BlackRock Capital Investment Corp (BKCC) 2007 Q3 法說會逐字稿

Good afternoon. My name is Cara and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Blackrock Kelso Capital Corporation Investor Teleconference. Our host for today's call will be Chairman and Chief Executive Officer, James R. Maher; Chief Operating Officer, Michael B. Lazar, Chief Financial Officer, Frank D. Gordon; and Chief Compliance Officer, Vincent B. Tritto.

(OPERATOR INSTRUCTIONS.)

Mr. Maher, you may begin your conference.

Thank you, and welcome to the Blackrock Kelso Capital Corporation's Third Quarter 2007 Earnings Conference Call. I am joined today by Mike Lazar, our Chief Operating Office; Frank Gordon, our Chief Financial Officer; and Vincent Tritto, our Chief Compliance Officer. We will begin by having Vinny talk about some general conference call information, including forward-looking statements.

Thank you, Jim. Before we begin our remarks today, I would like to point out that during the course of this conference call we may make a number of forward-looking statements. We call your attention to the fact that Blackrock Kelso Capital's actual results may differ from these statements. As you know, Blackrock Kelso Capital has filed with the SEC reports which list some of the factors which may cause Blackrock Kelso Capital's results to differ materially from these statements. Finally, Blackrock Kelso Capital assumes no duty to update any forward-looking statements.

I would now like to turn the call back over to Jim.

Thank you. We are delighted to have the opportunity to speak with you this afternoon. As most of you know, Blackrock Kelso Capital is a business development company that was initially funded in the summer of 2005 with a private capital raise of approximately $530 million. We founded Blackrock Kelso Capital with our partners at Blackrock and the principals at Kelso in 2004. Our goal is to provide debt and equity capital to middle market companies.

We are pleased with our third quarter results. We continue to develop on our goals of becoming a premier provider of capital to middle market companies and providing an attractive return to our stockholders. Since our inception in July 2005, we've built a strong team of investment professionals - 18 today, an extensive outreach program to access middle market companies, and a well-diversified investment portfolio of $1.1 billion in assets. On average, the coupon bearing securities in that portfolio have delivered an annualized yield in excess of 12.5% year to date.

We view the recent turbulence in the credit markets as an opportunity for Blackrock Kelso Capital to apply our thorough investment selection process to enhance the risk adjusted returns of our investment portfolio. As you know, as a business development company our balance sheet leverage is limited to 1-to-1 and Blackrock Kelso Capital had balance sheet leverage of less than .5-to-1 on September 30. We do not and will not make any mortgage or real estate loans and do not own any CDOs or CLO securities.

We closed our initial public offering at 10 million shares of common stock on July 2. That offering raised $150 million net to Blackrock Kelso Capital. Yesterday, our Board of Directors declared a third quarter dividend of $0.43 a share. This dividend will be paid on December 31 and represents an 11.9% annualized yield on our net asset value and over 13% based on yesterday's closing price. Our dividends are derived from our taxable income. Third quarter net investment income was $0.44 a share, and Mike and Frank will discuss more of our financial results shortly.

We continue to be pleased with the investment opportunities that have resulted from our outreach program. As a result of these efforts, we invested $124 million in seven investments with new and existing relationships during the third quarter. We examined some 130 investment opportunities during the quarter and nearly 1,000 since our initial funding in 2005. We attribute our success to our terrific investment team. We are particularly proud to have accomplished this during a quarter that was characterized by slowing transaction volume for sponsor-led leveraged buyouts.

Activity in the middle market, which we define as companies with EBITDA between $10 and $50 million, slowed significantly in August. It has since picked up, albeit at lower levels than earlier this year. We continue to see many opportunities and believe that the significant changes in the environment for broadly syndicated loans and public high yield debt will provide a great opportunity.

We continue to believe that senior loans, often secured by first or second liens on assets, are the best place to find high risk-adjusted rates of return in the marketplace today. On September 30, our portfolio consisted of 59 companies and was 71% invested in senior secured loans and senior notes. At the end of the third quarter, 6% of our portfolio was invested in equity securities, and of those securities more than half of our equity assets are invested in preferred rather than common equity. The remainder of our portfolio, or approximately 23%, was invested in unsecured or subordinated debt securities.

