MidCap Financial Investment Corporation 8.00% Notes due 2028 (MFICL) Q2 2016 Earnings Report, Transcript and Summary

Good morning and welcome to Apollo Investment Corporation's earnings conference call for the period ending September 30, 2015. At this time, all participants have been placed in listen-only mode. The call will be opened for a question-and-answer session following the speakers' prepared remarks. [Operator Instructions]. I will now turn the call over to Elizabeth Besen, Investor Relations Manager for Apollo Investment Corporation.

Thank you, operator and thank you for joining us today. With me today are Jim Zelter, Chief Executive Officer, Ted Goldthorpe, President and Chief Investment Officer and Greg Hunt, Chief Financial Officer. I 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 September 30, 2015 and filed our quarterly 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. Greg will then follow and discuss the financial results in greater detail. We will then open the call to questions. For the quarter, we reported net investment income of $0.21 per share, which reflected higher dividend income, offset by a decline in income from prepayments and lower fee income compared with prior quarter. Net asset value declined 2.2% to $7.83 per share during the quarter and the decline was primarily driven by some marks in our oil and gas investments. During the quarter we invested $204 million, sold $80 million of assets and received $200 million in principal payments. All in all, net investment activity was negative $75 million for the quarter. During the quarter we focused on investing in existing portfolio companies and executing on our stock purchase plan. We used a portion of proceeds from repayments in sales to repurchase $21 million of stock, while maintaining leverage. Assuming the price of our stocks, stays at current levels relative to net asset value, we intend to continue repurchasing in the current quarter as part of our announced plan. Let me take a moment to address some of the concerns that have been raised about our oil and gas exposure. We are very cognizant in today's market conditions. We continue to closely monitor our investments and believe in a long-term prospects of the industry. The firms deep industry and technical expertise has enabled to build and structure portfolio that we believe, will perform over the long-term. We will continue to be patient and disciplined in our approach during this continue period of this allocation. Lastly, turning our discussions to our dividend, the board approved a $0.20 dividend for shareholders of record as of December 21, 2015. With that, I'll turn the call over to Ted.

