Earnings Call Transcript - ICMB Q3 2022

Operator, Operator

Welcome to the Investcorp Credit Management BDC earnings release for the third quarter that ended on March 31, 2022. Your speakers for today's call are Mike Mauer, Chris Jansen, and Rocco DelGuercio. I will now turn the call over to our speakers. You may begin.

Michael Mauer, Co-Chief Investment Officer

Thank you, operator, and thank you for joining us on our third 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?

Rocco DelGuercio, CFO

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.

Michael Mauer, Co-Chief Investment Officer

Thank you, Rocco. I'd like to start by updating Investcorp's ownership stake in ICMB. On Thursday, May 5, Investcorp entered into a stock purchase agreement to purchase 2,165,000 shares at the March 31 NAV from Cyrus. Cyrus was an original seed capital investor in the predecessor private fund and the anchor investor in ICMB. Cyrus has been invested in ICMB for over 10 years between the predecessor fund and the existing BDC. This position has created significant overhang in the stock as Cyrus was an unnatural long-term holder with an excess of a 20% position. Investcorp's intention in buying the stock was multifold. This demonstrates continued commitment to ICMB and conviction in the underlying value of the investments at NAV. It also reduces the overhang in the stock and allows all shareholders to see this commitment and benefit from the reduced overhang. This past quarter, we saw the broader markets face significant volatility and a slowdown in the number of transactions in the loan market, driven by geopolitical events. The majority of transactions we saw were either LBOs or refinancings. We have typically found that in a highly competitive market environment, our best opportunities come from companies we already lend to as these deals tend to have better structures. As we continue to see strong competition for deals, we see pressure coming from both tighter pricing and higher closing multiples. However, we remain focused on credit quality and are selective about the structures we are willing to lend into and thorough in our due diligence process. This quarter, we were successful in deploying our capital at an average yield of 8.25%. We made 2 new investments and invested in 3 of our existing portfolio companies, none of which were covenant light in a sponsor-friendly market environment. We also continue to execute under the plan to co-invest in equity positions with Investcorp's North America Private Equity Group with more momentum in the pipeline under that plan. We continue to focus on the portfolio rotation that we began earlier this year while maintaining our credit discipline. This past quarter, we opportunistically sold out of positions in the portfolio in favor of new opportunities with higher yield and better loan structures. Our investment activity during the quarter continues to be balanced between club loans and middle-market lightly syndicated loans. We have also further reduced our exposure to energy equipment and services, which represents 5.4% of the portfolio compared to a year ago at 10.1%. Additionally, we continue to make progress with legacy credit issues in the portfolio. We completed the restructuring of Fusion Connect in January. I'll speak more about that later in the call. Chris will now walk you through our investment activity during the March quarter and after quarter end. After his discussion, Rocco will go through our financial results. I'll finish with commentary on the restructuring of Fusion Connect and our non-accrual investments, our leverage, the dividend, and our outlook for the rest of 2022. As always, we'll end with Q&A. With that, I'll turn it over to Chris.

