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Edited Transcript of ABDC earnings conference call or presentation 7-May-19 1:30pm GMT

Q1 2019 Alcentra Capital Corp Earnings Call

NEW YORK May 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Alcentra Capital Corp earnings conference call or presentation Tuesday, May 7, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ellida McMillan

Alcentra Capital Corporation - CFO, COO, CAO, Treasurer & Secretary

* Peter Glaser

Alcentra Capital Corporation - President & MD

* Suhail A. Shaikh

Alcentra Capital Corporation - CEO & Head of U.S. Direct Lending

* Vijay P. Rajguru

Alcentra NY LLC - Co­-CIO at Alcentra Limited

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Conference Call Participants

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* Leslie Shea Vandegrift

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Ryan Patrick Lynch

Keefe, Bruyette, & Woods, Inc., Research Division - MD

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Alcentra Capital Corporation Q1 2019 Earnings Call. (Operator Instructions)

I would now like to turn the conference over to your host, Ms. Ellida McMillan, you may begin.

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO, CAO, Treasurer & Secretary [2]

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Thank you, Rusty. Good morning, and welcome, everyone, to Alcentra Capital Corporation's First Quarter 2019 Earnings Call. I'm joined this morning by Vijay Rajguru, Chairman of the Board of Directors and Global Chief Investment Officer, Manager of Alcentra. Also joining us today are Suhail Shaikh, Chief Executive Officer of the company; and Peter Glaser, the company's President.

Before we begin please note that this call is being recorded. A replay information is included in our May 6 earning release. It will be posted on the Investor Relations section of Alcentra Capital Corporation's website, which can be found at www.alcentracapital.com. Please note that this call is the property of Alcentra Capital Corporation. Any unauthorized rebroadcast of this call in any form is strictly prohibited.

Today's call may include forward-looking statements and projections. We ask that you refer to our filings with the SEC for important factors that may cause actual results to differ materially from those anticipated in any forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required by law.

To obtain copies of our SEC filing, please visit our website or call Investor Relations at (212) 922-8240.

The format for today's call is as follows: Vijay, Suhail and Peter will provide an overall business and portfolio summary and I'll then provide an overview of our results, summarizing the financials, followed by a Q&A.

I will now turn it over to Vijay.

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Vijay P. Rajguru, Alcentra NY LLC - Co­-CIO at Alcentra Limited [3]

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Thank you, Ellida. Good morning. Thank you for joining us to discuss our results for the first quarter of 2019. I will keep my remarks brief and let Suhail, Peter and Ellida provide you with details on our quarterly activity.

I continue to be pleased with the progress we are making in the turnaround and rotation of Alcentra Capital Corp.'s portfolio. This is the company's third consecutive quarter of NAV per share growth, and our net investment income per share has consistently exceeded the dividend payment during the past 6 quarters. This is a testament to management and the investment team's continued focus on stabilizing the book in a competitive environment for direct lending.

While the purpose of today's call is to discuss our results for the first quarter, let me quickly address the Board of Directors' vision to enter into a strategic review process, which we announced on April 4, 2019. The Board of Directors has entered into a formal review process to evaluate strategic alternatives for the company, including a sale of the company, a business combination and any other strategic transaction. And the Board has authorized its committee of independent directors to lead the process. The Board is pleased with the progress management continues to make in rotating ABDC's legacy assets and stabilizing NAV.

At the same time, as management continues to focus on increasing value for the stockholders, the Board believes it's also important to explore additional options that may be available to further enhance the value of the company. As a result, the Board decided to enter into a formal process to evaluate potential strategic alternatives. There can be no assurances that the review will lead to a transaction.

The Board has full confidence in our management and investment teams to deliver continued positive results to stockholders and continue to generate stable, consistent book value per share growth for Alcentra Capital Corp.

I'll now turn it over to Suhail to provide you with highlights of the quarter. Suhail?

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Suhail A. Shaikh, Alcentra Capital Corporation - CEO & Head of U.S. Direct Lending [4]

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Thank you, Vijay. Good morning, everyone. We're pleased with our performance in the first quarter of 2019. As Vijay mentioned, our team continues to focus on rotating legacy assets into our stated strategy of upper, middle market senior-secured credits. We were busy this quarter in successfully exiting several of our legacy investments, reducing the size of our concentrated positions and adding new investments consistent with our revised strategy, all with the backdrop of a relatively light-volume quarter in the direct lending market.

As I do each quarter, let me start by sharing some views on the market. First quarter was one of the lowest-volume quarters in the past 3 years for middle-market lending. Private equity buyouts in the middle market remained muted, leading to a general dip of new money financing. Most of the activity was focused on add-on financings and opportunistic refinancings and recapitalizations. This lack of volume was largely driven by volatility experienced in the broader syndicated markets towards the end of the year and a decline in sponsor-to-sponsor buyout activity.

We find that in times like these, there are often attractive opportunities for deploying capital. As Peter will discuss later, we were able to capitalize on some unique opportunities given our relationships with sponsors and club lenders.

We ended the quarter with $213.7 million in fair value of our investment portfolio with 29 possessions, including 28 companies and 1 rated debt security in a CLO. Our NAV per share improved from $11.13 to $11.17 when factoring in share buybacks during the first quarter. Net investment income per share of $0.22 was 1.2x greater than the $0.18 quarterly dividend, and NII per share has consistently exceeded dividend for the past several quarters. We also declared a special dividend of $0.15 payable in July 2019. Ellida will provide more details regarding this special dividend later.

Our regulatory debt-to-equity ratio of 0.58x was consistent with the previous quarter. Leverage remains below our target of 0.75x, giving us dry powder for new investments.

We made several value adjustments in the first quarter to 7 names based on company-specific circumstances, resulting in a slight net increase in unrealized depreciation on investments during the quarter. Write-downs in the quarter included Battery Solutions' equity value by $0.5 million and Envocore's debt and equity by $2.7 million. Both of these write-downs were a result of softness in the financial performance of the respective company.

Write-offs were as follows for Q1: Champion ONE's value by $0.2 million, and Superior Controls Inc. By $0.6 million, both based on realization of the investment; Conisus' equity value by $1.7 million and Lugano's equity value by $0.2 million based on the company's improving financial performance; Goldentree's CLO loan possession by $0.3 million based on mark-to-market during the end of the quarter.

The average portfolio investment on a cost basis was $7.7 million and $7.5 million on a fair value basis. Measured on a fair value basis, first lien debt comprised 70% of the portfolio; second lien positions, 20%; and subordinated debt, 1%.

Equity positions comprised approximately 8%, a slight decrease versus 9% at the end of Q4 2018 measured by fair value.

As we realize the equity investments in the portfolio, we will seek to continue to invest the proceeds in more income-generating assets of upper, middle-market company.

We received proceeds from repayments, loan, dispositions and amortizations of approximately $50 million, while new investments and add-ons totaled approximately $26 million during the quarter and shortly thereafter.

Our weighted average yield on debt investments stayed consistent with last quarter at approximately 11.2%. Total capital transition since the announced strategy shift in the second half of 2017 has been approximately $188 million, including share repurchases. This is an increase of approximately $27 million from Q4 2018.

The team has been very focused on successfully rotating the book and driving growth in book value per share. As Vijay mentioned, we have grown book value per share in each quarter for the past 3 quarters, and I'm confident in our ability to continue this trend.

During the first quarter and shortly thereafter, we realized the following investments, which included optimizing some of our concentrated positions: $6 million of the first lien and $2 million of the second lien of Carlton Group; entire debt and equity holdings of approximately $7 million of Champion ONE; $5 million of Impact Group; approximately $7.5 million of debt and equity investment in Superior Controls; $6 million second lien position on VVC Holding, doing business as Virence; and approximately $15 million in debt and equity investments in FST Technical Services. All of these realizations, we achieved at or above amortized cost. We had only one investment on nonaccrual, Southern Technical Institute, consistent with Q4 2018.

Our watchlist of 8 names has also remained steady. The underlying companies on this watchlist are showing signs of improvement, and we continue to work actively with their management teams and sponsors to monitor the investment.

We believe that our strategy will continue to generate growth in book value per share and provide long-term value creation for stockholders.

Peter will now take you through some of our portfolio originations during the quarter. Peter?

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Peter Glaser, Alcentra Capital Corporation - President & MD [5]

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Thank you, Suhail, and good morning, everyone. As Suhail noted earlier, we remained active in originating sponsor-backed senior-secured credits despite a light-volume environment. This was driven by our team's strong relationships with sponsors and club partners and Alcentra's significant presence in the global subinvestment grade credit market.

Some of the new investments that we made during the quarter and subsequent to the quarter end include Institutional Shareholder Services, a $3 million investment in the first lien and $1.9 million in the second lien of a Genstar portfolio company. This was sourced directly from the sponsor when Genstar merged 2 of their portfolio companies, ISS and Strategic Insight, and we were able to provide support in a syndicated first lien and a privately placed second lien deal.

GCC Imperial Holdings, $8.5 million investment in the unitranche transaction for Golden Gate buyout. This was a secondary purchase from the lead underwriter. We had been monitoring this investment at the end of Q4, and were able to negotiate an attractive purchase price given the market dislocation.

Cambium Learning Group, $4.7 million in the second lien in a take-private transaction by Veritas of this educational software business. This investment was bolstered by the incremental support of our European direct lending platform as announced and discussed as a subsequent event at the end of Q4 2018.

