BlackRock Capital Investment Corp (BKCC) 2014 Q4 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 hosts 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 Advisor Laurence D. Paredes and Steve Sterling of BlackRock.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

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

Welcome to our fourth 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 compliments this call. Shortly, Jim and Mike will highlight some of the information contained in the presentation. 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 March 2015 Investor Presentation link in the Presentations section of the Investors Relations page.

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

Thank you, Larry. Good afternoon and thank you for joining our call today.

We had a very good fourth quarter and an excellent year. We harvested several of our successful equity positions and have generated investment income that exceeded our current dividend level both for the quarter and the year.

Highlights include new investments of more than $235 million relative to exits of $84 million. This amount includes the investment we made in Gordon Brothers Finance Company, our largest single investment since inception. That brings our total new investments to more than $530 million for the full year.

Adjusted net investment income equaled $0.26 per share, exceeding our $0.21 dividend. For the full year 2014, our net investment income as adjusted was $0.91 per share, relative to distributions declared of $0.89 per share.

Realized gains during the year provided another $1.30 per share of earnings with no accompanying distribution requirement. This resulted in $2.21 per share of combined net investment income and realized gains.

We have 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 our NAV of $0.52 per share for the quarter to $10.49. This represents an increase of nearly $1.00 per share over the last 12 months.

We believe that setting the dividend at a level that is largely covered by interest and dividend income, rather than capital appreciation, realized gains, and fee income, has allowed us to grow net asset value. Thanks to the redeployment of proceeds from equity sales into income producing assets, our run rate net investment income pre-incentive fee was $0.22 per share on a pro forma basis at year-end. This run rate does not consider the impact of fee income, which would of course result in even higher pre-incentive fee NII.

As we outlined in our last several conference calls, an important part of our portfolio strategy has been focused on harvesting some of our investments in equity securities. Overall in 2014, the sales of our equity interest in Arclin, ECI, and Advanstar produced net realized gains of $99.2 million, and generated $153.2 million of proceeds available to redeploy into income-producing assets. The companies in which we have remaining equity investments, such as USI, Penton, Progreso, and others, generally continue to perform well.

It remains our goal to affect further reductions in our equity portfolio over the next year. The rate of return on these investments continued to be accretive to our overall returns.

Notwithstanding exiting a net $100 million of equity investments during the year, the equity exposure in our portfolio increased from -- to 21% from 18% at the end of the third quarter due to the continued appreciation of our existing investments. The current equity balance in the portfolio is down slightly from 22% at year-end 2013.

The first quarter of 2015 has been somewhat slower than normal with respect to volume of new transactions. Market conditions remain frothy, as an abundance of capital continues to seek investments in the leveraged finance space as fewer new middle-market M&A transactions limit the supply of investment opportunities.

I'd like to now turn the call over to Mike.

Thank you, Jim.

In advance of this conference call we posted our quarterly investor presentation to our website and an overview of our fourth quarter results starts on page 2. We are pleased with the continued solid performance of our investment portfolio. Net assets increased to $782 million and net asset value per share increased to $10.49 per share from $9.54 per share at the beginning of the year. Total investments stood at $1.26 billion at year-end.

With respect to earnings, our portfolio generated investment income of $37.9 million for the fourth quarter, which was a significant increase relative to the $33.2 million earned in the prior quarter. While interest income was relatively flat for the prior two quarters, fee income was $4.6 million higher.

Fees obviously remain important part of our direct investing business. Income derived from fees tends to be consistent over the long run but can be volatile in any particular quarter. For the fourth quarter fee income totaled $9.5 million, which is above our longer-term average.

We believe that our adjusted net investment income, which removes hypothetical gains fees and 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 $19.5 million in the quarter compares with $17.3 million in the third quarter, and equated to $0.26 per share compared with $0.23 per share in the prior quarter.

Our net investment income as adjusted of $0.26 per share relative to distributions declared of 21% -- $0.21 per share results in net investment income dividend coverage of 125%. In the fourth quarter we continued to focus on opportunities in the secured and senior debt -- in secured and senior debt investments, and negotiated transactions where appropriate structures could be put in place. Given the current high leverage levels in the market, we are still focused on investments with a reasonable level of tangible asset coverage. Since year-end 2013 we have increased our percentage of first lien loans from 13% of the portfolio to 26.9% of the investment portfolio today.

The fourth quarter was very productive for our new investment activity. During the quarter we invested in the following portfolio companies either in first lien secured lien -- first lien secured loans, second lien loans, or in one case, a series of securities issued by a company whose entire business is focused on asset-based lending. We hope to structure a first lien unitranche term loan to Vertellus Specialties provided $55 million of the $455 million loan, earning a 3.5% capital structuring fee or $1.9 million. Vertellus is a specialty chemicals business operating in two major segments, agriculture and nutrition, and specialty and materials.

