Fidus Investment Corp (FDUS) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fidus Investment Corporation First Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's conference, Mr. John Heilshorn from LHA. Sir, you may begin.

Thank you, Jimmy. And good morning, everyone. Thank you for joining us for Fidus Investment Corporation's first quarter 2018 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 will contain certain forward-looking statements, including statements regarding the goals, strategies, beliefs, future potential and operating results and cash flows of Fidus Investment Corporation.

Although management believes these statements are reasonable based upon estimates, assumptions and projections as of today, May 4, 2018, 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 Securities and Exchange Commission. Fidus undertakes no obligation to update or revise any of these forward-looking statements.

With that, I'd like to now turn the call over to Ed Ross. Ed, good morning.

Good morning, and thank you, John. And good morning, everyone. Welcome to our first quarter 2018 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 our views about deal activity. 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 good start to 2018 with our first quarter adjusted net investment income, which we define as net investment income excluding any capital gains and incentive fee attributable to realized or unrealized gains and losses, increasing 8.8 -- 8.7% year-over-year to $8.9 million or $0.36 per share.

Our debt and equity investments continued to perform well in the first quarter, affirming our diversified portfolio approach which includes prioritizing quality over quantity, focusing on capital preservation and investing with a long-term view.

In the first quarter, we realized net gains of $5.5 million related to our equity investments. As of March 31, 2018, our net asset value, or NAV, was $398.2 million or $16.28 per share. Net asset value per share grew a respectable 1.4% from our 2017 year-end level.

I'm pleased to announce that we have received a Greenlight letter from the SBA and, earlier this week, submitted our application for our third SBIC license. On March 23, 2018, 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 $10.2 million or $0.42 per share.

For the second quarter of 2018, the Board of Directors has declared a regular quarterly dividend of $0.39 per share, which is payable on June 22, 2018, to stockholders of record on June 8, 2018.

In the first quarter of 2018, we invested $60.9 million in debt and equity securities. Of this amount, $56.9 million was channeled to 5 new portfolio company investments. In each case, these businesses met our investment criteria, including 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.

Let me briefly recap each of our new portfolio company investments. We invested $19.5 million in second lien debt and common equity of AVC Investors, LLC, doing business as Auveco, a provider of fasteners and auto body hardware to the automotive aftermarket and general industrial markets. $10.5 million in second lien debt and common equity and made a commitment for up to $0.1 million of additional common equity of B&B Roadway and Security Solutions, LLC, a leading manufacturer of traffic control and perimeter security solutions. $9.8 million in second lien debt in common equity of CRS Solutions Holdings, LLC, doing business as CRS Texas, a technology-enabled provider of comprehensive point-of-sale solutions to the hospitality end market. $11 million in second lien debt and common equity of SpendMend, LLC, a leading provider of spend visibility and audit recovery services to the health care industry. And $6.1 million in subordinated debt and preferred equity and common equity of the Tranzonic Companies, a value-added supplier of disposable maintenance, cleaning, personal care and safety products to the away-from-home marketplace.

In addition, we invested $3.5 million in second lien debt of Thermoforming Technology Group, LLC, in support of an acquisition and $0.5 million in common equity of Vanguard Dealer Services, LLC, in support of an acquisition.

From a repayments and realizations perspective, we also had an active first quarter. Proceeds totaled $36.1 million, including we received payment in full on our second lien debt investment in United Biologics. We exited our debt investment in Comprehensive Logistics and received payment in full on subordinated debt, including a prepayment penalty of approximately $0.5 million. And we exited our equity investment in World Wide Packaging and realized a gain, net of estimated taxes, of approximately $5.2 million.

As reported in the first quarter press release, subsequent to quarter end, on April 3, 2018, we invested $7.8 million in subordinated debt and common equity of UBEO, LLC, a premier provider of printer, copier and related office equipment sales and services. On April 12, 2018, we invested $12 million in second lien debt, preferred equity income and equity of Power Grid Components, Inc., a supplier of high-quality, mission-critical products used in the North American electric power grid. On April 19, 2018, we exited our debt investment in Allied 100 Group, Inc. We received payment in full of $13 million on our subordinated debt.

The fair market value of our investment portfolio at March 31, 2018, was approximately $632.2 million, equal to approximately 103% of cost.

