BlackRock Capital Investment Corp (BKCC) 2008 Q2 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 and Chief Financial Officer Frank D. Gordon.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. [OPERATOR INSTRUCTIONS]

Mr. Maher, you may begin the conference.

Thank you, Cara and I'd like welcome everybody to our second quarter conference call. As Cara mentioned, I'm joined by Mike Lazar, our Chief Operating Officer, and Frank Gordon, our Chief Financial Officer.

We will begin by having Frank 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 to your attention 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.

Yes, thanks, Frank.

We're delighted to have the opportunity to speak with you this afternoon. We're pleased with our second quarter. We continue to deliver on our goals of becoming a premier provider of capital to middle-market companies and providing attractive returns to our stockholders.

Since our inception in July of 2005, we've built a strong team of investment professionals and an extensive outreach program to access middle-market companies. Today, we have a well diversified investment portfolio of more than $1.1 billion in assets. And at the quarter end, the weighted average yield on our invested capital was 11.3%.

While the second quarter was certainly another difficult one for the credit markets and for financial service companies, BlackRock Kelso Capital completed another solid quarter. We continued to utilize our direct sourcing model and high credit underwriting standards to structure sound investments in middle-market companies. Since our inception, we've invested in excess of $1.8 -- $1.7 billion across more than 100 portfolio companies.

We continue to view the turbulence in the credit markets as an opportunity for BlackRock Kelso Capital to enhance the risk-adjusted returns of our investment portfolio. As a business development company, our balance sheet leverage is limited, as you know, to 1.0 to 1.0. And BlackRock Kelso Capital had balance sheet leverage of approximately 0.7 to 1 on June 30th.

Again, I don't know that we have to remind you of this, but I'd like to point out that we do not make, have not made any mortgage or real estate loans and do not own any CDOs or CLO securities.

Earlier today, our Board of Directors declared a third quarter dividend of $0.43 a share. This dividend will be paid on September 30th and represents a 14% annualized yield on our net asset value and over 18% based on yesterday's closing price.

Net investment income for the second quarter was $0.44 a share.

Generally, valuations of our portfolio investments stabilized in the second quarter. Our net asset value stood at $12.31 on June 30th, which represents a decrease in AV per share of $0.29 from March 31st, approximately $0.09 of that diminution is a direct result of the high rate of the participation in our [Grip Plan]. Our shareholders purchased more than 1.3 million shares at less than $9.00 per share on June 30th. Now, 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 direct calling effort. As a result of this effort, we invested $80 million during the second quarter. We examined approximately 100 investment opportunities during the quarter and have examined well over 1,200, since our initial funding in July of 2005.

We attribute our success to our terrific investment team. We are particularly proud to have accomplished this during a quarter that had exhibited extremely low overall transaction volume for sponsor-led leveraged buyouts.

During the second quarter, the credit markets were generally characterized by continued instability. While transaction volume and activity in the middle market remains significantly slower than it was at this time last year, we continue to see many opportunities today that are of higher quality.

We believe the changes in the environment for syndicated loans and public high yield debt, which remain at suppressed levels of activity and valuation, have reduced opportunities for higher returns at reduced leverage.

For the first half of 2008, debt multiples for larger LBOs dropped from 4.7 times to 6 -- from -- dropped to 4.7 times from 6.2 times in 2007, while equity grew to represent an historic level of approximately 44% of LBO deal capitalization. This environment continues to provide a great opportunity for BlackRock Kelso Capital.

Our underwriting process is focused on investments in low capital intensive, high free cash flow businesses. Our transactions are structured based on our underwriting credit cases, which factor in the effects of recessionary environments on each of the company's cash flow forecasts.

We believe that being actively involved in the due diligence construction of the assets that we acquire provide us with a very conservative portfolio. The terms of the loans in which we invest are conservatively constructed with adequate covenants, security and other protections. We continue to make investments we're able to play an active role either as the sole or lead investment or as a member of a small club of investors. We pay very close attention to the level of involvement and commitment of the financial sponsors with whom we do business. Investments made in these negotiated lead and club transactions represent more than 70% of the assets in our portfolio today.

We continue to make progress in our efforts to match our floating rate assets more closely with our floating rate bank debt funding. As of June 30th, more than half of our debt investments bore interest at fixed rates, despite being comprised of more than 50% senior secured loans. This compares to 60% of our debt investments bearing floating rate interest at the end of 2007.

More than 85% of the capital that we invested during the second quarter was invested in fixed-rate securities.