Completed the transaction with Gordon Brothers Group whereby we launched Gordon Brothers Finance Company, a majority-owned portfolio company. We invested just under $95 million consisting of $71 million of newly issued LIBOR + 11% senior notes with a 1% floor, $13 million of newly issued 13.5% coupon preferred stock, and we paid $10.6 million for 80% common equity ownership of the Company. We also earned a $3 million capital structuring fee in conjunction with this transaction.

This Company is focused on asset-based secured senior lending. We invested just under $15 million in the first lien term loan of Oxford Resources, a producer of thermal coal that is used primarily by regional electric utilities and is sold under long-term contracts. The loan has a floating-rate coupon of LIBOR + 11.5% and a 75-basis point floor.

Lastly, we invested in a directly sourced and negotiated second lien loan for a new private equity sponsored transaction. Our loan to Pioneer Sand Company supports a JLL buyout of the business from the current family owners. Our $20 million loan has a coupon of LIBOR + 8.50% with a LIBOR floor of 1%.

Terms of exits during the fourth quarter Advanstar Communications was acquired by UBM plc, a UK-based media company. Total proceeds of $26.2 million on our combined preferred and LLC interests resulted in realized gains of $14.1 million. As of last quarter-end, our combined investments in Advanstar accounted for over 13% of our total equity investments at fair value.

Significant exit transactions in the quarter also included the previously disclosed realization of our investment in AmQuip Crane Rental, from which we received proceeds of $41 million and a prepayment penalty of $1.6 million. Our realized IRR was more than 15%. We also exited our small opportunistic purchase of Expert Global with an IRR of 13.7%.

After quarter-end, M&M Traditional Holdings was sold to a subsidiary of Berkshire Hathaway, my tech holdings. Our 11.5% common equity ownership generated net proceeds of approximately $14.3 million, and this resulted in a $9.3 million realized gain and represented a further increase of $2.5 million above our mark for this investment at last quarter-end. Inclusive of escrow proceeds, our IRR on this investment is over 18%.

Our borrowing costs fell to a rate of 5.2% for the fourth quarter as a result of an increase of leverage to 5.6 -- to 0.56 times from 0.43 times net of cash at the end of the third quarter. This is a result of our incremental borrowings being drawn under our revolving credit facility, which is our lowest cost of capital, as well as the effect of our credit facility pricing reduction completed earlier this year.

Jim and I are extremely proud to be leaving the Company in excellent position, perhaps the best position it has been in during its history. At $1.26 billion, the portfolio had the benefits of scale and diversification and has continued upside in many of its equity positions. Our debt portfolio has been carefully constructed based on fundamental credit underwriting, and is comprised of a diverse pool of well-structured junior and senior debt investments with low internal correlation and substantial excess return relative to risk.

We have achieved a double-digit IRR on the $3.7 billion of total investments we have made since inception nearly ten years ago. This is all the result of lots of blocking and tackling by a terrific investment team who I would like to commend and thank for their hard work and their dedication.

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

Thanks Mike, and hello everyone. I will take a few moments to review some of the other details of our 2014 fourth quarter financial information. For the three months ended December 31, 2014, our earnings were $0.73 per share and our GAAP net investment income was $0.05 per share, as compared to $0.26 per share on an adjusted basis. The adjusted net investment income increased over the prior quarter due to higher fee income in the fourth quarter offset by increases in base management fees and incentive fees.

The composition of our portfolio remained fairly stable in the fourth quarter. Senior secured loans comprised 52% of the portfolio, representing a 2 percentage point decrease from the prior quarter. Unsecured and subordinated debt securities increased by 3 percentage points to 18% of the portfolio, while the composition of our portfolio invested in senior secured notes decreased 1 percentage point to 8%.

The weighted average yield of the debt and income-producing equity securities in our portfolio at their current cost basis decreased slightly to 11.6% at December 31 as compared to the prior quarter. The weighted average yield on our senior secured loans and other debt securities at their current cost basis also decreased slightly at 11.2% and 12.5% compared to prior quarter respectively.

At December 31 we had approximately $448 million in debt outstanding, $10 million in cash and cash equivalents, and $271 million net cash and availability under our revolving credit facility. Subject to leverage and borrowing-based restrictions, at December 31 our asset coverage ratio was 271%.

Compared to last year, our weighted average cost of debt decreased 28 basis points to approximately 5.2%. This was due to our securing more favorable pricing of our credit facility earlier this year.