We ended the quarter with debt and equity investments and 63 active portfolio companies, plus 3 portfolio companies that have sold their underlying operations. The breakdown on a fair value basis between debt and equity remain fairly stable with 82% in debt and 18% in equity investments, providing us with high levels of current and recurring income from 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 remained strong and in line with prior periods.

First, we track the portfolio's weighted average investment rating based on our internal system. And 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 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 company's combined ratio of total net debt through Fidus' debt investments to total EBITDA. For the first quarter, this ratio was 3.8x compared to 3.5x 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 first quarter, this metric was 3.4x compared to 3.5x for the same quarter last year.

The soundness of these metrics reflects our philosophy of maintaining significant cushions to our borrower's enterprise value in support of our capital preservation and income goals. Two of our investments, Restaurant Finance Co, LLC, and Six Month Smiles Holdings, Inc., remain on nonaccrual status as of March 31, 2018. With respect to Six Month Smiles, it's an extremely fluid situation. And as a result of both events and company performance, the risk level has increased substantially. As a result, we wrote down the value of Six Month Smiles Holdings investment to 0 this quarter. We remain in active discussions with both of these companies.

Turning to business conditions in our target market. While M&A activity continues at a reasonably healthy level and deal flow remains stable, the quality of deals that we are seeing in the pipeline has been more erratic over the past month. The first quarter was relatively unchanged for us from 2017. And as of today, we currently don't see any issues that would cause a dramatic expansion or contraction in our deal flow.

Notwithstanding an uptick in interest rates and energy prices, the overall economy continues to grow at a slow but steady rate. Repayments and realizations, of course, are always a wild card in our business, but we've been successful in redeploying of our exit proceeds. We will, as we always do, focus on industries we know well, leveraging our knowledge and relationships and be highly selective with our cautious and deliberate approach to investing in businesses that we believe will perform well over the long term.

By adhering to our proven investment strategy to grow and further diversify investment portfolio, we remain well positioned relative to our goals of preserving capital and generating attractive risk-adjusted returns.

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 2017.

Total investment income was $18.2 million for the 3 months ended March 31, 2018, a $1.2 million increase from Q4 2017. Interest in peak income increased by $0.6 million related to incremental assets under management and investment timing as the majority of our new Q4 investments took place late in the quarter.

Fee income increased by $0.4 million due to a $0.5 million prepayment fee from the repayment of our debt investment in Comprehensive Logistics. Dividend income in Q1 was $0.3 million versus $0.2 million in Q4. Total expenses, including income tax provision, were $10.9 million for the first quarter, approximately $1.5 million higher than the prior quarter, primarily due to an increase in interest expense related to an increase in debt outstanding, a modest increase in the weighted average interest rate related to our public debt offering, and interest on SBA debentures that were repaid in late February as well as a higher accrued capital gains incentive fees.

Interest expense increased by $0.7 million. Approximately $0.2 million of the increase was related to the acceleration of noncash amortization expense on the SBA debt repaid in Q1. G&A expenses increased by $0.1 million. Base management and income incentive fees increased by a total of roughly $0.2 million and accrued capital gains incentive fees increased by $0.6 million. Interest expense includes the interest paid on Fidus' SBA debentures, public notes, and line of credit as well as any commitment and unused line fees and amortization of deferred financing cost. As of March 31, 2018, the weighted average interest rate on our outstanding debt was 3.8% versus 3.6% at year-end. As of March 31, we had $264.5 million of debt outstanding, including our $50 million public debt offering of 5.875% notes due 2023 completed in the first quarter.

Net investment income, or NII, for the 3 months ended March 31, 2018, was $7.4 million or $0.30 per share versus $0.31 per share in Q4 2017. Adjusted NII was $0.36 per share in Q1 versus $0.35 per share in Q4. 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 3 months ended March 31, 2018, Fidus had $5.5 million of net realized gains primarily related to a $6.8 million realized gain from the exit of our equity investment in Worldwide Packaging, offset by a $1.7 million in estimated tax expenses related to realized gains on equity investments held in taxable subsidiaries. Our net asset value at March 31, 2018, was $16.28 per share, which reflects payment of a $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 $632.2 million, consistent with our debt-oriented investment strategy, our portfolio on a cost basis was comprised of approximately 5% first lien debt, 65% second lien debt, 19% subordinated debt and 11% equity securities.

