Fidus Investment Corp (FDUS) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fidus Investment Second Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference Mr. Ed McGregor with LHA. Sir, you may begin.

Thank you, Kaylee, and good morning, everyone. Thank you for joining us for Fidus Investment Corporation's Second 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 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 customary Safe Harbor disclosure regarding forward-looking information included in the earnings release. The conference call today contains certain forward-looking statements, including statements regarding the goals, strategies, beliefs, future potential, operating results and cash flow of Fidus Investment Corporation. Although management believes these statements are reasonable, based on the estimates, assumptions and projections as of today, August 4, 2017, 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'd like to turn the call over to Ed Ross. Ed?

Thank you, Ed, and good morning, everyone. Welcome to our second quarter 2017 earnings call.

I will start our call by commenting on our activities and the results for the second quarter. I'll then provide some comments about investment activity and the performance of our investment portfolio before offering our views about the remainder of 2017. Shelby will go into more detail about our second quarter financial results and liquidity position. After that, we will open the call for questions.

As announced in June, Fidus completed a common stock offering that raised net proceeds of $32.3 million for the company at an offering price well above NAV. In line with our approach of managing the business for the long term, the offering further strengthens our balance sheet and provides incremental equity capital, the launch of third SBIC license, subject to SBA approval and continue to make holding company investments.

Turning to our second quarter highlights. I'm pleased to report solid second quarter results, as net investment income increased to $9 million or $0.39 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, rose 12.2% to $9.2 million or $0.40 per share. Our portfolio of debt and equity investments continued to perform well in the quarter, adding to a steady record of performance that's been driven by our focus on investing in companies that have positive long-term outlooks, strong yet defensible market positions, operate in industries we know well and generate excess free cash flow for debt service and growth.

As of June 30, 2017, our net asset value was $388.4 million or $15.87 per share, up $0.07 on a per share basis from Q1 2017.

On June 23, 2017, Fidus paid a regular quarterly dividend of $0.39 per share. At June 30, estimated spillover income, or taxable income in excess of distributions, was $12.7 million or $0.52 per share.

For the third quarter of 2017, the Board of Directors has declared a regular quarterly dividend of $0.39 per share, which is payable on September 22, 2017, to stockholders of record on September 8, 2017.

In the second quarter of 2017, we invested $32.1 million in debt and equity securities. Of this amount, $23.5 million was channeled to 2 new portfolio company investments.

Let me briefly recap each of our new portfolio company investments. We invested $12 million in subordinated notes and warrants of Midwest Transit Equipment, Inc., a leading distributor of school and commercial buses and related maintenance and repair services; $11.5 million in subordinated notes and common equity of NGT Acquisition Holdings, LLC, doing business as Techniks Industries, a market leader in the fragmented cutting tools and tool holders market.

In addition, we invested $8.6 million of capital in existing portfolio companies, including $6.4 million in an add-on to our subordinated notes and common equity of Pugh Lubricants; $1.5 million in an add-on to our senior secured loan of Plymouth Rock Energy; $0.4 million of new preferred equity of FDS Avionics Corp., doing business as Flight Display Systems; $0.2 million in a draw on our senior secured revolving loan to inflection; and $0.1 million in an add-on to our common equity of US GreenFiber. From a repayments and realization perspective, we had a less active quarter relative to the investments we made. Proceeds totaled $19 million, including the following exits of portfolio company investments: we received $0.9 million from the sale of our equity investment in Anatrace Products, resulting in a realized gain of $0.9 million; we received payment in full of $6.4 million on our debt investment in inthinc Technology Solutions; and we received $7.6 million on our debt investment in FTH Acquisition Corp. and relinquished our preferred equity in FTH for no consideration, resulting in an aggregate realized loss of $1.3 million.

Regarding our exit of FTH Acquisition Corp., we weighed a number of variables, including our overall return and the resources involved in monitoring the investment, and made a conscious decision from a long-term risk management perspective that this was the right thing to do even though we had to exit at a discount.

