BlackRock Capital Investment Corporation
Q3 2017 Earnings Call Transcript

Published: 9 Nov 2017

[Operator:]

Good morning. My name is Sara, 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. Lines have been placed on mute. After the speakers complete their update, they will open the line for question-and-answer session. [Operator Instructions] Thank you. Mr. Paredes, you may begin.

[Laurence Paredes:]

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 document 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, Mike 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 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 highlights.

[Michael Zugay:]

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 consultation with the advisor pointed 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 Alternatives Operations group and has a deep accounting in operations background spending over 35 years. We have welcome Mike to the team and you'll be hearing from him later on the call. Now I'd like to start by giving an update on the quarter's business and financial highlights and 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 $0.19 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, or a 4.4% quarter-over-quarter decrease. The decline in large part was due to the underperforming of two legacy positions which I will cover in more detail in the portfolio overview section. Our leverage profile remains relative low by industry standards at 0.42 times 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 or pricing all of which have reduced the attractiveness of such opportunities. As had been the case the last several quarters the current market conditions for middle market leverage 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 three 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 regards 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 two entities. We believe that our equity 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 our tender offer. We have ample liquidity to repay the balance of these notes and proceeds from the revolving credit facility at maturity in February 2018. We incurred approximately $1.3 million of one-time 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 one set negative drag on net investment income due to the impact of higher interest expense associated with having two 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 NNI 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 three investments. A $15 million L+7.00 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+11.00 unsecured debt to Gordon Brothers Finance Company. Nearly all of the repayment activity in the quarter was represented by three 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 Water Pik, second lien term loan and a par repayment totaling $9.5 million across our first and second lien term loans to SOURCEHOV, with the second lien being repaid at 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 four new portfolio companies. As of September 30, Senior Loan Partners as committed and funded amounts of $210 million and $197 million respectively in 19 borrowers. Given the first lien nature of the underlying investments, the strong risk adjusted returns. We intend to continue to deploy capital into Senior Loan Partners. With the repayment development 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 in 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 non-accrual status. At this time, we do not have any major updates with regard to restructuring in 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 right size the balance sheet of the Company and to provide liquidity in order to better position the Company to execute on its three year business plan. We are working constructively with the first lien debt holders, other members of our mezzanine tranche and the equity sponsor with the goal of resolving the situation is quickly and as efficiently as possible. There can be no certainty of outcome at this point in time. Those quarter end, Advanced Lighting technologies was restructured and recapitalized. In summary Advanced Lighting was restructured via at debt for equity exchange to which certain debt holders, including BCIC electively acquired substantially all of the equity of the Company and that provided additional capital to help fund growth initiatives. This investment was also placed our non-accrual status this quarter, as a restructuring was not consummated so 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 2% decline in the overall fair market value of the portfolio. Reinvestment, SVP Worldwide, MBS Group Holdings in advance lighting accounted for the vast majority of the decreases in valuations this quarter. In the case of MBS Group Holdings, and investment bank hire to you run a sale process. Final stage after the due diligence process, it may lower in the initial indications. We are threatening evaluating final bid proposals and we’re 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 hold with the decline in LTM EBITDA. The negative movements this quarter were partially offset by increases valuations of U.S. Well Services, TELUS, AGY and Red Apple. Given the equity, equity light nature of these investments, they're highly sensitive 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.

[Michael Pungello:]

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 or $0.17 per share for the three 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 earned during the preceding quarter and $0.5 million earned during the prior year quarter. Excluding fee income and $0.6 million insurance reimbursement in the prior quarter related to previously disclose legal settlement, total investment income decreased approximately 8% compared to the prior quarter and decreased approximately 12% as compared to this quarter one-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 cancelled, 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, two investments were in non-accrual status, amounting 2.7% of our total debt investments at fair market value, and 8.9% at amortized cost, compared with zero last quarter. Our average internal investment rating at fair market value at September 30, 2017 was 1.30 as compared to 1.34 as of June 30, 2017. As compared to the comparable 2016 period weighted average, our nine-month 2017 weighted average cost of debt increased 131 basis points to 5.66%. The was primarily driven by (1) one-time items related to our liability management activities, including the early repayment of our $17.0 million of 6.6% Notes and $15.0 million Term Loan during the second quarter of 2017, (2) lower average balances on our revolving credit facility and higher average balances on our 2022 convertible notes as a percentage of total debt and (3) higher Libor rates for the current period. Excluding the aforementioned one-time items the weighted average cost of debt for the nine-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 appreciation 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 valuations. As previously disclosed, we announced the waiver of incentive management fees based on income from March 7, 2017 to December 31, 2018. For the three 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 investments 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.