Our average portfolio company investment on a cost basis was $9.7 million at the end of the first quarter, which excludes 3 investments in portfolio companies that sold their operations during the process of winding down. We have equity investments in approximately 89.4% of our portfolio companies with an average fully diluted equity ownership of 7.1%.

Weighted average effective yield on debt investments was 12.7% as of March 31. The weighted average yield is computed using the effective interest rate for debt investments at cost, including the accretion of original issued discount and loan origination fee, but excluding investments on nonaccrual, if any. Under our share repurchase program, we purchased approximately 45,000 Fidus shares at an average price of $12.94 or a total purchase of approximately $582,000 in Q1.

Now I'd like to briefly discuss our available liquidity. As of March 31, our liquidity and capital resources included cash of $32.8 million and $50 million of availability on our line of credit, resulting in total liquidity of $82.8 million. As discussed in our year-end earnings call, we prepaid $43.8 million of SBA debentures in advance of scheduled maturity dates at the end of February. These debentures had an average interest rate of 4.9%. As a result, we currently have $64.5 million of remaining debentures at FMC with maturity dates ranging from September 2020 to March 2025.

In Q1, we borrowed $27 million of SBA debentures under our second SBIC fund, FMC 2, and as of March 31, have $150 million outstanding under FMC 2. In aggregate, we have $214.5 million of SBA debentures and $50 million of public notes totaling $264.5 million of debt outstanding for a total debt-to-equity ratio of 0.66 versus approximately 0.62 as of year-end 2017.

As Ed mentioned, subsequent to quarter end, we invested in 2 new portfolio companies and received a repayment. Taking into account subsequent events, we currently have total liquidity of $76 million, which includes cash of $26 million and $50 million of availability on our line of credit.

One final comment regarding Q2 before I turn the call back to Ed. As our existing registration statement has expired, we filed a new registration statement that was declared effective earlier this week. In conjunction with the expiration of our prior registration statement, we will incur approximately $250,000 of noncash expense in Q2 related to unamortized expenses or roughly $0.01 per share of incremental expense.

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 Jimmy for Q&A. Jimmy?

(Operator Instructions) Our first question comes from Robert Dodd with Raymond James.

First question, I got to ask about prospects for double leverage. Obviously, you guys have never been over [1 to 1] all in, even when you've been allowed through the SBIC vehicle. So I mean, is there any intent to either ask board or shareholder approval to change the asset coverage ratio cap for you guys?

Sure. Great question. Great question. I think, I guess, just talking about the agg first, again, I think at the margin, we think it's a positive for the industry and thus, I think it's good for us as well. And I think operating reform is a positive. Leverage, as we know, is a double-edged sword, but can be a positive. But as we sit here today, we don't need to utilize the increase in the leverage opportunity to perform well for our shareholders given our investment strategy. So for us at this point, we don't think there's a need to do anything. So we're very much taking kind of a wait-watch-and-see approach at this point in time.

Got it. Got it. Another one that I think just changed, the SBIC limit per license. I think just ticked up to -- you know, obviously the -- you've got 150 on SBIC 2 right now, but -- which was the previous cap. Correct me if I'm wrong. Has that just gone up to $175 million so you can cap a little bit more in that one, while -- and then second, tied to that, last quarter you sounded a little bit more cautious about how long it takes except for the potential third license process, but a Greenlight letter already. I mean, are things moving faster than you expected and is there anything you can point at as to why?

Sure. A couple questions in there. I think from our perspective, the SBIC license, obviously, a very good thing. I think we are planning at the moment on utilizing $150 million of debentures with regard to that license. And if we can go to $175 million, I don't think that's clear at this point, then we will consider that clearly. But I think the expectation is to hopefully get the license and utilize $150 million of debentures. From a timing standpoint, I think things have been moving slowly, I think, really in 2017 at the SBA. That would be my perspective. But I do think things have picked up a little bit here in 2018. That doesn't mean that -- I mean we just put the [4 million] application in this week, we expect that to take some time. So our hope is, hopefully by year-end, we hear something and can come as -- can accomplish a full receipt of a license. But it's going to take some time is my guess.

