Investcorp Credit Management BDC, Inc.

Q4 2022 Earnings Conference Call


spk05: Welcome to the InvestCorp Credit Management BDC conference call. Your speakers for today's call are Mike Maurer, Chris Jensen, and Rocco DelGherzio. Operator assistance is available at any time during this conference by pressing the zero button. A question and answer session will follow the presentation. I would now like to turn the call over to your speakers. Please begin.
spk01: Thank you, Operator, and thank you for joining us on our fourth quarter call today. I'm joined by Chris Jansen, my co-chief investment officer, and Rocco DelGherzio, our CFO. Before we begin, Rocco will give our customary disclaimer regarding information and forward-looking statements. Rocco?
spk02: Thanks, Mike. I would like to remind everyone that today's call is being recorded and that this call is the property of InvestTalk Credit Management, D.E.C. 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 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 predictions. 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 filing, 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, Michael Mauer.
spk01: Thank you, Rocco. The June quarter marks our fiscal year end. This quarter and the 10-week since quarter end have seen significant volatility in the broader markets as the Fed hiked rates several times and both supply chain and inflationary pressures continued. Interest rates rose well above our average floor levels and credit spreads widened in the broadly syndicated market going into the quarter end, although spreads have moderated somewhat in the week since. spread lining in the middle market has been more moderate. Despite the impact that credit spreads have had on the fair value of our debt investment, the underlying operating performance across most of our portfolio continues to be strong. The primary market saw an increase in activity in the June quarter. Our pipeline remains robust and has been focused More on new LBOs. We made three new investments and reinvested in one of our existing portfolio companies, none of which were Covenant Light and three of which were club financings. We continue to execute under our plan to co-invest in equity positions with InvestCorp's North America Private Equity Group with one new position in this course. We also saw several of our loans in our portfolio get refinanced. Although the market has been active despite this volatility, we haven't chased yields with unattractive structures, even where we are comfortable with the fundamental investment opportunity. We remain selective about the structures we lend into and rigorous in our diligence. We've generally seen loans with higher yields, stronger coveted, protections and lower closing leverage multiples. This quarter, we were successful in deploying capital at an average yield of 10.4%. Our investment strategy has not wavered and we continue to maintain our credit discipline. Even in the face of the macroeconomic backdrop, we remain focused on investing in middle market companies with attractive pre-cash flow characteristics defensible market positions, and strong management teams and sponsors. Sector selection remains a key tool in our portfolio management decisions. We're focused on resilient end markets and are consciously avoiding adding exposure to sectors that are most vulnerable in periods of recessionary environments. Chris will now walk through our investment activity during the June quarter and after quarter end. After his discussion, Rocco will go through our financial results. I'll finish with commentary on our NAV, non-accrual investments, our leverage, the dividend, and outlook for 2023. As always, we'll end with Q&A. With that, I'll turn it over to Chris.
spk00: Thanks, Mike. We invested in three new portfolio companies this quarter. We fully realized our positions in three portfolio companies. We also fully realized our position and then reinvested in one existing portfolio company. First, we invested in the club financing for American nuts, which supported the refinancing of the company and the acquisition of BSD merchandise. American nuts provide procurement, processing, and packaging services of nuts, seeds, and dried fruits. The acquisition of BSD merchandisers creates a fully verdant vertically integrated business. Our yielded cost is approximately 10.7%. We led the club financing of WorkGenius, supporting its acquisition of JVC. WorkGenius is a technology-integrated staffing firm that focuses on end-to-end freelance hiring. We invested in both the first lean term loan and common equities. Our yield on the term loan at cost is approximately 9.7%. We made our third equity co-investment alongside InvestCorp's North American Private Equity Group. Cross-country consulting, listed in our schedule of investments as Victor's CCC Aggregator LT, is a business advisory firm offering corporate advisory services to Fortune 500 companies. Klein-Hirsch refinanced its debt as part of a conversion to an ESOP structure. Our existing investment was fully realized with an IRR of approximately 12.5%. We invested in the new last-out term loan, which had a yield at cost of approximately 11%. Regarding our other realization, the new JEXPRO loans made in the first quarter will be paid in April as the company merged with Lawson Products. Our fully realized IRR on the term loan was approximately 19.7%. Although we were pleased with the return on the revolver and the delayed draw, the IRRs are not meaningful given the short holding period. We fully realized our position in ASEA, which was acquired by DZS. Our position was refinanced as part of that transaction. Our fully realized IRR was approximately 23.7%. we opportunistically exited our position in Momentum Manufacturing Group in favor of new opportunities that we originated this quarter. Our fully realized IRR was approximately 6.5%. After quarter end, we invested in four new portfolio companies and had one realization in an existing portfolio company. First, we invested