[Michael Zugay:]

Thank you, Mike. We thank you for your participation in today's call. This concludes our prepared remarks. With that, Operator, we would like to open the call to questions.

[Operator:]

Thank you. [Operator Instructions] We will go first to Jonathan Bock of Wells Fargo Securities.

[Joseph Mazzoli:]

Good morning. Joe Mazzoli filling in for Jonathan Bock. So first question what was the investment that led to the $5.6 million tax charge. And then also kind of related question to that is what confidence can you give investors that some of these one-time 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 be helpful.

[Michael Zugay:]

Hey Joe. It’s Mike Zugay here. Thank you for your questions. On question number one, with regard to the tax liability, so we use BlackRock Corp for all of our equity co-investments in 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. That number could fluctuate up and down depending on the accounting for the tax liability calculations. So this quarter in particular to answer your question directly U.S. Well was the culprit if you will that led to that increase and the creation of the deferred tax liability.

[Michael Pungello:]

Joe and just one other point on that, in terms of it being – this is Mike 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 at U.S. Well that's a positive contributor to the NAV.

[Joseph Mazzoli:]

Okay. That is very helpful. So there wasn’t an offset and of course it was just paid on the gain.

[Michael Zugay:]

Joe, just to be clear. It's not paid because it's not a realized gain, it's just booked, but it's not a cash transaction. So what Mike was referring to is this quarter U.S. Wall was marked up, so it impacted NAV 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.

[Joseph Mazzoli:]

Okay. That's helpful. And just one more point for clarification. So I understand just on the cash transaction, but if that investment in U.S. Well 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?

[Michael Zugay:]

Correct. Usually what you have is NOLs that offset. That offset those potential liabilities. In this case the increase in value used up – just to use simple dollar, Mike used the attritional accounting terms here, but the increase used up the NOLs that existed in the BlackRock Corp for that investment.

[Joseph Mazzoli:]

Okay. Thank you very much for that clarification. 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?

[Michael Zugay:]

Yes. Joe, good question. So Senior Loan Partner's, currently our equity commitment to that vehicle it $85 million. I believe using rough numbers we’re about $66 million funded on that $85 million commitment. That is the use of our 30% bucket. It's one of the only – there are few other ones, but it’s the majority of our 30% bucket. So we can over time increase our [indiscernible] 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 JV too, 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?

[Joseph Mazzoli:]

Yes, that’s very helpful.

[Michael Zugay:]

With regards to Gordon Brothers, separate portfolio company, Gene Martin is the CEO of that business. 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 our portfolio expands. Our commitment can expand as a contract we get repaid on our sub notes with a 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 and could call for another – anywhere between $20 million and $60 million of incremental investments from us, over the next 18 months now. Now how that actually plays out as a function of the deals that they see. We are we are more than happy to support Gordon Brothers in their growth initiatives, just given the asset class that they're investing in and their track record and the sophistication of their team.

[Joseph Mazzoli:]

That's great and thank you for that clarification, clearly no doubt very attractive returns available in those two investments. And just as a one quick final question, what is the legacy portfolio cut off date? Is there a specific date and then also what is NBA has really legacy investment or is that a kind of a BlackRock Capital Investment?

[Michael Zugay:]

Okay, so the legacy cut off, I’ll answer this in words. So legacy cut off 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, its a legacy investment. Any investment made after that is what we're defining as the portfolio of the disk management team is put together. So that the line in the sand. MBS to be honest with you that was a – I believe with the 2006 initial investment, so clearly a legacy investment and it was restructured I believe and 2014, prior to BlackRock ownership. So definitely a legacy investment for MBS and we continue to evaluate what we're going to do in a go forward basis with that portfolio company.

[Joseph Mazzoli:]

Okay, thank you. That's it for me thank you for taking my questions.

[Michael Zugay:]

Thanks, Joe. Appreciate it.

[Operator:]

[Operator Instructions] We’ll go next to question Paul Johnson of KBW.