We believe that being actively involved in the due diligence and structuring of assets that we acquire provides us with a conservative portfolio. The terms of our loans in which we invest are largely different from those available when buying broadly syndicated loans from Wall Street dealers. We continue to make investments where we are able to play an active role, either as the sole or lead investor or as a member of a small club of investors. Investors made--investments made in these lead or club transactions represent approximately 70% of the assets in our portfolio as of September 30.

We opened our Chicago office during the second quarter and continue to execute our strategy of being close to where the middle market investments are created - directly with the sponsors and intermediaries engaged in the business. Further, we expect to have an operating presence on the West Coast by early next year.

Our terrific investment--our team of investment professionals continues to grow with the addition of one new Managing Director in the third quarter. Also, during the third quarter, we added a new Vice President of Finance.

We used the net proceeds of our equity offering to reduce borrowings under our revolving credit facility at the beginning of the third quarter. This capital left us with capacity for new investment opportunities in what has become an attractive investment environment. We also extended our revolving credit availability and expect to add to our borrowing capacity during the fourth quarter. Perhaps more importantly, the failure of larger commercial and investment banks to syndicate some of the larger LBO credits that they have underwritten has effectively closed that potential source of capital to the smaller companies that are our customers.

We're very pleased with the results of the third quarter and of the year-to-date. We continue to demonstrate our ability to originate and structure investments in the middle--in middle market companies. These investments produce high risk-adjusted returns with a high reoccurring yield and the opportunity for higher total return from structuring and the prepayment fees and from equity investments.

Mike Lazar will now review the quarter's investments in more detail.

Thank you, gentlemen. Thank you to everyone for joining our earnings call today. I'm pleased to report that Blackrock Kelso Capital Corporation invested a total of approximately $124 million in seven companies during the third quarter. Two of these investments involve companies with which Blackrock Kelso Capital previously completed a transaction.

Our ability to invest throughout the capital structures of middle market companies affords us the opportunity through being flexible to capture the best risk-adjusted returns available in a variety of different companies and industries. During the second quarter, six of the seven new investments made by Blackrock Kelso Capital were made in senior loans or senior notes. We made one investment in holding company debt at an attractive discount to par.

During the third quarter, we were able to take advantage of the dislocation in the larger syndicated bank credit markets. As you know, conditions in the broadly syndicated credit markets changed dramatically during the third quarter as a result in part of events in the subprime mortgage sector. The impact on the credit markets from middle market companies was muted, however, because [lead] lenders to middle market companies, such as Blackrock Kelso Capital, tend to retain rather than further distribute their credit exposure. This is contrary to the norm in the broadly syndicated markets.

Furthermore, the broadbased selling of loans that accelerated in that broadly syndicated market during the third quarter did not occur in the middle market due to the significantly smaller presence of CLO investors in that marketplace. Nonetheless, the valuations of the quoted portion of our portfolio declined during the third quarter, along with those of most other credit related investments. Slightly less than half of the dollar value of our portfolio has a dealer quote. Quotes on this portion of the portfolio were down $16.8 million. Total portfolio unrealized depreciation was approximately $20 million, or less than 2% of the portfolio.

In our view, most of the declines in the quoted loans were not based on actual trades or changes in the long term prospects of the underlying companies, but instead on dealers' relative value estimates. At quarter end, our net asset value per share was $14.51.

Despite this market dislocation, we've been able to utilize our relationships to identify quality investments with attractive risk-adjusted returns. We continue to believe that in this marketplace hard work is rewarded and our willingness and ability to roll up our sleeves affords us the opportunity to make investments with a focus on preservation of capital while earning attractive yields and returns.

