Investcorp Credit Management BDC, Inc. Q4 FY2021 Earnings Call

Welcome to the Investcorp Credit Management BDC, Inc. scheduled Earnings Release of Fourth Quarter Ended June 30, 2021. Your speakers for today's call are Mike Mauer, Chris Jansen and Rocco DelGuercio. A question-and-answer session will follow the presentation. I'll now turn the call over to your speakers. You may begin.

Thank you, operator, and thank you to all of you for joining us on our fiscal year-end call today. I'm joined by Chris Jansen, my Co-Chief Investment Officer; and Rocco DelGuercio, our CFO. Before we begin, Rocco will give our customary disclaimer regarding information and forward-looking statements. Rocco?

Thank you, Michael. I would like to remind everyone that today's call is being recorded and that this call is the property of Investcorp Credit Management BDC. Any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by visiting our Investor Relations page on our website at icmbdc.com. I would also like to call your attention to the Safe Harbor disclosure in our press release regarding forward-looking information and remind everyone that today's call may include forward-looking statements and projections. Actual results may differ materially from these projections. We will not update forward-looking statements unless required by law. To obtain our latest SEC filings, please visit our Investor Relations page on our website. At this time, I'd like to return the call back to our Chairman and CEO, Michael Mauer.

Thanks, Rocco. The June quarter marks our fiscal year-end; we had a very active quarter with both highlights and challenges. We had a lot of activity from our investment standpoint, both in terms of new investments and realizations. Chris will go into detail on a name-by-name basis. Three of our four new portfolio company investments were in club loans, including one which we co-led with a partner. The fourth was a middle-market syndicated loan. We continue to believe that the best value lies in the core middle market. We also see the relevance of thoughtful structuring and covenants. The pace of refinancing activity in the broader market seems to have slowed somewhat. Of course, it's also possible that the summer doldrums hit early this year, but we had two refinancings announced mid-summer and none since. Our pipeline is less focused on refis now and more on new LBOs. While there is still pricing pressure on new deals, the market's frenzy feeling we saw four or five months ago seems to have abated somewhat. We extended our financing capacity and lowered our costs during the quarter and also during the current quarter. As we discussed last quarter, we repaid our 2023 notes and issued new notes due 2026. This had some one-time effects on our earnings this quarter which Rocco will discuss. More recently, we secured a new credit facility with Capital One which will eventually replace our borrowings under the UBS facility. Rocco will go into more detail later in the call. One thematic point I would like to make is that we have made great strides towards stabilizing the net asset value. We have reduced volatility by exiting investments as we did with Exela Technologies this quarter. We have received payments on Deluxe over the past year which have reduced our current fair value to 4% of our original cost. We have also substantially eliminated downside risk to our NAV through our marks, specifically on 1888 and PGi. I know that both of these positions have been of concern to you as well as to us for several years now. Coincidentally, both have reached the point of restructuring at the same time. Negative marks on these two positions over the past quarters have offset and overshadowed our team's great work across the rest of the portfolio. Now, with limited downside left, we think the entire portfolio is poised to rebound. Some examples include 4L, Techniplas, and Arcade Bioplan, all of which have recovered from the fair value low points and have begun to appreciate as the underlying borrowers' performance has improved. Chris will now take you through our investment activity during the June quarter and after quarter-end. Rocco will discuss our financial results, and I'll finish with commentary on our financing activity, our leverage, and Investcorp's share purchases, the dividend, and our outlook over the next few months. As always, we'll end with Q&A. With that, I'll turn it over to Chris.

