Investcorp Credit Management BDC, Inc. (ICMB) Q1 2017 Earnings Report, Transcript and Summary

Welcome to the CM Finance first quarter earnings release conference call. Your speakers for today's call are Mike Mauer, Chris Jansen and Rocco DelGuercio. [Operator Instructions]. A question-and-answer session will follow the presentation. I will now turn the call over to your speakers. Gentlemen, you may begin.

Thank you operator. Thank you all for joining us this afternoon. With me are Chris Jansen, my Co-Chief Investment Officer and Rocco DelGuercio, our CFO. Before we begin, Rocco will first 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 is the property of CM Finance, Inc. Any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of this call will be available by using the telephone numbers provided in our press release announcing this call. I would 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. We ask that you refer to our most recent 10-Q filing for important factors that may cause actual results to differ materially from projections. We will not update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.cmfn-inc.com. At this time, I would like to return the call back to our Chairman and CEO, Mike Mauer.

Thank you, Rocco. As with our call in August, I will begin today's call with a discussion of the leveraged finance market. I will turn the call over to Chris to walk through our portfolio activity in the quarter and then Rocco will speak about our financial results. I will conclude with a discussion of our portfolio. Leveraged finance new issue volumes continued to increase in the second quarter. The tightening spreads and more broadly friendly terms we noted on our last quarter continue to be seen in the most new issue in the loan market. Almost three-quarters of first lien issuance in the primary market is covenant-lite. The preponderance of new issue syndicated second lien loans today are highly levered covenant-lite long-dated with weak inter-creditor protections. Leverage multiple of in the broadly syndicated market and the upper middle market have continued to creep up and unfortunately deal terms continue to have an issuer friendly bias. All-in-all it's very challenging time to find opportunities with terms and structures attractive to us in the leveraged loan market and the middle market. Fortunately, we have the ability to be extremely selective in choosing our new investments and we continue to pass on a number of deals due to pricing aggressive capital structure or weak protections for the lenders. I would now like to turn the call over to Chris to discuss our investment activity.

Thanks Mike. We have made five investments during the quarter, including adding to our position in two existing portfolio companies and three investments in new portfolio companies. We had three realizations which included one of our three new portfolio company investment. While I spoke about a few of our new investments and realizations on the last call in August, I will run through all of our new investment activities for you now. We added to our positions in the first lien loan of Premier Global Services or PGI, as well as our positions in School Specialty's first lien loan. Our initial investment above PGI and School Specialty were both made in our fourth fiscal quarter, which ended on June 30. These were our two additions to investments in existing portfolio companies during the quarter. As I spoke about on August call, our second lien loan to Maxim Crane was repaid at its 101 call premium. Maxim was acquired by Apollo and merged with AmQuip Crane. Our realized IRR on the Maxim investment was 11.1%. We invested in the merged company, renamed Cloud Crane. We received a very small allocation of the second lien notes and chose to sell the position at a small gain rather than purchasing more at a premium to the new issue price. There is no IRR to report as we held it for a short period of time. Cloud was one of our three new investments and Maxim and Cloud Crane are two of our three realizations in the quarter. Our third realization was our investment in Language Line's second lien loan. The company sponsor, ABRY Partners, sold the company to Teleperformance resulting in the full repayment of our loan in September at its 101 call premium. A fully realized IRR was 13.3%. We made a new investment in the first lien loan of FleetPride, the largest independent distributor of aftermarket heavy-duty truck and trailer parts in North America. FleetPride is owned by TPG. We purchased our position at a discount and our yield at cost on the investment is approximately 10.6%. Our final new investment in the quarter was in the first lien loan for Redbox. Apollo acquired the former parent company of Redbox in July and financed the company through two separate standalone facilities. Redbox rents DVD and Blu-Ray movies and video games through a network of about 40,000 kiosks throughout the United States. Our yield at cost is approximately 10%. Since quarter end, we have had two investment realizations and have made two new investments. We realized our investment in NWN Corporation, both in its first lien loan in our equity coinvestment. We made this investment approximately one year ago. Our fully realized IRR including our loan and equity investments was 11.8%. Our investment in JAC Holdings was called at its make whole premium last week. Make whole premium was approximately 115%. The sponsor, Wynnchurch, recently agreed to sell the company to Argonaut. Our realized IRR was 18.3%. Our first new investment since quarter-end is in a new second lien loan for PGI, Premiere Global Services. This is a club deal at the same issuer as our existing first lien loan. Our yield at cost is 11.5%. Our second new investments after quarter-end is in the first lien loan of Dayton Superior. Dayton is a leading manufacturer and supplier of concrete construction products in North America which is supported by engineering and other value-added services. The yield at cost is approximately 10.1%. I would like to note, that of our new investment in PGI's first and second lien loans, School Specialty, FleetPride, Redbox and Dayton Superior, only FleetPride is covenant-lite. We had 22 portfolio companies as of June 30, 22 as of September 30 and we have 21 today. As of September 30, our largest industry concentration was in gaming at 15.5% of the portfolio at fair value. This is down from 19.5% as of last quarter and the reduction is the result of a partial pay down of our loan to Land Holdings. Our second largest sector was energy at 12.2%, followed by autos and telecommunications, each at 11.4%. Our fifth largest sector exposure was business services at 7.1%. While unscheduled repayments have been the challenge in our effort to increase our total number of portfolio company investments, we are pleased to have diversified our industry concentration and we have continued to reduce our average for this position size from $14 million a year ago to $12 million today. I would now like to turn the call over to Rocco to discuss our financial results.

