BlackRock Capital Investment Corporation
Q3 2016 Earnings Call Transcript

Published: 3 Nov 2016

[Operator:]

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

[Larry Paredes:]

Good morning and welcome to BlackRock Capital Investment Corporation's third quarter 2016 earnings conference call. Before we begin our remarks today, I would like to point out that certain comments made during the course of this conference call and within corresponding documents contain forward-looking statements subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may and similar expressions. We call to your attention the fact that BlackRock Capital Investment Corporation's actual results may differ from these statements. As you know, BlackRock Capital Investment Corporation has filed with the SEC reports which list some of the factors which may cause BlackRock Capital Investment Corporation's results to differ materially from these statements. BlackRock Capital Investment Corporation assumes no duty to and does not undertake to, update any forward-looking statements. Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, BlackRock Capital Investment Corporation makes no representation or warranty with respect to such information. Please note we have posted to our website an investor presentation that complements this call. Shortly, Steve will highlight some of the information contained in the presentation. The presentation can be accessed by going to our website at www.blackrockbkcc.com and clicking the November 2016 investor presentation link in the presentation section of the Investor Relations page. Thank you. I would now like to turn the call over to Steve Sterling, BlackRock Capital Investment Corporation's Chairman and Chief Executive Officer, who will provide an update on your quarterly results.

[Steve Sterling:]

Thank you, Larry and good morning. Yesterday, after the market closed, we announced the company’s third quarter financial results. The announced results showed net investment loss of $0.03 per share and net asset value per share decreased by $0.75 or 8.2% to $8.38. Excluding a non-recurring litigation expense net investment income would have been $0.21 per share providing distribution coverage of 101%. The third quarter proved to be another difficult period. As we continue to work through issues pertaining to the legacy portfolio, including the pending settlement of the AL Solutions litigation. To be clear, the Company’s portfolio challenges remain concentrated in legacy investments. Since March 6, 2015, which is when we assumed responsibility for managing the investment activities of the Company, our team has deployed over $400 million in performing new investments. We are pleased to have come to an agreement in principle for the settlement of AL Solutions litigation. For the affected families and our client shareholders, we welcome the closure an elimination of uncertainty arising from this tragic events that occurred in 2010. While there can be no assurance we anticipate final settlement to occur in the fourth quarter. Consequently during the period, the Company recognized a legal settlement expense pertaining to the litigation of $17.5 million or $0.24 per share. We anticipate payment of the settlement during the fourth quarter. Separately, we are pursuing claims under available insurance policies. This may partially mitigate this cost to the company. At this time, we are not certain of the amount or time you never see of such insurance proceeds. In the amount if any may not be material. You will find additional details pertaining to the case in the 8-K filed on October 6, 2016 or in the recently filed third quarter 10-Q. Unfortunately during the period, additional setbacks primarily from legacy investments resulted in $33 million or $0.46 per share in unrealized losses due to portfolio valuations. And increase the portfolio’s average risk rating on a fair market value basis from 1.31 to 1.40. Overall, the portfolio fair market value relative to cost was 90.2%. Risk-rated three and four investments had a total fair market value of $113 million at an average mark of 49 and represented 19% of net asset value. Nearly 70% of this exposure was concentrated in two precisions, SVP Worldwide and U.S. Well Services. Each of these situations has unique circumstances. But which the team is working to address with their respective management teams and owners. Similar to Hunter Defense and Vertellus, our role in these investments positions the team well to manage and influence the situations to maximize value for our client shareholders. The headwinds created by these legacy issues have constrained management’s degree of freedom in deploying net new capital as we look to balance the Company's financial leverage in an absolute level of net investment income. As you may recall, during the second quarter of 2015 new management made strategic decision to monetize $161 million of legacy equity in positions. In order to increase flexibility and position for growth in net investment income. This capital has been recycled into income earning assets. However, the anticipated growth has not followed in light of the legacy portfolio challenges. Both for reasons of market conditions which were by the way for sure. And our continued prudent risk management as of quarter end, the company remained moderately leveraged at 0.55 times, pro forma for the litigation settlement. Additionally, the company continue to maintain good liquidity at over $250 million supporting flexibility and capacity for new investments. Looking forward, we seek to deploy net new capital across three core channels of opportunity. Including one BCIC Senior Loan Partners, LLC which we still refer to as Senior Loan Partners. The first lien joint venture that we closed in June of this year, which had about 25% of the committed equity capital deployed during this quarter. Two, our investment in Gordon Brothers Finance which is an established asset-based lender. In three, direct investments in junior capital instruments. Our investments in Senior Loan Partners and Gordon Brothers Finance which are anticipated to generate low double-digit returns for the Company, provide us with exposure to a diverse pools of well secured, top of the capital structure opportunities with a low loss given default risk profiles. Further our investment activity here strengthens the sponsor relationships, we have in the middle-market that are important to our longer term direct junior capital middle-market investment strategy. Finally, in regards to investing in junior capital opportunities. In our view, the strong market conditions have eroded, risk-adjusted returns in this part of the capital structure. Our team has been working diligently and with discipline to unearth attractive investment opportunities. To this end, during the period. Our idea generation rose 65% sequentially. Well, our conversion rates across the sourcing funnel meaningfully declined as we concluded these opportunities to be largely unsuitable for the company. We remain generally constructive on the U.S. economic outlook. But appreciate it that we are late in the business cycle and confronted with structurally weak growth in elevated risks. Consequently, while the momentum of origination activity is continued into the fourth quarter. We will continue to execute our disciplined approach to investment selection, portfolio construction in prudent use of Company financial leverage. Mike will now discuss investment portfolio developments.

