Investcorp Credit Management BDC, Inc. Q2 FY2022 Earnings Call

Welcome to the Investcorp Credit Management scheduled earnings release of the second quarter ended December 31, 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’d now like to turn the call over to speakers. Please begin.

Thank you, operator, and thank you all for joining us on our second quarter 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?

Thanks, Mike. 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 copies of our latest SEC filings, please visit our Investor Relations page on our website. At this time, I’d like to turn the call back to our Chairman and CEO, Michael Mauer.

Thank you, Rocco. Our December quarter was the busiest one in our history. We invested in seven new portfolio companies and made additional investments in seven other portfolio companies. We supported LBO acquisitions and existing portfolio companies, among other uses of proceeds. This diverse set of investments continues to support the portfolio rotation we began earlier this year. As we promised last quarter, we've added to our total count of portfolio companies, decreased concentrations in a number of industries we lend into, and maintained a moderate average position size, all with the goal of increasing the stability of our results. We completed the restructuring of Fusion Connect in January, as well as the conversion of 1888's Term Loan B into equity. With these restructurings complete, we continue to address significant legacy credit issues in the portfolio. I'll speak more about the details later in the call. It continues to be challenging to maintain price and structure in a highly competitive market environment, but we were successful in deploying our capital at an average yield in excess of 8% during the quarter. Only one of our new investments which is covenant light in a market environment which is increasingly sponsor-friendly. Since the real story of the quarter is our new investment activity, I'd like to turn the call over to Chris. After his discussion, Rocco will go through our financial results. I'll finish with commentary on our investments, on non-accrual, the restructurings of 1888 and Fusion Connect, our leverage, the dividend and our outlook for 2022 as well, and as always, we'll end with Q&A. With that, I'll turn it over to Chris.

Thanks, Mike. We invested in seven new portfolio companies this quarter as well as seven existing portfolio companies. We had six full realizations as well. Please bear with me as there is a lot to cover this quarter. We invested in the first lien loan of LaserAway, a portfolio company of Ares Management. LaserAway is a leading chain of laser hair removal and skincare boutiques. Our yield at cost is approximately 7.1%. We invested in the first lien loan of Patriot MMG or Momentum Manufacturing Group to back the LBO of the company by One Equity Partners. Momentum provides metal machining, welding, bending, and finishing services. Our yield at cost is approximately 6.9%. We also invested in a club financing for ArborWorks. We participated in the revolver, term loan, and made a small co-investment in the equity. ArborWorks provides utility clearing, vegetation management, and disaster relief services. The transaction supported the LBO of the company by New State Capital. Our yield at cost is approximately 8.5%. We invested in the revolver and first lien loan of South Coast Terminals backing its LBO by Platform Partners. South Coast is a contract manufacturer of specialty chemicals and lubricants. Our yield at cost is approximately 7.5%. We also invested in the revolver, delayed-draw term loan, and first lien term loan of Xenon Arc, which provides tech-enabled distribution solutions for specialty chemicals and materials. Peak Rock is the sponsor. Our yield at cost is approximately 7%. We participated in an upsizing of Crafty Apes' term loan, joining a club deal and supporting the company as it made an acquisition. Crafty Apes' is a visual effects company serving the TV and film production industries. Gemspring is the sponsor. Our yield at cost is approximately 7.9%. Finally, we made our first equity co-investment alongside Investcorp’s North American private equity group. RESA Power, listed in our scheduled investments as Investcorp Transformer Aggregator LP, provides field services, power systems, and specialty distribution of related products to utility, power generation, corporate, and government customers. In terms of investments in our existing portfolio companies, we made a small incremental loan to Gexpro to support an acquisition. Our yield at cost is approximately 9%. Our loans to Gexpro were refinanced after quarter end, which I'll talk about in a moment. We also made a small incremental loan to Fusion Connect to support its liquidity during the restructuring process. Our yield at cost was approximately 12%, as the Gexpro loan was refinanced after quarter end. Mike will provide additional detail about Fusion's restructuring later in the call. We made an incremental loan to Easy Way, which was a new portfolio company for us last quarter. Easy Way is a designer and manufacturer of cushions, covers, umbrellas, and other accessories for the outdoor furniture market. Our yield at cost is approximately 8.9%. Galaxy Universal purchased a number of footwear brands from Sequential Brands in Sequential’s bankruptcy auction. Galaxy manages these brands already and we're pleased to participate in this transformational acquisition. Galaxy's existing term loans were refinanced and the new first-lien loan yields approximately 7.4% of costs. We made an additional investment in the first lien loan to AgroFresh, a food sciences company whose products prolong the useful life of fruits. We had a subscale position and are now comfortable with our hold size. Our yield at cost is approximately 7.2%. We provided incremental loans to Klein Hersh alongside our club partners. Klein Hersh’s financial performance has been outstanding and leverage today is below closing leverage. This helped us get comfortable with the fact that the use of proceeds was a dividend to the sponsor, New State Capital. Our yield at cost is approximately 8.3%. Finally, we provided a small incremental loan to ASI to help the company make an acquisition. Our yield at cost is approximately 9.5%. Turning now to our realizations. As I mentioned last quarter, our loan to ZeroChaos was repaid in full, as the company was acquired by PRO Unlimited. Our fully realized IRR was approximately 11.2%. I mentioned a minute ago that we participated in Galaxy Universal's new financing as the company acquired assets in Sequential Brands bankruptcy auction. This new first lien loan refinanced our old loan for a fully realized IRR of approximately 12.8%. We also opportunistically exited our position in Pixelle Specialty Solutions in favor of new opportunities that we originated this quarter. Our fully realized IRR was approximately 8.9%. We also received repayment in full for One Sky as the company exited the syndicated loan market in favor of utilizing an EEPC financing. Our fully realized IRR was approximately 10.8%. We also sold our position in United Road Services, which was one of our positions with the risk rating of 3. Our fully realized IRR was approximately 4.1%. Finally, we fully realized our position in Veteran Services or Lockwood. This was always intended to be a short-term hold, and we are very pleased with the outcome and with our IRR, which was approximately 24.4%. After quarter end, we had both investments and realizations in two portfolio companies. First, our loan to Gexpro was fully refinanced with a realized IRR of approximately 10.4%. We took part in the new club financing for the company, which includes a new first lien term loan, a delayed-draw term loan, and a revolver commitment. Our yield at cost on Gexpro’s funded revolver is approximately 7.5% and term loan is approximately 7.4%. We also had realizations and new investments in Fusion Connect. Mike will talk more about the restructuring later in the call. The exit term loan was fully refinanced at a call premium with a realized IRR of 13.4%. We rejoined book runners on the new first lien term loan, which has a yield at cost of approximately 9.6%. We also participated in the company’s new Series A preferred equity, which has a PIK coupon of 12.5% and a yield at cost of approximately 13.1%. Using the GICS standard as of December 31, our largest industry concentration was commercial services and supplies at 12.5%, followed by internet and direct marketing retail at 8.3%, energy equipment and services at 7.6%, professional services at 7%, and software at 6.4%. Our portfolio companies are in 23 GICS industries as of quarter-end, including our equity positions. As of December 31, we had 38 portfolio companies, an increase of two from September 30.

