Investcorp Credit Management BDC, Inc. Q1 FY2024 Earnings Call

Welcome to the Investcorp Credit Management BDC, Inc. Schedules Earnings Release for First Quarter Ended September 30, 2023. Your speakers for today's call are Mike Mauer, Suhail Shaikh, and Rocco DelGuercio. A question-and-answer session will follow the presentation. I would now like to turn our call over to your speakers. Please begin.

Thank you, operator, and thank you for joining us on our first quarter call today. I'm joined by Suhail Shaikh, my co-CIO and President of Investcorp Credit Management BDC; 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 would like to turn the call back over to our Chairman and CEO, Mike Mauer.

Thanks, Rocco. The September quarter marks the first quarter of our fiscal year. We saw primary deal activity in the middle market increase, characterized by acquisition financing and, to a lesser extent, leveraged buyouts and refinancings, as well as dividend recapitalizations. Since our last call, we saw our pipeline increase at a healthy rate, albeit at a slower pace compared to historical norms. We remain optimistic that deal activity in the primary market will continue to pick up over the next few quarters and that we will continue to see compelling investment opportunities. Our investment activity during the quarter was characterized by opportunistic investments in the secondary market. Importantly, we invested in four new companies and added to our position in one existing portfolio company. These investments were all in borrowers we are familiar with, have previously invested in, or have exposure in our other managed funds across the platform. The weighted average yield of our debt investments made during the quarter was 12.3%, a 20 basis point decrease in the weighted average yield of investments that were made during the quarter ended June 30. Additionally, we continue to remain highly selective when it comes to new investments. We are specifically focused on lending into companies that are sponsor-backed, have financial covenants, high free cash flow, and are recession-resilient businesses. As we look at our borrowers operating performance, the credit quality of our performing portfolio continues to remain stable. Our weighted average interest coverage ratio for our performing debt investments is approximately 2x, and our loan-to-value ratio is approximately 41%. Looking ahead toward the rest of the fiscal year, our focus is on portfolio management and risk mitigation. We are focused on our nonperforming investments and reducing this amount. We continue to work towards diversifying our investments in new borrowers to reduce our position sizes to an average of 2% to 3% of our total portfolio and to work with our current borrowers that have covenant or liquidity issues in this high-interest rate environment. We increased our number of borrowers to 40 from 36 as of June 30 and the number of GICS industries across our portfolios to 24 from 21 when compared to the previous quarter ended June 30. During the quarter and post-quarter end, we had two repayments. As mentioned on our last call, we are also expecting several repayments over the next few quarters. Our dividend coverage is an important consideration when making new investments. Suhail will now walk through our investment activity during the September quarter and after quarter end. Rocco will go through our financial results. I'll finish with commentary on our nonaccrual investments, our leverage, the dividend, and our outlook. As always, we'll end with Q&A. With that, I'll turn it over to Suhail.

