BCP Investment Corp (BCIC) 2011 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Kohlberg Capital Corporation first quarter 2011 earnings conference call. An earnings press release was distributed earlier today Friday, May 6, 2011. If you did not receive a copy, the release is available on the Company's website at www.kohlbergcapital.com in the Investor Relations section.

At this time all participants are in a listen-only mode. Following today's presentation instructions will be given for the Question and Answer Session.

(Operator Instructions)

As a reminder, this conference is being recorded today, Friday, May 6, 2011. This call is also being hosted on a live webcast which can be accessed at our Company's website www.kohlbergcapital.com in the Investor Relations section under Events. In addition, if you would like to be added to the Company's distribution list for news, events, including earnings releases, please contact Denise Rodriguez at 212-455-8300.

At this time Management would like to inform you that certain statements made during this conference call, which are not historical, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Although Kohlberg Capital Corporation believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, it can give no assurance that these expectations will be attained. Factors and risks such as those described in the risk factors section of our 10-K and sections of our Forms 10-Q and other SEC documents filed during the course of the year could cause actual results to differ materially from expectations.

Now at this time for opening remarks I would like to introduce Chris Lacovara, Chairman. Chris, go ahead, please.

Thanks very much. Thank you all for joining Kohlberg Capital for a review of the Company's first quarter 2011 financial results. I will open the call with some broad commentary about our activities during the quarter, as well as our financial performance. I will then turn the call over to Dayl Pearson, our Chief Executive Officer, who will discuss our investment portfolio in more detail. After that, our Chief Financial Officer, Mike Wirth, will provide a recap of our first quarter financial results and performance. We will then open the lineup for your questions at the end of the call.

Before I cover the financial details, a couple of reminders. First, as we noted in our year-end earnings call, we repaid in full the outstanding balance of our secured credit facility on January 31, 2011. As a result of our pay off of this facility, approximately $73 million of collateral previously securing the facility was released to us. In addition, we also received a settlement payment of $2 million from the lenders which we recognized in the first quarter of 2011.

Also, in mid-March we issued $60 million in convertible notes. With the issuance of these convertible notes and as we move forward into 2011, we will also continue to evaluate our equity and debt financing options which will allow us to focus on balance sheet growth.

Let me now present some first quarter financial metrics and commentary. On March 31, 2011, our NAV per share was $8.64. For the three months ended March 31, 2011, net investment income was $0.22 per share as compared to $0.11 per share for the first quarter of 2010. The Company declared a dividend of $0.17 for the first quarter of 2011.

For the three months ended March 31, 2011, KCAP had $7.3 million of total income as compared to total income of $7 million for the first quarter of 2010. The increase in the Company's investment income is primarily due to the recognition and receipt of a $2 million settlement payment from our prior lenders. Partially offsetting the overall positive impact on net investment income was the fact that as per GAAP we recognized much of our annual audit expense in the first quarter instead of accruing those expenses ratably over the entire year. As well as the occurrence of additional accounting related fees related to our recent convertible debt issuance. This increase is also offset by a reduction in the interest income generated by our loan portfolio which had much smaller average balances as a result of paying off our secured lending facility in the first quarter of 2011.

Although Katonah Debt Advisors had earnings for the quarter, no dividend was paid up to the Company from KDA. However, it is anticipated that such distributions will be made later this year to Kohlberg Capital. Our KDA managed CLOs continue to perform well with quarter-over-quarter increases in their distributions to us.

The KDA managed CLO funds are benefiting on two fronts. First, as an income producing investment for KCAP. And, second, as fee generating income producer for Katonah Debt Advisors, our wholly-owned asset manager.

All KDA managed CLO funds continue to make their distributions to the junior securities we hold as investments. And all senior and subordinated management fees are being paid to KDA on a current basis. The management fee stream paid to KDA is based on the par value of the assets managed and thus provides a relatively stable income street not subject to potential volatility in the market prices of the underlying assets being managed. This stable income stream allows KDA to make periodic distributions to KCAP in the form of a dividend. As of March 31, 2011, KDA had approximately $1.9 billion of assets under management.

