Fidus Investment Corp (FDUS) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fidus Investment Corporation's first-quarter 2014 earnings conference call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the call over to Stephanie Prince of LHA. Ma'am, you may begin.

Thank you, Candace, and good morning, everyone. Thank you for joining us for Fidus Investment Corporation's first-quarter 2014 earnings conference call. With me this morning are Ed Ross, Fidus Investment Corporation's Chairman and Chief Executive Officer, and Cary Schaefer, Chief Financial Officer and Chief Compliance Officer.

Fidus Investment Corporation issued a press release yesterday afternoon with details of the Company's quarterly financial results. A copy of the press release is available at the Investor Relations page of the Company's website at fdus.com.

I would like to remind everyone that today's call is being recorded. A replay of today's call will be available by using the telephone numbers and conference ID provided in the earnings press release.

In addition, an archived webcast replay will be available on the Investor Relations page of the Company's website at fdus.com following the conclusion of this conference call.

I'd also like to call your attention to the customary Safe Harbor disclosure regarding forward-looking information included in the earnings release. The conference call today will contain certain forward-looking statements, including statements regarding the goals, strategies, beliefs, future potential, operating results, and cash flows of Fidus Investment Corporation. Although management believes these statements are reasonable based on estimates, assumptions, and projections, as of today May 9, 2014, these statements are not guarantees of future performance. Time-sensitive information may no longer be accurate at the time of any telephonic or webcast replay. Actual results may differ materially as a result of risks, uncertainties and other factors including but not limited to the factors set forth in the Company's filings with the SEC. Fidus undertakes no obligation to update or revise any of these forward-looking statements.

I'd now like to turn the call over to Ed Ross. Ed?

Thank you, Stephanie, and good morning, everyone. Welcome to our first-quarter 2014 earnings call. Today I will begin with highlights of our results for the first quarter before discussing current market conditions, investment activity and the performance of our investment portfolio. I will then turn the call over to Cary who will go into more detail about our financial results and liquidity position before we open up the call for questions.

After an outstanding 2013, the first quarter of 2014 was a solid start to the new year. Fidus's business fundamentals remain strong, and we generated net investment income of $5.4 million or $0.40 per share. Our adjusted net investment income, which we define as net investment income excluding any capital gains incentive fee attributable to realized and unrealized gains and losses, was $5.1 million or $0.37 per share. We realized net capital gains of approximately $1.8 million from two portfolio companies. As of March 31, 2014, net asset value was $15.22 per share.

As we said on our last earnings call, the Board of Directors regularly reviews our distribution policy as they seek to balance and maintain capital allocation flexibility. This quarter due to our spillover income and realized capital gains, we are pleased to report that on May 5th our Board of Directors declared two special cash dividends totaling $0.10 per share. These are in addition to the regular quarterly dividend for the second quarter of $0.38 per share, which is payable on June 27, 2014 to stockholders of record on June 13, 2014. Special dividends are comprised of two equal payments of $0.05 per share and will be payable in July and August of 2014.

Since the beginning of the year, market fundamentals have remained sound, and for Fidus deal flow has been relatively strong and up on a year-over-year basis. We continue to manage our business with a focus on performing well over the long term. This means we are willing to be patient for the right opportunities to add to our investment portfolio. And for this reason, the number of new investments we make will vary from quarter to quarter. As an example, we closed on one new portfolio company investment this past quarter compared to adding five new portfolio company investments in Q4 of 2013.

Another result of our quality over quantity approach is that our senior secured, our unitranche debt portfolio, has increased from approximately 12% of our portfolio a year ago to just over 19% on a cost basis as of March 31.

As many of you have heard us say before, we seek to invest in high quality, lower middle-market companies that are market leaders in their respective niches that operate in industries we know well to generate excess free cash flow for debt service and investment and have positive long-term outlooks. And from a debt structuring perspective, we look to maintain significant cushions to our borrower's enterprise value in support of our capital preservation and income goals. While we continue to be opportunistic in the broader lower middle-market, we also continue to be highly disciplined, maintaining our focus on capital preservation and attractive risk adjusted returns for our shareholders.

