BlackRock Capital Investment Corp (BKCC) 2016 Q3 法說會逐字稿

Good morning. My name is Keith and I will be your conference facilitator today for the BlackRock Capital Investment Corporation third quarter 2016 earnings call. Hosting the call will be Chairman and Chief Executive Officer, Steven F. Sterling; Head of Investments for BlackRock's U.S. Private Capital Group, Michael J. Zugay; Chief Financial Officer and Treasurer, Donna M. Milia; General Counsel and Corporate Secretary of the Company, Laurence D. Paredes and Nik Singhal, Investor Relations and Strategy. Lines have been placed on mute. After the speakers complete their update, they will open the line for question-and-answer session. (Operator Instructions).

Mr. Paredes, you may begin the conference call.

Good morning and welcome to BlackRock Capital Investment Corporation's third quarter 2016 earnings conference call. 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 Capital Investment Corporation's actual results may differ from these statements.

As you know, BlackRock Capital Investment Corporation has filed with the SEC reports, which list some of the factors which may cause BlackRock Capital Investment Corporation's results to differ materially from these statements. BlackRock Capital Investment 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 Capital Investment Corporation makes no representation or warranty with respect to such information.

Please note we have posted to our website an investor presentation that complements this call. Shortly, Steve will highlight some of the information contained in the presentation. The presentation can be accessed by going to our website at www.blackrockbkcc.com and clicking the November 2016 investor presentation link in the presentations section of the Investor Relations page. Thank you.

I would now like to turn the call over to Steve Sterling, BlackRock Capital Investment Corporation's Chairman and Chief Executive Officer, who will provide an update on our quarterly results.

Thank you, Larry. Good morning. Yesterday after the market closed, we announced the Company's third quarter financial results. The announced results showed net investment loss of $0.03 per share and net asset value per share decreased by $0.75 or 8.2% to $8.38. Excluding a non-recurring litigation expense, net investment income would have been $0.21 per share, providing distribution coverage of 101%.

The third quarter proved to be another difficult period, as we continue to work through issues pertaining to the legacy portfolio including the pending settlement of the AL Solutions litigation. To be clear, the Company's portfolio challenges remain concentrated in legacy investments. Since March 6, 2015, which is when we assumed responsibility for managing the investment activities of the Company, our team has deployed over $400 million in performing new investments.

We are pleased to have come to an agreement in principle for the settlement of the AL Solutions litigation. For the affected families and our client shareholders, we welcome the closure and elimination of uncertainty arising from this tragic event that occurred in 2010. While there can be no assurance, we anticipate final settlement to occur in the fourth quarter.

Consequently during the period, the Company recognized a legal settlement expense pertaining to the litigation of $17.5 million or $0.24 per share. We anticipate payment of this settlement during the fourth quarter. Separately, we are pursuing claims under available insurance policies that may partially mitigate this cost to the Company. At this time, we are not certain of the amount or timing of receipt of such insurance proceeds and the amount, if any, may not be material. You will find additional details pertaining to the case in the 8-K filed on October 6, 2016 or in the recently filed third quarter 10-Q.

Unfortunately during the period, additional setbacks primarily from legacy investments resulted in $33 million or $0.46 per share in unrealized losses, due to portfolio valuations and increased the portfolio's average risk rating on a fair market value basis from 1.31 to 1.40. Overall the portfolio fair market value relative to cost was 90.2%. Risk-rated three and four investments had a total fair market value of $113 million at an average mark of 49 and represented 19% of net asset value. Nearly 70% of this exposure was concentrated in two positions, SVP Worldwide and US Well Services. Each of these situations has unique circumstances for which the team is working to address with their respective management teams and owners. Similar to Hunter Defense and Vertellus, our role in these investments positions the team well to manage and influence the situations to maximize value for our client shareholders.