As reported in our second quarter press release, subsequent to quarter-end, we have had an active start to the quarter.

On July 13, 2017, we exited our equity investment in EBL, LLC for a realized gain of approximately $2.2 million. Concurrently, we invested $10 million in subordinated notes in a new common equity investment in EBL, LLC.

On July 14, 2017, we exited our debt investment in Anatrace Products, LLC.

On July 18, we invested $10.2 million in senior secured loans of Tile Redi, LLC, a leading manufacturer and marketer of bathroom products for use in tiled showers. The company serves both do-it-yourselfers and commercial end users throughout the U.S., primarily selling into the home remodeling and renovation end markets.

On July 21, 2017, we invested $12.8 million in subordinated notes and common equity of Marco Group International OpCo, LLC, a manufacturer and distributor of surface preparation equipment, parts and supplies to industrial contractors primarily in the downstream energy infrastructure and industrial markets.

July 28, we invested $7.8 million in subordinated notes, preferred equity and common equity of ControlScan, Inc., a leading provider of payment security, managed firewall and managed network solutions and one of the nation's foremost PCI compliance companies.

Fair market value of our investment portfolio at June 30, 2017, was approximately $553.3 million, equal to approximately 104% of costs.

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 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 tracked several quality measures on a quarterly basis to help us monitor the overall stability, quality and performance of our investment portfolios. 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.

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 second quarter, this ratio was 3.5x compared to 3.1x 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 have in aggregate to meet their debt service obligations to us. In the second quarter, this metric was 3.6x compared to 3.6x for the same quarter last year.

The soundness of these metrics reflects our philosophy of maintaining significant cushions to our borrowers' enterprise value in support of our capital preservation and income goals. As of June 30, one of our investments, Restaurant Finance Co, LLC, remained on nonaccrual status, and we continue to engage in active discussions with regard to this situation.

As we look to the second half of 2017, we see a relatively healthy market environment for us at this point. The economy is expected to maintain its slow but steady pace of growth. And M&A activity looks to remain active with competition for deals in our target lower-middle market ever present, but manageable. The flip side of this, of course, is that we may also experience active level of repayments and realizations in the second half of 2017, as we have several companies evaluating strategic and financing alternatives.

Overall, we feel good about the opportunities the market is providing us and remain focused on making new investments in our cautious, defensive and deliberate manner. As always, we rely on our core strengths, including our relationships, our industry knowledge and our ability to offer flexible capital solutions. Equipped with ample liquidity, we would look to grow and further diversify our investment portfolio, while maintaining an acute focus on generating attractive risk-adjusted returns and capital preservation.

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 2017.

Total investment income was $17.3 million for the 3 months ended June 30, 2017, a $1.1 million increase over Q1. Interest income increased by $0.6 million primarily related to more assets under management. Fee income increased by $0.6 million due to investment activity and approximately $0.5 million of these related to the exit of our debt investments in inthinc Technology Solutions. Dividend income in Q2 was $0.6 million, a decrease of $0.1 million from Q1.

Total expenses, including income tax provision, were $8.3 million for the second quarter, consistent with Q1. Interest expenses decreased by $0.1 million. G&A expenses decreased by $0.1 million. Base management and incentive -- income incentive fees increased by a total of roughly $0.4 million. And accrued capital gains incentive fees decreased by $0.1 million. Interest expense includes the interest paid on Fidus' SBA debentures and line of credit as well as any commitment fees.

As of June 30, 2017, the weighted average interest rate on our outstanding debt was 3.7% versus 3.9% in Q1. As of June 30, we had $217.3 million of debt outstanding.

