BlackRock Capital Investment Corp (BKCC) 2014 Q3 法說會逐字稿

Good afternoon. My name is Ginger 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, Corinne Pankovcin; and Secretary of the Company and General Counsel of the Advisors, Laurence D. Paredes; and Steve Sterling of BlackRock. (Operator Instructions)

Thank you. Mr. Maher, you may now begin the conference.

Welcome to our third-quarter conference call. Before we begin, Larry will review our general conference call information.

Thank you, Jim. Before we begin our remarks today, I would like to point out that certain comments made during the course of this conference call and within corresponding documents contain forward-looking statements subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may, and similar expressions. We call to your attention the fact that BlackRock Kelso Capital Corporation's actual results may differ from these statements.

As you know, BlackRock Kelso Capital Corporation has filed with the SEC reports which list some of the factors which may cause BlackRock Kelso Capital Corporation's results to differ materially from these statements. BlackRock Kelso Capital Corporation assumes no duty to and does not undertake to update any forward-looking statements.

Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, BlackRock Kelso Capital Corporation makes no representation or warranty with respect to such information.

Please note that we have posted to our website an investor presentation that complements this call. Shortly, Jim and Mike will highlight some of the information contained in this information. At this time, we would like to invite participants to access the presentation by going to our website at www.BlackRockKelso.com and clicking the November 2014 investor presentation link in the presentations section of the investor relations page.

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

Thanks, Larry. Good afternoon and thank you for joining our call today. We had an active and productive third quarter. Third-quarter highlights include new investments of more than $142 million and exits of approximately $117 million. Since quarter end, we have made more than $180 million of additional investments, including our investment in Gordon Brothers Finance Company.

That brings our total new investments to more than $475 million for the year to date, including more than $300 million in the last four months. Mike will cover our new investments a bit later in the call.

Adjusted net income equaled $0.23 per share, exceeding our $0.21 dividend. We've had increases in the valuations of many of our remaining equity positions. The net realized and unrealized gains on our portfolio contributed to an increase of NAV of $0.18 per share to $9.97 per share, an increase of $0.59 over the last 12 months.

We continue to focus on harvesting some of our investments in equity securities. And although we didn't have any meaningful sales of equities during the quarter, on October 1st a UK company -- a media company -- announced its intentions to buy Advanstar Communications. We expect that this transaction will close on the first quarter of 2015.

With respect to the balance of our equity positions, the companies generally continue to perform well. And although it remains our goal to exit them on an orderly basis over time, we expect to continue holding a substantial portion of them over the near to medium term.

Several of these companies are in the process of being sold, which may result in further reductions in our equity portfolio over the next few quarters. The rate of return on these investments continues to be accretive to our overall results.

Notwithstanding this continued focus on exiting certain of our equity investments, the equity exposure in our portfolio increased to 18% from 17% at the end of the second quarter, due to the continued appreciation on our existing investments.

Market conditions generally have remained aggressive throughout the year, including most of the third quarter. Overall, leverage and new transactions remains high, rates remain low, and protections remain weak in the more liquid credit markets. This continues to be a challenge, but one that we continue to succeed in overcoming. Our direct lending model with a heavy reliance on due diligence and transaction structuring continues to provide us with good investment opportunities.

Markets were certainly more volatile towards the end of the third quarter into the early part of the fourth quarter than they had been in the first half of the year. We have been able to take advantage of this in the weeks after the third quarter end by acquiring positions and some slightly more liquid names that we had followed in the past at attractive prices during the recent market dislocation.

I would now like to turn the call over to Mike.

Thanks, Jim. In advance of this conference call, we posted our quarterly investor presentation to our website, and an overview of our third-quarter results starts on page 2. We have had an active quarter for new investment activity. The activity has continued after quarter end, and October was a busy month for us.

We have made quite a few meaningful investments in the fourth quarter so far, and overall we have invested more than $300 million since the end of our June quarter. We are pleased with the overall continued solid performance of our investment portfolio. Net assets increased to $743 million, and net asset value per share increased to $9.97 per share from $9.54 per share at the beginning of the year.

Total investments stood at $1.1 billion at quarter end. Our net investment income, as adjusted, of $0.23 per share relative to distributions declared of $0.21 per share, results in dividend coverage of 111%. Realized gains during the year provided another $1.12 per share of earnings with no accompanying distribution requirement, resulting in $1.77 per share of combined net investment income and realized gains, for dividend coverage of 260%.

Last quarter in discussing our dividend, we stated that we believe that by setting the dividend at a level that is largely covered by interest and dividend income, rather than capital appreciation, realize gains and fee income, we would be in a solid position to grow net asset value. This has proven true in the year-to-date period, as evidenced by our increasing NAV.