Dayl and Mike will elaborate further on some of my comments. And now I would like to turn the call over to Dayl, our President and Chief Executive Officer. Dayl?

Thank you, Chris.

I will start with highlights for the quarter and then review our portfolio of middle market corporate loans and equity and our new origination activity. First, there was a complete repayment of our secured credit facility and the settlement of the related lawsuit that we had brought against our lenders. Second, the repayment was followed a month and-a-half later by our issuance of unsecured convertible notes, as Chris mentioned.

By the time we reached the settlement with our lenders on September 10, 2010, to resolve the litigation we initiated against them, the outstanding balance of the facility had already been reduced to $137 million, mostly through repayments of loans at or above par. Over the course of the fourth quarter of last year and into this January, we had repayments or made asset sales that completely paid off the facility, and this had less than a 2% impact on our net asset value. As a result of our activities and paying off the secured credit facility, we had the opportunity to sell some lower yielding assets which resulted in an increase in our net spread. We continue to see repayment of lower yielding assets at par which allow us to further increase our net spread as we invest these proceeds in higher yielding assets going forward.

In March, we issued $60 million of convertible notes with a 5-year term and a fixed rate of 8.75%. The proceeds from the issuance of these notes will primarily be invested in mezzanine and other junior securities, which will further increase our net spread and be accretive to our NAV. I should mention that we were reluctant to invest a significant portion of our balance sheet in mezzanine securities in 2007 and 2008 due to what we believed were excessive leverage multiples based upon, in many cases, inflated EBITDA levels due to the strong economy.

Today, both leverage multiples and EBITDA levels are lower, and therefore we believe the risk return profile of middle market mezzanine is more attractive. As always, we will continue to be focused on credit quality and will manage and monitor our risk appropriately.

As of March 31, 2011, the weighted average yield on par of our income producing loan and bond portfolio was approximately 8.7% compared to 8.6% at the end of the year. The yield on our loan and bond portfolio, coupled with our overall CLO portfolio that is yielding over 20% on fair value, provides reasonable net interest spread before factoring in any distributions that may be made from Katonah Debt Advisors. Our two largest CLO fund investments, Katonah 10 and Katonah 2007-1, represent 78% of our total CLO investments and 88% of KDA managed CLOs. And they are currently yielding an average return of 23% on fair value.

Our valuation process, as it always has, focuses, first, on the attributes of the subject asset, the credit quality, performance, industry, and other unique characteristics of the investments. We also factor in the present value of future cash flows from each investment, as well as other market factors. Our valuation approach is unchanged from previous quarters.

As a result, the fair value of our portfolio more closely tracks to broader market yields for high yield and leveraged loans. As of March 31, 2011, our weighted average mark on our debt securities portfolio remained unchanged at 70 as compared to year end. As far as CLO portfolio, our weighted average mark was 75, a slight increase from the 74 weighted average mark of December 31.

CLO equity positions in our CLO investments rarely trade -- or trade privately, and thus it is typically difficult to obtain a market rate indicator for these positions. As a result, we establish a fair value using a discounted cash flow valuation model using market inputs. Again, this policy is unchanged from previous quarters.

Our 100% ownership of KDA was valued at approximately $42 million based upon its assets under management and prospective cash flows at March 31, 2011. Our total investment portfolio at the end of the quarter was $194 million.

Looking at the composition of our investment portfolio, our portfolio continues to hold up well. At the end of the first quarter our debt securities totaled approximately $88 million and represented 45% of the investment portfolio. With our secured lending facility now paid off, our portfolio balance is more heavily weighted to second lien and mezzanine investments, which we deem appropriate, especially given the current more conservative nature of the debt markets we participate in. As a result, secured first lien loans now represent 26% of debt securities and second lien loans now represent 68%. Approximately 3.9% of our investments are fixed rate investments which yield approximately 10.4%.