Thanks, Mike. We invested in five new portfolio companies this quarter and one existing portfolio company. We had six full debt realizations across five portfolio companies as well. Our first new investment was in a club loan for NWN Corporation. We invested in NWN once before in 2015. The company, which has grown substantially under the ownership of New State Capital, is a leading provider of managed cloud services, solutions, and systems. Our yield at cost is approximately 7.7%. Our second new investment was in the first lien term loan for innovations in nutrition and wellness or INW. INW, which was purchased by Cornell Partners, formulates and produces a variety of products for the vitamin, mineral, and supplement markets. Our yield at cost is approximately 7.4%. Our third new investment was in the first lien loan for Lockwood, shown in our financial statements as Veteran Services LLC. Our loan to Veteran Services is a one-year bridge facility to support the redevelopment of a former hospital in the Chicago metropolitan area. Our yield at cost is approximately 17.7%. Our fourth new investment was in the first lien loan for WIS International, a portfolio company of Centre Lane Partners. WIS provides inventory verification services and merchandising services to customers across various retail industries. Our yield at cost is approximately 9.5%. Finally, our fifth investment was in the first lien loan for Lenox Corporation, another portfolio company of Centre Lane Partners. We co-led this club deal with our partners at Capital Dynamics. Our loan supported the combination of Lenox, Hampton Forge, and Oneida to form the leading tabletop business focused on the better market. Our yield at cost is approximately 9.2%. We also made an additional investment in Barry Financial Group term loan, which is an existing portfolio company investment. Our yield at cost on this incremental investment is approximately 9.5%. Turning now to our realizations during the quarter. Alta Equipment refinanced its term loan in early April with the proceeds of the bond offering. Our fully realized IRR was 17.8%. Flow Control amended its credit facilities in April. As part of this amendment, we opted not to roll our Term Loan C position into the new facility and we were repaid at par. Our fully realized IRR was 9.2%. GEE raised equity in the public markets to repay its debt facilities in full. Our fully realized IRR was 22.8%. ACProducts or ACTi refinanced its loans in connection with the acquisition of the company by Platinum Equity. Our fully realized IRR on this investment was 7.9%. We also sold our positions in Exela's term loan and bonds. Mike will discuss this further in his commentary. Our realized IRR on the term loan was negative 2.6% and the IRR on our position in the bond was a positive 4.9%. Since quarter-end, we made several additional investments and had one full realization. We invested in a club loan to Easy Way, a portfolio company of Insight Equity. Easy Way is a designer and manufacturer of cushions, covers, umbrellas, and other accessories to the outdoor furniture market. Our yield at cost is approximately 8.5%. We invested in the first lien loan to AgroFresh, a food sciences company whose product prolongs the useful life of fruits. Our yield at cost is approximately 7.3%. We also invested in an incremental term loan and delayed draw facility for Empire Office, one of our existing portfolio companies. Our yield at cost on this incremental investment is approximately 8.9%. We also made an additional investment in Techniplas' equity as part of the strategic acquisition of Nanogate, which is expected to be highly accretive and complementary to the existing business. Finally, we also invested in an incremental term loan to Golden Hippo, which had repaid a significant amount of debt to facilitate the purchase of additional equity by the ESOP. Our yield at cost is approximately 8.6%. After quarter-end, we received the repayment in full of infrastructure and energy alternatives or IEA. The company placed a bond to repay its loan in full. Our realized IRR was approximately 11.8%. We were also repaid on our investment in Hyperion as the company refinanced its first and second lien loans in the broadly syndicated market. Our fully realized IRR was approximately 7.6%. Using the GICS standard as of June 30, our largest industry concentration was professional services at 10.6%, followed by energy equipment and services at 8.3%, containers and packaging at 7.6%, construction and engineering at 6.5%, and commercial services and supplies at 6%. Our portfolio companies are in 25 GICS industries as of quarter-end, including our equity and warrant positions. As of June 30, our portfolio count was 36 versus 35 at March 31. I'd now like to turn the call over to Rocco to discuss our financial results.