I'll begin my comments with current market conditions and then discuss our investment activity for the quarter. The September quarter was marked by heightened volatility due impart to concerns with global growth and uncertainty about Federal Reserve policy. Leverage loan issuance declined quarter-over-quarter and year-over-year. Slower CLO issuance and retail fund outflows contributed to higher clearing yields and lower loan prices. During the quarter, high yield bond spreads increased 156 basis points based on JP Morgan high yield index and leverage loan spreads increased 72 basis points based on JP Morgan leverage loan index. That said, the middle-market were not immune is generally insulated from trends in the broadly syndicated market and typically reacted to lag to changes in liquid credit markets. Recent volatility in liquid credit markets has led to better structure in terms in our market. We believe middle-market spreads continue to offer interesting risk adjusted returns. With this backdrop, sponsors have become more cautious and our origination activity was somewhat muted. During the quarter, we invested $204 million in four new portfolio companies and nine existing companies. The weighted average yield on investments made was 10.3%. As Jim mentioned, our origination activity focused on investing in existing portfolio companies. We continue to focus on secured debt opportunities which accounted for 62% of the investments made during the period. During the period, we exited $280 million investments of which $80 million were proactive sales and the rest and the remaining balance for repayments. The yield on investments sold was $11.3 million and the yield on repayments was 10.9%. We continue maintain a significant portion of our portfolio in floating rate debt to better position ourselves for an expected rise in short-term rates. At the end of September, 58% of the portfolio was floating rate essentially unchanged from the end of June. Moving to specific investment activity, during the quarter. We invested $54 million in a secured debt of Smart Start in connection with its acquisition by a sponsor. Smart Start is a market leader serving the ignition interlock device industry. We syndicated down a portion of our debt investment to a whole level of $34 million at the end of September. This transition is another example of our syndication capabilities. We invested $17 million in secured debt of Mediaocean to support its acquisition by a sponsor. Mediaocean is a leading provider of media management systems to the advertising agency sector. Our aircraft leasing business Merx Aviation continues to pursue opportunities as well as manages its existing portfolio including the monetization and refinancing of aircraft. During the quarter, Merx returned approximately $70 million of capital to Apollo Investment. At the end of September, aircraft represented 14.4% of the overall portfolio at fair value. Merx's has achieved sufficient scale, which has enabled the business to self-fund several of its most recent transactions. Exits, which includes sales, repayments and revolver pay downs totalled $280 million for the quarter. Sales totalled $80 million including partial monetization's of our investment in Deep Gulf, Smart Start and Confie Seguros. Repayments for the quarter totalled $200 million including a partial repayment of our investment in Merx Aviation and full repayments of our Croma [ph], Alion Science and Technology and Lloyd Education. Moving to our oil and gas exposure. As Jim noted, we continue to closely monitor our investments in this area and believe in the long-term prospects of the industry. As we said before, our portfolio is well diversified by borrower on geography. Our strategy on lending against producing, upstream, oil and gas reserves with an emphasis on significant asset coverage. Although PDP coverage is declined with drop in oil prices, we're still comfortable with our asset coverage. We believe our marks reflect the underline fundamentals of each borrower and stress in the industry. Oil and gas represented 15% of our portfolio of $480 million at end of September. Down from 16% or $531 million at the end of June on a fair value basis. The decline was due to the monetization of a portion of our first lien debt investment in Deep Gulf and the exit of our unsecured investments in Denver Parent as well as fair value adjustments on the portfolio. At the end of September, 82% of the oil and gas portfolio was in secured debt and included core borrowers and no new oil and gas investments were made during the quarter. Regarding Miller Energy, the company filed for bankruptcy in early October. While second lien debt investment in Miller was placed on non-accrual, is now the most senior debt in the capital structure and our investment has been value on a recovery basis. We continue to work with the company through the bankruptcy process and to-date, we've not had provided any incremental capital. We expect the company to emerge from bankruptcy in early 2016. Moving to credit quality, the portfolios weighted average restricted [ph] on a cost basis increased to 2.3 at the end of September from 2.2 at the end of June a fair value basis increased from 2.2 to 2.2 from 2.1 over the same period. So weighted average, net leverage over investments increased to 5.6 times at the end of September up from 5.5 times at the end of June. And the weighted average interest coverage remained at 2.5 times. At the end of September investments on non-accrual status represented 2.2% of fair value of the portfolio and 4.7% on a cost basis, compared to 0.4% and 2.5% respectively at the end of June. With that, I'll now turn the call over to Greg. Who'll discuss financial performance for the quarter.

Thank you, Ted. Total investment income for the quarter was $98.4 million down 3% quarter-over-quarter and down 17% year-over-year. The decline quarter-over-quarter is attributable to lower prepayment income and lower fee income as well as lower asset base. Interest income for the September quarter included $4.5 million of prepayment income compared to $8 million in the June quarter and $21.9 million in the year ago quarter. The year ago quarter included an elevated level of prepayment income. Dividend income for the quarter increased due to the growth of our investments in shipping and solar energy, which are structured as common, preferred equity respectively and which should provide recurring dividend income. The amount of dividend income may vary quarter-to-quarter based on asset mix. But the run rate, should be approximately $10 million to $11 million per quarter. PIK income for the quarter was approximately $6.8 million or 6.9% of total investment income down from $9.5 million or 9.3% of total investment income in the June quarter. The decline was primarily attributable to the exit of our investment in PlayPower. Expenses for the September quarter totalled $48.8 million compared to $50.7 million last quarter and $53.2 million for the same period a year ago. This sequential decrease listed in due to a decrease in incentive fees, management fees and interest expense. As a reminder, $225 million of our senior secured net notes matured in early October and $200 million of convertible notes will mature in January 2016. These notes have a blended interest rate of approximately 6%. We are using our credit facility, which has an interest rate of LIBOR plus 200 to replace the maturing debt. As a result, we expect to realize approximately $17 million, of the annual interest savings, which translates into approximately $0.06 per share of incremental net investment income per year. Net investment income was $49.6 million or $0.21 per share for the quarter, this compares to $51 million or $0.22 per share for the June quarter and $65.7 million or $0.28 per share in the year ago quarter. For the quarter, the net loss on the portfolio totalled $51.3 million or $0.22 per share compared to a net loss of $44.6 million or $0.19 per share in the June quarter and a net loss of $23.7 million or $0.10 per share for the year ago quarter. The net loss of $51.3 million includes $30.2 million of realized losses. Approximately $28.5 million of the realized losses were previously recognized in unrealized depreciation. Negative contributors to the performance for the quarter included our investments in Miller Energy, Artsonig, Osage and SquareTwo. Positive contributors to the performance for the quarter and included our investments in LVI Renewable Funding and Merx Aviation. In total, our quarterly operating results decreased net asset by $1.8 million or $0.01 per share compared to an increase of $6.4 million or $0.03 per share in the June quarter and an increase of $42 million or $0.18 per share for the year ago quarter. On the liability side of our balance sheet, we have $1.4 billion debt outstanding at the end of the quarter, essentially unchanged quarter-over-quarter. We continue to operate within our target leverage range. Company's net leverage ratio which includes the impact of cash and unsettled transactions stood at 0.73 at the end of September, essentially unchanged from the June quarter. During the September quarter, we referred to approximately 3.3 million shares of common stock for an aggregate cost of $21.2 million. At the end of September, our portfolio had a fair value of $3.2 billion and consisted 98 companies across 26 industries. Weighted average yield on the debt portfolio at cost was 11.6% up 10 basis points quarter-over-quarter. The increase in overall yield is mostly due to the increase in our preferred investments, which had a higher yield, than the rest of our debt portfolio. This concludes our prepared remarks. Operator, please open the call to questions.