Thanks Chris. For the quarter, our net investment income was $3.9 million or $0.29 per share. As of September 30, the fair value of our portfolio was $264.2 million compared to $272.1 million at June 30. Our investment activity accounts for an $8.9 million decline in our portfolio, which was offset by $1 million increase in our net changes in our marks. At September 30, the weighted average yield of our debt portfolio including amortization was 10% compared to 9.8% at June 30, 2016. Our portfolio was comprised of 90.2% floating rate and 9.8% fixed-rate investments. Our average portfolio company investment was approximately $12 million and our largest portfolio company was approximately $29 million. 63.1% of the portfolio is in first lien investments and 36.8% of our investments are in second lien and we currently do not hold any unsecured investments. Additional information regarding the composition of our portfolio is included in our Form 10-Q, which was filed yesterday. At September 30, we were at 0.72 times levered compared to 0.81 times levered as of June 30. With respect to our liquidity, as of September 30, we had $12.6 million in cash, $16.1 million in restricted cash and $35.5 million of capacity under our $50 million revolving credit facility with UBS. With that, I return the call over to Mike.

Thanks Rocco. I want to provide the details behind the aggregate mark on our positions in energy and oilfield services, which increased slightly this quarter. We had significant changes to marks for Caelus and U.S. Well. We also concluded the financial restructuring of our investment in AAR, which I will speak about in a moment. Caelus continues to benefit from excellent well results. They have hedged profile which extend into 2018 and an improved oil price environment versus earlier this year. We continue to feel very good about the Caelus investment between the solid operating results and the Smith Bay discovery announced in October. Our mark increased from 65 to 70 this quarter. Until this quarter, U.S. Well Services results have frankly exceeded our expectations. However, the pricing environment for pressure pumping services has been challenging and we have begun to see the weakness reflected in the company results. The team and I are working closely with our fellow lenders as this situation develops. We reduced our mark from 89.5 to 75 this quarter. On a more positive note, after working with the company and our fellow lenders over the past year, we have concluded the financial restructuring of All Around Roustabout, AAR. Historically, CM Finance has held a first lien loan to AAR Intermediate Holding company LLC and warrants at the same entity. Today, our investment has been restructured into a new Term Loan A and Term Loan B, a direct equity investment and an undrawn revolving commitment of approximately $1 million. The old first lien loan was partially equitized resulting in the lenders taking majority ownership of the company and the remaining loan was restructured into a first out and last out, the Term A and Term B. Our revolver commitment is intended to fund working capital as the company recovers. We have placed the Term A on accrual while the Term B remains on nonaccrual. Our old warrants were canceled. This restructuring reduces debt and in particular the cash interest burden on the company, while preserving our ability to recoup value in the future. The aggregate fair value of our Term A, Term B and equity position is the same as our fair value on the pre-restructured first lien loans as of June 30. We are pleased with the overall performance of our portfolio. Our portfolio yield improved from 9.8% last quarter to 10% this quarter. While at the same time, we increased our exposure to first lien assets from 57.7% to 63.1%. We have also reduced the percentage of our portfolio on nonaccrual to 4.5% at fair value. Looking to the future, I am pleased to tell you all that we have secured a new credit line with Citibank. This is a multiyear revolving credit facility that will replace our revolving line with UBS. Our term loan with UBS that has over two years to run remains unchanged. Our new Citi revolver has a higher effective rate when drawn but has substantially lower upfront cost. Importantly, it has a two-and-a-half year life. On November 3, our Board of Directors declared a distribution for the quarter ending December 31, 2016 of $0.3516 per share, payable on January 5 to shareholders of record as of December 16, 2016. This dividend is our final one at this rate and is consistent with both the promise we made at the time of the IPO and our contractual waiver of incentive fees in order to cover the dividend through calendar 2016. Due to our three-year high watermark, which was triggered in December 2015, we did not earn any incentive fees during the quarter ended September. We expect to partially earn our incentive fee in the current quarter ending December. We are committed to paying an attractive, sustainable dividend to our shareholders. Our Board of Directors supports us in this aim and we have done an extensive review of our dividend over the past quarter. Our objective in setting the March 31, 2017 dividend is to ensure that our dividend policy going forward is consistent with our ability to generate NII without reducing our investment quality by reaching for yield or changing our focus from secured lending opportunities. With that in mind, we have taken the proactive step of reducing our dividend level for the first calendar quarter of 2017 to $0.25 per share, which is an 11% yield as of the close of business yesterday. We are not taking a view on future rate increases and our new dividend level does not assumed rate hikes in the near term. We see opportunities in secured investments in both primary and secondary markets. Quality origination is always challenging but our team continues to identify attractive risk reward with meaningful structural protections for our investments. In a challenging market for lenders, we have made a conscious decision to focus on moving up the capital structure. Overall, the portfolio is positioned to perform well into the New Year. While there will continue to be investments experiencing fundamental headwind, the portfolio as a whole continues to show signs of stability and appreciation. Our underwriting will always focus on the quality of the management teams, capital structures, our security and covenants for the protection and preservation of capital over the long-term. We continue to believe that being patient and conservative is the right approach. With that operator, please open the line for Q&A.

[Operator Instructions]. Our first question comes from Ryan Lynch from KBW. Please state your question.

Hi. Good afternoon and thank you for taking my questions. First one, I just had a clarification on JAC holdings. You said that was called to date and that there was a make whole premium of 115%. So if I do the math on that, that's about $2 million. One, is that correct? And number two, is that going to flow through the interest income line? Or is that going to come through a gain line item?

Income. Other income line.

Well, I am sorry, Rocco. Number one, this is Chris, Ryan, that's correct. It's probably a little less than $2 million but the first part is correct.

And it will fall to the other income line, not as capital gain.

Okay. And then, in regards to the dividend, you guys obviously did a lot of work and lot of math on the dividend. So is it fair to assume that you guys have set the dividend at a level that you guys expect to fully earn or maybe over earn going forward assuming you guys are fully earning the incentive fee or at least the incentive fee expense fully turning back on?

So let me answer that a couple -- there is a couple of pieces to your question there. First, we have looked at it and we have been, we think, conservative around making sure that we can cover the dividend over the foreseeable future and that's the $0.25. Around the incentive fee, we have not made any assumptions as far as markups and down in the portfolio and the three-year look back will continue to apply at least for another year as we had a large write-down in the fourth quarter of 2015. With that having been said, we do expect to partially earn our incentive fee in most, if not all, quarters going forward. Now, I caveat it, partially earn, because of the look back.

Okay. And then you guys had net repayments in calendar 3Q. It looks like so far quarter date of calendar Q4, you guys also have net portfolio repayments. So how much of the net prepayment have you guys have had in Q3 and Q4 as you all wanting to delever your balance sheet versus maybe a bit of jus the ebbs and flows of lending in unpredictable market as well as maybe seeing less attractive opportunities giving competition?

