MCG Capital's CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.28.14 | About: MCG Capital (MCGC)

MCG Capital (NASDAQ:MCGC)

Q1 2014 Earnings Conference Call

April 28, 2014 9:00 am ET

Executives

Keith Kennedy – President, Chief Executive Officer

Richard Neu – Chairman

Jane Alley – Chief Financial Officer (interim)

Tod Reichert – General Counsel, Chief Compliance Officer

Analysts

Troy Ward – KBW

Christopher Nolan – MLV

Rick Fearon – Accretive Capital Partners

Operator

Good morning and welcome to the MCG Quarter 2014 Earnings investor call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. Should anyone require operator assistance, you can press star and then zero on your touchtone telephone. As a reminder, today’s call is being recorded.

I’d now like to turn the conference over to your host for today, Mr. Keith Kennedy, CEO. Sir, you may begin.

Keith Kennedy

Good morning and welcome to the Q1 2014 Earnings call for MCG Capital Corporation. I’m here with Rick Neu, our Chairman; Jane Alley, our interim Chief Financial Officer, and Tod Reichert, our General Counsel and Chief Compliance Officer.

Before we begin, Tod will take us through the Safe Harbor statement.

Tod Reichert

Good morning everyone. Before we begin, we’d like to remind you that various statements we may make during this morning’s call will include forward-looking statements as defined under applicable securities laws. Management’s assumptions, expectations and opinions reflected in those statements are subject to risks and uncertainties that may cause actual results and/or performance to differ materially from any future results, performance or achievements discussed in or implied by such forward-looking statements, and the company can give no assurance that they will prove to be correct. Those risks and uncertainties are described in the company’s earnings release and in its filings with the Securities and Exchange Commission.

With that, I’ll turn the call over to our President and CEO, Keith Kennedy.

Keith Kennedy

Thank you, Tod. We pre-released our earnings on April 21 and our results are in line with that release, which I will have Jane go over in more detail momentarily. First, let me provide some color on the quarter, key portfolio accounts, and actions I’ve taken since becoming President on March 5. I’ve also asked Rick Neu to join us to provide his thoughts on the quarter, which he will do at the end of the call and before we open the call for Q&A.

As I mentioned on the last call, I had articulated a plan to visit key accounts over two quarters. I made significant progress visiting portfolio companies and I expect to substantially complete these trips by the next time we talk in July. As Jane will cover in more detail, we continue to repurchase shares and on April 25, 2014, our Board of Directors authorized a new stock repurchase program of up to $50 million. On April 25, 2014, our Board of Directors also declared a dividend of $0.07 per share payable May 30, 2014 to shareholders of record as of May 9, 2014.

As you are aware, this quarter we recorded two large marks for unrealized depreciation which I would like to discuss in more detail. Subsequent to our last call Education Management, our fifth-largest investment at that time, and the sponsor notified us that the company continues to face operational, financial and business challenges. We are working closely with the sponsor and are taking active steps to be constructive in an effort to help the company to get back to a solid operating tempo. In the meantime, we marked down our investment by $15.2 million to reflect the present issues and business challenges facing the company. Radiopharmacy, our largest investment and last internal equity investment, actually beat their Q1 2014 forecasts; however, we continue to evaluate price and volume stability in a market dominated by three large providers and in light of cost increases that suppliers are trying to push through the system. We marked down our investment by $6.3 million to reflect the challenge in the core business. The remaining $1.8 million in net investment losses principally relates to tag equity investments for equity investments in businesses that we do not control. We have 12 equity investments with a total fair value of $20.2 million or $1.7 million per investment, excluding investments that we hold at zero fair value. Excluding Radiopharmacy investments, our average equity investment is $1.2 million.

We expect monetizations to continue to accelerate as several of our borrowers are accessing the senior loan market at very attractive rates and with favorable returns. If this happens, it will have a short-term impact of boosting our net operating income but it will have the long-term impact of reducing our net earning assets. We believe that the market remains at levels consistent with the height of the credit cycle and we are focusing our near-term energies on the stabilization of our portfolio. We are making important personnel decisions involving our investment management team, but I’m holding off on expanding our business development initiatives until I’m satisfied with the portfolio and the stabilization of our NAV. Concurrently, we are using excess cash flow to repurchase our stock in the open market. We believe this is the best short-term use of capital to build NAV for our shareholders.

Given our assessment of current market conditions, the unpredictable nature of portfolio monetizations, and our focus on stabilizing our portfolio, we do not anticipate providing forward-looking guidance relative to our net operating income, origination volumes, expense levels or other operating metrics. Any previous guidance should no longer be relied upon. We believe this change allows us to concentrate on our portfolio and our long-term strategies.