We're pleased with our results of the second quarter. We continue to demonstrate our ability to originate, to structure investments in middle-market companies that produce high, risk-adjusted returns. We are pleased with the performance of our portfolio investments and in particular with the financial support that certain sponsors have committed to the companies that have found themselves in difficult situations.

Mike Lazar will now review our portfolio and investment activity in more detail.

Thank you, Jim, and thank you, everyone, for joining our earnings conference call today.

I'm pleased to report that BlackRock Kelso Capital invested a total of approximately $80 million in five companies during the second quarter. Three of these investments involve companies with which BlackRock Kelso Capital had previously completed a transaction. New investments included $15 million in a fixed-rate senior loan to a sponsored buyout in the healthcare sector, a $10 million floating-rate senior loan to a leading provider of inorganic and specialty chemicals at a significant purchase discount and $15 million of fixed-rate, first-lien debt to a Canadian retailer of consumer staples.

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. In the current market environment, we are finding that by being selective, we're able to make new investments not only at higher yields, but also at lower levels of leverage.

We believe that our portfolio is well positioned for the current economic environment. On June 30th, our net portfolio consisted of 64 companies and was 60% invested in senior secured loans and 5% invested in senior notes. At the end of the second quarter, only 4% of our portfolio is invested in equity securities. The remainder of the portfolio or approximately 31% was invested in unsecured or subordinated debt securities.

We experienced $23.5 million of portfolio runoff during the second quarter. More than half of our repayments were of floating rate loans with coupons of LIBOR plus 550 or lower.

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

Total portfolio unrealized depreciation during the quarter was approximately $9.9 million. At quarter end, our net asset value per share was $12.31 compared to $12.60 at the end of the first quarter. The unrealized depreciation on investments does not have an impact on our current ability to pay distributions to shareholders.

More than 40% of the dollar value of our portfolio is valued by dealer quotes. Quotes on this portion of the portfolio were down approximately $3.5 million during the second quarter. As we hold most investments to maturity, we anticipate that for investments in companies with adequate fundamental performance, we will not ultimately realize losses in value.

Our quarterly shareholder distribution of $0.43 is supported by $0.44 of net investment income as well as estimated quarterly taxable income of $0.46. Since inception, BlackRock Kelso Capital's distribution to shareholders have been derived almost exclusively from taxable net investment income.

The largest portion of the increase in unrealized depreciation for non-quoted, appraised investments relates once again to one portfolio company, Tygem Holdings, otherwise known as Al Solutions. That has -- that company has significantly underperformed its plan and its historical results, due to several company-specific events as well as due to general market conditions. BlackRock Kelso Capital continues to be actively involved in working out a recovery, taking an active role on the company's board of directors. In the aggregate, the value reflected in our GAAP financial statements for this company is carried at less than 25% of its cost.

While we have seen some companies with credit issues during the second quarter, we find the condition of the portfolio to be strong today. Our investments are well diversified with our largest exposures to media and publishing companies, to companies that provide business and other services, to consumer products companies and to healthcare businesses. Overall, these industries represent just about half of our total portfolio.

We are pleased that the performance of our portfolio companies continues to be strong with an overall weighted average rating of 1.32 using our 1.0 to 4.0 credit rating scale. This compares to a 1.30 at March 31st and 1.23 at December 31st. Approximately 4% of investments at value is rated 3.0 or 4.0, with 96% of the portfolio rated 1.0 or 2.0.

As of June 30, 2008, we have investments on non-accrual status representing approximately 1.5% of portfolio value. The fair market value of these assets is just under $18 million at June 30th compared with just over $8 million as of March 31st. More than half of the non-accrual value and the entire quarterly increase relates to one investment, again Tygem or Al Solutions.

In the second quarter, BlackRock Kelso Capital earned structuring and upfront fees combined with discounts equal to about 4% relative to its new investments.

Currently, our ratio of borrowings to net assets is 0.7 to 1.0, leaving us with sufficient capacity for new investment opportunities in what is now a very attractive investment environment. We borrow under our revolving credit facility at LIBOR plus 0.875% and our term loan facility at LIBOR plus 150 basis points. At June 30th, we had borrowings of approximately $484 million.

Our access to middle-market transactions continues to increase as we continue to work our direct sourcing efforts. We remain focused on finding the best risk-adjusted returns in middle-market companies, where we are able to play an active role in due diligence and transaction structuring.

Now, I'd like to turn the call over to Frank Gordon to review some of the GAAP financial information for the second 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 second quarter of 2008.

