Fidus Investment Corp (FDUS) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fidus Investment's Second Quarter 2018 Earnings Conference Call. (Operator Instructions)

As a reminder, today's conference is being recorded. I'd now like to introduce your host for today's conference, Ms. Jody Burfening. Ma'am, please go ahead.

Thank you, Liz, and the good morning, everyone. And thank you for joining us for Fidus Investment Corporation's Second 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 the call will be available by using telephone numbers and conference ID provided in the earnings press release.

In addition, an archived webcast replay will be available on the Investor Relations page of the company's website following the conclusion of this conference call.

I'd also like to call your attention to the customary safe harbor disclosure regarding forward-looking information including in -- included in the earnings release and on today's call.

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 3, 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 and 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 Ross. Good morning, Ed.

Good morning, Jody, and thank you. Good morning, everyone, and welcome to Fidus' Second Quarter 2018 Earnings Call. I will open today's call with a recap of our investment strategy, then discuss our second quarter results, our investment portfolio performance and offer views about deal activity.

Shelby will go into more detail about the second quarter financial results and liquidity. After that, we'd be happy to take your questions.

Our primary goal was to deliver stable to growing dividends and net asset value on a per share basis. We aim to achieve this goal by focusing on capital preservation and the generation of attractive risk-adjusted returns.

Our strategy is to build a well-diversified portfolio of debt investments and, to a lesser extent, equity investments in lower middle market businesses that are niche market leaders.

Importantly, we manage and invest with a long-term approach and perspective, seeking to invest in businesses that we believe will perform well over the long term, with an emphasis on companies that operate in industries we know well, that generate excess cash flow for debt service and investment and that have positive long-term outlooks.

From a debt structuring perspective, we look to maintain significant cushions to our borrowers' enterprise value in support of our capital preservation and income goals.

Within that framework, second quarter operating results were in line with our expectations. Adjusted net investment income, which we define as net investment income excluding any capital gains incentive fee attributable to realized or unrealized gains and losses, was $8.7 million or $0.36 per share, reflecting a high level of current and recurring income from debt investments.

In the second quarter, we realized net losses of $15.2 million, primarily related to our investments in 2 portfolio companies. As of June 30, 2018, our net asset value, or NAV. Was $396.3 million or $16.20 per share.

On June 22, 2018, 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 $9 million or $0.37 per share.

For the third quarter, the Board of Directors has declared a regular quarterly dividend of $0.39 per share, which is payable on September 21, 2018, to stockholders of record as of September 7, 2018.

Turning now to our investment activity during the second quarter. We invested $43.1 million in debt and equity securities, of which nearly 3/4 of went to 3 new portfolio companies of $31.3 million. Let me briefly recap each of our new portfolio company investments.

We invested $11.5 million in second lien debt and preferred equity in American AllWaste LLC doing business as Wastewater Transport Services, a vertically integrated provider of nonhazardous wastewater collection, processing and disposal services. We also made a commitment for up to $3 million of additional second lien debt. $12 million in the second lien debt, preferred equity and common equity in Power Grid Components Inc., a supplier of high-quality mission-critical products used in the North American power grid. And $7.8 million in subordinated debt and common equity in UBEO, LLC, a premier provider of printer, copier and related office equipment sales and services.

In terms of repayments and realizations, proceeds totaled $29.2 million. We received payment in full on our subordinated debt investment in Allied 100 Group, Inc. We elected to exit our debt investment in New Era Technology, Inc. and received payment in full on our second lien debt, including a prepayment penalty of approximately $0.1 million. We received payment of $0.5 million related to the exit of our debt investment in Six Month Smiles Holdings Inc. as we made a deliberate decision to exit the situation rather than invest incremental dollars in a turnaround. As a result, we realized a $8.9 million loss. And we received [$24 million] related to the exit of our debt and equity investments in Inflexxion, Inc. and realized a $6.4 million loss. In addition, we received a nominal profits interest in IBH Holdings, LLC, which acquired the assets of Inflexxion.

