Investcorp Credit Management BDC - Q3 2023

Transcript

Operator (participant)

Welcome to the Investcorp Credit Management BDC, Inc schedules earnings release for Q3 ended March 31st, 2023. Your speakers for today's call are Mike Mauer, Suhail Shaikh, and Rocco DelGuercio. Operator assistance is available at any time during this conference by pressing zero pound. A question-and-answer session will follow the presentation. I would like to now turn the call over to your speakers. Please begin.

Michael Mauer (Chairman and CEO)

Thank you, operator, and thank you for joining us on our Q3 call today. I'm joined by Suhail Shaikh, my co-CIO, 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. At this time, I'd like to turn the call back over to our Chairman and CEO, Michael Mauer.

Michael Mauer (Chairman and CEO)

Thank you, Rocco. The March quarter marks the Q3 of our fiscal year. The beginning of 2023, there continued to be limited new issuance and refinancing opportunities, driven by broader market uncertainty and high interest rates. The H2 of the March quarter, we saw the level of activity pick up slightly. The collapse of Silicon Valley Bank and Signature Bank led to a broadly accepted credit contraction for middle market banks, which will further increase our opportunities. We saw our deal flow pick up after a slow December quarter, primarily driven by secondary opportunities across all industries. Especially during periods of market volatility, we actively focus on opportunities in both existing portfolio companies across our platform, as well as in sectors we are familiar with. During the quarter, we invested in one new portfolio company and three existing portfolio companies.

We have typically found that in a highly competitive market environment, our best opportunities come from companies we already lend to, as these tend to have known performance and better structures. The investments we made during the quarter and after quarter end were all sponsor backed. Even in a competitive environment, we remain optimistic about our pipeline and believe our portfolio is well-positioned to benefit from any further increase in interest rates. The weighted average yield of our debt investments during the quarter increased approximately 25%-13.4% from 10.7% at 12/31. Although our pipeline is robust, we continue to be very selective when investing in new credits. We remain focused on investing in high free cash flow and recession-resistant businesses. The credit quality of our current portfolio remains stable.

Despite a challenging market environment, the weighted average EBITDA of our debt investments improved quarter-over-quarter. This is supported by the substantial amount of equity cushion in our portfolio companies, provided by well-established middle market sponsors. Our weighted average loan-to-value ratio for all debt investments is approximately 50%. We are proud of the continued improvement in the credit quality of our portfolio. Suhail will now walk through our investment activity during the March quarter and after quarter end. Rocco will go through the financial results. I'll finish with commentary on our non-accrual investments, our leverage, the dividend, and our outlook for the rest of 2023. As always, we'll end with Q&A. With that, I'll turn it over to Suhail.

Suhail Shaikh (CIO)

Thank you, Mike. As Mike mentioned, we've been seeing a steady flow of new opportunities. These typically fall in two main categories: add-ons or secondary purchases of existing portfolio investments and opportunistic secondary purchases and refinancings of new companies. We're beginning to see some new sponsored platform transactions, but the volume is significantly below our historical experience. We invested in one new portfolio company and three existing portfolio companies this quarter. We also fully realized our position in two portfolio companies. During the quarter, fundings for commitments and new investments totaled approximately $11.1 million. In the same period, repayments totaled approximately the same amount of $11 million. We invested in Sandvine, a portfolio company of Francisco Partners.

We have been an investor in Sandvine. For over four years, the company is a leading provider of active network intelligence and security solutions for network operators and enterprises globally. We invested in the first lien term loan. Our yield at cost is approximately 11.8%. We opportunistically added to our position in two existing portfolio companies. First, we invested in the first lien term loan of LaserAway. LaserAway is a leading chain of laser hair removal and non-invasive aesthetic dermatology centers. Our yield at cost is 11.3%. Second, we invested in a priority term loan of Bioplan. Bioplan provides packaging and sampling solutions to the beauty and fragrance industry. Our yield at cost is approximately 15.8%. We also participated in a small equity raise for Techniplas, one of our existing portfolio companies.