in Archer Systems. which supported the LBO of the company by Fortress. We invested in the Revolver Term Loan and Common Equity. Archer is an outsourced provider of administrative services focused on providing mass tort settlement services. Our yield at cost is approximately 9.9%. We invested in Evergreen North American Industrial Services, a portfolio company of the Sterling Group. We invested in the revolver and turn lawn. Evergreen is a provider of industrial cleaning and related specialty cleaning services. Our yield at cost is approximately 9.5%. We also invested in the club financing of PBI Holdings Inc. to support the LBO company by middle ground capital. PBI Holdings is a leading flow control distributor focused on MRO applications in diverse end markets. Our yield at cost is approximately 9.7%. We also invested in the club financing for Ameriquith LLC to support the acquisition of the company by JMC. Ameriquip is a designer and manufacturer of add-on equipment for OEMs in the construction, waste, lawn care, and snow removal markets. Our yield at cost is approximately 10.9%. Lastly, we fully realized our position in Lenox as the company made a substantial acquisition and refinanced its debt. Our fully realized RRR was approximately 12.5%. Using the GIC standard as of June 30th, our largest industry concentration was professional services at 11.6%, followed by IT services at 9.3%, internet and direct marketing retail at 9.0%, household durables at 7.4%, and trade and company and distributors at 6.7%. Our portfolio companies are in 20 GIX industries as of quarter end, including our equity and market positions. As of June 30th, we have 35 portfolio companies, unchanged from March 31st. As of today, we have 38 portfolio companies. I'd now like to turn the call over to Rocco to discuss our financial results.
spk02: Thanks, Chris. So the quarter ended June 30, 2022. Our net investment income was $2.5 million, or 18 cents per share. Our fair value on our portfolio was $233.7 million, compared to $242.0 million on March 31. Our portfolio's net decrease from operations this quarter was approximately $4.1 million, our debt investments during the quarter had an average yield of 10.4%, while realizations and repayments during the quarter had an average yield of 12%, and fully realized investments had an average IRR of 23.7%. Although this was distorted by the timing of a delayed draw before the repayment of GS Operating, which created an exceptionally high IRR, Excluding GS operating, the IRR was 15.3%. The weighted average yield of our debt portfolio was 10% and an increase of 186 basis points from March 31. Approximately 22.9% of this change is the result of the increase in LIBOR sulfur. As of June 30th, our portfolio consisted of 35 portfolio companies 91.9% of our investments were first lien, and the remaining 8.1% 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 instruments. The average floor on our debt investments was 1.03%, Our average portfolio investment was approximately $6.7 million, and our largest portfolio company is Fusion at $13.2 million. We had a gross leverage of 1.57 times and net leverage of 1.48 times at June 30th compared to 1.71 gross and 1.63 net, respectively, for the previous quarter. As of June 30th, we had six investments on non-actual, which included all three investments in PGI, two investments in 1888, and one in Deluxe. With respect to our liquidity, as of June 30th, we had $9.2 million in cash, of which $6.6 million was restricted cash, with $31 million of capacity under our revolving credit facilities with Capital One. Additional information, and the composition of our portfolio is included in our Form 10, which we expect to file on Monday, September 12th. With that, I'd like to return the call back over to Mike.
spk01: Thank you, Rocco. First, I'd like to address the decline in NAV this quarter, which is driven from a variety of factors, including the broad-based markets movement in credit spreads and a few specific portfolio companies, including Technoplast, CareerBuilder, and PGI. Approximately one-third of the change in unrealized depreciation in value of investments for the quarter is related to the markdown of the Technoplast position, which was driven by inflationary headwinds into the auto sector and volatility in the public equity markets. Our valuation is based on the fair value of the company using public comparables. If we look at the trends in the stock price of the public comp set we use, the significant decline from the quarter-ended $331 to the quarter-ended $630 has recovered, with modest but broad-based gains over the past few weeks. CareerBuilder's underlying business has been experiencing challenges for some time. For confidentiality reasons, I can't give details about the company's performance. That said, the revolver matured in July, and the term loan matures in less than one year. Quotes have declined during the quarter. Our market is informed by all of these factors. However, we are optimistic that a constructive conclusion is possible. and we believe that short maturity provides a catalyst for M&A or capital markets activity. Career Builders Mark accounted for just over 10% of the change in unrealized depreciation in value of investments for the quarter. We experienced a significant write-down in our position in PGI this quarter. Efforts to monetize the company's assets have thus far been short of our expectations. We no longer expect to recover value on our term loan or second lien positions. We do expect a recovery on our revolver position, although that may take some time to fully realize and we expect significant impairment on that position. PGI is responsible for a further 14% change in unrealized depreciation in value of the investment. The majority of our portfolio is marked using the yield method. Our fair value takes into account movements in broad market spread, as well as company specific factors, both positive and negative. Over one third of our NAD decline this quarter is attributable to the