Thank you, Mike. As Mike mentioned, the quarter's activity was a continuation of executing on opportunistic investments in the secondary market and selectively looking at new buyout financing. Sponsored middle market direct lending new morning volume in the quarter was approximately 36% lower year-over-year. However, we saw primary deal flow pick up during the quarter and have continued to see an increase post-quarter end. Our pipeline remains robust, and we believe that we can continue executing on our investment thesis that Mike mentioned. During the quarter ended September 30, we invested in four new portfolio companies and one existing portfolio company. We also fully realized our position in one portfolio company. During the quarter, fundings for commitments on new investments totaled approximately $15.5 million at cost, with a weighted average yield of approximately 12.3%. In the same period, repayments totaled approximately $6.8 million from one investment that I mentioned, with an investment IRR of approximately 16.4%. Let me now take you through our investment activity. First, we invested in the first lien term loan of Axiom Global. Axiom is a leading provider of expert legal talent offering legal counseling and representation services. Axiom is a portfolio company of Permira, a sponsor we know well. We have been an investor in Axiom for a few years in our other portfolios, and we were able to purchase it at an attractive price, with a yield at cost of approximately 13.9%. We also invested in the first lien term loan of Congress. Congress is a portfolio company of partners and provides mission-critical engineering, construction, and maintenance services to a diverse customer base in the broadband and other adjacent industries. Our yield at cost is approximately 12.2%. This was also a secondary purchase for the portfolio. Congress has been a portfolio company of ours and other funds for several quarters. We also made a secondary investment in Multicolor, also known as LABL or label. A CD&R portfolio company, label is a global leader in the prime label manufacturing industry. Our yield at cost is approximately 10.9%. As with Axiom and Congress, Multicolor or label was also a secondary purchase of a name that we own in other vehicles that we manage. Finally, we also invested in FleetPride, an American Securities Capital Partners backed company. FleetPride is a national distributor of aftermarket parts for the U.S. heavy-duty truck industry. Our yield at cost is approximately 10.4%. This is a name we have been tracking for a while. Furthermore, given Investcorp's private equity arm used to own the business several years ago, we were able to leverage their expertise to diligence our investment. Our last investment was the addition of our existing position to AMCP Clean Acquisition Company, also known as PureStar. This is a good example of an opportunistic secondary purchase of a credit that we already own and were able to source some paper for an attractive price. PureStar is a portfolio company of Cornell Capital. It is one of the largest commercial laundry providers to the hospitality industry in the U.S. We invested in the first lien term loan, with a yield at cost of approximately 15.2%. During the quarter, we fully realized our position in infusion's term loan, which was refinanced. We remain investors in infusion's preferred and common equity. Our fully realized IRR was approximately 16.4%, as I mentioned earlier. After quarter end, we invested in three new portfolio companies and fully realized our position in two portfolio companies. First, we supported the LBO of Alphia by PAI Partners. Alphia is a contract manufacturer of premium drive pet food ingredients. We invested in the first lien term loan, with a yield at cost of approximately 10.7%. We have been investors in Alphia through our other funds and were able to re-underwrite the risk for the new LBO. Second, we invested in the first lien term loan of Victra, also known as LSF9 Atlantis Holdings, LLC. Victra is the largest exclusive independent retailer for Verizon Wireless. We purchased Victra in the secondary market at an attractive price. A yield at cost was approximately 13.7%. Our team has had a longstanding history with this name. We also made a proprietary preferred equity investment in Discovery Behavioral Health, a Western Equity Board Partners portfolio company. Discovery is one of the largest providers of residential and outpatient treatment for behavioral health services across eating disorders, mental health, and substance abuse. A yield at cost is approximately 20.4%. We fully realized our position in the first lien term loan of Advanced Solutions International, also known as ASI. We originally invested in the first lien term loan and preferred equity in September 2020 of ASI. We remain investors in the preferred equity. Our fully realized IRR on the term loan was approximately 10.8%. We also fully realized the position in the first lien term loan of Cook & Boardman, which was retailed as part of an LBO by Platinum Equity. Our fully realized IRR was approximately 8.5%. As Mike mentioned, I'd also like to note that the GICS standard was updated in May of this year. As such, our industry categorization for existing portfolio companies has changed in some cases and our industry ratings have also changed. As of September 30, our largest industry concentrations are trading companies and distributors at 17.1%, professional services at 11.5%, followed by IT services at 7.5%, software at 6.15%, and containers & packaging at 6.1%. Our portfolio companies are in 24 GICS industries as of quarter end, including our equity and warrant positions, which is an increase of three industries from the previous quarter. I'd now like to turn the call over to Rocco to discuss our financial results.

Thanks, Suhail. For the quarter ended September 30, 2023, our net investment income was $1.6 million or $0.11 per share. The fair value of our portfolio was $223.4 million compared to $220.1 million on June 30. Our net assets were $83.8 million, a decrease of $3.9 million from the prior quarter. Our portfolio's decrease from operations this quarter was approximately $1.7 million. Our debt investments made during the quarter had an average yield of 12.3%. The realizations and repayments during the quarter had an average yield of 14.6% and an average IRR of 16.4%. The weighted average yield of our debt portfolio was 11%, a decrease of 150 basis points from June 30. As of September 30, our portfolio consisted of 40 portfolio companies, 89.7% of our investments were first lien, and the remaining 10.3% is invested in equity warrants and other positions. 99.7% of our debt portfolio was invested in floating-rate instruments and 0.3% in fixed-rate investments. The average floor on our debt investments was 1.1%. Our average portfolio company investment was approximately $5.6 million, and the largest portfolio company investment was in Bioplan at $13.6 million. We had a gross leverage ratio of 1.58 and a net leverage of 1.41 as of September 30, compared to 1.54 and 1.44, respectively, for the previous quarter. As of September 30, our nonaccrual investments as a percentage of fair value were 10.6% compared to 4.1% for the quarter ended June 30. With respect to our liquidity, as of September 30, we had approximately $14.3 million in cash, of which $14.2 million was restricted cash, with $28.8 million of capacity under our revolving credit facility with Capital One. Additional information regarding the composition of our portfolio is included in our Form 10-Q, which was filed yesterday. With that, I'd like to turn our call back over to Mike.

