BlackRock Capital Investment Corp (BKCC) 2017 Q3 法說會逐字稿

Good morning. My name is Sarah, and I will be your conference facilitator today for the BlackRock Capital Investment Corporation Third Quarter 2017 Earnings Call. Hosting the call will be Chief Executive Officer, Michael J. Zugay; Interim Chief Financial Officer and Treasurer, Mr. Michael Pungello; General Counsel and Corporate Secretary of the company, Laurence Paredes; and Nik Singhal, Investor Relations and Business Strategy. (Operator Instructions) .

Mr. Paredes, you may begin.

Good morning, and welcome to BlackRock Capital Investment Corporation's Third Quarter 2017 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 uncertainty. 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 statement.

As you know, BlackRock Capital Investment Corporation has filed with the SEC reports which lists 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, Mike will highlight some of the information contained in the presentation. Presentation can be accessed by going to our website at www.blackrockbkcc.com and clicking the November 2017 Investor Presentation link in the Presentations section of the Investors page.

Thank you. I would now like to turn the call over to Mike Zugay who will provide an overview of the business and third quarter highlight.

Thank you, Larry. Good morning, and thank you for joining our third quarter earnings call. Before we begin, I would like to introduce Mike Pungello, our interim CFO. As we have previously announced, on October 20 the Board of Directors, in consultation with the advisor, appointed Mike as the Interim CFO. Soon, we will begin the process of identifying potential candidates for a permanent CFO.

In addition to his interim CFO duties, Mike is co-head of BlackRock's global alternative operations group and has a deep accounting and operations background spanning over 35 years. We have welcomed Michael to the team, and you will be hearing from him later on the call.

Now I would like to start by giving an update on the quarter's business and financial highlights, then move to the current market environment and our investment activity during the third quarter. Lastly, I will discuss the underlying portfolio performance before turning it over to Mike to discuss our financial results in a bit more detail.

For the third quarter, net investment income was $0.17 per share. Based on the $0.18 per share distribution declared by our Board of Directors, there was approximately 92% distribution coverage this quarter. Additionally, net asset value per share decreased from $8.33 per share last quarter to $7.96 per share as of September 30 for a 4.4% quarter-over-quarter decrease. The decline in large part was due to the underperformance of 2 legacy positions, which I will cover in more detail in the portfolio overview section.

Our leverage profile remains relatively low by industry standards at 0.42x, and we have ample liquidity of over $320 million to support new investment activity. Our leverage ratio has seen a declining trend over the last several quarters, primarily because we are highly selective on new investment opportunities. We have passed on many potential opportunities due to credit quality, structure and to our pricing, all of which have reduced the attractiveness of such opportunities.

As has been the case, the last several quarters, the current market conditions for middle-market leveraged loans can be generally categorized as being highly competitive or in other words, borrower friendly. The abundance of junior capital available, coupled with tighter supply has led to spread compression, especially for second lien loans. We are seeing higher total leverage levels and weaker structures, especially more covenant-light loans in the upper end of the middle market, greater than $50 million of EBITDA. Given this backdrop, we are focused on borrowers with strong underlying credit profiles with a bias toward first lien senior secured loans.

Our 3 core channels for deployment continue to be: investments in high-quality junior capital opportunities; our portfolio company investment in Gordon Brothers Finance Company; and our portfolio company investment in BCIC Senior Loan Partners, our first lien joint venture. With regard to BCIC Senior Loan Partners and Gordon Brothers Finance Company, both entities have underlying investments and diversified pools of primarily first lien loans that generate attractive risk-adjusted returns, yielding greater than 11% on our investments in each of these 2 entities. We believe that our liquidity profile puts us in a favorable position, as we patiently deploy capital into these core strategies.

From March 6, 2015, when BlackRock assumed responsibility for managing the investment activities of the company, the end of the third quarter, our team has deployed approximately $600 million into new investments. As of September 30, approximately 50% of our investment portfolio by fair market value is represented by investments deployed by the new advisor.

Quickly turning to the liabilities of the company. In the quarter, we redeemed approximately $60 million or 52% of our 5.5% unsecured convertible notes due 2018 via a tender offer. We have ample liquidity to repay the balance of these notes with proceeds from the revolving credit facility at maturity in February 2018.

