Fidus Investment Corp (FDUS) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fidus Investment Corporation's second-quarter 2015 earnings conference call. (Operator Instructions). As a reminder, today's conference call is being recorded.

I would now like to turn the conference over to Jody Burfening. Please go ahead.

Thank you, Candace, and good morning, everyone. Thank you for joining us for Fidus Investment Corporation's second-quarter 2015 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 on 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 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. 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 7, 2015, these statements are not guarantees of future performance. Time-sensitive information may no longer be accurate at the time of any telephonic or webcast reply.

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.

With that, I would now like to turn the call over to Ed.

Good morning, Ed.

Good morning, Jody, and thank you. Good morning, everyone. Welcome to our second-quarter 2015 earnings call. I will start our call by highlighting our results for the second quarter, followed by a discussion of our investment activity and the performance of our investment portfolio. Then Shelby will go into more detail about our financial results and liquidity position. After that we will open the call for questions.

Our investment portfolio continued to deliver sound results during the second quarter. As a result, our Board of Directors increased the regular quarterly dividend from $0.38 to $0.39 per share. On a year-over-year basis, we grew our adjusted net investment income by 19%. We also realized a $5.3 million capital gain on our Connect-Air equity investment.

Credit quality remains sound, and we exited the quarter with approximately $100 million of liquidity to fund portfolio expansion. As of September 30, 2015, (sic - see press release, "June 30, 2015") our net asset value was $246.9 million, or $15.18 per share. All in all, we are pleased with our financial performance for the quarter.

From an operating perspective, we generated net investment income of $6 million or $0.37 per share for the second quarter, while 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 $6.1 million or $0.38 per share.

On June 25, 2015, we paid a regular quarterly dividend of $0.38 per share and a special cash dividend of $0.02 per share to stockholders of record on June 11, 2015. For the third quarter of 2015, as I mentioned, the Board of Directors has declared a regular quarterly dividend of $0.39 per share, which is payable on September 25, 2015, to stockholders of record on September 17, 2015.

As a reminder, we have an outstanding balance of spillover income, or taxable income in excess of distributions, of roughly $13.2 million at June 30.

During the second quarter, we remained true to our investment strategy, investing in companies that operate in industries we know well that generate excess free cash flow for debt service and growth, and that have positive long-term outlooks and strong yet defensible market positions.

We invested $28.3 million in the quarter, including investments in two new portfolio companies; $11 million in senior secured debt, subordinated notes, and common equity; and also committed $0.5 million in a senior secured revolving loan of Microbiology Research Associates, Inc., a provider of outsourced microbiology testing and consulting services for the pharmaceutical, hospital, and cosmetics end markets; and $14.3 million in subordinated notes and common equity of The Wolf Organization, LLC, a provider of branded specialty building products serving the independent dealer channel.

Our deep industry experience in the healthcare and building products arenas, and understanding of business drivers, played a critical role in our winning these deals.

In addition to these new portfolio investments, we collectively invested an additional $3 million across four existing portfolio companies. The nature of our business, in particular the timing and frequency of closings that vary from period to period, means that the amount of capital we invest in any given quarter will fluctuate.

To put the second quarter's investments in perspective, in the first half of 2014, we invested $24.7 million, including investments in two new portfolio companies. That stood in stark contrast to the second half of 2014, when we invested $125.1 million, including investments in 10 new portfolio companies.

For the first half of 2015, we have invested $67.9 million, including investments in seven new portfolio companies. In addition, subsequent to the close of the quarter, we invested $8 million in the subordinated notes and common equity of Vanguard Dealer Services.

Proceeds from repayments and realizations totaled $22.7 million in the second quarter, with $16.7 million of the total coming from our early quarter exit of our debt and equity investments in Connect-Air International in connection with the sale of the company. The remaining $6 million in proceeds came from seven other investments.

Last Friday, we exited our equity investments in Westminster Cracker Company, and will recognize a gain of approximately $1.7 million on our preferred and common equity investments in the third quarter.

The fair market value of our investment portfolio at June 30, 2015, was approximately $420 million, equal to approximately 100% of costs. We ended the quarter with debt and equity investments in 47 portfolio companies, with equity positions in roughly 83% of them.

The breakdown of our portfolio, on a fair value basis between debt and equity, remained fairly stable, with 88% in debt and 12% in equity investments. Our portfolio is structured to provide high levels of current income from our debt investments and the opportunity to realize meaningful capital gains from our equity-related investments. We believe that creating a high-quality equity portfolio can provide not only incremental profits, but also a reasonable margin of safety for Fidus.

