Fidus Investment Corp (FDUS) 2017 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fidus Investment Corporation's First Quarter 2017 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 Ed McGregor of LHA. Please go ahead.

Thank you, Candice, and good morning, everyone. Thank you for joining us today for Fidus Investment Corporation's First Quarter 2017 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 after the close with details of the company's quarterly financial results. A copy of this 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 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 5, 2017, these estimates 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 the 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'd like to turn the call over to Ed Ross. Ed?

Thank you, Ed, and good morning, everyone. Welcome to our first quarter 2017 earnings call. I will start our call by highlighting our results for the first quarter, followed by comments about investment activity and the performance of our investment portfolio and then offer views about the remainder of 2017. Shelby will go into more detail about our first quarter financial results and liquidity position. After that, we will open the call for questions.

We had a solid start to start 2017 with our first quarter net investment income increasing 11.3% year-over-year to $7.9 million or $0.35 per share, and our adjusted net investment income, which we define as net investment income, excluding any capital gains incentive fees attributable to realized and unrealized gains and losses, rising 13.9% to $8.2 million or $0.37 per share. Overall, we continue to execute well, as reflected in the performance of our portfolio of investments, the stability and capital preservation of the portfolio and capital gains opportunities from equity investments.

As of March 31, 2017, our net asset value was $354.8 million or $15.80 per share, up slightly from our 2016 year-end figures. On March 24, 2017, Fidus paid a regular quarterly dividend of $0.39 per share. At March 31, estimated spillover income, or taxable income in excess of distributions, was $12.4 million or $0.55 per share. For the second quarter of 2017, the Board of Directors has declared a regular quarterly dividend of $0.39 per share, which is payable on June 23, 2017, to stockholders of record on June 9, 2017. In the first quarter of 2017, we invested $55 million in debt and equity securities. Of this amount, $35 million was channeled to 3 new portfolio company investments. In each case, these businesses adhere to our investment strategy of focusing on companies that have positive long-term outlooks, strong yet defensible market positions, operate in industries we know well and that generate excess free cash flow for debt service and growth. Let me briefly recap each of our new portfolio company investments. We invested $12.3 million in subordinated notes and common equity of New Era Technology, Inc., a provider of end-to-end IT solutions primarily to the state and local government, education and healthcare markets; $12.3 million in subordinated notes and common equity of Revenue Management Solutions, LLC, a leading provider of services that match, reconcile and facilitate the posting of healthcare payments received against submitted claims for healthcare providers, benefit managers and billing companies; and $10.5 million in subordinated notes and common equity of TransGo, LLC, a specialty manufacturer and designer of aftermarket automotive transmission parts and repair kits. In addition, we invested $20 million of capital in existing portfolio companies, including $10 million in new subordinated notes of Worldwide Express, helping finance a recapitalization of the company and an ownership transition; $2.8 million in a new subordinated note of Caldwell & Gregory; and $5.6 million in an add-on to our subordinated notes in Accent Food Services. From a repayments and realizations perspective, we also had an active first quarter. Proceeds totaled $47.7 million, including we received payment in full on our Worldwide Express subordinated notes and sold a portion of our equity for realized gain, net of estimated taxes, of approximately $5 million. Concurrently, we rolled over $4 million of our equity investments into a new equity investment in this portfolio company. We received payment in full on our debt investment in Grindmaster Corporation, and we also received payment in full on our debt investments in Caldwell & Gregory, LLC.

As reported in our first quarter press release, we had one subsequent event occur following the quarter's end. On April 7, 2017, we sold our equity investment in Anatrace Products, LLC, for a realized gain of $0.9 million.

The fair market value of our investment portfolio at March 31, 2017, was approximately $536.6 million, equal to 104% of cost. We ended the quarter with debt and equity investments in 55 active portfolio companies. The breakdown on a fair value basis between debt and equity remained fairly stable with 84% in debt and 16% in equity investments, providing us with high levels of current and recurring income from our debt investments and the continued opportunity to realize 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 first quarter, these metrics remain 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 March 31, the weighted average investment rating for the portfolio is 2.1 on a fair value basis, in line with prior periods. Another 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 first quarter, this ratio was 3.5x compared to 2.9x 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 first quarter, this metric was 3.5x compared to 3.5x for the same quarter last year.

