 million as compared to $23.7 million for the year ended December 31, 2016. Compensation expenses for the year ended December 31, 2016, include previously announced one-time items, totaling $7 million relating to the retirement of the company's former CEO and the resignation of the company's former CIO. In addition to the impact in 2016 of the one-time charges noted above, 2017 compensation expenses were $600,000 lower -- excuse me, 2017 composition expenses were $600,000 lower than 2016, primarily related to lower discretionary compensation. For the year ended December 31, 2017, general and administrative expenses totaled $5.4 million as compared to $4.4 million for the year ended December 31, 2016.

For the year ended December 31, 2017, our efficiency ratio was 17.5%, which we believe continues to be one of the lowest efficiency ratios in the BDC industry. Our 2017 net investment income was $72.2 million or $1.55 per share as compared to $58.9 million or $1.62 per share during the year ended December 31, 2016. Net investment income for 2016 included the $7 million of one-time compensation expenses that I just mentioned, which had an impact of $0.19 per share. During the year ended 2017, we recognized net investment losses totaling $51.6 million, also during 2017, we recorded net unrealized depreciation totaling $48.4 million. As a result of these events, our net decrease in net assets resulting from operations during the year ended December 31, 2017, totaled $28.7 million. On a per share basis, our net decrease in net assets resulting from operations during 2017 was $0.62 per share. Finally, from a liquidity and capital resources perspective, as of December 31, 2017, our current liquidity totaled approximately $545 million, consisting of a combination of cash on hand, available bank borrowings and SBA debentures.

And with that, operator, we will open the call to questions.

(Operator Instructions) Our first question comes from the line of Ryan Lynch with KBW.

I was just curious, have you guys been seeing any pushback from potential borrowers or looking for capital from TCAP? Given just the uncertainty surrounding the company's future given the strategic review.

Ryan, good morning, thank you for your message. Look, we've been -- we have been, and continue to be, active in the market, thanks to our long-standing history as a company and the longevity of our senior coverage officers here, we have extremely good relationships in the financial sponsor community, and those relationships continue, and our dialogue and our flow continues.

Okay. And then, from the G&A side, obviously G&A bumped up this quarter, given the things that are going on in the company. As that process continues in the first quarter, should we expect G&A to stay at this $2 million-ish type level versus, kind of, the $1.1 million you guys experienced in Q1 through Q3 of '17?

Ryan, it's Steven. My personal opinion would be, it's probably not as high as the $2 million or the full $1 million difference. But it's probably not equal to where we were last year either. We will have certain other expenses, I would imagine it will flow through, but I think in the fourth quarter, you saw more of those as we were gearing up for things so to speak.

Okay. And then, I believe you guys mentioned in the prepared remarks, $21.5 million of appreciation due to 11 stronger performing equity investments. I was just curious, of the $21.5 million of write-ups in these equity investments, was any of that driven by favorable changes due to tax reform getting in place? Or were they -- are these just companies that are just having stronger underlined fundamental trends?

Ryan, of the -- in the equity write-ups this quarter, there was a significant grouping that accounted for equity changes over $1 million in terms of write-ups and that totaled about $0.45 per share. That was about 11 companies and 7 out of those 11 companies are in active M&A processes. So to answer your question, the write-ups were primarily driven more by M&A related processes as opposed to tax changes.

Our next question next comes from the line of Chris York with JMP Securities.

So Ryan touched on 3 of them. So I'll switch to a couple of others. I believe, your senior loan investment in the passport, was it originated about a year ago under the Triangle 2.0 strategy. If the valuation of the mark has declined over the last 2 quarters. So could you help me understand or describe some of the inputs driving the deterioration? And what was not anticipated net underwriting?

Chris, good morning. Just to recount for everyone, Passport Food's is a manufacturer of Asian and other ethnic food products, and they sell primarily through the food service and retail and club channels. This quarter, the senior debt investments is valued at 85% of cost versus 90% of cost last quarter. The primary driver of the decline in performance was the unexpected loss in Q3 of the companies key product line. And that loss resulted in lower sales and contributed to the performance decline. Since that time, they have revamped their business plan. They have a pipeline that's robust for new customers and products, but that shift is going to take a little bit of time in order to rebuild the lost sales related to the key product line that was lost. So we still believe in the company long-term. We believe operational performance will improve, but the write-down was based on the slight delay in the expected improved performance.

Got it. Last question from me, over the last couple of years, you have received management and other fees from SRC. Do you expect to receive these fees going forward as a result of the SPZ with CRS?

Chris, it's Steven. At this point, there is not anything that we see with the -- with company that would change that view, obviously, your question is very future-looking. So I hope you will forgive us if we -- sorry, we can't foretell what may happen in ultimate quarters. But right now, we -- that's our consistent fee.

Our next question is from the line of Robert Dodd with Raymond James.

First one, you're probably not going to -- want to answer about the process -- I mean, you did declare a schedule in your Annual General Meeting for 2nd of May. Is that -- do you have any reasonable expectations? Are you going to be able to give shareholders a more thorough update on the strategic review process by that date?

