Good morning, ladies and gentlemen, and welcome to the KCAP Financial, Inc. Conference Call. An earnings press release was distributed yesterday. If you did not receive a copy, the release is available on the company's website at www.kcapfinancial.com in the Investor Relations section.

As a reminder, this conference call is being recorded today, Wednesday, February 27, 2019. This call is also being hosted on the live webcast, which can be accessed at our company's website at www.kcapfinancial.com in the Investor Relations section under Events.

Today's conference call includes forward-looking statements and projections, and we ask that you refer to KCAP Financials most recent filings with the SEC for important factors that would cause actual results to differ materially from these projections. KCAP Financial does not undertake to update its forward-looking statements unless required by law.

I would now introduce your host for today's conference, Mr. Dayl Pearson, President and Chief Executive Officer of KCAP Financial. Mr. Pearson, you may begin..

Good morning and thank you all for joining KCAP Financial for a review of our full-year 2018 results. I am joined today by Ted Gilpin, our CFO; and Ted Goldthorpe of BC Partners. A lot has happened since our last earnings call in November. So let me comment on our strategic initiatives.

As previously announced, the company entered into a stock purchase and transaction agreement with BC Partners Advisors L.P., an affiliate of BC Partners LLP pursuant to which the company's management function will be externalized.

At a special meeting of our company's stockholders held on February 19, 2019, the company's stockholders approved an advisory agreement between the Company and Sierra Crest Investment Management LLC, an affiliate of BC Partners.

If the transactions contemplated by the Externalization Agreement are completed and closing conditions are satisfied or appropriately waived, upon closing of the Externalization, the Company will commence operations as an externally managed BDC managed by the Adviser.

We expect this transaction to close around the end of the first quarter at which time BC Partners will make a distribution to shareholders of record on the closing date of approximately $0.67 per share. We'll be setting a closing date in the next few days and disclose this in a press release.

On November of 8, 2018, we entered into an agreement with LibreMax Intermediate Holdings under which our wholly-owned subsidiary Commodore Holdings agreed to sell Katonah Debt Advisors, Trimaran Advisors, and Trimaran Advisors Management to LibreMax for a cash purchase price of approximately $37.9 million.

This transaction closed on December 31, 2018. The strategic initiatives will reposition the company.

What causes the fourth quarter to be a transition quarter making comparisons with previous quarters difficult? These transactions had an impact on both our income statement and balance sheet in the fourth quarter and will also have an impact in the first quarter of 2019.

Now let me give you a high level summary of our 2018 fourth quarter and full-year financial highlights before handing it over to Ted Gilpin. For the year ended December 31, 2018, our NII was approximately $10 million or $0.27 per share. Quarter distribution was $0.10 compared to $0.10 paid in the third quarter.

At the end of the quarter, KCAP had approximately $27 million in investable cash primarily from the disposition of AMA which we intend to redeploy in transactions that generate cash flows. We need to fund further distribution to shareholders.

As discussed previously, we are seeing the benefits of the BC relationship increase deal flow and attractive investment opportunity to invest at the year-end cash. Excluding our $25 million Great Lakes investment commitment rather, we have closed approximately $22 million of VCP sourced loans to-date.

In addition, approximately $15 million in assets approved by the KCAP Investment Committee that have not closed and more assets identified in the closing pipeline. Our credit committee continues to -- our credit quality rather continues to be solid.

But as with the broader BDC market, we have experienced an uptick in the number of non-accruals assets in this quarter including our investments in Tank Holdings which is in the process of being restructured. As of December 31, 2018, our weighted average mark-to-market to PAR on debt securities portfolio was 90 compared to the Q3 mark of 93.

In terms of our CLO portfolio, our weighted average mark-to-market value to PAR was 64 as of December 31, versus the weighted average mark-to-market to PAR of 72 as of the end of Q3. Both of these have been driven by the sell-off in the loan market at year-end and have somewhat recovered since year-end.

Our CLO investment portfolio at the end of the fourth quarter totaled approximately $44 million. Q4 was a period of weakness and volatility in the broadly syndicated loan market and this volatility was magnified in the CLO equity marks.

At the end of the fourth quarter, debt securities totaled approximately $148 million and represented about 54% of the total investment portfolio. First lien loans now represent 54% of our debt portfolio. Junior loans represent 46%. And now, I'll ask Ted Gilpin to walk through the details of our financials.

Ted?.

Thank you, Dayl. Good morning everyone. As of December 31, 2018, our net asset value stood at $158 million or $4.23 per share was down from $182 million or $4.87 per share at the end of 2017.

Fourth quarter saw substantial movement downward in our CLO equity investments and our investment in the joint venture due to widespread dislocations in CLO markets accounting for approximately $0.26 per share. Net investment income for the year was $10 million versus $11 million in 2017. NII per share was $0.27 in 2018 versus $0.30 per share in 2017.