The headwinds created by these legacy issues have constrained management's degree of freedom in deploying net new capital as we look to balance the Company's financial leverage and absolute level of net investment income. As you may recall, during the second quarter of 2015, new management made the strategic decision to monetize $161 million of legacy equity positions in order to increase flexibility and position for growth in net investment income. This capital has been recycled into income earning assets, however, the anticipated growth has not followed in light of the legacy portfolio challenges. Both for reasons of market conditions, which were bubbly for sure, and our continued prudent risk management, as of quarter end the Company remained moderately leveraged at 0.55 times pro-forma for the litigation settlement. Additionally, the Company continued to maintain good liquidity at over $250 million, supporting flexibility and capacity for new investments.

Looking forward we seek to deploy net new capital across three core channels of opportunity including 1) BCIC Senior Loan Partners, LLC , which we shall refer to as Senior Loan Partners, the first lien joint venture that we closed in June of this year, which had about 25% of the committed equity capital deployed during this quarter; 2) our investment in Gordon Brothers Finance, which is an established asset based lender and 3) direct investments in junior capital instruments.

Our investments in Senior Loan Partners and Gordon Brothers Finance, which are anticipated to generate low double-digit returns for the Company, provide us with exposure to diverse pools of well secured, top of the capital structure opportunities with low loss given default risk profiles. Further, our investment activity here strengthens the sponsor relationships we have in the middle market that are important to our longer-term direct junior capital middle market investment strategy.

Finally, in regards to investing in junior capital opportunities, in our view, the strong market conditions have eroded risk-adjusted returns in this part of the capital structure. Our team has been working diligently and with discipline to unearth attractive investment opportunities.

To this end during the period, our idea generation rose 65% sequentially while our conversion rates across the sourcing funnel meaningfully declined as we concluded these opportunities to be largely unsuitable for the Company. We remain generally constructive on the US economic outlook but appreciate that we are late in the business cycle and confronted with structurally weak growth and elevated risks. Consequently, while the momentum of origination activity has continued into the fourth quarter, we will continue to execute our disciplined approach to investment selection, portfolio construction and prudent use of Company's financial leverage.

Mike will now discuss investment portfolio developments.

Thank you, Steve. Overall, middle market loan volumes continue to be depressed as compared to loan volumes over the past several years. However, there was a modest increase in activity during the period from the previous two quarters. During the quarter, we experienced an uptick in investment opportunities with both sponsor and non-sponsor related companies versus the first and second quarter of 2016.

Not only did we see more investing opportunities in LBOs, but we also observed the resurgence of dividend recapitalizations. As per S&P LCD, dividend recapitalization transactions accounted for 38% of middle market loan volume in the third quarter as compared with 18% during the year-to-date period. The fact that we are seeing an increase in dividend deals and general refinancing activity is primarily the result of strong investor demand and increased competition in a yield hungry environment. Investor demand, especially for borrowers with solid credit profiles is leading to slight increases in leverage multiples and the tightening of credit spreads. Additionally, we are seeing continued pressure on the structural elements that has given rise to more covenant lite transactions.

Turning to our investment activity during the quarter, we had approximately $30 million of net prepayments in our portfolio, primarily due to the previously disclosed repayment of our aggregate $69 million position in MediMedia. Other repayment activity was light in the quarter. Our gross deployments in the quarter totaled approximately $44 million substantially, all of which was through incremental capital deployments into four existing portfolio companies.

First, being $2.6 million of 12% subordinated debt and equity interests in First Boston Construction Holdings, LLC, the proceeds of which were used to fund growth initiatives. Second, being $9.5 million of L+1100 unsecured debt and preferred equity in Gordon Brothers Finance, also used to support the company's growth initiatives. Third, being $7.5 million of L+1000 second lien term loan in Pomeroy Group. We purchased Pomeroy's second lien term loan at a discount to par from another member of the second lien club. Our total exposure in Pomeroy is now $27.5 million of face value.

