Fidus Investment Corp (FDUS) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fidus Investment Corporation's second quarter 2014 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference is being recorded. And I would like to introduce your host for today's conference, Miss Stephanie Prince, of LHA. You may begin.

Thank you, Sam, and good morning, everyone. Thank you for joining us for Fidus Investment Corporation's second quarter 2014 earnings conference call. With me this morning are Ed Ross, Fidus Investment Corporation's Chairman and Chief Executive Officer; and Shelby Sherard, Chief Financial 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 August 8, 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 second quarter 2014 earnings call. Before I begin my comments, I'd like to introduce Shelby Sherard. As many of you know, she joined Fidus in early June. Shelby brings a wealth of relevant experience to Fidus and has been a valuable addition to our firm. So, you've got another welcome Shelby.

Thank you.

For today's call, I'll start by highlighting our results for the second quarter before discussing current market conditions, investment activity, and the performance of our investment portfolio. I'll then turn the call over to Shelby who will go into more detail about our financial results and liquidity position before we open up the call for questions.

Turning to second quarter highlights, we generated solid financial results producing net investment income of $5.5 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. As of June 30, 2014, net asset value was $15.09 per share.

Our business fundamentals remain strong. Deal flow has been strong for Fidus. Market activity has increased. And we are well-positioned for a more active second half of the year. Furthermore, I'm pleased to report that in June we established our first revolving credit facility, a $30 million line led by ING Capital, enabling us to diversify our funding sources for future investment opportunities.

The board of directors has declared a regular quarterly dividend for the third quarter of $0.38 per share, which is payable on September 26, 2014 to stockholders of record on September 12th, 2014. Furthermore, in light of our available spillover income, the board previously declared two special dividends totaling $0.10 per share. The first special dividend of $0.05 per share was paid on July 31st and the second special dividend of $0.05 per share will be paid on August 29, 2014 to stockholders of record on August 25, 2014.

Regarding our dividend distributions, we seek to balance and maintain capital allocation flexibility. Our primary objective is to deliver long-term value to our shareholders in the form of stable and growing dividends including periodic special dividends. We also have a goal of growing our net asset value on a per-share basis over time. Balancing these goals is important to us and the board will, as before, consider these objectives when making distribution decisions.

Since the beginning of the year, activity levels have increased for Fidus and we are expecting a more robust second half of the year. M&A pipelines are reported to (inaudible) and we're starting to see the benefit of these higher levels of activity. Relative to 2013, deal activity in 2014 has been more M&A-driven, involving multiple players versus refinancing. As a result, Fidus has experienced a lengthening of transaction closing cycles.

We do expect more investment opportunities to come to fruition in the second half of the year. For example, we invested $10.5 million on July 3rd in one new portfolio company and, just yesterday, we invested $20 million in another. I'll discuss both in further detail shortly.

We continue to remain patient and disciplined, focused on capital preservation and performing well over the long term. One result of this approach is that our senior secured or unitranche debt portfolio has increased from approximately 11% of our portfolio a year ago to just over 21% on a cost basis as of June 30th. As we've said in the past, the number of new investments we close will vary quarter by quarter.

As of June 30, 2014 we had debt and equity investments in 37 portfolio companies with a total fair value of $310 million, which equates to approximately 96% of cost. And despite the high level of repayments and realizations that we've experienced over the last 12 months, we increased our investment portfolio on a cost basis by approximately $37.8 million or 13% year over year.

In May we completed a $6 million debt investment in Oaktree Medical Centre, which does business as Pain Management Associates. This new portfolio company is an operator of healthcare clinics and toxicology laboratories focused on the treatment of patients suffering from chronic pain or acute pre- and post-operative conditions.

In the second quarter we received proceeds from repayments and realizations of $5.8 million from Convergent Resources as payment in full on their subordinated notes. This repayment was driven by the sale of the company.

As I mentioned earlier, we made investments in two new portfolio companies subsequent to quarter end. We invested $10.5 million in subordinated notes and common equity of U.S. Greenfiber LLC, a leading manufacturer of residential recycled fiber insulation products across the United States. We also invested $20 million in second-lien notes in Pinnergy, a leading provider of fluid management and drilling services for oil and gas wells located throughout Texas and Louisiana.

Durign the second quarter we wrote down our investment in Avrio to zero and placed the debt investment on non-accrual due to a meaningful increase in the risk in this investment. We also put the PIK interest of Paramount Building Solutions on non-accrual status as we work to better position the company for future growth.