Now turning back to the first quarter, as of March 31, 2014, we had debt and equity investments in 37 portfolio companies with a total fair value of $310 million, which represented approximately 96% of costs. And despite the high level of repayments and realizations that we experienced over the last 12 months, we increased our investment portfolio on a cost basis by approximately $42 million or 15% year over year.

We invested $17.3 million in one new and four existing portfolio companies. At the end of the quarter, we made an $18.7 million debt and equity investment in FAR Research, a leading developer and manufacturer of specialty and fine chemicals to a diversified set of end markets. We made add-on investments in four existing portfolio companies during the quarter, including $6 million in FCA packaging.

We received proceeds from repayments and realizations that totaled approximately $13.6 million from four portfolio companies during the quarter, including net realized capital gains of approximately $1.8 million from two of those companies. First, our subordinated loan investment in Apex Microtechnology was fully repaid. However, we continue to hold our equity in warrant investments. This repayment was driven by strong company performance, which hopefully will benefit our remaining equity investments in Apex.

Second, we successfully exited our debt and equity investments in Nobles Manufacturing in connection with a sale of the company and as a result recognized a net realized gain on our equity investment of approximately $1.7 million. We are extremely pleased with this outcome, which demonstrates our strategy of investing in sectors where we have a differentiated level of experience. In this case, the aerospace and defense sector.

Unfortunately due to increased risk and uncertainty of one of our portfolio companies, S.B. Restaurant Co., we have written our investment in this company down to zero. Obviously a very disappointing situation. However, I would highlight that write-downs and losses are part of our business, and it is because of this business reality and in the effort to mitigate such losses that we have established an investment strategy to maintain a well-diversified investment portfolio.

We also continue to believe that creating a high-quality equity portfolio can provide not only incremental profits but also a reasonable margin of safety.

Turning to our portfolio performance, we tracked several quality measures on a quarterly basis to help us monitor the overall stability, quality and performance of our investment portfolio, which we are pleased remains strong and in line with prior periods.

First, we track the portfolio's weighted average investment rating based on our internal system. Under our methodology, 1 is outperform and 5 is an expected loss. As of March 31, the weighted average investment rating for the portfolio was two on a fair value basis which is consistent with prior periods. The credit performance of the portfolio remains solid as well with our portfolio company's combined ratio of total net debt through Fidus's debt investments to total EBITDA of 4 times. We believe this is a prudent level of risk for our portfolio.

And finally, we track the combined ratio of our portfolio company's total EBITDA to total cash interest expense, which was 3 times in the first quarter. We believe that this level is an indicator that our portfolio of companies as a whole currently has significant cushion to meet their debt service obligations to us. Overall these metrics reflect our long-standing conscious and deliberate investment approach which continues to remain intensely focused on capital preservation.

In summary, the first quarter was a solid start to the year. Business fundamentals remain healthy. The market is competitive but sound, and deal flow activity levels are relatively strong for Fidus. In this current, stable to slow growth economic environment, we believe that deal flow levels should remain consistent with what we are seeing now. And due to the sheer size and fragmentation of the lower middle market, our target market continues to be attractive and generally less competitive than the broader markets. To drive our business, we continue to focus on our strengths, including our relationship base, industry knowledge and ability to offer flexible capital solutions.

In looking forward, we will maintain our highly selective investment approach as we believe that our strategy of investing in high-quality businesses with strong market positions and positive long-term outlooks will continue to result in the generation of attractive risk-adjusted returns for our shareholders.

Now I'll turn the call over to Cary to provide some details on our financial and operating results. Cary?

Thank you, Ed, and good morning, everyone. I will now review our first-quarter results in more detail and close with comments on our liquidity position.