Thank you, Rocco. As mentioned earlier, we continue to remain focused on portfolio management and risk mitigation, especially for our borrowers that are experiencing periods of strength. We added three borrowers on nonaccrual, including two investments in ArborWorks, CareerBuilder, and Klein Hersh's last out term loan. Since quarter end, there has been continued development in our borrowers. While we are bound by confidentiality, the company's operating environment remains challenged, and we continue to have an active dialogue with all parties. While CareerBuilder continues to pay its interest, the company's fundamental performance has been weak for some time. We put the loan on nonaccrual as we believe there is significant doubt of full recovery of principal. We continue to make progress rotating the portfolio and expect progress on the remaining nonaccruals over the next 12 months. Our NAV per share declined 4.46% from the previous quarter end. Our gross leverage this quarter was 1.58x, above our guidance of 1.25x to 1.5x. Our net leverage was 1.41x, which is within the target range, and as mentioned last quarter, we expect to see our gross and net converge. As of November 6, our gross and net leverage were 1.68x and 1.51x. As we have previously stated, the adviser will waive the portion of our management fee associated with base management fees over 1x leverage. The company is expected to earn its dividend through the next quarter ended December 31. Our Board of Directors declared a dividend for the quarter ended December 31, 2023, of $0.12 per share, as well as the supplemental distribution of $0.03 per share, both payable on January 8, 2024, to stockholders of record as of December 14, 2023. It is worth noting that the $0.03 supplemental distribution is related to fiscal year 2023 spillback. As we look to the rest of our fiscal year, we will continue to work on rotating and diversifying the portfolio, all while focusing on mitigating risk in our borrowers experiencing short-term periods of stress or volatility. Our investment strategy has not wavered, and we continue to remain focused on capital preservation and maintaining a stable dividend. We are optimistic about our pipeline and our ability to deploy capital in high-quality investments. That 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 Mr. Paul Johnson with KBW.

Just a couple for me. But in terms of investments that you made during the quarter, it sounds like there's a decent amount of secondary activity. I mean, can you just kind of speak to what you guys are seeing in the secondary market versus what you can receive, obviously, in the primary market? And if that's more of kind of a one-time 3Q type of thing or a secondary type of purchases, something you probably expect to remain more active with in the future quarters?

Well, thank you for the question. This is Suhail. Let me take it a couple of different ways. So, I think the investments that we made are investments that we own in other portfolios to be managed. So while there are secondary opportunities, these are investments that we have, and we were able to find attractive opportunities to pick up additional paper that ICMB benefited from. So, we are always looking for things in the marketplace to add to our positions or, frankly, in some cases, even sell as we think there’s an opportunity to not position at a healthy rate of return. So that's part one of the question. Part two is, as we've mentioned, subsequent to the quarter end, we had a couple of investments that we made that are brand new investments that are not secondary investments, and those are Alphia that I mentioned and Discovery Behavioral Health. Both of those are new investments. Now, Alphia was one that we had in our portfolio. It's getting refinanced, and we underwrote that risk as part of a new buyout. Discovery was a brand new investment. So, I think our pipeline is actually reasonably healthy, but we're being super selective about what to go after, how to tackle, and frankly, credits that we know; right now, we'd rather own more of those than go into things where we don't like the structure or the pricing of. Hopefully, that answers your question.

Yes. That's very helpful. My next question is just kind of on NII this quarter, $0.11. I know Mike said that you expect to cover the dividend next quarter, the core dividend. I guess what do you foresee next year? I mean, do you look at this quarter as sort of a depressed level of NII, where you'd expect that to obviously kind of trend back up to the core dividend level or possibly higher? What sort of, I guess, levers do you have to kind of move NII up from this quarter just being at this low level?