The soundness of these metrics reflect our philosophy of maintaining significant cushions to our borrower's enterprise value in support of our capital preservation and income goals. In Q1, we placed one of our investments, Restaurant Finance Co, LLC., on nonaccrual status, which represented 1.8% of the total portfolio at cost and 1.3% of the portfolio on a fair value basis. Given the tough restaurant climate, we remain in active discussion with the company on a path forward.

Turning to our outlook. Market dynamics, thus far, in 2017 are painting a relatively stable picture for us. The overall economy continues to grow at a slow, but steady rate. M&A activity, particularly in our target lower middle market, remains at a reasonably healthy level. Competition in the private debt and equity markets remain strong. Against this backdrop, we continue to be highly selective, maintaining a cautious and deliberate approach to investing that emphasizes quality over quantity. Of course, this selectivity means that we will experience quarter-to-quarter fluctuations in our investment activity levels. In any event, we will rely, as we always have, on our core strengths, including our relationships, our industry knowledge and our ability to offer flexible capital solutions. We have sufficient liquidity to continue to invest in businesses that we believe will perform well over the long term, ones that can generate attractive risk-adjusted returns and preserve capital. By adhering to our proven investment strategy to grow and further diversify our investment portfolio, we believe we remain well positioned relative to our goal of delivering a stable to growing dividend over the long term. 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 first 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, Q4 2016.

Total investment income was $16.2 million for the 3 months ended March 31, 2017, a $1.1 million decrease from Q4 2016. Interest income increased by $0.4 million, primarily related to more assets under management, which was offset by a $0.4 million decrease in fee income due to fewer investments in Q1. Dividend income in Q1 was $0.7 million versus $1.8 million in Q4, a decrease of $1.1 million, primarily related to higher-than-usual distributions received in Q4 from equity investments in 9 portfolio companies, including $1.1 million in distributions of earnings and profits related to dividend recasts for 2 of our equity investments: The Wolf Organization and World Wide Packaging.

Total expenses including income tax provision were $8.3 million for the first quarter, approximately $1.2 million lower than the prior quarter, primarily due to a decrease in accrued capital gains incentive fees in Q1 and excise taxes accrued in Q4. Interest expense decreased by $0.1 million related to the repayment of $24.8 million of SBA debentures.

G&A expenses increased by $0.1 million, base management and incentive -- income incentive fees decreased by a total of roughly $0.1 million and accrued capital gains incentive fees decreased by $0.7 million. 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 March 31, 2017, the weighted average interest rate on our outstanding debt was 3.9% versus 4.1% in Q4.

As of March 31, we had $199.3 million of debt outstanding. The SBA debentures maturing in March 2018, that were repaid at the end of February, had an interest rate of 6.2%, higher than our weighted average cost of debt. Net investment income, or NII, for the 3 months ended March 31 was $7.9 million or $0.35 per share versus $0.39 per share in Q4 2016.

Adjusted NII was $0.37 per share in Q1 versus $0.43 per share in Q4. Adjusted NII is defined as net investment income, excluding any capital gains incentive fees 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 3 months ended March 31, 2017, Fidus had $6.4 million of net realized gains, primarily related to the partial sale of our equity investment in Worldwide Express operations. This was partially offset by a related accrued tax expense of $1.4 million.

Our net asset value at March 31, 2017, was $15.80 per share, which reflects payment of the $0.39 per share regular dividend in March.

Turning now to portfolio statistics. As of March 31, our total investment portfolio had a fair value of $536.6 million. Consistent with our debt-oriented investment strategy, our portfolio on a cost basis was comprised approximately of 73% subordinated debt, 16% senior secured loans and 11% equity securities. Our average portfolio company investment on a cost basis was $9.4 million at the end of the first quarter. We have equity investments in approximately 88.1% of our portfolio companies with an average fully diluted equity ownership of 7.2%. Weighted average effective yield on debt investments was 12.9% as of March 31. 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.