We incurred approximately $1.3 million of onetime expenses related to the partial tender of the 5.5% notes above par, which shows up on the balance sheet as a negative $0.02 impact to NAV. Additionally, we experienced approximately $0.01 negative drag on net investment income due to the impact of higher interest expense associated with having 2 unsecured convertible notes outstanding. If the 2018 notes were paid off entirely from the beginning of the quarter through quarter-end, we would have picked up approximately $0.01 of NII per share, all else being equal.

Turning to our investment activity during the quarter. We made new investments of approximately $35 million, which was more than offset by repayments and other exits totaling $76 million or a net $41 million decrease in our portfolio due to investment activity.

Our gross deployments in the quarter were primarily represented by 3 investments: a $15 million L 700 second lien term loan to Midwest Physician Administrative Services, a new portfolio company; $9.3 million of incremental equity to Senior Loan Partners; and $7.1 million of incremental L 1100 unsecured debt to Gordon Brothers Finance Company. Nearly all of the repayment activity in the quarter was represented by 3 portfolio company exits: A par repayment of our $32.5 million Recorded Books second lien term loan; a par repayment of our $32.2 million Waterpik second lien term loan; and a par payment totaling $9.5 million across our first and second lien term loans to SourceHOV, with the second lien being repaid at a premium due to contractual call protection.

Our $9.3 million investment into Senior Loan Partners funded our share of the equity commitment. Senior Loan Partners made investments into 4 new portfolio companies. As of September 30, Senior Loan Partners has committed and funded amounts of $210 million and $197 million, respectively, in 19 borrowers. Given the first lien nature of the underlying investments and strong risk-adjusted returns, we intend to continue to deploy capital into Senior Loan Partners.

With the repayment deployment activity this quarter, we now have 32 companies in our portfolio at a fair market value of $834 million. The weighted average yield of debt and income-producing equity securities at fair market value was 10.8% as of September 30. This is down from 11.3% last quarter, mainly due to our investment in SVP Worldwide going on nonaccrual status.

At this time, we do not have any major updates with regard to restructuring and rotation activity in the portfolio, but we continue to strive to make measurable progress. We have been working with stakeholders involved in the SVP Worldwide investment to rightsize the balance sheet of the company and to provide liquidity in order to better position the company to execute on its 3-year business plan. We are working constructively with the first lien debtholders, other members of our mezzanine tranche and the equity sponsor, with the goal of resolving the situation as quickly and as efficiently as possible. There can be no certainty of outcome at this point in time.

Post quarter-end, Advanced Lighting Technologies was restructured and recapitalized. In summary, Advanced Lighting was restructured via a debt-for-equity exchange pursuant to which certain existing debt holders, including BCIC, selectively acquired substantially all of the equity of the company and have provided additional capital to help fund growth initiatives. This investment was also placed on nonaccrual status this quarter, as the restructuring was not consummated till after quarter-end.

We had greater volatility in the valuations this quarter due to certain legacy investments, which primarily drove a negative $18.2 million change in fair market value versus last quarter or a 2% decline in the overall fair market value of the portfolio.

Three investments: SVP Worldwide; MBS Group Holdings; and Advanced Lighting accounted for the vast majority of the decreases in valuations this quarter. In the case of MBS Group Holdings, an investment bank was hired to run the sales process. Final bids after the due diligence process came in lower than the initial indications. We are currently evaluating final bid proposals in order to make a decision on the path forward for MBS.

For Advanced Lighting, the majority of the change in valuation was driven by the finalization of the restructuring terms and the impact on the original investment, coupled with the decline in LP and EBITDA.

The negative movements this quarter were partially offset by increases in valuations of U.S. Well Services, Vertellus, AGY and Red Apple. Given the equity and equity-like nature of these investments, they are highly sensitive to movement in EBITDA, and these businesses all saw varying degrees of EBITDA improvement that drove the valuations higher.

With that, I would like to turn the call over to Mike 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 2017.

GAAP net investment income, NII, was $12.1 million with $0.17 per share for the 3 months ended September 30, 2017. Relative to distributions declared of $0.18 per share, our NII distribution coverage was 92% for the quarter.

Fee income earned on prepayment, commitments and administration during the current quarter totaled $0.2 million as compared to $0.1 million earned during the preceding quarter and $0.5 million earned during the prior year quarter. Excluding fee income and a $0.6 million insurance reimbursement in the prior quarter related to a previously disclosed legal settlement, total investment income decreased approximately 8% compared to the prior quarter and decreased approximately 12% as compared to this quarter 1 year ago.

