MidCap Financial Investment Corp (MFIC) 2015 Q4 法說會逐字稿

Good morning and welcome to Apollo Investment Corporation's earnings conference call for the period ending March 31, 2015.

(Operator Instructions)

I will now turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

Thank you, Operator, and thank you, everyone, for joining us today. With me today are Jim Zelter, Chief Executive Officer, Ted Goldthorpe, President and Chief Investment Officer and Greg Hunt, Chief Financial Officer.

I'd like to advise everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Investment Corporation and that any unauthorized broadcast, in any form, is strictly prohibited. Information about the audio replay of this call is available in our earnings press release.

I'd also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking information. Today's conference call and web cast may include forward-looking statements. Forward-looking statements involve risks and uncertainties including, but not limited to, statements as to our future results, our business prospects and the prospects of our portfolio Company. You should refer to our registration statement and shareholder reports for risks that apply to our business and may adversely affect any forward-looking statements we make. We do not undertake to update our forward-looking statements or projections unless required by law.

To obtain copies of our SEC filings, please visit our website at www.apolloIC.com. I'd also like to remind everyone that we've posted a supplement financial information package on our website which contains information about the portfolio, as well as the Company's financial performance. At this time, I'd like to turn the call over to Jim Zelter.

Thank you, Elizabeth. This morning we reported earnings for the quarter and the fiscal year ended March 31, 2015 and filed our 10-K. I'll begin with a brief overview of our results for the quarter and the year and discuss some additional business highlights. Then I'll turn the call over to Ted, who will discuss the market environment and our investment activity for the quarter and finally, Greg will close out, overviewing financial results in greater detail. We will then open the call up to questions.

We were very active in FY15. During the year, we invested $2.2 billion, consisting of $1.3 billion in 60 new portfolio companies and approximately $900 million in 47 existing portfolio companies. We remain selective in our approach, with a focus on secure debt which we believe offers the most attractive risk-adjusted return and accounted for 60% of our activity in our portfolio at the end of March compared to 56% a year ago. We experienced significant repayment activity in our portfolio, which provided approximately $844 million of liquidity for us to reinvest during the year.

We took advantage of periods of strength in the market during the year to derisk the portfolio by monetizing select investments and reduce certain larger legacy exposure. We also took advantage of periods of volatility during the year to deploy capital and improve overall returns, which Ted will address.

Despite a market environment of yield compression throughout much of the year, we were generally able to maintain our overall portfolio yield. We achieved this by continuing to execute on our portfolio optimization strategy of rotating out of lower yielding investments and redeploying into less liquid, higher yielding investments, which we believe offer more attractive risk-adjusted returns.

In total, we sold $1.4 billion of investments during the year. The yield on assets sold during the year was 9.8% and the weighted average yield on our debt portfolio at the end of the year was 11.2%, up 10 basis points from a year ago. At the end of March 2015, we had a diversified $3.3 billion portfolio, consisting of investments in 105 companies and 35 different industries.

Turning to our financial results, we reported net investment income of $0.22 per share for the quarter and $0.96 per share for the year, exceeding our quarterly and annualized dividend, respectively. At the end of March, net asset value per share was $8.18, down 3% from the end of December, and down 5.7% year over year. Despite that decline in NAV, we are comfortable with the overall fundamentals and credit quality of our portfolio.

Looking ahead, we are optimistic regarding the opportunities for providers of flexible capital such as ourselves, particularly as new bank regulations impact lending by banks of certain segments of the market. We believe the collective scale of our platform enables us to participate and yet be selective in the marketplace today. We will continue to execute on our strategy of selectively deploying capital and actively monetizing select investments to improve the existing portfolio's overall returns. We will also seek to monetize non-yielding positions and redeploy those proceeds into income producing assets, again, a point Ted will highlight later in this discussion.

During the year, we also continued to focus on the right side of our balance sheet by diversifying our liabilities and reducing our borrowing costs. Greg will address our recent capital raising activities in more detail.

In March, the Board of Directors re-approved the investment advisory and management agreement with Apollo Investment management under the same terms and with the same waivers as last year. Inclusive of the waivers, our effective base management fee is 1.77% and our effective incentive fee rate is 17.7%, based on the current number of shares outstanding. Also and finally, the Board approved a $0.20 dividend for shareholders of record as of June 19th, 2015.

