Fidus Investment Corporation (FDUS) Q1 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Fidus Investment Corporation’s First Quarter 2015 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder this conference may be recorded. I would like to introduce your host for today’s conference, Mr. Jody Burfening. Please go ahead ma’am.

Thank you, Michelle and good morning everyone. Thank you for joining us for Fidus Investment Corporation's First Quarter 2015 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, 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 08, 2015 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 would now like to turn the call over to Ed Ross. Ed?

Good morning Ed. Good morning, everyone. Welcome to our first quarter 2015 earnings call. I will start our call by highlighting our results for the first quarter followed by a discussion of our investment activity and the performance of our investment portfolio. Then Shelby will go into more detail about our financial results and liquidity position. After that we will open up the call for questions. Fidus performed well during the first quarter against our stated long term objectives of delivering stable and growing dividends with an emphasis on capital preservations. We delivered a solid first quarter across key measures covering our regular dividend with net investment income and ending the quarter with a solid level of liquidity this portfolio expansion. In addition, we maintained high credit quality metrics in our portfolio with none of our debt investments on non-accrual status. As of March 31, 2015 net asset value was $244.7 million or $15.18 per share. Fidus generated net investment income of $6.2 million or $0.39 per share for the first quarter, while adjusted net investment income which we defined as net investment income excluding any capital gains incentive fee attributable to realized and unrealized gains and losses was $6.3 million or $0.39 per share. On March 26, 2015 we paid a regular quarterly dividend of $0.38 per share to stockholders of record on March 12, 2015. For the second quarter of 2015, the board of directors has declared a regular quarterly dividend o $0.38 per share and a special dividend of $0.02 per share both of which are payable on June 25, 2015 to stock holders of record on June 11, 2015. As a reminder, we have an outstanding balance of spillover income or taxable income in excess of distributions of $13.8 million at March 31. Since the beginning of the year, industry fundamentals and our target lower middle market remains solid with M&A activity continuing to drive deal flow for Fidus similar to last year. Although the pace of activity during the first quarter eased up a bit compared to the second half of 2014. We closed debt and equity investments totalling approximately $39.6 million including investments in five new portfolio companies. Two of these deals closed late in the quarter. Against the backdrop of stable industry fundamentals we have stayed true to our investment strategy investing in companies that operate in industries we know well, that generate excess free cash flow for debt service and growth and that have positive long term outlooks and strong yet defensible market positions. I’ll now give you a brief description of the new portfolio of company investment. We invested $5 million in subordinated notes and warrants of Ice House America, a manufacturer and operator of automated ice vending machines. $8 million in subordinated notes of Six Month Smiles Holdings, a provider of short-term cosmetic orthodontic solutions, $6.4 million in senior secured notes of Stagnito Partners, a provider of business information services to the convenience store, food, retail and pharmacy markets in the United States and Canada. $6 million in senior secured notes and preferred equity of X5 Opco, a customer-focused provider of a complete suite of telecommunications solutions to enterprise, government and wholesale clients in the Pacific Northwest and $9.5 million in subordinated notes in common equity of U.S Pack Logistics, a provider of same-day and last-mile courier services throughout the United States. In addition to these new portfolio investments we invested an additional $3.8 million in Carlson Systems Holdings in support of an add on acquisition. Proceeds from repayments and realizations totalled $24.7 million in the first quarter, primarily due to refinancing at two portfolio companies. First, Eblens [ph] we financed its debt and repaid our $9.6 million subordinated debt investment in full; secondly IOS acquisitions primary subsidiary was sold. As a result, we received full repayment of our $14.3 million subordinated debt investment and a $0.3 million equity distribution. We still have our equity position in IOS acquisitions. The IOS sale reduced our exposure to energy services sector, now we have only one portfolio company with meaningful exposure roughly 5% of the total portfolio on a cost basis. In addition, subsequent to the end of the quarter we exited our debt and equity investments in Connect-Air International and Acentia, in connection with the sale of both companies. As a result, we realized a gain on our equity investment in Connect-Air of approximately $5.3 million while our exit of Acentia was near cost. We are extremely pleased with the Connect-Air outcome which illustrates the benefits of our deliberate strategy of structuring our portfolio to provide high levels of current income from our debt investments and capital gains from our equity related investments. Given as a balance of stability and incremental profits to generate attractive risk adjusted returns. As our investments in both Connect-Air and IOS acquisitions were fairly sizeable, our assets under management as of today are roughly comparable with December 31, 2014. Given strong industry fundamentals, solid deal flow and our track record of successfully reinvesting proceeds from payments and realizations, we believe we are well positioned to continue building our portfolio in a reasonable timeframe. However, as a reminder we are patient investors focussed on managing the portfolio for the long term. The number of new investments we make has and will continue to fluctuate from quarter to quarter. Turning back to the first quarter, the fair market value of the portfolio of March 31, 2015 was approximately $413 million equal to approximately 101% of cost. We ended the quarter with debt and equity investments in 47 portfolio companies with equity positions in roughly 83% of them. In terms of portfolio performance, we track several quality measures on the quarterly basis to help us monitor the