Christopher Jansen, Co-Chief Investment Officer

Thanks, Mike. We invested in 2 new portfolio companies this quarter as well as 3 existing portfolio companies. We fully realized our positions in 5 portfolio companies and also refinanced our position in Gexpro and fully realized our position in the Fusion exit loan. We invested in the first lien loan of AHF Products, which supported the LBO by Paceline Equity Partners. AHF Products is a leading producer of hard surface and solid wood flooring in North America. Our yield to cost is approximately 7.4%. We made our second equity co-investment alongside Investcorp's North American Private Equity Group. S&S Truck Parts LLC, listed in our scheduled investments as Pegasus Aggregator, is one of the largest suppliers of new aftermarket parts for medium- and heavy-duty vehicles. In terms of investments in current portfolio companies, our existing loans at Gexpro was refinanced in January as part of a larger transaction which backed several acquisitions. Our yield at cost on Gexpro's funded revolver is approximately 7.5%, and the term loan and delayed draws approximately 7.4%. We also made an additional investment in the equity of Techniplas to support an asset purchase of a molded product facility sold by Lyle Industries. As part of Fusion's restructuring process, we were a joint lead arranger 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%. Mike will provide additional detail about Fusion's restructuring later in the call. Turning now to our realizations. Our loans at Gexpro was repaid in full as the company refinanced in January. Our fully realized IRR was approximately 10.4%. Our second realization was ProFrac Services. ProFrac completed the acquisition of FTS International in March, and we were refinanced out of our position. Our fully realized IRR was approximately 9.9%. We also received repayment in full for Fusion's exit loan as the position was refinanced through the broader restructuring of the company. Our fully realized IRR was approximately 14.1%. We exited several investments opportunistically this quarter in order to reduce our leverage and rotate into higher-yielding credits. We fully realized our position in Veregy with an IRR of approximately 9.7%, QualTech with an IRR of approximately 8.7%, Flow Control with an IRR of approximately 8.1%, and Galaxy with an IRR of approximately 7.2%. After quarter end, we invested in one new portfolio company, one existing portfolio company, and had 2 realizations in existing portfolio companies. First, the new Gexpro loans made in the first quarter were repaid in April as the company merged with Lawson Products. Our fully realized IRR on the term loan was approximately 19.7%. Although we are pleased with the return on the revolver and the delayed draw, the IRRs are not meaningful given the short holding period. We invested in the club financing for American Nuts, which supported the refinancing of the company and the acquisition of DSD Merchandisers. American Nuts provides procurement, processing, and packaging services of nuts, seeds, and dry fruits. The acquisition of DSD Merchandisers creates a fully vertically integrated business. Our yield at cost is approximately 9.9%. Lastly, we fully realized our position in Klein Hersh, as the company simultaneously refinanced its loans and converted to an ESOP. Our fully realized IRR was approximately 11.8%. We also invested in a new transaction. Our yield to cost is approximately 9.2%. Using the GICS standard as of March 31, our largest industry concentration was trading companies and distributors at 9.5%, followed by IT services at 9.2%, Internet and direct marketing retail at 9.0%, professional services at 7.8%, and household durables at 7.1%. Our portfolio of companies is in 20 GICS industries as of quarter end, including our equity and warrant positions. As of March 31, we had 35 portfolio companies, a decrease of 3 from December 31. I'd now like to turn the call over to Rocco to discuss our financial results.

Rocco DelGuercio, CFO

Thanks, Chris. For the quarter ended March 31, 2022, our net investment income was $1.8 million or $0.12 per share. The fair value of our portfolio was $242 million compared to $269.4 million on December 31. Our portfolio's net decrease from operations this quarter was approximately $63,000. Our investments in debt purchased during the quarter had an average yield of 8.25% while realizations and repayments during the quarter had an average yield of 8.59%. Fully realized investments had an average IRR of 9.56%. The weighted average yield of our debt portfolio was 8.14%, a decrease of 2 basis points from December 31. As of March 31, our portfolio consisted of 35 portfolio companies. 91.8% of our investments were first lien, the remaining 8.2% is invested in equity warrants and other positions. 91.3% of our portfolio was invested in floating rate instruments and 0.5% in fixed rate investments. The average yield on our debt investment was 1.04%. Our average portfolio company investment was approximately $6.9 million, and our largest portfolio company is Fusion at $13.4 million. We had a gross leverage of 1.71x and net leverage of 1.63x as of March 31 compared to 1.74 gross and 1.39 net respectively, for the previous quarter. Our net leverage adjusted for open sales and open purchases was 1.41x as of March 31 compared to 1.61x for the previous quarter. As of March 31, we had 6 investments on non-accrual, which included all 3 investments in PGI as well as the other 2 investments in 1888. With respect to our liquidity, as of March 31, we had $7.6 million in cash, of which $4.7 million was restricted cash, and $7.3 million of 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.

Michael Mauer, Co-Chief Investment Officer

Thank you, Rocco. We are proud of the progress that we have made repositioning the portfolio, and we continue to remain selective in our new investments. We continue to focus on adding club deals that were originated through the team's relationships as well as add-on investments and refinancings of existing portfolio companies. We remain focused on the credit quality of our deals, including the comprehensive evaluation of loan credit and documentation and downside protection. Fusion completed its restructuring in January. We were joint lead arrangers on the new first lien loan. We refinanced Fusion's exit loan. We are also a backstop party to the company's new money Series A preferred equity. By virtue of our backstop commitment as well as our investment in the Series A preferred equity, we received warrants with a fair value of $636,000. The take-back loan, which was the bulk of the company's debt, was equitized into Series B equity and we will convert to common shares upon the receipt of regulatory approvals, which we anticipate will occur later this year. We also received out-of-the-money warrants. The restructuring significantly deleveraged Fusion's balance sheet and positions the company to execute on its growth initiatives. Our gross leverage this quarter was 1.71x, above our guidance of 1.25 to 1.5x and 3 basis points lower than last quarter. Our net leverage was 1.63x. Due to the timing of investments and repayments, our leverage remained above the target range. As mentioned last quarter, we expect to see our gross and net leverage generally converge with both around the high end of our target range. As of May 2, our gross leverage was 1.48 and our net leverage was 1.45x at the high end of our target range. As we have previously stated, the adviser will waive the portion of our management fee associated with base management fees over 1 turn of leverage. We did not cover our March quarterly dividend with NII. Through the fiscal year-end to date, the company has earned its dividend and is expected to earn its dividend through the fiscal year ending June 30, 2022. Our Board of Directors declared a distribution for the quarter ended March 31, 2022, of $0.15 per share, payable on July 8 to shareholders of record as of June 17. We believe the dividend level is stable and sustainable and that it represents an attractive yield given the market price of ICMB stock. As mentioned earlier, we continue to remain selective on our new investments and our portfolio repositioning strategy. We are focused on improving industry concentration and diversification and managing our average position size, all of which help manage risk. Our investment strategy has not wavered. We are focused on investing in primarily first lien loans, preserving capital and maintaining a stable dividend while creating upside to the NAV through our existing and new equity investments. As we enter the last quarter of our fiscal year, we expect to continue executing on our strategy and expand the diversity and stability of our portfolio. That concludes our prepared remarks. Operator, please open the line for Q&A.