On September 26, 2017, the company purchased approximately $60 million in aggregate principal amount of its $115 million 5.5% unsecured convertible senior notes due 2018, the convertible notes. Pursuant to a cash tender offer at a purchase price equal to $1,015 per $1,000 principal amount of notes purchased plus accrued and unpaid interest, using borrowings under the credit facility and cash on hand. All convertible notes purchased in the tender offer were retired and canceled and are no longer outstanding under the indenture. The aggregate purchase price of the convertible notes was approximately $60.9 million.

As of September 30, 2017, 2 investments were in nonaccrual status, amounting to 2.7% of our total debt investments at fair market value and 8.9% at amortized cost compared with 0 last quarter.

Our average internal investment rating at fair market value at September 30, 2017, was 1.3 as compared to 1.34 as of June 30, 2017.

As compared to the comparable 2016 period weighted average, our 9-month 2017 weighted average cost of debt increased 131 basis points to 5.66%. This was primarily driven by: one, one-time items related to our liability management activities, including the early repayment of our $17 million of 6.6% notes and $15 million term loan during the second quarter of 2017; two, lower average balances on our revolving credit facility and higher average balances on our 2022 convertible notes as a percentage of total debt; and three, higher LIBOR rates for the current period. Excluding the aforementioned onetime items, the weighted average cost of debt for the 9-month period of 2017 was 5.23%.

Net unrealized depreciation on investments before tax increased $19.3 million during the current quarter, bringing total balance sheet unrealized depreciation on investments before tax to $57.1 million.

During the quarter, gross unrealized depreciation on investments of $24.6 million was offset by $42.8 million of gross unrealized depreciation on investments for a net $18.2 million of depreciation due to portfolio valuation.

As previously disclosed, we announced a waiver of incentive management fees based on income from March 7, 2017, to December 31, 2018.

For the 3 months ended September 30, 2017, $1.5 million of incentive management fees based on income were waived pursuant to this announcement.

The cumulative amount of such incentive management fees waived since March 7, 2017 is $5.1 million.

During the quarter, there was no accrual for incentive management fees based on gains.

At September 30, 2017, we had total liquidity of approximately $389 million, consisting of $5 million in cash and cash equivalents and $384 million of availability under our credit facility. However, our availability for portfolio company investment is limited to approximately $323 million in order to comply with the 200% asset coverage requirement.

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

Thank you, Mike. We thank you for your participation in today's call. This concludes our prepared remarks.

With that, operator, we'd like to open the call to questions.

(Operator Instructions) We'll go first to Jonathan Bock of Wells Fargo Securities.

Joe Mazzoli filling in for Jonathan Bock. For the first question, what was the investment that led to the $5.6 million tax charge? And then, also, kind of, and a related question to that is, what confidence can you give investors that some of these onetime surprises will not occur in the future, right? I think it was about a year ago, there was an $18 million charge related to a legal settlement. So for investors, this is essentially paid out of NAV. So if you could provide some color around that, that'd be helpful.

It's Mike Zugay here. Thank you for your questions. On question number one, with regards to the tax liability. So we use blocker corps -- a blocker corp for all of our equity co-investments and any equity securities that we have. They're part of an LLC. So for this quarter, the U.S. Well investment was marked up and created that tax liability. Now that number could fluctuate up and down depending on the accounting for the tax liability calculation. So this quarter, in particular, to answer your question directly, U.S. Well was the culprit, if you will, that led to that increase in -- or in the creation of the deferred tax liability.

Joe and just, one other point on that, in terms of it being -- this is Michael Pungello, by the way. In terms of it being a surprise. It's actually just a reduction of the gain we took on the investment. So net-net for the quarter, right, U.S. Wells was a positive contributor to the net.

Okay, that is very helpful. So there was an offset and, of course, it was just paid on the gain.

But Joe, there, just to be clear, it's not paid, because it's not a realized gain. It's just booked. And -- but it's not a cash transaction. So what Mike was referring to is, this quarter, U.S. Well was marked up. So it impacted NAV positive -- positively by about rough numbers, $15 million increase quarter-over-quarter in that. And the tax implication was a $5 million tax liability. So net-net, it was a positive contributor to NAV and it is not a cash transaction.

Okay, that's helpful. And just one more point for clarification. So -- and I understand it's not a cash transaction, but if that investment in U.S. Well is sold, it of course will be a cash transaction, I believe. And then, also, for other BDCs that have LLC equity, don't they structure these deals in a way where they can avoid having this deferred tax liability?