Total investment income was $10.6 million for the three months ended March 31, 2014, an increase of $0.7 million or 7.6% over the $9.8 million in total investment income for the three months ended March 31, 2013. This increase was primarily attributable to higher average outstanding debt investments, as well as investment related activity during the first quarter of 2014, compared to the first quarter of 2013. Interest income increased 6% to $9.6 million compared to $9 million in the prior year quarter. Dividend income was roughly flat with last year at just under $400,000. Fee income, which fluctuates from quarter to quarter depending on the level of new investments or prepayment activity, was $610,000 for the first quarter of 2014 compared to $406,000 in last year's first quarter, primarily as a result of an increase in prepayment activity. Total expenses, including income tax revisions, were $5.1 million for the first quarter, an increase of $0.2 million or 4.6% over the $4.9 million of total expenses at the same period last year. Interest expense on our SBA debentures was approximately $1.8 million for the first quarter of 2014, in line with the first quarter of 2013.

As of March 31, 2014, the weighted average fixed interest rate on our SBA debentures remained at 4.6% before fees. The base management fee increased $0.1 million due to higher average outstanding total assets plus cash during the first quarter of 2014. Incentive fees in the first quarter of 2014 decreased $0.3 million, driven by a capital gains incentive fee reversal of $0.4 million in connection with a net loss on investments after realized gains of $2.1 million.

Administrative service expenses, professional fees and other general and administrative expenses totaled approximately $1.1 million for the quarter, 63% higher than the first quarter of 2013, which totaled approximately $699,000. This increase was primarily due to an increase in personnel and change in timing of audit-related work.

Net investment income or NII for the three months ended March 31, 2014 increased by 10.6% to $5.4 million or $0.40 per share compared to $4.9 million or $0.38 per share for the first quarter of 2013. Adjusted NII was $5.1 million or $0.37 per share for the first three months of 2014 compared to $4.9 million or $0.38 per share for the first quarter of 2013.

Adjusted NII is defined as net investment income, excluding any capital gains incentive fee expense or reversal attributable to realized and unrealized gains and losses on investments. A reconciliation of NII to adjusted NII can be found in our earnings press release that was issued yesterday afternoon and is also posted on the Investor Relations page of our website.

For the three months ended March 31, 2014, Fidus realized capital gains on investments net of taxes of $1.8 million resulting from exits in investments in two portfolio companies as Ed discussed earlier. We recorded net unrealized depreciation on investments of $3.9 million for the first quarter of 2014, which is comprised of unrealized depreciation of $1.9 million related to the reversal of unrealized appreciation upon the exit of investments during the quarter.

Also includes net unrealized depreciation of $3.4 million on debt investments, partially offset by net unrealized appreciation of $1.4 million on equity investments. Taken together, these activities resulted in a net increase in net assets resulting from operations for first quarter of 2014 of $3.4 million or $0.25 per share compared to a net increase in net assets resulting from operations of $4.6 million or $0.36 per share for the first quarter of 2013.

Per share income results for the quarter ended March 31, 2014 are based on weighted average shares outstanding of 13.8 million compared to 12.9 million weighted average shares outstanding for the first quarter of 2013. This increase reflects a common equity offering Fidus completed in February of 2013, which was completed at a price accretive to net asset value. Our net asset value at March 31, 2014 was $15.22 per share, which reflects payment of the $0.38 per share regular dividend in March.

Turning now to portfolio statistics. As of March 31, our total investment portfolio had a fair value of $310.4 million, approximately 96% of cost, and consistent with our debt-oriented investment strategy, our portfolio on a cost basis was comprised of approximately 66% subordinated debt, 19% senior secured loan, and 15% equity and warrant securities. Our average portfolio company investment on a cost basis was $8.7 million at the end of the first quarter. We had equity investments in approximately 92% of our portfolio companies with an average fully diluted equity ownership of 7.6%. Weighted average effective yields on net investments was 14.4% as of March 31, 2014, in part reflecting the higher mix of senior secured loans in our portfolio on a year-over-year basis. And we have investments in one portfolio company on nonaccrual status, which are excluded from our weighted average effective yield on debt calculations.

As of March 31, 2014, our liquidity and capital resources included cash and cash equivalents of $40.7 million in unfunded SBA commitments of $30.5 million. In addition, we have access to an additional $15 million of SBA leverage. These resources provide Fidus with ample capital to support its growth and diversification goals.