Techniplas is a global manufacturer of plastic components for automotive industry. As mentioned above, we fully realized our position in Liberty Oilfield Services, which was refinanced. Our fully realized IRR was approximately 11.3%. We also fully realized our position in AgroFresh, which was repaid as part of our take-private transaction by Paine Schwartz Partners. Our fully realized IRR was approximately 10%. After quarter end, we invested in two new portfolio companies. First, we invested in the first lien term loan of PureStar, also known as AMCP Clean Acquisition Company. This is a good example of an opportunistic secondary purchase of a credit that we had been tracking. 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 and delayed draw term loan.

Our yield at cost is 15.7%. We invested in the first lien term loan of America's Auto Auction, formerly known as XLerate Group. This is another example of an investment that we own in other portfolios, and we're able to find an attractive opportunity to purchase in the secondary market. A Brightstar Capital Partners portfolio company, XLerate Group or America's Auto Auction, is a fully serviced used vehicle auction services provider for B2B customers. Our yield at cost is 13.3%. Using the GICS standard as of March 31st, our largest industry concentrations were trading company and distributors at 15.9%, professional services at 14%, followed by IT services at 10.8%. Commercial services and supplies are at 6.5%, and software remain at 6.2%.

Our portfolio companies are in 20 GICS industries as of quarter end, including our equity and warrant positions. I'd now like to turn the call over to Rocco to discuss our financial results.

Rocco DelGuercio (CFO)

Thanks, Suhail. For the quarter ended March 31, 2023, our net investment income was $2.5 million or $0.18 per share. The fair value of our portfolio was $221.3 million compared to $228.6 million on December 31. Our net assets were $88.2 million, a decrease of 3.6% from prior quarter. Our portfolio's net decrease from operations this quarter was approximately $1.1 million. Our debt investments made during the quarter had an average yield of 12.8%. Our realizations and repayments during the quarter had an average yield of 11.9%, and our average IRR was 10.7%.

As Mike mentioned, the weighted average yield on our debt portfolio increased 270 basis points to 13.4% as of December 31. As of March 31, our portfolio consisted of 35 portfolio companies. 90.6% of our investments were in first lien, and the remaining 9.4% is invested in equity warrants and other positions. 99.6% of our debt portfolio was invested in floating rate instruments and 0.4% in fixed rate investments. The average floor of our debt investment was 1.1%. Our average portfolio company investment was approximately $6.3 million, and our largest portfolio company investment is Fusion at $12.5 million.

We had a gross leverage of 1.65x and a net leverage of 1.49x as of March 31, compared to 1.55x gross and 1.46x net respectively for the previous quarter. As of March 31, we had four investments on non-accrual, which included PGi revolver and three investments in 1888. This is a decrease of four investments from the previous quarter. With respect to our liquidity, as of March 31, we had approximately $14.1 million in cash, of which $11.2 million was restricted cash with $33.1 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. I'd like to turn the call back over to Mike.

Michael Mauer (Chairman and CEO)

Thank you, Rocco. As mentioned last quarter, we acquired an SMA and had an initial close on our institutional fund. This doubled our platform AUM, expanding our level of investable assets and reducing average expenses across the funds. We also have an opportunity to grow the platform throughout the year. We believe that the scale and experience of our expanded team and platform positions us to be more meaningful to the market in terms of sourcing and origination. I would like to also address that we have made significant headway in completing our portfolio rotation initiative. The number of portfolio companies on non-accrual were reduced from eight in the previous quarter to four investments in the current quarter. Those four investments across two companies.

First, on Deluxe, we have recovered 80.9% of our principal and received principal and interest, representing 106% of our cost on that position to date. We believe future recoveries are likely to be minimal at this stage and have decided to write off the remaining position. [audio distortion] In the first lien and second lien loans are not expected to realize any recovery on those, and as such, those were written off. Bioplan successfully completed a balance sheet restructuring during the quarter. We currently hold positions in the term loan. The two loan positions are on accrual, and we're excited about the company's prospects going forward. In summary, we expect significant progress on the remaining non-accruals over the next 12 months. Our NAV declined 3.6% this quarter.