Before I turn it over to Jane to go through the financials, I want to thank Hagen Saville for all that he has done over 16 years in various leadership roles with the company. For all the challenges the company faced, in my opinion Hagen always had the shareholders’ interest at the forefront of everything he did. I look forward to continuing to work with him on the board of Radiopharmacy investors as a principal and RSPIC fund, which enjoys a very favorable track record of lending money to U.S. small businesses.

I will now ask Jane to outline the specific results for the quarter.

Jane Alley

Thank you, Keith. Good morning everyone. I plan to speak about our first quarter 2014 results for the period ended March 31, 2014. You may also find our Q1 2014 investor presentation in the Investors center under Events and Presentations. The slide deck includes key metrics and other highlights that I’m going to mention on the call today.

The following highlights occurred during the three months ended March 31, 2014. Net operating income or NOI was $4.3 million or $0.06 per share. Net loss was $18.9 million or $0.27 per share, principally driven by marks in Education Management and Radiopharmacy investors. At March 31, 2014, our NAV per share was $4.37, down $0.37 since December 31, 2013. The $0.37 NAV bridge is comprised of $0.06 of NOI and $0.03 attributable to stock transactions, offset by $0.33 of net investment losses and $0.125 of dividends declared.

During the quarter, we made $6.7 million of advances and we monetized $26.4 million of our portfolio. At March 31, 2014, our portfolio at fair value was $326 million, sequentially down $43 million. On Page 11 of the investor presentation, we walk you through recent changes in our investment portfolio.

At March 31, 2014, we had $83.4 million in unrestricted cash and $30.4 million in restricted cash from our SBIC. In addition, we had $2.4 million in other restricted cash accounts.

During the quarter, we repaid and terminated our 2006-1 trust. As a result of the repayment, we reduced our outstanding borrowings by $25 million from $175 million to $150 million. Our only remaining outstanding debt is our SBIC debentures.

On April 21, 2014, we terminated our Bank of America unsecured revolving credit facility that was set to expire in November 2014. As shown on Page 6 of the investor presentation, during the quarter we incurred accelerated deferred financing costs of $0.1 million, litigation expenses of $0.3 million, and severance costs of $0.2 million, which make up about a penny per share. We expect to incur approximately $3.9 million of these costs in the second quarter of 2014. For the quarter, excluding interest expense, our total operating costs were $3 million or approximately 0.7% of total assets of $449 million. For the quarter, our total (indiscernible) at fair value was 11.4% and our average cost to borrow was 5.2%.

As shown on Page 15 of the investor presentation, we added Education Management’s $4.9 million senior secured loan to the balance of loans on non-accrual at fair value. The cost and fair value of our loans on non-accrual is 12.2% and 3.1% respectively of our loan portfolio.

For the three month period ended March 31, 2014, we repurchased 2,759,267 shares of our common stock at a per-share weighted average purchase price of $3.84. From January 1, 2014 to April 24, 2014, we repurchased 6,641,888 shares of our common stock at a per-share weighted average purchase price of $3.78. We spent $10.6 million to buy back stock in the first quarter of 2014 and $25.1 million year-to-date through April 24, 2014.

With that, I’ll turn it back to Keith.

Keith Kennedy

Thank you, Jane. As I mentioned earlier, I’ve asked Rick to provide his thoughts on the quarter.

Richard Neu

Thanks Keith. On behalf of the board, I also want to thank Hagen for his years of leadership at MCG. Hagen has been more than instrumental in many of the successful debt and equity monetizations MCG has realized the past 2.5 years, which now exceed $600 million. We very much wish him well in his future endeavors.

I also want to thank Keith for accepting his new role as Chief Executive Officer. Keith is an inclusive leader, a clear communicator, and has demonstrated an extensive knowledge of all facets of our business. Keith’s counsel to the MCG board and responsiveness to our shareholders has been invaluable and we firmly believe that he’s the right person to execute the near-term portfolio of capital management strategy for MCG.

On a final note, I want to clearly communicate that the board of MCG is clearly disappointed with the results that we have reported the last two quarters. I want to assure you that the board remains fully engaged and completely supportive of the near-term strategy articulated by Keith.

Thank you for your continued interest and ongoing support, and with that I’ll turn the call back to Keith.

Keith Kennedy

Thank you, Rick, and with that this concludes our prepared remarks for the quarter and we will now open the line for questions. Operator?

Question and Answer Session

Operator

[Operator instructions]

Our first question comes from the line of Troy Ward of KBW. Your line is open. Please go ahead.

Troy Ward – KBW

Great, thank you. Good morning guys. Keith, can we just start with—obviously both Color Star and Education Management are disappointments – that’s pretty obvious. What’s interesting is they are both post-credit crisis deals, so obviously that raises even additional flags. But in your new role, can you talk about what you potentially see from a front-end perspective on the originations but also on the back end – I mean, we’re constantly monitoring portfolio companies and to see something constantly blow up in such a short time frame is really worrisome. So is there potentially a back-end structural issue from a monitoring perspective as well?