At March 31 we had four issuers on non-accrual status, representing less than 1% of total assets. Subsequent to quarter end we have learned that an auction process for one of those names will most likely yield a significant cash payment to the lenders which should be well above the current fair market value. We have been told that a payment will be made by the end of the second quarter, but we will not recognize any increase in fair market value until the payment is actually received.

Following our issuance of senior unsecured convertible notes in mid-March, we had approximately $71 million of cash as of March 31 which will be primarily used to fund future investments. By quarter end, investments representing over 20% of the net proceeds of the convertible debt issuance have been identified, which will reduce this cash balance in favor of interest earning assets.

Subsequent to quarter end we funded an additional $18 million in new investments spread over 3 new portfolio companies. In addition, we have a healthy pipeline of new mezzanine and unitranche loans, including a signed term sheet for $10 million and outstanding proposals for an additional $25 million. Given the highly competitive environment and our rigorous credit process, there is no guarantee that any of these potential new deals will materialize.

Now I will ask Mike to walk through the details of our financial performance. Mike.

Thank you Dayl. Good morning, everyone --rather good afternoon, everyone.

For the quarter ended March 31, 2011, we reported net investment income of approximately $5 million or $0.22 per share compared to approximately $2.6 million or $0.11 per share for the first quarter of 2010. Our total investment income for the quarter ended March 31, 2011, was approximately $7.3 million as compared to approximately $7 million for the same 2010 period.

In the first quarter of this year, when we repaid in full our secured credit facility, we recognized the receipt of a $2 million settlement against our prior lenders. Offsetting that $2 million settlement income is a reduction in investment income for a middle market loan investment portfolio, primarily due to lower average investment balances on which interest is earned.

The decrease in average loan investment balances between the two first quarter periods -- i.e., 2011 and 2010 -- is a result of the sale, prepayment and amortization of such investments during the intervening year. Rather than reinvest those proceeds, they were primarily used to fully repay on January 31, 2011, the outstanding balance of our secured credit facility which had a balance of $218 million at the beginning of 2010. As a result, our portfolio of loan investment assets at March 31, 2011, was $88 million as compared to $276 million a year earlier.

For the three months ended March 31, 2011 and 2010, approximately $3 million and $2 million of investment income, respectively, was attributed to dividends earned on CLO equity investments. The increase in income attributed to dividends earned on CLO equity investments is due to the enhanced financial performance of such investments and their resultant distributions to us.

Last year at March 31, 2010, approximately 19% of our total CLO fund securities at fair value made no distributions to us. In the first quarter of 2011, nearly 100% of the total CLO fund securities we own are making distributions to us. Given that our CLO portfolio has an average remaining term of 8 years, we expect to continue receiving significant equity distributions from our CLO investments for many more years.

Katonah Debt Advisors made no dividend distributions to us in the first quarter of this year. And as Chris had mentioned, we expect the KDA to make some regular distributions, as needed, during the remainder of 2011.

Expenses for the quarter ended March 31, 2011, totaled approximately $2.3 million as compared to approximately $4.4 million in 2010. The decrease in expenses for the first quarter of 2011 relative to 2010 is due to a significant decrease in interest expense due to lower average outstanding borrowings, and the fact that we were fully unlevered for approximately half of the 2011 first quarter.

Non-interest expense for the first quarter of 2011 was approximately $2 million which is approximately $300,000 higher than compared to the first quarter of last year. This increase is primarily due to an increase in professional fees for accounting services related to our recent unsecured convertible debt offering, which cannot be capitalized. And also a third-party advisory service for strategic analysis of debt and equity alternatives during the quarter.

Realized losses of approximately $1.8 million or $0.08 per share were recognized for the 3 months ended March 31, 2011, primarily due to the sale or settlement of certain assets below their original cost. These realized losses are offset by unrealized gains of approximately $6.4 million, which reflect the continued recovery at fair values across our investment portfolio.

