MidCap Financial Investment Corp (MFIC) 2016 Q2 法說會逐字稿

Good morning and welcome to Apollo Investment Corporation's Earnings Conference Call for the period ending September 30, 2015. At this time all participants have been placed in listen-only mode. The call will be opened for a question and answer session following the speakers' prepared remarks. (Operator instructions).

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

Thank you, operator, and thank you 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 webcast 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 companies. You should refer to our registration statement and shareholder reports for risks that apply to our business that 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 like to remind everyone that we posted a supplemental 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 ended September 30, 2015 and filed our quarterly 10-Q.

I'll begin my remarks with a brief overview of our results for the quarter and discuss some additional business highlights. I will then turn the call over to Ted who will discuss the market environment and our investment activity for the quarter. Greg will then follow and discuss the financial results in greater detail. We will then open the call to questions.

For the quarter we reported net investment income of $0.21 per share, which reflected higher dividend income offset by a decline in income from prepayments and lower fee income compared to the prior quarter.

Net asset value declined 2.2% to $7.83 per share during the quarter and the decline was primarily driven by some marks in our oil and gas investments.

During the quarter we invested $204 million, sold $80 million of assets and received $200 million in principal payments. All and all net investment activity was negative $75 million for the quarter.

During the quarter we focused on investing in existing company, portfolio companies, and executing on our stock purchase plan. We used a portion of proceeds from repayments in sales to repurchase $21 million of stock while maintaining leverage. Assuming the price of our stock stays at current levels relative to net asset value, we intend to continue repurchasing in the current quarter as part of our announced plan.

Let me take a moment to address some of the concerns that have been raised about our oil and gas exposure. We are very cognizant of today's market conditions. We continue to closely monitor our investments and believe in the long-term prospects of the industry.

The firm's deep industry and technical expertise has enabled us to build and structure a portfolio that we believe will perform over the long term. We will continue to be patient and disciplined in our approach during this continued period of dislocation.

Lastly, turning our discussions to our dividend, the Board approved a $0.20 dividend for shareholders of record as of December 21, 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.

The September quarter was marked by heightened volatility due in part to concerns about global growth and uncertainty about Federal Reserve Policy.

Leveraged loan issuance declined quarter-over-quarter and year-over-year. Slower CLO issuance and retail fund outflows contributed to higher clearing yields and lower loan prices.

During the quarter high-yield bond spreads increased 156 basis points based on JP Morgan High Yield Index and leveraged loans spreads increased 72 basis points based on the JP Morgan Leveraged Loan Index.

That said, the middle market, while not immune, is generally insulated from trends in the broadly syndicated market and typically react to the lag to changes in liquid credit markets.

Recent volatility in liquid credit markets has led to better structure and terms in our market. We believe middle market spreads continue to offer interesting risk-adjusted returns.

With this backdrop sponsors have become more cautious and our origination activity was somewhat muted. During the quarter we invested $204 million in four new portfolio companies and nine existing companies. The weighted average yield on investments made was 10.3%.

As Jim mentioned, our origination activity focused on investing in existing portfolio companies. We continue to focus on secure debt opportunities, which accounted for 62% of the investments made during the period.

During the period we exited $280 million of investments of which $80 million were proactive sales and the remaining balance were repayments. The yield on investments sold was 11.3% and the yield on repayments was 10.9%.

We continue to maintain a significant portion of our portfolio and floating-rate debt to better position ourselves for an expected rise in short-term rates. At the end of September, 58% of the portfolio was floating-rate, essentially unchanged from the end of June.

Moving to specific investment activity, during the quarter we invested $54 million in secured debt of SmartStart in connection with its acquisition by a sponsor. SmartStart is a market leader serving the ignition interlock device industry.

We syndicated down a portion of our debt investment to a hold level of $34 million at the end of September. This transaction is another example of our syndication capabilities.

We invested $17 million in secured debt of Mediaocean to support its acquisition by a sponsor. Mediaocean is a leading provider of media management systems to the advertising agency sector.

Our aircraft leasing business, Merx Aviation, continues to pursue opportunities as well as manage its existing portfolio including the monetization and refinancing of aircraft. During the quarter Merx returned approximately $70 million of capital to Apollo Investment. At the end of September Aircraft represented 14.4% of the overall portfolio at fair value.

Merx has achieved sufficient scale, which has enabled the business to self-fund several of its most recent transactions.