Got it. Got it. Another question, just on the debt. I mean it looks like another dividend reversal this quarter, 106,000 in the noncontrol section. Obviously, there was one last quarter as well. Any color on that? I mean is there anything we should read into that in terms of the quality of information you're getting from portfolio companies about what the character of dividends is versus capital repayments? I mean, 2 in a row.

Sure.

No. So that has to do with -- we record dividend income and we have to do estimates based on the character of that dividend. And then some don't actually receive the K-1s associated with that until subsequent periods. And so that has to do with kind of a onetime true-up related to dividend income that we had recognized in 2017, but didn't receive the K-1 information until first quarter of 2018.

I guess, I mean, that's kind of the point, you see. I don't think dividend reversals, to my recollection, it never happened before except for the last couple of quarters. So I mean, the question is it does depend on the character, depends on what the company has told you over the time, et cetera, et cetera. But has that information quality changed to the point -- are your estimates getting less reliable, I guess, is the question?

No, no. I don't think it has. I think what you're probably seeing is because now, dividend income is broken out by controlled versus affiliate versus noncontrolled, you're seeing a little bit more detailed information as opposed to, in prior quarters, it was more of 1 line items. So things kind of netted out.

Fair enough. Fair enough. Last one for me. Can you give us, call it estimate of what your spillover income is? Because obviously, you've had some additional realized gains and you already had a decent slug of spillover? But where do you stand today on that front?

It's $0.42 per share.

And our next question comes from Chris Kotowski with Oppenheimer.

I know normally you can't say much about individual companies and investments, but it's just I noticed the mark on Pinnergy of $3 million cost investment equity went from $15.6 million to $23.6 million. And that just seemed like a big move. And I was wondering, is there an event that is triggering that or -- well, let me leave it there and see what you can say.

No. It's a great question. The -- this is a business that was performing very well, obviously went through the cycle. We went through a restructuring. We retained some of our debt and obviously are a very meaningful equity holder in this business now. And quite frankly, the valuation is based on just performance. It's performance-based. The company is performing both operationally and, from a financial perspective, extremely well. So that's the driver.

And I'm curious, I guess. I don't remember your ever having a equity investment quite this big. And what's your desire, willingness, capacity, however you want to phrase it, to hold this for the longer term or -- and do you have any control over the exits? Or?

Sure. No, it's a great question. And as I'm sure you've seen, our equity portfolio now is over $110 million or about $110 million on a fair value basis and -- which is substantial, and it is something that we would like to monetize some of these investments and rotate them into more yielding investments, if you will, or debt investments. But at the same time, they're performing well and we're obviously pleased with the outcome of where we are. So what I would say is we do not have control over -- really, we only have control over 1 company. So we don't have control of these exits. But some of them are getting to a more mature point, if you will. And so our hope is to, over the next, you call it 12, 18 months, to monetize some of these equity investments, and that would obviously be a good thing for Fidus. And so that is one of our goals to the extent we can influence it. Hopefully that's helpful, but we really don't have a controlling stake, if you will, to drive these. But we definitely can give our opinions and try to do the best we can with regard to exits.

Okay. And I noticed the Six Month Smiles, you obviously marked to 0. Is that loss then crystallized and they're to offset any realized gains or is that still to be done?

That is -- that loss is not crystallized at this point or that write-down is the right definition, if you will. It is a situation, but -- and I think I commented on this last call, but over the last 24 months, not much has gone according to plan with regard to this company. And it's been both company performance as well as other events that I need to keep confidential that have been big negatives to our investments here recently. And so it's extremely fluid. I do hope to be able to provide some clarity on our next call. We're working hard and in active discussions, but obviously the risk profile is reflected in the valuation at this point.

Our next question comes from Ryan Lynch with KBW.