Now I'd like to briefly discuss our available liquidity. As of March 31, our liquidity and capital resources included cash and cash equivalents of $19.1 million, unfunded SBA commitments of $51 million and $50 million of availability on our line of credit, resulting in total liquidity of $120.1 million. Additionally, in Q1, we requested SBA approval for the remaining $25 million of SBA debentures for Fidus Mezzanine Capital II, which is not reflected in our total liquidity as of March 31. Now I will turn the call back to Ed for concluding comments. Ed?

Thanks, Shelby. 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 over to Candice for Q&A. Candice?

(Operator Instructions) And our first question comes from Robert Dodd of Raymond James.

Just -- Ed, you made multiple references to the potential for equity gains, and I wonder if that's sending us a signal about the activity in the markets. I mean, obviously, unrealized appreciation on the equity [warrants] something like $25 million. So there's quite a lot there potentially. Do you think that we're likely to see those materialize at a somewhat higher rate? And then, isn't that -- when those realization event -- type of events occur, would you say that's correlated with higher prepayments and we could see potential overall gains, but then declines in overall portfolio as prepayment activity picks up?

Sure. It's a great question, Robert. I wish I had a crystal ball, but -- I think just to address the questions, overall, it's, I think, a healthy M&A market. And as you know, we have equity investments in a large, large percentage of our portfolio companies. And so I do think it's going to continue to be, what I would say, a healthy, I'm not going to use the word, robust, but healthy M&A market, and thus we're working hard on the origination side to participate in that. But to your point, we also think there will be some realizations on both the debt side as well as on the equity side through the year. Do I think it's going to be an abnormal level? I don't think so. But I do think, most of the deals, both on the -- most of our originations and most of our repayments today are being driven by M&A activity, so we are hopeful that we will see some gains this year or some incremental gains this year. Obviously, we've had some thus far as well. So with regard to prepayments, some of these companies, quite frankly, have been in the portfolio for a while and don't -- won't have prepayment fees and then there are others that will have some. So I think that's going to be a mix. And though I don't have an average or a normal number there, I do think there will be some, but I don't think that's going to be abnormal either. Hopefully that's helpful.

Yes, that's helpful. If I could, one more. On the attachment point and the cash interest coverage, where we see cash interest coverage 3.5x, stable year-over-year. But the attachment point up to 3.5x versus 2.9x, so obviously, can you give us some color on the drivers there? I mean, I appreciate coupon compression, you'd expect cash interest coverage to go up less than the attachment point. But is that the driver or is there some other effect that's leading to the disparity in changes between those 2 credit metrics?

Yes, I think the -- I do think the attachment point maybe is a little higher on the senior lending, which lowers the rates. So I think that probably matters a little bit, and then I do think yields, there has been some compression over time relative to a year ago. I think to the leverage point, I think what I would say there, it is -- our portfolio is leveraged higher than it was a year ago. Some of that has to do -- I think the portfolio is probably on the newer side, if you will, at least with regard to the originations over the last 15 months or 18 months. And then also part of that, especially over the last 9 months, through some efforts on our part, I would say the average deal is a little bit larger deal, little bit larger company. And with that becomes usually higher purchase price multiples and higher leverage. And so that is also a phenomenon. It's really just more mix than anything else, just bigger companies and with that comes a little higher leverage. So that's probably the primary driver on the leverage side.

And our next question comes from Bryce Rowe of Baird.

I wanted to ask a couple of questions. Ed, was kind of pleasantly surprised to see that you had net positive originations for the quarter. I think last quarter's call, you talked about that possibly not being positive. So that was good to see. Just -- so curious, what's your thinking just generally for the next couple of quarters in terms of net flows into the investment portfolio, if you got a good enough crystal ball? And then #2, for Shelby, just curious from a liquidity or cash perspective, where do you work those cash balances down to or where are you comfortable working those down to before you use the credit facility or draw more SBA debentures?

