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Edited Transcript of BKCC earnings conference call or presentation 9-Mar-17 3:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 BlackRock Capital Investment Corp Earnings Call

NEW YORK Mar 9, 2017 (Thomson StreetEvents) -- Edited Transcript of BlackRock Capital Investment Corp earnings conference call or presentation Thursday, March 9, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Laurence Paredes

BlackRock Capital Investment Corporation - General Counsel, Corporate Secretary

* Michael Zugay

BlackRock Capital Investment Corporation - CEO

* Donna Milia

BlackRock Capital Investment Corporation - CFO, Treasurer

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Conference Call Participants

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* Jamie Sirockman

Wells Fargo Securities, LLC - Analyst

* Ryan Lynch

Keefe, Bruyette & Woods, Inc. - Analyst

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Presentation

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Operator [1]

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Good morning. My name is Carolyn and I will be your conference facilitator today for the BlackRock Capital Investment Corporation fourth-quarter 2016 earnings call.

Hosting the call will be Chief Executive Officer Michael J. Zugay; Chief Financial Officer and Treasurer Donna M. Milia; General Counsel and Corporate Secretary of the Company Laurence V. Paredes; Nik Singhal, Investor Relations and Business Strategy; and Marshall Merriman, head of portfolio management for BlackRock's US private capital group. (Operator Instructions). Thank you.

Mr. Paredes, you may begin the conference call.

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Laurence Paredes, BlackRock Capital Investment Corporation - General Counsel, Corporate Secretary [2]

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Good morning and welcome to BlackRock Capital Investment Corporation's fourth-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 uncertainty. Many of these forward-looking statements can be identified by the use of words such as anticipates, believes, expects, intends, will, should, may, and similar expressions. We call your attention to 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 statement.

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've posted to our website an investor presentation that complements this call. Shortly, Michael 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 March 2017 investor presentation link in the presentation section of the Investor Relations Page. Thank you.

I would now like to turn the call over to Michael Zugay, who will provide an overview of the business and fourth-quarter highlights.

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Michael Zugay, BlackRock Capital Investment Corporation - CEO [3]

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Thank you, Larry. I'm joined by many of our senior team members, most of whom you will recognize from previous calls, but today Marshall Merriman is also here with us. Marshall has been a senior member of the BCIC investment team since its inception and was recently promoted to head of portfolio management. Marshall is intimately familiar with the existing portfolio and has been instrumental in leading our deal teams through many of the challenged credits we have faced over the past year.

I'd like to start by giving an update on the fourth quarter's business and financial highlights, including some of our recent announcements regarding our distribution and incentive fee waiver, then discuss the broader credit and economic environment and, finally, our investment activity and portfolio performance.

For the fourth quarter, net investment income was $0.24 per share, or $0.22 per share excluding an insurance reimbursement payment received related to the previously announced AL Solutions legal settlement. We are pleased to report this recovery and we continue to pursue claims under available insurance policies that could further mitigate the impact of the AL Solutions settlement. At this time, we are not certain if any additional insurance proceeds will be recovered and the amount, if any, may not be material.

Net asset value per share decreased from the third quarter by $0.17, or 2%, from $8.38 per share to $8.21 per share. The decline was primarily due to markdowns on the legacy equity positions that we will further discuss when we cover the portfolio.

Additionally, we announced a reduction to our quarterly distribution to $0.18 per share versus the prior distribution of $0.21 per share. Our Board and our management team believe that a reduction was necessary due to a variety of factors that have reduced the earnings capacity of the current portfolio relative to the prior distribution level. The underperformance of our oil and gas investments and a select few of non-energy-related investments have led us to the decision to realign the distribution with the run rate net investment income of the current portfolio.

During the past year, we have been working hard to restructure many of the underperforming legacy investments. For the most part, the restructuring activity is behind us, and certain debt investments have been or are anticipated to be partially or entirely converted into equity investments. The time required to rotate out of these positions is inherently unpredictable, but we intend to be patient and diligent in order to maximize recoveries.

Additionally, the Company's investment advisor, in consultation with our Board of Directors, has agreed to waive 100% of the income-based incentive fees for the next 21 months. Based on the current earnings run rate of the Company, we estimate the fee waiver will amount to approximately $0.03 to $0.04 per share per quarter. This will allow us to create shareholder value as we monetize and redeploy the equity proceeds into income earning assets, consistent with our strategy of continuing to build a defensive portfolio that generates a more stable stream of income.

The portfolio challenges remain concentrated in certain legacy investments. Since March 6, 2015, when we assumed responsibility for managing the investment activities of the Company, our team has deployed approximately $475 million in performing new investments. As of December 31, 2016, approximately 40% of the portfolio is represented by investments deployed by the new advisor.

We remain modestly levered by industry standards at 0.55 times, with ample liquidity at over $260 million to support new investment activity.

