Fidus Investment Corp (FDUS) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fidus Investment Corporation's second-quarter 2016 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.

I would now like to turn the call over to Ms. Jody Burfening of LHA. Ma'am, you may begin.

Thank you, [Takia], and good morning, everyone. Thank you for joining us for Fidus Investment Corporation's second-quarter 2016 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'd 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 customer Safe Harbor disclosure regarding forward-looking information, including 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 5, 2016, 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.

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

Good morning, Jody, and thank you. And good morning, everyone. Welcome to our second-quarter 2016 earnings call. On today's call, I'll be commenting on our recent common stock offering and reviewing our second-quarter results, the performance of our investment portfolio, and our views about deal flow for the rest of 2016. Then Shelby will go into more detail about our financial results and liquidity position. After that, we will open up the call for questions.

As announced during the quarter, Fidus completed a common stock offering that raised net proceeds of $43.7 million for the Company at an offering price of $15.27 per share. This offering was a strategically positive move for us. We plan to use these proceeds to make investments in lower middle market companies in accordance with our investment objectives and strategies to repay outstanding indebtedness under our credit facility and to take advantage in the increase in allowable borrowing capacity under the Small Business Investment Company, or SBIC Debenture Program, subject to SBA approval.

Our second-quarter results were generally solid. Total investment income rose 8.1% year over year to $13.8 million and was largely supported by a 5.6% increase in total interest income. 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, increased 7.1% to $6.5 million, or $0.38 per share.

As of June 30, 2016, our net asset value was $298 million, or $15.52 per share. On June 24, 2016, Fidus paid a regular quarterly dividend of $0.39 per share. As of June 30, 2016, estimated spillover income, or taxable income in excess of distributions, was $15 million, or $0.78 per share.

For the third quarter of 2016, our Board of Directors has declared a regular quarterly dividend of $0.39 per share, which is payable on September 23, 2016 to stockholders of record on September 9, 2016.

From an investment perspective, our second quarter came in quite light. As you may recall from our last earnings call, market turmoil at the beginning of the year brought the M&A market nearly to a standstill. With a deal pipeline short of high-quality opportunities, we invested a total of $2.1 million in debt and equity securities in existing portfolio companies. As expected, this was one of our slower investment periods.

Comparatively, we had a more active quarter in terms of repayments and realizations, receiving proceeds of $14.5 million in the period, which included a realized gain of $0.5 million, which primarily resulted from the exit of our debt and equity investments in Safety Products Group, LLC.

Investment activity has picked up as expected. As reported in our second-quarter press release, subsequent to quarter end, we invested $17.25 million in debt and equity investments in Rohrer Corporation, a manufacturer of high-visibility, graphically intensive packaging for consumer products.

Furthermore, we exited three investments. First, Carlson Systems Holdings, Inc. We exited our debt investment receiving payment in full, and we received a distribution from our equity investment recognizing a gain of approximately $4 million. Second, National Truck Protection Company, we exited our debt and equity investments receiving payment in full on our senior secured loan and recognizing a gain of approximately $1 million on our equity investment. And third, Paramount Building Solutions, we realized a loss of approximately $12 million on our debt and equity investments. Paramount has been on non-accrual status for the past year and fully written down before the second quarter.

Turning to our portfolio construction and metrics, the fair market value of our investment portfolio at June 30, 2016 was approximately $453 million, equal to 101% of cost. We ended the second quarter with debt and equity investments in 53 portfolio companies and with equity positions in roughly 85% of them.

The breakdown on a fair value basis between debt and equity remained fairly stable with 85% in debt and 15% in equity investments providing us with high levels of current income from our debt investments, and the continued opportunity for capital gains from our equity-related investments.

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 one is outperform, and a rating of five is an expected loss. As of June 30, the weighted average investment rating for the portfolio was two on a fair value basis, unchanged compared to prior year's period.

Another metric we track is the credit performance of the portfolio, which is measured by our portfolio company's combined ratio, total net debt through Fidus' debt investments to total EBITDA. For the second quarter, this ratio is 3.1 times compared to 3 times for the same quarter last year.