[Paul Johnson:]

Good morning everyone. Thanks for taking my questions. My first question is just kind of centered around sort of your outlook for run rate earnings, clearly waiving incentive fees pretty big benefit to shareholders, the rest of next year. But as I look at the run rate of earnings, just wondering if that – are you guys confident with growth and running at your optimal leverage rate to be able to sustain a pretty healthy yields to stay above roughly 9% ROE on your dividend currently?

[Michael Zugay:]

Hey, Paul. This is Mike Zugay here. Thanks for calling 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 as 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 level by industry standards and we do have two very attractive moves right now with Gordon Brothers and Senior Loan Partners to generate very good risk adjusted returns that generate cash NII and or very good contributors to get into you know 9-ish, 10%-ish ROE. So as we look forward we're in a very fortunate position to have the ability to expand to relatively high quality portfolio company investments that have diversified pools are primarily first lien loans. So the quality in the diversification that used to investments provide us in the return profile are very attractive in the marketplace and give us a high degree of confidence in our sustainability or dividend level.

[Paul Johnson:]

Thanks for that. That's a good answer. And then my next question just is really kind of on your just outlook on investment I mean we understand a willingness to be patient selective with the capital deployment. We definitely prefer that approach but I am just wondering if we can get a sense of sort of what your outlook for new investments are I mean clearly can 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 that help to propel leverage up that optimal level?

[Michael Zugay:]

Yes, look for investments for straight away second lien loans as you heard in my prepared remarks and some of the stuff in the press release it is a competitive environment out there and I'll give you one just relatively quick example of what we're seeing in the marketplace. One of the companies we are looking at that it was a rather large EBITDA business it was a middle market issue or kind of made an acquisition to get into the area both kind of $75 million to $100 million that loan - that secondly lien loan that we were really interested in additional price stock was around L+7.50% to L+7.75% and in tightening to L+6.75% with effectively no L+ID. I mean that's gives you a sense of where of what's going on the second lien market right now. We're not seeing that same level of spread compression that you're seeing in the second lien market and the first lien market. So our outlook for investments and what we have control over is senior but not what we had influence over a Senior Loan Partner. So we continue to find really good risk adjusted return in the first lien market. Gordon Brothers is also other there, hustling to find opportunities and to invest in and 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 careful and very patience on what we deploy. We just don't want to run into situations where we're stretching on structure 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 into page 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. That something dramatically changes in the second lien market to increase the yields there. We’re going to continue to just be patience on that front and aggressively pursue the other two options.

[Paul Johnson:]

Thanks. Those are all my questions.

[Michael Zugay:]

Thanks Paul.

[Operator:]

[Operator Instructions] Our next from JPMorgan, we will go to Rick Shane.

[Melissa Wedel:]

Hi. It’s Melissa Wedel for Rick Shane. I was hoping that you guys could elaborate on the fundamental performance that drove the make higher for U.S. Well Services. And then also provide an update on some of the outperformance at Red Apple Stores?

[Michael Zugay:]

Yes. Melissa, thanks for the call. This is Mike Zugay speaking here. Look the fundamental performance for U.S. Well, the company has – as goes with drilling activity in the Marcellus and Utica regions. That area is experiencing very robust drilling activity at this point in time. So that our business is in those two regions and we're – the company is performing very well that all other fleets are utilized and performance of the company is increasing dramatically versus the prior year’s period. So to be very specific, EBITDA growth at that company is driving evaluation. With regard to Red Apple, that business we've 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 a relatively near-term is figuring out ways to reduce some of the marketing expenses of the company, it is incurring. So we've made some tweaks to the direct marketing campaign at the company and its increasing EBITDA, which is driving the evaluation, so once again there EBITDA fundamental, EBITDA growth driving valuation.

[Melissa Wedel:]

Okay, got it. Thank you. And I’m wondering as a follow-up, if you have any insights into any anticipated repayments in Q4?

[Michael Zugay:]

That happens relatively quickly, the one area that we do have some of the ability into the deal in the marketplace, Superior Vision, which is on our books as Wink. They are making a rather large acquisition and it's going from about from – basically quadruple EBITDA and getting done in the 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 that's a big component of what we have reset the visibility into at this point, and there always be a couple portfolio company runs for quarter and hopefully we're offsetting that with new investments, whether it's in our Senior Loan Partners, Gordon Brothers or other new Junior Capital Investments.

[Melissa Wedel:]

Okay, great. Thank you. End of Q&A

[Operator:]

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.

[Michael Zugay:]

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

[Operator:]

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