I will now move onto recap and discuss our balance sheet. At March 31, 2011, our total investment portfolio of $194 million represented approximately 72% of total assets, with cash of nearly $71 million making up most of the difference. Our liabilities consist of $60 million from the convertible debt issuance, and approximately $12 million payable for open trades for purchases of investments that had not yet settled at quarter end. Convertible debt notes have a 5-year maturity and a fixed interest rate of 8.75%. These notes can convert to common shares at an initial conversion price of $8.44 which represented a 10% premium over the market price close of the stock on the date of pricing. This initial conversion price is also above our NAV determination of $8.21 as of December 31, 2010.

At the end of the first quarter our asset coverage ratio was 428%, well above the minimum 200% requirement for a BDC. Our net asset value at quarter end was $197.2 million or $8.64 per share. At March 31, 2011, we had accumulated undistributed net investment income of $5.8 million, or approximately $0.26 per share, a portion of which represents the first-quarter dividend declaration of $0.17 per share which was paid on April 29, 2011 to shareholders of record on April 8, 2011. In determining the dividend for the first quarter, considerations included the estimated quarter net income, anticipated net income for the full year, the timing and amount of interest and dividend distributions from investments, and sustainability and smoothing out of dividend over future quarters.

The aforementioned discussions on the first quarter of 2011 results were also discussed in our quarterly report on Form 10-Q which will be filed shortly and our annual reports on Form 10-Q, and our annual reports of 10-K which are available at our website www.kohlbergcapital.com or at www.sec.gov.

And with that, we would like to turn the call back over to the Operator to start the Q&A session. Operator?

(Operator Instructions)

Troy Ward with Stifel Nicolaus.

Could you talk a little bit about KDA not paying a dividend this quarter and why that business sometimes pays a dividend and sometimes it doesn't?

Sure. We look at the cash flows and the liquidity that's needed, both at KCAP and KDA. KDA, because of canned dividend distributions essentially whenever it likes to, we sometimes look at that, see what the distributions are in future quarters and to somewhat smooth out the dividend, if you will, so that we don't have a lot of volatility in earnings. And we can make sure that earnings essentially cover the dividend that we make in every quarter.

If you recall last year, it was very lumpy with regard to KDA because last year KDA recovered all of its subordinate management fees that had been accrued when some of the CLO funded managed cut off the subordinate fee payments in 2009. And as a result, from a GAAP perspective, that income is still accrued at KDA because it was highly reasonable and highly probable that those fees would be recovered from the CLOs. But from a cash flow perspective KDA didn't have the cash flow to make any dividends in 2009.

A lot of that was caught up during the course of 2010 when those subordinate management fees did come in cash, and KDA was pretty flush with cash. KDA had earnings for last quarter. It had cash to make a distribution, but it was decided not to have a distribution made up to the parent company.

Great. That's great color.

I believe last time you talked about KDA can typically generate $2.5 million to $3 million a quarter. Is that still a reasonable run rate for that business?

That's a year, not a quarter.

I apologize, yes, a year.

Of revenue? Are you talking about revenue or cash distributions?

I am sorry, I misspoke. Cash distributions on an annualized basis of $2.5 million to $3 million.

Annualized basis, yes, probably.

$2 million to $2.5 million.

Okay, great. And can you talk about, as you're now starting up your originations -- first, what cash level do you need to keep at the holding company and look at what dry powder do you have to make new investments? And then can you talk a little bit about what you're seeing in the origination pipeline for your business?

Sure. We still do have a lot of liquid assets, so I think it is a combination of liquid assets and cash. And I think we want to have $20 million to $25 million of more liquid assets in cash at KCAP. Again, there is the ability to continue to upstream from KDA as well, so that's a rough number, but I think we would like to have the proceeds of the offering fairly reasonably invested. Some of that may be in liquid assets.

In addition we're continuing to get repayments and so liquidity really is not an issue for us, certainly at this point, and we don't foresee it this year.