Part of the total return that we generate on these investments is derived from the structuring fees that we earn on many of the investments that we make. These structuring fees are typically paid in cash at the time of a new transaction and are treated as income for tax purposes. GAAP amortizes these fees over the life of the investment, which can result in a timing difference between our net investment income and our dividends. In the third quarter, Blackrock Kelso Capital earned structuring and upfront fees equal to approximately 1.25% relative to new investments.

During the third quarter we made several significant new investments. We were able to find and capitalize on these investment opportunities as a result of our active origination program, our access to sponsors and management teams, our thorough due diligence process, and the resources of our partners at Blackrock and the principals of Kelso.

New investments included Berlin Packaging, LLC, the second largest distributor of rigid packaging in the United States. The company caters to the food and beverage, household, personal care, and healthcare markets. It benefits from large economies of scale and sourcing products, providing its customers with best pricing and on-time deliveries. Blackrock Kelso Capital provided $24 million of financing to support the acquisition of the company by Investcorp during the third quarter.

Alpha Media is one of the world's leading men's lifestyle media companies with two major magazine publications, Maxim and Blender. Blackrock Kelso Capital structured and invested $20 million in a $40 million second lien term loan in a change of control transaction led by Quadrangle.

Van Houtte is the leading gourmet coffee roaster packager and merchandiser in Canada with the number one retail coffee brand. In addition, the company is the largest coffee services provider in North America. Blackrock Kelso Capital worked with the private equity sponsor and lead senior bank lender to invest $25 million in a senior second lien loan to support the acquisition of the company by Littlejohn and Company.

During the third quarter, we were able to take advantage of the market conditions to make two portfolio investments at significant discounts to their face value. These discounts are amortized into income under both tax and GAAP accounting, and therefore are not recognized as taxable income during the third quarter. This is unlike the treatment for structuring fees earned on many of our new investments, which are taxable upon receipt.

We expensed $90.8 million of portfolio runoff during the third quarter. In the aggregate, the yield on those assets that were refinanced, repaid, or sold was approximately 10.6%, based on current LIBOR rates. While this amount of principal repayment is unusually large when compared with originations of $124 million, we are pleased that we collected prepayment and related fees and capital gains equal to more than 1.5% of par value in connection with these repayments.

The condition of our portfolio is excellent. The economy has been and remains strong and our investments are well diversified. Our largest exposures were to companies that provide business and other services to media and publishing companies and to consumer products companies. Overall, these represent--these industries represented just under half of the total portfolio at September 30.

The fair market values in our GAAP financial statements are derived by quotations for those securities that are traded, and by engaging third party valuation firms to perform valuations on all non-traded portfolio investments on a company-by-company, security-by-security basis for each investment every quarter.

The economies continued to perform well in the third quarter, as have Blackrock Kelso Capital's portfolio companies. Our current portfolio is rated 1.2 on average, using our 1-to-4 credit rating scale. We utilize this scale as an internal management tool and believe it to be quite conservative. As of September 30, 2007, we have no loans in accrual and just under two-thirds of our investments for interest at a floating rate. Our investments in 59 portfolio companies were made in 90 different securities.

At September 30, the leverage multiple for all of the debt investments across our portfolio was between 4.5 and 5 times. The media EBITDA for our portfolio companies was approximately $32 million. This level of leverage represents the highest rather than the average dollar at risk in these portfolio companies for our coupon-bearing investments. This represents lower levels of leverage and much more conservative transaction structures than have been available in the liquid credit markets and in large leveraged buyouts.

As Jim mentioned, we have capital to invest under our revolving credit facility. We borrow at LIBOR plus seven-eighths and at September 30 we had availability of more than $150 million. Our revolving credit facility, which we extended during the fourth quarter, has a total facility size of $500 million. Furthermore, we expect to increase our availability under our bank credit agreement during the fourth quarter.

The fourth quarter is off to a good start with an increasing number of attractive investment opportunities for Blackrock Kelso Capital. Middle market deal activity has regained its strength and our access to these transactions continues to increase as we add to our already established investment team and grow our outreach and marketing effort. We remain focused on finding the best risk-adjusted returns in middle market companies where we're able to play an active role in due diligence and transaction structuring.