With respect to earnings, our portfolio generated investment income of $33.2 million for the third quarter, which was relatively consistent with the $33.8 million earned in the prior quarter. While interest income was approximately $400,000 higher in the second quarter, fee income was $1 million lower.

Fees remain an important part of our direct investing business. Income derived from fees tends to be consistent over the long run, but occasionally volatile in any particular quarter in the short run. For the third quarter, fee income totaled $4.8 million, which is just slightly above our longer-term average. Fees on exited transactions were $900,000 compared with fees of $2.6 million on new commitments.

Other fees include amendment fees, agent fees, consent fees and others. Removing fee income, our remaining investment income increased from $27.9 million to $28.3 million on a quarter-over-quarter basis.

Of course, we believe that our adjusted net investment income, which removes hypothetical fees and then adds an adjustment to account for incentive fees earned on income, is the better indication of our quarterly performance. Reconciliation of these GAAP and non-GAAP measurements appears on page 11 of our investor presentation.

Adjusted net investment income of $17.3 million in the quarter compares with $16.8 million in the second quarter, and equated to $0.23 a share, consistent with the prior quarter.

In our middle-market credit business, hands-on attention to detail is of paramount importance to each investment. Our credit process includes a rigorous detailed analysis of the performance and prospects of the companies, the stability of the industries in which they operate, the strength of the management teams, the covenant packages, and a critical assessment of the assets that support each investment.

During this period of somewhat aggressive behavior in the credit markets, we remain focused on these important principles. Our focus remains on investing our capital in first-lien loans, other senior loans, and transactions with asset support.

We are often drawn to more complex situations where these conditions are more likely to be met, but where returns are not sacrificed. In the third quarter we continued to focus on opportunities and secured and senior debt investments, and in negotiated transactions where appropriate structures could be put in place.

Our current investment pipeline is also focused on investments that are generally more senior in the capital structures of the companies we are investing in. Given the current high leverage levels in the market, we are still focused on investments with a reasonable level of tangible asset coverage.

As a result of this strategy, we have been transitioning the portfolio to a heavier weighting in first rather than second-lien loans, and in secured rather than unsecured or subordinated notes. Since year-end 2013, we have increased our percentage of first-lien loans from 13% of the portfolio to more than 25% of the investment portfolio today.

This focus has increased our allocation to companies in the energy sector, as asset coverage and lower loan-to-value ratios have been more prevalent. Currently, investments in companies in the energy industry comprise 11.1% of the portfolio, up from 5.4% at year end.

Barring significant market changes, we do not expect to increase our allocation to energy transaction significantly from this point forward.

In the third quarter, two of our three largest investments were made in first-lien secured loans. During the quarter, we funded $60 million of our $85 million commitment in a first-lien loan to GSE Environmental. We subsequently sold $17.6 million of our investment to a third-party, netting an upfront fee of $1.3 million on both transactions.

GSE manufactures geosynthetic products used in industrial and civil projects to support environmental protection. The coupon on this loan is currently 11%.

We helped structure a new second-lien credit facility to Hunter Defense Technologies and provided $45 million of the $80 million tranche, earning a $1.1 million capital structuring fee. Subsequently, we earned a $1.1 million amendment fee for consenting to the acquisition of HDT. HDT is a designer and manufacturer of tactical shelters, heating and cooling units, and air filtration systems for military and commercial end markets.

We invested $20 million in the MD America Holdings senior secured first-lien term loan. MD America is an upstream oil and gas exploration and production company with nearly 15,000 net acres of leasehold in the East Texas Woodbine.

While we are certainly focused on oil prices, our first-lien secured position gives us comfort that we have ample loan-to-value coverage based on producing and proven reserves at even lower oil prices.

Based on its 9.5% floating-rate coupon and its issue discount, our underwritten return in this transaction is 10.8% to maturity.

In general, our portfolio companies continue to perform quite well. We had no investments on nonaccrual at quarter end and no material net change in the weighted average ratings of our portfolio companies since year end.

Significant exit transactions in the quarter included the realization of our investments in A&A Manufacturing and TriMark, each of which resulted in a realized internal rate of return in excess of 15% over more than seven years.

In addition, we exited our investments in Citrus Energy and Townsquare Media, with IRRs of 14.8% and 9.9%, respectively. After the end of the third quarter, we also exited our investment in AmQuip Crane Rental, and received proceeds of $41 million and a prepayment penalty of $1.6 million. Our realized IRR was also 15%.