Thanks, Chris. For the quarter ended December 31, 2021, our net investment net income was $2.1 million or $0.15 per share. The fair value of our portfolio was $269.4 million compared to $245.3 million on September 30. Our portfolio’s net increase from operations this quarter was approximately $3.4 million. Our investment in new debt during the quarter had an average yield of 7.8% while realizations and repayments during the quarter had an average yield of 11.8% and fully realized investments had an average IRR of 12.8%. The weighted average yield of our debt portfolio was 8.16%, an increase of 4 basis points from September 30. As of December 31, our portfolio consisted of 38 portfolio companies, 95.3% of our investments were in first lien and the remaining 4.7% invested in equity, warrants, and other positions. 99.5% of our debt portfolio was invested in floating rate instruments and 0.5% in fixed rate investments. The average LIBOR floor of our debt investment was 1.1%. Our average portfolio company investment was approximately $7.1 million and our largest portfolio investment was Empire Office at $12.8 million. We had a gross leverage of 1.74 and net leverage of 1.39 as of December 31 compared to 1.63 gross and 1.47 respectively for the previous quarter. As of December 31, we had four investments on non-accrual, which included all three investments in PGi as well as Deluxe and one investment on partial accrual, Fusion take back loan. With respect to our liquidity, as of December 31, we had $36.1 million in cash, of which $19.8 million was restricted cash, with no unused capacity under our revolving credit facility. Additional information regarding the composition of our portfolio is included in our Form 10-Q, which was filed yesterday.