With that, I will turn the call over to Ted.

Thank you, Jim. I'll begin my comments with current market conditions and then discuss our investment activity for the quarter. During the quarter, the leverage loan asset class experienced light supply, moderating retail outflows, and strong CLO issuance. The lackluster level of new issuance activity and strong technicals resulted in lower clearing yields and higher secondary prices in the liquid credit markets. That said, the middle-market lending environment, while not immune, is generally insulated from trends in the broadly syndicated market. During the period, middle-market yields rose following a similar increase in large cap yields in the December quarter.

Based on data from S&P Cap IQ, the premium for middle-market loans compared to large institutional loans increased during the period from 77 basis points to 103 basis points. We believe the middle market currently offers lenders superior risk-adjusted returns as the overall demand for capital from middle-market companies exceeds supply. We believe the current higher yielding environment presents opportunities for us to reposition our existing portfolio without compromising credit quality.

With this backdrop, our origination pace was seasonally slow as we invested $372 million during the quarter in eight new portfolio companies and 15 existing companies. We continue to focus on secured debt opportunities. During the quarter, we exited $476 million of investments, of which 71% were proactive sales, as we continue to rotate out of lower-yielding assets. Floating rate assets represented 52% of the debt portfolio on a fair value basis at the end of the quarter, up from 42% a year ago.

We also continue to focus on non-sponsor activities, which accounted for 52% of investments made during the quarter. Non-sponsor investments accounted for 57% of the portfolio at the end of the quarter, up from 47% a year ago.

Moving to investment activity, during the quarter Merx, our aircraft leasing subsidiary, purchased a portfolio of aircraft from one of the largest aircraft lessors. The majority of the purchase price was internally funded by Merx and we funded the remaining $18 million. The portfolio includes 11 aircraft with an average age of six years, with staggered leases maturities and eight different lessees.

Merx has been able to generate liquidity from the sale of aircraft as well as from earnings to fund much of this transaction. At the end of March, Merx owned 77 aircraft and aviation accounted for 15.4% of the fair value of our portfolio. Our overall allocation target for this vertical was 15% to 20%.

We also invested $25 million in the secured debt of ChyronHego in connection with its acquisition by a financial sponsor. ChyronHego provides broadcast graphics creation, play out and real time data visualization solutions for live television, news and sports production.

We also invested $33 million in secured debt of Telestream in connection with its acquisition by a sponsor. Telestream is the market leader in providing transcoding software solutions that enable the delivery of video content, to any format, to any audience, regardless of how it's created, distributed or viewed.

We also invested $10 million in the secured debt of Saba Software in connection with its acquisition by a sponsor. Saba is the leading provider of learning and talent management enterprise solutions.

Regarding our exposure to oil and gas, most of our borrowers have reduced CapEx and several companies have raised equity during the period, providing them with additional liquidity. At the end of the quarter, oil and gas represented 13.9% of the portfolio on a fair value basis, compared to 13.6% at the end of December. Secured debt accounted for 74% of the total oil and gas portfolio at the end of the period. As with all our investments, we continue to monitor these investments closely.

Exits, which include sales, repayments and revolver pay downs, totaled $476 million for the quarter. We continue to sell lower yielding assets and the weighted average yield for investments sold was 10%. Sales totaled $336 million for the quarter, including our full exit of our positions in US Renal and American Energy Utica. We also reduced our exposure to other investments, including the partial sale of our investments in Hunt Companies, Kronos, Walter Energy, amongst others.

We continue to see a few of our investments get refinanced with new deals. Repayments for the quarter totaled $121 million, including our investments in American Tire, Panda Temple, and Niacet, amongst others. Revolver pay downs totaled $18 million.

Overall, we believe our credit quality remains strong. The portfolio's weighted average risk ratings were unchanged and remained at 2.2 on a cost basis and 2.1 on fair-value basis. Our Holdco unsecured debt investment in Denver Parent, or Venoco, was placed on non-accrual status for the quarter. At the end of March, non-accrual investments represented 0.1% of the fair value of the portfolio, compared to 0.3% at the end of December. On a cost basis, these investments represented 1.3% of the portfolio at the end of March, compared to 1% at the end of December.