[Mike Zugay:]

Thank you, Steve. Overall middle-market loan volumes continue to be depressed as compared to loan volumes over the past several years. However, there was a modest increase in activity during the period from the previous two quarters. During the quarter we experienced an uptick in investment opportunities with both sponsor and non-sponsor related companies versus the first and second quarter of 2016. Not only do we see more investing opportunities in LBOs but we also observe the resurgence of dividend recapitalizations. As per S&P, LCD dividend recapitalization transactions accounted for 38% of middle-market loan volume in the third quarter, as compared with 18% during the year-to-date period. The fact that we are seeing an increase in dividend yields and general refinancing activity is primarily the result of strong investor demand and increased competition in the yield hungry environment. Investor demand especially for borrowers with solid credit profiles is leading to slight increases and leverage multiples and the tightening of credit spreads. Additionally, we are seeing continued pressure on the structural elements that has given rise to more covenant lite transactions. Turning to our investment activity during the quarter, we had approximately $30 million of net prepayments in our portfolio. Primarily due to the previously disclosed repayment of our aggregate $69 million position, MediMedia. Other repayment activity was light in the quarter. Our gross deployments in the quarter totaled approximately $44 million substantially all of which was through incremental capital deployments into four existing portfolio companies. First being $2.6 million or 12% subordinated debt and equity interests in First Boston Construction Holdings, LLC. The proceeds of which were used to fund growth initiatives. Second being $9.5 million of L1100 unsecured debt and preferred equity in Gordon Brothers Finance. Also used to support the Company's growth initiatives. Third being $7.5 million of L1000 second lien term loan in Pomeroy Group. We purchased Pomeroy’s second lien term loan at a discount to par with another member of the second lien club. Our total exposure in Pomeroy is now $27.5 million of base value. Finally, we deployed $21 million into Senior Loan Partners to fund our 85% share of its equity. Senior Loan Partners made three new underlying investments namely one, $10 million first lien term loan to AP Plastics Group, LLC, a provider of high quality PVC compounds primarily used to make vinyl for building product applications; two a $7 million first-lien term loan to Pasternack Enterprises, Inc. a specialty distributor of components and connectors for radio frequency and other technology related products. And three, $9.5 million commitment in first lien exposure to NSM Sub Holdings Corp., a provider of rehab solutions for patients with loss of mobility. We believe there is a good pipeline of future opportunities for Senior Loan Partners as we continue to ramp the partnership. The weighted-average yield on all income bearing investments deployed in the quarter was 11.9%. Moving to non-accruals Vertellus, Shoreline and Advanced Lighting remain the only investments that we are on non-accrual status at the end of Q3 2016. Subsequent to quarter-end Vertellus completed the 363 sale to its term loan lenders and we’ll move off non-accrual status. Pro forma for Vertellus non-accruals represented $4.7 million at fair market value, a 0.5% and 4.4% at amortized cost. The Vertellus restructuring has resulted in a much improved capital structure. And increased financial flexibility to invest in growth initiatives. We played a meaningful role in the restructuring as a member of the ad hoc group of term loan lenders a credit bid for the assets through the 363 sale process. We continue to be supportive of the company and we’ll serve on the Board of Directors going forward. We thanks its management team for their efforts and look forward to our continued partnership. With regard to Shoreline and Advanced Lighting, there have been no meaningful new developments. In both of these situations, our role is more limited given our relatively small investment positions. As we look at the rest of the portfolio, we have been particularly focusing time and resources on SVP Worldwide and U.S. Well Services. In our filings, you will see that these two positions represented about $78 million at fair market value in both sustained additional declines in fair market value. In regards to SVP Worldwide, this unsecured mezzanine investment was mark down to 61 from 64 last quarter. We are a material investor with board observation rights. We continue to believe in the long-term prospects of the company but recognize there is work to be done in the near-term. With respect to U.S. Well Services, we are invested in both its first lien term loan and junior preferred equity. Both of these instruments recognize decline in fair market value with the preferred equity position decreasing from $10.6 million to zero. We continue to be supportive of the company and the management team, but the pricing environment for pressure pumping services and its core geographies has deteriorated over the past several months. With that, I would like to turn the call over to Donna for some additional details regarding our financial results.

