Fidus Investment Corp (FDUS) 2022 Q1 法說會逐字稿

Welcome to Fidus First Quarter 2022 Earnings Conference Call. My name is Hilda, and I will be your operator for today. (Operator Instructions) As a reminder, this conference is being recorded.

And now I would like to turn the call over to Ms. Jody Burfening. You may begin.

Thank you, Hilda, and good morning, everyone, and thank you for joining us for Fidus Investment Corporation's First Quarter 2022 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 the 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 also like to call your attention to the customary safe harbor disclosure regarding forward-looking information included on today's call. The conference call today will contain 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 6, 2022, 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 would now like to turn the call over to Ed. Good morning, Ed.

Good morning, Jody, and good morning, everyone. Welcome to our first quarter 2022 earnings conference call.

On today's call, I'll start with a review of our first quarter performance and our portfolio at quarter end, and then offer you an update of our views on deal activity in the lower middle market. Shelby will cover the first quarter financial results and our liquidity position. Once we have completed our prepared remarks, we'll be happy to take your questions.

During the first quarter, with deal activity in the lower middle market at reasonably healthy levels, we grew our debt portfolio through a combination of our strong relationships with deal sponsors, our industry knowledge and our differentiated perspective on financing solutions. While global supply chain disruptions and inflationary pressures on input costs, labor and freight continue to weigh on many businesses' operations and profitability, we found solid opportunities that fit our strategy of investing in high-quality, lower middle-market businesses that possess resilient business models that generate excess levels of cash flow to service debt and then have positive long-term outlooks.

Adjusted net investment income, which we define as net investment income, excluding any capital gain incentive fee attributable to realized and unrealized gains and losses, was $10.6 million or $0.43 per share compared to $11.2 million or $0.46 per share last year. Net asset value was steady at $486.5 million or $19.91 per share, reflecting solid operating performance and net realized gains, along with increased total dividend payout for the first quarter.

As you may recall, last quarter, the Board of Directors, recognizing the extremely strong portfolio performance and exceptionally high level of net realized gains in 2021, increased the base dividend from $0.32 per share to $0.36 per share and increased the supplemental dividend calculation from 50% of surplus income generated by our portfolio to 100%. Thus, Fidus paid a base quarterly dividend of $0.36 per share in a supplemental cash dividend of $0.17 per share for a total dividend of $0.53 per share during the first quarter. For the second quarter on May 2, 2022, the Board of Directors declared a base dividend of $0.36 per share and a supplemental dividend of $0.07 per share, equal to 100% of the surplus in adjusted NII over the base dividend from the first quarter, which will be payable on June 24, 2022, to stockholders of record as of June 10, 2022.

In terms of originations and repayments, after 5 consecutive quarters of elevated levels of repayments, we had net originations in the quarter of $91.2 million (sic) [$91.3 million]. We invested $114.4 million in debt and equity securities, nearly all of which was invested in debt securities and new portfolio companies. Following a trend that has started well before the pandemic, the largest percentage of debt investments was in first lien debt, amounting to $76.7 million for the first quarter.

In terms of new portfolio companies, we invested $101.2 million in 7 of them, consisting of: $10.8 million in first lien debt and common equity in AOM Intermediate Holdco, LLC doing business as AllOver Media, a leading provider of alternative, out-of-home advertising across the C-store and gas station, retail, truck side and transit markets, among others; $14.4 million in subordinated debt and common and preferred equity in CIH Intermediate LLC, a technology-based risk management firm that provides education and customized price risk management services to businesses affected by volatility in the agriculture markets; $14.5 million in first lien debt in Fishbowl Solutions, LLC, a leading provider of inventory management and manufacturing software.