This event was preceded by the loss of a material contract that created liquidity issues, among others, for the portfolio company, and as a result, the company was sold in an expedited manner.

As reported in our second quarter press release, subsequent to quarter end, on August 1, 2018, we exited our debt and equity investments in Jacob Ash Holdings, Inc. We received payment in full on our debt investments and redeemed our preferred equity investments for approximately $1.4 million.

Turning to our portfolio construction and metrics. The fair market value of our investment portfolio as of June 30, 2018, amounted to $646.2 million, equal to 105.6% of cost. We ended the quarter with 65 active portfolio companies and 2 portfolio companies that have sold their underlying operations.

The breakdown on a fair value basis between debt and equity was 81.5% in debt and 18.5% in equity investments, providing us with high levels of current and recurring income from debt investments and the opportunity to monetize equity-related investments. As of June 30, 2018, we had investments in 3 portfolio companies on nonaccrual status, representing approximately 2.8% and 0.6% of the total portfolio on a cost and fair value basis, respectively. In addition to Restaurant Finance Company, LLC, we placed Cavallo Bus Lines Holdings, LLC on nonaccrual in Q2. Cavallo has recently faced rapidly deteriorating business fundamentals. We're working with all of our constituents on an extremely fluid and difficult situation.

As of quarter end, we have a residual debt investment in Inflexxion of $0.2 million that is on nonaccrual, while working capital not included in the sale is liquidated.

Moving to 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 solid. First, we track the portfolio's weighted average investment rating based on our internal system. Under our methodology, rating of 1 is outperform, and a rating of 5 is an expected loss. As of June 30, the weighted average investment ratio for the portfolio was 2 on a fair value basis, in line with prior periods. We also track 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 3.8x compared to 3.5x 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. For the second quarter, this metric was 3.9x compared to 3.6x for the second 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.

Finally, in closing, I'll comment on deal flow and business conditions in our market. I mentioned on our last quarter's call that the quality of deals in the pipeline have been erratic, and after a mediocre couple of months, we're now seeing higher-quality deal flow. As we look forward, these indications, along with solid economic growth and the prospects of healthy M&A activity, create the conditions for us to continue to selectively grow the portfolio by investing in companies that operate in industries we know well, generate strong free cash flow and have positive long-term outlooks. Although we have some recent portfolio company developments to manage through, overall, our portfolio remains well positioned, providing us with a high level of current and recurring investment income and the opportunity to monetize mature equity investments.

Write-downs and losses are part of the business. To put this quarter's developments in perspective, since our IPO, we have recognized $16.8 million of net realized gains, i.e. cumulative realized gains have exceeded cumulative realized losses.

Given the business reality of write-downs and losses and in an effort to mitigate such losses, our investment strategy calls for maintaining a well-diversified portfolio. We continue to believe that having a high quality equity portfolio can provide not only incremental profits but also a reasonable margin of safety.

Currently, approximately 19% of our portfolio fair value is comprised of equity investments, above historical and targeted levels.

As I mentioned on last quarter's call, we hope to realize a fair amount of capital gains on some of our more mature equity investments over the next 6 to 12 months.

We've a lot of confidence, and our strategy has worked well for us. We intend to stay focused on our goals of preserving capital and generating attractive risk-adjusted returns 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 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 2018. Total investment income was $18.1 million for the 3 months ended June 30, 2018, a $0.1 million decrease from Q1 2018. Interest and PIK income increased by $0.6 million related to incremental assets under management, offset by placing our debt investment in Cavallo Bus Lines Holdings on nonaccrual. Fee income decreased by $0.7 million primarily due to a larger prepayment fee in Q1 from the repayment of our debt investment in Comprehensive Logistics.

Dividend income in Q3 (sic) [Q2] was $0.3 million consistent with Q1. Total expenses, including income tax provision, were $9.2 million for the second quarter, approximately $1.7 million lower than the prior quarter, primarily related to the capital gains fee accruals.