Aegis Sciences Corporation, $4.9 million secondary purchase of the first lien. This was in addition to the $2.4 million we completed shortly after Q4.

In summary we continue to use our relationships and the strengths of the broader Alcentra platform to source attractive opportunities for Alcentra Capital Corporation.

Ellida will now take you through the detail of our Q1 operating results.

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO, CAO, Treasurer & Secretary [6]

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Thank you, Peter. For the 3 months ended March 31, 2019, total investment income was $6.4 million, a decrease of $1.8 million from the $8.2 million of total investment income for the 3 months ended March 31, 2018. This decrease was due primarily to 2 prepayment penalties approximating $1.4 million that was received in the first quarter of 2018, along with the continued transition of the portfolio to senior secured loans.

For the 3 months ended March 31, 2019, interest and PIK income comprised $6.2 million and other nonrecurring income was $0.2 million.

For the 3 months ended March 31, 2019, total net expenses were $3.5 million, after the waiver of management fees, a decrease of $0.7 million from the $4.4 million of total net expenses for the comparable 2018 period. Net expenses decreased primarily due to the management fee reduction and temporary waiver that commenced in May of 2018. The basement management fee was $0.7 million and there was a reversal of previously approved incentive fees of $0.5 million.

For the 3 months ended March 31, 2019, professional fees and other general administrative expenses totaled $1.6 million, an increase of $0.3 million from March 31, 2018. This increase was due largely to an increase in professional fees and director fees, both primarily relating to stockholder activist activities and the Board's formal review process to evaluate strategic alternatives for the company as well as an increase in our excise tax payable. These were offset by a decrease in consulting fees.

We expect that director fees, insurance fees and other professional expenses may increase on a go-forward basis in light of recent stockholder activist activities and the Board's formal review process to evaluate strategic alternatives for the company.

Net investment income for 3 months ended March 31, 2019, was $2.9 million or $0.22 per share as compared to $3.8 million or $0.27 per share for the 3 months ended March 31, 2018. The net realized loss from portfolio investments was $0.5 million in Q1 2019 and the net unrealized depreciation was $0.2 million. The realized losses due to the loss from the sale of Tunnel Hill netted against the gains from the sale of FST common equity. The net unrealized depreciation is due to the reclass of the FST sale of equity from unrealized to realized and the reclass of the Tunnel Hill sale from unrealized to realized along with some small foreign currency translation unrealized appreciation.

Net increase in net assets resulting from operations totaled $2 million or $0.15 per common share for Q1 2019. That's compared to a net increase in net assets resulting from operations totaling $3.5 million or $0.25 per common share for Q1 2018. These are based on weighted average shares outstanding of 12,906,379 and 14,198,651 from March 31, 2019 and 2018, respectively.

As of March 31, 2019, Alcentra had a balance of $4.4 million in cash, $55 million outstanding in InterNotes and $28.6 million in outstanding borrowings under our credit facility.

As Suhail mentioned earlier, the Board of Directors has declared a special spillover dividend in the amount of $0.15 per share to our shareholders. As a RIC, we are required to distribute all or substantially all of our income from a particular tax year to our stockholders by a specified date in the subsequent tax year in order to avoid incurring corporate tax on the income.

In the first quarter of 2018, the Board of Directors lowered our quarterly dividend from $0.25 per share to $0.18 per share due to the expected time needed to effectuate on our then-disclosed portfolio rotation plan.

However, due to the ability of our investment team to manage the perceived troubled credits and the pace at which the team is able to execute on the portfolio rotation plan in 2018, we over-earned the $0.18 per quarter dividend by a healthy margin during 2018, which is reflected in the $0.15 per share special spillover dividend.

I'd now like to turn the call back over to Suhail.

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Suhail A. Shaikh, Alcentra Capital Corporation - CEO & Head of U.S. Direct Lending [7]

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Thank you, Ellida. Before we begin our Q&A, I want to reiterate that our management and investment teams remain focused on our long-term value creation goals while the Board also continues to explore alternatives through its strategic review. We ask that you focus your questions around our first quarter results as we cannot comment further on the strategic review at this time.

We'd now like to open the call for questions and answers. Rusty, would you kindly open the call up?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Leslie Vandegrift from Raymond James.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [2]

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My first question. On the special, you just mentioned in the prepared remarks, over-earning in 2018, thus paying out the special dividend. What was your spillover before you paid it out? And what it -- what will it be after as well?

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO, CAO, Treasurer & Secretary [3]

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So after, we'll have completely, I guess, eliminated the spillover. Coming into 2019, the spillover amount was $11.1 million.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [4]

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Okay. And other -- some other BDCs in the space, not all, but maintain a bit of spillover. How much do you feel is a good level to maintain before paying out going forward?