In terms of portfolio performance, we track several quality measures on a quarterly basis to help us monitor the overall stability, quality, and performance of our investment portfolio. In the second quarter, these metrics remained 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, a rating of 1 is outperform, and a rating of 5 is an expected loss. As of June 30, the weighted average investment rating for the portfolio was 2 on a fair value basis, in line with prior periods.

As many of you know, 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.

One metric we track is the credit performance of the portfolio, which is measured by our portfolio companies' combined ratio of total net debt, through Fidus' debt investments, to total EBITDA. For the second quarter, this ratio was 3 times, compared to 3.7 times for the same quarter last year.

The third measure we track is the combined ratio of our portfolio companies' total EBITDA to total cash interest expense, which is indicative of the cushion our portfolio companies have, in aggregate, to meet their debt service obligations to us. In the second quarter, this metric was 3.5 times, compared to 3.3 times for the same quarter last year.

In June, we placed our debt investments in Paramount Building Solutions, LLC, on non-accrual, as we voluntarily deferred our cash interest with the goal of providing the company with incremental growth capital. Our Paramount debt investments represent approximately 1% of our investment portfolio on a cost basis. We continue to closely monitor the company's performance and are working closely with the company's management team.

Regarding our thoughts about market conditions, this year appears to be unfolding in a similar fashion to last year. The market remains healthy, and the fundamentals look strong. The same factors that have recently driven M&A activity remain in place: the strong liquidity position of the financial sponsor community, the aging of private equity portfolios, access to debt, and a strong appetite to invest in high-quality businesses.

Consequently, we expect deal flow in our target lower middle-market to remain healthy. And while we like to remind you about the lumpiness in our quarterly investment activity, we are cautiously optimistic that our second half will see higher deal activity than our first half.

This outlook is, of course, dependent on the US economy continuing on its current path of slow, steady growth.

We continue to manage our business for the long term, with the goal of delivering stable and growing dividends to our stockholders. As you can see from our results for the second quarter and the first half of the year, our portfolio continues to perform and our Board's decision to increase the regular quarterly dividend is indicative of their belief in our ability to continue to grow and diversify our investment portfolio in a very deliberate manner, with an acute focus on generating attractive, risk-adjusted returns and capital preservation.

As we go to market, we remain focused on what we view to be our competitive advantages. These include our relationships, our industry knowledge, and our ability to offer flexible capital solutions. These advantages enable us to identify companies that we believe will perform well over the long-term, with an emphasis on companies that possess strong cash flow characteristics and enduring business models.

Now I will 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 will review our second-quarter results in more detail, and close with comments on our liquidity position. Similar to last quarter, I will be providing comparative commentary versus the prior quarter, Q1 2015.

Total investment income was $12.8 million for the three months ended June 30, 2015, in line with Q1. Incremental interest income of $0.2 million related to higher average assets under management, was offset by a $0.3 million reduction in fee income. The decrease was primarily related to two prepayment fees received in Q1 2015.

Total expenses were $6.8 million for the second quarter, approximately $0.2 million higher than the prior quarter. Interest expense increased by $0.2 million, and base management fees increased by $0.1 million, which were offset by a $0.1 million decrease in G&A expenses.

Interest expense includes the interest paid on Fidus' SBA debentures and line of credit, as well as any commitment and unused line fees. As of June 30, 2015, the weighted average interest rate on our outstanding balance was 4.2%.

Net investment income, or NII, for the three months ended June 30, 2015, was $6 million, or $0.37 per share versus $0.39 per share in Q1 2015. Adjusted NII was $0.38 per share in Q1 versus $0.39 per share in Q1. The quarter-over-quarter decrease was driven by a decrease in transaction fees related to investment activity in Q2 versus Q1, and slightly higher interest expense and management fees.

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 June 30, 2015, Fidus had $5.3 million of net realized gains related primarily to the sale of Connect-Air International, Inc. Our net asset value at June 30, 2015, was $15.18 per share, which reflects payment of the $0.38 per share regular dividend and a $0.02 per share special dividend in June.

Turning now to portfolio statistics. As of June 30, our total investment portfolio had a fair value of $420.1 million. Consistent with our debt-oriented investment strategy, our portfolio on a cost basis was comprised of approximately 68% subordinated debt, 21% senior secured loans, and 11% equity and warrant securities.

Our average portfolio company investment on a cost basis was $8.9 million at the end of the second quarter. We have equity investments in approximately 83% of our portfolio companies, with an average fully diluted equity ownership of 7.9%.