Keith Kennedy

Troy, we’re very focused in on the investment management side of this. I’ve made some moves on that side of the company and I’ll continue to focus in on that. Separate the Color Star issue, I think as Hagen said, is a fraud which we are pursuing, and I think that adds to difficulties identifying those. On Education Management, the sector is a challenging sector and I think the company has had some operational issues. It’s a company that was a 7, $8 million EBITDA company and those companies have a lot of operating leverage in them, and we had a guy here who believed strongly in the sector and things go against these companies. We’re investing in companies with 3 to $7 million of EBITDA, some of these companies 10 to $15 million; but the heart of what we do is 3 to $7 million of EBITDA, and we’ve found on occasion operational issues occur in these companies and we believe that the company has the infrastructure – seven schools and a good sponsor – and we’re trying to play it out with the company and be constructive.

Troy Ward – KBW

And Keith, on the last call you alluded that you were hoping to hire some folks and do some things to grow the platform, and I think I heard that you’re putting those things on hold. Can you talk about how you’re going to assess kind of the timeline as you view when is it time to continue to focus on capital management, i.e. probably not put capital to work and continue to buy stock, versus when do you start to maybe put other plans in place, or is that ever a possibility?

Keith Kennedy

Well, I think it’s a possibility. Look, I have the shareholders’ interest at heart and building NAV and not destroying NAV, and I have to put my handprint on it. I have to be comfortable that the book is the way it needs to be based on the facts and circumstances in front of us, and I’m going in and evaluating all of those. So until I make those assessments, I don’t want to bring people in and make promises that I don’t feel like I can live up to, and I don’t want to give guidance, for example, to you guys if I’m not going to be able to achieve it. So I need time to evaluate that, and I think that’s what we’re trying to indicate.

Troy Ward – KBW

Okay, one more and then I’ll hop back in the queue. Rick, if you don’t mind, a question posed at you. It’s definitely been a challenging time for MCGC. Our team here has been involved with the company for a decade. As Chairman of the Board and a recent interim CEO, I believe you are in a very unique position to offer some perspective. I think you’ve done a very good job. As the head of the Board, can you just outline kind of what steps the board took throughout this process? Was there discussions to take different routes, potentially search outside for some type of—someone to parachute in and do a restructuring altogether or even align the operations down?

Richard Neu

Hi, thanks for the question and long-term interest. I would say that you’re asking about how the board reviews various strategic alternatives, and I think Hagen did a good job responding to that question on the last call. We truly—we know who we work for and we understand where our fiduciary obligations lie, and I would tell you that this board has been and will always be open to evaluating all alternatives, weighing it against our standalone plan. So at this particular point in time, we’ve clearly had some portfolio surprises. The last two quarters before that, we had, I think, exhibited relatively good stability, and so as Keith alluded to, I think at this point the most viable next step for us is to have Keith and his team redouble his efforts on making sure the portfolio has in fact stabilized; and in the meantime on the positive side, we have in excess of $100 million in liquidity which gives us some flexibility, particularly relative to where the stock is trading.

So it’s disappointing and I would not lose sight of the fact that coming out of the credit crisis and the bubble, we have had many successful monetizations, as I alluded to earlier; but unfortunately, the misses have been big when we’ve missed, unacceptable, basically the same teams, people and processes involved that created the good results. So we’re taking it a quarter at a time and excited that Keith has accepted this new challenge and is immensely talented with a good strong team behind him, so.

Troy Ward – KBW

Great, thanks.

Richard Neu

Thank you.

Operator

Thank you, and once again ladies and gentlemen, to ask a question, please press star and then one. Our next question comes from the line of Christopher Nolan of MLV Company. Your line is open. Please go ahead.

Christopher Nolan – MLV

Hi. Thank you for taking my call. Second quarter severances – how much of that is related to Hagen Saville and how much is related to others?

Keith Kennedy

We don’t break that out.

Christopher Nolan – MLV

Okay. Then the deal originations in the quarter were $6 million as opposed to $37 million in the prior quarter. What has changed internally in terms of your process which would account for such a slowdown? I know you mentioned that you’re sort of stepping back and looking at things, but how are you changing things relative to what you were doing earlier?

Keith Kennedy

I’m making personnel moves and I’m not making investments in a market where I think the terms and structure relative to buying our stock are not accretive to our shareholders.

Christopher Nolan – MLV

Okay, so right now it’s fair to say that the focus is really now just reorienting the MCG house internally before going out forward and looking at new investments, correct?