2018 saw approximately $0.04 of non-recurring expenses which had a negative impact on NII. Net investment income per share for the fourth quarter of 2018 was $0.06 down from $0.07 per share in the second and third quarters of 2018. Total realized and unrealized losses in 2018 were $19.4 million versus $3.5 million in 2017 and $19.4 million in 2016.

Net loss including realized and unrealized losses was $9.6 million or $0.26 per share versus net income of $3.4 million in 2017. Taxable distributable income was $9.2 million or $0.25 per share. Total distributions were $0.40 per share with a return of capital of $5.7 million or $0.15 per share.

Total debt was approximately $100 million in both 12/31/2018 and 12/31/2017. On 12/31/2018, our asset coverage ratio was 249% and for the year there was a NAV return of negative 4.7% and a total market return of 13.2%. For December 31, 2018, KCAP completed the sale of substantially all of its Asset Manager Affiliates.

This resulted in a distribution from Commodore Holdings to KCAP of $33.8 million all which was return of capital. The remaining fair value of our Asset Manager at 12/31/2018 of $3.5 million relates solely to KCAP management, the Manager of our joint venture with F3C.

Therefore the cash distribution of $33.8 million plus the $3.5 million fair value of the remaining AMA equals $337.3 million of total value at 12/31/2018 versus $35.8 million fair value for all of the AMAs as of 9/30/2018. And with that, I'd like to turn it over to Ted Goldthorpe from BC Partners for a few comments..

Thanks Ted. We are very excited closing the transaction and we appreciate the support of our shareholders. We are looking forward to engaging with all our stakeholders going forward. And with that, we'd like to turn the call back to the operator for any questions..

[Operator Instructions]. Our first question comes from Chris York of JMP Securities. Your line is open..

Good morning guys and thanks for taking my questions.

So Ted as you evaluate the portfolio today, are there investments you consider to be non-core or Legacy that could be subject to rotation under your and BC's management?.

That's a great question, Chris. I mean I think the answer is largely no. We thought the non-core part of the business with the CLO manager which we monetize. So I don't think you're going to see a massive wholesale rotation of portfolio over a short period of time but you'll see a rotation over a longer period of time as we originate new assets..

Got it. And then diving a little bit more deeply in the investment portfolio, Dayl or Ted, could you explain the marks in two of your investments and then potentially the recovery or risk and changes in the future marks.

Specifically, I'm curious about the drivers of the write-downs in the Freedom 3 JV which has declined for a couple of quarters is now marked at 74% of cost.

And then Dayl, as you alluded to Tank Partners which you said is in the process of being restructured, a little bit more color on both of those?.

Sure. I think, as I said, Tank is in the process of being restructured. We see significant conversion of the lender's position in -- into equity in owning a majority then of Tank. Tank is recovering in its market.

So in it's -- obviously had several difficult years with a lack of drilling activity in the Permian Basin and other places but company has a pretty solid backlog. But we just thought it was prudent to restructure the position and convert a significant portion to. So we don't really anticipate further write-downs in that.

But then again it's going to be depending upon the performance of the company going forward. As I said, they have a solid backlog. They have a solid backlog of business right now. So we're pretty confident that that will convert into revenue and cash flow.

In terms of the JV, I think a lot of that was driven by the fact again the other underlying financing is a CLO type financing and so we have the value, the CLO, a lot of loans in there that got hit at year-end due to market dislocation even though there aren't necessarily a lot of trading activity in those middle market loans.

It's still you have to mark-to-market, a lot of that is recovered in the first quarter and we would anticipate that recovery to continue. So we think that's more of a short-term event as it is with the CLO equity securities..

Got it.

Just to be clear in terms of the assets of Freedom 3 JV, there is no real credit issues there that would explain that the market is more mark-to-market?.

It’s all mark..

Yes, mark-to-market..

It's all mark-to-market. The JV continues to perform to expectations..

And then how about the recoveries there, so if we are at a market 74% of the Amortized cost, you mark it down I believe from 80%.

Is it fair to say that most of that is being given back year-to-date?.

I would say the vast majority of that has come back since quarter -- since 12/31..

Okay.

And then what are the expected transaction or friction costs borne by KCAP in the first quarter related to the Externalization?.

Well, there will clearly be some friction costs, we haven't put a full number on it yet for the first quarter but there'll be obviously some legal expenses, some deal expenses, there'll be some personnel expenses, there'll be expenses.

So I would expect there to be some pressure on the expenses in the first quarter as it relates to closing out the transaction..

Yes. And there are certain expenses that were borne by the Asset Manager partially borne by the Asset Manager such as rent, insurance, and other things like that which are now fully borne by KCAP.

So there will be a little bump in the expenses in the first quarter for that as well which we expect will normalize over the year as we consolidate and externalize..

Okay.

Is there any way we could quantify a potential range of those one-time expenses?.

It’s difficult to do at this point. We're still working through..

Yes, I really see there's a couple of pieces there, I just don't have the answer to yet..

Got it, okay. And then, Ted, so you have once you close here, you'll have $70 million in capital loss carryforwards.

So will your go-forward strategy include ways to utilize these carryforwards by investing either in securities or maybe even companies with capital gain potential?.

I don't think that's a core part of our strategy on a go-forward basis. It's always been -- we've always looked at in previous public companies that we've been involved we've tried to take advantage of that. That's been very difficult.

Might have been rooted out particularly in period of time like the taper tantrum a couple of years ago and other situations where we -- there might be some one-off and credit opportunities for us to do that. But I think we're really got to focus on our core middle market lending business..

Got it.

And then last one is what is your target leverage and then ROE potential be under this target leverage upon close?.

Yes, I think the answer is yes. I think the answer is I don't foresee us going above one to one anytime soon. And I think that the range of large typically like to use is somewhere between 0.6 and 0.8.

And so I would find it very hard to believe that we're going to be above the one to one test and there's certain things in our debt documents that prevents it anyway. So shareholders are protected in any case. So I think that's a longer-term discussion.

So I don't think you're going to see the target -- the debt target really change on a go-forward basis..

Got it. Very helpful. That's it for me. Thanks for taking my questions and congrats on close..

Thanks, Chris..

Our next question comes from Paul Johnson of KBW. Your line is open..

Good morning guys. Thanks for taking my questions.

My first question was around $75 million of investments that you received from BC Partners and I didn't quite catch, was $22 million that you funded quarter-to-date, is that included in that $75 million of investments?.

Yes, that plus the $25 million commitment to the Great Lakes Unit Tranche joint venture. So that gets you to $47 million. We have another $15 million, we expect to close before the end of the quarter so that would get you to somewhere of $60 million to $65 million.

So we're pretty far along that road right now, it's taking a little bit longer than we had hoped to. The loans always take longer to close than you expect and transfers are harder than you expect and things like that but we're well on our way to getting to the $75 million..

Okay, great..

And I will say we have a very robust pipeline at the moment. So I think that should happen early in the second quarter..

Okay.

I mean can you describe some of the loans that are in the pipeline or the one also from BC Partnerships the terms or are the senior loans, first lien assets, just what are you potentially looking at this quarter?.

The vast majority of these are first lien assets. There are couple of opportunistic second lien assets but they're generally in fairly low leverage situations. So they're not sort of what you think of as a traditional sort of mezzanine like second lien stuff with BC.

I would say most of the companies are in sort of $12.5 million to $30 million EBITDA range somewhere bigger. There is nothing below. I don't think $12.5 million in mezz balance because anything below $15 million at the moment.

Although there maybe a couple in the pipeline but traditional middle market senior stretch, senior unit tranche type loans, we'd like being in sort of the first dollar position in these loans particularly in the current marketplace and I think the yields are attractive.

I think based upon what we've closed right now the yields are sort of in the high-single-digits, very high-single-digits..

Okay. Thanks for that. And then I guess I'd also ask maybe this is a question for Ted Goldthorpe.

What's the outlook for the CLO portfolio in terms of its role in your go-forward strategy? You announced about 15% of the portfolio today, you expect to maintain that, grow that as you guys take over managing the BDC?.

Yes, I mean I think you will see the shrink over time. I don't think you are going to see us include that as part [ph] of our strategy, it's going to take obviously to shrink that portfolio and some of it happens organically as some of these CLOs reset. But yes, I would expect that to be a smaller part of the go-forward strategy..

Okay. And then last two questions I guess one on the leverage, the two-to-one goes into effect next month. Are you guys in the bonds I know aren't callable until September.

I mean are you guys looking to call those since possible are you okay running below one-to-one leverage in the meantime what's your thoughts on outstanding bonds?.

There's no real rush from our perspective because it's unlikely we're going to get close to one-to-one leverage in the short-term, short-term being now and September.

But as always and we didn't say it on this call but we say it on all of our calls, we're always looking at financing alternatives and so it's something we are constantly looking at and discussing internally and we'll continue to be going forward.

I don't know Ted; if you have anything you want to add to that?.

No, I think that's right..

Okay. And lastly what are the remaining items essentially that need to be or conditions that need to be satisfied for the transaction to close? And 10-K was kind of one of the bigger hurdles and now that's out of the way.

So where are some of the remaining things that need to be satisfied for the transaction?.

I think it's mostly rudimentary stuff like key, phone, space, a lot of little stuff. Nothing that's really all that hard. It just all takes time. We want to make sure it's all done properly, so that there are no potential issues that overhang the closing.

So I think the idea is to make sure everything is completely locked down before we close on the transaction. But there's nothing that's outstanding, that's bad up to this point..

Our next question comes from Christopher Nolan of Ladenburg Thalmann. Your line is open..

Great, thank you.

The non-accruals did that reflects sort of a year-end cleanup of sorts?.

Well, it really reflected one larger position right which was Tank.

We're looking at Dan Gilligan, right?.

[Indiscernible] go to [indiscernible] effort..

Yes. I mean most of those are tiny positions; the only real significant one is Tank..

Am I correct that you actually -- your cost basis in Tank actually went up quarter-to-quarter, correct; is that correct?.

Capitalization of the peak..

Got it.

And then, for Ted Goldthorpe, look back you guys have alluded to a look back when you take over, when does that look back take effect, when does it go back to?.

So it's currently contemplated, but it's not a look back in the Externalization agreement..

So there is no look back?.

There's no look back as of now..

Okay. And then when you guys issued the press release in terms of going externally, you indicated good risk adjusted return target for KCAP.

Are you able to specify what that might be?.

Yes. I mean I think, I mean let's take a step back. I think the broader strategy is obviously we wanted to monetize the field manager which is not generating NII and dividend coverage which we've done. And then obviously redeploy that into NII earning assets. So we've kind of largely done that as Dayl alluded to earlier in the call.

And number two is obviously increase our reliance on first and first lien of unit tranche like assets and obviously reduce our reliance on CLO assets. We actually like the CLO business and like CLO equities, we just don't think it's necessarily the right structure to have them into a BDC.

And so I think if you look at where yields are today on both first lien and unit tranche [indiscernible] on an unlevered basis I would expect our new originations to come out around 10%. That's roughly where we originate as of today just given the LIBORs..

Okay, great. Thanks. And that’s basically it from me. Thank you very much for taking my call..

Thank you, Chris..

Our next question comes from Angelo Greenough [ph]. Your line is open..

Good morning and thanks for taking my call. Dayl and Ted, congratulations on --.

Thanks. Thanks, Angelo..

On doing this for the company, I think it’s a great move. Ted from BCP in the filings I didn't see anything really talking about a debt strategy and restructuring KCAP’s debt. And if I have to imagine that the new organization under your managements can have access to more favorable terms.

So can you tell us maybe a strategy of how you see that going forward?.

Yes. So I think you're referring to our liability side of our balance sheet. You have to say one of the big advantages of being in a big financial system like BC Partners is because we use so much financing because we paid so much in fees through the various investment banks and banks. We often times get asked cheaper cost of funding.

And so if you compare some of the External Managers to some of the Internal Managers or smaller managers versus larger managers, you can see there's definitely a benefit on the liability side.

So we would expect on a spread basis obviously LIBOR is up and down, we should be able to get financing costs that are lower over time which obviously all drops to the bottom-line for our shareholders..

Yes.

I noticed it wasn't part of your pro forma and I was surprised that actually refinancing the liabilities wasn't actually part of the case being made?.

It's absolutely -- it's actually a really good point. To be honest with you, it's just very hard to quantify because a lot of bonds that we are refinancing are non-callable. So it's like we would be making a forward estimate of where markets and spreads were at the time we're going to refinance all this debt.

So I think vis-à-vis, I think we're going to -- I think this is a big part of the value that we bring actually amongst other things consumer origination and other things we bring. But I think the ability to produce financing costs and again these vehicles are cost of capital vehicles. I think -- I think that's a big advantage that you'll see..

And do you have a philosophy; you have a mix of fixing the debt?.

Yes, I mean -- I mean I obviously I want to match assets and liabilities and I don't want to make a big bet on interest rates. I mean it’s not what we're good at. If you ask me 2010, I would have told you interest rates are going up which took six or seven years to play through. So I would say again like we're very good at underwriting credit.

We're not good at underwriting macro, so we don't like to take a lot of risk in terms of interest rate risk. That being said, some of our assets are fixed. The cheapest thing in the world right now is financing. There is ability to raise longer-term fixed rate debt that has no covenants. Obviously that's something we have to look at.

So I think you'll see a decent amount of floating rate liabilities in our capital structure. But if we can opportunistically tap the baby bond market or other markets where we can lock in long-term cheap financing for our shareholders, I think that might give us sense..

There are no further questions. I'd like to turn the call back over to Dayl Pearson for any closing remarks..

Thank you all for joining us today and thank you for the questions and the robust discussion and we look forward to talking to you at the end of when we file our first quarter financials. Thank you very much..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day..