Exits which include sales, repayments and revolver pay downs, totaled $280 million for the quarter. Sales totaled $80 million for the quarter including partial monetizations of our investment in Deep Gulf, SmartStart and Confie Seguros.

Repayments for the quarter totaled $200 million including a partial repayment of our investment in Merx Aviation and full repayments of our Chroma, Alion Science & Technology and Laureate Education.

Moving to oil and gas exposure, as Jim noted, we continue to closely monitor our investments in this area and believe in the long-term prospects of the industry. As we've said before, our portfolio is well diversified by borer and geography, our strategy on winning against producing upstream oil and gas reserves with an emphasis on significant asset coverage.

Although PDP coverage has declined with a drop in oil prices, we are still comfortable with our asset coverage. We believe our marks reflect the underlying fundamentals of each borrower and stress in the industry.

Oil and gas represented 15% of our portfolio or $480 million at the end of September, down from 16% or $531 million at the end of June on a fair value basis. The decline was due to the monetization of a portion of our first lien debt investment in Deep Gulf and the exit of our unsecured investments in Denver Parent as well as fair value adjustments on the portfolio.

At the end of September, 82% of the oil and gas portfolio was in secured debt and included nine core-borers and no new oil and gas investments were made during the quarter.

Regarding Miller Energy, the company filed for bankruptcy in early October. Our second lien debt investment in Miller was placed on non-accrual and is now the most senior debt in the capital structure and our investment has been valued on a recovery basis.

We continue to work with the company through the bankruptcy process and to date we have not had to provide any incremental capital. We expect the company to emerge from bankruptcy in early 2016.

Moving to credit quality, the portfolio's weighted average risk rating on a cost basis increased to 2.3 at the end of September from 2.2 at the end of June and on a fair value basis increased from 2.2 -- to 2.2 from 2.1 over the same period.

The weighted average net leverage of our investments increased to 5.6 times at the end of September, up from 5.5 times at the end of June and the weighted average interest coverage remained at 2.5 times.

At the end of September investments on non-accrual status represented 2.2% of fair value of the portfolio and 4.7% on a cost basis compared to 0.4% and 2.5% respectively at the end of June.

With that I will now turn the call over to Greg, who will discuss financial performance for the quarter.

Thank you, Ted. Total investment income for the quarter was $98.4 million, down 3% quarter-over-quarter and down 17% year-over-year. The decline quarter-over-quarter is attributable to lower prepayment income and lower fee income as well as a lower asset base.

Interest income for the September quarter included $4.5 million of prepayment income compared to $8 million in the June quarter and $21.9 million in the year ago quarter. The year ago quarter included an elevated level of prepayment income.

Dividend income for the quarter increased due to the growth of our investments in shipping and solar energy which are structured as common and preferred equity respectively and which should provide reoccurring dividend income. The amount of dividend income may vary quarter-to-quarter based on asset mix but the run rate should be approximately $10 million to $11 million per quarter.

PIK income for the quarter was approximately $6.8 million or 6.9% of total investment income, down from $9.5 million or 9.3% of total investment income in the June quarter. The decline was primarily attributable to the exit of our investment in PlayPower.

Expenses for the September quarter totaled $48.8 million compared to $50.7 million last quarter and $53.2 million for the same period a year ago. This sequential decrease was due to a decrease in incentive fees, management fees and interest expense.

As a reminder, $225 million of our senior secured net notes matured in early October and $200 million of convertible notes will mature in January 2016. These notes have a blended interest rate of approximately 6%. We're using our credit facility, which has an interest rate of LIBOR plus 200 to replace the maturing debt. As a result, we expect to realize approximately $17 million of annual interest savings which translates into approximately $0.06 per share of incremental net investment income per year.

Net investment income was $49.6 million or $0.21 per share for the quarter. This compares to $51 million or $0.22 per share for the June quarter and $65.7 million or $0.28 per share for the year ago quarter.

For the quarter the net loss on the portfolio totaled $51.3 million or $0.22 per share compared to a net loss of $44.6 million or $0.19 per share in the June quarter and a net loss of $23.7 million or $0.10 per share for the year ago quarter. The net loss of $51.3 million includes $30.2 million of realized losses. Approximately $28.5 million of the realized losses were previously recognized in unrealized appreciation.

Negative contributors to the performance for the quarter included our investments in Miller Energy, Artsonic, Osage and SquareTwo. Positive contributors to the performance for the quarter included our investments in LVI, Renewable Funding and Merx Aviation.