Equity positions represented a majority or $2.3 million of this decline. While this is disappointing, we believe that we will see a bounce back in the coming quarters. We had three portfolio companies which declined in value by $500,000 or more. First, we marked down our investment in ArborWorks. ArborWorks is a vegetation management company providing services to utility companies. Their results have been challenged by weather patterns in California, their largest market. We reduced the mark in our equity positions in Techniplas due to increased margin pressures and low production volumes in the auto industry. We also marked down our equity position in Fusion due to changes in model inputs related to market conditions. Our gross leverage this quarter was 1.65x, above our guidance of 1.25x-1.5x.

Our net leverage was 1.49x, which is within the target range. As mentioned last quarter, we expect to see our gross and net leverage generally converge. As of May 15th, our gross and net leverage were 1.59x and 1.56x. As we have previously stated, the advisor will waive the portion of our management fee associated with base management fees over one turn of leverage. We covered our March quarterly dividend with NII. Company is expected to earn its dividend through the next quarter, ending June 30th.

On May 4th, 2023, the board of directors declared a distribution for the quarter ended June 30th, 2023 of $0.13 per share, payable on July 7th, 2023 to stockholders of record as of June 16th, and a supplemental distribution of $0.05 per share payable on July 7th, 2023 to stockholders of record as of June 16th, 2023. As we continue into the H2 of 2023, we remain very optimistic about our team's ability to deploy capital in high-quality credits. Our growing platform will allow us to be more meaningful as club partner. Gives us expanded reach into origination and brings new and valuable relationships with private equity sponsors. Our growth will provide you, our investors, an increasingly diversified portfolio as we have access to a larger set of opportunities in the market.

Our goal has not wavered and has always focused on capital preservation and maintaining a stable dividend. This concludes our prepared remarks. Operator, please open the line for Q&A.

Operator (participant)

Thank you, ladies and gentlemen. At this time, we will conduct a question and answer session. If you would like to state a question, please press seven pound on your phone now and you will be placed in the queue in the order received. Or press seven pound on your phone anytime to remove yourself from the queue. Please listen for your name to be announced and be prepared to ask your question when prompted. We are now ready to begin. Our first question is from Chris Nolan. I'm opening the line now. Go ahead, please.

Chris Nolan (SVP)

Hey guys, congratulations on improving the non-accruals in the quarter. On Deluxe, did I hear you correctly that there was an 89% recovery?

Michael Mauer (Chairman and CEO)

I believe it's 80.9% recovery on cost excluding the interest. Including the interest, it was 106% of our invested capital.

Chris Nolan (SVP)

Okay, great. In the comments that you guys participated in an equity raise for one of your portfolio companies, would that be a rights offering?

Michael Mauer (Chairman and CEO)

It was a rights offering. We participated, so we were not diluted down. It was less than $500,000.

Chris Nolan (SVP)

Okay. I guess, on that note, given that you're focused on sponsored deals, has there been conversations about from your sponsors where if they have to raise equity for their portfolio companies, you know, they want you to participate? What are your thoughts around that?

Suhail Shaikh (CIO)

Chris, this is Suhail. The short answer is no. I mean, I think in a couple of situations, we're looking at sponsors come to us with a preferred equity investment opportunity so that they don't have to refinance the existing capital structures. As an equity co-invest, if that's what you're looking for? No, we haven't been asked to participate in any equity co-invest with outside sponsors.

Michael Mauer (Chairman and CEO)

Just to clarify. In initial investment, we have looked at small equity co-invest, and you'll see them in our portfolio, but that's rare, you know, few and far between, and that's at our option.

Chris Nolan (SVP)

I guess final question on leverage. Given the uncertain economic times, is the intent to maintain leverage in your target area, which is last I know, 1.4x-1.5x?

Michael Mauer (Chairman and CEO)

The answer is yes. As we continue to look at new opportunities, as we, you know, reinvest money coming back in, we're not looking to invest incremental capital, but reinvestments are all, you know, never say 100%, but are principally lower risk, more equity, better covenants. We're improving the quality of the portfolio and maintaining a consistent leverage against that.

Chris Nolan (SVP)

Great. That's it for me. Thank you.

Michael Mauer (Chairman and CEO)

Thank you, Chris.