Now I will turn the call back to Ed for concluding comments. Ed?

Thanks, Cary. As always, I would like to thank the outstanding team at Fidus and our shareholders for their continued support.

Before turning the call back over to Candace, I have an additional announcement to make. As you may know, last November we disclosed a CFO transition with Cary moving back to the senior investment professional role while retaining her position as Chief Compliance Officer. I'm pleased to announce that we have completed our search for a new CFO and that we are appointing Shelby Sherard to the position effective June 2, 2014. Shelby is an accomplished financial executive from the financial services industry with the applicable set of skills in accounting and tax, public company experience, and leadership capabilities that we are looking for. We are thrilled she is joining Fidus, and we look forward to her contributions to our business success.

I'd also like to thank Cary for ensuring a smooth transition of CFO responsibilities and for all her efforts and great contributions towards our success. Great job, Cary. Thank you very much. I will now turn the call back over Candace for Q&A.

(Operator Instructions). Bryce Rowe, Robert Baird.

Thinks. Good morning, Cary.

Good morning, Bryce.

Good morning.

A couple -- I guess a couple of questions here. As you talked about the nonaccrual having written it down to zero, just trying to understand what your thought process is in terms of how that credit ultimately gets resolved -- timeline, etc. And then if you could also comment on the status of the Rio investment and how that is playing out today?

Sure. Thanks, Bryce. With regard to S.B. Restaurant Co., certain segments -- I think I mentioned this last call -- the casual dining industry are being meaningfully impacted by a variety of issues, but most importantly I think are competitive pressures. Also, certain geographic regions -- in particular, ones this company operates in are also highly competitive.

So it is a situation where the level of risk has increased substantially again this quarter, and thus the write-down and the overall uncertainty of the situation is also much higher. That's probably all I care to comment on at this point. I mean, it's a tough situation is what I would say.

With regard to [Navreo], obviously this Company has been an investment of ours for a while. Navreo has not performed to our expectations, as you well know. There continues to be a higher level of risk as reflected in the valuation. Sequestration has not helped certain of these companies and markets, quite frankly. We are very pleased with the operating improvements that the new management team has made. Upon having said all that, the valuation reflects a very high level of risk, which is the situation.

Ed, that's helpful. And then just I guess a follow-up, you guys have quite a bit of spillover income. Obviously you are going to contribute some of that here in this first quarter with still some surplus leftover. I can certainly understand your comments about the board maintaining some flexibility. How do you guys think about that surplus -- especially relative to how much it actually is. It's a good problem to have, but maybe just some commentary on how you are thinking about it.

Sure. Sure. Well, and I think I mentioned some of these before, but if you think about the board and really the management team's objectives, first and foremost, it is to deliver long-term value to our shareholders in the form of stable and growing dividends. That includes making periodic special distributions over time as it makes sense to the board.

We also have a goal of growing our net asset value on a per-share basis over time as we believe that is a winning long-term strategy whereas a declining NAV is a much tougher strategy, as you well know.

And lastly, I'd say we are a pretty conservative bunch. We intend on managing the business with a very high margin of safety. So with regard to distributing spillover income, I think that the board will continue and has every quarter will continue to consider our spillover position and how it will be utilized on an ongoing basis, I'd say through 2014 and thereafter.

As you are aware, we made two special distributions last year, and we are obviously very pleased to announce the additional two distributions here in the third quarter. And finally, I'd say there's quite a bit of time left in this year. I think we like the idea of letting the year unfold a little bit more before we make too big decisions. But at the same time, you know, the balance for us is balance, quite frankly. It is balancing distributions, it is balancing growing our NAV, and it is balancing periodic special distributions, which we will continue to think about as we move forward.

Thanks, Ed. That's helpful

Okay.

Robert Dodd, Raymond James.