Finally, we deployed $21 million into Senior Loan Partners to fund our 85% share of its equity. Senior Loan Partners made three new underlying investments, namely, (i), a $10 million first lien term loan to AP Plastics Group, LLC, a provider of high-quality PVC compounds primarily used to make vinyl for building product applications, (ii) a $7 million first lien term loan to Pasternack Enterprises, Inc., a specialty distributor of components and connectors for radio frequency and other technology related products and (iii) a $9.5 million commitment in first lien exposure to NSM Sub Holdings Corp, a provider of rehab solutions for patients with loss of mobility. We believe there is a good pipeline of future opportunities for Senior Loan Partners as we continue to ramp the partnership.

The weighted average yield on all income bearing investments deployed in the quarter was 11.9%.

Moving to non-accruals, Vertellus, Shoreline and Advanced Lighting remained the only investments that were on non-accrual status at the end of Q3, 2016. Subsequent to quarter end, Vertellus completed the 363 sale to its term loan lenders and will move off non-accrual status. Pro forma for Vertellus, non-accruals represented $4.7 million at fair market value or 0.5% and 4.4% at amortized cost.

The Vertellus restructuring has resulted in a much improved capital structure and increased financial flexibility to invest in growth initiatives. We played a meaningful role in the restructuring as a member of the ad hoc group of term loan lenders that credit bid for the assets through the 363 sale process. We continue to be supportive of the company and will serve on the Board of Directors going forward. We thank its management team for their efforts and look forward to our continued partnership.

With regard to Shoreline and Advanced Lighting, there have been no meaningful new developments. In both of these situations our role is more limited given our relatively small investment positions.

As we look at the rest of the portfolio, we have been particularly focusing time and resources on SVP Worldwide and US Well Services. In our filings you will see that these two positions represented about $78 million at fair market value and both sustained additional declines in fair market value. In regards to SVP Worldwide, this unsecured mezzanine investment was marked down to 61% from 64% last quarter. We are a material investor with Board observation rights. We continue to believe in the long-term prospects of the company, but recognize there is work to be done in the near term.

With respect to US Well Services, we are invested in both its first lien term loan and junior preferred equity. Both of these instruments recognize a decline in fair market value, with the preferred equity position decreasing from $10.6 million to zero. We continue to be supportive of the company and the management team, but the pricing environment for pressure pumping services in its core geographies has deteriorated over the past several months.

With that, I would like to turn the call over to Donna for some additional details regarding our financial results.

Thank you, Mike. I will take a few minutes to review additional financial and portfolio information for the third quarter of 2016. For the third quarter 2016, GAAP net investment loss and net investment loss as adjusted were both losses of $2.1 million or $0.03 per share. Excluding the one-time legal settlement expense during the quarter of $17.5 million net investment income was $15.4 million or $0.21 per share. As compared to the comparable 2015 period our nine month 2016 weighted average cost of debt decreased approximately 100 basis points to 4.35%. This was primarily driven by refinancing our $158 million 6.5% senior secured notes with proceeds from our credit facility and the subsequent lowering of the interest rate margin on the credit facility pursuant to the amendment and restatement earlier in the year.

During the quarter, there was no accrual for incentive management fees based on gains due largely to the net unrealized depreciation in the portfolio as of September 30, 2016. Furthermore, no incentive management fees based on income were earned and payable for the quarter as the distributable income amount was reduced below the hurdle by the net unrealized depreciation in the portfolio for the trailing four quarter period.

Relative to distributions declared of $0.21 per share, our distribution coverage was 101% for the quarter, excluding a one-time legal settlement expense during the quarter of $17.5 million. As of quarter end, our run rate net investment income, as adjusted, is $0.22 per share based on average fee income over the trailing 12-month period and $0.20 per share, excluding any fee income implying a distribution coverage of 105% and 94%, respectively.