Yes, Paul, it's Mike. Thank you for your question. This is an area I know you are focused on, and we are as well. There are a couple of key aspects we are concentrating on. The main issue is that our nonaccrual levels are high, and we need to reduce them. We can achieve this in two ways. One way is to work with the group to convert that back to an accrual status in some manner. I cannot provide further details on that due to the current discussions. This is one area we are collaborating on with the Company and the sponsor. The other option, as Suhail mentioned earlier, is to sell those assets and reinvest in what we believe are better opportunities; that's another option. Additionally, we have equity that we have either purchased or co-invested in, and some that we have restructured. This involves working with other lenders, the Company, etc., to convert those. These are the main strategies we're focusing on, and we are committed to rotating the portfolio. We have made significant progress in that area, but there is still more work to be done.

Last question for me. Unless anything's changed, I believe Investcorp is still around a 10% owner of the stock based on the position that they bought several years ago. If I'm just looking back, I mean, NAV has down fairly materially since that time, around 43%. I believe that NAV declined since that quarter that Investcorp came in to the adviser. I mean, I guess what is, I guess, Investcorp's level of engagement here? How active are they with the business today versus when they came in? Just curious, kind of trying to get our thoughts around what they think of performance and what sort of the plan is going forward here.

So, there are two or three pieces to that answer, and I think a critical one, which Rocco will go back in and double checked, but I'm pretty sure Bloomberg has it right. And I could be off by 30 days, but somewhere around June 1, give or take 30 days, Investcorp increased its own tip to 24.9% of stock. So, that was a statement 1.5 years plus, give or take; it was commitment to the public BDC to put more money in. The second thing is how are they focused on it? I will tell you that the CEO has a formal meeting scheduled every 30 days with Suhail and me to talk about what we are doing, how we are thinking about it. We are focused on it. It is a critical investment to think about how we grow the platform, and we need to make sure that the public BDC is part of that strategy and that we are doing the right thing by shareholders. So, it's got attention. It has received additional capital from the initial September 2019 investment. And trust me, we've got ongoing dialogue with our CEO beyond the formal meeting.

Thanks for that. Thanks for the direction on the ownership level. That's all for me. Thanks for taking my questions.

Our next question comes from Mr. Robert Dodd with Raymond James.

Just touching on the nonaccrual question again, Mike. I mean, I think in your prepared remarks, you made a reference to progress over the next 12 months. I mean, is that the kind of timeframe we're looking at to resolve, to get the nonaccrual level down to something that might be well in line with the industry? Or can you give us an idea of the kind of timeframe you're talking about?

Yes, Robert, I would love to say that I have a crystal ball that says this is the quarter where it will be down below the industry average. I will tell you that we have active dialogue on almost everyone. I don't want to say everyone because even if you look at it, some of those really are not active restructurings; they are more in liquidation, and some of those are small. But the major ones we are very focused on. We'd like to see those resolved in six months. I said 12 months. We don't know because we're not the sole lender, and we deal with the group, and we have to manage a lot of constituents in that process, but I hope that it's much sooner than the 12 months.

Got it. Just that on the dividend, the $0.03 supplemental to your point, I think you also said that was to do with essentially last year's spillover. So presumptively, that $0.03, the supplemental program will not be continuing. I just want to be clear there with investor expectations. It's just going to be the base dividend going forward.

Hi, Robert, it's Rocco. Yes, correct. Correct.

Got it. I asked Rocco about this last quarter. We are now less than 12 months to the reinvestment period expiring with Cap One on the revolver. Can you give us an update on that front?

Yes, as you mentioned, we discussed this in our previous call. Since this is the first quarter following the annual call, we have a shorter timeframe than usual between calls. We are engaged in a normal dialogue with Capital One regarding our revolver. There is no acceleration on our part, and nothing is holding us back. We do not foresee any issues with Capital One as our revolver provider.

And our last question comes from Christopher Nolan with Ladenburg Thalmann.

Any guidance you can give in terms of where you think leverage is going to be, particularly in light of the increase in nonaccruals? And should we expect an excise tax in 2024, given the lack of a supplement?

Rocco, do you want to take the excise tax?

Yes, we will have an excise tax. A few years ago, many of you may remember that several BDCs opted to keep the excise distribution and pay the tax on it since it is a cost-effective way to finance. This excise tax will be similar to what we've seen in our financial statements in the past.

And Chris, on the leverage side, there are two pieces: there is the ratio and there's a nominal. So leverage, we would expect to decrease our nominal amount because we have brought our NAV down. We continue to focus around the 1.25 to 1.5 range, which means that absolute borrowings will decrease from a target perspective to be in that range.

Thank you very much. And after that, we have no questions in the queue.

Thank you everyone. We look forward to the next call in about 90 days. Thank you.

Thank you, everyone.

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