$22.4 million in first lien debt and common equity in Micronics Filtration Holdings, Inc., doing business as Micronics Engineered Filtration Group, Inc., a global provider of aftermarket and OEM filtration equipment and consumables for use in mining, chemical, wastewater and various other industrial end markets; $15 million in second lien debt in Quest Software U.S. Holdings, Inc., a global cybersecurity data intelligence and IT operations management software provider; $19.1 million in first lien debt, subordinated debt and preferred equity in Tedia Company, LLC, a leading manufacturer high-purity solvents and chemicals focused on laboratory, pharmaceutical and biotech end markets; and $5 million in first lien debt and common equity in Zonkd, LLC, a leading supplier of products and services to the home furnishing industry.

In terms of repayments and realizations in the first quarter, we received proceeds totaling $23.2 million, of which $12.1 million or a little more than half of the total was due to the monetization of equity investments. In terms of sales and exits, we received payment in full of $6.8 million on our second lien debt in Mirage Trailers. In addition, we received a distribution of $2.5 million and realized a gain of $0.3 million on our equity investments related to the sale of the business.

We received proceeds of $2.2 million and realized the gain of $0.2 million related to the sale of Frontline Food Services. And we received proceeds of $7.1 million and realized a gain of $6.1 million related to the exit of our equity investment in SpendMend.

Subsequent to the end of the quarter, we invested a total of $19.5 million in 2 new portfolio companies. We invested $8.5 million in first lien debt and made a commitment up to $1 million of additional first lien debt in Choice Technology Solutions, LLC, doing business as Choice Merchant Solutions, LLC, a leading omnichannel global payments platform.

We invested $11 million in second lien debt of Virtex Enterprises, LP, a leading vertically integrated electronic manufacturing services provider. We also received $10.9 million in repayments consisting of payment in full of $8.8 million, including a prepayment penalty on our first lien debt investment in Comply365, LLC.

We received a distribution of $2.4 million from our equity investment in TransGo and realized a gain of $1.9 million related to the sale of the business. The fair value of the portfolio at quarter end was $812 million, equal to 112.8% of cost, reflecting the underlying solid performances of our portfolio companies and net originations for the quarter.

We ended the first quarter with 74 active portfolio companies and 10 companies that have sold their underlying operations. Including net originations of $91.2 million, our overall portfolio remains healthy and well structured to produce recurring income, and through our equity investments, to provide us not only with incremental profits but also a reasonable margin of safety.

From a risk perspective, our portfolio, including a net addition of 4 portfolio companies, remain well positioned for the current investment environment. Our residual investments in GreenFiber and K2 are on nonaccrual.

With net originations primarily in first lien debt during the quarter, our portfolio on a fair value basis remains weighted in favor of first lien debt. In terms of the total portfolio mix on a fair value basis, debt investments increased to 80% of the total compared to 77% as of December 31, 2021. Total yield on debt decreased from 12.3% last quarter to 11.9%.

Our outlook for 2022 is unchanged from the perspective we shared with you last quarter. We still expect continued healthy deal activity in the lower middle market driven by both M&A and refinancings, and we continue to see several opportunities to monetize equity investments as some of our portfolio companies have initiated strategic alternative discussions.

Having grown our debt portfolio during the first quarter after 5 consecutive quarters of heightened repayments, we believe we are well positioned to further increase income-producing assets going forward. In doing so, we will adhere, as always, to our proven underwriting standards, our focus on high-quality businesses and our long-term goal of generating attractive risk-adjusted returns, while delivering value to our stockholders.

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 2021.

Total investment income was $20.5 million for the 3 months ended March 31, a $3.6 million decrease from Q4, primarily due to a $1.6 million decrease in interest income, including PIK; a $1.4 million decrease in fee income; and a $0.6 million decrease in dividend income.

The decrease in interest income was driven by a decrease in average debt investment balances outstanding given higher volume of repayments in Q4 and new Q1 investments being more back-end weighted in addition to lower weighted average yield on debt in Q1 versus Q4.