I would now like to turn the call over the Frank Gordon to review some of the GAAP financial information for the third quarter.

Thanks, Mike, and hello, everyone. I will now take a few moments to review some of the details of our GAAP financial information for the third quarter. Investment income totaled $34.2 million and $92.4 million, respectively, for the three months and nine months ended September 30, 2007, compared to $15.1 million and $36.0 million for the three months and nine months ended September 30, 2006. The increases reflect the growth of our portfolio and the transition of the portfolio from temporary to long term investments as the portfolio was not yet fully invested in the prior periods.

Net expenses for the three months and nine months ended September 30, 2007 were $11.8 million and $38.7 million, respectively, versus $4.1 million and $8.3 million, respectively, for the corresponding periods in the prior year. Of these totals for the three and nine months ended September 30, 2007, negative $.1 million and positive $9.4 million, respectively, were performance-based incentive fees, and $5.3 million and $14.5 million, respectively, were interest and other credit facility expenses.

Performance-based incentive fees totaled $1.3 million for each of the corresponding 2006 periods and there were no interest and other credit facility expenses in those periods. Expenses net of performance-based incentive fees, interest, and other credit facility expenses, for the three and nine months ended September 30, 2007 were $6.6 million and $16.9 million, respectively. Overall, the increase in expenses was driven primarily by an increase in base management fees resulting from the growth of our portfolio, the incurrence of performance-based incentive fees, and the incurrence of borrowing costs under our credit facility.

Net investment income totaled $22.4 million and $53.7 million, or $0.44 per share and $1.23 per share, respectively, for the three and nine months ended September 30, 2007. For the corresponding periods in 2006, net investment income totaled $11.0 million and $27.7 million, or $0.30 per share and $0.76 per share, respectively.

Total net realized gains/losses for the three and nine months ended September 30, 2007 were gains of $.3 million and $.6 million, respectively, compared to a gain of $.1 million and a loss of $.1 million for the three and nine months ended September 30, 2006. For the three and nine months ended September 30, 2007, the net change in unrealized appreciation/depreciation on our investments, foreign currency translations, and cash equivalents, was depreciation of $20.2 million and $22.2 million, respectively, versus appreciation of $.3 million and $2.1 million, respectively, for the three and nine months ended September 30, 2006.

Net unrealized appreciation/deprecation was net depreciation of $20.8 million at September 30, 2007 and net appreciation of $1.4 million at September 30, 2006. For the three months and nine months ended September 30, 2007, the net increase in net assets from operations was $2.5 million and $32.1 million, or $0.05 per share and $0.74 per share, respectively, compared to $11.4 million and $29.7 million, or $0.31 per share and $0.82 per share, respectively, for the three and nine months ended September 30, 2006.

With that, I'd like to turn the call back to Jim.

Thank you, Frank. Looking forward to the fourth quarter and into 2008, we continue to be very excited about our business and about our prospects. We intend to continue to grow the successful business that we've built over the past 2.5 years. We will continue to expand our portfolio one step at a time by seeing more opportunities, by performing extensive due diligence, and by playing an active role in the structuring of the investments that we make. We will follow this up by monitoring these portfolio companies actively. We continue to focus on preservation of capital and on finding the best risk-adjusted returns throughout the capital structure of the middle market companies in which we invest.

Finally, I'd like to take the time to thank the talented investment team at Blackrock Kelso Capital and our partners at Blackrock and at Kelso for their dedication to the success of Blackrock Kelso Capital Corporation.

Will the operator now please open the call to questions?

(OPERATOR INSTRUCTIONS.) Your first question comes from the line of James Shanahan with Wachovia.

Thank you. Good afternoon.

Hi.

I have a question about the interest income line. You commented that there were unusually large prepayment and related fees - 1.5% of par on the 98 million. Did that flow through then the interest income line?

It's $90.8 million of repayments during the quarter.

Pardon me.

And that number did flow through the interest income line.

And when you say unusually large, is that the 1.5% fee or are you referring to the repayments as being unusually large?