As you may have seen, Magnetation, one of our portfolio companies, filed for bankruptcy earlier this month and as a result, this investment will be placed on non-accrual status for the June quarter. The weighted average net leverage of our investments increased slightly to 5.5 times, up from 5.4 times and the weighted average interest coverage improved to 2.6 times, up from 2.5 times.

Before turning the call over to Greg, I'd like to briefly discuss a transaction that was just announced last night. We recently entered into agreement to sell our investment in PlayPower to a private equity firm. Our investment in PlayPower accounted for 3.4% of the total portfolio at fair value by the end of March and included a preferred investment and non-yielding common equity investment. Importantly, the sale will reduce the amount of equity in the portfolio, as well as the amount of PIC income, as we expect to redeploy the proceeds from the sale into cash-producing assets.

For the March quarter, PIC income accounted for 9% of total investment income, and excluding PlayPower, would have accounted for 7% of total income. As a result, we expect our cash dividend coverage to improve. This transaction is subject to customary closing conditions and it is expected to close by the end of June. With that, I'll turn over the call to Greg and he'll discuss financial performance for the quarter.

Thank you, Ted. Total investment income for the quarter was $102.1 million, down 7% from last quarter and up 6% year over year. The decrease quarter over quarter was mainly due to lower prepayment income and lower fee income. Interest income for the March quarter included $4.4 million of prepayment income, compared to $9.3 million in the December quarter and $5.5 million in the year-ago quarter. For the full year, interest income included $44 million of prepayment income.

The portfolio yield improved to 11.2% at the end of the quarter, slightly above the prior quarter and a year ago. Expenses for the March quarter totaled $50 million, compared to $53.4 million last quarter and $46.8 million for the year-ago quarter. The sequential decrease was due to lower incentive fees associated with decreased level of investment income generated during the period, as well as lower management fees associated with the decrease in the average portfolio. The decrease was partially offset by a slight increase in interest expense associated with the $350 million of debt issued during the quarter, which I will discuss in a few minutes.

Net investment income was $52.1 million, or $0.22 per share, for the quarter. This compares to $56.7 million, or $0.24 per share, for the December quarter, and $49.6 million, or $0.22 per share, for the year-ago quarter. For the quarter, the net loss on the portfolio totaled $63.8 million, or $0.27 per share, compared to a net loss of $76.1 million, or $0.33 per share, for the December quarter, and a net gain of $20.3 million, or $0.09 a share, for the year-ago quarter. The portfolio's net realized loss for the quarter was $53.6 million, compared to a net realized loss of $74.7 million for the December quarter, and a net realized gain of $17.3 million for the year-ago quarter.

The unrealized loss for the March 2015 quarter was driven by both our quoted and non-quoted investments. Approximately half of the net loss for the quarter is attributable to equity investments, which can fluctuate due to changes in the level of Company earnings and valuation multiples. Negative contributors for the quarter included our equity investments in LVI and PlayPower, as well as our debt investment in Avaya, among others. Positive contributors to the performance for the quarter included our investment in generation brands and gains on a handful of quoted positions.

The net loss for the quarter included approximately $10.2 million of net realized losses, although most of the amount was previously recognized in earnings. Realized losses related to our investment in Walter Energy, Molycorp and PetroBakken. In total, our quarterly results decreased net assets by $11.8 million, or $0.05 per basic share, compared to a decrease of $19.5 million, or $0.09 per share, for the December quarter and an increase of $69.9 million, or $0.31 per share, for the year-ago quarter.

On the liability side of the balance sheet, we had $1.5 billion of debt outstanding at the end of the quarter, down slightly from $1.6 billion at the end of December. The Company's net leverage ratio, which includes cash and unsettled transactions, was 0.72 at the end of March, down from 0.74 at the end of December.

As Jim mentioned, we continue to focus on the right side of our balance sheet. During the quarter, we issued $350 million of 10-year unsecured debt with a coupon of 5.25%. The issuance was our first public unsecured institutional debt offering and had participation from over 20 institutions. We are appreciative of their support. While the immediate use of proceeds was to pay down borrowings under our revolver, the debt substantially replaces debt that is maturing in the next several quarters.