Interest expense was in line in Q1. In Q2, we incurred approximately $0.3 million of noncash expense related to unamortized deferred operating expenses on our [old] registration statements, a roughly $0.01 per share of incremental expense. Total G&A expenses, which included the noncash charge, increased by $0.1 million. Base management and income incentive fees increased by $0.1 million, and accrued capital gains incentive fees decreased by $1.8 million. Interest expense includes interest as well as any commitment and unused line fees. As of June 30, 2018, the weighted average interest rate on our outstanding debt was 3.8%. As of June 30, we had $271.5 million of debt outstanding, including $214.5 million of SBA debentures, $50 million of public notes and the $7 million outstanding on our line of credit.

Our debt-to-equity ratio was 0.69x or 0.14x regulatory leverage, excluding exempt SBA debentures.

Net investment income or NII for the 3 months ended June 30, 2018, was $9 million or $0.37 per share versus $0.30 per share in Q1 2018.

Adjusted NII was $0.36 per share in both Q1 and Q2. 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 June 30, 2018, Fidus had $15.2 million of net realized losses related to the write-off of 2 investments. We realized an $8.9 million loss from the exit of our debt investment in Six Month Smiles and a $6.4 million loss on our debt and equity investments in Inflexxion.

Our net asset value at June 30, 2018, was $16.20 per share, which reflects payment of the $0.39 per share regular dividend in June.

Now turning to portfolio statistics. As of June 30, our total investment portfolio had a fair value of $646.2 million. Consistent with our debt-oriented investment strategy, our portfolio, on a cost basis, was comprised of approximately 4% first lien debt, 68% second lien debt, 17% subordinated debt and 11% equity securities.

Our average portfolio company investment, on a cost basis, was $9.4 million at the end of the second quarter, which excludes 2 investments in portfolio companies that sold their operations during the process of winding down.

We have equity investments in approximately 90% of our portfolio companies with an average fully diluted ownership of 6.4%. Weighted average effective yield on debt investments was 12.7% as of June 30. The weighted average yield is computed using the effective interest rate for debt investments at cost, including the accretion of original issue discount and loan origination fee but excluding investments on nonaccrual, if any.

Now I'd like us to briefly discuss our available liquidity.

In June, we increased our credit facility by $25 million and now have total capacity of $75 million. As of June 30, our liquidity and capital resources included cash of $24 million and $68 million of availability on our line of credit, resulting in total liquidity of $92 million.

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

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

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

(Operator Instructions) Our first question comes from the line of Chris Kotowski with Oppenheimer.

Looking at the -- your investment levels average -- investment levels, that was up slightly from the first quarter and kind of in line or slightly better than what we are looking for, but the revenues were down a bit. And I wonder if you could decompose that a little bit. What's the impact of the nonaccruals? And was there any just basic spread tightening in the quarter?

Chris, let me take a shot at this, and I think Shelby will look at some things while I'm talking for a second. I -- obviously, Cavallo is a -- was a nonaccrual for the quarter, and that was the addition. I don't think there was, I think -- fees maybe weren't as big as some quarters. But I don't think there was any spread tightening that I'm aware of, maybe just nominal but nothing material. So those would be my answers. And so I think -- I don't see any real changes in what you're looking at.

That's right. The biggest new factor in Q2 was actually placing Cavallo on nonaccrual, and that was $0.01 per share of impact.

Okay, yes. And is there any other color you can give on Cavallo in terms of is it an economic sensitivity issue or idiosyncratic company management issue and the prospects for recovery there?

Sure. I can't say a lot. I don't think it's -- it makes sense or is appropriate. But I'd say the company is a provider of charter bus services, primarily focused in the Midwest -- or on the Midwest. The customers include group tours, schools and athletic teams. What I would say is the valuation reflects a meaningful increase in the risk profile of our investment. It's a pretty difficult situation that happened, kind of materialized in a pretty rapid way in the last 3 to 4 months. And what I would say is historically, it's a family-run business that became more institutionalized, and I think it's struggled with that transition, in particular more recently.