Total expenses, including income tax provision, were $10.2 million for the first quarter, approximately $11.5 million lower than the prior quarter, primarily due to a $9.3 million decrease in the capital gains incentive fee accrual. Note, the capital gains incentive fee is accrued for GAAP purposes, however, is only payable annually in arrears to the extent that cumulative realized gains exceed realized losses and unrealized depreciation. Excluding the accrued capital gains incentive fees, total expenses in Q1 were $9.9 million, a $2.2 million decrease versus Q4, due to a $1.6 million decrease in income incentive fees in the annual excise tax accrual, which was $0.5 million in Q4.

In Q1, we repaid $20 million of SBA debentures in our second SBIC Fund and borrowed $41.5 million of SBA debentures in our third SBIC Fund, so net incremental SBA debentures of $21.5 million. We ended the quarter with $395.9 million of debt outstanding, comprised of $128.5 million of SBA debentures, $250 million of unsecured notes and $17.4 million of secured borrowings.

Our debt-to-equity ratio as of March 31 was 0.8x or 0.6x statutory leverage, excluding exempt SBA debentures. The weighted average interest rate on our outstanding debt was 3.7% as of March 31.

Net investment income, or NII, for the 3 months ended March 31 was $0.42 per share versus $0.10 per share in Q4. Adjusted NII, which excludes any capital gains, incentive fee accruals or reversals attributable to realized and unrealized gains and losses on investments, was $0.43 per share in Q1 versus $0.49 per share in Q4. For the 3 months ended March 31, we recognized approximately $6.9 million of net realized gains, primarily from our equity investments in SpendMend and Mirage Trailers.

Turning now to portfolio statistics. As of March 31, our total investment portfolio had a fair value of $812 million. Our average portfolio company investment on a cost basis was $9.7 million, which excludes investments in 10 portfolio companies that sold their operations or are in the process of winding down.

We have equity investments in approximately 82.1% of our portfolio companies, with an average fully diluted equity ownership of 4.3%. Weighted average effective yield on debt investments was 11.9% 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 nonaccrual, if any.

Now I'd like to briefly discuss our available liquidity. As of March 31, our liquidity and capital resources included cash of $86.1 million, $21.5 million of available SBA debentures and $100 million of availability on our line of credit, resulting in total liquidity of approximately $207.6 million.

Now I'll 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 over to Hilda for Q&A. Hilda?

(Operator Instructions) We have a question from Matt Tjaden from Raymond James.

Ed, one of the start out on the credit outlook. Be interested kind of how you see the credit outlook for year-end '22 today versus how it changed versus maybe 6 or 9 months ago.

Sure. Great question. Obviously, there is a lot going on in the world today, whether it's geopolitical or, obviously, inflation and rising interest rates. But for us, obviously, the portfolio complexion has changed for us from an -- on an -- the senior debt portfolio is now almost 70% of our debt portfolio. So that's a good thing as we think about the ebbs and flows of different businesses we're investing in.

But what I would suggest is our portfolio -- the quality of our portfolio today is maybe as good as it's ever been. We feel great about what we've seen and their ability to deal with the issues of today. And so obviously, we're being very thoughtful and deliberate as we move forward, as we originate new investments, but also as we manage our portfolio. But we feel great about the quality of the portfolio today and don't expect any material changes to the negative at this point.

Got it. That's helpful. Maybe following up on the portfolio composition. Surprising given the healthy level of originations in the quarter, looked like equity balance at cost was pretty much flat. I'd be interested in kind of any high-level color on what you're seeing in terms of deal flow for equity co-invest opportunities.

Sure. I think, if I'm not mistaken, we did make incremental equity investments last quarter to the tune of just shy of $5 million. So we're continuing to invest in the -- or make co-investments in our portfolio companies when it makes sense and doing it to a degree that, obviously, we're comfortable with and we like.

So our cost basis has not changed materially, nor has our fair value, something we're very, very proud of. We would -- we do see a fair bit of M&A activity still taking place. A large majority of the activity in Q1 was M&A driven, and we are also seeing continued M&A activity from both a realization perspective as well as a new investment perspective.

So we would expect that trend to continue. So as I think about equity as a percentage of cost for us, as we move forward, I think 10% or a little less is the goal for us, and that's what we would expect going forward.