Net investment income, or NII, for the 3 months ended June 30, 2017, was $9 million or $0.39 per share versus $0.35 per share in Q1 2017. Adjusted NII was $0.40 per share in Q2 versus $0.37 per share in Q1. 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 June 30, 2017, Fidus had $0.4 million of net realized losses, primarily related to the exit of our debt and equity investments in FTH Acquisition Corp. A $1.3 million realized loss on FTH was partially offset by a $0.9 million realized gain on the exit of our equity investment in Anatrace Products.

Our net asset value at June 30, 2017, was $15.87 per share, which reflects payment of the $0.39 per share regular dividend in June.

Turning now to portfolio statistics. As of June 30, our total investment portfolio had a fair value of $553.3 million. Consistent with our debt-oriented investment strategy, our portfolio on a cost basis was comprised of approximately 73% subordinated debt, 16% senior secured loans and 11% equity securities. Our average portfolio company investment on a cost basis was $9.7 million at the end of second quarter, which excludes 5 investments in portfolio companies that sold their operations are in the process of winding down. We have equity investments in approximately 86.7% of our portfolio companies with average fully diluted equity ownership of 7.3%. Weighted average effective yield on debt investments was 13% 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 nonaccrual, if any.

Now I'd like to briefly discuss our available liquidity. On June 20, we issued 1.75 million shares at a price of $16.80 per share above NAV and a follow-on offering with an additional 263,000 shares from the overallotment issued on June 29, raising total net proceeds of $32.3 million.

Also in Q2, the SBA approved an additional $25 million commitment for incremental debentures and Fidus Mezzanine Capital II, our second SBIC fund. As of June 30, our liquidity and capital resources included cash of $50.8 million, unfunded SBA commitments of $58 million and $50 million of availability on our line of credit, resulting in total liquidity of $158.8 million.

As Ed discussed, we've had an active start to the third quarter with a number of subsequent events, which were funded with available cash and net proceeds from the equity offering. Taking into account subsequent events, our liquidity is currently $131.8 million, which includes $23.8 million of cash. Approximately $18.6 million of cash is currently held at Fidus Mezzanine Capital, or FMC, our first SBIC fund, which is in the process of winding down. At the end of August, we expect to use excess cash at FMC to pay down additional SBA debentures with interest rates ranging from 5.3% to 6.4% and maturity dates ranging from September 2018 to March 2019.

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

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

I'll now turn the call back to Kaylee for Q&A. Kaylee?

(Operator Instructions) Our first question comes from the line of Leslie Vandegrift with Raymond James.

I just had a couple of quick ones. I know you discussed just then as well, Shelby, about the -- using the deployments already somewhat in third quarter. But if I already have an outlook for the timing on the remainder of that new equity raise being used. Do we think third quarter is going to be fast-paced all the way through or is some of that going to spill into fourth?

Great question, Leslie. I wish I knew. We're -- I guess what I would say is -- it's a relatively healthy market. As we sit here today, we are working hard with the portfolio, we are also working on some potential new investment opportunities. I think that the thing that I would mention here is that given it's a healthy M&A market, we do have several companies that are at least looking at strategic alternatives and financing alternatives. And so our current expectation is maybe slow growth, but we are going to have some repayments and if we look at the full year, there is a scenario where we don't see incremental growth over June, where repayments could match new investments. And so it's hard to tell at this point, both new investments and repayments are very unpredictable. And so that'd be my answer. I think we're taking a cautious approach to growth right now.

And I would just add from a cash management perspective, we will be able to utilize the cash from the equity offering. But as Ed kind of mentioned, we will have some repayments, and to the extent we have repayments that come in FMC, our first SBIC fund, that will be idle cash and so we can pay down debentures prior to September 1 and March 1 kind of annual, semiannual payment date. We'll have some lumpiness with cash management just as we get repayments in our SBA fund.

Okay, perfect, thank you. And then, on restaurant finance, the only nonaccrual right now. You got a slight markdown again this quarter, and I know you said that you're still in active discussions with them. Is there any more detail on the update there?

