MidCap Financial Investment Corporation (MFIC) Q1 2016 Earnings Report, Transcript and Summary

Good morning and welcome to Apollo Investment Corporation's earnings conference call for the period ending June 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 like to turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

Thank you, operator and thank you everyone for joining us today. With me are Jim Zelter, Chief Executive Officer, Ted Goldthorpe, President and Chief Investment Officer and Greg Hunt, Chief Financial Officer. I would 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 would 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 of companies. You should refer to our registration statement and shareholder reports for risks that apply to our business and 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 would also like to remind everyone that we have posted a supplement financial information package on our website, which contains information about the portfolio as well as the company's financial performance. At this time, I would like to turn the call over to Jim Zelter.

Thank you, Elizabeth. This morning we reported earnings for the quarter ended June 30, 2015 and filed our 10-Q. I will 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. And finally, Greg will discuss our financial results in greater detail. We will then open the call to questions. For the quarter, we reported net investment income of $0.22 per share, which reflected a decline in the average size of the investment portfolio, offset by income from prepayments and structured products. Net asset value declined 2.1% to $8.01 per share and the decline resulted primarily from the final purchase price adjustments related to the sale of our investment in PlayPower, some commodity related investments and several of our legacy holdings. We continue to be very focused on commodity related investments, particularly oil and gas and we have substantially exited any mining investments. During the quarter, we invested $509 million, sold $334 million of assets and received $198 million in prepayments. All-in net investment activity for the quarter was a negative $23 million. We remain selective in our approach with a focus on secured debt, which we continue to believe currently offers the most attractive risk-adjusted returns. Looking ahead to the regulatory landscape, we remain optimistic regarding the opportunities for providers of flexible capital such as ourselves and we believe that the scale of our platform enables us to participate and be selective in the marketplace today. We will continue to execute on our strategy of seeking to selectively deploy capital and monetize select investments, particularly non-yielding positions. Consistent with our commitment to deliver shareholder value, we have adopted a $50 million stock repurchase program. Given where our stock is currently trading, we intend to begin repurchasing shares as soon as possible. In addition, the company held its annual meeting of stockholders and special meeting yesterday. At these meetings, the company's stockholders approved all three proposals. We greatly appreciate the support of our shareholders on these matters. Lastly, turning our attention to our dividend. The Board approved a $0.20 dividend for shareholders of record as of September 21, 2015. With that, I will turn the call over to Ted.