Hello, everybody. A couple of questions specifically on the numbers. On the OpEx level, Cary, you mentioned some of that was due to timing of audit work, which I obviously continual audits at year end. Q1 tends to be higher. Can you give us any color on how much of the total OpEx was kind of one time or -- another way of looking at it -- what's the returning run rate you would expect from the combination of those line items, given an average period of activity? Obviously it varies with originations as well.

Sure. No, it is a good question, and obviously one of the drivers of the expense increase is the admin fee itself. I think when you look at it on a year-over-year basis, it did increase between Q1 of 2013 and 2014, but it is relatively consistent with our Q4 levels, which just reflects the hires that we made during the back half of the year. So I think that kind of explains part of the increase.

With respect to the timing, I think we did several things -- some of the audit work got pushed into Q1. We also have moved up some of our shelf registration, and then there's some other related work. And I kind of -- I will look at that as in probably the hundred thousand dollar range, is what that dollar amount shift is. And then I think the other thing, we obviously have other expenses that come periodically throughout the year, but I do think something in that range would make sense.

Okay. Were there -- at the top line were there any reversals or any unusual items because, frankly, when I look at it stripping out all the fees -- the upfront as well as the transaction fees, which you have now split out in the press release, which is handy -- and looking at the fact that your Q1 average portfolio -- obviously the ending portfolio is relatively comparable, but it grew a lot during the fourth quarter by an average that was below the ending value. Q1 average significantly higher than Q4, yet adjusted for fees, the interest income was actually down sequentially. So were there reversals? Were there a lot of amendments during the quarter that drove down coupons? I mean can you give us more color on why that interest income dropped with the larger average portfolio?

Well, you should answer first, then I'll comment.

I think -- I guess with the breakout of the fees -- if you exclude the fees from our investment income for the quarter, we are really up just about $600,000 quarter over quarter on a total interest income line

kind of combined with a dividend income. And there's not anything I would say unusual in there. I do think we are seeing as you look back at a year ago that the yields have come down on the portfolio relative to where we were Q1 of 2013, and I think as we highlighted some of that has to do with the increase in the mix of senior secured loans, as well as just ongoing market condition.

But I think on an overall basis we are up -- like I mentioned, that is $600,000 or so, and there isn't anything unusual in there.

Just if I can interrupt there because just to clarify those numbers exactly, I mean the total fee income upfront and transaction fees in the fourth quarter was $1.214 million. So the interest income ex all those fees was [95] in the first quarter taking out upfront and transaction fees, which were just over $700,000. That's [945]. So that certainly doesn't look up $600,000 to me. So am I missing something here?

That's apologies. I was comparing Q1 of 2013. I missed that you were comparing Q4. I apologize. No -- and I think the increase in the portfolio -- I mean we did make the investment increase in Q1 came at the very end of the quarter -- excuse me. So it is up slightly, but it hasn't kind of had its full chance to contribute to the portfolio -- I mean, to the income for the quarter.

And we also had one repayment on June 2nd.

Correct.

So that was early on. I think -- Robert, I'll just add one other comment back to this yield. Obviously our yield went down -- on the debt portfolio went down from 14.5% to 14.4% from year end. If you go back to the third quarter -- and I'm going from memory here, so no one hold me to this, but I think we were more like -- I think there was a decline in the yield during that quarter, which is kind of like 14.8% to 14.5%. But I think that is -- those are the only comments that I would make or add to the discussion.

Thank you. And then -- just kind of the outlook for the year -- I mean some of your comments in terms of any time a management team start to say we are willing to be patient for the right opportunities -- I mean, A), that's good because obviously as investors don't want to lose NAV and capital.

On the other hand, it does sound that perhaps you are not seeing the quality of opportunities that you hoped to see. Is there anything more you could add to that, and maybe the deployment ramp is going to take longer than you had previously thought? Is that kind of a quality of deals or any more color would be helpful there?

Sure. It's a great question, Robert. I think for us, as we mentioned in our prepared remarks, we mentioned this a couple of times. We have made a concerted effort as a management team to drive an increased origination, and I think we've done a nice job of that.