Operator (participant)

Thank you very much. Our next question is Mr. Robert Dodd. I'm opening the line now.

Robert Dodd (Director)

Okay. Thank you. First following up on Chris' question, the obviously you're at 1.59x now in May on leverage. What kind of time frame do you expect to get back down to, you know, in the target range of 1.15x?

Michael Mauer (Chairman and CEO)

I'd expect at quarter end that we're back in that range. That's the expectation. If you look at 12/31, net leverage was 1.46x. At 3/31, it was 1.49x. We'd expect to be somewhere around there on a net leverage at 6/30.

Robert Dodd (Director)

Got it. Thank you. On the credit facility, I mean, in your opening remarks, like you talked about, you know, disruption in the banks and granted Capital One isn't exactly a regional. Have you started having any conversations with them about amending the facility? I mean, it doesn't spot and mature until 2026. The revolving period or the investment period ends next year. Any preliminary discussions that have occurred on that front?

Michael Mauer (Chairman and CEO)

We've continued to have an active dialogue with Capital One, all positive. There's been no indications that they are starting to pull back on the credit that they want to commit to us or the sector. Yes, we have ongoing dialogue with them.

Robert Dodd (Director)

Got it. Thank you. One last one, if I can, on following up on Chris' question again. Techniplas. I mean, you said you participated in the rights issue, put in less than $500,000. It got written down obviously during the quarter because of margin pressures, et cetera, that you talked about. I mean, yes, you did want to be diluted, but at the same time, you're putting more capital into a, you know, one of your larger write-downs this quarter. Could you give us, you know, any more thoughts on the capital purpose beyond non-dilution, which may or may not be, you know, beneficial to shareholders?

Michael Mauer (Chairman and CEO)

Yeah. I'd make a couple observations. Number one is kind of from our cost basis of that equity, we're averaging down. That having been said, we don't wanna keep putting more money in if we don't think this will recover. We think they are a critical supplier to Tier 1 OEMs, to top platforms. I think we've all seen the inventory constrained, especially from the foreign production, and they've been hurt by that. The forecast is that that's starting to normalize, but I've, you know, personally and anecdotally, I've not seen that fully normalized. We expect this to recover over the next 12 to 24 months and did not wanna see that over a small investment hurting our existing investment.

Robert Dodd (Director)

Got it. Thank you.

Michael Mauer (Chairman and CEO)

Thank you very much, Robert.

Operator (participant)

If you'd like to ask a question, please press seven pound on your phone. Again, that's seven pound if you'd like to ask a question. Our next question is from Paul Johnson.

Michael Mauer (Chairman and CEO)

Hi, Paul.

Paul Johnson (VP)

Good afternoon, guys. Thanks for taking my question. Yeah, I only have one today, but I wanna get a sense. I mean, it sounds like you guys have obviously made some investments in the platform, you know, since Investcorp came on, possibly raised some funds along the way. I was just hoping to maybe get a sense of, like, how many people, I guess, at Investcorp today, including yourselves, you know, are working directly on the BDC?

Michael Mauer (Chairman and CEO)

Well, the direct team on the BDC is about 12 people. Indirectly, there's another 30 people in Investcorp Credit, which expands to other liquid and separate accounts that we leverage off of research and flow and relationships. There is the middle market private equity team that we interact with constantly, from a standpoint of, I'll call it club origination, networking, and other deal flow opportunities. It's a broad base that we work within at Investcorp.

Paul Johnson (VP)

Got it. Thanks for that. I guess, you know, just with the leverage, you know, obviously it sounds like it's kind of a focus to get that down further back into line with the target range. Among all the other funds that you have access to with Investcorp, I mean, has the, you know, I guess, maintenance of leverage been, you know, any kind of a constraining factor for you guys in terms of participating on deals?

Michael Mauer (Chairman and CEO)

No, it has not.

Paul Johnson (VP)

Okay. Thanks. That's all for me.

Michael Mauer (Chairman and CEO)

Thank you very much, Paul. We appreciate it.

Operator (participant)

If you'd like to... there are no more questions at this time.

Michael Mauer (Chairman and CEO)

Thank you very much, operator, and thank you everyone for dialing in.