Thanks, Chris. For the quarter ended June 30, 2021, our net investment income was $1.5 million or $0.11 per share. Normalizing for the redemption of the 2023 notes and the write-off of capitalized offering expenses for those notes, our NII would have been $2.3 million or $0.17 per share. The fair value of our portfolio was $245 million compared to $251 million on March 31. Our portfolio's net decrease from operations this quarter was approximately $11.9 million. Our new debt investments during the quarter had an average yield of 10.3%, while realization, repayments during the quarter had an average yield of 12.8%, and fully realized investments had an average IRR of 13.9%. The weighted average yield of our debt portfolio was 8.04%, a decrease of 73 basis points from March 31. The majority of this decrease is attributable to the repayment of our loan to GEE Group. As of June 30, our portfolio consisted of 36 portfolio companies; 93.7% of our investments were first lien, 2.5% of our investments were second lien, and the remaining 3.8% is invested in equity, warrants, and other positions. 96.1% of our debt portfolio was invested in floating rate instruments and 3.9% in fixed-rate investments. Our average LIBOR floor on our debt investments was 1.04%. Our average portfolio investment was approximately $6.8 million, and our largest portfolio company was varied at $13 million. We were 1.7 times levered as of June 30 compared to 1.96x leverage as of March 31, and our net leverage as of June 30 was 1.5 times. We had four investments on non-accrual and one investment on partial accrual as of June 30. With respect to our liquidity, as of June 30, we had $12.6 million in cash, of which $6.8 million was restricted cash, as well as $20 million capacity under our revolving credit facility with UBS. Finally, on August 23, we closed on a new credit facility with Capital One. The new facility has an interest rate of LIBOR plus 2.35% compared to UBS' LIBOR plus 3.15%, resulting in an 80 basis point savings. It has a three-year investment period. The new facility will replace the existing UBS credit facility which is set to mature in early December. More details regarding this facility are available in our recently filed 10-K and our 8-K filed on August 25. I would also like to note that the December quarter will have one-time costs related to the two credit facilities until the UBS credit facility rolls off in early December. Additional information regarding the composition of our portfolio is included in our Form 10-K which was filed yesterday. With that, I'd like to turn the call back over to Mike.

Thank you, Rocco. Over the past several months, we have established a new set of leverage facilities to provide us with expanded flexibility and lower cost. In April, we closed on $65 million of new notes due 2026. As Rocco noted, there was a one-time cost associated with writing off the remaining capitalized offering cost of the 2023 notes which reduced our NII by approximately $0.06. More recently, we secured a new credit facility with Capital One. Our new facility with Capital One will replace our borrowings with UBS. Our guidance on leverage remains a target of 1.25 to 1.5 times. We have been working to reduce our leverage over the past two quarters, bringing it down from 1.96 in March, which was inflated due to the note refinancing I just described, to 1.72 times in June. Today, it stands at approximately 1.68 times. We're going to continue to work toward reducing our leverage over the coming quarters, and I note that the persistently high leverage is not the typical result of our normal investment activity but rather a direct consequence of the decrease in our NAV. On that front, I'd like to discuss the decline in our book value. This quarter, we took significant markdowns on two portfolio company investments in particular. These were 1888 and PGi. Both have been credit concerns for some time and both were already on non-accrual. While for confidentiality reasons, I cannot discuss many of the details of these companies, I would like to share more color on each with you all. 1888 has several term loans. We have begun discussions for a balance sheet restructuring in recognition that subordinated term loan B will not resume paying interest and that 1888 would benefit from the equitization of a significant portion of its debt. By restructuring into an equity interest, we will retain the ability to realize upside value if the company's performance recovers. PGi has been on non-accrual for several months after it defaulted on interest payments to both the first and second lien loans. Lenders in both tranches have been working together constructively to preserve liquidity and define a path toward recovering value. I can't go into detail about the restructuring at this point, but we believe our mark appropriately limits further downside risk in our position. We believe that reducing further downside risk to our NAV was an important theme for us this quarter, in addition to our marks on 1888 and PGi; we also sold our holdings in Exela Technologies after a significant increase in the market price of the debt. We exited at a near zero IRR after holding the positions through remarkable price volatility. This exit reduces uncertainty in the portfolio, especially should Exela ultimately restructure, which we view as a real possibility. As part of 1888 and PGi, we have two marks below 50 as of June 30. DSG or Deluxe is in a wind-down position which I have discussed in prior quarters. We have marked a position as a sum of the probable future cash receipts. As recoveries are realized, the principal balance is reduced and the marks adjusted based upon our most recent view of remaining sources of value. It's a small position but I would like to note that we have recovered in excess of 74% on our investment at this time and we expect to recover additional amounts in the future. As of today, the fair value of DSG represents approximately 4% of our original cost. Fusion's second out take-back paper is marked at 47 this quarter. This is indicative of our underlying challenges facing the business, as well as the unsustainable capital structure which was on the business during its bankruptcy two years ago. I would note that we continue to mark the first out loan at par due to its low loan-to-value, and we have a great deal of confidence in the company's management and their vision for the future. In addition to working hard to limit further downside on our NAV, we have a number of positions with asymmetric upside potential. We own equity positions in 4L, ASI, Techniplas, as well as 1888 and Fusion. Techniplas has begun to see recovery and, as Chris noted, made an acquisition which should be immediately accretive. 4L is stable and is, we believe, positioned for future recovery. ASI continues to perform well. Beyond our current portfolio, we also recently received expanded exemptive relief to co-invest with Investcorp's private equity funds, which will allow us to invest in equity of Investcorp's LBOs alongside them. I would like to note we will never invest in the debt of an Investcorp portfolio company in order to avoid conflicts. However, we are excited about investing alongside our private equity partners and the prospect of creating additional avenues for NAV growth. We did not cover our June quarterly dividend with NII. As Rocco noted, however, one-time costs associated with writing off capitalized offering costs from our 2023 notes served to bring our NII per share from $0.17 to $0.11 per share. Except for these one-time costs, we more than covered the dividend. We are committed to a disciplined investment approach and we are confident that we have the appropriate capital resources to generate NII to cover the dividend going forward. As we committed to do, we waived the portion of our management fee associated with base management fees over 1x leverage. Our Board of Directors declared a distribution for the quarter ended September 30, 2021, of $0.15 per share payable on October 14 to shareholders of record as of September 24. The Board did not declare a supplemental distribution this quarter. We believe the dividend level should be stable and sustainable and the supplemental distribution approach remains the best way to capture fluctuations in the portfolio's income generation. Investcorp made two separate commitments to purchase shares in ICMB. While Investcorp did not make any open market purchases under its 10b5 program or any purchases of shares at NAV during the June quarter, Investcorp has made purchases to fulfill all of its commitments during the current quarter. In summary, since March 31, we have successfully invested in seven new portfolio companies despite a challenging environment for origination. We remain focused on club deals where we find better structural protections, pricing, and covenants that are typically in current vintage broadly syndicated transactions. We are also looking at existing portfolio companies for opportunities to make incremental investments. We will manage the portfolio through the cycle and keep our focus on consistent income generation and preservation of shareholder capital. That's the end of our prepared statements. Operator, please open the line for Q&A.