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

Thank you, Corinne.

As I am sure you are all aware, BlackRock Kelso Capital Advisors entered into an agreement last autumn with BlackRock Advisors LLC, through which BlackRock will acquire certain assets of the Company's investment advisor. The shareholder vote on February 18 approved the transaction and the appointment of BlackRock as the Company's new investment advisor at the close of the transaction.

The closing of this transaction is expected to happen in the very near future. At closing, Mike and I will be stepping down from our roles with the Company. I'm confident in speaking for Mike when I say we are both very proud of the Company and its many accomplishments, and are honored to have built and led it.

Going forward, I expect to 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, a Managing Director at BlackRock and their Head of Global Capital Markets, is with us today. Steve has joined us today and while he does not have any prepared remarks, he is here to address any questions you may have about BlackRock and their rationale for this transaction, as well as their strategy going forward.

Mike and I, along with Larry and Corinne, have been assisting Steve and the BlackRock team. After the transaction closes, Steve will assume the CEO role of the Company. We passed the management of the Company to BlackRock at a time that we believe BKCC is in its strongest-ever position. The dividend is covered by interest income. There is in excess of $120 million of unrealized appreciation in the Company's assets, and the performance of both its debt and equity positions continue to be strong.

We have invested more than $3.7 billion over nearly 10 years, and 168 portfolio companies in the middle market. It has taken a lot of hard work from a lot of individuals successfully acting as one team dedicated to our business.

On behalf of Mike, Corinne, Larry, and myself, I would like to take this final opportunity to extend my thanks and appreciation to each of the members of our investment team for all of their efforts in 2014. They have each individually done a tremendous job in contributing to our success, and their teamwork has driven our business to new heights. As a significant shareholder, I would like to reiterate my vote of confidence in our team and in BlackRock going forward.

With that I'd like to thank you for joining our call today. Operator, would you now please open the call for questions?

(Operator Instructions)

Well, if there are no questions, I'd like to thank all of you for attending this conference call. And if you have any further questions, feel free to give us a call at your earliest convenience. Thank you.

I'm sorry, we did just have a couple come in queue.

Okay.

Fin O'Shea, Wells Fargo Securities.

First, a basic question. We saw some pretty good markups on some of the equity holdings in the portfolio. Can you give us an update as to whether those were material operating improvements or are these sponsor bid-driven?

And second, on top of that, would this accelerate your appetite to monetize these and deploy, given that's your strategy? Thank you.

Sure, it's Mike. The contribution of, in terms of the total increase, is spread across a couple of different portfolio names, some of which we mentioned in prepared remarks. I think it was a combination of improving financial condition of some of these companies combined with higher market multiples, evident in today's leveraged buyout marketplace, and in particular one of the assets has been marked up pretty significantly in the quarter because our third party that does the valuations had an observable event happen to it, the most comparable company in the industry at a higher multiple, while that business' EBITDA continues to improve quarter over quarter.

In terms of liquidating these investments, as you know from looking at the business over a long period of time, it takes a while to exit our equity investments. We've mentioned for a while now that this is an active part of our business strategy, we've been doing it over time with some of our other investments. Some continue to appreciate, and all of them are always up for high consideration in terms of trying to exit and trying to turn those appreciated assets into cash for redeployment into interest-bearing securities.

So we're always trying to sell everything. We want to make sure that we are good fiduciaries in that regard and that we are able to capture as much appreciation as is reasonably possible over the near term, and we continue to examine each business, business by business, as conditions change and evolve in the marketplace.

The only thing I would add to that is I think we are more enthusiastic today about selling these positions because they have run their course in terms of, to some extent, of the appreciation that we expected to garner. As we said before, we've said in the past that we intended to hang onto these positions until we were able to realize fully what we expected. I think we are, by definition, a lot closer to that point in time.

Okay, great, thank you. And just another one on Gordon Brothers to help understand there. If you can give us some color on what yields these guys deploy at? And then, if I'm right, it's a $269 million portfolio, your total contribution is $94 million, and then $10.6 million of that, which is the majority of the equity. Is there leverage on top of this?

Senior to our investment in the Company at its various levels there is asset-based financing against this portfolio of assets, as you would expect in any type of finance company. You can sort of deduce the map using round numbers, using the round numbers that you just used in your question to figure out that the amount of leverage above us or that is senior to us in this transaction that is secured, is a pretty reasonable amount with good pricing that affords us the opportunity to make good returns in a type of leverage environment that's not dissimilar to those in the BDC.

Okay, great, thank you.