Write-downs and losses are an inevitable part of our business. It is because of this business reality and in the effort to mitigate such losses that we have an investment strategy that includes maintaining 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 for Fidus. When evaluating our portfolio as a whole, we remain pleased with the overall quality and construct of the portfolio.

Turning to portfolio performance, we track several quality measures on a quarterly basis that help us monitor the overall stability, quality, and performance of our investment portfolio, which we are pleased remain strong and in line with prior periods. First, we track the portfolios weighted average investment rating based on our internal system. Under our methodology, a rating of 1 is outperform and a rating of 5 is an expected loss. As of June 30th, the weighted average investment rating for the portfolio was 1.9 on a fair value basis, in line with prior periods.

The credit performance of the portfolio remains solid as well with our portfolio companies' combined ratio of total net debt to Fidus' debt investments to total EBITDA of 3.7 times. We believe this is a prudent level of risk for our portfolio.

And, finally, we track the combined ratio of our portfolio companies' total EBITDA to total cash interest expense, which was 3.3 times in the second quarter. We believe that this level is an indicator that our portfolio companies, as a whole, currently have significant cushion to meet their debt service obligations to us. Overall, these metrics reflect our longstanding cautious and deliberate investment approach.

From a debt structuring perspective, we look to maintain significant cushions to our borrowers' enterprise value in support of our capital preservation and income goals. As we've said many times, we seek to selectively invest in high-quality, lower middle market companies that are market leaders in their respective niches, that operate in industries we know well, that generate excess free cash flow for debt service and investment, and have positive long-term outlooks. And due to the sheer size and fragmentation of the lower middle market, our target market continues to be active and attractive and generally is less competitive than the broader markets.

This strategy, combined with Fidus' competitive differentiators, our relationship base, industry knowledge, and the ability to offer flexible capital solutions will, we believe, continue to result in the generation of attractive risk-adjusted returns for our shareholders. Now, I'll turn the call over to Shelby to provide some details on our financial and operating results. Shelby?

Thank you, Ed, and good morning, everyone. I'm pleased to say that I've now been at Fidus for two months and am very excited to be here. As I look forward to getting to know everyone, please do not hesitate to give me a call with any questions that you may have. I'll now review our second 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 June 30, 2014, an increase of $0.1 million over the $10.5 million of total investment income for the three months ended June 30, 2013. Interest income was $9.3 million compared to $9.6 million in the year-ago period, a decrease of 3%.

Dividend income increased to $513,000 up from $350,000 in the last year's second quarter. This was due to an increase in the income-generating preferred equity securities in the portfolio. Fee income, which fluctuates from quarter to quarter depending on the level of new investments or prepayment activity, was $783,000 for the second quarter of 2014 compared to $465,000 in the last year's second quarter primarily due to a $552,000 prepayment fee related to the Convergent Resources repayment.

Total expenses were $5.1 million for the second quarter, a decrease of $2.2 million or 30.6% over the $7.3 million of total expenses in the same period last year. Interest expense was approximately $1.8 million for the second quarter of 2014, roughly in line with the second quarter of 2013. Interest expense includes the interest paid on Fidus' SBA debentures as well as the commitment fee on our recently-closed line of credit.

As of June 30, 2014, the weighted-average fixed interest rate on our SBA debentures was 4.5% before fees. The base management fee was in line with the prior-year period. The incentive fee declined by $2.5 million to $853,000.

Administrative service expenses, professional fees, and other general and administrative expenses totaled approximately $1 million for the quarter, 23% higher than the second quarter of 2013, which totaled approximately $831,000. This increase was primarily due to a year-over-year increase in personnel. Included in expenses for the Q2 2014 are some one-time items related to corporate legal expenses and the CFO transition that come to approximately $100,000.

Net investment income, or NII, for the three months ended June 30, 2014 was $5.5 million or $0.40 per share, while adjusted NII was $5.1 million or $0.37 per share. 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.

For the three months ended June 30, 2014, Fidus realized $59,000 in capital gains on investments net of taxes related to an escrow payment. We recorded a change in unrealized depreciation on investments of $2.1 million attributable to net unrealized depreciation of $4.1 million on debt investments, primarily related to non-accruals, and net unrealized appreciation of $2 million on equity investments. Taken together, these activities resulted in a net increase in net assets resulting from operations for second quarter of 2014 of $3.4 million or $0.25 per share.