Weighted average effective yield on debt investments was 13.3% as of June 30. The weighted average yield is 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, if any.

Repayment activity is expected to continue to modestly impact the portfolio yield, as some higher-yielding loans are paid off and replaced with loans priced at current market rates, which are lower than the rates on the more mature loans.

Now, I'd like to briefly discuss our available liquidity. As of June 30, our liquidity and capital resources included cash and cash equivalents of $14.5 million; unfunded SBA commitments of $45.3 million; and $39.5 million of availability on our line of credit, resulting in a total of $99.3 million. Taking into consideration subsequent events, our liquidity is now closer to $94.2 million.

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

Ed?

Thanks, Shelby. As always, I'd like to thank our team and the Board of Directors at Fidus for their dedication and hard work, and our shareholders for their continued support.

I will now turn the call back over to Candace for Q&A. Candace?

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

Ed, just wanted to ask about the potential for some buyback activity since you have now reported earnings, especially with the stock down here at a pretty significant discount to book value.

It's a great question, Bryce. And we have discussed it at the Board level, and I think it's what I would call an ongoing discussion. I don't think it's something we're looking to do imminently. But if -- what I would call the overhang, or whatever word you want to use -- continues, then it's clearly a discussion that we have thought about and talked about, and are continuing to think about, quite frankly. I don't have anything more than that, but it's definitely a discussion topic.

Okay, that's helpful. And then just wanted to touch on Paramount and the move to non-accrual. Do you foresee any kind of resolution or restructuring over the near term? Kind of curious how you think it could play out over the near term, given the move to non-accrual status. Thanks.

Sure. It's a great question. Paramount has been in our portfolio for quite some time; before we went public, actually. And the company has clearly had some ups and downs. We did go through a restructuring last fall, in October. And we are in there with other institutional investors, and we are continuing as a group to support the growth of the business. So, there's nothing imminent there at all.

I think we've had some good operating progress recently. But we are -- so we are continuing as a group to support the business. But what I would say is the valuation on our books reflects the risk of the situation.

Got it. Great. Thanks, guys. Appreciate it.

(Operator Instructions). Robert Dodd, Raymond James.

On Westminster, looking at the books at the end of the quarter, it was marked at about a $600,000 unrealized gain; and then you sold it a month later at a $1.7 million gain. That's a delta, so it implies that your fair value valuation here in the quarter, 30 days in advance, was kind of off by a fair amount.

Did it catch you by surprise? I'm just trying to get a feel. Or is it an indication of just how conservatively you value the equity positions?

I wouldn't say it caught us by surprise -- that we knew a transaction was being worked on. We were not given the valuation information by the control party of that transaction, despite asking some questions. I think they were pretty careful with it. So all our valuations reflected what we viewed as the fair value of the business.

But, clearly, in today's market for strategic assets -- and I think this was viewed as a strategic asset -- people were willing to pay up for it. So it was a transaction where we knew there was something potentially going on -- so there are no guarantees in life, as we all know -- but we did not know the valuation levels. So, that's what I would say. We were obviously pleased with the outcome. We got a premium valuation to how we've been looking at it.

No doubt, no doubt it was good result. Just next on Microbiology Research, looking in the investment there, you've got a $3.75 million, 6% senior loan. That's the lowest coupon piece of paper on your books, by a pretty decent margin.

Can you give us any color on -- was that the decision to do that, rather than just the sub piece at 12 -- was that the requirement to get the deal, that the guys just wanted one lender? And is there any intention to maybe move that piece or expectations that if the 6% pace will get refinanced out or anything like that? Just a little bit more color on the decision or that the process as to why it was structured that way, which is a little unusual on the coupon, on one of those pieces for you guys.

Sure, it's a great question, Robert. I guess, first, I'd start with we go to market as a solution provider. So we're looking for what we believe is very high quality businesses, A type businesses, if you will. And we try to provide solutions for those companies.

In this case, providing the senior debt was something that was a desire of the control party here. And so we looked at the overall equation and the quality of the asset and said, you know, we'll do that. I will also tell you the intent is for us not to hold that piece of paper over the long term. But when I say long term, I'm talking 18 months to 24 months.

But it's not meant to be on our books for the next, whatever -- 2 to 5 years. But we do go to market as a solution provider and make those decisions when the underlying quality of the assets makes sense. So that was the decision thought process.