The weighted average stated interest rate on our outstanding debt today is approximately 5.08%. Pro forma for our upcoming debt maturities and assuming the same amount of debt outstanding, our blended average borrowing rate should improve by 100 basis points. We also continue to receive strong support from our banks and our credit facilities. Subsequent to year end, we amended our revolving credit facility to extend the maturity by 18 months to April 2020 and increased total commitments by $40 million, for total facility of $1.3 billion.

In addition, the stated interest rate on the facility was changed from LIBOR plus 200 to a formula based calculation, based on a minimum borrowing base, resulting in a stated interest rate of either LIBOR plus 1.75 or LIBOR plus 200 BPS. As of today, under this formula, the stated interest rate on the facility is LIBOR plus 200. We are appreciative of our lenders and for their support.

This concludes our prepared remarks. Operator, you may open the call to questions.

(Operator Instructions)

We have a question from the line of Robert Dodd with Raymond James.

Hi, guys. Couple of questions. First of all, on the oil and gas side, on Caza and Miller, both of which, if I look at the equities, the public equities out there, look highly stressed. If we look at Caza, obviously I think you deferred a covenant test until September, yet neither of them have any substantial or material at all incremental mark downs this quarter. Can you just give us a bit more background on that and if there are parameters what would need to happen for you to feel that mark downs would be necessary on those two assets?

Okay. Listen, we don't want to go into a whole bunch of detail about individual portfolio companies. What I'd say is both companies exhibit what a lot of our oil and gas companies have. They have full covenants. They have -- both Caza and Miller are both secured debt with small RBL carve-outs and we continue to believe that we're covered by the asset value. So every quarter, when we update our valuation, our valuations we do every single quarter and send it out to private valuation firms. Each quarter, we're re-evaluating the engineering underlying our asset coverage and on both of these we feel -- if we feel like there's a big change, we obviously reflect it in the marks.

Got it. One housekeeping one, while I remember. The deployment number in the quarter you indicated at $370 million. If I go to the cash flow statement, the investments made and funded in the quarter were $480 million. Can you just reconcile that? Is it a timing issue, or payable, or what am I missing there?

The cash flow is for the full year.

Well, obviously, I took the delta between the full year and the nine months, obviously.

So it could be just we exclude -- we often exclude revolvers from our deployment number, because we're in and out of those, so we could exclude that. We'll take a look at it.

Got it. Thank you. One final one if I can. On the waiver, and obviously you've extended that for another year, but even if I look at the two years where it's been in place, on the pre-incentive fee GAAP net income, if I can, the management fees are 36% of that.

The bottom line question is, is that waiver big enough, given the level of losses unrealized in some cases, but realized losses are greater over the last two years than net unrealized. So can you give us any more thoughts on what it would take to make a greater adjustment on that management fee, either the waiver or just the base management fee on a permanent basis.

I would just say the Board and Management go through a pretty rigorous process at year end, when we look at the industry, the corporation, the strategic objectives that we achieved and the Board has voted this as the fee ongoing with the waivers, as you mentioned. And we collectively believe that this is the right structure for our Company and it will be addressed next March on a subsequent year as all BDCs are. I'd say one overriding aspect is there's a whole host of strategic objectives that were put forth when this Management team came on several years ago and notwithstanding a very challenging market, this management team has done a very nice job achieving a lot of those in the Board's eyes. Really believe that's the right structure for us to move forward at this point in time.

Okay. Got it. Thank you.

Our next question comes from Greg Mason with KBW.

Great. Good morning. First on the $20 million write-down in the PlayPower equity, I assume that should be relatively close to your exit value on the sale of that asset post quarter end?

Yes, so we -- just taking a huge step back, right? Us -- again, when you look at the mark-to-market this quarter, a lot of it was driven by legacy equity positions. Obviously a big focus of the Management team is to exit some of these older vintage private equity investments and redeploy that into earning assets. We announced the sale of PlayPower last night. Obviously we marked it.

We knew, we had a pretty good idea of where the bid was at quarter end. And we decided -- collectively, we decided to sell it and redeploy those assets into yielding assets. It should, longer term, as I mentioned in the comments, A, it reduces the amount of PIK income in our portfolio pretty materially, and number two, it allows us -- it's pretty accretive from an NII basis for us, because we can redeploy non-earning assets into earning assets.