Per-share income results for the quarter ended June 30, 2014 are based on weighted-average shares outstanding of 13.8 million. Our net asset value at June 30, 2014 was $15.09 per share, which reflects payment of the $0.38 per share regular dividend in June.

Turning now to portfolio statistics as of June 30th, our total investment portfolio had a fair value of $310.5 million or approximately 96% of cost. And consistent with our debt-oriented investment strategy, our portfolio on a cost basis was comprised of approximately 64% subordinated debt, 21% senior secured loans, and 15% equity and warrant securities, which reflects a modest increase in the mix of senior secured debt investments in the Fidus portfolio. For comparison, at June 30, 2013, our portfolio was comprised of approximately 74% subordinated debt, 11% senior secured loans, and 15% equity and warrant securities.

Our average portfolio company investment on a cost basis was $8.8 million at the end of the second quarter. We have equity investments in approximately 91.9% of our portfolio companies with an average fully-diluted equity ownership of 7.6%.

Weighted-average effective yield on debt investments was 14% as of June 30th. The weighted-average yields are computed using the effective interest rates for debt investments at cost including the accretion of original-issue discount and loan origination fees, but excluding investments on non-accrual. The higher repayment levels over the past 15 months have also impacted the portfolio yield as some higher-yielding loans have been paid off and replaced with loans priced at current market rates, which are lower than the rates on the more mature loans.

As of June 30th, our liquidity and capital resources included cash and equivalents of $40.7 million and unfunded SBA commitments of $29.5 million. In addition, we have access to an additional $50 million of SBA leverage and, as Ed mentioned, we broadened our funding sources during the quarter by closing on a $30 million line of credit.

On a final note, before turning the call back to Ed, on June 30th Fidus received exemptive relief on our second SBA fund, which simply means that SBA debt outstanding is not considered senior securities for purposes of asset coverage requirements. Now, I will turn the call back to Ed for concluding comments. Ed?

Thanks, Shelby. As always, I'd like to thank the outstanding team and the board of directors at Fidus for their hard work and our shareholders for their continued support. I'll now turn the call over to Sam for Q&A.

(Operator Instructions). Bryce Rowe, Robert W. Baird.

Thanks. Good morning.

Good morning, Bryce.

Ed, I just wanted to ask a couple of questions. First, on the credit facility. With the level of availability within the SBA debenture program and then now the new credit facility, just wondering how we as analysts should think about usage of that credit facility relative to the SBA over the near term as you book more investments.

Sure. Great question, Bryce. I think, obviously what the credit facility does for us is a few things. It just increases our liquidity at both the holding company for investment and for other purposes. I think, as we look at it -- and those other purposes would include non-SBIC deals.

But I would say we're going to continue to obviously invest cash. I think that's the smartest thing. And then we have the $30 million line of credit for further liquidity. But, once we get to that point, if the transactions that we are closing or investing in fit the SBIC, then our intent would be to continue to use the SBIC program to its fullest extent. So, that's how we're going to kind of think about it and move forward. Is that helpful?

Yes, that is helpful. Second question, unrelated. You've obviously booked some investments subsequent to quarter and Shelby noted the, I guess, spread compression or pricing compression you've experienced over the last 15 months, although somewhat minimal relative to the rest of the industry. Just trying to get a feel for the yields that might have come with the newer investments and any feel for what kind of spread compression of pricing compression you'd expect over the near term. Thanks.

Sure. It's a great question and I'll give you a little detail But, yields, as you know, have come down over the last 12 to 18 months. And we have tried to do a good job of maintaining our yields. I would say that the investments that we made here in the third quarter or early on in the third quarter have been lower than what they were in the first half of the year on a weighted-average basis. These companies, both of them, are probably what I would say larger lower middle market companies and what comes with that is a little bit lower yield. So, one of them is in the, call it, the mid 11s% and the other one is in the mid 12s%. The first one I just mentioned is a second-lien investment on a larger portfolio company.

You know, as we look forward, Bryce, just a couple more comments, I do think yields will continue to come down a little bit. If I look at how we've been investing over the past 12 months or so, yields are at lower rate generally speaking, not materially so, but generally speaking, lower rate than what our portfolio yields today. So, I would expect it to continue to come down a little bit, but not in big movements.

Okay, that's helpful. Thanks.