More of the latter than the former. So we are comfortable running in a 0.8 plus, 0.8 minus leverage. And that is easy, I think it was 0.82 at the end of last quarter. So we are comfortable with that leverage level. That having been said, we are not rushing to redeploy. We have been redeploying. We have got several things in the pipeline right now. We hope at least one of those closes in the next three, four weeks, no assurances. And there's two or three that have, I think, 80% or better probability of closing over the next eight to 12 weeks. So we are looking to redeploy and to bring that leverage back up from the 0.71 that is at today -- or at 0.30, let me --

Sure. Yes. And then just one last one. Given the competitive environment where there is clearly being some pressure on yields as well as covenants in new loans being issued today as well as you all have continued to focus on doing more secured lending and obviously not reaching for yield, is it fair to assume that you guys portfolio yield is going to be ticking down over the next couple of quarters, assuming that there is no real substantial changes in the environment as we sit here today?

In answer to that, I would say, that's probably more of a historical answer than a present one. What I mean by that is, over the last six months, our target yield has trended toward 10% plus or minus. If you ask me that question a year ago to a year-and-a-half ago, we would have been 50 to 100 basis points higher. Two years ago, we were definitely a target yield of 11% plus or minus. So we have trended down over the last three to six months. We have probably stabilized on what our target yield is for new investments and that's around 10%. And we will have some that are over and some that are under. And most of those will be first lien that are under and second lien over, but that's a generalization that does not always hold.

Okay. Thank you for taking my questions.

Yes. The only thing, just last point on that is, if you look at the net average for the quarter ended 9/30, it was about 10.2%, just shy of that. And the net additions post 9/30 is close 10.6%. And the 10.6% has a second lien it that we mentioned, PGI, where the 10.2% is all first lien.

Okay. Understood. Thanks guys.

Thank you. We appreciate the question.

Our next question comes from Robert Dodd from Raymond James. Prepare state your question.

Hi guys and again, thanks for the color on the dividend framework and the market. Looking at one of the issues, Land Holdings prepaid, or we paid, about half during the quarter. Any expectations on the other half, obviously to the context of Ryan's question, is jus that Lands at 12% yield, right, so repaying half, hence the lower yield. And any view on whether other half is going to come out any time soon?

Yes. Hi Robert, it's Chris. Probably in the next six months would cone out but there is nothing imminent there. The call premium steps down again in June. So that give us some good runway to that and we think we feel pretty comfortable about it being out for the next three to six months. There have been no indication or conversations with the sponsor there who was an individual. It gets pretty granular with conversations with him and there have been none in the last two or three months.

Got it. Obviously your energy, thanks for the update on those, any other areas in the market or on your portfolio that you are avoiding, particularly industry rather than just -- or any other signs anywhere you are also seeing about what the next phase is? Obviously, energy, we are now kind of on the swing a little bit, thankfully. Retail had its worries. Anything else market wise, not necessarily portfolio wise, where you think issues are starting to come up?

Well, you have mentioned a couple of industries there. One energy, everyone knows and can see our portfolio, we are not looking put anything more on. There is lots of opportunities if you want to. The second one is, we did Redbox which is considered a retailer. We look at it as a distribution channel. It is retail, but in the retail context what we are definitely avoiding is specialty retail. I think that's been a consistent theme since the first day of our IPO. We don't like things that are fad-driven and on top of that, if you look at structurally, over the last five to 10 years and I think it's accelerating right now that retail and structural retailer, I mean specialty retailers are being disintermediated by the online option. And so we are continuing, not starting but continuing, to avoid that.

Got it. And to that, following up on that point, specialty retail and also more focused on things like that, there seems to be, it's a foot traffic rather than a consumer spending issue. So from that perspective and I don't call Redbox, et cetera, I know it's online, but do you know, when you were underwriting I am assuming you did, where their machines are in terms of, I mea, obviously if there are mall locations, I would be worried about the foot traffic. If they are outside a gas station, less so or a grocery store. I mean, do you know what the breakdown of where they are?

Yes, excellent question, Robert. They are grocery store, there is over 40,000 different kiosks. So they cover broadly the vast majority of United States. They have a nationwide agreement with Walgreens. So it hits where people go shopping every day for staples in such a low-cost option versus video-on-demand for most of America and it definitely gets into the convenience factor. And what really the cement for us was that it's very low leveraged and there are excellent structural protections for the lenders within the covenants of the first lien term loan.

I think one of the key things they and Chris touched on it, in the underwriting process here, Redbox when you examine it, is the installed base of 40,000 kiosks over everything from drugstore to convenience stores, grocery stores and I am sure there is some in some mall-base, but it's not a mall based system that is set up. On top of that, from a lender structure, this is a business that over the medium term in our underwriting diligence we really, really like. On a long-term, that's an equity question and I am not -- our team is not prepared to take a view on that. So from a structure of the loan, it's heavily amortized, cash flow sweep and will be a shorter average life than our other investments.

Okay. Thank you for that color. I appreciate it. That was my last question. Thank you,

Thank you Robert. I appreciate it.

Our next question comes from Chris Kotowski from Oppenheimer. Please state your question.

Yes. Thank you. Looking at your equity investments. I mean, they are all carried pretty much at de minimis valuations and I know we shouldn't count on anything coming out of that. But can you go through where there is significant potential? And I guess what I mean by that is, were all these stakes acquired post to work out? So in a new and reasonably refreshed capital structure? And where is your ownership a significant portion of the total company?

I will take that and then I will let Chris chime in. So there is a couple. One is, All Around Roustabout. So we believe and I just talked about Redbox probably being a shorter than average life, I would turn around and tell you that the AAR, due to the cycle we are going through the restructuring we just completed, will be a longer than average life investment. We are not expecting a recovery to the level in which we originally underwrote it. That company was doing over $40 million of EBITDA at that point and you can put whatever multiple you would like to put on it, but I think a conservative multiple would have been four to five times. And at four to five times, that infers a firm value of $160 million to $200 million. There is debt on it of less than $80 million and we own approximately just a tad under 12% of the equity in that. So given that we don't expect a full recovery, we do think there is upside. We do think that EBITDA will go significantly north of $10 million and probably north of $20 million. We are not assuming that it goes north of $30 million in any of cases today and we do assume that, as you cycle back to an active market and I don't know if that's in the $50-s or into $60-s, but our base case says that oil will be $45 to $50 range for quite a while. Then we will fully recover all of our debt and there ill be value down the road to the equity. Today, we don't think that value is more than much of an option value and you can see that from where we have it marked. Chris, do you want to comment on PR Wireless?

Yes. The other equity investment in the form of warrants that we hold is in PR Wireless or Open Mobile. Wireless is probably that the fourth wireless player in Puerto Rico. That deal was structured with the lenders receiving basically stapled onto the term loan, altogether about 20% warrant in the company. And similar to AAR, we would expect at some point to get some value out of that. But at this point, the company continues to slightly delever and is performing adequately. So there is no immediate value to those warrants as we expect right now.

And the other two below that [indiscernible]?

Yes. NWN was one that we sold that was a de minimis, $150,000-some odd of equity that we bought. We sold it basically for that amount. So that one is out. And the last one is --

I think that was sold at cost.

It was sold at cost.

And that is all factored into the IRR as we talked about on NWN.

Okay.

And the last, which is really kind of just, not an anomaly but it's our out of the money warrants in Endeavour which we evaluate either zero or one, but it's just a line item in our financial statements. We wouldn't expect to get any value for that.

And that was one there was no cost to retain as part of AAR loan that we bought and we may ascribe some cost to it from a GAAP perspective but again, that was not something we bought for equity.

Okay. Thank you.

That's similar in PR Wireless as well. We ascribe some value to the loan purchase to those warrants but we didn't pay anything for them.

Okay. All right. Good Thank you.

[Operator Instructions]. At this time, we have no further questions.

Thank you operator. We would like to thank everyone for joining us today and we look forward to speaking with you in February. Thank you.