[Operator Instructions] your first question comes from the line of Kyle Joseph with Jefferies

Good morning, guys. Thanks for taking my questions. Regarding, your liabilities I know you've mentioned that you'd refinance the upcoming converted and senior secured notes with the credit facility from a longer term perspective, do you continue to finance that with the credit facility or are you going to look to turn that out eventually?

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

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

Yes, so if you strip out oil and gas and obviously aircraft because it's not applicable. Again our portfolio, all these headwinds that have been faced in the credit markets by large companies, currencies China all these other things. We're not really seeing in our portfolio and the reason is because - the underlying portfolio we lend it to our, are generally lower [ph] to the US economy, the private US companies and the US economy is doing okay. So we're - the health of our overall portfolio away from oil and gas is actually pretty good and the underlying business trends are stable. So it's not a great US growth environment, but obviously the US economy is doing okay.

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

Yes, I'd say we've definitely seen spread widening better in the middle-market. The environment is good. I will say that we, we've seen a market slowdown in activity levels. So that means repayments are down, but it also means new originations are down and that's driven by obviously the choppy markets, but also I think there's just isn't a lot of private equity sponsor activity right now. So and the second I would say is because where we operate with our leverage levels and because we're buying back stock. Like we don't anticipate material portfolio growth because obviously we're using some of our repayments in sales to buy back stock and so I don't think you're going to see material portfolio growth over the next couple of quarters.

That makes sense, thank you and then, just lastly a little modelling question in terms of the expense where, is there any impact on that as a result of the buyback?

No, not. No there isn't.

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

Your next question comes from the line of Robert Dodd with Raymond James

Hi, guys actually it's Leslie, this morning. How are you doing?

Good, thank you.

So I've got a quick question for you on [indiscernible] I know the dates have been moved back to the end of this month again. I noticed the mark for the quarter was pretty much at the exact level with last quarter, were you pushing back [indiscernible] the investment theory the first lien and the equity interest there. Why aren't we not marking down yet and are we looking at mark downs in the fourth quarter? Any color on that would be nice, thank you.

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

And so you believe that the, well I guess the lack of mark down. What the odds are on par with what you've believe before for getting that total value out with showing no mark down pretty much at all? I guess, we're expecting, I guess a small mark down, with the continued push.

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

Okay, thank you.

Your next question comes from the line of Doug Mewhirter with SunTrust

Hi, good morning. Two questions, first. Did I hear you correctly that, the - I guess the lender. There's no more lenders ahead of you in Miller Energy that one, I guess is ABL or first lien got pick and all the way out.

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

Okay thanks for that. Also I just noticed in your new investment. I know it wasn't, it wasn't a terribly active quarter. But you actually increased marginally the number of investments that are I guess lower in the capital structure equity like security structured products. I guess, could you just walk through your reasoning for that because I know you've said you're trying to stay high in the capital structure, yet there was some incremental investments that were sort of going against that grain.