marked down positions marked down using the yield method. Since June 30th, spreads have tightened fairly significantly, making us optimistic about a reversal of some of these mark-to-market effects. Our gross leverage this quarter was 1.57 times above our guidance of 1.25 to 1.5 times, and 14 basic points lower compared to last quarter. our net leverage was 1.48 times in the target range. As mentioned last quarter, we expect to see our gross and net leverage generally converge. As of September 2nd, our gross and net leverage were 1.63 times. As we have previously stated, the advisor will waive the portion of our management fee associated with base management fees over one time's leverage. We covered our June quarterly dividend with NII. Through the calendar year to date and fiscal year end, June 30th, the company has earned its dividend and is expected to earn its dividend through the next quarter ending September 30th. On August 25th, our board of directors declared a distribution for the quarter ended September 30th, 2022 of 15 cents per share. payable on October 14th to shareholders of record as of September 23rd. We believe the dividend level is sustainable and stable, and that it represents an attractive yield given the market price of ITMD stock. Looking ahead, we remain highly focused on our risk management. Although we cannot predict the timing of the Fed's action, we believe the portfolio is well positioned to benefit from any increase in short-term rates and defensively positioned to navigate broader macro and geopolitical challenges. We believe we will continue to maintain our credit discipline and invest primarily in first lien floating rate loans in a diverse set of industries. We remain focused on finding investment opportunities with attractive pricing, structural protections, and structural protections in order to achieve our goal to preserve capital and maintain a stable dividend. Thank you. That concludes our prepared remarks. Operator, please open the line for Q&A.
spk05: Ladies and gentlemen, at this time we will conduct a question and answer session. If you would like to state a question, please press 7 pound on your phone now, and you will be placed in the queue in the order received. Or press 7 pound at any time to remove yourself from the queue. Please listen for your name to be announced and be prepared to ask your question when prompted. You're now ready to begin. Our first question comes from Robert Dodd with Raymond James. Robert, go ahead, please.
spk04: Hi, guys. Hi, Mike. I'm all in in your prayer remarks for me. You said the underlying operating performance of most of the portfolio companies remains strong. Obviously, some not the case. I mean, you outlined some specific ones, obviously. Are there any others? Because if I do them there, it looks like you said just over a third was mark-to-market, which implies two-thirds wasn't. That implies there's something more than Technoplast Career Builder and PGI accounting for probably credit markdowns. Can you give us a, you know, is that just the small pieces of 1888, or is there another business? Obviously, we don't have the 10K, so I can't see the marks at the moment, but is there another business or anything like that where there are incremental performance and credit concerns?
spk01: Robert, the short answer is no, there's not credit concerns away from the ones you've highlighted. I think if you look at CareerBuilder and Technoplast, those two account for, I think, over half of the NAV write-down, and then a third of it being market spread, so you're between 80% and 90%, and their balance, I think, are small movements, but Chris,
spk00: Yeah, hey, Robert. PGI is an additional 15% of that, so those three names basically are two-thirds. Got it.
spk04: And then just on that, I mean, with bankruptcy, we go up, inflation still running high, obviously. It sounds like that was having an impact. I mean, if we look forward, rather than, you know, the numbers you've already seen, which obviously, in fact, we're looking in terms of performance numbers, Are there any areas where you're concerned about the high levels of inflation, you know, eating away at interest coverage or anything like that? I mean, also in the program, you talked about staying away from certain industries. So, obviously, there are. Now, do you have any exposure there that you'd be worried about if, you know, LIBOR or SOFA or whatever goes to 400 basis points, which is close to where the forward curve is?
spk00: indicating at most yeah i think a couple of things robert i think um the last you know three or four quarters in particular we've been really focused on lower leveraged companies uh when i look at the bulk of our companies they are uh you know two plus and three plus times levered um you know, as they tended to be on the smaller side, we wanted to put another level of conservatism in there. And on all of our management calls, we're asking about more labor input costs and things of that nature, in addition to the diligence we're doing up front. That's really where we see a lot of the cost pressures with a lot of our investments. And today, You know, I don't think any management teams are really bullish on labor costs, but by and large, they have them, A, under control, and B, have taken other cost-saving initiatives out of their cost of goods sold to allot for that.
spk01: And Robert, I just add a couple of things that on the ones that Chris highlighted that we've been focused around lower leverage is two other key things. We've been focused around loan-to-value. It's typically been at the high end, low 50%. It's been, you know, significant equity in junior capital and principally equity below us in all new deals. covenant heavy, not covenant light. And the other thing we've been focused on is the quality of EBITDA, to your point around cash availability. And we've done a lot of sensitivities around LIBOR increases beyond where we are, as well as sensitivities to EBITDA deterioration. And we feel very good about the portfolio.