Thank you, Jim. I will begin my comments with current market conditions and then discuss our investment activity for the quarter. Despite some headwinds, including concerns about Greece, China and the continued debate around timing of a potential U.S. rate hikes, leverage loan market conditions strengthened during the quarter as a result of market technicals. Despite a pickup in leverage loan volumes during the quarter, net new supply declined slightly amidst substantial repayments. Strong CLO issuance and flat leverage loan fund flows contributed to narrower clearing yields and higher loan prices. That said, the middle market lending environment, while not immune, is believed to be generally insulated from trends in the broadly syndicated market. Pricing in the middle market remain relatively unchanged during the period. We believe the middle market currently offers lenders superior risk-adjusted returns as the overall demand for capital to middle market companies exceeds the supply. With this backdrop, our origination activity picked up following a seasonally slow March quarter. During the quarter, we invested $509 million in 10 new portfolio companies and 20 existing portfolio companies. The weighted average yield on investments made was 10.5%. As Jim mentioned, we continue to focus on secured debt opportunities which accounted for 61% of investments made during the period. During the period, we exited $532 million of investments, of which $334 million were proactive sales. The yield on investments sold was 11.3% and the yield on repayments was 11.2%. We continue to increase our exposure of floating rate debt to better position us for an expected rise in short-term rates. 59% of the debt portfolio was floating rate at the end of the quarter, up from 52% at the end of March. Moving to specific investment activity. We have been actively investing in sectors away from our specialty verticals, aviation and oil and gas. During the quarter, we invested $23 million in secured debt of Emergency Communications Network, the largest SaaS-based provider of emergency communications within state and local government market. We also invested $15 million in secured debt of STG-Fairway Acquisitions, or First Advantage, a provider of comprehensive screening, identity and information solutions that give employers and housing providers access to actionable information. We also invested $34 million in the secured debt of Deltek, an existing portfolio company, which is a leading provider of enterprise software and solutions to project focused businesses globally. In addition, Merx continues to pursue opportunities, as well as actively manages the existing aircraft portfolio. Given the current competitive landscape, during the quarter, Merx monetized several aircrafts at attractive levels. Regarding our oil and gas exposure, our portfolio remains well diversified by borrower and geography. As a reminder, our strategy focuses on lending against producing upstream oil and gas reserves with an emphasis on asset coverage. At the end of June, 82% of our oil and gas portfolio was in first and second lien debt. Although PDP coverage has declined with the drop in prices, we still remain comfortable with asset coverage. In addition, several of our borrowers are working to improve their liquidity by reducing CapEx, selling non-core assets, issue equity or other strategic alternatives. As of the end of June, oil and gas represented 16% or $531 million of our portfolio and included 13 borrowers. All of our oil and gas investment activity during the quarter related to existing portfolio companies. Our March generally reflects the underlying fundamentals of each borrower and widening spread in these securities, given the stress in the sector. Regarding our investment in Miller. The company recently paid down the vast majority of its RBL and our investment is effectively the most senior in the capital structure. The company is undergoing a capital repositioning plan, including potentially refinancing or restructuring of its debt and selling non-core assets. Regarding our investment in Venoco which we had a strategic exchange where we rolled unsecured debt at a premium to market value for second lien secured notes and invested additional capital in the company's first lien notes. We believe we have enhanced our position in the capital structure, which is designed to benefit us in the lower for longer environment. We also upsized our investment in Deep Gulf's first lien term loan facility by $30 million to fund the development of the loan. And we invested an incremental $25 million in Canacol as part of our delayed draw commitments to the company. Exits, which include sales, repayments and revolver pay downs totaled $532 million for the quarter. Sales totaled $334 million for the quarter, including a full exit of our investments in PlayPower, Molycorp and PetroBakken. Repayments for the quarter totaled $198 million, including our investment in purchase of options for BCA. With the exit of PlayPower and BCA, we have reduced the amount of equity and PIK in our portfolio, which improve dividend coverage as we redeploy the proceeds into cash income producing assets. We currently have a diversified $3.3 billion portfolio measured at fair value consisting of 102 portfolio companies across 25 industries. Overall, we believe the credit quality of our portfolio remains relatively strong. The portfolios weighted average risk ratings were unchanged and remained at 2.2 on a cost basis and 2.1 on a fair value basis. The weighted average net leverage of investments remain constant at 5.5 times and interest coverage decreased to 2.5 times, down from 2.6 times. As mentioned in our last earnings call, Magnetation, one of our portfolio companies, filed for bankruptcy. As a result, our original first lien investment in this company was placed on nonaccrual status. At the end of June, investments on nonaccrual status represented 0.4% of the fair value of the portfolio compared to 0.1% at the end of March. On a cost basis, these investments represented 2.5% of the portfolio at the end of June compared to 1.3% at the end of March. Regarding our regarding our investment in Magnetation, in mid-July the company received court approval to enter into a restructuring support agreement, a small portion of our first lien notes rolled into the debt and the remainder will be converted into second lien notes in convertible in preferred equity per the terms of existing RSA. With that, I will now turn the call to Greg, who will discuss the financial performance for the quarter.

Thank you, Ted. Total investment income for the quarter was $101.7 million, relatively flat compared to last year and the year-ago quarter. With that said, the composition of our income has changed with a decrease in investment income due to the lower income bearing investment portfolio, offset by prepayment income and dividends. Interest income for the June quarter included $8 million of prepayment income compared to $6.7 million in the March quarter and $6.1 million in the year-ago quarter. 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. We expect these investments to generate recurring dividends. There were no nonrecurring dividend for the June quarter, compared to the prior quarter, which included a $1.4 billion one-time dividend. The amount of dividend income may vary very quarter-to-quarter based on asset mix, but the run rate should be slightly below the current level, given the exit of PlayPower. PIK income for the quarter accounted for a 7.9% of total investment income, down from 9% last quarter. As Ted mentioned, the decline in PIK was due to the exit of our investment in BCA and should decline further next quarter with the exit of PlayPower. Expenses for the quarter totaled $50.7 million compared to $50 million last quarter and $49 million for the year-ago quarter. The slight increase was due to an increase in interest expense and G&A expenses, partially offset by lawyer management fees. The increase in interest expense is attributable to a full quarter of interest on our $350 million 10-year debt issuance completed during the March quarter. As a reminder, we have $225 million of 6.25% senior notes maturing in October and $200 million of 5.75% convertible notes maturing next January. These notes have a blended interest rate of approximately 6%. We intend to use our revolving credit facility which currently has an interest rate of LIBOR plus 200 to replace the maturing debt. Upon the maturity of these notes and assuming the same amount of outstanding debt, the blended interest rate on our total debt outstanding should decline by approximately 100 basis points. Net investment income was $51 million or $0.22 per share for the quarter. This compares to $52.1 million or $0.22 per share for the March quarter and $53.6 million or $0.23 per share for the year-ago quarter. For the quarter, the net loss on the portfolio totaled $44.6 million or $0.19 per share compared to a net loss of $63 8 million or $0.27 per share for the March quarter and a net gain of $11.1 million or $0.04 a share for the year-ago quarter. The net loss of $44.6 million includes $81 million of realized losses. Approximately $63 million of the realized losses were previously recognized as unrealized at March 31, 2015. Negative contributors to performance for the quarter included our investments in PlayPower, SquareTwo, Artsonig, Miller Energy and Magnetation. Positive contributors to performance for the quarter included our investments in Venoco, Gen Brands, Merx Aviation and AMP Solar UK. In total, our quarterly operating results increased net assets by $6.4 million or $0.0.3 per share, compared to a decrease of $11.7 million or $0.05 per share for the March quarter and an increase of $64.6 million or $0.27 per share from the year-ago quarter. On the liability side of our balance sheet, we had $1.4 million of outstanding debt at the end of the quarter, down slightly from $1.5 billion at the end of March. The company's net leverage, which includes the impact of cash and unsettled transactions, stood at 0.72 times at the end of June, unchanged from the end of March. The company's debt-to-equity was 0.73 times at the end of June, down from 0.77 times at the end of March. At the end of June, our portfolio had a fair value of $3.3 billion, down slightly quarter-over-quarter. The weighted average yield on our debt portfolio at cost was 11.5%, an increase of 30 basis points from the end of March. The change in the overall yield was due to three factors, investment activity, an increase in rates from amendments on a few existing positions and the placement of one of our investments on nonaccrual. Regarding yield on investment activity, the yields on new debt investments were 10.5%. the yield on debt investment sold were 11.3%. Excluding PlayPower, the yield on investments sold were 10.2%. The yields on prepayments were 11.2%. The increase in the yield as a result of amendments and PIK elections accounted for approximately 20 basis points of the 30 basis points increase. This concludes our prepared remarks and now we will open the call to questions.

[Operator Instructions]. Your first question comes from Terry Ma of Barclays.

Hi guys. So given the reduced focus on your specialty verticals, can you maybe just talk about what sectors you find attractive right now? And maybe just talk at a high level about how you think about oil and gas exposure going forward?

Yes. So I would say, we are actually finding a lot of value in our just bread and butter middle market lending business. When we say reduced focus, obviously we are still very focused on the aircraft or other specialty verticals. There our opportunity set in the last, at least, three months has really picked up in middle market. So when you look at quarter-to-date activity, we are still finding really good value in just plain vanilla sponsor finance. And we are probably less opportunities to deploy new capital in places like aviation and oil and gas. Regarding our debt portfolio is, listen, we are very, very focused on it. Obviously we feel still feel like we have got good asset coverage. But obviously oil prices are much lower. So it's a portfolio that we spend a lot of time on. It is really concentrated in just a couple of investments and it's a portfolio we continue to monitor very closely. And just for context, we continue not to see today, we continue not to find a lot of attractive new origination opportunities as we sit here today.

Okay. Got it. And can you maybe just give a little more color on Miller and how well you think your investments cover there?

So I would say, obviously we are obviously focused on Miller. Miller, I would point the people to the press release that Miller put out last week about update on their business and strategic alternatives and asset sale [indiscernible]. And I think that's pretty self explanatory.

Okay. Got it. I think that is it from me. Thanks.

Your next question comes from Kyle Joseph of Jefferies.

Hi. Good morning, guys. Thanks for taking my questions. I know the first half the year started out relatively slow in terms of deal flow. Just wanted to get your outlook for the remainder the year and thoughts on if we will see net investments go to the positive this year?

Yes. Listen, if you think about gross versus net investment activity, new originations for us are typically pretty correlated with repayments. And I would say, we have been in a relatively benign period of repayments and our investment is not as robust. So I think over the next six to 12 months, I think our portfolio should be around flat. Obviously, things can change. If you look at our existing pipeline, which is pretty good and you look at our repayment pipeline, which we have got a decent amount of visibility on, I would say, I don't think we expect a material increase or contractor of portfolio through the rest of the year.

Okay. And then just looking at the sales in the quarter, I know the average yield on the sales was bumped up by PlayPower, but what motivated the sales in the quarter? Was it trying to reduce exposure to certain industries? I guess that's my question.