In total our quarterly operating results decreased net assets by $1.8 million or $0.01 per share compared to an increase of $6.4 million or $0.03 per share in the June quarter and an increase of $42 million or $0.18 per share for the year ago quarter.

On the liability side of our balance sheet we had $1.4 billion of debt outstanding at the end of the quarter, essentially unchanged quarter-over-quarter. We continue to operate within our target leverage range. The Company's net leverage ratio, which includes the impact of cash and unsettled transactions, stood at 0.73 at the end of September, essentially unchanged from the June quarter.

During the September quarter we repurchased approximately 3.3 million shares of common stock for an aggregate cost of $21.2 million. At the end of September our portfolio had a fair value of $3.2 billion and consisted of 98 companies across 26 industries. The weighted average yield on the debt portfolio at cost was 11.6%, up 10 basis points quarter-over-quarter. The increase in overall yield was mostly due to the increase in our preferred investments which have a higher yield than the rest of our debt portfolio.

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

(Operator Instructions). Your first question comes from the line of Kyle Joseph with Jefferies.

Thanks for taking my questions. Regarding your liabilities, I know you've mentioned that you'd refinanced the upcoming convert and senior secured notes with the credit facility. From a longer-term perspective do you continue to finance that with the credit facility or are you going to look to term that out eventually?

Well, I think that, as you know, we termed out about $650 million worth of our debt in three different tranches over the past three years. And so I think currently our plan is to use our revolver to refinance both our -- the senior notes which came due in October and then the convert in January.

Okay great, thanks. And then just aside from the energy side of the portfolio, can you talk about the revenue and EBITDA growth trends of your companies that you have in your portfolio?

Yes so if you strip out oil and gas and obviously aircraft because it's not applicable, again our portfolio -- all these headwinds that are being faced in the credit markets by large companies, currencies, China, all these other things, we're not really seeing in our portfolio. And the reason is because our -- the underlying portfolio companies we lend to are generally levered to the US economy. They're private US companies and the US economy is doing okay.

So we're -- the health of our overall portfolio away from oil and gas is actually pretty good and the underlying business trends are stable. So it's not a great US growth environment but obviously the US economy is doing okay.

Okay thanks. And then can you talk a little bit about your outlook for capital deployment going forward? Obviously you guys want to continue the buyback. But in terms of your investment outlook into new investments, I know you mentioned that terms are becoming a little more favorable. I know you haven't seen -- necessarily seen the spread widening in the middle markets that you've seen in the broader credit markets. But just sort of your outlook for deployment into new investments.

Yes I'd say we've definitely seen spread widening and better terms in the middle market. The environment is good. I will say that we've seen a market slowdown in activity levels. So that means repayments are down, but it also means new originations are down and that's driven by obviously the choppy markets, but also I think there just isn't a lot of private equity sponsor activity right now.

So -- and the second thing I'd say is because where we operate with our leverage levels and because we're buying back stock, like we don't anticipate material portfolio growth. Because obviously we're using some of our repayments and sales to buyback stock. And so I don't think you're going to see material portfolio growth over the next couple quarters.

That makes sense, thank you. And then just lastly, a little modeling question in terms of the expense ware, is there any impact on that as a result of the buyback?

No there isn't.

Okay thank you. Well, thanks very much for answering my questions.

Robert Dodd, Raymond James.

Hi, guys, actually it's Leslie this morning. How are you doing? So I've got a quick question for you on Caza. I know they've been moved back to the end of this month again. I noticed the mark for the quarter was pretty much at the exact same level as last quarter. If we keep pushing back the covenant test on the investment there, the first line in the equity interest there, why have we not marked it down yet? And are we looking at markdowns in the fourth quarter? Any color around that would be nice. Thank you.

Yes, so it's a public company so you obviously have the latest press release. The other thing in the press release is that obviously they're working to refinance us out. And so again, there's a ? the company, as are a lot of our oil and gas companies, are looking for ways to take us out. And so obviously they've publicly announced they're trying to refinance us out shortly. So I'll leave it at that.

Okay, so you believe that they -- I guess the lack of markdown means that you believe the odds are on par with what you believed before for getting that total value out which slides that markdown pretty much at all? I guess -- we were expecting I guess a small markdown with the continued push.