The third measure we track is the combined ratio of our portfolio company's 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 3.6 times compared to 3.5 times for the same quarter last year.

The strength and stability of these metrics reflect our philosophy of maintaining significant cushion to our borrower's enterprise value, a critical determinant of our capital preservation and income goals.

As of June 30, our debt investments in two portfolio companies were on non-accrual status, which represented approximately 6% of the current portfolio cost. As I mentioned on our last call, we had decided to place Pinnergy on non-accrual status at the beginning of Q2 to reflect the increased risk of this investment from persistent difficult industry conditions in the energy sector. We are currently continuing to work with all stakeholders on this situation. Paramount Building Solutions, LLC was the other portfolio company on non-accrual at the end of Q2, an investment we've now exited.

All things considered, our debt portfolio performed reasonably well, our equity portfolio is also doing quite well with the value of a number of our investments written up as a result of both solid specific company performance and selective aggressive M&A activity. These write-ups drove meaningful NAV growth for the quarter.

Turning to our outlook, market dynamics thus far in 2016 have painted a mixed picture, while the overall economy has remained in a slow but steady growth state. M&A activity that matters to us essentially ground to a halt in the first quarter of the year on concerns ranging from a troubled oil and gas market to economic uncertainty to geopolitical unrest. This slow start for M&A activity has reversed, however, and activity has picked up as fears of a near-term recession have receded.

As a result, we are looking at a greater number of quality opportunities presently. Deal competition is not insignificant for these companies in the private debt and equity markets, however, and it is important that we wait for the right deals to come along, sticking to our discipline of choosing quality of quantity and managing for the long term.

Our goal in this process is to grow and further diversify our investment portfolio in a very deliberate manner with an overriding focus on generating attractive risk-adjusted returns and capital preservation.

Fortunately, we have time-tested strategies and disciplines in place, ones we are confident will support our long-term capital preservation and income goals. And at the end of the day, I think we'll get our fair share of these deals. Of course, a more active M&A market may also give rise to a greater level of repayments and realizations, which may dampen portfolio growth for the year.

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'll review our second-quarter results in more detail and close with comments on our liquidity position. Please note, I will be providing comparative commentary versus the prior quarter, Q1 2016.

Total investment income was $13.8 million for the three months ended June 30, 2016, a $0.9 million decrease from Q1 2016. Interest income decreased by $0.7 million primarily related to placing Pinnergy on non-accrual status.

A $0.7 million decrease in fee income due to more investment activity and prepayment fees in Q1 was offset by a $0.5 million increase in dividend income primarily related to distributions from equity investments received in Q2. We also recognized $0.3 million in fee income from amendment fees.

Total expenses including income tax provision were $8.9 million for the second quarter, approximately a $1.3 million higher than the prior quarter due to an increase in accrued capital gains incentive fees. Interest expense was in line with the prior quarter, G&A expenses decreased by $0.1 million, and base management and income incentive fees decreased by a total of roughly $0.1 million, which were offset by a $1.5 million increase in capital gains incentive fees.

Interest expense includes the interest paid on Fidus' SBA debentures and the line of credit as well as any commitment and unused line fees. As of June 30, 2016, the weighted average interest rate on our outstanding debt was 4.2%. As of June 30, we had $214 million of debt outstanding as summarized in footnote 6 to our financial statements.

Net investment income, or NII, for the three months ended June 30 was $4.9 million, or $0.29 per share, versus $0.43 per share in Q1. Adjusted NII was $0.38 per share in Q2 versus $0.44 per share in Q1.

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. Our reconciliation of NII to adjusted NII can be found in our earnings press release that was issued yesterday afternoon and is also posted on our Investor Relations page of our website.

For the three months ended June 30, 2016, Fidus had $0.4 million of net realized gains primarily related to the sale of the operations of Safety Products Group. We also recorded $7.5 million of net unrealized depreciation on investments primarily related to a write-up of three equity investments including Carlson Systems Holdings, which was sold subsequent to quarter end.

Our net asset value at June 30, 2016 was $15.52 per share, which reflects payment of the $0.39 per share regular dividend in June as well as the equity offering.