Not that I think it's appropriate to share. I would say we are very active in this situation. The valuation reflects the increase in the risk profile relative to last quarter and it's a dynamic situation as well I would say. And so we are continuing to work with the company to try to optimize the outcome for all parties and particularly us. So that's why...

I know, I know. It's -- sometimes you can't give more detail on those. But the last question just for a modeling issue, spillover income as of June 30?

I'm sorry, one more time.

Spillover income as of June 30. Do you guys have that number?

So its $0.52 per share or about $12.7 million.

Our next question comes from the line of Bryce Rowe with Baird.

Ed, I was wondering if maybe you could touch on the Pinnergy write-up in that 1 equity tranche?

Sure. As you know, the energy sector for a solid 24 months was dismal overall. There has been an increase in activity levels really since, call it, the middle of last year or third quarter of last year. Pinnergy has benefited from that increase in activity levels and I would say is performing maybe better than the sector, that's what I hear from some of the people, call it, third-party valuation folks and whatnot. So I think we're -- as we've stated in the past, Pinnergy has got a strong asset base, blue chip customer base and in our opinion is well positioned in that sector, albeit it was horrible for a while as we all know. So it's been a nice kind of pick up, if you will, and overall activity for the company since again, mid-last year or third quarter of last year.

Okay. That's helpful. Then, Shelby, just wanted to clarify the upcoming repayments of SBA debentures. It looks to be about $32 million and maybe I just didn't hear it clearly, but are you using cash within that SBIC subsidiary to repay or cash from the holding company?

We'll be using cash from within the SBA subsidiary to repay. And so the point I was trying to make is that currently, we have about $18.6 million within that subsidiary to use for operating expenses, distributions to the holding company and repayment of debt. And so my hope would be that we would be able to repay at least $12 million, if not potentially a little more, come September 1. Any and all repayments will in fact come from cash from within that fund.

Right, right. Okay. And so if you already get some level of repayments over the course of this quarter, would you potentially try to pay down that next tranche that you have outstanding? Or would you wait until, I guess until, next period, 6 months later to potentially prepay that?

Yes. Unfortunately that's a timing challenge just depending on the timing of when we got a repayment. So if we got a repayment in August, I would prepay by September 1. If we got a prepayment anytime after September, I would wait until March, just because from an interest perspective, there's no benefit of prepaying until March.

Our next question comes from the line of Chris Kotowski with Oppenheimer.

Just a piggyback on Bryce's question. It's roughly $32 million you said, and I'm kind of curious like what is the go to rate and if we look beyond just this quarter, let's say, the next 12 to 18 months, should we expect that whole $32 million to go and to -- and what's the -- I guess, overall, I think, you're going faster, but I think you said $5.6 million to $6.2 million. So you're going from something like near 6% rate? And what's the go to rate on that?

Yes. So let me just step back and kind of clarify because there are a lot of moving pieces. I was trying to kind of highlight, given we've had a fair amount of subsequent event activity. As of today, we sit on about $23.8 million of cash in total. And of that $23.8 million, about $18.6 million is within the Fidus Mezzanine Capital or SBIC fund. And so that's the available cash that we would look to use to pay down SBA debentures. So we've got about $11.95 million of debentures with the maturity date of September of 2018, and those debentures have an average interest rate of about 6.4%. So those would be the first debentures that we would look to pay down. To the extent we have additional excess cash that we could use to pay down debentures prior to September 1, we would pay down the next tranche, which has interest rate of 5.3%. So that's where -- with some combination of debentures with 6.4%, hopefully a little bit with 5.3%, and maturity dates of September 2018 and potentially some with March of 2019.

And your go to rate would be somewhere around 4%, right?

For new debentures, yes. So the good news is, as luck would have it, the debentures within our first fund, which is our oldest fund, that mature have the higher interest rate. And so we're getting to pay down, as you kind of saw in Q1, some of the interest was higher, interest rates and that's helping bring down our weighted average cost of debt.