In terms of their underlying returns, there's quite a variety from transaction to transaction. These tend to be smaller companies, and again, their focus on what they do is much more specifically tied to the valuation of the assets that are securing the loans, assets that, in many cases, are available for liquidation should the loans not continue to perform. These are different types of companies than you would see as a typical company investment in the BDC.

Okay, thank you.

Arren Cyganovich, Evercore ISI.

I was wondering if you could talk a little bit, I don't know if Steve's available to talk about their philosophy once you have a change in the advisor and what type of investment opportunities are you looking to target under the new Management team?

First, I apologize, my voice is a little bit poor. I've been sick with the flu. I'd also like to just maybe take a moment and congratulate Jim and Mike and the investment team at BlackRock Kelso for a fabulous 2014 and certainly a solid ending in the fourth quarter, in a nice business that has been built with a lot of hard work and sweat equity and through some tough times in the marketplace. And so for that, congratulations to you all for the good work that you've done.

We're very excited about assuming responsibility for the management contract of the BDC. We think that the current course relative to portfolio construction and portfolio management is recently in line with what we would otherwise do at this state, which is to say that the course of monetization of the equities is a critical consideration.

Jim just highlighted that a few moments ago. We will certainly be very focused on that. We think that's integral to ultimately redeploying the proceeds that are currently locked up, and pretty meaningful sum in equities into productive assets that can earn current income and enhance the ROE of the business.

So our focus will definitely be on NII growth and about ensuring quality coverage of our dividend, and about continuing to raise the ROE of the business. From a portfolio construction point of view, we would continue at this moment in where we are in the credit cycle to buy secured risk, certainly to more asset intensive businesses, less volatile businesses, less beta overall. So I don't think that one should expect a material change in approach as to the previous management team in terms of where our focus will be in the near term on a go-forward basis.

Great, thanks, that's helpful, and then in terms of the types of investments that you'd be seeking, is it still along the lines of a directly originated, well-underwritten private focus, or would you also include some opportunistic secondary market purchases as well?

Yes, that's a great question. Look, we are a direct investment business, we are not a secondary markets business. We will focus our efforts on creating value through direct relationships with the various sourcing channels that I think are available.

That includes directly with companies as well as with sponsors and other forms of intermediaries, but we certainly want to be in a position that we can, in fact, affect the quality of the underwrite, the structure. At the end of the day, what's most important to us is preserving capital, protecting our clients' capital. So owning the pen relative to that origination exercise is certainly an important consideration for us.

That's good to hear. And then in terms of the change in the new fee structure, what was the thought process putting a two-year transition period for that? Why not just do it immediately upon closing transaction?

This is Larry speaking. That was part of the negotiated transaction, and at the time BlackRock felt that from a legal and regulatory perspective, delaying the rollout of the amendments for a two-year period would be in the best interest of the stockholders.

Okay, that's fair. And then in terms of the current investment pace, did you provide any update on terms of quarter-to-date activity in terms of new investments and exits from the portfolio? And then I guess secondly, Jim had mentioned that the environment still seems somewhat frothy, which is going against somewhat from what we're hearing from other management teams as being a much better investing environment over the past several months versus the past several quarters.

Let me address the second point first. I think you are right, things are better, but I would be -- it would certainly, in my mind, be far from being anything other than frothy at this point in time. In terms of investments, our exits this quarter, the only one that we have talked about is the M&M sale.

I would expect at this point in time we have several opportunities on our plate for acquisitions and we also have at least one possible exit that could happen. I would expect, depending on what happens with those particular transactions, that we would end the quarter somewhere around where we are today in terms of total net assets. Arren, it's Mike. I would just add that we have seen, over a long period of time, that the first quarter tends to be seasonally slow in our business. People do like to close new leveraged buyout private equity transactions, there's sort of a rush to year-end. I think that was very much true in 2014 as well.

We don't view it as unusual to get a slow start in this sort of January, February timeframe of any new year. And we are, in fact, now starting to see things pick up quite a bit in terms of activity level. To comment on Jim's comment on the frothiness, yes, there has been slight easing in the liquid credit markets in the last month or two versus the run-up to year-end.

I think there were a lot of structural reasons that the run-up to year-end happened. A lot of people wanted to print CLOs in 2014, and that had an effect on the marketplace in which we exist also.

But when you look at the statistics, the year ended on a very, very high note in terms of high leverage, lower covenant levels, less protections, and yields. And while there may be some slight easing off of that, easing off of a pretty high level so we still want to be pretty cautious and I'm sure that going forward, BlackRock will want to engage in that same kind of cautious and thoughtful behavior in terms of portfolio construction.

Okay, thanks. And then just a thank you to Michael and Jim for your help over the past few years.

Our pleasure.