Robert, it's Steven. As I'm sure, you know, and appreciate '40 Act companies have to declare their annual meeting within a certain number of days from year-end, and so that's the time we've always had our meeting and so we, in the normal course, which is how the company, per Ashton's comments earlier, is operated. Have scheduled that meeting, and we look forward to posting that meeting. And as we said in prepared remarks, we can't make any comment on the strategic process. But when there's something to announce at the conclusion of it, we will announce what we can.

Got it. On the portfolio, obviously, you said some markdowns on the nonaccruals, I don't (inaudible) any great, great shocks there. Two that -- you mentioned on markdowns on other nonaccrual assets of that $5.7 million some of that was PCX, some of that was Technology Crops and a couple of others. Those 2 were already, what I would lump in, I mean, there were marked below 80% of cost last quarter, obviously, they've come down a little bit more this quarter. When you talked about the nonaccruals, obviously, the marks were for the nonaccruals so company specific issues for PCX, Technology Crops they were already having issues? Have those issues deteriorated even further? And any visibility on a probability that those issues could continue to accelerate and potentially become an incremental nonaccrual?

Robert, it's Ashton. Let me start with PCX quickly just as a quick reminder, they manufacturer close tolerance aerospace components that are used in military and civilian aircraft. This is a 2014 investment for us. It's valued at 72% this quarter versus 79% last quarter. The one thing of note here is that the company completed a debt recap in the first quarter of 2018, and fundamentals behind the company are actually much improved. The primary driver of the write-down this quarter was an adjustment of our interest rate as part of an all-encompassing recap of the company. And so it was a reduction in our interest rate from 10.5% down to 6% that was the primary driver of the write-down this quarter. So, I think, from where we sit, we feel very encouraged by the progress of the company and the backlog of the company and the overall environment for defense spending. So I think again, the key driver of the write-down was the interest rate reduction.

Got it. And then -- got it, right

Robert, I'm just going to say on Technology Crops that you mentioned as well is -- you know that was a 2009, investment (inaudible) for us. Last quarter, I think it was valued at 77% of cost, this quarter 70% of cost, so it's a write-down of about $800,000. Based on our restructuring at the company, we amended our sub-debt terms, and we have reduced our -- I think our rate was 12 and 5 -- 5% PIK, 12% cash to just simply 12% cash. So here again, there's no real change in the operations of the company. We just -- similar to PCX, we -- given the lower economics we are receiving, that mathematically produced a write-down.

Got it. And then one last one if I can, obviously, Ashton, you addressed it in response to an earlier question that your relationships with the private equity community continue. But when we look at the -- how am I -- if any, how much of the lower level of origination in the fourth quarter, could you allocate, and obviously, it's a competitive market and quarters are choppy. But is there any allocation of that, that could be pointed to say as a result of, the lack of better term, management distraction, you've had another large project with a review for everybody on ongoing during that process. Has that reduced the amount of time available for management and originators to get out and make calls, press the flesh, so to speak and originate deals?

Robert, just with respect to -- I think you said a lower level of originations in Q4 of 2017. I would just point out, if you did say that, I guess, I would, respectfully, disagree with that characterization. At $92 million, that's very consistent with previous quarters in which the typical level of origination, that's very much in line with how we've originated in the past. So I'd say, we're very proud of the level of originations that we had in the quarter and its, again, a reflection of our relationships.

Certainly, the process -- the strategic processes has taken management time, but we've been very disciplined and focused on our outreach in our origination efforts, and again, I would just say that our touch points, our flow, and our level of dialogue with our financial sponsor community has never been stronger as you can imagine. We're being very proactive in reaching out to our sponsor network and ensuring that we stay in their flow, and we stay top-of-line.

Our next question comes from the line of Jonathan Bock with Wells Fargo Securities.

Joe Mazzoli filling in on for John Bock. So the first question is a 2-part question. So we see about $191 million of cash on the balance sheet as of 12/31. So is this deleveraging part of the strategic review in terms of just increasing optionality? And then also, I guess, we would assume that you'd use this cash to pay down the credit facility?

Joe, it's Steven. Thank you for your question. The amount of cash we have on the balance sheet at year-end is in no way related to anything particular to the board's review of strategic alternatives. It's just the timing differences, sometimes it's associated when you have more repayment than investments. And to the part of your question why the senior credit facility hasn't been paid down with that cash is, I'm sure, you can appreciate with your knowledge of the company that some majority of this cash is held at our SBIC funds. And so less of it is held at the, what we would call, the holy company where the credit facility legally is. And the credit facility with the unused fee that, as I'm sure you're aware the credit facility has in it even if we were to pay down -- we're sort of -- we pay down effectively the mathematical breakeven. So we technically could pay it down a little more, but it wouldn't necessarily be to our benefit given the terms of it. The holding company does have a little bit more cash, but it's not considerably more, most of the cash is held at the funds. Hope that helps.

That does, that totally makes sense. And the next question is, so the stock is trading at about 0.8x price to net asset value and Triangle Capital has historically, certainly managed the balance sheet in ways that have been very accretive for shareholders by issuing above net asset value and stock repurchases at these levels would, of course, also be highly accretive to net asset value. Now we understand that the effective shareholder-owned management contract becomes less valuable if there were less assets, but, kind of, for more traditional M&A, higher NAV per share through repurchases that would be a higher purchase price. So what are your thoughts on stock repurchases at this point? And of course, is -- there's a number of different scenarios under the strategic review where stock repurchases could add value?