Investment income totaled $34.9 million and $70.6 million for the three and six months ended June 30th, 2008, respectively, compared to $33.2 million and $58.3 million for the three and six months ended June 30th, 2007. The increases reflect the growth of our portfolio as a result of the deployment of debt capital under our credit facility and equity capital from our initial public offering in July 2007.

Net expenses for the three and six months ended June 30th, 2008, were $11.6 million and $24.1 million, respectively, versus $15.8 million and $26.9 million for the three and six months ended June 30th, 2007.

Of these totals, for the three and six months ended June 30th, 2008, $4.3 million and $9.5 million were interest and other credit facility expenses. Interest and other credit facility expenses totaled $5.4 million and $9.1 million for the corresponding periods in 2007.

In addition, performance-based incentive fees totaled $5.8 million and $9.5 million for the three and six months ended June 30th, 2007. There were no incentive fees for the six months ended June 30th, 2008.

Expenses net of performance-based incentive fees, interest and other credit facility expenses for the three and six months ended June 30th, 2008, were $7.3 million and $14.6 million, respectively, compared to $5.7 million and $10.3 million for the three and six months ended June 30th, 2007. Overall, the increase in expenses was driven primarily by an increase in base management fees resulting from the growth of our portfolio and an increase in other general and administrative expenses.

Net investment income totaled $23.3 million or $0.44 per share for the three months ended June 30th, 2008, and $46.5 million or $0.88 per share for the six months ended June 30th, 2008. Taxable income exceeded our GAAP net investment income during the three and six months ended June 30th, 2008. For the corresponding periods in 2007, net investment income totaled $17.4 million or $0.42 per share and $31.4 million or $0.79 per share.

Total net realized gains or losses for the three and six months ended June 30th, 2008, were losses of $1.5 million and $1.3 million, respectively, compared to gains of $0.5 million and $0.3 million for the three and six months ended June 30th, 2007.

For the three and six months ended June 30th, 2008, the net change in unrealized appreciation or depreciation on our investments and foreign currency translation was depreciation of $9.9 million and $72.8 million, respectively, versus depreciation of $5.2 million and $2.0 million for the three and six months ended June 30th, 2007. Net unrealized depreciation was $130.3 million at June 30th, 2008, and $0.6 million at June 30th, 2007.

For the three and six months ended June 30th, 2008, the net change in net assets from operations was a net increase of $11.9 million or $0.22 per share and a net decrease of $27.6 million or $0.52 per share, respectively. For the corresponding periods in 2007, the net increases in net assets from operations were $12.6 million or $0.31 per share and $30.0 million or $0.75 per share.

Earlier today, our Board of Directors approved a share repurchase plan. Under this plan, we may repurchase outstanding shares of our common stock from time to time in open market or privately negotiated transactions. The repurchase program will not obligate us to acquire any specific number of shares and may be discontinued at any time. We intend to fund any repurchases with available cash. The repurchase plan is expected to be in effect through the earlier of June 30th, 2009, or until the approved number of shares have been repurchased.

With that, I would like to turn the call back over to Jim.

Thanks, Frank.

Looking forward into the second half of 2008, we continue to be very excited about our business and about our prospects. The portfolio is well diversified, conservatively constructed and performing well. We remain focused on preservation of capital and on providing the best risk-adjusted returns for our shareholders.

Finally, I'd like 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.

Cara, will you now please open the call to questions?

[OPERATOR INSTRUCTIONS] Your first question comes from [Faro Battini] with Credit Suisse.

Good afternoon. I was wondering if you could just address maybe your funding portfolio and any short-term maturities? And also, your liquidity position?

Mike?

Sure, this is Mike. Our credit facilities -- both the revolving credit facility and the term loan facility don't expire until the very end of 2010 and the capital is available to us on a revolving basis until that time. In addition, the credit facilities that we have have accordion features that allow us, with additional capital, to increase the size of those facilities should we find additional lenders to join in under the existing facility. So, we have that in place until, I believe, it's December the 6th of 2010.

Availability. We have $484.0 million drawn under those facilities at the end of the second quarter. The total amount of those facilities is $545 million of availability and that's prior to any increase that we may or may not seek under the accordion feature.

Yes, I think it's also fair to say that we have some expectations of certain securities on our portfolio of some significance being refinanced in the next quarter also.

Okay. Great. Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of James Shanahan with Wachovia.

Hi, guys. How are you?

Very, Jim.

Good. Very busy day and I apologize I really hadn't had a lot of time to really spend on the press release here, but I had a couple questions.