Ladies and gentlemen, at this time, we will conduct a question-and-answer session. We are now ready to begin. Our first question comes from Christopher Nolan. Please state your question.

Hi, guys. What's the advance rate on the new Capital One facility, Rocco?

The advance rate?

Yes.

I'm sorry.

It varies, Chris. It varies on the advance rate in total.

Hello?

Hello? Yes, okay.

Okay. Sorry. It should average about where we were with UBS, which is about 60%. It depends upon the portfolio. There are different advance rates for obviously different classes of loans and also there's a size factor as well.

Understood. Are there private equity sponsors associated with that company?

There was a sponsor, it's Mike. Thanks for the question. Before I answer that, I did want to clarify one thing. I think earlier, Rocco going through his statements, talked about net leverage and it sounded like 1.5 to 2.58, just to be clear for everyone, I want to clarify that. On 1888 in the initial transaction back in 2014, there was a sponsor. When it was restructured several years ago, that sponsor was removed. They were fundless and did not have additional capital to put in. So the lenders stepped into the equity and some of the strategic sellers continue to participate. At this point, the strategic sellers are helping from an operating standpoint but not from a capital standpoint. That's the Wells family out in the DJ Basin.

Great. I have a final question about 1888. It's a term B loan that is non-accrual. Does that one turn into equity, or does all the exposure turn into equity?

We expect that there is still some debt associated with it. We are in the process of finalizing whether it is the term loan B or another amount, but that has not yet been determined.

Our next question comes from Robert Dodd. Please state your question.

Hi, guys. I've got a few. First one is kind of a housekeeping one. In the case, Fusion Connect is marked as like partial non-accrual. Can you explain what that means? I think it is counted fully in your non-accrual numbers that you give us but it's listed as partial. So what's the distinction there?

Yes. It has a 3% cash component and an 8% PIK. The PIK portion is currently on non-accrual, so we are only recognizing the cash payments.

I appreciate the clarification. Mike, you mentioned that you expect to cover the dividend this quarter without the one-time cost, which would have resulted in $0.17. However, you also had very high fee income this quarter, the highest in my records for at least the past three years. So, you're confident that either fee income will remain high, or if the refinancing market has slowed down, you can still cover the dividend with just regular fee income.