spk04: Got it. I appreciate that, Carla. Thanks. If I can, one more. On the dividend issue, you said, you know, you expect to earn it in the September quarter, and I realize it's hard to project out long-term, especially with the Fed doing whatever they're going to do. But just conceptually, to earn the dividend with NAV where it is right now, hopefully it will bounce, but where it is right now, you need an income of maternal equity before realizing it's lost or unrealized as well. of about 9.5%. Do you believe that the business at this size with the management piece structure, the cost of debt, et cetera, the overhead cost, can the business sustain a 9.5 income ROE long term, which is what, you know, even as rates move around, that's what you need to earn the dividend. Do you believe that's feasible with the business as it stands?
spk01: Yes. Short answer. We looked at it. Yep. Appreciate it. Thank you very much, Robert.
spk05: Our next question comes from Chris Nolan with Levenberg Tolman. Chris, go ahead.
spk06: Hi. Given the delay in the K, can you tell us what the percentage of the portfolio, the amount of cruel investments were on a cost basis and fair values?
spk01: what is it yeah the um as of june 30th the non-accruals uh based upon a fair value are 1.08 approximately 2.5 million dollars fair value and cost payments I do not have that information.
spk02: I'll have to get back. We'll get back. I'll have to get back. The numbers of Cisco, the non-accruals have not changed from quarter to quarter, so they are the exact same non-accruals.
spk01: So the names have not changed. The amounts have actually gone down quarter over quarter. So that non-accrual fair market value is 3.4 in March, and it's now 2.5.
spk06: Okay. And then I guess in terms of your operating leverage, taking it all in and understanding to Robert's point earlier about the dividend, you're operating at a very high leverage at a time when, you know, the economy can really weaken and your credit quality can, you know, erode quickly. What's your plan in terms of your debt-to-equity ratio going forward for the second half of the calendar year?
spk01: Yeah, and I think we were over 1.7 at a point earlier in the December quarter, March, and it came down from there. June, we were at net of 1.48, 1.57 gross. We're around 1.6 now. That is knowing that we've got some maturities and repayments coming in. We're going to continue to try to target in this 1.25 to 1.5. Now, we may straddle back and forth, but we want to stay away from where we were earlier in the year in that 1.7 range. Chris?
spk06: Okay. Can you sustain the dividend at a 1.25 leverage ratio, or would it have to be higher than that?
spk01: In the range of the 1.25 to 1.5, yes. Okay. Thank you.
spk06: Okay.
spk05: Thank you very much. Thank you. Thank you very much. Our next question comes from Paul Johnson with KBW.
spk03: Yeah, good afternoon, guys. Thanks for taking my question. I only have one. I was just wondering if we can get kind of your expectations around, you know, the portfolio yield for the portfolio. Obviously, with rates coming higher, VCs are going to benefit from that, mainly floating rate assets in there. We've seen kind of a trend with the yield differential coming down with higher yielding investments that getting repaid or exited. Do you have any kind of expectations in terms of the benefit you might expect for yield in the portfolio kind of going forward with higher rates or do you kind of expect for the most part to maintain relatively what you have today, give or take some benefit from QP?
spk01: Let me answer that with maybe some detail. As we watch LIBOR and SOFR go up, we've had contracts that keep rolling off and resetting, although the resets are causing an average to increase. June has not seen a peak. That will continue over the short to medium term. That's number one. Number two is it spreads while they are they're widening not tightening which is in my experience over 25 years you know that won't continue for the high quality borrowers where you keep seeing the base rate go up you'll see a little bit of contraction on uh spread but we're actually seeing that uh widen a bit right now and we're continuing to see uh first lean and first lean or first lean stretch but first lean loans have significant equity components in new deals. I'd say that if you go back two, three quarters, the average yield was probably around 840, 850 on the portfolio. That has increased. New deals we're looking at on the low side are nine to nine and a half. And I'd say the core of what we're looking at is over 10% on new deals. And that's an all-in yield, including that SOFR where it is today, as well as the spread and assuming a OID of 2%. So, long way of saying, if you look at our portfolio today, I think there is some increased potential in it. I wouldn't say it's significant. In my definition of significant would be over 100 basis points on average, but I do think that the directionally is up, not down from where it is today.
spk03: Appreciate that. It's great. These are all my questions for today.
spk01: Thank you.
spk05: Thank you very much, Paul. And as a reminder, if you have any questions, please press 7-pound. We have no further questions.
spk01: Thank you very much. We appreciate everyone's time.
spk05: This concludes today's conference call. Thank you everyone for attending.

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