Got it, great. And obviously the blended coupon on all the debt and there is, like, 10%, which is pretty reasonable anyway. Just circling back to -- kind of jumping around -- the first one. Earlier in the year, if I recall this -- you pointed out that it looked like the potential for gains, because equity valuations had been up, particularly for strategics, and that aligns with your comments for Westminster.

It appears obviously with the Westminster exit that is continuing or paying out as you expected. Is there any additional commentary on that, and what we -- I don't want to try and force you to comment on what to expect from the rest of your equity book going forward -- but any additional color there would be really helpful.

Sure. No, it's -- obviously, it's a great question. It's one we're obviously paying very close attention to. We very much like the quality of our portfolio, which includes the quality of our equity portfolio. And given the M&A environment -- and I will tell you, M&A is driving both originations and repayments.

And so, any projected repayments, if they involve a sale of a business, and we would hope to participate from an equity perspective, at least in most of our portfolio companies. And so, I do think that's going to be part of the equation as we continue to move forward.

At least, right now, as we look at it, M&A is driving a lot of the market. The outlook looks pretty good. And so our hope is to continue to participate in the market from that perspective.

Okay, got it. Thank you.

Chris Kotowski, Oppenheimer.

Most of my questions were asked. But just one thing we hear from the big private equity sponsors is that this is a great environment in which to sell assets, but a tough environment to put new money to work, because equity valuations everywhere are kind of stretched. And so, again, in the large space where it is a bit more visible, the amount of new LBO activity has come down quite a bit.

And I'm wondering, is that -- are you seeing that also in the middle-market space, that it's a good time to take gains but not a good time to put money to work?

It's a great question. And quite frankly, Chris, it depends. It's deal by deal. But as I look at it on an overall basis, I think the -- our markets, the valuations are lower, so we're not participating very much -- or at all, really -- in what I call the large LBO markets; so, greater than $50 million in EBITDA, but really greater than $25 million. We are under that, and that's the norm for us. And so, in that market, valuations are lower.

One of the opportunities we have as we invest in these more lower middle-market businesses is to grow them; obviously professionalize them, if you will; and hopefully you get a higher mark on the way out than where you went in. And that's one of our strategies, quite frankly.

I think the other thing that's different than the larger market is leverage levels in the larger market are pretty high. They are right up there with the peaks previously. And I would tell you -- and some of it has to do with the regulatory environment. I think banks are less aggressive from a leverage perspective.

And so when you look at our overall leverage at 3 times -- now, part of that is just the de-leveraging of the portfolio, meaning EBITDA has grown, and cash flows have paid back debt. But I think that's indicative of the fact that the leverage profile of our market is very different than the leverage profile of the large market.

And so, valuations are in line with that. There's a limit on how much equity folks will put in a deal, so I do think valuations are lower. But these businesses are also less diverse and smaller, so there's reason behind that. So hopefully that's helpful to the equation for you, but I don't -- so.

Okay. That's it for me. Thank you.

Vernon Plack, BB&T Capital Markets.

Ed, I'm sorry if I missed this. But can you give me your latest thoughts on funding continued growth, assuming -- let's assume that the equity markets aren't that accommodative, quite some time. How are you thinking about that? How are you thinking about accessing additional capital to grow?

It's a great question. Obviously we have -- I think it's around $45 million of availability in our SBIC license, our second license, so that's clearly a focus. We have about $40 million of availability under our line of credit, and then we have some cash.

I think as you move forward, the options include growing the line of credit and obviously raising equity if the markets get a little bit better. And then also doing a baby bond deal is an option as well, if we deem that to make sense for the Company and for the shareholders.

So those are the three options that I see today. I do think there's -- continues to be at least positive rhetoric regarding the whole SBIC family of funds issue, where maybe that goes up and you can increase your exposure to 350 from 225. But that's to be figured out. And we're not counting on that. But I thought I would highlight it, because there seems to be some pretty positive rhetoric regarding that getting approved.

And I know there has been; and with any [kind of luck], hopefully that will come through. I know that -- are you still thinking in terms of keeping some availability? I know, in the past, we've talked about you keeping, let's say, the next 12 months' worth of regular dividends from a liquidity standpoint.

That's how we think about it. We wouldn't purposely use up all of our liquidity just to make investments. I think keeping 20 to 25, or roughly a full year's worth of regular dividends, makes sense from our perspective. That's the only prudent thing to do. So, you are correct in your thinking.

Okay. That's great. Thank you, Ed.

(Operator Instructions). And I'm showing no further questions at this time.

I'd like to turn the conference back over to Mr. Ross for closing remarks.

Thank you, Candace. 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 weekend.

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