Okay. Thanks, Bryce. Obviously, both very good questions. I think I'll kick this off. In terms of the market, and I touched on this in the prepared remarks, I think the market, as we see it, at least in the lower middle market, is pretty healthy. So deal flow is good. And we are seeing, I would say, ample high-quality situations and pursuing those. Interestingly, we did have a couple of deals in the last 45 days, where we were awarded them, but they fell apart. Just the diligence wasn't panning out on our end, so we let those deals go. But having said that, we're still very busy right now on the new investment front, and so we are hopeful to have an active next 4 or 5 months is what I would say. So if I think about originations, I hope -- I think this will be a slower quarter than last quarter for sure, and I think on the repayment side, it will also be slower. So we're hopeful for some modest portfolio growth this quarter, but that is very hard to predict, both on the originations and on the repayment side. So I go back to activity levels, and they are very healthy. We're continuing to see a steady stream of flow. Some of it's good, some of it's bad. But there's clearly enough to pursue. So I think that part of it's very healthy. Hopefully, that answers the first question, and I'll pass it off to Shelby.

So on the liquidity side, Bryce, I like to aggressively manage cash as much as possible to minimize interest expense. But unfortunately, I do have to be mindful of what's the kind of near-term net (inaudible) and where do we have cash, meaning is it at that holding company or is it at the SBIC. What I would tell you today is, out of that, call it, $19.1 million, about $10 million of that really is at the holding company, so I should be able to work that down, especially with the payment of the Q2 dividend. And then we typically have a preference of utilizing the SBA program. So if we have investment opportunities that fit the SBIC criteria, we would look to invest those in FMC II first. So it may mean some borrowing against the SBA fund and then just using cash as we need to at the holding company. So hopefully that kind of gives you a little bit of insight. The only other thing I would add, just to be mindful of, particularly as we kind of get to the end of Q2, we do need to be mindful of our FMC debt maturities, and so we're still pretty far out in front of the [maturing] debt, but you will see us from time to time start to accumulate cash from repayments in anticipation of paying down debt.

And our next question comes from Chris Kotowski of Oppenheimer.

Just with the new nonaccrual loan. I wonder if you could characterize it? Is it -- is there a sector issue or is it idiosyncratic or is it in some way tied to some -- whatever regional economic weakness in the markets they serve?

Sure. Great question, Chris. And the answer is, it's a little bit of everything. I think all restaurants are being impacted a little bit by just the competition, if you will, in the restaurant sector. But this company, last fall, had to weather a hurricane, had to weather some bathroom bill in North Carolina that has recently been overturned, but it greatly reduced the convention activity in Charlotte, in particular, and then they also had riots in Charlotte. And so there's a variety of things that has impacted, if you will, the Charlotte restaurant world, and we were one of them. So -- and we have restaurants in other places as well, but that still is one of the drivers for sure. So we're currently working with the company on a mutually agreeable path forward. And what I would say is, the valuation reflects the increased level of risk on our investments.

Okay. And then, I mean, I guess you've touched on it by saying that your activity levels are very high. But I guess, I would say the common theme of the BDC earnings season thus far has been that it's been difficult to keep assets on the books and that there are heavy prepayments. And I mean -- I think that's been the recurring theme of most of the earnings calls I've listened to. But you seem to be immune from that. And is that just that you play in a different segment of the market? Or any theory on why that seems different?

Yes, I think that the broader market is very different, Chris, and then people are looking to refinance and get lower rates wherever possible. That does happen in our segment for sure, but I think it's a lot less at the end of the day. So we are not immune to it. What I would say, and it's back to the comment I made earlier, is I think most of the activity, really, for a pretty good period of time now for us, has been M&A-driven activity. So on the origination front, there's typically some kind of M&A event. And then also on the repayments and realization side. That's what we're seeing. We do expect to have a healthy level of repayments this year, but they're going to be mostly, at least that's our expectation, M&A-driven events. I'm sure there'll be a couple of surprises here and there, but that's what we've seen thus far. So I think there is a little bit of we're in a different market and maybe just a little lucky as well. But that's what we expect going forward further.

And our next question comes from Arren Cyganovich of D.A. Davidson.

With the portfolio yield, it declined just modestly, the 20 basis points quarter-to-quarter. Is there a trend there that you're seeing within the -- your book of potential pipeline of opportunities that you'll expect further compression or is this somewhat going to be stable from this point?