Troy Ward, KBW.

And I'd like to start off as well, Jim and Mike, just wanted to say congratulations and thanks to both of you. It's been a pleasure to get to know you and working with you on BKCC over the past seven years, and our team here definitely wishes you the best in your new role and all your future endeavors.

Thank you.

Mike, real quick, Michael, just a couple quick housekeeping questions. In the fourth quarter as we look at kind of the yield on the assets, can you tell us was it weighted more, the originations in the quarter, was there any significant weighting either to the front or the back of the quarter that could help us with the yield on the portfolio in the coming quarters?

Sure, that's a good question. I think our single largest investment in the quarter and of all time is the aggregate investment in Gordon Brothers. And that's a relatively high coupon pair of securities and the two interest-bearing securities. And again, you'll see that that transaction didn't close until right around just about a minute or two before the middle of the quarter.

So that single timing would have a pretty big effect. Oxford, a smaller investment, but again, first lien loan good coupon, that closed right at the end of December.

Okay, so you've got about exactly half of the income that Gordon Brothers would have generated for a full quarter?

Just slightly more than half.

Okay, great. And as we look at the remaining equity gains in the portfolio, what is your ability to affect the sale and actually maybe continue to move out of some of those? What is your ability to do that from a control perspective?

Well, we don't control any of the big positions that we are in. But we have relationships with all of the investors in those transactions and we've made it quite clear that it's our desire to move on in each of those cases. As you can well imagine, in some cases we have more influence than in others, but I think our interests are in part just because of the passage of time and the maturity of these investments.

It's clearly aligned with the other investors in these transactions. So as I said earlier, we are certainly closer to the end than we were a year ago, just largely because of the maturity of these transactions. They have been held by their investors for quite some time and I think they may have a little bit of different timing than our immediate desire might be, but it's certainly -- I don't see any long-term [holes] here.

Great, and then just switching gears a little bit to Steve, can you just talk a little bit about the future? First of all, in one of your comments earlier you talked about, you just mentioned credit cycle. Where do you think we are in the current credit cycle and what are some of the key factors you look for as you look at the overall middle market?

So, one can never know for sure where you are in the cycle. It's best guess. Certainly, it feels like we're well into the game, using the baseball analogy.

I think, though, I'm pretty bullish on the US economy, certainly in 2015. I feel good about where we are there. Certainly from a metrics point of view, looking at things like employment, capacity utilization, are certainly macro indicators that would give you some sense of where, potentially, we are in a cycle. But as we think about the investment horizon over the next 12 to 18 months, it feels to me like we are in a pretty good position at the marketplace.

But we are dealing with assets that are pretty sticky and certainly in a higher-risk part of the market, being the middle market. We think we can mitigate that risk through good underwriting decisions, good structuring decisions, and we think there's good opportunity to extract value but we want to be very prudent in terms of our portfolio construction and the situations that we play. Not all that dissimilar, I think, to what the team has done heretofore, we'll continue to be, I think, fairly vigilant around that selection process.

Okay, great, and then one final one, Steve, it's just a quick question about capital allocation. Given where the shares are trading now, assuming you're trying to stay in that range, you've had a nice lift off a very depressed price, but up to around 90% of book value, even under with the nice move-in book value, how do you feel about using capital for share buybacks in the current environment?

Good question. Look, we will evaluate all aspects of value creation for the shareholders, and stock buybacks are certainly one aspect of that. But there are a lot of things to consider in that decision of buyback versus investment analysis, including but not limited to, certainly, the friction costs associated with that as well as the opportunity costs.

Portfolio risk and capital markets considerations vis-a-vis float, so we want to take a pretty holistic view and determine what we think is in the best interest of the shareholders over the longer term, which is really sort of BlackRock's view around managing client capital. So again, I think everything is under consideration but I think we need to take qualitative as well as quantitative factors into account as we make those decisions. We reinstituted our share repurchase program at our most recent Board meeting after having put it on hold during the pendency of this transaction.

I apologize, I was on mute, can you guys still hear me?

We can now.

I just followed up, and just I assume the window was closed so now that you've reinstated, have there been any shares purchased? And is the window currently open following the filing of the 10-K here?

The window hasn't opened, but at this time we can't comment on purchases.

Okay.

(Multiple speakers) other than comment.

Okay, thanks for your guys' comments and, Steve, thanks and look forward to working with you in the future.

Look forward to working with you as well.

Doug Harter, Credit Suisse.

Thanks; my questions have been asked and answered.

There are no further questions at this time.

Well, once again, thank you all for attending this conference call, and we stand ready, willing, and able to answer any questions you have that come to mind after the end of the call. Thank you.

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