We are pleased with our accomplishments in the quarter and year-to-date period. Our origination platform has generated great investment opportunities. We continue to harvest our successful equity positions. We have generated investment income that continues to exceed our current dividend level.

We are also particularly proud to have completed a transaction with the Gordon Brothers Group subsequent to quarter end to form Gordon Brothers Finance Company. Our investment in Gordon Brothers Finance Company provides us with access to a growing company that provides specialized financing and an array of capital solutions for asset-rich clients.

We are hopeful that this new portfolio Company investment will provide even more investment opportunities in the future.

With that, I would now like to turn the call over to Corinne to review some additional financial information for the quarter.

Thanks, Mike, and hello, everyone. I will now take a few moments to review some of the details of our 2014 third-quarter financial information.

For the three months ended September 30, 2014, our earnings were $0.39 per share and our GAAP net investment income was $0.26 per share, as compared to $0.23 per share on an adjusted basis. The adjusted net investment income remained relatively flat due to slightly lower fee income in the third quarter, offset by decreases in the base and incentive management fees, interest and credit facility fees, and other expenses.

The composition of our portfolio remained fairly stable in the third quarter. Senior secured loans comprised 54% of the portfolio, representing a 6 percentage point increase from the prior quarter. Unsecured and subordinated debt securities decreased by 4 percentage points to 15% of the portfolio, while the composition of our portfolio invested in senior secured notes and equity securities remained relatively unchanged at 9% and 18%, respectively.

The weighted average yield of the debt and income-producing equity securities in our portfolio at their current cost basis remained relatively stable at 11.8% at September 30. The weighted average yield on our senior secured loans and other debt securities at their current cost basis were close to flat at 11.4% and 13%, respectively.

At September 30, we had approximately $360.2 million in debt outstanding, $42.5 million in cash and cash equivalents, and $391.5 million of net cash and availability under our revolving credit facility. Subject to leverage and borrowing-based restrictions relative to our $1.1 billion portfolio, we continue to have sufficient debt capacity to deploy in attractive investment opportunities.

At September 30, our asset coverage ratio was 304%. In the near term, we expect to use the availability under our credit facility and cash flows from operations to meet our liquidity needs. Compared to last year, our weighted average cost of debt decreased 30 basis points to 5.2%. This was due to our securing more favorable pricing of our credit facility earlier this year.

Average debt outstanding increased from $359.5 million last year to $414.6 million this year, resulting in a 1.1% increase in total borrowing costs during the quarter.

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

Thanks, Corinne. As you are now aware, BlackRock Kelso Capital Advisors has entered into an agreement with BlackRock Advisors, LLC, through which BlackRock will acquire certain assets of the Company's investment advisor.

It goes without saying that we are limited to what we can say on today's call. However, I wanted to offer a brief overview ahead of the filing of a proxy statement regarding the proposed transaction in the near future. On closing the transaction, subject to shareholder approval, BlackRock Advisors, LLC will become the investment advisor to the BDC.

BlackRock currently owns approximately 32% of BKCA, the current advisor, and has held its interest since the advisor was formed. For sake of clarity, BlackRock is not acquiring BKCC, but will become the new advisor at close.

Upon completion of the transaction, Mike and I will be stepping down from our roles in the Company. I will remain on the Board of Directors and will become a senior advisor to BlackRock to assist in the transition of the business.

Mike has also agreed to serve as an advisor to BlackRock in transitioning the business, including portfolio responsibility and business operations.

Steve Sterling, head of Global Capital Markets at BlackRock, is with us today. Mike and I will be working with Steve and his team. At the closing, Steve will assume the role of CEO of the Company, subject to Board approval.

I would like Steve to take a moment to discuss BlackRock's rationale for this transaction. Steve?

Thank you, Jim. We are very excited about the proposed transaction. Jim, Mike and the entire BlackRock Kelso team have built an impressive business. It is greatly respected in its markets, and we look forward to building on its success in the future.

BlackRock believes that taking an active role as the manager of BKCC will allow it to leverage the full power of the BlackRock platform to provide BKCC with expanded investment opportunities. The BKCA team will be joining BlackRock and will be able to leverage BlackRock's existing network to have greater access to investment opportunities.

BlackRock will continue to evaluate the current strategy to determine how best to achieve its stated goals.

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

Thanks, Steve. Until the proxy statement is filed, as I have indicated already, we will have limited ability to answer questions regarding the transaction. So I would ask you to please focus your questions on our third-quarter results. We expect to initiate a proxy solicitation in the near future to seek shareholder approval.

On behalf of Mike, Corinne, Larry and myself, I would like to take this opportunity to extend our thanks and appreciation to our investment team for all of their efforts. They have each done a tremendous job in contributing to our terrific year-to-date results.