The fees are not unusually large. Actually, it's the amount of repayments relative to new investments.

Okay, right. Got it. I was--wanted to be clear on that point.

Yes.

Just as a follow up question, it would seem in this environment that pre and repayments would likely decline. I'm wondering if you can comment on where we might see those volumes in the fourth quarter and into the first part of '08.

Yes. It's Jim Maher. I think that in the fourth quarter we're likely to see very few repayments. We don't really know of anything at the moment that's likely to be repaid and in prior quarters we have a pretty--we've had a pretty good idea of what was going to get repaid in that quarter early in the quarter. So I think you're absolutely correct that repayments will decline in the fourth quarter. And at the moment, it could be--based on the visibility of what we have today, it could be a very, very low number.

This is Mike Lazar. I would further comment that of the $90.8 million that was repaid during the quarter, a significant portion of that, approximately half actually, related to one investment where the underlying portfolio company was sold.

Okay. Thanks. I'm sure there are others. I'll get back in the queue.

Sure.

(OPERATOR INSTRUCTIONS.) Your next question comes from the line of [Joseph Ralingo] with CCM.

Hello, gentlemen. I have a quick question about the final earnings that I was reading on the news release. I'm sorry, I'm a little confused. I'm a little late on the call here. But I know it was $0.44 was the quarterly number. Is that correct?

That's correct.

And that was against expectations that--with the analysts coming in at around 42 or so?

We're not--I'm not sure what the analyst consensus was.

Okay. And then, there was another news release that it actually wound up after some items to be only $0.05. Can you explain that to me? Did I read that incorrectly?

Sure. Maybe Frank Gordon should take the first crack at the difference between the $0.05 and the $0.44.

Sure. The $0.44 represents the total net investment income from our portfolio, and that's before any changes in the market value of the investments in the portfolio. The $0.05 represents the difference due to changes in the market value of our portfolio. So the difference between $0.44 and $0.05 was due to a small amount of realized gains and the rest due to a decline in the market value on average of the investments in our portfolio.

Okay. And then, it all boils back to the net asset value number that I believe you guys had gone over earlier was about $14.51?

That's correct.

Okay. So that's after everything you just mentioned, correct, as far as the adjustments and what not at the end of the day? If you do the division and do the math, it's about 14.51 on the NAV.

That's correct.

Okay. I appreciate your time, guys. Take care.

(OPERATOR INSTRUCTIONS.) You have a follow up from the line of James Shanahan with Wachovia.

It's been a long day in this sector and perhaps everyone is asleep at the switch here. The--.

--We noticed that on the screen earlier today.

Well, I'm looking at my clock here and we have quite a bit we still have to do. So just one more quick one. I want to kind of get you on the record here regarding the outlook for the growth in the portfolio and your financing options. Michael, I know we've talked about this in the past. But one more quarter like you've had with minimal repayments, and you're going to be bumping against the limits of your credit facility with JP Morgan. What are the potential financing options that you believe are open to you today, and what should we expect in terms of funding costs for that incremental debt capacity?

Sure. This is Mike. I--as you know, since our inception we've used debt capital very much on an as needed basis, not trying to have too much--pay for too much capacity that we weren't going to use in the foreseeable future. Having said that, you're correct. We--as of 9/30 we had about $150 million available under that revolving credit facility. And we are currently in the market approaching potential bank lenders for a $300 million term loan. We launched the syndication of that about a week ago. And banks are currently working through their various processes and we would expect to have access to that capital sometime during the fourth quarter.

The pricing on that we would expect to reflect a little bit more of the current market conditions, rather than the seven-eighths over LIBOR that we pay on the revolver. And we're currently expecting that that will be priced at 150 basis points over LIBOR for the term loan.

Well, that's a lot of terrific color. Thanks very much, and thanks for holding the call.

Okay.

(OPERATOR INSTRUCTIONS.) I'm showing no questions at this time, sir.

Well, thank you all very much. We appreciate it. And if you have any further questions, feel free to give Frank a call. Thank you. Goodbye.

This concludes today's conference call. You may now disconnect.