Thank you, Rocco. 1888 has been a difficult investment for us. After a significant period of negotiations, the term loan B has been fully equitized. This reduces debt at the company by approximately 60%, while leaving the lenders' and equity holders' interest aligned to cost holdings. We also played a major role in the balance sheet restructuring of Fusion Connect. Fusion exited bankruptcy two years ago, but with an unsustainable debt structure driven by the structural demand by certain other lenders. Through this restructuring, we hope the company reduce secured debt by approximately 80%. We were the joint lead arranger on the new first lien loan which refinanced Fusion's exit loan. We also were a back-stop party to the company’s new money Series A preferred equity providing additional income for our shareholders. The take back loan, which was the bulk of the company’s debt, was equitized into Series B equity and will convert to common shares upon the receipt of regulatory approvals, which we anticipate will occur later this year. We also received warrants with multiple strike prices, some of which are immediately in the money. As I stated last quarter, we think that 1888, PGi, and Fusion have limited ability to introduce negative volatility to our NAV at this point. Instead, we think the growing number of equity investments in the portfolio, while small in terms of fair value at this point, have the potential to appreciate over the coming years. Our gross leverage this quarter was 1.74 times, above our guidance of 1.25 to 1.5 times. That said, our net leverage of 1.39 times, which is within the number we manage to. This quarter, especially active investment cycle, included unexpected fluctuations in the timing of investments in repayments, including a need to hold cash for closing on deals after quarter-end. We expect to see our gross and net leverage generally converge with both around the high end of the target range. As we have previously committed, we waived the portion of our management fee associated with base management fees over one turn of leverage. We covered our December quarterly dividend with NII. Looking at our portfolio on a run rate basis, we expect to continue to cover the dividend in March and going forward. Our disciplined investment approach and appropriate capital resources leave us well positioned to continue to generate sufficient NII. Our Board of Directors declared a distribution for the quarter ended March 31, 2022, of $0.15 per share, payable on March 31 to shareholders of record as of March 11. We believe the dividend level is stable and sustainable and that it represents an attractive yield given the market price of ICMB stock. For the six months ended December 31, we invested in nine new portfolio companies and eight existing portfolio companies. The fourth quarter was our busiest to date and I am proud of what the team accomplished during what is traditionally a market low. We deployed capital without compromising our principles, focusing on club deals with strong structural protections, pricing, and covenants. We will continue to manage the portfolio with the goal of consistent income generation and preservation of shareholder capital. As we enter 2022, we have visibility into probable repayments as well as several promising deals in the pipeline, which will enable us to continue our portfolio rotation. We expect to continue our focus on optimizing the portfolio for yield diversity and stability. This concludes our prepared remarks. Operator, please open the line for Q&A.

Ladies and gentlemen, at this time, we will conduct a question-and-answer session. Our first question comes from Robert Dodd from Raymond James. Please state your question.

Hi, guys. Several questions. I mean first on the restructured assets. I mean Fusion Connect. I mean, just kind of, I mean the take-back term loan was marked down in the December quarter of this year, and then the restructuring occurred after that. I mean can you give us on that was the markdown because of some new weakness in the business or was it just a function of that's where the negotiations came out in terms of the restructuring framework?

Yeah. Hey, Rob. It's Chris. Much more of the latter, the business is stabilizing. The new management teams have been in there for a while. So there is no market change in the business.

Okay, that's a good point. Looking at the new pricing, I think you mentioned it's 9.6% on the new loan, which seems quite appealing for a business that has faced some challenges this year. Can you provide any insight into this? Considering there have been restructurings in the past couple of years, the pricing on the new loan appears favorable.

The group of lenders providing financing has also supported the preferred equity, and there were appealing warrants related to the pricing as well. While the rate may be slightly lower, the overall economics of the deal are favorable, so we find it quite compelling.

Got it. I appreciate that. One last question about leverage. Mike, I value your insights regarding the high leverage ratio of 1.39. There's a payable aspect, so not all that cash is available to reduce the net leverage. It's above the upper limit of the range, so what timeframe should we anticipate to reach that upper limit? Additionally, regarding the target range of 1.25 to 1.50, what market conditions would lead you to favor the lower end over the higher end? What factors should we consider that would influence your positioning within that range?

So Robert, I'm glad you asked that because there has been some activity post quarter end. So if I look at it and close a business today for identified repayments that we've been told we're getting repaid. And I don’t know if that’s over two weeks or six weeks and some monetizations that we've done. If I pro forma that and I look at the net cash for payables. We are either slightly above or I think we're slightly below 1.5. I think it's like 1.49, okay. So we're at that level today. How long will it take us to get there? We're going to get there today, the 1.5 net of everything.

I'm doing so yeah. Okay. Yes. Go ahead, sorry.