Yes, absolutely. Good talking to you, Bryce.

Robert Dodd, Raymond James.

Hi, guys. And actually just to follow up on a couple of Bryce's. On the pricing side, as you said in the comments, you've gone from unitranche, for example, 11% a year ago to 21% now. Obviously, that's not the same as a straight mezz, but how much of the pricing, if you can give us any color is kind of like-for-like versus -- and you mentioned here obviously larger companies at a lower price. Unitranche is usually priced a little bit differently than straight mezz. How much of it is mix-related versus like-for-like pricing and the mix, obviously, on your choice to move a little bit larger companies and shift to a little bit more senior secured than straight mezz?

Yes, it's a very good question, Robert, and it's kind of hard to give you an exact answer. I don't have that detail in front of me. But, I will tell you that the unitranche investments that we have made, our whole portfolio is actually still yielding quite well, even our mezz portfolio. But the one that we made in the first quarter, for instance, was in the mid 11s%, I believe. So, you're definitely going to have -- and so, that over the last 12 months, definitely has impacted our yields a little bit.

And then I would say, from a mezzanine perspective, what we're seeing in the market, and it really depends on the size of the company -- is it a $15 million EBITDA business or is it a $3 million EBITDA business -- the pricing ranges really in the 11% to 14%. And depending on that size is where the pricing is going to end up. We have seen people, for great investments on the subordinated debt side, actually go to 10% but it was a much larger EBITDA business and very high free cash flow and what I would consider on a comparative basis, moderate leverage. So, risk-adjusted returns is how we think about the business. But, I think both mezz returns and the mix has impacted our overall yields a little bit.

Okay, great. Another one on the cash liquidity. I mean I don't know if you have this number handy, but how much of the cash you have on hand is currently at the holding company versus within an SBIC vehicle where you can't get at it for anything but an SBIC-eligible asset?

Sure. Great question. I don't have that in front of me. I don't know that Shelby does, but I'll give you my quick answer and she can correct me. I think, largely, our cash is at our first SBIC fund and the holding company. I think it was probably at quarter end about 60-40 but I'm --

That's about right, yes.

I'm estimating. So, in terms of percentage. So, the $40 million that referenced at June 30th, about 60%, and there was a little bit at FMC 2, meaning SBIC 2. But, about 60% at the SBIC and then the other 40% at the holding company.

Great, perfect. So then, one more, if I can. I mean last quarter you talked about that you were seeing a lot of deal flow but turning down more because the terms basically didn't fit the profile, the risk-return that you were looking for, which is a good angle to take. So, I mean now, in early Q3, we've seen a couple of pretty sizeable, a $10 million and $20 million for $30 million. Obviously some of that may have been pushed back from Q2, you said, by lengthening closing cycles or not. Is this an indication that you're seeing terms normalize to kind of deals that, obviously, you're willing to do? Or, on the negative side, is it an indication that terms aren't shifting and you've shifted your return parameters a little bit?

It's a great question, Robert. And I think I got to go back to a lot of the statements we've made in the past, which is; our focus is on risk-adjusted returns and, quite frankly, capital preservation. And so, when we're reducing our yields, we're doing it in a manner where we're comfortable and happy with the risk-adjusted returns. So, I think that is really how we drive our decision making. I think the other thing I would say; it's the deal business and it can be erratic as you well know and I'm sure you've heard many talk about.

Yes.

There were seven deals during the second quarter that I thought had a chance at one point in time of actually closing during the quarter and we ended up closing one. We still have three of those that we're working on. We closed, obviously, a couple here recently. And a couple have gone away for a variety of reasons; diligence reasons as well as, believe it or not, sellers saying; oh, I don't know what I'm going to do with the cash so why don't I provide the financing. So, there's a variety of -- it's the deal business, is what I would say, and it can be erratic. And so we've experienced some of that of late or at least during the first six months.

Okay, perfect. Thanks a lot.

Yes, absolutely. Good talking to you.

Chris Kotowski, Oppenheimer.

Yes, good morning. I wonder if you could talk about the credit environment in general. And, obviously, the markets have been under stress and we've seen some non-accruals. Is there what you would call deterioration in the markets? Or is it pretty much business as usual?

Sure. It's obviously a very good question and I'll answer that in a couple ways, Chris. And I think I will also touch on our portfolio because I think it makes sense to do so.