Correct. Usually, what you have is NOLs that offset those potential liabilities. In this case, the gain -- the increase in value used up for -- just to use -- simple dollar -- Mike used the official accounting terms here. But the increase used up the NOLs that existed in the blocker corp for that investment.

Okay, and the next question, could you kind of remind us of the opportunity set within Gordon Brothers and then also the Senior Loan Fund? Clearly, these strategies are delivering attractive returns. How large can these grow in the coming quarters as a percentage of the portfolio?

Yes, Joe, good question. So Senior Loan Partners, currently, our equity commitment to that vehicle is $85 million. I believe, using rough numbers, we're about $66 million funded on that $85 million commitment. That is a use of our 30% bucket. It's one of the only -- there are a few other ones, but it's the majority of our 30% bucket. So we can, over time, increase our exposure to Senior Loan Partners. So we've got, call it, $19 million of additional capacity in the current JV. We can expand the JV. We can have another -- a JV 2. But ultimately, the 30% bad asset bucket will be the limiting factor on how big Senior Loan Partners can be. And right now we've got room on the current commitment that I just described and probably another -- room for another, call it $80 million to $85 million of additional commitments, if we chose to use all of the remaining bad asset bucket for Senior Loan Partners.

With regard to Gordon -- Is that helpful?

Yes, that's very helpful.

With regards to Gordon Brothers, a separate portfolio company, Gene Martin is the CEO of that business. They've -- they're doing asset-based loans, they've got a great team, a great team of originators there. They're very good, top-quality performers in the asset class that they invest in. We would -- it's kind of hard to predict the ebbs and flows of our commitment to Gordon Brothers. As their portfolio expands, our commitment can expand. As it contracts, we get repaid on our subnotes with the company. But as far as that business goes, they're in growth mode. So their portfolio can expand as big as the opportunity set that they see, to stay kind of right in the middle of the fairway of the types of deals that they look at. What that means for us, from our perspective is, we would like to support that growth. We are enthusiastically able to support that growth. And their business plan could call for another, anywhere between $20 million and $60 million of incremental investments from us over the next, you know, 18 months. Now how that actually plays out is a function of the deals that they see. But we are more than happy to support Gordon Brothers in their growth initiatives. Just given the asset class that they're investing in, their track record and the sophistication of their team.

That's great, and clearly, no doubt, very attractive returns available in those 2 investments. And just as a -- one quick final question, what is the legacy portfolio cutoff date? Is there a specific date? And then also, was MBS really a legacy investment, or is that a, kind of, a BlackRock Capital investment?

Okay. So legacy cutoff -- I'll answer those in order. So legacy cutoff is, any investments that were made prior to BlackRock's ownership of the advisor, which is March 6, 2015. Any investments that were made prior to that is a legacy investment. Any investment made after that is what we're defining as, the portfolio that this management team has put together. So that's the line in the sand. MBS, to be honest with you, that was a -- I believe it was a 2006 initial investment, so clearly, a legacy investment. It was restructured, I believe, in 2014, prior to BlackRock's ownership. So definitely a legacy investment for MBS. And we continue to evaluate what we're going to do on a go-forward basis with that portfolio company.

(Operator Instructions) We'll go next to Paul Johnson of KBW.

My first question is just, kind of, centered around, sort of, your outlook for run rate earnings, and clearly waiving incentive fees is a pretty big benefit to shareholders throughout the rest of next year. But as I look at the run rate of earnings, I'm just wondering if -- are you guys confident with growth and running at your optimal leverage rate to be able to sustain a pretty healthy yield to stay above like, roughly a 9% ROE on your dividend currently?

Paul, this is Mike, Mike Zugay here. Thanks for calling in and thanks for the question. We don't give forward guidance on the run rate or outlook for earnings. But I can tell you, as we set the dividend level from $0.21 to $0.18 a few quarters ago, we factored in -- a lot of things into the calculus to get to that number to give us a high degree of confidence in the $0.18 dividend number. We are, at this point, relatively low levered by industry standards, and we do have 2 very attractive moves right now with Gordon Brothers and Senior Loan Partners to generate very good risk-adjusted returns that generate cash NII and are very good contributors to getting to 9-ish, 10-ish percent ROE. So look, as we look forward, we're in a very fortunate position to have the ability to expand 2 relatively high-quality portfolio companies -- portfolio company investments that have diversified pools of primarily first lien loans. So the quality and the diversification that these 2 investments provide us and the return profile are very attractive in the marketplace and give us a high degree of confidence in our -- the sustainability of our dividend level.

That's a good answer. And then my next question, just, is really, [kind of] on your, just, outlook on investments, I mean, we understand the willingness to be patient and selective with the capital deployment. We definitely prefer that approach. But I'm just wondering if we can get a sense of, sort of, what your outlook for new investments are. I mean, clearly getting leverage up to an optimal level is key to getting earnings back up above the dividend. So I'm wondering if you could give any sort of commentary on that and maybe identify any other catalyst that would help to propel leverage up to that optimal level.

Yes, look, the outlook for investments for straightaway second lien loans, it -- as you heard in my prepared remarks and some of the stuff in the press release, it is a competitive environment out there. I'll give you one just relatively quick example of what we're seeing in the marketplace. One of the companies we were looking at, that -- the -- it was a rather large EBITDA business. It was a middle-market issuer and kind of made an acquisition to get into the area above, kind of, $75 million to $100 million. The -- that loan, that second lien loan that we were really interested in, the initial price talk was around L750 to L775. It ended up tightening to L675 with effectively no OID. I mean, that just -- that will give you a sense of where -- of what's going on in the second lien market right now. We are not seeing that same level of spread compression that you're seeing in the second lien market, in the first lien market. So our outlook for investments and what we have control over is senior -- not -- what we have influence over, is Senior Loan Partners. So we continue to find really good risk-adjusted return in the first lien market. Golden Brothers is also out there, hustling to find opportunities to invest in. We are fully supportive of anything that they bring to the table and additional capital that they would need. So our outlook for those two, I would say, is very positive. The outlook for second lien loans, we are being very, very careful and very patient on what we deploy. We just don't want to run into situations, where we are stretching on structure or pricing or terms, and then find ourselves with poor-performing credits. So we are only focusing on the absolute best credit profile that we see for second lien opportunities. That may mean, as you saw this quarter, with our investment in DuPage, it's L7. But it's a very solid, very good sleep-at-night credit with a very low loan-to-value with great sponsorship behind that deal. So we're just being very selective. So look, unless something dramatically changes in the second lien market to increase the yields there, we're going to continue to just be patient on that front and aggressively prefer -- pursue the other 2 options.

(Operator Instructions) Up next from JP Morgan, we'll go to Rick Shane.

It's Melissa Wedel for Rick Shane. I was hoping that you guys could elaborate on the fundamental performance that drove the mark higher for U.S. Well Services and then also provide an update on fundamental performance at Red Apple stores?

Yes. Melissa, thanks for the call. This is Mike Zugay speaking here. Look, the fundamental performance for U.S. Well, the company has -- went -- as goes with drilling activity in the Marcellus and Utica regions, that area is experienced -- experiencing very robust drilling activity at this point in time, so that our business is in those 2 regions, and we are -- the company is performing very well. All their fleets are utilized, and performance of the company is increasing dramatically versus the prior year's period. So it's EBITDA -- to be very specific, EBITDA growth at that company is driving the valuation. With regard to Red Apple, that business, we have been working with the management team to figure out ways to increase cash flow and put the company in a better position to generate more EBITDA. So one of the initiatives that we've had in the relatively near term is a -- is figuring out ways to reduce some of the marketing expenses that the company is incurring. So we made some tweaks to the direct marketing campaign at the company and it's increasing EBITDA, which is driving excuse me, the valuation. So once again, there, EBITDA growth, fundamental EBITDA growth driving the valuation.

Okay, got it. And I'm wondering, as a follow-up, if you have any insight into any anticipated repayments in 4Q?

The -- that stuff happens relatively quickly. The one area that we do have some visibility into, to deal what's the marketplace, Superior Vision, which is on our books as Wink, is a deal that -- they're making a rather large acquisition. It's going from about -- from -- it's basically quadrupling EBITDA and getting done broadly syndicated loan market. So we'll be losing that investment. It's about $37.5 million. And there's other activity as well. But that's a big component of what we at least have the visibility into at this point. And there will always be a couple portfolio company runoffs per quarter. And hopefully we are offsetting that with new investments, whether it's in Senior Loan Partners, Gordon Brothers, or other new junior capital investments.

And it appears there are no further questions at this time, I would like to turn the conference back over to our speakers for any additional or closing remarks.

Thank you very much for your participation in the call. We look forward to speaking with you guys. Anytime there's questions, please give us a call. And thanks again.

And again, that does conclude today's conference. We thank you all for joining us.