In terms of originations, I think the middle market, we're looking at some data today, and using loan volume as a proxy for deal volume, the large syndicate loan market recovered last year to its 10-year average in terms of new issuance. It was right at its 10-year average for the last 10 years. The middle market was at 40% of its 10-year average last year. So the middle market really is much slower to recover in terms of new deal volume.

In the first quarter of this year, essentially it did 40% of what it did last year. So you're definitely starting to see deal volume pick up. We're seeing a lot of flow, some of it very good, some of it not so good. We're continuing to be very careful, but we are putting money to work. We do have a lot in the pipeline.

And pricing -- is there some pressure on pricing? Less pressure on structure yes, but no pricing pressure. But it is still that, for the mezzanine, minimum of 12% cash return. For the unitranche, that's more in the 10% to 11% cash return. But with opportunities for equity co-investments, in some cases warrants, which obviously have some significant future upside potential.

Great. One quick modeling question. You talked about audit fees and professional fees higher this quarter. What should we think about as a normalized run rate for those?

We had audit fees -- you can't accrue audit fees ratably over the course of the year. You actually have to expense them as they're actually incurred. So we base that on the progress billings that we get from our auditors. So you will see the bulk of the audit fees essentially come in, in the fourth quarter. And then I don't know if it is 50/50, but fourth quarter and the first quarter.

You will have ongoing fees for the quarterly reviews which will be significantly less, so you will see audit fees dropping or accounting related fees dropping in the second and third quarters. The accounting related fees related to the recent convertible debt issuance -- some of the costs of issuing that debt can be capitalized and amortized over the life of the deal. Accounting fees do not fall into that bucket, so that's an expense in the quarter that those are incurred. So that was a fairly significant increase.

Putting it in cents per share, it is probably $0.01 to $0.02 a share higher in the first quarter.

Yes, that's probably about right, yes.

Charlie Tris with Tiburon Capital.

Quick question. Where are you in the approval process with respect to the SBA, if you're at all got a timetable that you can tell the shareholders

And then the second question is, there was some talk in the press release that you're exploring other capital raising opportunities which includes potentially pref shares, credit facility, as well as this SBA. Can you comment a little bit of what direction or what right now management is working with respect to new capital initiatives?

We haven't really spoken at all about the SBA or SBIC process. It is something we have looked at internally, but this is not something we have discussed publicly. Nothing regarding preferred shares either. So I am a little confused by the question.

They're, within the press release, saying that such financing arrangements may include a secured credit facility, the issuance of [cash] secured So I am just more referring to the open-ended paragraph that you have in your press release.

We're going to look at all types of capital raising activities. And I think we're going to be very careful, as we have been in the past, about raising new capital. And we're going to do what we think is best for the shareholders in terms of that.

I think, as you can imagine, given our experience with senior secured credit facilities in 2009 and 2010, the board is very careful and judicious in terms of how much leverage we will put on it in a senior secured facility with short triggers and et cetera. So we're going to be very careful in assessing that. Obviously, from a cost of capital perspective it is attractive but it can end up being very expensive, as we found out.

So we're going to look at all of those avenues. So I wouldn't want to really handicap it at this point because it is a decision the board is going to have to make. And right now, given the fact that we have a lot of cash, and we have to deploy a significant portion of that cash, I don't think that we have any great need to pursue those avenues.

(Operator Instructions)

Our next question comes from Troy Ward.

Great, thank you. One quick follow-up. With the convertible debt, what accounting methodology do you plan on using for that -- net sure settlement or if-converted basis?

It would be on an if-converted basis. We do not have the option to redeem in cash or shares. So it would be on an if-converted basis. So that will give some funky earnings per share on a diluted basis going forward which everybody should understand a little bit better.

I am not showing any other questions in the queue at this time.

Okay. Then we'll wrap up. We appreciate you all joining us for the call and we look forward to talking with you next quarter.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.