The composition of our portfolio remained fairly stable in the third quarter as compared to the second quarter. Secured debt decreased 3 percentage points to 69% at quarter end, primarily due to the prepayment of MediMedia during the quarter. Unsecured and subordinated debt increased 2 percentage points to 16% due to a combination of deployments during the quarter as well as net depreciation in our total portfolio resulting in a smaller overall portfolio at fair market value. Equities increased 1 percentage point to 15% mainly due to the deployment of $21 million into Senior Loan Partners.

During the third quarter, net unrealized depreciation increased $10.4 million, bringing total balance sheet unrealized depreciation to $104.7 million. Gross unrealized depreciation of $36.1 million during the quarter was offset by $3 million of gross unrealized appreciation due to changes in portfolio valuations and $22.8 million of unrealized appreciation due primarily to the reversal of previously recognized unrealized depreciation on the New Gulf investments.

At September 30, we had total liquidity of $271 million, consisting of $7 million in cash and $264 million of availability under our credit facility. At September 30, our net leverage after accounting for the pro forma impact of a one-time $17.5 million legal settlement, stood at 0.55 times. We had an asset coverage ratio of 288% and we were in compliance with all financial covenants under our debt agreements.

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

Thank you, Donna. The Company's financial results for the period were disappointing as we sustained additional negative marks pertaining to the legacy portfolio and recognized a loss associated with a long outstanding litigation claim relative to AL Solutions. The team is working very diligently in addressing portfolio challenges to protect client shareholder capital. Our financial position with moderate net leverage at 0.55 times and over $250 million of liquidity, afford us significant flexibility to navigate the challenges and, concurrently, to selectively deploying new capital into income earning assets.

I am proud of our team's focus, discipline and hard work as we balance important attention to managing challenged legacy positions with a concerted effort in sourcing new opportunities. With the Hunter Defense and Vertellus restructurings now complete, these businesses are now refocused on growth to create value for us, as the new owners. We are optimistic these circumstances will ultimately prove to be successful reorganization events. With similar intensity, we are now particularly focused on SVP Worldwide and US Well Services.

Our idea generation kicked up during this period and this momentum has carried through into the fourth quarter. Consistent with past communications, we remain highly disciplined in investment selection, given the generally weaker quality of opportunities and recognizing where we stand in the business cycle. As touched upon in the prior calls, in the absence of compelling risk-adjusted return opportunities in junior debt investments, we have focused our attention on deploying capital through follow-on investments in Gordon Brothers Finance, which invests in asset-based loans and Senior Loan Partners, which invests in traditional first lien senior secured loans.

In closing, I would like to take a moment to thank our team, who has worked tirelessly to deliver for our client shareholders. Further and most importantly, I would like to thank each of you for your support.

Operator, you may now open the call for questions.

(Operator Instructions) Jonathan Bock, Wells Fargo.

Good morning and thank you for taking my question. Steve, obviously, we appreciate your comments on disappointment, understandably we get that the losses due or unforeseen negative events can impact performance, clearly as it has done here. Our question starting out would be, can you explain why this additional litigation expense needs to be borne by your shareholders and not by your manager?

Hey its Larry Paredes, I'll take this question. So, there has been no finding of any debilitating conduct on the part of 52nd Street with respect to the AL Solutions matter. And indemnification of 52nd Street, which is the former advisor is contemplated within the investment management agreement that was in place between the Company and 52nd Street. So the Company has determined to indemnify 52nd Street and will pay out the entire settlement amount.

I get it. So that's the legal reason I understand, but explain to me why you wouldn't want to cover this loss out of your manager?

This is a debt and equity investment of the BDC, that was done back in 2010. Investing in middle market companies naturally comes with its inherent forms of risk, whether they're credit risk or litigation risk and the like, so this is an undertaking of the BDC. It's a liability of the BDC and so as a consequence, that's where it ultimately gets paid out is the BDC.