Turning now to portfolio statistics. As of June 30, our total investment portfolio had a fair value of $452.7 million. Consistent with our debt-oriented investment strategy, our portfolio on a cost basis was comprised of approximately 74% subordinated debt, 15% senior secured loans, and 11% equity securities.

Our average portfolio company investment on a cost basis was $9.2 million at the end of the second quarter. This excludes four investments in portfolio companies that sold their operations and are in the process of winding down.

We have equity investments in approximately 85% of our portfolio companies with an average fully diluted equity ownership of 7.6%. 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 per debt investments at cost including the accretion of original issue discount and loan origination fees, but excluding investments on non-accrual if any.

Now I would like to briefly discuss our available liquidity. On May 27, we issued 2.5 million shares above NAV and a follow-on offering with an additional 375,000 shares from the over-allotment option issued on June 10, raising net proceeds of $43.7 million.

As of June 30, our liquidity and capital resources included cash and cash equivalents of $59.1 million, unfunded SBA commitments of $11 million, and $50 million of availability on our line of credit resulting in a total of $120.1 million.

Taking into account investment activity subsequent to quarter end, our liquidity is currently around $142.5 million. Furthermore, we have submitted a commitment application requesting SBA approval for an additional $50 million of SBA debentures for Fidus Mezzanine Capital II.

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

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 to Takia for Q&A. Takia?

Thank you. (Operator instructions)

Bryce Rowe, Baird.

Thanks. Good morning, guys. Just a question on some of the activity here subsequent to quarter end. Shelby, you guys mentioned prepayment fees that were associated with two of the three exits here early in the third quarter. Can you help us, from a modeling perspective, in terms of what those might be in the third quarter?

Absolutely. On Carlson, we received $260,000, and on National Truck, we got $45,000. So again, some healthy prepayment fees that kick start the third quarter.

Right, that's great. And then one, I guess, follow-up to the prepared remarks about the SBA or applying for additional SBA commitments of $50 million. Have you guys, I guess, committed additional capital to SBIC II yet?

Yes, we did. So with our $50 million of additional debentures that we've requested approval for, we committed $25 million to Fidus Mezzanine Capital II. And that was partly use of our equity-offering proceeds.

That's great. Thank you, guys. That's it for me for now.

Robert Dodd, Raymond James.

Hi. Just a simple one first. Let's do it in kind of reverse order of complexity. On the gains and the [realized] loss, obviously, in subsequent to the quarter end, are those all -- including the equity on Carlson and National Truck, which was obviously marked up -- so were those all in line with the mark? So basically we could have a net realized loss, but that's going to be precisely offset by a reversal on the unrealized line? Or is there going to be a material mismatch?

No, I think you're statement is correct. So they were kind of marked appropriately if that's the right way to think about it.

Perfect, thank you. On Pinnergy, you gave some comments. I mean, last quarter, I think I got kind of the impression you hoped it'd be sorted out by the end of the year. Any additional color you can give us on kind of timeline you expect?

I do think your timeline would be during this quarter, we'll have some kind of restructuring. But I don't really have much of an update that I can give you at this point. I mean, we have multiple constituents in the capital structure. We are all in deep discussions, is what I would say, and I would characterize the situation as fluid at this point.

Great. On the activity rebound, obviously it's relatively early stages. I presume you haven't got a lot of signed LOIs out yet. So I mean, what's kind of your confidence level that those are [really] going to turn into -- whether you win them or not, because obviously you mentioned competition obviously -- but the confidence level that's actually going to turn into real closings on the M&A front versus it's kind of an activity blip because everybody's gotten bored, but maybe they aren't actually going to close the deals?

Sure, sure. That's a great question, Robert. I think, as you know, with M&A activity and originations, they're erratic; they're very hard to predict. I will tell you we are very busy, so my confidence in getting some incremental new investments made here in the third quarter is, I'd say, high. But to what degree, I think there's no way for me to say that.

But I would also say -- and I mean, the good news is we've got what I would consider a strong portfolio and a healthy portfolio. What that gives rise to is repayments as well, and I mentioned that in the prepared remarks. And so we could have some more repayments as well.