So the key thing is, we want to operate in this call it, 1.40 to 1.50, and we're going to blip up and when we see things coming in order to fund in advance of the repayments. That's kind of what we were doing at December quarter end because we had some visibility getting down at 1.25 as kind of a, I'll call it a target rate would be we'd be operating in a 1.10 to 1.30 range because of repayments that come in, in advance of being at that 1.50. So I don't see that in the near term, I see us trying to stay in this 1.25 to 1.50 range.

Got it. On one housekeeping one if I can. The interest expense looked a little higher than I was expecting. Obviously, there were two revolvers, functional during the quarter. One of them is the UBS one has gone down. But were there any one-time expenses related to the exit of the UBS facility, which obviously is done and dealt with that?

Yeah. Hi, Robert. It's Rocco. So because we had the two facilities because we had the UBS facility through mid-November, we incurred this $485,000 in interest, of which $150,000 of it was a breakage fee.

Got it. Thank you. Yeah. Appreciate it. Thanks.

No worries.

Our next question comes from Christopher Nolan from Ladenburg. Please state your question.

Hi. Rocco, you said 150,000 breakage fees, so that's the non-recurring for the quarter?

Correct.

Okay. And then, are you guys assuming any sort of action by the Federal Reserve to increase interest rates, and if so, how many rate hikes are you expecting?

We're expecting rate hikes. We internally are not viewing on ops, but we debate that first hike can be 25 to 50. And as you know, we've got, I'll call it, round figures 30% odd fixed rate in our liabilities. Our LIBOR floors average at about 1.10. But they're not all here. We've got some at 0.75, so that will our assumption is that at least six to nine months before we get the benefit of rising LIBOR. So we've got fixed on part of the debt, we will have a little bit of increase, but on the asset side, we're seeing, I’d say stability to a little bit of lift on the LIBOR plus 5.5 to 6 where everything was, and we're seeing a little bit of lift to that not a lot on the spread right now.

Great. A follow-up question, American Telecom conferencing. There are a lot of moving pieces in the quarter. Did you guys mention it on your prepared remarks, or if you just did, I missed it.

Yeah. Hey, Chris. It's Chris. The mark basically stayed fairly static. The company is making progress on operating the business and maximizing value for the lenders and stakeholders. Don't anticipate much upward movement at this point. They're just operating the business and trying to maximize profits or restore back to profits, actually.

And Chris, would you characterize this as a likely restructuring candidate in coming quarters?

More of a sale in the next 12 months to 24 months.

Sure.

Thank you, Chris.

Thank you.

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

Hey. Good afternoon, guys. Thanks for taking my questions. Going back to one of Dodd's questions just on the leverage. It sounds like you guys have a decent amount of insight into the quarter in terms of where repayments are coming in, in that sort of thing, but just kind of taking into account where you guys stand today on a gross basis and then that combined with your unfunded commitments, I believe there are around 14 million, correct me if I'm wrong there. I mean how do you guys coming off of a really active quarter that you had, how do you balance out, I guess your investment activity for the quarter in terms of your ideal position holding sizes? Did the level of unfunded commitments do you have today, does that in any way kind of construct, what you would like to hold on the balance sheet or I guess any insight into how you're kind of balancing that out in today's market?

Yes, Paul. It's Chris again. We are aware of the unfunded commitments and we manage them very carefully, making it a primary focus in our portfolio strategy. We typically maintain a small number of liquid assets that we can adjust as needed. We operate around our target levels, although it's never a guarantee, and that approach was reflected in our performance this past quarter. Ultimately, the unfunded commitments do not significantly restrict our management of the portfolio.

Got it. And how much insight do you have on those unfunded commitments per se, of how much do you think are readily available to be drawn by your portfolio companies versus that are subject to milestones and maybe unlikely to be drawn upon?

I'd say more than half but we mentally always assume they all can be drawn.

Sure. Okay. And then my last question, just a quick one, do you guys have any insight into in terms of when you might be earning an incentive fee again?

So if I model out assuming kind of what we're going through now. We're looking at probably September of 23-ish I would guess.

For modeling purposes, we are currently operating at a portfolio run rate with approximately 1.45 to 1.5 times leverage. We anticipate that the unlevered rate will remain around its current level and do not expect any significant increase in our realized or unrealized gains. These factors would contribute to our earnings in the September quarter, which we would not recognize until that time.

Okay. Got it. Yeah. I understand. All right, that's all from me. Thanks for taking my question.

Thank you very much.

At this time, we have no further questions.

Thank you very much everyone. Moving forward to talking to you next quarter.

This concludes today's conference call. Thank you for attending. Have a great day.