Well, I would just say that there's a process we go through with our mark policy and with our outside auditors and with our Board. And while there is some variability in it, the information and the inputs led us to believe that we should keep the mark at its current level. And certainly I understand your perspective and your question, but the process we went through led us to conclude that the mark should stay at its current level.

Okay, thank you.

Douglas Mewhirter, SunTrust.

The -- two questions. First, did I hear you correctly that the -- I guess the lender -- there's no more lenders ahead of you in Miller Energy? That that one, I guess it was ABL or First Lien got taken all the way out?

Yes so where the -- even though Miller Energy is classified as a second lien, there's no debt ahead of us. And when it filed for bankruptcy the company had ample liquidity so we didn't have put in any new money.

Okay thanks for that. Also, I just noticed in your new investments, I know it wasn't a terribly active quarter, but you actually increased marginally the number of investments that are I guess lower on the capital structure, equity and the equity like security structured products.

I guess could you just walk through your reasoning for that? Because I know that you have said you're trying to stay high in the capital structure, yet there are some incremental investments that were sort of going against that grain.

Yes, yes, that's a great -- I'm actually really happy you asked that question. So really there's really two drivers of that which are two investments and both of them are related to our renewable energy business. So we're not buying [CLO] equity. We're not buying common equity in companies. It's the way they're classified.

So one is our UK solar platform, which is obviously contract -- where basically we have contracted cash flow streams from the UK government. And the other investment is obviously the one we have in California which is lending against solar assets, which are structurally senior to the mortgage which are very, very low LTV, very safe.

So I know it's -- when you see preferred equity or structured products immediately you think of equity risk or CLOs or other things. And these are much different risk profile than those. So we actually view this as consistent with our overall strategy.

And I would add those were two existing investments where we have made a commitment and they are just a drawdown of the facility that we've offered the company.

Right, so they're more warehouse type of facilities that we have.

Okay thanks, that was a helpful answer. That's all my questions.

Terry Ma, Barclays.

I just wanted to get a sense of how much stock you've bought back since quarter end and whether or not it's reasonable to assume the Board may have another buyback program in place toward the beginning of next year?

So we've disclosed the amount of stock that we've bought back with the 3.3 million shares. The Board has authorized us to buy back up to $50 million worth of stock so we have $28 million to go under that authorization.

Yes and obviously there's -- just a reminder that we obviously have to live by the blackout periods. So we're in a blackout period during earnings.

Okay got it. And so just looking forward, it looks like any buybacks and new investments will be funded from repayments and proactive sales. So can you maybe just give us some color on how you're thinking about churning that portfolio? Whether or not there are any industries you may want to reduce exposure to or any that you may want to increase?

Yes I would say it's by industry. I'd say listen, I think our -- I mean well, so we've reduced our mine exposure to zero so we have de minimis mine exposure. And then in oil and gas again, our pipeline is just not that robust. We're just not seeing a lot of new opportunities in oil and gas. And, as I said -- as I mentioned earlier, there's a number of processes underway to either refinance or other things with our portfolio. So I think naturally over the next couple quarters you'll see our energy exposure decrease is our expectation.

And then away from that, again we're seeing really good spreads and pretty interesting risk/reward in our middle market part of our business, just our generic sponsor finance business. So I think you'll see most of the new origination just be to the bread and butter traditional middle market sponsor business.

Okay got it and then just looking at the first lien investments you exited this quarter, it looks like the yield is 11.5%. Is there anything to call out there?

Sorry, so what was the last part of the question?

The yield on the first lien investments you sold or got repaid this quarter was 11.5%. It was slightly higher than I expected. Is there anything to call out there?

Oh. So part of it was -- well, there's two things I'd say. One is we monetized part of an oil and gas investment at our mark, which we thought was a good statement, both to the market and also to our Board.

Number two -- and that was a high yielding investment. And then number two, obviously we returned a bunch of capital from Merx, which you know is obviously at the higher end of the yields.

Okay got it, thank you. That's it for me.

Chris York, JMP Securities.

Just one question this morning, given the backup in the secondary markets and some of the more liquid loans, what are your thoughts on deploying capital in some names that you've either previously underwritten or invested in?

Listen it's just not core to our strategy to be adding to new liquid risk. And so if there's a name that -- if there's an idiosyncratic situation where we've privately underwritten a name that we think is mispriced, we may look at that. But if you look at our activity over the last six months our big, big focus is on origination. And so I don't think you're going to see us deploy material amounts of money in syndicated securities.