And so I think there'll be more investment activity on the origination side. But if I were a guessing man, repayments may outpace originations this quarter. That's quite possible. But again, I think we think that's a healthy thing over time. So we're managing the business for the long term, but that's kind of the state of play.

We also think it will be an active fourth quarter just based on deal flow and pipelines. And so it's too early to tell how it all plays out, but we feel very good about the activity levels.

Okay, perfect. You kind of preempted the next part of that question. Obviously, your $40 million in repayments so far at fair value, $34 million at cost between the National Truck and Carlson versus obviously $17 million in deployments. So you're net down at the moment. As you said, that's not necessarily a bad thing. You could have gains on those, et cetera.

So to that point, and then also Shelby's comments that the unrealized depreciation, most of that was concentrated in three assets. One of those, Carlson, has already exited for a gain. Is there -- should we read anything into the potential for those other two to be potential exits as well? And obviously that, to your point, would put some stress on portfolio growth. And that shouldn't be your target necessarily, right? That's opportunistic.

But I mean, just from that perspective, on that gain side, I mean, are you seeing, particularly with those other two non-Carlson assets that were written up in the quarter, are those -- is that going to give us some likelihood that those get repaid as well, and that put additional repayments?

No, it's a great question. I wouldn't focus just on those. I mean, the good news is, the write-ups, they were -- some were obviously much more material than others, but there was a lot more that were written up than written down, and that's a positive.

And a lot of that -- a little bit of that was what I would say selective M&A activity. I mean, we've had three processes this year -- or three companies that have not been in a process, i.e. an M&A process, but they've gotten serious interest from prospective buyers; so preempted a process, if you will. So that gives you a sense of the M&A market for high-quality companies.

I think the other part of the equation is there's been some pretty good performance in some of our portfolio companies, and that's driven value accretion. So I wouldn't pick on those two. But I do think we do have several companies that are in the middle of a process, if you will, a strategic alternatives process, and those very well could materialize into some gains. But I don't want to pick on those two because I don't think that's appropriate.

Okay, I appreciate it. Thanks a lot.

Chris Kotowski, Oppenheimer.

Yes, I guess staying on the theme of the day, in addition to BDCs, we cover some of the large cap private equity sponsors. And one of them on their earnings call this quarter said, oh, this is a much better time to reap than to sow. And [on balance], they're there realizing more capital than they're deploying. And I'm wondering, do you find that attitude expressed among the middle market sponsors a lot?

Yes, I mean, I think the sponsors actually -- I think, absolutely. I think what we are seeing in the market today is that if people or firms or owners of companies that are looking to find liquidity in the near to medium term, they're thinking very seriously about doing it right now. The equity markets are, what I would say -- private equity markets are aggressive, and the debt markets are, I think, rational, but also aggressive, especially from a structure and pricing perspective.

There's not a big change, to be honest. It's been that way for a while other than in the first quarter when the concerns were out there and the public markets were kind of upside down. I think people backed up a little bit. But there really wasn't much activity, so that made some sense.

So we are -- I think if people are looking to get liquidity any time soon, they're probably doing it right now or starting the process or in the middle of a process because it's a good time to be selling, I guess. No different than what you just said.

And then, I guess, just -- you know we've had lower energy prices now for a couple of months, and I'm not sure what you can say, but does that -- how does that flow through to Pinnergy's business fundamentals? Does it, or is this kind of too little too late?

No, I think it does flow through to the fundamentals. What I -- I'll give you my perspective, and that is, clearly prices are much higher than they were at the beginning of the year. They got towards [50]. They're not there at the moment.

But I think from an operations perspective, we've been bottoming out for the last couple of months. I think we expect an uptick in activity in the energy market. Is it two months from now? Is it four to six months from now? I don't know. But we do think that will happen. I think Pinnergy operates in some low-cost basins, which is a good thing for the company, and so we are hopeful, but there's a lot of wood to chop. So it's a fluid situation from our perspective.

Okay, thanks. That's it for me.

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

Thank you, Takia, and thank you everyone for joining us this morning. We look forward to speaking with you in our third-quarter call in early November of 2016. Have a great day and a great weekend.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day.