Okay. And then kind of just a bigger picture question for Ed, I guess, is the large cap private equity companies that we follow have been raising record pools of capital. And I'm wondering about the sponsors in your space. Are they also raising funds now that are bigger than the ones before? Or is there more capital available for transactions or less say the next couple of years?

Chris, I think, they are taking advantage of the opportunity and raising more capital. I don't know that, that is changing the market environment, if you will. It's -- the come -- the lower middle market has had plenty of cash to pursue high quality situations for quite a while now. And what we're seeing in the market is a continuation of that theme. So valuations are at high levels and maybe close to peak levels currently and our expectation is for that to continue. But again, for only the what I would call the highest quality opportunities out there. So I think it's a good thing for our market overall. There is a high degree of interest in the buyout world, if you will, in our market. And there's a fair bit of capital out there. And we're looking to try to support folks as they make acquisitions in situations that we think are really high caliber. So I think it's really positive.

And our next question comes from the line of Ryan Lynch with KBW.

I just have a couple remain, most of mine have been answered. Just one question on EBL. That was obviously a good investment that you guys had. You guys had a nice gain in your equity investment this quarter. Can you talk about what -- why that company was able to have such success? As well as you guys also reinvested $10 million into the sub-notes of that company again. So I just wanted to know what was your thought process behind reinvesting in a company which had obviously been successful, but it's also a company in the retail industry which is obviously facing some major headwinds for various reasons. So can you just talk about why you guys decided to reinvest in a company that had been successful, but also is in a really tough industry right now?

Sure. It's a great question, Ryan. It's an issue we clearly discussed. And it's quite a long time, quite frankly. But we've been in the -- we first invested in that business, I think, in 2012. So we've watched it, gone to board meetings for a long period of time. And we've had consistent, call it, financial success and operational success throughout that period. So it's a very high-quality company. It's focused on more urban markets, if you will, in the northeast. They sell a lot of shoes, if you will, so Nike, Adidas and others and then other branded apparel, if you will, focused on the urban marketplace. They've got great relationships with the suppliers, in particular with Nike and Adidas. And the overall business is interestingly more of a cash business and less susceptible to e-commerce, which is a concern of ours as we invest going forward. It's an opportunity in some cases, but it's a concern in the sector that you're talking about. And so it's one that's somewhat interrelated, at least currently, from the e-commerce competition. And so we view it as a company that has very good unit economics, high free cash flow and has opportunity to grow. So with a balanced growth and debt repayment, we like the debt play and we like the equity investment again as well. So it's differentiated from our perspective.

Okay, got it. And then, just one more, when you guys -- I'm going to ask you to, if you can generalize, when you guys go out and are making subordinated debt investments, what is your ability to control how those -- how the pricing is structured on those investments via be them fixed versus floating. I mean, obviously, the majority of your portfolio is fixed rate investments, which matches the liability structure of your balance sheet. But I'm just wondering, do you guys have the ability to structure subordinated debt investments that you make as floating rate and do you guys have any desire to do that more often in the future given where rates have been and where they feel like they're going?

Sure. It's a great question and a tough question, Ryan. I would tell you that in some cases, we do have the ability to structure floating rate deals. We did invest in a senior secured loan here in July and that was floating rate. But I would say, a large majority of most subordinated debt or restructuring were second liens, but most second lien loans in our marketplace are fixed. I do think we have the ability to, in some cases, opportunistically could structure them with floating rates, I think you'd have to start a little lower and basically sell that, we think the rates would rise over time, and we are trying to insulate ourselves. We thought about doing that in some cases, and we do think about it. It's just -- at the moment we're, I guess, we've structured the deals the way we have. It's what we could get away with, if you will, for lack of a better term as well as what we thought was prudent.

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

Thank you, Kaylee. And thank you, everyone, for joining us this morning. We look forward to speaking with you on our third quarter call in early November 2017. 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 wonderful day.