Operator, Operator

Our first question comes from Paul Johnson with KBW.

Paul Johnson, Analyst

First question is just kind of about the market and the investment pipeline that you're looking to build. I guess, with just kind of the advent of the unitranche and the growth of that product and direct lenders and what they have to offer to the market, is that pushed out in any way, I guess, kind of the more traditional club deals and affected any sort of the syndicated deals that you guys participate in?

Michael Mauer, Co-Chief Investment Officer

Thanks, Paul. It's Mike. Before I answer your question, Rocco just reminded me that I misspoke earlier in the call, the distribution that the Board of Directors declared is for the June 30 quarter ended, not March 31, I just wanted to correct that. And coming back to your question, we are seeing actually a reasonable pipeline of deals to look at. The emergence of the unitranche that you're talking about, and I'll use some names generically, but Blackstone, KKR, Apollo, these large, multibillion-dollar direct lending vehicles, they tend to focus on a lot larger deals than we focus on. The deals we're focused on are typically on the low side, $40 million to $60 million tranche up to a couple of hundred million. My experience in running into and talking to a lot of former colleagues at some of those places is that probably around the upper end of that range I just gave is where they get interested. So deals that are $100 million, $150 million, it's almost hard for them to do them when you look at their allocation policy across all the vehicles. And so they are very focused on the middle market that is probably $50 million to $200 million of EBITDA. And so those tranches, by definition, are $200 million to $500 million. It really is not affecting us at this point. And we are still seeing many club deals and less of the lightly syndicated from the regional banks, but very good flow from partners in the club arena.

Paul Johnson, Analyst

I understand, thank you for that. I have another question regarding the debt marks for the portfolio. This quarter, the BDC experienced a write-down of about $1.9 million. Is this due to more mark-to-market spread widening, or does it reflect any specific credit deterioration that we should be aware of?

Christopher Jansen, Co-Chief Investment Officer

It's Chris Jansen. The changes are primarily due to some spread widening from the end of last year to the start of this year, but we are seeing spreads start to tighten again. The performance figures from the fourth quarter and the early part of this year have been unexpectedly strong. We haven't encountered any significant resistance or downward trends operationally. It's mainly been a matter of spread widening, and in the case of Techniplas, our significant equity holding, the market comparisons have dropped by nearly two full turns. This isn't connected to the operational performance of Techniplas or anything else in our portfolio.

Paul Johnson, Analyst

I appreciate that. I also have a question about the dividend level. I know you mentioned in your prepared remarks that the Board and the company believe it is sustainable at its current level. Given the gap between net interest income this quarter and the dividend, could you discuss the actions you can take to bring net interest income back within that dividend range? Additionally, any insights on factors that could help improve that situation would be great. Is it related to interest rates, refinancing, or something else?

Michael Mauer, Co-Chief Investment Officer

Sure, Paul. I'm glad you asked that because I want to provide a bit more context. We came in at $0.12, while the dividend is $0.15. The $0.03 gap includes $0.02 related to a one-time excise tax this quarter. Without this tax, we would have reached $0.14. Regarding leverage, although it appears to be increasing this quarter, we had several sales that hadn't settled. If our receivables had been cash, we would have been below our target range or able to pay down the Capital One facility with the available cash. Maintaining our portfolio at its current level helps us aim for that $0.15 dividend. The rising interest rate environment will be beneficial overall. As you know, we have shifted from 60% first lien to 90% first lien over the last four to six years. Given the current inflation and outlook, we expect to maintain our exposure in the range of 80% to 90% first lien since we are facing increased risk due to inflation affecting companies.