As stated on our previous calls, we seek to deploy capital across three core channels, including, one, BCIC Senior Loan Partners, our first lien joint venture, which had about 50% of its committed equity capital deployed as of year-end; two, our investment in Gordon Brothers Finance Company, an asset-based lender; and, three, direct investments in junior capital instruments. With regard to junior capital opportunities, we continue to be highly selective on credit, as spreads tightened and terms generally tilted to be more borrower friendly in the fourth quarter.

Leverage levels were fairly consistent quarter over quarter, but covenants were set a little wider on many new deals and several of the larger middle-market issuers were able to pursue syndicated deals, oftentimes covenant light. Purchase price multiples remained elevated, as double-digit multiples are becoming even more commonplace.

With the election cycle behind us, much of the volatility in the first part of 2016 has given way to a sustained period of positive momentum in the equity and credit markets. Generally, there is an expectation that lesser regulation and a pro-business environment will lead to more job creation and a stronger US economy. There's a lot of speculation that exists as to how potential deregulation and tax reform may impact the financial sector and corporations, but there is not enough concrete information to have a clear picture as to the materiality of any potential changes.

Turning to our investment activity in the quarter, we had approximately $1.4 million of net repayments. The repayments were primarily represented by two transactions, one, a $35 million par repayment of BPA Labs, and two, a $20 million par reduction in our investment in Sur La Table.

Our gross deployments in the quarter were primarily represented by two investments, the first being $20 million L1000 second lien debt to a new portfolio company, Paragon Films, and second being $20.2 million into Senior Loan Partners to fund our 85% share of its equity. Senior Loan Partners made three new investments, which we highlighted in our press release. We continue to believe there are good risk-adjusted investment opportunities for Senior Loan Partners as they continue to ramp.

Moving to non-accruals, Shoreline and Advanced Lighting remain the only investments that were on nonaccrual status at the end of Q4 2016. Subsequent to quarter-end, Advanced Lighting is expected to come off nonaccrual status, as we completed an amendment that will result in a lower, more achievable cash pay interest amount for the borrower. We had our position marked at 25 at year-end.

Additionally, on February 24, 2017, Shoreline's plan of reorganization was confirmed by the bankruptcy court. Our position continued to be marked at zero. After the court approved 363 sale to the first lien lender group, our claim is on a liquidating bankruptcy trust. We do not believe there will be a material recovery on this asset.

Pro forma for these two events and barring any new developments, we do not anticipate having any investments on nonaccrual at the end of Q1 2017.

As we look at the rest of the legacy investments in the portfolio, we have been particularly focusing time and resources on SVP Worldwide and U.S. Well Services. In January 2017, a comprehensive restructuring of U.S. Well was completed, and the balance sheet was right-sized and financial flexibility was added through a PIK feature on the reinstated debt. We now hold both debt and equity in U.S. Well and have a seat on the Board.

With regard to the SVP Worldwide, our mezzanine investment was marked to 62.5%. We are a lead investor in our tranche and we are in active discussions with the various stakeholders as we continue to evaluate the various options available to us in order to maximize our recovery.

Some of the more significant marked movements this quarter were concentrated in AGY, BMS, and MBS Group, all being legacy equity investments. The valuations for equity investments are highly sensitive to movements in EBITDA, and each of these companies experienced EBITDA declines, which drove the declines in fair market valuations.

With that, I would like to turn the call over to Donna for some additional details regarding our financial results.

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Donna Milia, BlackRock Capital Investment Corporation - CFO, Treasurer [4]

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Thank you, Michael. I will take a few minutes to review additional financial and portfolio information for the fourth quarter and full year of 2016.

Both GAAP net investment income and NII as adjusted were $17.1 million, or $0.24 per share, and $54 million, or $0.74 per share, respectively, for the three months and year ended December 31, 2016.

Relative to 2016 distributions declared of $0.84 per share, our NII distribution coverage of 89% for the year.

Fee income during the current quarter totaled $2.6 million, as compared to $500,000 earned during the preceding quarter. Current-quarter investment income also includes a $1.1 million insurance reimbursement received in connection with the previously disclosed AL Solutions legal settlement. Excluding fee income and the insurance reimbursement, investment income decreased approximately 5% compared to the prior quarter and 20% as compared to this quarter one year ago. The decreases were a result of a net reduction in the overall income-producing assets over the year, as well as certain investments on nonaccrual status through the course of 2016.

The portion of our portfolio invested in equity securities increased during the quarter to 17% at year-end, primarily due to the deployment of $20.2 million of equity capital into Senior Loan Partners. Our portfolio composition of secured debt at fair market value decreased to 66% at year-end, primarily resulting from the repayment of BPA Labs during the quarter.