Great. Last one for me, just on, again, kind of following up on the Q1 originations. I'd be interested, Ed, do you think any of that was kind of a pull forward from what was already a strong Q4? Or was that primarily underwritten in Q1?

Sure. Great question. Let me talk about the market for a second and also talk about originations and repayments for that matter. But overall, what I would say is investment activity was solid, though there was pull forward from Q4, for sure. Probably, 2 or 3 of those investments really were originating in Q1 and just took longer to close.

What we're seeing in Q2 this -- thus far reflects a pretty similar stance. I think deals are maybe a little bit harder to get over the finish line. There are potentially more issues out there, like performance issues. In some cases, they get in the way of deals. But we expect continued pretty good activity levels nevertheless.

So the market today seems to be primarily focused on companies that have not been meaningfully impacted by COVID-19 or the supply chain issues and overall inflation dynamics that obviously many companies are experiencing and facing. And in fact, we're continuing to see a premium paid for those businesses that are operating without meaningful incident or concern of those issues.

There's obviously a fair bit of pent-up demand and a lot of liquidity designed to invest in high-quality assets. In fact, I would say, private equity and private debt war chest, for lack of a better word, are near-record levels today. So as I would -- as I sit here today, I would suggest activity levels are still reasonably solid in the lower middle market but obviously nowhere near last year.

From an investment originations perspective, we -- most of our originations are first lien investments. Obviously, we're also making opportunistic second lien and subordinated debt investments in superlative companies and situations, and we expect to continue to do that as we move forward.

We expect Q2 to be an overall solid origination quarter, but maybe not as strong as Q1 in the aggregate. We've made 2 new platform investments so far this year, as I mentioned, and we do expect some additional origination activity this quarter as well. Having said all that, we're continuing to be very deliberate and careful, at the same time taking advantage of the best opportunities that we're uncovering.

And then so from a repayments perspective, we are seeing very little on the debt side, and a little bit of that has to do with -- our portfolio is much younger than it's been in the past, and we're not seeing anywhere near the activity levels that we saw last quarter -- or last year. And we're expecting this quarter to kind of reflect the same thing as last quarter, which is a good thing. So hopefully, that's helpful on the market and overall origination and repayment activity.

Our next question comes from Ryan Lynch from KBW.

First question I just had was just on kind of how you guys are evaluating kind of the current marketplace. Obviously, there's some -- a lot of dynamics going around, a lot of uncertainties in the broader economy today.

Has that changed your investment focus on the types of businesses you guys are willing to invest in? Or are you guys just digging in further on those potential risks? Because one of the issues, I think, is that along -- especially with a lot of the inflation and labor issues is those are -- have just started in 2022, and the financial impacts haven't really -- are basically unknown on how that's going to all flow through. So how are you kind of managing those pretty big unknowns when you guys are looking to deploy capital today?

Sure. It's a great question, Ryan. I think for us, and thankfully, I think for some time, most companies had to -- been working at adjusting to the, what I would call, the new normal and are finding ways to prosper. And what that means, in many cases, needing to raise prices to offset price increases.

So having pricing power is a very important element of managing this risk. And thankfully, we feel well positioned given almost all of our portfolio companies have exhibited pricing power in this market. So first and foremost, I would say that. And thankfully, we've been focused on those companies that have more pricing power.

Secondly, we do focus on businesses that -- high free cash flow business is no different than before in a relatively stable demand characteristics. And I think that strategy has and will continue to serve us well and help mitigate some of the risks that you've highlighted.

And then other pieces of the puzzle for us that are really important are investment structuring, which is 40% to 60% equity cushions at somewhat a minimum, depending on the situation in the company. And then how we're underwriting is -- there's no change there from our perspective in terms of enterprise value-level cushions, interest coverage and whatnot.

So again, we feel -- we're going to kind of stick to our knitting, focused on the companies that operate in industries we know well and the companies that are, quite frankly, being less affected or expected to be less affected by the environment that we're all living in. We also do focus on opportunistic situations where there's strong asset bases. And also we feel good about that strategy as we move forward as well. So hopefully, that's helpful. You there, Ryan?