Okay. Great. And on the energy write-downs in the quarter, fairly broad-based. It looks like -- what would you say is the portion of those that are just mark-to-market versus credit impairment and have those changed post quarter end with the rebound in oil?

I mean, I think the vast majority of the mark downs we took this past quarter, again, it's always a very hard to forecast where oil prices are going to go. We still feel very, very good about the coverage on a lot of these. We've marked them down pretty broad-based to be prudent, but obviously with oil coming back this quarter and again, just with our coverage statistics and everything else, we continue to feel pretty good about the credit quality of this portfolio. So it was more broad-based linked to what I would say is, they weren't Company specific issues, it was much more -- it was more broad-based energy issues.

Okay. And then on the revenue side, dividend income popped this quarter after running, call it, $7 million for the last several quarters, up to $11 million this quarter. Any color on the dividend income this quarter and how we should think about that going forward?

We're starting to receive -- as you know, we were investing in some of our solar investments and those are now starting to generate dividends. So that's the primary piece of that. And then we also received a special dividend from ADT during the quarter.

And can you quantify that special dividend so we can think about a run rate going forward?

Yes, the special dividend was about $1.4 million.

So do you think a $10 million run rate is kind of the way we should --

$10 million is (multiple speakers). We do have -- we have numerous investments that we've made both in our solar business and also in shipping that will ultimately start to build dividend capacity. But at this point, that's a fine runway.

If you go through it name by name by name, the vast majority of this is more recurring. There's only that one special from ADT, which was a small part of the total amount.

Okay. And then one final question. Just following up on Robert's question on the waiver. I appreciate you doing that again. But do you think the market gives you credit for the more attractive fee structure that you've made, given that it doesn't -- it's not permanent. You guys have been expending it each year, but do you think you could get more credit if you just made it permanent? What do you think changes to where you wouldn't actually waive that going forward?

I think that's a good question. I think that we have a lot of dialogue with our investors, our shareholders and our stakeholders and I think they appreciate that the commitment that Apollo has made in terms of buying back stock and making the fee waivers. We feel that we have the right incentives and alignment of interest in coming up with this structure. Certainly there's -- it seems in the last year or two, there's been a bit more discussion on the topic. I think we feel good about where we've ended up in terms of what we've done and what we've delivered, but certainly I can't speak for the overall marketplace in aggregate, but we feel that our investors appreciate what we've done and we're working hard on their behalf to perform.

Great. I think with the waiver a 1.7% base fee and 17% carry is attractive. I just don't know that the market appreciates, it given all the documents that still state 2% and 20% and uncertainty about the future around that. I appreciate the comments, guys. Thanks.

Thank you.

Thanks.

(Operator Instructions)

Our next question comes from Jonathan Bock with Wells Fargo Securities.

Good morning. Thank you for taking my question. Real quick, just looking at an additional name in the portfolio, Ted, so when I look at SquareTwo Financial, I see that it was marked at roughly $0.90 on the dollar as of the end of the quarter. Yet if you look at where the marks are today, it's obviously down a bit more. Could you give us kind of an update?

People understand that there's going to be volatility in equity or volatility in perhaps energy investments as a result of the markets, yet when you look at a financial services company, which SquareTwo is, it would be helpful for the market to understand perhaps if this is an idiosyncratic issue and really what the problems were so as to not assume that credit losses may potentially tick up if performance like in that loan continues. Just an update there would be helpful, Ted, if you could.

Sure. Yes, so again, that one is a marked security that had been in our portfolio for a long time. We know this company very well. It's been -- Apollo's been around this company for a very long time. They buy basically distressed receivables from large banks and there's obviously, with all this regulatory change, it's kind of slowed down their originations. And we continue to think there's a lot of asset value there backed by receivables. You can kind of go you through it.

But it's not a typical financial services company. They're basically buying -- they're buying distressed credit card receivables and working them out. So we continue to think there's a lot of asset value there and again, it's a quoted security. It's subject to mark-to-market. What I'd say broadly on some of these more liquid securities, which is obviously a much smaller part of our portfolio today, is there is a lot more volatility given the lack of liquidity in the markets today and this whole theme of lower inventory of broker dealers and everything else is really manifesting itself. There's a name that really don't trade that often, but the quotes move around quite a bit.