So then the natural question would be, okay, what's the hip ratio? And the hip ratio has probably gone down a little bit, I would say. And your comment of is the quality as good, I would probably suggest not materially worse, but definitely we are being very careful right now. And if the quality is not there, we are shying away. And so I do think there probably is an overall mix of the quality -- on an overall mix basis, the quality has maybe gone down a little bit.

The other piece is, there's competition out there, right? So I think you've got to add those two elements together, and what I will tell you is again the environment is stable. Deal flow is pretty good. I think we are being very patient in how we kind of proceed, and we really are trying to manage the business. We mentioned these in our comments as well -- very much on a long-term basis. And so we want to do is try to have the highest quality investments and are focused on risk-adjusted returns, which also gets to the fact that we increased our unitranche or secured debt portfolio, and that's primarily on the lower end of the market. But we are seeing on a relative basis very attractive risk-adjusted returns in that segment.

So it's a balanced approach. Quality probably is down just a little. But I think, you know, you've got to combine that also with there is competition out there and us operating in what I would say is a very deliberate manner.

Thank you for the color.

Sure. Absolutely. Good talking to you, Robert.

Vernon Plack, BB&T.

Thank you. Ed, I was looking for just a little more clarification. I know that you touched on the origination activity and how maybe this past quarter is indicative of what you're expecting going forward. I'm just trying to get a sense as I look just in terms of recent past. I think for the past five quarters, your originations averaged around $33 million a quarter, and last quarter was roughly half of that.

So just in terms of new business, obviously it's very lumpy. I mean in the fourth quarter, you did [70], and in the fourth quarter -- in the first quarter, you did [17]. So it does move around. But I'm trying to get a sense for just what you hope to originate this year. Last year's total I think was [149] in new investments. Are you expecting that type of investment activity for 2014, or is it going to be closer to that [17] a quarter number?

Good morning. It is a great question. I think what we were trying to articulate is a couple of things. One is you know it is a lumpy business, and that's actually the way we are obviously managing the business.

I think originations going forward -- if you go back actually a couple of years and we spent a lot of time talking about this -- our goals when we first were a public company were to invest call it $15 million to $25 million per quarter, knowing that we could be on either side of that at any point in time.

You know, I think we are continuing to try to grow the portfolio in a very methodical basis, and that is what we would expect going forward. But it's hard to predict originations, and it's also hard to predict repayments. So, as I think about it, last quarter was a light quarter for us, and I will tell you we will have more light quarters. But that would not be in my opinion as I look here today the expectation for every quarter or the expectation going forward.

So we are going to continue to have quarters like this, but at the same time, I think deal flow is robust enough to also have quarters that are greater than this quarter.

Okay. That's okay.

I don't know if that's helpful. I'm being a little careful with my words. It's hard to predict the outcome.

I completely understand how difficult that is. I do know that what we are hearing from some others as well is that our prepayment activity is actually expected to be -- no guarantees -- but expected to be probably less than it was in 2013. I know 2013 was a fairly high year for you in terms of exits -- in fact, net growth for the year was just $18 million. So does it feel as though the repayment activity would probably be less than it was last year?

Yes. I think so. I think, there's a couple of things -- when you look at last year, we had a couple or several companies where they were actually almost reduced, where there were repayments, as well as new investments. So recapitalizations. So those numbers are a little bit high.

I would say repayments this year -- our view is we have a pretty mature portfolio at this point. It will continue to be a part of the business. We do believe it will be less than 2013 -- very much so. But at the same time, we will continue to have repayments every quarter or something close to that, I would suggest.

Okay. Well, that's helpful. Thank you.

Absolutely. Good talking to you, Vernon.

Chris Kotowski, Oppenheimer.

I'm sorry. My questions were asked and answered. Thank you.

Thanks, Chris.

And I'm showing no further questions at this time. I would now like to turn the call back over to Mr. Ed Ross for any closing remarks.

Thank you, Candace, and thank you, everyone, for joining us this morning. We look forward to speaking with you on our second-quarter call in early August. Have a great day and have a great weekend.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all discuss. Have a great day, everyone.