Unsecured debt increased to 17% due to net depreciation in our total portfolio, resulting in a smaller overall portfolio at fair market value. Total portfolio yield increased 30 basis points sequentially, from 11.4% as of last quarter-end to 11.7%, largely a result of the Vertellus restructuring, removing the investment from nonaccrual status.

Year over year, our 2016 weighted average cost of debt decreased 141 basis points to 4.37% and our 2016 borrowing costs on a dollar basis are more than 30% lower than the prior year, resulting in annual savings in financing costs of $0.10 per share. This was primarily driven by refinancing our $158 million, 6.5% senior secured notes with proceeds from our revolving credit facility, coupled with the subsequent lowering of the interest-rate margin on the credit facility pursuant 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 December 31, 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.

Net unrealized depreciation decreased $12.5 million during the current quarter, bringing total balance-sheet unrealized depreciation to $92.3 million. During the period, gross unrealized depreciation of $17.2 million, primarily from legacy assets, was partially offset by $3.2 million of gross unrealized appreciation. Further, there was $26.4 million of unrealized depreciation during the period, due primarily to the reversal of previously recognized unrealized depreciation on the Vertellus restructuring.

At December 31, we had total liquidity of $260.7 million, consisting of $10.7 million in cash and $250 million of availability under our credit facility. At December 31, our net leverage stood at 0.55 times, unchanged from the prior quarter. We had an asset coverage ratio of 275% and we're in compliance with all financial covenants under our debt agreements.

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

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Michael Zugay, BlackRock Capital Investment Corporation - CEO [5]

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Thank you, Donna. In closing, I would like to thank our investment team for their dedication and commitment to our goal of providing our shareholders with stable and strong risk-adjusted returns, primarily through income-generating investments. Thank you for your participation in today's call and for your continued support. With that, Operator, we would like to open the line to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Jonathan Bock, Wells Fargo Securities.

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Jamie Sirockman, Wells Fargo Securities, LLC - Analyst [2]

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Hi, guys, Jamie Sirockman filling in for Jonathan. While the fee waivers are definitely welcomed, what are your long-term thoughts on an appropriate fee structure?

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Michael Zugay, BlackRock Capital Investment Corporation - CEO [3]

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Thanks for calling in. This is Michael here. Look, I think what you are seeing here is we're looking to create long-term shareholder value. We view this step one of a long-term fee waiver as being very quantifiable and very favorable to our shareholders.

Quite frankly, this wouldn't be possible if we weren't part of a large platform like BlackRock. We are seeing benefits to being part of the BlackRock platform in really kind of every node of value creation, from sourcing, from information to monitoring. Each of these areas are meaningful and benefit the shareholders from the broader BlackRock platform.

The new fees that we're referring to just kicked in. I think this provides us time to rotate out of the reorg equities and really deploy -- redeploy into income-earning assets. So as part of this period of time that we've now given ourselves, I think we can reassess, work with the Board on any longer-term adjustments that would be necessary, but we view this as being very shareholder friendly, immediately benefitting the shareholders, and setting us up for the opportunity to rotate out and move forward.

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Jamie Sirockman, Wells Fargo Securities, LLC - Analyst [4]

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Sure. That definitely helps a lot. And kind of getting a little more specific, I'm looking at the growth in the BCIC JV. It looks like you guys put a lot of equity into the fund. It's grown assets a good bit, but it looks like the fund is still slightly underleveraged. What's your target leverage there and how do you see that ramping up in the next few quarters?

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Michael Zugay, BlackRock Capital Investment Corporation - CEO [5]

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It's a good question. So the way the fund works, the first dollars going into the fund for the first investments are all equity, so what you end up doing is you end up overequitizing until you hit a minimum equity amount.

We have since reached that minimum equity amount, so what you'll see is investments going forward as we're adding new investments and we saw it towards the very last part of the fourth quarter, but instead of deploying -- if it's a $10 million investment into a new portfolio company in the JV, instead of investing $10 million, that number will go down dramatically. And right now, given the fact that we would be in an overequitized situation, the next several investments we may not have to deploy any additional capital as those roll into the portfolio.

So that's kind of how the facility works, but to answer your question about how do you -- when do you get to optimal leverage, really, as we're modeling things out, optimal leverage is around $200 million to $225 million of assets in the joint venture, so we'll continue to ramp up to that number and leverage will be increasing along the way.

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Jamie Sirockman, Wells Fargo Securities, LLC - Analyst [6]

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Great. Thanks. I really appreciate the time. That's all the questions for me.

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Michael Zugay, BlackRock Capital Investment Corporation - CEO [7]

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Thanks, Jamie.

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Operator [8]

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Ryan Lynch, KBW.

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Ryan Lynch, Keefe, Bruyette & Woods, Inc. - Analyst [9]

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Good morning. First off, I appreciate your guys' willingness to waive the incentive fees. I think that's a very shareholder-friendly benefit feature and I appreciate you guys doing that.