First of all, actually, I want to make a comment. The share buyback is -- did some quick math here and it works out -- looked to me, to be roughly maybe 1.3 million shares at $9.00 a share or $12.0 million and not a significant amount in terms of dollar value. But, I think, it sends an important message to the market that buying stock back below book value is a lot more powerful, than selling equity below book value. And so, I think, this is a positive development and hope -- and your demonstration of market leadership hopefully sends a message to some of your peer companies, which see the opportunity and think that the right thing to do is raise capital. And I don't think that's always the case. It can be very costly.

So, having said that, without your commentary, I just wanted to make that point. And --

We agree.

We agree.

We agree.

I'm sorry?

We agree.

We agree. I think we all said at the same time, we agree.

And then, I guess a follow-up and I recall actually asking this question on the last earnings conference call. We -- when we try to forecast the earnings for this Company, we find very little difference between our earnings' estimates and what you report. I mean, there's some volatility from here to there, but the big change is this incentive fee. And I would like to understand -- I think, it's -- I think, it also sends a strong message that in -- when the stock's low in AV you're not accruing incentive fees, but I want to know if we should expect, at some point, if there's been an accrual and we should expect some big catch-up with regards to the incentive fee when the stock price recovers. Will there be a quarter when the $4.0 million, $5.0 million, $6.0 million of incentive fees that your accruing per your management agreement, all of a sudden they're going to run through the income statement? Or how we should think about that potential event?

Well, the way it works mechanically is, it's not an accrual. There's no accrual, because it is and until it's earned there's no accounting mechanism to accrue it. But once on a rolling four quarter basis, we look at net asset value. And net -- when net asset value reaches a level that it was at anytime in the previous four quarters, you then have the opportunity to receive incentive fees. Now, that calculation and the way that calculation is made, it -- once you've got above that threshold of net asset value, then it is possible -- it is conceivable that you could get anywhere, depending on how far above that net asset value number, you could get in -- depending on earnings in that particular quarter, you could get -- you could get full recovery of a year's -- up to a year's incentive fees.

So, we have, at this point in time, not received incentive fees for the last four quarters. As we move forward to the next quarter, we will then have permanently forgone the incentive fees for the third quarter of 2007. As we move to the end of this year, we will have permanently forgone incentive fees for the second half of 2007, and so forth and so on. And that's the mechanics of the way it works.

Yes, this is Mike, I would add just one minor thing to what Jim just said, which is that the fees -- any incentive fees, to the extent there are any incentive fees, they're never payable out of -- purely out of a NAV increase or out of marks. It's always out of cash returns. So, the conditionality of the NAV recovery is much like an on-off switch, but you, in addition to that, we needed to have earned the cash to make the fee payable above the hurdle rate, et cetera.

Okay, so --

What also happens from a mechanical standpoint, because of the way of this -- the way this is constructed is that once you have paid -- if you ended up in a situation where you paid incentive fees for an entire year in one quarter, then in the next quarter, it's more than likely, given the mechanics, that you wouldn't be paying incentive fees in that quarter.

Okay. Well, the --

It's very complicated. It's very cumbersome. And it doesn't work very well as it's currently constructed.

Well, frankly, it's benefiting us as shareholders, and -- but not --

Sure, it's working the way it's supposed to, except once it kick -- and that's fine, I'm not suggesting that there's anything wrong with that, what I'm suggesting is once it kicks back in again, it gets a little bit complicated.

But it begs a follow-up question and I'm kind of hogging all the time here and I apologize for that, but it begs a follow-up question that -- I know that the manager is a private company. I'm not asking you to disclose the P&L of the manager, but all of these -- as it puts strain on the manager and the manager's profitability and the manager's ability to reward and compensate its employees. And does that become an issue for -- the attrition or could you have retention issues if you can't pay bonuses or you have to tighten up other salaries and benefits, for example, because the manager has to be profitable or at least breakeven?

Yes, I think, given the underlying fee structure, we feel comfortable with being able to retain people at the manager. The owners of the managers are the ones, who effectively pay the price regarding the incentive fee.

Has there been any changes in the ownership structure of the manager?

No. Nothing meaningful, anyway. Let me put it that way.

Okay. Well, thank you.

Sure. Thank you.

[OPERATOR INSTRUCTIONS] It appears that there are no further questions at this time. I would like to turn the call back to management for further comments or any closing remarks.

Well, I'd like to thank everybody for taking the time to participate. And if you have any further questions, feel free to call either Frank or Mike or myself. And we look forward to talking to you at the end of next quarter. Thank you.

And that concludes today's BlackRock Kelso Capital Corporation investor teleconference. You may disconnect at this time.