I just have one. Yes, when we look at the debt capital structure with your SBIC 1 kind of winding down, I know you guys are kind of tapped down on SBIC 2 and then looking to get a third SBIC, but obviously that's always uncertain with [as they get close] to the SBA. When I look at incremental growth on your balance sheet, it looks like that would probably come from cash on the balance sheet and then next would be the credit facility. You guys -- had you guys continued to grow nicely as you did quarter, do you guys foresee issuing any more unsecured debt or would you guys want to draw down more leverage on the credit facility assuming the growth continues to go on? The reason I ask is because the way your investment portfolio is set up, you guys, I believe, have about $25 million-or-so of floating rate investments, but predominantly your investment structure, your investments are fixed rate, and so I was just wondering if you draw too much on the credit facility, you get kind of a interest rate, fixed versus floating mismatch. So just what are your thoughts about the debt capital structure going forward given the uncertainty of SBIC 3?

Sure. Great question, Ryan. I think first and foremost, and you mentioned most of them. I do think we like having diverse sources, if you will, of debt. So like the fact that we obviously issued some public bonds last quarter. And so that is an option to increase those a little bit, that's one. Secondly, we obviously have a line of credit. It is unfunded as we sit here today. So we've got good availability there, but we also have the ability to increase that. And I think that is an option for us and something that we are considering, quite frankly. I don't think that's going to be a majority of our debt. But I do think it's an option for growth capital. And so I think we should utilize that. And then you have the SBIC debentures that we're hopeful to get that approval and utilize those proceeds as well. So those are from a debt perspective. Those are -- we like the diversity and we plan to access probably all 3 over time, but the timing, there's no need at the moment, but I think it makes sense to access all 3 as we grow.

And the only other thing I would add, just from a liquidity perspective, as you noted, we're in the process of winding down our first SBIC funds and we made a sizable debt prepayment here in the first quarter. So with that debt prepayment, we have the ability to upstream cash to create additional liquidity at the holding company as we receive repayments in the debt fund. So we can do return of capital distributions that will provide additional source of cash liquidity later this year.

And our last question for today comes from Mickey Schleien with Ladenburg.

All the good questions, I think, have been reviewed. I do have a couple that hopefully will shed a little more light on the quarter. And I did see that portfolio way declined from the fourth quarter a little bit. I was trying to understand that a little bit better in terms of what was the yield on the new investments you made versus your exits? Or another way of looking at is how much prepayment risk is there still existing in the portfolio?

Sure, sure. Great question. And I guess, just to answer your question very directly. The average yield was about under 12%, so it was 11.8% in Q1. And then from a repayments perspective, in particular, Comprehensive Logistics driving it, it was 15%, was the yields on the debt that was repaid. And so those moves were the primary drivers of the change. What I would say is a couple of things as we move forward. We're continuing to invest in companies that we believe both have very enduring characteristics as well as defensive qualities. And in particular, over the past couple of years, we've continued to strategically focus on what I would say a little bit larger companies within our core market. So fewer sub-$5 million EBITDA businesses and more between $5 million and $10 million or even over $10 million and quite a few over $10 million in EBITDA. And with that focus, our overall yields could drop a little from where we are today, so -- but I don't think it would be a material drop at this point. But that has been a strategic move that we've kind of made over the last 2 to 3 years and that continues.

That's really helpful. That is helpful. And my last question. I think Shelby said something about nonrecurring amortization of expenses for the SBA prepayment. Could you just repeat that information?

Yes. So towards the end of my commentary, I was talking about in -- well, there's 2 thoughts there. There's one that's -- in Q2, we'll have about an additional $0.01 of incremental expense that's noncash amortization related to cost on our registration statements that has now expired since and we've put in a new one. But also -- yes, so in the first quarter, as I mentioned, we repaid $43.8 million of SBA debentures. And so with that repayment, we had to accelerate the deferred financing fees associated with those debentures and that was about $200,000 of accelerated noncash expense that hit Q1.

Okay. That's the number I was looking for. And lastly, Shelby, can you tell us how much of your cash is in the SBIC subsidiaries?

Sure. At this point, I'd say it's about half and half in terms of half being at the holding company and then half, the remaining half of the $26 million being in the SBIC subsidiaries.

And most of that would be in the first license, right, because if I'm not mistaken, you're going -- I'm sorry?

So in the first license, it's about $3.5 million and then the residual [10] in second license.

Thank you. And there are no further questions in the queue. I would like to turn the call back over to Ed Ross for any closing remarks.

Thank you, Jimmy. 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 have a great weekend.

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