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO, CAO, Treasurer & Secretary [5]

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So I think a lot of the, I guess, the accumulation there, Leslie, was just on, obviously, we had a change in management, we had a change in strategy. So I think there was a little bit of time needed to wait and see how things would play out. So I think going forward, the management would have to assess what we think is a reasonable amount to keep as spillover. I know that there's a good practice to keep some. I'm not sure that we've necessarily determined an exact figure yet.

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Suhail A. Shaikh, Alcentra Capital Corporation - CEO & Head of U.S. Direct Lending [6]

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Yes. I think we do have some, as Ellida pointed out that we have available. And I guess in terms of the number, we'll just wait and see how the year progresses and the base of our rotation to determine what that offer should be.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [7]

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Okay. And on -- you mentioned Envocore and Battery Solutions in the prepared remarks. Just can you give me a bit more color on those markdowns?

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Suhail A. Shaikh, Alcentra Capital Corporation - CEO & Head of U.S. Direct Lending [8]

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Yes. So the company's Board -- our underlying companies for individual company reasons had some underperformance relative to their budget. In the case of Battery Solutions, really, that markdown was really taken on the equity portion of the investment. In the case of Envocore, we've had to sort of look at both the debt and equity and see where we are on that based on the financial performance.

What I would say to you is that both of those companies since our valuation process, as we have been monitoring, I mean I think they are fairly stable. And so we don't see any further deterioration as we sit here today. And as I mentioned in my remarks, we are monitoring the situations very, very closely along with our other partners in the deal and obviously with the company and the sponsors. So that's all I can say, but I'd say that we don't see a whole lot of downside there relative to what we have -- where we've partnered based on what we know today.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [9]

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Okay. Yes. And my last question this morning. On -- you mentioned in the prepared remarks, the volatility at the end of '18, early '19, allowing you to do some opportunistic investments, ones that may not have been in the wheelhouse before. Which of the new investments did that...

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Suhail A. Shaikh, Alcentra Capital Corporation - CEO & Head of U.S. Direct Lending [10]

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Yes. So Aperio is a good example. That's the deal that we got a look at, at the end of Q4. In fact, we were unable to sort of participate in that transaction given where the pricing was. And once the dislocation happened, we were able to sort of negotiate a fairly attractive price to purchase that investment. Cambium was the other one, very similar sort of a process, which we were monitoring at the end of Q4 and then ended up transacting on it in Q1. And so those are the 2. -- Aegis was also, in fact, similar in that the -- well, it's a large enough loan but really trades more by appointment as opposed to maybe a liquid basis. And so we were able to monitor that loan and be able to pick up a small position in Q4 and then followed it up with another smaller amount in Q1.

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Operator [11]

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(Operator Instructions) We have one more question from Ryan Lynch from KBW.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [12]

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First one, regarding share repurchases. While the Board is doing their strategic review process, will you guys still be able to and do you guys intend to continue to repurchase shares?

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Suhail A. Shaikh, Alcentra Capital Corporation - CEO & Head of U.S. Direct Lending [13]

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Ryan, thank you for the question. Yes. We -- our 10b5 program is in place, and we have not made any amendments to the program. The program itself has some features that will either allow us -- allow the brokers to go into the marketplace to do the purchases or not. So as of now, I think that we had some purchases in February, but we had none in March. So that's -- so we're not eliminating the program if that's the question.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [14]

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Okay. Yes. Yes. I just want to make sure that there was no change in that with the ongoing strategic review. Okay. And then, Ellida, you mentioned as far as the expenses go and the professional fees regarding the recent activity. Is Q1 a pretty good run rate for those fees? Or do you guys anticipate those to actually increase further from the Q1 levels?

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Ellida McMillan, Alcentra Capital Corporation - CFO, COO, CAO, Treasurer & Secretary [15]

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I would say that probably right now, it's a good run rate to use if you're modeling out.

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Operator [16]

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(Operator Instructions) If there are no questions at this time, I would now like to turn the conference back to Suhail Shaikh.

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Suhail A. Shaikh, Alcentra Capital Corporation - CEO & Head of U.S. Direct Lending [17]

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Thank you, Rusty. Thank you, everyone, for joining us this morning for Alcentra Capital Corp.'s first quarter earnings call. We look forward to your interest. And if you have any further questions, please do feel free to reach out to management and we'd be happy to answer them. Thank you, everyone. Rusty, thank you.

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Operator [18]

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This concludes today's conference call. Thank you for joining. Have a wonderful day. You may all disconnect.

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Suhail A. Shaikh, Alcentra Capital Corporation - CEO & Head of U.S. Direct Lending [19]

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Thank you.