Yes and that's a great. I'm actually really happy, you asked that question. So there is really two drivers of that, which are two investments and both of them related to our renewable energy business. So we're not buying CLO equity, we're not buying common equity in companies. It's the way, they're classified. So one is our UK Solar platform, which is obviously. We're basically, we've contracted cash flow streams from UK government and the other investment is obviously the one, we have in California, which is lending against solar assets, which are structurally senior to mortgage, which are very, very low LTV, very safe. So, I know it's - when you see preferred equity or structured products and immediately think of equity risk or CLOs or other things and these are much different risk profile than us. So we actually view this as consistent with our overall strategy.

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

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

Okay, thanks that was a helpful answer. It's all my question.

Thank you.

Your next question comes from the line of Terry Ma with Barclays

Hi, good morning. I just wanted to get a sense of how much stock you bought back since quarter and whether or not, it's reasonable to assume the board may have another buyback program in place for the beginning of the next year?

So we've disclosed the amount of stock that we brought with a 3.3 million shares and the board is authorized us to buy back up to $50 million worth of stocks that we have $28 million onto go on to that authorization.

And obviously, there's just a reminder of that. We obviously have to live by the blackout periods. So we're in a blackout period during earnings.

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

Yes, obviously it's by industry. I'd say, I'd say listen I think our - we've reduced our mining exposure to zero. So we've de minimis mining exposure and then in oil and gas, again our pipeline is just not the robust. We're just not seeing a lot of due opportunities in oil and gas and as I said, and as I mentioned earlier. There is a number of processes underway to either refinance or other things to that portfolio. So I think naturally over the next couple of quarters, you'll see our energy exposure decrease, as our expectation. And then away from that, again we're seeing really good spreads in pretty interesting risk award in our middle-market part of our business to searching their sponsored finance business. So I think you'll see, most of the new origination just beat [ph] the bread, butter traditional middle-market sponsor business.

Okay, got it and then just looking at the, first lien investments you existed this quarter. It looks like the yields 11.5%, is there anything call out there?

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

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

No, so part of it was. Well it's two things I'd say, one is, we monetized part of oil and gas investment at our mark, which we thought was a good statement both to the market and also to our borrowers. Number two and that was a high yielding investment and then number two. Obviously we returned a bunch of capital from Merx, which is obviously at the higher end of yield.

Okay, got it. Thank you. That's it from me.

Your next question comes from the line of Chris York with JMP Securities

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

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

Got it, thanks Ted.

Your next question comes from the line of Troy Ward with KBW

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

I think, obviously you've seen that portfolio ramp up, pretty materially the last couple of years because it was like an early - it was all in the originations. Now you're seeing, some assets roll off, we were monetizing some assets. I think, that the percentage of our portfolio that's devoted to aircraft is going to remain, reasonably stable in the kind of range, you've seen it in the last couple of quarters. That could may increase slightly but I don't feel, see it either increased or decreased materially.

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

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

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

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

Okay, very well, thanks.

Sorry, yes. Thank you.

[Operator Instructions] your next question comes from the line of Jonathan Bock

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

Yes, I mean I think obviously the markets reacted to it. The company we feel is generates a lot of cash and we feel very good about it. And obviously a lot of noise when the Apple program. We don't know exactly how it's going to impact in long-term. But I think we feel pretty good about the credit today.

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

So we won't get into the specifics around because it's a private company with an NDA. We won't get into the specifics around SquareTwo, specifically but again, the CFTC [ph] is going after bad actors within the debt collection space off which we don't think, SquareTwo is one of them and so long-term it should benefit their business. Just given the - if you look at the Journal article today and who is publicly disclosed that they went after. Obviously SquareTwo is not mentioned. So longer trend, they continue to go after kind of abusive practices, those who have good compliance and everything else, should overall benefit.

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

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

Yes, bought our fleet 737s and Airbus 320 highly used and they're very flexible planes.

Okay, great. Thank you guys for answering my questions.

Thanks, Joe. Thank you.

And your final question comes from the line of Aaron [indiscernible] with D.A. Davidson and Company

Quick question, I missed what Greg has said about the dividend income I think overhead something about $10 million or $11 million as a run rate, how does that compare to the maybe like $14 million in this quarter?

Right, so that's what we think as we look forward that's our run rate. As our warehouses move along on their, for example in this quarter we had $2.8 million from some renewable energy and that may change overtime as though as portfolio securitized.

Got it. Sorry I just missed that, gentlemen. Thank you.

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

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

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