I would also like to thank all of you for your time and attention today.

(Operator Instructions) Troy Ward, KBW.

Great. Thank you and good afternoon. Welcome, Steve. My questions actually are going to focus more on the transaction. And if you can't answer them, I guess I understand. My thought -- a question, we've seen a couple of these external managers change, and one of the things that we've seen that I think shareholders greatly appreciated and made a good signal to the market, so to speak, was the acquiring entity or the new external manager actually going in with some additional capital and buying shares in the open market, as kind of a way to get skin in the game to align themselves with shareholders.

Is there any thought, Steve, for BlackRock to do this on this coming transaction?

Unfortunately at this time, I think until we've actually filed the proxy, we do want to reserve comment as obviously we have just announced today, and it remains subject to approval by BKCC shareholders. So we are pretty limited as to the conversation that we can engage that I am able to address at this time.

Okay, I fully understand that. And then just real quick, from a Board perspective, Jim, can you talk about the Board of BKCC as they entered into this, was there any thought -- as the current Board of BKCC before they into it, maybe nothing to do with the proxy, of making adjustments to the management agreement? If nothing else, just to maybe provide some clarity on how, as you know, the confusing way that some of the agreement works now with regard to earnings.

Do you think any of that can possibly be reworked or potentially some alignment, some other alignments put into the external management agreement?

Hi, Troy. It's Larry Paredes. Again, unfortunately, until the proxy statement is filed we are somewhat limited in what we can discuss, and can't address that at this time.

Okay. Well, thank you.

(Operator Instructions) Jon Bock, Wells Fargo Securities.

Good afternoon, and thank you for taking my questions. So I'll start with maybe a few fundamental questions on the quarter, and it's good to see the beat, so thank you for outlining that.

Can you walk through, Mike and Jim, why originating assets at attractive yields at around 10%-ish, maybe 11%-ish, is attractive when you could have bought back your stock at effectively the same rate, and not only generated earnings accretion but also book value accretion at the same time? I am just -- I'm curious.

Then I guess as a follow-up, if you were to buy back stock, wouldn't buying back stock make the price for BKCA a bit cheaper, considering assets under management go down?

Well, in terms of buying back stock, we have a program in place; it has been in place for some -- quite a long period of time, and it is triggered based on a share price, a price per share that we buy stock below that price. We've been doing that for a long period of time.

Jon, it's Mike. I would just add, obviously that is an automated program that is set well in advance. Whether or not shares were purchased in any particular quarter really relates to the market activity during that time.

As you would expect, we have no day-to-day control over making some type of decision about stock buybacks. So we do have a program, it is automated, it is set in advance, and it runs.

Okay. I guess -- would you determine -- I'm sorry, go ahead, sir.

I was just going to say, I mean I think part of the equation is that you may be missing is in all of these transactions, velocity is important, and there are fees on the front end and the back end. So just comparing whatever the rate is on any particular transaction to some -- to net asset value or the yield on the portfolio, I think is a little bit spurious.

We take that into consideration when we set the price at which we put our program in place.

I guess kind of maybe taking a step forward, just broad brush strokes but, Larry, what is your kind of view on how shareholder value can be created inside the BDC structure? We understand making good loans and a strong credit culture is a big part of that and it has always been a big part of the institution you work for.

So maybe just -- your thoughts on shareholder value creation, how it is effectively done and how it is effectively lost. That would be good for all the potential investors or new investors that are sitting on this call today.

Hey, Jon, it's Mike again. I think -- I believe that you have a pretty decent understanding, and I am happy to review how Jim and I together think about shareholder value and our investment process and how we go about things. I think you might have meant to direct your question not to Larry but rather to Steve --

Oh, sorry.

-- who I think can speak in some high-level generalities about BlackRock, but I am not sure how much deeper he can go. So I would sort of ask Steve to fill that in.

Thanks, Mike.

Thanks, Mike. I think, as stated earlier as it pertains to the filing of the proxy, we do want to be very mindful and sensitive to our obligations as it is associated with that. So I do want to reserve comment.

Clearly, as a fiduciary for our clients, we will act in a manner consistent with what we think is the long-term interest of our clients. So as a principal matter, that is the way in which we approach these items.

As we move forward and we get the filing of the proxy and further down the process, I'm certainly happy to engage in a more granular conversation vis-a-vis the strategy that we would look to pursue to accomplish that.

I understand completely and, guys, thank you very much, and look forward to that forthcoming proxy. Thank you.

No further questions in queue at this time.

If there are no other questions, I thank you all for attending the call today. And as always, we are available for your additional questions. Thank you.

Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time, you may now disconnect.