I think the credit environment continues to be relatively solid. I do think it's not an environment where we want to be the, quote-unquote, volume leader in terms of putting dollars out the door. And the reason for that is, again, we're focused on risk-adjusted returns. And I think it's a good environment. It's an active environment. But we're really focused on quality over quantity.

And so, I don't think there has been a deterioration in the credit environment. As we all know, the first quarter for most companies was a little slower and I think a lot of that had to with the weather. The second quarter, GDP is up. Our portfolio would tell you was in a slow growth mode on a both an EBITDA basis and a revenue basis. So, I think it is performing fine and I think that reflects the current credit or part of the credit environment, if you will.

Just to touch on our portfolio for a minute because I think that's part of your question. As a whole, we feel very good about the health and the construct of our portfolio. And, as I mentioned, I would characterize it as being slow growth. But, within the portfolio, we clearly have some companies that are exceeding expectations and then we have some that are underperforming to varying degrees. And so, company-specific outcomes is really what's driving our portfolio, if you look at it on an individual basis. And that's what we would expect, quite frankly, if you have 37 portfolio companies. It's also why we've been building our portfolio from a diversification standpoint. That's been a goal of ours and it's also a goal of ours that as we continue to move forward.

I don't think it makes sense to talk about the performance of the individual portfolio companies for obvious reasons that I've stated before. But, just mentioning Avrio, obviously our investments in Avrio have been underperforming for some time and several events that transpired over the last couple of months meaningfully increased the risks of our investments in the company. And so the current level of risk is reflected in our valuation of the securities we invested in. And Paramount falls in a different category for sure, but it had a couple events that occurred recently that increased our risk so we're currently working with management to position the company for the future.

Overall, I'd say we continue to be pleased with the overall quality and construct of our portfolio and, importantly, the results of our portfolio that it has generated over the past three years have been very strong. However, as I stated in our prepared remarks, losses and write-downs are inevitable events for a lender and us. And, as many of you know, we have purposely structured our portfolio focusing on debt but have coupled those debt investments with meaningful equity investments in a large majority of our portfolio companies. So, from our perspective, if we do our job, our equity investments should not only offset our investment losses, but also should provide incremental gains. And to that point, our investment portfolio has generated over $30 million in net realized gain since our IPO, which has also been coupled with strong NII results.

So, as we look forward, we continue to be pleased with the composition and the construct of our portfolio. And we believe we are well-positioned to deliver stable and growing dividends including making special distributions from time to time. And then we also believe we're well-positioned to grow our NAV over time, which is also one of our goals. So, hopefully that's helpful and gives you a little flavor for the overall market as well as our portfolio.

Yes, thank you. That's it for me.

Okay. Thanks, Chris.

Vernon Plack, BB&T Capital Markets.

Thanks. Ed, I wanted to follow up on your comments regarding the investment pipeline, how that has set the stage for what should be a more robust second half of the year. And speaking of the pipeline, can you tell me does it continue to accelerate today? In other words, is the pipeline growing today versus, say, 30 days ago, 60 days ago? And, with that, I'm just wondering what that tells you about your marketing efforts and your staffing levels and everything that's associated with that.

Sure. Interestingly, what I would say is deal flow for us has been pretty good all year. I do think there is a noticeable increase over the past -- it really started a couple months ago. But the M&A environment, I think the pipeline has picked up. And so, that creates a lot of work because you're looking at auctions as well some proprietary deals. But, it's a very good thing, I think, for everyone. So, it's a real positive and so we would expect for a much more active second half of the year than we would the first half of the year.

We're pretty well staffed right now. We hired a principal in December. We just recently hired another analyst. So, we're continuing to grow our human capital base, if you will, in line with our portfolio. So, I think we feel pretty good about the team we have right now and what they're doing. And so now we're just trying to kind of execute on the highest-quality opportunities that we can find. The challenge, as you know, is what comes with a robust deal environment means you're also going to have some repayments.

Sure.

And so we do expect repayments to elevate a little bit over the first half of the year. And that's a good thing. We make investments with the idea of getting our capital back in a reasonable timeframe and typically with the goal of the company being sold at some point in time. And we think that will happen with some of our portfolio this year. But, it's a good environment. We're just trying to be cautious and highly selective.

Okay. That's helpful, thank you.

Sure, absolutely.

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

Thank you, Sam. And thank you, everyone, for joining us this morning. We look forward to speaking with you on our third quarter call in early November. Have a great day and a great summer weekend.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect.