TCPC - NASDAQ

Ladies and gentlemen, good afternoon. Welcome, everyone, to BlackRock TCP Capital Corp.'s First Quarter 2024 Earnings Conference Call. Today's conference call is being recorded for replay purposes. [Operator Instructions] And now I would like to turn the call over to Katie McGlynn, Director of the BlackRock TCP Capital Corp. Investor Relations team. Katie, please proceed.

Thank you, Emily. Before we begin, I'll note that this conference call may contain forward-looking statements based on the estimates and assumptions of management at the time of such statements and are not guarantees of future performance. Forward-looking statements involve risks and uncertainties, and actual results could differ materially from those projected. Any forward-looking statements made on this call are made as of today and are subject to change without notice. Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, we make no representation or warranty with respect to such information. Earlier today, we issued our earnings release for the first quarter ended March 31, 2024. We also posted a supplemental earnings presentation to our website at www.tcpcapital.com. To view the slide presentation, which we will refer to on today's call, please click on the Investor Relations link and select Events and Presentations. These documents should be reviewed in conjunction with the company's Form 10-Q, which was filed with the SEC earlier today. I will now turn the call over to our Chairman and CEO, Raj Vig.

Thanks, Katie, and thank you for joining us for TCPC's Q1 2024 Earnings Call, which is also officially the first earnings call for TCPC, as a combined entity, post our successful combination with our former affiliate BC, BlackRock Capital Investment Corp, BCIC. Today, I'm joined by our President, Phil Tseng; and our CFO, Erik Cuellar. We are also joined today by Michaela Murray, who will be taking over the Investor Relations role from Katie McGlynn, who is leaving the firm to pursue other opportunities. I'd like to officially welcome Michaela to the show. As a reminder, Katie has been a valued member of the TCPC team and private net platform since 2018, who was instrumental in structuring and closing the recent merger. She's been a great partner and friend and will be sorely missed. We, of course, wish her well in her future endeavours. For today, I will begin with a few comments on the successful completion of our merger with BCIC. I'll then provide an overview of our first quarter results. Phil will follow with an overview of the investment environment and our portfolio and investment activity, and Erik will then review our financial results as well as our capital and liquidity in greater detail. Finally, I will wrap up with a few comments on the opportunities we see ahead before taking your questions. As I mentioned earlier, during the first quarter on March 18, we closed our affiliate merger with BCIC. As a reminder, since BlackRock's acquisition of TCP's platform in 2018, the investment activities of both TCPC and BCIC were managed by one team under the current leadership. The merger simply formalizes the combination of these 2 materially overlapping portfolios and delivers meaningful value for our shareholders through the greater scale and targeted operating efficiencies. This includes a lower overall fee structure from the larger combined entity, the likelihood of more efficient access to capital and income accretion for the company and ultimately for our shareholders. From this point forward, we will be discussing financial results for the entity on a combined basis. Now let's give a review of the highlights of our first quarter results. I am pleased to report that for the first quarter of 2024, TCPC delivered adjusted net income of $0.45 per share, an increase from $0.44 per share in the prior quarter. Our run rate NII remains among the highest in TCP's history of a public company. And our annualized net investment income return on equity for the quarter was 14.7%. And NII continues to benefit from relatively higher base rate -- base rates and spreads. During the first quarter, our NAV declined 6.4%, primarily due to net unrealized losses on portfolio companies previously discussed, including our investments in 2 Amazon aggregators, Thrasio and Razor, along with our equity investment in invention. The write-downs in the first quarter are mostly the result of circumstances specific to a handful of companies. And as we have stated before, we do not believe these situations are any indication of broader credit challenges in our portfolio. The majority of our portfolio of companies continue to report revenue and margin expansion with many generating sustained performance improvements. That said, I again want to provide commentary on a few of the names that contributed to the portfolio markdowns. Thrasio and Razor both operate in the Amazon aggregator space. And as we have discussed on previous calls, the aggregators are consolidated of small to medium-sized brands that sell through Amazon's market-leading third-party platform. This sector was initially impacted by [indiscernible] related supply chain issues and then by slowing growth in online consumer spending, as supply chain issues alleviated resulting in excess inventories and overleveraged balance sheet. Given the persistent operating and liquidity challenges that resulted, Thrasio, one of the largest annual aggregators opted for a balance sheet restructuring via a Chapter 11 filing in February 2024, which we supported given the net benefits from that process. Although a fair bit of work remains ahead of us, we expect ultimately Thrasio to emerge with a lower and more manageable debt structure, as well as a leaner and more efficient operating profile. This should allow the company to remain a leader in the sector and to focus on our return to profitability, post emergence and what we continue to believe the long-term and viable and attractive industry. By contrast, Razor group also addressed challenges via consolidation and acquired Perch in March, solidifying the combined entity's position as a global leader in the space. Similar to Thrasio's stand-alone restructuring effort, we expect the strategic combination to drive a more efficient operating structure than either company could have achieved in the near-term stand-alone. We also believe that further consolidation and cost optimization are likely to continue in this space and ultimately, there will be fewer, larger scale and better capitalized vendors serving it. We will continue to update you on the progress of each of these as we are able to. Next, I'll discuss Edmentum, an online learning provider, which, as we noted last quarter, is navigating a reversion to a more normalized but still positive demand environment. Demand for its tools and services spikes during the pandemic but that has since corrected following the successful return to in-person attendance in many schools. Relative to pre-pandemic levels, digital education and remote learning services continue to grow in popularity at Covenant and Edmentum remains well positioned in an industry with positive secular trends. As a reminder, our current investment in Edmentum is a residual equity position after we received full repayment on our loan to the company. As a long-standing player in the direct lending space, our team has experienced lending across market cycles and has developed unique expertise and a proven track record of success, working through challenging credit -- challenging credit situation. We are leveraging this expertise, believe we have the right teams in place and are proactively working with management teams, equity owners and other lenders to improve performance and achieve positive outcomes for our investments. Most importantly, outside of these situations, the credit quality of our portfolio remains strong. As of March 31, 2024, our internal risk rating was relatively unchanged from December 31, 2023, and reflects the fact that the majority of our portfolio companies are substantially in line or ahead of base case expectations. Our Board of Directors declared a second quarter dividend of $0.34 per share, which implies a 132% NII coverage based on our first quarter adjusted NII. The second quarter dividend is payable on June 28, to shareholders of record of June 14. We have always taken a disciplined approach to our dividend with an emphasis on stability and strong coverage from our recurring net investment income. Throughout TCPC's 12-year history, we have consistently covered our dividend with recurring net investment income and have also paid several special dividends, including in the most recent quarters. Now I will turn it over to Phil to discuss our investment activity and portfolio.

Thanks, Raj. I'll start with providing an update on our portfolio and highlights from our investment activity during the first quarter and then provide a few comments on the investment environment. In the first quarter of 2024, we invested $20 million, primarily in senior secured loans. Deployments in the quarter included loans to 4 new and 3 existing portfolio companies. Consistent with our strategy, our emphasis remains on companies and established business models and proven core customer bases that make them more resilient across economic cycles. In reviewing the opportunities, we emphasize transactions where we are positioned as a lender influencer, where we have a direct relationship with the borrower and the ability to leverage our more than 2 decades of experience in negotiating deal terms and conditions that we believe provide meaningful downside protection. We believe this has been a key driver of our low realized loss rates over our history. We also see emerging opportunity on the horizon, as pent-up M&A transactions come to market. As the bid-ask spread and valuations for higher-quality assets narrow, we expect market participants who have been sitting on the sidelines to be more active. Actual interest rate cuts should help to catalyze a pickup in M&A, due to the lower debt service costs for prospective borrowers. And based on our conversations with market participants, we're optimistic about activity in the near to medium term. In this environment, our industry specialization continues to be an advantage, as it provides 2 key benefits for us. First, it enhances our ability to assess and effectively mitigate risk in our underwriting, when we negotiate terms and credit documentation. And second, it expands our deal sourcing capabilities with sponsors and nonsponsors, who value our industry experience, which lends itself to more reliable execution for borrowers. Follow-on investments in existing companies continue to be an important source of opportunity for us. About half of the capital we deployed over the last 12 months was to existing portfolio. One of the recent investments made during the first quarter was an investment in PMA Asset Management. PMA is a leading money market asset manager serving local government, K-12 education and other public sector entities. The company provides its public sector clients with a comprehensive suite of investment advisory, fund administration and capital markets advisory services. BlackRock provided capital to support the sponsor's acquisition of PMA. We believe this investment offers an attractive risk-adjusted return and provides a unique opportunity to invest in a scaled money market asset manager that has exhibited [indiscernible] growth over its history. New investments in the first quarter were offset by dispositions and payoffs of $24 million. As part of our ongoing portfolio management, we closely monitor and directly engage with our existing portfolio companies, proactively assessing both current and projected performance relative to our original underwriting assumptions. In the limited situations where performance is below our expectations, we're engaged with the management teams and the owners to proactively drive performance improvements and ensure our capital remains well protected. Managing situations where capital may be at risk is a top priority for our team. And we believe our 20-plus years of experience in managing portfolios through cycle is a significant competitive advantage for TCPC. We are pleased to report that the majority of our portfolio companies continue to deliver revenue growth and margin expansion as they successfully navigate the higher rate environment lingering inflation and general uncertainty in the economy. We believe this reflects the durability of companies in the middle market, as well as our ability to pick the right industries and the right companies and to structure transactions that are good for our borrowers and for our investors. Now I'll turn to our portfolio. As a reminder, these figures relate to our consolidated portfolio following a merger with BCIC. At quarter end, our portfolio had a fair market value of approximately $2.1 billion. 91% of our investments were senior secured debt, spread across a wide range of industries providing portfolio diversity and minimizing the concentration risk. At quarter end, our diversified portfolio consists of investments in 157 companies. And our average portfolio company investment was $13.5 million. As the chart on Slide 7 of the presentation illustrates, our recurring income is distributed broadly across our portfolio. And is not reliant on income from any one company. In fact, more than 75% of our portfolio companies each contribute less than 1% to our recurring income. 80% of the portfolio are first lien, providing significant downside protection and 97% of our debt investments are floating rate. The overall effective yield on our debt portfolio was 14.1%, reflecting the benefit of higher base rates and wider spread on new investments. Investments in new portfolio companies during the quarter had a weighted average effective yield of 14.7%, exceeding the 14% weighted average effective yield on exited position. To date, we have had no prepayment income in the second quarter. And looking forward, we believe we're well positioned to continue to deliver attractive returns, given that our team has one of the longest track records in direct lending of any of the publicly traded BDCs. Irrespective of when the Fed rate cuts commence, we believe we will be in a slower growth and an elevated rate environment for the foreseeable future and could see a range of macroeconomic scenarios. But in periods like this, we believe our experience and our deep industry knowledge provide us advantages and result in strong results throughout various market cycles. The market environment that persisted over the past year is changing. For a large part of 2023, we saw wider spreads. We saw more conservative leverage profiles and generally stronger structural protections. However, for much of this year so far, we've seen a broader repricing, and we expect this to continue. This means managers have to work harder to identify deals with favorable economics and favorable structures. As we noted last quarter, there's been an increased bifurcation of the direct lending market, which continues to persist today. Many have observed more borrower-friendly trends such as tightening pricing and covenant-light deal structures. These are especially prevalent in the upper middle market or large cap direct lending market, given the robust return of banks to that segment. However, in the core middle market, where we focus, there's been less impact by this trend. We continue to benefit from lower leverage overall in the presence of maintenance companies and fewer [indiscernible], all of which lead to generally to entire documentation [indiscernible]. We continue to see a durable yield premium for our transaction flow relative to the broadly syndicated market. Now I'll turn it over to Erik to walk through our financial results as well as our capital and liquidity positioning.

Thank you, Phil. As Raj noted, our net investment income in the first quarter benefited from the increase in base rates over the last 21 months and was $0.45 on an adjusted basis for the quarter. As detailed in the earnings press release, adjusted NII excludes amortization of the purchase accounting discount resulting from the merger with BCIC and is calculated in accordance with GAAP. The full reconciliation of adjusted NII to GAAP NII, as well as other non-GAAP financial metrics is included in the earnings press release and 10-Q. Today, we declared a second quarter dividend of $0.34 per share. We remain committed to paying a sustainable dividend that is fully covered by our net investment income regardless of the interest rate environment as we have consistently done over the last 12 years. Investment income for the first quarter was $0.90 per share. This included recurring cash interest of $0.78, nonrecurring interest of $0.02, recurring discount and fee amortization of $0.03 and PIK income of $0.05. PIK income remains in line with the average over our history. Investment income also included $0.02 of dividend income. Operating expenses for the first quarter were $0.35 per share, including $0.21 of interest and other debt expenses. Incentive fees in the quarter totaled $5.8 million or $0.09 per share. Operating expenses for the quarter reflected the impact of the lower management fee rate, since the closing of the transaction on March 18. We expect other synergies and expense savings to materialize over the next few quarters. Net realized losses for the quarter were $168,000 or less than $0.01 per share. Net unrealized losses in this first quarter totaled $23 million or $0.37 per share, primarily reflecting unrealized markdowns on previously discussed investments as Raj described earlier. The net increase in net assets for the quarter was $5.1 million or $0.08 per share. As of March 31, we have 5 portfolio companies on nonaccrual, representing 1.7% of the portfolio at fair value and 3.6% at cost. During the quarter, we added 2 portfolio companies to nonaccrual status, including Aventiv previously known as Securus, as well as Gordon Brothers, a preexisting nonaccrual portfolio company from the acquired BCIC portfolio. Turning to our liquidity. Our balance sheet positioning remains solid, and our total liquidity increased to $409 million at the end of the quarter relative to our total investments of $2.1 billion. This included available leverage of $286 million and cash of $121 million. Unfunded loan commitments to portfolio companies at quarter end equaled 4% of total investments or approximately $91 million, of which only $57 million were revolver commitments. Net leverage, excluding SBIC debt for the quarter is 1.08x well within our target range of 0.9 to 1.2x leverage. Our diverse and flexible leverage program includes 3 low-cost credit facilities; 3 unsecured note issuances and an SBA program. Given the modest size of each of our debt issuances, we are not overly reliant on any single source of financing, and our debt maturities remain well added. Additionally, we are comfortable with our current mix of secured and unsecured financing. And we expect to address the upcoming maturity of our 2024 notes in the near future. Combined, the weighted average interest rate on our outstanding borrowings including debt assumed as a result of the merger, increased modestly during the quarter to 5.08%. That average interest rate is up only 217 basis points since March of 2022, while base rates increased more than 500 basis points during this period. This is the result of our lower overall cost of capital. Now I'll turn the call back over to Raj.

Thanks, Erik. Since we took TCPC public in 2012, we've delivered a 10% annualized return on invested assets and an annualized cash return of 9.7% to our shareholders. We are very proud of these results which include performance during periods when base rates were substantially lower than they are today. We believe this performance remains at the high end of our peer group and speak to our ability to consistently identify attractive middle market investment opportunities at premium yields and to deliver exceptional returns to our shareholders across market and economic cycles. Following our successful merger with BCIC, we look forward to continuing to deliver financing solutions to our borrowers and structure transactions to deliver attractive returns to our shareholders. And with that, operator, please open the call for questions.

[Operator Instructions] Our first question today comes from the line of Robert Dodd with Raymond James.

On Thrasio, et cetera, the aggregator space. I mean on Thrasio particularly, I mean, the bankruptcy got resolved, I think, after quarter end. And I just want to clarify, I think in the docs in the discussion was in 5 recovery below the mark that you currently have, it carry that. Is that factored in or because you disagree about the valuation of the business long-term potentially? Or is it because it happened after the quarter end, that was not fully known at the time you were evaluating some of these positions?

Robert, I think I got most of that question, but I think the question was, is the bankruptcy after quarter end. Is that correct?

It was resolved at the quarter end, right? I mean it was finalized. And what I read was implied value to senior lenders 20%, which obviously is lower than the current market that you have to carry that. So is that a disagreement with the valuation, which is fine? Or is it that it wasn't factored in yet because it hasn't been resolved yet?

Yes. So let me -- I think I get the question. So [indiscernible] valuation procedures are done through third-party [indiscernible] and they'll take into account all the circumstances at the time of the valuation. The bankruptcy process is kind of a different process where the valuations that are being put forth may be more strategic depending on where you are in the capital structure. So will there be differences potentially? Yes. Are they -- are folks looking at it for the same purpose? Not necessarily. And I guess what I would say is we have maintained a valuation process and policies, we think are appropriate for portfolio marketing, the value -- the bankruptcy itself was really a collective decision of something that was a more strategic tool to do some additional financing, clean up the capital structure and other liabilities. But I will say for any company, not just Thrasio but in general, where there is a restructuring, either [indiscernible] you're just going to see, as you know, Robert, more volatility and maybe a variance in marks, until the ultimate realization. That probably happens here. That probably happens with the other aggregators and it has happened with Edmentum, where, ultimately, we're doing right by the process, giving all the information that's available, including the filing. But ultimately, the realization is cash based. And I think in the case of Edmentum at least even though the equity is volatile, we've taken all our cash and the original debt off at par plus. And here in the effort is going to be maintaining the rigor on the valuation, but really focusing on the recovery on a realized basis, which will probably be a couple of years of work and the restructuring. But yes, the valuations may differ. Our folks will take operating results in hand I don't think they're going to necessarily take the bankruptcy valuation at face value versus the information we give them around forecast, projections and things of that sort. Hopefully, that answers your question.

Absolutely.

And Robert, as it relates to the 3/31 mark, this loan actually has had some trading activity even through the bankruptcy process. So it's quoted, and that's what drove the mark at 3/31.

Got it. I understand there's a lot of moving parts in there. Then next question, I think you, Phil, said you expect activity in the market for pickup and as rates decline. So is there -- looking at the curve today and it moves around a lot, rates aren't really projected to decline materially at all this year based on the curve today, and I will change that. So can you give us any more color. I mean, are you expecting the activity level to remain very moderate so long as rates stay here? Or are there other factors that [indiscernible].

Yes, that's a good point. You're right. The forward yield curve is dramatically different than it was, let's say, a few quarters ago, I think a few quarters ago, folks were expecting rates to kind of stabilize down in the mid to high 3s in about 18 months. But I think we're now looking at probably closer to mid-4s. So you're right, rates are not expected to come down as dramatically. So we are moderating our expectations because real rate touch will drive more higher equity valuations and more processes will probably get done. But I think the fact that rates have normalized here, I'm not sure folks are really expecting rate to increase, given what's been talked about in the market in the last few weeks. But we are continuing to hear from market participants, whether they're investment bankers or private sponsors that there are a lot of processes underway. There are a lot of nonprocessed processes meaning there are a lot of premarketing of deals, trying to do some price discovery on assets. And so that tells us that there is some momentum underway. The second is we're continuing to hear from clients out there, institutional investors that they are continuing to demand distributions coming back from their GPs. So they're putting more and more pressure in order to give more money for future vintages to get money back. And so what you're seeing our GPs trying to really test the market. But two, if they're not selling businesses outright, then they are looking at other ways of distributing capital back to their clients like dividend recap, maybe some continuation type vehicles. Dividend recaps are areas that we've -- sorry, deal profiles that we funded over the course of the past several quarters for great assets, where that delevered over time, we're happy to continue to put good money on the situation. So I think we're cautiously optimistic, Robert, but I agree, the yield curve not showing a more dramatic reduction is -- is something that we should be watching closely.

Got it. And I appreciate that answer. And then I wonder if I can take it in a slightly different direction as well. I mean you mentioned as well that it's harder to find favorable deals, and I'd certainly investigate in like LBO financing and things like that. Over the last decade, I mean you have to call it that -- you guys have shown a lot more flexibility than some [indiscernible] in terms of willingness to do other kind of deals, ABL financing for retail, leasing, other areas of the market that you look at. Is that something we should expect to see increasingly over the next couple of years, if the market for LBOs maybe stays a little bit more moderate. Should we see more of these other verticals for you guys? Or how are you thinking about operating in an environment hypothetically where LBO activity remains modular for prolonged periods?

Yes. Great question, Robert. I think that also -- you have an insight that perhaps goes beyond the public vehicle is the platform itself, which has existed well before the BDC was public. And I think as you highlight, we've always been able to pivot to things that are low maybe I won't say opportunistic in risk, but areas that are maybe a little less picked over like leasing. And I think even aviation or things of that sort. I think one of the benefits of the merger that we don't speak about is as much as the greater scale also allows us to think through some of those things and perhaps you're taking advantage of that. I will say just as an additional element, even if new LBO activity is abated, keep in mind that the existing portfolio even through the last couple of years, and I expect going forward will always be a good source of deals, add-on investments because as the portfolio remains healthy, those companies are good about taking advantage of less help elsewhere, whether it's through M&A or other types of consolidation. But to answer your question, as we see things that are interesting areas where we can do the credit work and we feel comfortable with the industry or the asset, I would say, we will take advantage of that. And I think the leasing is a good example. We've also done more ABL structures, where there's less of a desire to be exposed to the entity but more desire to be covered by the discrete asset. And I think as the environment gives rise to those opportunities, our team is very well positioned to take advantage of that. But it's always going to be a credit-first downside protection type of approach.

Our next question comes from Christopher Nolan with Ladenburg Thalmann.

Katie, congratulations. Michaela, welcome. On the maturing debt that you guys referred to earlier, what's the thought in terms of where you're going to refinance that? Is it going to be bond issuance because you -- and for that, are you able to leverage your investment-grade rating, do you think? Or you're going to turn to bank financing?

Yes, Chris, good question. We're certainly looking to address those maturities in the near future. We're very happy with what we've seen in the capital markets within our sector. So definitely, that will be a factor. We also like our current mix of secured versus unsecured. So all of that will come into play. We -- really, the only reason we hadn't addressed it to this point was the pending transaction, and we just wanted to wait till that was done to be able to address the maturity. But we plan to do so in the near term.

All right. And then I read an article, where Moody's is taking a dimmer view on private credit in general. Does this -- does your funding cost really turn on just having an investment-grade rating?

I mean I think any credit issuance is correlated to a rating, ours is no different. I would just clarify that the article, 2 things was more broader based than honing in on our issues specifically. And it wasn't a downgrade. It was an outlook change, which we have seen them do before in the past in the sector. So whether that actually really impacts the pricing, I think, is TBD as we're exploring that. I also think the net movement in pricing has been favorable over the last 12 to 18 months. And you can see that in issuance -- issues and issuances that have hit the market with some very directly, I think, comparable deals. So stay tuned. I think we're going to do the responsible thing and sort of exploring the options. Obviously, the write-up is not irrelevant, but how relevant it is, is sort of TBD. And I think the -- fortunately, we've had a very long well-established investment-grade rating in the market. So I think, hopefully, our bond investors and others, looking at it, we'll keep that in line.

The next question comes from Paul Johnson with KBW.

I'm just curious, what was the driver of the higher other income this quarter. Was there anything in particular driving that amendments or dividends or anything like that?

Yes, we did have $0.02 of nonrecurring income, just amendments in general and a couple of prepayments that we received any time that we have any prepayments that tends to accelerate any -- an advertised discount or exit fee that might be linked to that investment.

And then just kind of higher level with the portfolio. There's a decent amount of software businesses in the portfolio. I know it's not something you've disclosed historically. But I'm just curious, I mean, are any of those ARR loans? And are you able to give any kind of sense of kind of what percent of the portfolio is ARR?

Yes. Thanks, Paul. So we have disclosed the percentage of software for ARR deals. But when we look at our portfolio in a more detailed way, our software and ARR portfolio -- so ARR is a subset of our software exposure. But generally speaking, it's been one of the sectors for us that held up the strongest. And the way we think about software actually is not as a broad brush kind of industry exposure. We actually look at it as more horizontal across a number of end market exposures. So the way we think about it, for example, is a risk management software provider or insurance company or insurance company that is [indiscernible] insurance in the services market. And then alternatively, a software provider that helps facilitate e-commerce transactions for retailers that perhaps is in the retail consumer market -- end market. So we actually view software exposure broadly as less correlated as a group, but much more susceptible to risks on the end markets. And when we look at it in that fashion, it's actually quite diversified.

We do not have any further questions. So I'll turn the call back to the management team.

Thank you. We appreciate your participation on today's call. I would like to thank our team for all their hard work and dedication and our shareholders and capital partners for their confidence and continued support. Thanks for joining us. This concludes today's call.