Our next question comes from Robert Dodd with Raymond James.

Just -- first, following up on a couple of Chris's questions. In the quarter, can you tell us if there was anything on the timing of the deals? I mean, were the originations really late in the quarter and the repayments early? Or were they just kind of spread out during the course?

I think they were more spread out if -- is what I would say. I think 2 of them may have -- was it 2 of them in April? But I think it was more spread out, is what I would say.

Okay, got it. And then on the Cavallo, just -- it was -- just to be clear, it was on nonaccrual for the full quarter?

Correct.

Right, got it. And then just -- I'll get on that one. I mean, last quarter, it was marked at [86], this quarter at [27]. I mean, that's without necessarily asking that you go into more details about what's going on. My -- correct me if I'm wrong here, but a sharp decline like that, I have -- a rapid deterioration, I think, is harder to recover from than a more moderate one, I guess. I mean, would you agree with that historically? Not necessarily talking about that asset in particular, but those kind of sharp deteriorations for other assets, not even just -- that you've done but other BDCs have done. Generally, my experience is it doesn't point to a great outlook for that asset.

Yes, I don't -- in general, I would -- I think that is exactly right. I think there are some scenarios that, obviously, you can recover from in full, and things can happen quickly, and you work through it. But this is a difficult situation, so your general assumption is, I think, right on. So...

Got it, got it. Then just on -- I mean, one of the things you mentioned, Ed, was deal quality. It seemed to improve. Would you say -- I mean, trying to nuance that down if I can. I mean, I presume that wasn't an easing of competition in terms of just seeing more because other people weren't [biting] them off quicker. So is it just -- are you now seeing just better-quality companies come or look for funding rather or get the acquired by (inaudible), obviously, rather than some competitive dynamic?

Sure. Yes, I think these things go in waves a little bit. People are getting ready for sales and trying to get it done by year-end. And so if I go back to the second quarter, the wave wasn't very large, generally speaking, on a relative basis to what it is now in terms of deal flow. And I would also say, for whatever reason, the quality of it for us, really almost throughout the quarter, was subpar. It doesn't mean we didn't see a few opportunities or a few more opportunities than we closed that we liked and ended up not winning because that happened once or twice, I think, in the quarter. But that's just part of the game. What I would say is, here, in July, and I think it's anticipation -- in anticipation of people trying to get some sales or realizations done by year-end, deal flow has picked up in a meaningful way, and the quality appears better. And so that's a positive from our perspective, and we -- obviously, we're to participate in some of that activity.

Right, right. Got it. And then last one for me. On -- you mentioned, obviously, a hope to realize some of your mature equity gains over the last -- next 6 to 12 months. I mean, obviously, you guys don't control when an exit happens. So where -- for lack of a better term, where does that hope come from? Are you actually hearing from some of those companies that they're looking to go through a sale -- or their owners rather than the companies necessarily, looking to go through a sale or exit process? Or is it more that you just think the market's pretty hot right now so you would just expect it to happen?

No. I mean, as you know, Robert, we monitor our investments on a weekly or monthly basis at a minimum, and we're going to quarterly board meetings in almost every case. So we're pretty up to speed on what is going on operationally as well as strategically as a company. And what I'd say is we have not a couple but numerous companies that are evaluating strategic alternatives. I don't think there's -- I do think we'll have incremental repayments this quarter. I think they're more debt-oriented this quarter. And our hope -- and you never know, none of these processes are guaranteed, but there are more than a couple of companies that are evaluating strategic alternatives or going through sale processes, and that's where the comment comes from. It's our expectation more in the fourth quarter that we'd have a -- actually, probably, a pretty robust level of realizations in the fourth quarter. But it's -- you never know. It's unpredictable as we know. And the deal doesn't close include until the day of and -- but that's the general theme and the general expectation at this point.