Yes. It's actually a great question. So I would bifurcate our sale activity into two buckets, or three buckets. One is, we monetized PlayPower, which obviously is a very large investment to us, some partial PIK income and partial non-yieldings. And we are going to redeploy those proceeds into things like stock buybacks and new originations, which we think is very productive for our shareholders. We also basically took down our mine exposure to a de minimis amount. We are really trying to get out of that sector. And then the third area is what we talk about a lot, which is selling more of our low yielding assets to help our yield expansion and we still have opportunities do that. So then we get to break our sales into three areas, reducing exposure to cyclical sectors. It's obviously the repayment of PlayPower or the monetization PlayPower. It's a very big exposure for us and selling out of legacy low yielding investments.

Okay. Great. And then can you give us your thoughts on capital allocation going forward on new investments versus share purchases? And how think our valuation there?

Well, I think, I mean certainly we were putting forth a positive statement. There's been lots of analysis done on cost of capital and I don't want to have that debate or discussion in this forum. There are some practical limitations between windows and other things and about how much stock you can actually buy back. But certainly as part of our portfolio right now, we think it merits the purchase. So if we can buy some stock in this range and the returns on that realizing the practical limitations, we think it makes sense for our overall portfolio.

All right. Great. Thanks a lot for answering my questions.

Your next question comes from Doug Mewhirter of SunTrust.

Hi. Good morning. Could you, I guess, give me a few clarifications on Venoco? Was the restructuring of your position, did that happen during the quarter or subsequent to the quarter end? And is it reflected on your statement of investments currently? Or will that change? It sounds like you shifted some things around.

Yes. So just for clarity. So it happened in the quarter that was reported. So that's reflect, the activity in Venoco has been reflected in the schedule of activity. And effectively, what we did, we took in unsecured risk and rolled it into secured risk. And so that will be all reflected in our scheduled investments.

And a question about the Venoco specifically, they gave an operational update on their website and they mentioned that part of their production disruption was due to actually pipeline that stopped working. Do they have any financial recourse to the pipeline company? And also do they anticipate that getting fixed anytime soon? And is that part of the reason why you reinvested in the company, for lack of a better term?

Yes. So again, the pipeline outage did not affect reserve coverage, but it does affect near-term cash flow. The outage happened subsequent to the transaction we had announced. And for an upper on Plains, which is the pipeline operator issued a public release. They had some comments about it in their latest earnings release. And I would just point you to those public comments made by Plains.

Okay. Thanks for that. And Greg, it looks like you have some and you may mentioned this in the preamble, but you have some convertible debt. It looks like it's coming due. Was that part of the debt that you said you would take out with your credit line? Or were you talking about a different set of note?

No. That is the convertible debt that comes due in January 2016.

Okay. Thanks. And one last question. It looks like your leverage is about 0.75 times, give or take. I suppose with just recycling your portfolio and buying back stock, that you are pretty comfortable with that range. You don't intend to tick it up or down significantly?

No. I think we have always talked about leverage growing from 0.5 to 0.75 and operating 0.65 on average. We are on a little bit towards the wider end, but we are comfortable right now. As Ted said, I think we think that our portfolio will be stable in terms of the overall size. It may increase a little bit. It may decrease a little bit. We don't see it materially expanding or contracting dramatically. And our view would be, being able to position the stock buyback in with some of proceeds we have gotten back from PlayPower that was a non-yielding asset. We feel comfortable where our leverage is today.

Okay. Great. That's all my question.

Your next question comes from Jonathan Bock of Wells Fargo Securities.

Good morning, guys. [Indiscernible] joining for Jonathan Bock here. I have a few questions about couple of portfolio companies. The first is Miller Energy. And on Miller's call last week, Miller's management indicated that a private financing source was providing $165 million that would pay down existing debt and for me, when I think of that, it seems that $165 million would probably be used to take out the ABL lender that sits in front of Apollo, as well as provide cash for the balance sheet for liquidity going forward. And also, given the situation that the company is in, it seems likely that maybe existing Miller Energy lenders would provide that $165 million. So my question, Ted, is really, would this improve liquidity going forward? And you how much time does this buy Miller? Does this materially improve their liquidity because I know they do have some relatively small legal claims against them that they were delaying as they waited for tax credits?

So what I would say is, again, there is very little in the way of debt ahead of us, if any at all. And what they have said publicly is they are working with a source to -- well, the contemplation is to take out our debt. And we can't comment on whether it's going to happen or not, we don't know. But obviously they are in the market trying to refinance out their existing capital structure. So I think you would read it as, I don't think they are out there saying they are going to put a whole bunch of debt ahead of us. I think there is effectively no RBL, as we are basically the first dollar in the whole capital structure. And what they have said publicly on their calls is they are trying to refinance debt or total debt.