Got it, thanks for that Steve. And then maybe jumping one additional step, so come March, I believe you're going to be renegotiating or you mentioned reevaluating the management fee structure to the extent that -- I believe you will eliminate the look back as it relates to unrealized losses. I'm curious now in light of this current performance and just because we're getting pretty close to March, what's your new structure needs to be right in light of where you are at today?

Look, I think the -- as you very well know the determination of what is appropriate relative to management fee structures and the like is a decision in the purview exclusively of the independent directors of the Board and that ultimately is evaluated in the context of fair and equitable vis-a-vis the market and so our Board, not dissimilar to any other board will evaluate it through that lens. Certainly, the directors as they contemplate renewal of an investment management agreement will evaluate the manager and the performance of the manager. Suffice it to say though, as pointed out in the earnings call, if you look at the performance of the management team today, we've put to work $400 million of capital as indicated in the previous 8-K that had been filed with a total return of 16.9%. So as further indicated in the call, the issues that we're navigating through on behalf of our shareholders are issues that existed before the change of the control. So I think from a Board point of view, obviously, one would expect, rightfully so, they'll take into consideration the performance of the new manager as it pertains to new manager decisions. So new investments are solid and critically important decisions relative to monetization of equity is solid. I see no reason as to why they would be any concerns on that dimension.

I think all board members are kind of -- what's right can be often times fungible. I think everyone would realize if the incentive fee structure allows you to collect incentive fees, while losses continue to (inaudible), whether you made that loan or not that would be something that would likely disadvantage the shareholders, so I'd imagine that always gets taken into account. Now, getting to US Well real quick, we noticed the equity was marked to zero in the quarter, but debt was down a bit, but still at 91% of par, walk us through, just in light of the credit issues that had surfaced, not your doing, I understand, but what's your asset coverage there, what gives you the comfort to keep that at 91% of par and how should we be looking at that investment going forward?

Great. I'm going to ask Mike to sort of address the question. Let me make a broad comment though. When it comes to oil and gas assets, obviously valuations have a lot more volatility to them particularly when you're at the bottom of the capital structure, given the nature of these underlying businesses with respect to volatility of EBITDAs as well as just overall valuation within, particularly the business services side of the oil and gas segment. So, when you look at the relative volatility of the equity vis-a-vis the first lien, you have to appreciate the amplitude of that will be much more substantive in equities that might otherwise be in debt.

So with that, I'll turn it over to Mike for further comments.

Yes, so the valuations as Steve mentioned are done by a third party valuation. So they take into consideration, a bunch of different factors when evaluating to make -- where those marks are going to shake out. I think from our side, as we look at this business, there're really kind of two factors that really impact their profitability and EBITDA, it's the utilization of the fleet and the pricing environment for the services. The pricing environment has been challenging. It continues to be challenging, especially in the regions for the Marcellus and the Utica, which is the primary areas that this company focuses on. So there's a lot of excess capacity, not just there, but overall in the market, which is depressing the pricing environment, which is impacting utilization as well. So, it's a tough environment and we're starting to see some signs of life and some signs that pricing may go in the right direction or in the favorable direction to the company, but we're definitely early in that shift and it really hasn't shifted yet. We're seeing signs that it may start to increase. So, we're bound by confidentiality agreements for all of our portfolio companies and I think that's the most I can tell you on that right now.

Thanks for taking my questions.

Thank you Jonathan.

(Operator Instructions) It appears we have no further questions in the queue at this time. I would like to turn the conference back to your presenters for any additional or closing remarks.

Terrific, thank you. Thank you again for joining the call. Obviously, as shared in our commentary, it was a difficult period and that we continue to remain steadfast and focused on working on behalf of you, our client shareholders. We are positioned to support the flexibility required as pertained to legacy portfolio. But as I said before, a concerted effort to driving new capital deployment, so with that, again, we appreciate your support, we remain focused. And if you have any questions please don't hesitate to reach out to us, subsequent to the call. Thank you. Have a good day.

Ladies and gentlemen, this concludes today's conference. We appreciate your participation.