Sure, great question, Arren, and good morning. I think the decline that took place this quarter is really due to primarily the 2 things. One is Worldwide. The new investment there is, call it, 250 basis points lower than where we were before, and so that's one piece of it. And the other one is, quite frankly, the restaurant finance, which was a higher-yielding investment, going on non-accrual. So those are the 2 primary drivers. As I look forward, and I think about even the last quarter, the yields on originations were in line with the yields on repayments. So I think there's going to be pretty good stability here. We clearly still have some older-vintage investments that, when they repay, they could cause a little bit of a downdraft. But I don't see a material change in our yields as I go forward, as least as we sit here today. So hopefully that's helpful. But -- so we're not projecting a big change in yields from our perspective.

Great. And then in terms of the portfolio quality, it sounds like, other than the one in nonaccrual, sounds fairly stable. Are there any industries that you're watching a little bit more closely these days for pockets of weakness? Or it's mostly just fairly stable as you can see it from the portfolio company level?

Sure. Great question. I think overall what we're seeing, and I'll just comment on the portfolio for a second, is stability and slow growth somewhat across the board. When I think about sectors to worry about, energy is one to think long and hard about. But the good news there is we are seeing a pretty good increase in operating activity levels in the field, if you will. And so that's been a positive from our perspective, but it's still at levels that would give you concern making a new investment. But that's a positive.

I think, on the consumer side, restaurants, obviously, there's been -- there's a fair bit of competition out there at the end of the day. And so that's one to pay attention to. And then e-commerce with regard to retail, you need to be paying attention to the impact that e-commerce could have on a company. And so we're -- those are 2 areas that we're paying attention to. And then the last one is healthcare. Healthcare services is an area where you can take reimbursement rate risk, and that's one where we have and we've done fine. But I would tell you, we're not looking to add to our portfolio with investments where there's significant reimbursement rate risk. So that's how we're seeing it right now.

And your next question comes from Ryan Lynch of KBW.

My first question, following up on the earlier conversation with Robert about the realizations. You mentioned potentially having some realizations in the portfolio later this year, which seem very positive, some of that being from some equity investments potentially. I'm just wondering, given the increase in valuations in the market and maybe even potential lofty valuations in the market that we're seeing today, does it ever make sense to pull back on making these equity co-investments on some of your -- on your subordinated debt when you guys have plenty of capital? Looked like you guys make equity co-investments in all 3 of your new investments, and that's always been a part of your strategy. But I'm just wondering if there's ever a point in time where valuations in the market get high enough where you don't think there's going to be much upside on these equity co-investments and you pull back from that strategy at all.

Great question, Ryan. I think, when we make an equity investment, we are -- each time we're looking at the debt investment and do we like that, and then do we like the equity investment. I think your point is well taken. We are in a market where the overall purchase price multiples in the M&A world are very high. But it does vary and the opportunity varies on an individual asset basis. And so that's how we look at it probably. We're paying attention to what's going on in the market, but we're also just looking at the overall quality of the company and the quality of the investment. And I think the companies where we've been investing right now, we feel very good about the long-term outlooks of the businesses where we're making equity investments. So point is well taken. It's a time to be selling if your investment is ripe enough to do so. But at the same time, there are plenty of opportunities out there, from our perspective, to invest in very high-quality businesses that can generate still attractive risk-adjusted returns. And so each time we make a debt or equity investment, that's how we're thinking about it. But we're seeing good opportunities on the equity side as well. But -- some -- they are higher prices than they were 10 years ago, but they're still attractive, at least from our perspective at this point.

Okay. And then, I think, in response to Bryce's question, you mentioned -- as far as capital deployment goes, you mentioned that a few deals actually fell apart later in the investment process cycle. So I was just wondering if you can give any sort of high-level color on why those deals fell apart. Was it more something changed in terms or the documentation or the strategy that you made the choice to pull back and not go follow through with those deals? Or was it more that the borrowers chose to go with somebody else in the market and maybe you got a different competitor that maybe was coming in with better pricing?

Sure. No, great question. In both cases, we pulled back. One was due to a background check of an individual, and the other one was new information that kind of came across the transom regarding potential concerns on the projections that we were given, or at least that impacted and created concerns regarding the outlook of the business. And so in both cases, we were the ones that pulled away there.

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

Thank you, Candice, 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 a great weekend.

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