Okay. Very helpful. The second question relates to My Alarm. The company was in market with the bond deal, I believe in June, that I think they were trying to price at around 10% or north of 10%. And that deal was pulled. So I am curious that the current first lien position in My Alarm, is more market par on the balance sheet, is that -- if you could just give some color? Was the bond deal viewed as more of a technical phenomenon versus where the value of the first lien currently sits?

Yes. So that bond deal was launched in a very tough market. I would say, listen subpar covenants, they tried to get a larger bond yield done than our facility provides them with less covenants. So it's not exactly an apples-to-apples comparison. So the bond deal that they launched went deeper in the capital structure with less covenants. And so it's not exactly apples-to-apples with our existing portfolio of loan. So we feel good about the position that we are in. I wouldn't read too much into it because they launched it into a really, really tough environmental in the middle of Greece and bunch of other things happening macro wise.

Okay. Very helpful. And then just finally, that looks like that position is now paying L plus 800 versus L plus 750 last quarter. Was there a step up, leverage based step up or something in the loan doc?

Yes. There was an amendment that was done that provided new terms of that piece of paper.

Okay. Very helpful. Thank you very much.

Your next question comes from Greg Mason of KBW.

Hi. Great. Guys, thanks for the commentary on Miller. I appreciate it. Just in the energy marks in general, given that oil has fallen off in July and feels like the credit energy markets have calling off since the June 30 numbers. Any sense that you can give us for where you think in general the energy portfolio is trading at in terms of flat to a percentage down? Just kind of a ballpark of where you think we are at maybe today versus quarter end?

I think our view is, we do watch this stuff very closely. You guys watch it very closely. I think that there is a lot of oil floating in the market but our sense is, we are probably flat to where the last quarter was. I know there is a lot of curiosity about the space and individuals. As Ted said, we understand what's going on in the macro. We feel we are happy that we are in the securities and where we are in the capital structure. Notwithstanding a challenging macro, we are working and we are on top of it. So to answer your question, Greg, I think we think that we are probably flat overall and expect more volatility.

Okay. Great. And Jim, just on the $50 million share repurchase. You said you are going to start it immediately. What is your --

I actually said, as soon as possible.

As soon as possible. What's the thought in terms of how quickly to deploy the $50 million? I am sure you could deploy it quickly or leak it out over a 12 month period. So just kind of your thoughts on the aggressiveness of that?

As I said earlier, Greg, there is a practical limitation in term various programs and how much stock you actually can buy back based on volume and windows and things of that nature. And I think that what we have tried to do is, the Board and management put a number out there that we expect to put to work over an appropriate period of time. So is that between now and year-end, I think that's a good window.

Yes. I think we don't want to announce a number that we didn't feel like we can stand up to. And Jim said, there is a lot of practical limitations on how much you can buy back. And so I think the message from the management team and the Board is, we intend to use this. This is not an announcement, but we intend actually use the buyback program.

That's a great message. Thanks guys. I appreciate it.

Your final question comes from the line of David Chiaverini of Cantor Fitzgerald.

Hi. Thanks a lot. I have a question on loan pricing trend. So the average portfolio yield at 11.5%, that's actually up quite nicely from 11.1% a year ago. I was wondering do you expect to stay, keep the portfolio around that 11.5% level based on what you are seeing in the market? Or do you expect it to pullback some?

Listen, our portfolio has been reasonably stable over the last three years. And so I don't think we expect large changes either way. But again we are feeling some risk reward versus just reward. And so lot of step up this quarter was related to things like but amendments and other things as well as some of the new originations. So I don't think we see a material change coming in our yields either way, up or down.

Okay. Thanks for that. And I was also curious about the fee rebates on CION Investment Corp. I know it's been pretty low the most recent few quarters. I was curious, in the second quarter the debt uptick at all and what are your thoughts there on a go forward basis?

Yes. David, it contributed a little bit directionally in our fees. As you know, we have the waivers and we then have the CION offset. So I think it's very helpful. The overall commercial reasonableness of our fees continue to improve.

Great. Thanks very much.

This concludes the question-and-answer session of today's conference. I would now like to the floor back over to Mr. Jim Zelter for any additional or closing remarks.

Well, great. Thank you, operator and thank you very much for all the time and questions today. We appreciate your support and we look forward to talking to each one of you in the near future. Have a good day.

Thank you. This concludes today's conference. Thank you for your participation. You may now disconnect and have a wonderful day.