With normal, Robert, thanks for the question. There are two things. One is with normal fee income, we expect to cover the $0.15. And we have done our models out through year-end. I think beyond year-end, we get a little bit into the guessing of the reinvestment rates and the level of the portfolio, etcetera.

Got it. Understood. Beyond year-end, it becomes trickier. Regarding Premiere Global or American Teleconferencing, you mentioned wanting to eliminate or reduce the downside NAV risk moving forward. However, when I examine your mark on that, there are 500 BDCs involved, and your market is significantly lower than others. Is there something different about your loan? You have some PIK on it, while I don’t think others do. I'm wondering if you are in the same tranche as the others. Or do you have specific insights about that business that explain why your mark is lower? For instance, while the lowest mark for others is 42, yours is at 15, indicating a very conservative approach. Can you provide more details on how that's marked? What factors were considered, or is this simply a matter of taking an ultra-conservative stance on the valuation?

Robert, I appreciate your careful wording of the question because it's sensitive due to the non-public information. My expectation is that we do not possess any asymmetric information compared to other first lien lenders. We believe that the focus is on the first lien, while the second lien has effectively negligible value. We recognize that it's a challenging loan, and if there's a valuation range, we prefer to operate at the conservative end of that range to minimize downside risk, although I can never claim to eliminate it entirely unless it’s zero. We've sensed some frustration from market shareholders and analysts regarding the various marks on the portfolio. This provides some context regarding the overall portfolio and specifically the situation with PGi.

Got it. Got it. And then I mean on the net leverage and obviously, things can move around as UBS gets replaced with Capital One, etcetera; you can allocate cash balances differently potentially. The 1.58, I presume that was quarter-end, what's the net leverage today after taking account obviously Investcorp have bought some stock at NAV which obviously gave you a little bit of an NAV, they bought at NAV per share. But obviously, that would have a beneficial impact on leverage, all other things being equal. So where do we stand today on that basis?

The net, it would be closer to 1.54.

Got it. Okay, that's it for me. Thank you.

Sure.

Our next question comes from Paul Johnson. Please state your question.

Hey, good afternoon, guys. Thanks for taking my questions. Just going off of Rob's last question. I'm just curious, going forward, I know you've had a little bit of net growth quarter-to-date. I mean how do you guys, I guess, balance any sort of new growth that you have? I mean are you planning on drawing more on the new facility? Or do you have just more visibility into incoming repayments? How do you balance all that which is the level of cash on the balance sheet? Obviously, leverage just running, I think, a little bit higher than your previous target of around 1.5 or so, I think, on the high end.

Just to clarify, the growth in what were you referring to?

Quarter-to-date, third quarter, just the investments that you've made quarter-to-date.

The gross investments show some visibility on upcoming repayments and redeployments. However, these amounts are not significant. We don't expect any negative impact on our overall net asset value today; rather, we anticipate modest growth. I’d like to emphasize that this growth strategy involves deploying into equity to increase the NAV, which will enable us to expand our asset base over a timeframe of 6 to 36 months. We have been working with Investcorp for over a year and a half to obtain orders for exemptive relief to co-invest. Currently, we hold about 4% in equities, and a substantial part of that consists of restructured equities that we will manage over time. We aim for a range of 4% to 10%, targeting this change in the near to medium term within 6 to 36 months. The final portfolio will be diversified and will include co-investments in Investcorp's sponsored deals as a means of growth.

Got you. Thanks for that. That was actually going to be my next question was on the private equity strategy which I think makes sense now that you are affiliated with the Investcorp platform. So, I appreciate it. Those were all my questions, and that's all I have today.

No, I appreciate it. Listen, I don't know how familiar all of you are with the Investcorp platform. But the private equity sponsored next year will be the 40th anniversary of them being a PE investor and one of the original private equity investors in the 80s always been focused on middle market and continues to be focused on middle market. So not only do we think that it will be accretive to shareholders to be able to exercise around a co-investment strategy, but it is now also starting to help us originate debt investments away from Investcorp deals because there are a lot of the market calls on Investcorp to lend to their PE deals; that's helping our partnerships on non-Investcorp deals. Any other questions?

At this time, there are no further questions.

Thank you very much. We appreciate it, everyone. We will talk to you next quarter.

This concludes today's conference call. Thank you for attending.