Yes, that's helpful. On the new terms for deals out, specifically regarding yields and spreads, I'm just curious as risk-free rates have continued to move higher and, obviously, the forward curve shows them significantly higher than where they are today. Have you started seeing any pushback on spread that you guys are going to market with?

And/or have you started seeing borrowers start pushing for more fixed rate debt solution versus floating rate? Just love to hear your opinion on any changes in kind of the market dynamics right now as you're approaching borrowers.

Sure. Great question, Ryan. I would tell, you in the lower middle market, we have not seen any real pushback on spreads at this point in time. I do envision at some point there will be some compression. But I don't think it will be overly meaningful, but that's always the case, especially with competition out there.

I would also say we have not seen a push for fixed rates, at least with regard to our first lien investments. So we have not seen any push or requirements to be competitive in the market from that perspective.

So no real change. Obviously, there is a big increase in short-term rates this week. But again, as we're working today and as we work over the last 1, 1.5 years, we have not seen any real pushes there in our market.

Our next question comes from Bryce Rowe from Hovde Group.

Let's see. Maybe I'll start with you, Shelby. Can you kind of just remind us how you're viewing the SBA and the access to the future SBA debentures? Obviously, you've been a little bit more active here recently using those debentures. So if you could just kind of break down what's left on II and how much more you have to go on III, even if there is some available beyond the $21.5 million that you have available to you right now.

Sure. So big picture, our second SBIC Fund, we are currently in wind-down mode. So that kind of means we'll opportunistically use cash proceeds from repayments as they come in to kind of continue to pay down SBA debt in the second fund.

And then the third fund, we are still within our investment period. And so again, opportunistically, as the pipeline grows and we have SBIC-eligible investments, we'll seek to put those in the third fund. And so that's why you kind of saw the paydown that you did in the first quarter of Fund II debt and then borrowings under Fund III debt because we were able to deploy more capital.

So at the end of March, on the third fund, we had about $78.5 million of SBA debentures outstanding, and so that fund can go up to $175 million. That's subject to certain SBA approvals and a little bit further equity capital commitments. But we have plenty of room to grow on the third fund, about a little bit less than $100 million.

And then on the second fund, we currently have $50 million. And again, you'll kind of probably see that come down as we have -- the next payment window will be September 1. And so we'll just evaluate does it make sense to redeploy cash to the BDC and make investments there or does it make sense to continue to pay down debt over time.

Got it. That's a great rundown. I appreciate it. And then maybe another question for me. Looking at spillover income, obviously, it bumped up here in the quarter. It sounds like you've got some more realized activity in the pipeline. Just curious how you're thinking about that as it bumps higher. Prospects for maybe a special at some point in '22 or early '23. Just any color around that would be helpful.

Sure. Bryce, obviously, it's early in the year, if you will. But obviously, at the same time, we did see a nice pop in our spillover position. We did not factor in our spillover position into the base dividend or, obviously, the supplemental given our new methodology.

We are continuing to monitor the position at this point. There continues to be, as you know, uncertainty in the U.S., and we like the idea of having a very large spillover position for a rainy day. And I think we're -- but we're monitoring kind of the overall situation and are continuing to think about it as we move forward.

But right now, we're in a place where we don't need to do -- make any adjustments of any significance. And so we like the position we're in. And we also like the fact that we were able to raise the dividend in a very -- the base dividend in a very meaningful way last quarter. And obviously, we'll continue to evaluate both the base and supplemental dividends as we move forward.

(Operator Instructions) And we show no further questions in queue. I would like to turn the call back to Mr. Ross for final remarks.

Thank you, Hilda, and thank you, everyone, for joining us this morning. We look forward to speaking with you on our second quarter call in early August 2022. Have a great day, and have a great weekend.

Ladies and gentlemen, this concludes today's conference. We thank you for participating. You may now disconnect.