Joe, I appreciate your question, while not differing with anything from a mathematical computation standpoint that you might have raised. It's a fairly simple matter from a legal standpoint, and we discussed this a bit on the third quarter call that our board is involved with, and therefore, the company, with review of strategic alternatives, for the company to be in the market buying its own stock, while at the same time, it is perhaps aware of material nonpublic information. I am sure you can understand the conflict that, that would create. And that's not something that we as a management team, nor our board would be comfortable with, and so any of this -- everything you allude to, frankly, it's just not possible right now from our standpoint. And so any of that type of activity would not occur until after we hit -- concluded the board has concluded its review of strategic alternatives.

Understand, understand. That's helpful. And then just one final question. The combined fair value of CRS increased from about $8 million to $20 million and it looks like this investment was restructured. I'm just curious, what led to the fair value improvement?

It's really 2 things. Number 1, during the fourth quarter, there were incremental investments made, so that accounts for a portion of the change. Number 2, when the company -- when CRS emerged from bankruptcy than we had a third-party valuation firm to a fresh start accounting analysis, which was helpful to our board in establishing valuation of that single asset. And then during the fourth quarter, CRS Reprocessing, LLC was merged with SRC, another portfolio company. And so what you're seeing in the fourth quarter is the combination of both of those values.

And our next question comes from the line of Christopher Testa with National Securities.

Just curious, how much of the problem assets, meaning, anything that's been written off as well as the current nonaccruals are within the SBIC?

Chris, it's Steven. I don't have that breakdown in front of me. So we can follow-up after the call with you, if you'd would like.

Okay, that's fair. And just touching on Joe's question about your leverage position a little bit. I'm just curious, obviously, with you guys below book and not able to really issue equity, how comfortable you would be in the current environment taking up total debt to equity?

Well, given the amount of cash we're sitting on right now, I don't think we're in the market to do anything from a leverage standpoint. We obviously, as you know, have from the prepared remarks, well north of $500 million of liquidity. So liquidity is not really an issue. We've got committed debt facility, a senior credit facility. We have the third SBIC license and a good partnership with the SBA. So we're really in good stead there right now.

Okay, got it. And can you quantify how much of TCAP 1.0 of cost is remaining and of this how much is already been written off?

Chris, I'm sorry to say, we don't have that page in front of us. But we, again, like your other question, we can follow-up with you off-line. I think a little more than 50% of the portfolio has been -- has shifted, if you will, into what we refer to as TCAP 2.0. But again to give you the exact write-down, we'll follow-up off-line.

Okay, no problem. And last one from me, just given you guys, obviously, have a lot of subordinating second lien on the book. With tax reform -- how much of your portfolio is leveraged enough that the loss of interest deductibility will offset any decrease in rates where we could see cash taxes actually increase?

Chris, given the recent passage of the tax law and with our individual portfolio of companies, that analysis has not been completed. But from a total standpoint of the portfolio, we're -- we don't believe there's, based on where our leverage point is, regardless of whether we're a unitranche, a second lien or a mezzanine position, we don't perceive that to be really much of a change when you net it all out.

And our next question from the line of Mark Drucker with Jefferies.

Any additional color you can share on new issued loan yields by category?

Mark, I'm sorry your question broke up on the line there.

Okay, no problem. So you shared 9.9% on new debt investments the average yield. I was wondering, can you share anything in addition to that in terms of yield by category?

Well, investments made during the quarter, you're just asking, are they what do they range between? Or you asking what type of securities where invested in first lien or second lien or?

Oh no, no, no, the yield specifically. So by category what were the yields in relation to where the portfolio stands today during the quarter?

I think very consistent with the overall portfolio. The -- what in the first quarter -- I mean, sorry, the fourth quarter..

Just typical, I mean in general, Mark, to answer your question for the Q4 investments, the unitranche investments would have been made around the call it, 7.5% to 8.5%, kind of debt way. If you will, the second liens would have been in the, call it, 8% to 10% range for those investments. Does that help?

Yes, it does. Thank you. Last question from me. Any insight you can share on prepayment and repayment trends over the next couple of quarters? I know it's difficult to predict.

It's really -- it's impossible to predict, unfortunately. We have elevated repayments in the fourth quarter. But if you were to get back and look at the company on a quarter-to-quarter basis, then you would see that it really does jump, it jumps around -- we had -- the last 2 quarters of 2017, we were in the third quarter $131 million or so in repayments and closer to about $143 million or so, including equity realizations. But then in the second quarter, we were at $35 million in the first quarter, we're at -- between $53 million and $54 million. And as you know, we announced or we said in the prepared remarks $171.9 million in the fourth quarter. So it really does, sort of, go in waves, and you just can't really predict one way or the other, unfortunately.

Well, we’re showing no further question. So Bridget, thank you for the call, and will conclude at this time.

Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone, have a wonderful day.