Keith Kennedy

We’re supporting our portfolio companies and we plan to make investments in several of our companies, and a vast number of our companies are excellent companies and are doing very well, so I’m not—you know, you always have these issues with select companies, so I don’t want you to feel like we’re not going to be out there investing or supporting our companies. We will; we’re just looking at it relative to the opportunities we have in front of us to build shareholder value through NAV and stock buyback.

Christopher Nolan – MLV

Okay, and then final question is taking the strategy where you’re basically pulling back a little bit, you’re focusing on supporting your existing companies, you’re buying back a lot of stock, you are supporting NAV per share but you’re also sacrificing revenue growth in terms of just your portfolio continuing to wind down, so you definitely have a limited amount of time you can do that. What sort of time frame are you giving yourself in terms of for this current strategy of retrenching before you can actually start to try to grow revenues? What sort of time frame are you looking at, because your revenue is going to continue to decline until the—

Keith Kennedy

We’re evaluating that on a quarter-by-quarter basis. We are looking at it, obviously.

Christopher Nolan – MLV

Okay, so no particular answer, just looking at it.

Keith Kennedy

That’s right.

Christopher Nolan – MLV

Okay, thank you for your answers.

Operator

Thank you. Our next question comes from the line of Rick Fearon of Accretive Capital Partners. Your line is open. Please go ahead.

Rick Fearon – Accretive Capital Partners

Good morning guys. I probably don’t need to say that we’re pleased with the management change, but I also just wanted to congratulate Keith.

Keith Kennedy

Thank you, Rick.

Rick Fearon – Accretive Capital Partners

I think the approach that you’ve outlined on holding off on expanding the business and development staff makes a lot of sense, and I’m happy to hear that you’ll look at the stock repurchase in comparison with the alternatives of investing in this market, and that that’s your focus at this point. I just wondered if you could comment on the thought process behind the stock purchase program that’s been put in place, beginning in May. I mean, you’ve got $4.37 of NAV and I think in April alone with the share repurchases that you’ve done, you’ve added $0.03 or $0.04 to per-share NAV in the month alone. But that was based on a volume level that allowed the company to buy back about 240,000 shares per day, which is, as you know, not the typical volume for MCG. So I’m just wondering if you anticipate the block purchases that now you’ll consider as a means of getting to that $50 million on the share repurchase program level, or how you think you might be able to get there with the current volume.

Keith Kennedy

Well, we’re evaluating block purchases on a daily basis and so inside these structures with our trading partner, we evaluate all those in the structure and we evaluate our ability based on the liquidity and volume levels and the stock how we get there when we set these programs up. That being said, we’re not a huge company and so we don’t know how the liquidity will play out over time. As you know, you can go back and chart the volume of our stock, and our stock has traded obviously much higher volume since March and accelerated through the end of March than it was in periods of stability. So I would imagine that those volumes could decline over time as we stabilize the book.

Again, I think we’re talking about a select number of portfolio companies and I’m thinking we predominantly have a lot—you know, we have a lot of cash relative to our total book, and that will stabilize things.

Rick Fearon – Accretive Capital Partners

And Keith, why is the concept of going out and doing a Dutch auction tender, why is this alternative more attractive—the alternative of going to the public market and hoping that we can amass enough shares to have a meaningful impact, versus just going out and doing, say, a $50 million Dutch auction tender? And that may be a question for Rick at the board level, but I’m sure you’ve done the analysis, Keith. What’s the thinking there?

Keith Kennedy

We have discussed it at length and we appreciate your presentation that you’ve given us on that – I think that’s been very helpful. We’ve had many discussions with different providers and investment banks in that regard. The issue is that we’re able to buy our stock in the open market at significantly more accretive prices than we are in a Dutch auction. The price to executing the liquidity concerns of doing a Dutch auction are a concern of ours, but we do keep it on the table; and at the point where that makes sense, I think the board is willing to consider that. So by no means should anybody have ever thought that that wasn’t on the table. We have been evaluating that, but that has not been a recommendation of any of the investment banks that are on the inside of the knowledge base that we have.

I’d also add that I think you should trust that I know the portfolio and that I’m making the best decisions that I can in terms of buying back as much stock as I think will be accretive and at what price it will be accretive.

Rick Fearon – Accretive Capital Partners

All right, thanks. I’ll jump back in queue if there are any other questions.

Richard Neu

Great, thank you, Rick.

Operator

Thank you, and I have no further questions in queue. I’d like to turn the conference back over to Mr. Keith Kennedy for any closing remarks.

Keith Kennedy

I’d like to thank everybody for the call. I’d also like to offer people to have a direct line. I clearly take all the calls from our investors and we remain open and diligent in trying to do everything we can to build our NAV and shareholder value for you, so that will be our next focus. We look forward to talking to you in July.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Have a great rest of your day.

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