Michael, maybe just a broader question for you, now that you officially have stepped on as the CEO of BKCC. How do you view BKCC's competitive advantage or strength in sourcing and underwriting new direct middle-market loans versus other players in the market?

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Michael Zugay, BlackRock Capital Investment Corporation - CEO [10]

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Yes, look -- Ryan, thanks for calling in. This is Michael here. The way -- we are in a very unique position here at BlackRock. We do benefit from being on this broad platform. From a sourcing side, it's really helping to be at the BlackRock platform as we're sourcing opportunities for the JV.

As you know, we're investing $10 million tickets into each of these companies. We're leveraging our sponsor relationships to get into those deals, but we're also using the BlackRock leverage that they have over in the global capital markets group to help on allocation there. So, as we're looking at the three pillars of growth that we're focused on, the JV is very much something that we're benefiting in being on the platform.

We also -- as you think about second lien and more direct investments, we do have great sponsor relationships. I think when you see the deals that we've done over the last, really, 18 months, these are situations on the junior capital side where we are lead investor. We are instrumental in driving the documentation, setting covenants. We've got a great relationship with the management team, and those are the types of things that are core to our business, and we are speaking for meaningful pieces of the junior debt capital in those transactions.

In some cases, we bring in partners; in other cases, partners bring us into deals as well. But, really, our guiding principle as we're looking at second lien investments is, one, do we have access to primary diligence? If we can't do primary diligence on the deal, then it's not going to be something that we will make a meaningful investment in.

Two, the documentation, absolutely critical for us to make sure that the documents that we're signing up to, that we are either instrumental in driving those documents or, too, that the documents have -- if a partner of ours brings us into it, the documents have the must-haves that are important for us.

And three, we have to have a relationship with the sponsor and the management team to really monitor the asset going forward. If those three elements don't exist, then it's not a deal for us.

So we are active. We are being highly selective on credit, the quality of credit. And as we see right now, we are being very opportunistic as we're looking at junior capital investments and we're seeing more -- or better relative value in the first lien, hence, one, the creation and, two, the ramping up of the Senior Loan Partners joint venture.

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Ryan Lynch, Keefe, Bruyette & Woods, Inc. - Analyst [11]

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Okay. As I looked, you talked about the three kind of buckets of the Senior Loan Partners, Gordon Brothers, and then also kind of junior-debt middle-market lending. Over the longer term, there's only -- at least the way you've currently structured your senior loan program, there can only be limited growth in that as far as deployments, and then Gordon Brothers, I'm assuming you can deploy some capital in there. But, really, it feels like the growth in your portfolio -- because you guys are underlevered today -- has to come from your middle-market lending platform and to junior capital investments.

Now if I look at your guys' portfolio, investment portfolio, over the last -- from 2014 through 2016, you guys have had negative net portfolio growth, meaning the portfolio shrunk. You guys are underlevered today. You also have a lot of stuff going on. You've talked about working through the legacy portfolio, restructurings, monetizing or rotating out of some of these larger equity positions.

What should we be thinking in terms of portfolio growth in 2017, considering you guys are underlevered today? Should we expect positive portfolio -- you know, net portfolio growth? And if so, how much? Or because you guys have so much going on today, do we not expect any net portfolio growth, and should we expect you guys to stay underlevered throughout 2017?

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Michael Zugay, BlackRock Capital Investment Corporation - CEO [12]

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It's a good question. We don't give specific guidance as to net new deployments going forward. That's just -- we haven't done that in the past.

But one of the constraints that we have right now is that we do have some of these restructured equity positions and inherently there is volatility in those. As we get more clarity to the performance of those companies, we'll have more confidence to deploy more capital.

I know I'm not exactly answering your question to give you guidance of what to put in your models, but I can tell you as we rotate out, as we get clarity and see performance in these re-org companies, we will then begin deploying net new dollars. But we're a little bit -- as you mentioned, there's a lot going on. We're a little bit hamstrung in our ability to do that in a meaningful way right now as we think about this quarter or the future quarter, but that's something where we absolutely want to get to the position. Every new piece of information that we have on the portfolio that gives us more confidence will then increase those net new deployments going forward.

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Ryan Lynch, Keefe, Bruyette & Woods, Inc. - Analyst [13]

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Okay. Those were all the questions for me. Thanks.

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Michael Zugay, BlackRock Capital Investment Corporation - CEO [14]

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Thanks, Ryan.

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Operator [15]

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(Operator Instructions). It appears we have no further questions at this time.

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Michael Zugay, BlackRock Capital Investment Corporation - CEO [16]

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Okay. Thank you very much. We appreciate everybody's time and look forward to speaking to you on the next call. Thank you.

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Operator [17]

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And that will conclude today's conference call. Thank you, everyone, for your participation. You may now disconnect.