Okay. Thanks, Ted.

Troy Ward, KBW.

Most of my questions have been answered. Ted, just to follow-up on Merx Aviation, you talked about they're at a point in their structure where they can do some self-funding. So what should we expect from that investment from a portfolio standpoint going forward?

Yes I think obviously you've seen that portfolio ramp up pretty material over the last couple years because it was like an early -- it was all new originations. Now you're seeing some assets roll off where we're monetizing some assets. So I think that the percentage of our portfolio that's devoted to aircraft is going to remain reasonably stable in the kind of range you've seen it in the last couple quarters.

So you know, that could -- it may increase slightly but I don't feel -- see it either increase or decrease materially.

Okay and then one final one. I think it was Terry that asked about kind of the current buyback. You talked about what you've done and what you have left. Does that expire? It seemed he was leading that it maybe expired at the end of the year. And do you think the Board will re up that if that's the case?

Can you repeat the question? I didn't hear the full question, I'm sorry.

I'm sorry, when does the buyback expire? I know you said you have $28 million left on the current authorization. When does that expire?

It doesn't have a drop dead date. So the Board has authorized management to execute that and we intend to do so, especially in light of where the current market is and current levels of our stock.

Okay very well, thanks.

(Operator Instructions). Jonathan Bock.

Hey, guys, this is Joe Mazzoli filling in for Jonathan Bock. Thank you for taking my question. The first question relates to Asurion. It looks like you guys invested an additional $20 million into the second lien position. Obviously this loan sold off with the announcement of Apple's financing plan which requires customers to purchase Apple Care, just curious if you could provide your perspective on the follow-on investment and kind of how Asurion's business could be impacted by Apple's new plan.

Yes I mean I think obviously the markets reacted to it. Company publicly just -- the company we feel generates a lot of cash and we feel very good about it and obviously a lot of noise around the Apple program. We don't know exactly how it's going to impact in the long-term but I think we feel pretty good about the credit today.

Okay great. Another question relates to SquareTwo. So the bonds have rebounded since kind of mid-quarter. They were near 50 and I think now they're trading near -- bid near 66. But yesterday I think there was a release by the FTC where they said they were going to crack down -- nationwide crackdown against abusive debt collectors. Do you think this is something that could potentially harm these bonds going forward?

So we won't get into the specifics around because it's a private company and we have an NDA. We won't get into the specifics around SquareTwo specifically. But again, the CFTC is going after bad actors within the debt collection space of which we don't think SquareTwo is one of them. And so long-term it should benefit their business.

Just given that if you look at the Journal article today and who is publicly disclosed that they went after, obviously SquareTwo is not mentioned. So longer term if they continue to go after kind of abusive practices, those who have good compliance and everything else should overall benefit.

Okay great. And just one final item on Merx. With the lower oil price environment it seems that airlines are maybe not as inclined to kind of invest in more fuel efficient airplanes. Are you seeing an extension to the average life of your airlines, or at least in terms of expectations -- your airplanes that is?

No, like we've been really seeing our underlying borrowers really change their strategy. And so the pipeline, the things we're seeing are really not different than what we saw at $100 oil. And again, our fleet is pretty young. Our average age is in the mid single-digits. And so the aircraft -- yes to your point, longer dated old aircraft are going to benefit more, disproportionately more from low oil prices but we don't own those. So our fleet doesn't really benefit from -- our fleet obviously benefits from low oil prices but not as much as an older fleet.

Okay.

We bought our fleet with 737s and Airbus [320s] highly used and very flexible planes.

Okay great. Thank you guys for answering my questions.

And your final question comes from the line of Arren Cyganovich with D.A. Davidson & Co.

Quick question, I missed what Greg had said about the dividend income. I think I had overheard something about $10 million to $11 million as a run rate. How does that compare to the -- I think you had like $14 million in this quarter?

Right so that's what we think as we look forward that's a run rate. Because as we -- as our warehouses move along there may -- for example, in this quarter we had 2.8 from some our renewable energy and that may change over time as those portfolios are then securitized (inaudible).

Sorry, I just missed that comment. Thank you.

There are no further questions at this time. I would now like to turn the call back to Jim Zelter.

Well, certainly on behalf of the Management Team and all the employees we thank you for your participation today and we look forward to having a full and robust conversation ongoing. Thank you very much.

This concludes today's conference. You may now disconnect.