And then also maybe just taking a moment to understand forward view of spreads and NOI, just looking at the churn this quarter, which obviously is a significant amount of first lien excellent while also still maintaining your yield, the view that has permeated the market today is that spreads continue to tighten, CLOs that do not have an ability to buy anything at [1 now are thinking 101] and it's hard to make math work. There's a lot of signs of spread compression becoming even more acute than it was in the past. So a question on maintaining yields, your on-boarding yields that were put on this quarter, which are very healthy, particularly at the first lien level, in the future, given the fact this quarter you ran in place and were keeping total debt yield at [10.2 relative to 10.4] that went off the books going forward, Ted, just your view on spread compression.

Yes. So the spread compression we've seen in the last couple months has really been seen in the syndicated markets. Middle-market spreads actually are pretty substantially wider today than syndicated spreads. That's not always the case. There's been periods of time over the last 12 months where the illiquid markets, sponsor finance business spreads are either on top of, or pretty close to, syndicated spreads.

Today I would agree with all of your comments. The syndicated market is very, very tight right now and things have been -- we've seen, again, sticky spreads in our middle-market business. We go through periods of time. If you go through our origination activity, our sponsor business is, I would say, is relatively consistent and we're actually still seeing pretty decent not only flow out of that business, but also decent spreads out of that business.

We're seeing very little value. It's not core to our strategy, but even if it was core to our strategy, we're seeing very little value in the syndicated markets. We're not buying CLO equity. We're not buying regular syndicated debt. We're not really seeing any value there today.

Great. And then one last question, conceptual in nature. There are -- there is a large middle-market lender that's likely no longer going to be part of a banking institution that it was once a part of. I think someone referred to it as McDonalds effectively getting out of the hamburger business.

The question here is, there are a few folks that can effectively even consider owning such a franchise and beyond who ends up with it, that's the question, lots of people have asked BDCs and executives really what happens, right? Because the types of loans that GE does doesn't necessarily impact some of the kitsch situational credit opportunities that Apollo does. And curious on your thoughts of potential share pickup and more importantly, really what the dynamic looks like in the future wherever this middle-market lender that's effectively being sold, wherever it ends up and how it impacts your business on a go-forward basis would be helpful, Ted.

Yes, I mean, listen, it's a real watershed event for our business. They are the 800-pound gorilla in our market. The announced asset sales they are contemplating are three times the size of the BDC sector. We haven't really seen the impacts today. We have not seen it competitively. We thought we would, but we really haven't seen -- they're very much in business and still competing with us every day and I think it remains to be seen.

But I think it just highlights the macro, which is these large regulated institutions, you have a very big, sophisticated, extremely smart operator deciding to exit a business that they've been in for a long time. And so it's a real watershed moment for our business. It should improve the competitive dynamics in our business, but it's really hard to say at this point. We really haven't -- as of today, we really haven't seen the impact day to day in our competitive environment, but obviously longer term it's inevitable that it will have implications.

Jim, given you sit atop the credit franchise over all of Apollo, just a view on kind of the competitive dynamic and where this sits, where this fits, where it does not, just generally speaking overall as one of the largest alternative credit providers in the space, kind of where GE could fit strategically for folks and where it could not.

Well, I think the bigger picture, John, is when you step back, what does it really mean for alternative capital providers and providers of illiquid capital vis-a-vis the broadly syndicated market. Certainly, I think that the growth of alternative asset firms, the growth of BDCs, the growth of the products that we provide to borrowers today has expanded over the last five years and will continue to expand and I think that whatever happens in this whole process, it will create a dynamic that investors will ask folks like us and our peers to play more of a significant role in providing debt capital solutions to companies. So I think it's just, as Ted said, certainly a major watershed event and the dynamic growth of a variety of players will continue to expand.

Thank you for taking my questions.

No problem. Look forward to it. Operator, any other questions?

No, there are no further questions at this time. I will turn it back over to Jim Zelter for any closing remarks.

Once again, we appreciate the forum to release our quarterly and yearly numbers. We appreciate the questions and the following from our shareholders and the analysts who cover us and look forward to talking in the near future. Take care. Thank you.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect your lines.