Okay, great. Got it. I was -- I just got one more, if I can, real quick. On the SBA side, I mean, first part, the liquidity, Shelby, you mentioned, obviously, $24 million in cash. Is any of that trapped down in one of the SBAs and essentially un-investable? And then the other part of that question is on the -- your application for the third license. I know there's no update, but is everything going as well as expected -- as hoped? Or any kind of qualitative commentary there?

Yes, on the cash question, I would tell you, about half of that $24 million was at the SBIC fund. However, we do have the opportunity to put that to work to upstream through retained earnings available for distribution. And some of the cash that we had at 6/30 was honestly just afloat because you might recall, I mentioned we had $7 million outstanding on the line, and that was a timing thing. And so (inaudible) went to quarter-end, the line has been paid down so now we have the full availability and decreased (inaudible). And then (inaudible) of the process -- that is kind of continuing to progress, and we are reasonably optimistic that we're making some headway there.

(Operator Instructions) Our next question comes from the line of Ryan Lynch with KBW.

First of all, this has to deal with -- first one just has to deal with pricing on new loans. Your guys' portfolio yield's been coming down for several years. It's still at a very elevated level relative to the rest of the BDC group. But as rates have been low for a long period of time, it's been coming down. Recently, though, in the last several quarters, you've seen rates start to rise. We've heard some other BDC's comment on some lenders. They're a little bit up market from you guys, but they're talking about lenders pushing back. And they're seeing some more pricing stabilization on yields. So just trying to get a sense of what is your anticipation for sort of yield kind of in the back half of the year? Do you guys expect to see some portfolio compression continue? Or should we expect that to kind of stabilize as you kind of mentioned the higher-quality deal flow coming through?

Sure. Great question, Ryan. I think it will -- most likely, it's in a stable to maybe low -- moved slightly lower depending on what deals are ultimately realized. Over the last, call it 6 months, the deals that we have invested in, the average yield has been just under 12%, at 11.9%. And then the repayments that we've had were at 13.5%. Now most of that happened in Q1. But there was that yield compression, if you will. But -- so that's kind of what I would expect going forward is similar yields as we've invested in over the last 6 months. And so that would tell you that maybe we would have a modest decline, but there's no guarantees of that. The rest of the portfolio is obviously remaining relatively stable. But -- so I -- and the other point I'd make, and I think I made this point last call, is we are continuing to focus on a little bit larger businesses within our market segment. So when you think about $3 million to $20 million EBITDA businesses, we're doing less of the, call it $4 million, $5 million, $6 million, $7 million EBITDA business than we probably did 3 years ago. And that's a strategic move we've made. And with that move, it brings a little bit lower yields. And so that's I think in concert with what I've said. I think it's stable to a little bit declining is what I would -- is how I would think about it.

That makes sense. That's helpful. Yes, and I definitely get it depends on -- yes, the yields and your repayments. And I know Jacob's repaid quarter to date, and that was about a 17% yield. So that's obviously going to pressure everything a little bit. But moving to a couple portfolio companies that kind of -- obviously, you mentioned -- talked a lot about Cavallo on the negative side. Just on the positive side, you guys had a nice -- basically, a $2 million write-up in, I believe it's called [Sandsteel]. And then you guys also had another $3 million write-up in your investment in Pinnergy. Can you just -- both being equity investments, can you just talk about what in those 2 businesses really drove the positive write-ups this quarter?

Sure, sure. I think, to be honest, in both cases, it's driven by the driver, which is EBITDA. So we've had pretty good growth in both companies from both a revenue and a earnings or EBITDA perspective. And those have been the drivers over the last quarter. So in both cases, it was just operating performance.

(Operator Instructions) I'm showing no further question in queue at this time. I'd like to turn the call back to Mr. Ross for closing remarks.

Thank you, Liz. And thank you, everyone, for joining us this morning. We look forward to speaking with you on our second (sic) [third] quarter call in early August of this year. 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.