Paul Johnson, Analyst

Got it. Appreciate that. And my last question, if I can, is just on the large holders selling out or partially selling out this quarter Cyrus Partners. I'm just curious if you have any details as far as was that a partner that was contributing, I guess, assets in any way? Or was there any sort of relationship there prior to the sale of their position? And I also ask if you are in dialogue with them in any way or any of your other large shareholders on potentially further exits of those large insiders?

Michael Mauer, Co-Chief Investment Officer

So let me start with the last part. I'm not aware of any near-term exit by any existing shareholder today, Cyrus or anyone else. I can't speak for what their plans are from a liquidity, from an appreciation, etc. But I'm not aware of any. I do talk to our shareholders. Cyrus has been a great partner for a very long time, dating back to the predecessor fund, it's well over 10 years that Cyrus was involved in this from seeding the original private fund, and there has been a view for a while that they wanted to get some liquidity. So this was creating overhang and it was an opportunity for us to show conviction around the NAV value and to relieve some of that overhang.

Operator, Operator

And our next question comes from Robert Dodd from Raymond James.

Robert Dodd, Analyst

Following up on Paul's question, if the goal was to reassure investors about the NAV, wouldn't it have been more effective for the manager to offer to buy back $15 million worth of stock for all investors instead of targeting just one? If the belief in NAV is strong, it would make more sense to provide everyone the chance to sell to the manager rather than create a financial advantage for a single investor.

Michael Mauer, Co-Chief Investment Officer

Yes, Robert, thank you for the follow-up. If that were the only objective, I would agree, but having a 25% shareholder who'd been in for 10 years had another objective alongside in parallel, and we are trying to solve for several items at the same time. So that was the road we chose.

Robert Dodd, Analyst

Okay. Understood. In your prepared remarks, Mike, you mentioned progress on some of the non-accruals. Although the names are unchanged, could you provide more details on the progress made? As you've mentioned in previous quarters, it's a long-term, multiyear process, but can you give us an update on that?

Michael Mauer, Co-Chief Investment Officer

Yes. And listen, there's a lot of names we've rotated out of. It's a great point that on our next call we should just highlight over the last 12 to 18 months, how we have actually rotated and give you some granularity around that. But a couple of names that we have spent time around I'll let Chris talk. And these are all still a work in progress, but there's lots of momentum on bringing in advisers, bringing in management, and shifting strategies. Techniplas, we equitized the debt. We went into the equity with a third party coming into the situation, putting fresh cash in. There have been small tag-on acquisitions made. There's been facility shutdowns, and there's a new CEO in. It's actually performing quite well. The comps are weak because of what's going on in the auto industry globally, but the company is performing quite well, and we feel very, very good about that. Fusion, new management is installed. There's a lot of activity going on looking at whether or not it's small acquisitions that need to round out the product suite in order to make it an attractive strategic alternative for others or whether there are some businesses that did not make sense and those are being addressed but new management, and we have recapitalized that to reduce the debt and put in preferred equity. So that's another major one when you look at it. I'll let Chris talk to PGI.

Christopher Jansen, Co-Chief Investment Officer

Yes. PGI is the new owner in there has been doing a great job at actually managing the business and preserving whatever value is there. It's hard to be too optimistic on that being a large increase from where we are right now, but we feel rock solid about the evaluation we have on it now, and we are looking for that to increase a bit, but not make up close to anywhere the losses, unfortunately.

Michael Mauer, Co-Chief Investment Officer

And Robert, I just appreciate all the questions and Paul also around. We knew that when Investcorp did the purchase, it would raise questions. And I just want to reiterate that at the Investcorp level, we know they own the manager, but it's not the manager, and it's not the BDC.

Robert Dodd, Analyst

100% understood. Last one, if I can, on the dividend. You said you expect to earn the dividend for the fiscal year. Just to clarify, is that before or after the excise tax payment?

Rocco DelGuercio, CFO

Paul, it's Rocco. Yes, with the excise tax payment.

Operator, Operator

And we have a question from Christopher Nolan from Ladenburg Thalmann.

Christopher Nolan, Analyst

Most of my questions have been asked. On 1888, excuse me if you answered this, it seems like you have a non-accrual PIK loan, but then you have an accruing cash loan. I'm just trying to get a clarification around that.

Michael Mauer, Co-Chief Investment Officer

Yes, it's a priority. The first priority is expected to be able to pay the interest and the principal there. The non-accruing PIK is where we have a question right now as we go through our valuations on whether or not that will be realized, and we'll continue to evaluate that on an ongoing basis.

Operator, Operator

And we have no further questions in queue at this time.

Michael Mauer, Co-Chief Investment Officer

Thank you, everyone. We appreciate the time and look forward to talking after the next quarter. Thank you.

Operator, Operator

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