[Donna Milia:]

Thank you, Mike. I will take a few minutes to review additional financial and portfolio information for the third quarter of 2016. For the third quarter 2016, GAAP net investment loss and net investment loss, as adjusted, were both losses of $2.1 million or $0.03 per share. Excluding the one-time legal settlement expense during the quarter of $17.5 million, net investment income was $15.4 million or $0.21 per share. As compared to the comparable 2015 period our nine months 2016 weighted-average cost of debt decreased approximately 100 basis points to 4.35%. This was primarily driven by refinancing our $158 million, 6.5% senior secured notes with proceeds from our credit facility and subsequent lowering of the interest rate margin on the credit facility pursuing to the amendment and restatement earlier in the year. During the quarter, there was no accrual for incentive management fees based on gains, due largely to the net unrealized depreciation in the portfolio as of September 30, 2016. Furthermore, no incentive management fees based on income were earned and payable for the quarter, as the distributable income amount was reduced below the hurdle by the net unrealized depreciation in the portfolio for the trailing four quarter period. Relative to distributions declared of $0.21 per share, our distribution coverage was 101% for the quarter excluding a one-time legal settlement expense during the quarter of $17.5 million. As of quarter end, our run rate net investment income, as adjusted, is $0.22 per share based on average fee income over the trailing 12 month period and $0.20 per share excluding any fee income, implying a distribution coverage of 105% and 94% respectively. The composition of our portfolio remained fairly stable in the third quarter as compared to the second quarter. Secured debt decreased 3 percentage points to 69% at quarter-end, primarily due to the prepayment of MediMedia during the quarter. Unsecured and subordinated debt increased 2 percentage points to 16% due to a combination of deployments during the quarter as well as net depreciation in our total portfolio resulting in smaller overall portfolio at fair market value. Equities increased 1 percentage point to 15%, mainly due to the deployment of $21 million into Senior Loan Partners. During the third quarter, net unrealized depreciation increased $10.4 million, bringing total balance sheet unrealized depreciation to $104.7 million. Gross unrealized depreciation of $36.1 million during the quarter was offset by $3 million of gross unrealized appreciation due to changes in portfolio valuations and $22.8 million of unrealized appreciation due primarily to the reversal of previously recognized unrealized depreciation on the New Gulf investment. At September 30, we had total liquidity of $271 million, consisting of $7 million in cash and $264 million of availability under our credit facility. At September 30, our net leverage after accounting for the pro forma impact of one-time $17.5 million legal settlement stood at 0.55 times, we had an asset coverage ratio of 288% and we were in compliance with all financial covenants under our debt agreements. With that, I would like to turn the call back to Steve.

[Steve Sterling:]

Thank you, Donna. The company’s financial results for the period were disappointing. As we sustained additional negative remarks pertaining to the legacy portfolio and recognized the loss associated with a long outstanding litigation claim relative to AL Solutions. The team is working very diligently in addressing portfolio challenges to protect client shareholder capital. Our financial position with moderate net leverage at 0.55 times and over $250 million of liquidity afford us significant flexibility that navigate the challenges. And concurrently to selectively deploying new capital into income earning assets. I’m proud of our team's focus discipline and hard work as we balance important attention to managing challenged legacy positions with a concerted effort in sourcing new opportunities. With the Hunter Defense and Vertellus restructuring is now complete these businesses are now refocused on growth to create value for us as the new owners. We are optimistic these circumstances will ultimately prove to be successful reorganization events. With similar intensity, we are now particularly focused on SVP Worldwide and U.S. Well Services. Our idea generation kicked up during this period and this momentum is carried through into the fourth quarter. Consistent with past communications we remain highly disciplined investment selection, given the generally weaker quality of opportunities and recognizing where we stand in the business cycle. As touched upon in the prior calls in the absence of compelling risk-adjusted return opportunities in junior debt investments, we have focused our attention on deploying capital through follow-on investments in Gordon Brothers Finance, which invest an asset-based loans in Senior Loan Partners, which invest in traditional first lien senior secured loans. In closing, I would like to take a moment to thank our team, who has worked tirelessly to deliver for our client shareholders. Further and most importantly, I would like to thank each of you for your support. Operator, you may now open the call for questions.

[Operator:]

Thank you. [Operator Instructions] We’ll take our first question from Jonathan Bock with Wells Fargo.

[Jonathan Bock:]

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

[Larry Paredes:]

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

[Jonathan Bock:]

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

[Steve Sterling:]

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

[Jonathan Bock:]

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

[Steve Sterling:]

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

[Jonathan Bock:]

Yes. I think all Board members are kind of – what’s right can be oftentimes fungible I think everyone would realize if the incentive fee structure allows you to collect incentive fees while losses continue to – whether you made that loan or not, that would be something that would likely disadvantage the shareholders. So I would imagine that always gets taken into account. Now you are getting to U.S. Well real quick. We notice the equity was marked to zero in the quarter, the debt was down a bit but still at 91% of par. Walk us through right just in light of the credit issues that it surfaced not you’re doing, I understand. But or is there asset coverage there? What gives you the comfort to keep that at 91% of par? And how should we be looking at that investment going forward?

[Steve Sterling:]

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

[Mike Zugay:]

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

[Jonathan Bock:]

Got it. Guys, thanks for taking my questions.

[Steve Sterling:]

Thank you, Jonathan.

[Operator:]

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

[Steve Sterling:]

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

[Operator:]

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