overall stability, quality and performance of our investment portfolio. In the first quarter these metrics remain strong and in line with prior periods. First, we track the portfolio’s weighted average investment rating based on our internal system. Under our methodology a rating of 1 is outperformed 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. As many of you know, 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. One metric we track is the credit performance of the portfolio which is measured by our portfolio of companies combined ratio of total net debt through Fidus’ debt investments to total EBITDA. For the first quarter this ratio was 3.1 times compared to 3.9 times 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 3.3 times compared to 3 times for the same quarter last year. Turning now to our cost [ph] about the rest of the year. The ageing of private equity portfolios, the strong liquidity position of the financial sponsor community, debt capital availability and a willingness to pay out for quality businesses should all continue to drive M&A activity. As a result, deal flow and our target lower middle market is currently expected to remain healthy, keeping in mind the new investment activity will be lumpy by nature. With these market conditions as a backdrop, our goal for the year is to continue to grow and further diversify our portfolio in a very deliberate manner with an acute focus on capital preservation and the generation of attractive risk adjusted returns. With an eye towards selectively growing and further diversifying our investment portfolio we are focussed on our competitive advantages, relationships, industry knowledge and the ability to offer flexible capital solutions. This approach enables us to identify companies that we believe will perform well over the long term with an emphasis on companies that operate in industries we know well that generate access free cash flow for debt service and investment and have positive long term outlooks. Now I will 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. Similar to last quarter I will be providing comparative commentary versus the prior quarter Q4 2014. Total investment income was $12.8 million for the three months ended March 31, 2015, a decrease of approximately $0.8 million from the $13.7 million of total investment income for the fourth quarter of 2014, due to $1 million decrease and fee income and a $0.4 million decrease in dividend income from FCA, LLC and income producing equity investment that was redeemed in Q4, offset by a $0.6 million of incremental and interest income related to increased average assets under management. Total expenses were $6.6 million for the first quarter, in line with Q4. Interest expense increased by $0.1 million and base management fees increased by $0.1 million which were offset by a $0.2 million decrease in incentive fee. Interest expense includes the interest paid on Fidus' SBA debentures and the line of credit as well as any commitment and unrealized [ph] fee. As of March 31, 2015, the weighted average interest rate on our outstanding debt was 4.2% versus 4% as of December 31, 2014 due to higher fixed interest rates on SBA debentures that pulled in late March versus the initial interim rates. Net investment income, or NII, for the three months ended March 31, 2015 was $6.2 million or $0.39 per share versus $0.42 per share in Q4 2014. Adjusted NII was $0.39 per share in Q1 versus $0.43 per share in Q4. The quarter-over-quarter decrease was driven by a decrease in transaction fees related to investment activity in Q1 versus 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 three months ended March 31, 2015, Fidus had no realized gains or losses versus $12.3 million of net realized losses in Q4 related to the write-off of our investment in Avrio. In Q1, Fidus recorded a net gain on investments of approximately $0.2 million versus a net gain of $0.7 million in Q4. Our net asset value at March31, 2015 was $15.18 per share which reflects payment of the $0.38 per share regular dividend in March. Turning now to portfolio statistics, as of March 31st, our total investment portfolio had a fair value of $412.6 million. Consistent with our debt oriented investment strategy, our portfolio on a cost basis was comprised of approximately 68% subordinated debt, 21% senior secured loans, and 11% equity and warrant securities. Our average portfolio company investment on a cost basis was $8.7 million at the end of the first quarter. We have equity investments in approximately 83% of our portfolio companies, with an average fully diluted equity ownership of 7.7%. Weighted average effective yield on debt investments was 13.3% as of March 31st. 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 fees, but excluding investments on non-accrual if any. Repayment activity continues to impact the portfolio yield as some higher yielding loans have been paid off and replaced with loans priced at current market rates, which are lower than the rates on the more mature loans. Now I’d like to briefly discuss our available liquidity. As of March 31st, our liquidity and capital resources included cash and cash equivalents of $16.4 million, unfunded SBA commitments of $46.5 million and $39.2 million of availability on our line of credit resulting in a total of $102.1 million. Taking into considerations subsequent events, our liquidity is now closer to a $120 million. Fidus filed a new registration statement in March 2015 as our prior registration statement expires later this year. The SBA [ph] declared a new registration statement effective April 30, 2015. As a result we will incur approximately $150,000 of one-time expenses in Q2, 2015 to write-off the unamortized financing costs related to the expiring registration statement. The NII impact will be approximately $0.01 per share. Now, I will turn the call back to Ed for concluding remarks. 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 Michelle for Q&A. Michelle?

Thank you. [Operator Instructions] Our first question comes from the line Robert Dodd with Raymond James. Your line is open. Please go ahead.

Hi, guys. On the kind of the market environment you talking about, obviously there’s a couple of push and pulls as I see. Can you give us a little bit more color on if the private equity activity level is remaining or expectative build or even remain strong. What do you think and I realize this is hard to project, right. What do you think of probable or potential repayments in the remainder of the year, obviously you had a fair amount of fall given obviously your primarily involved with those same sponsors and some of those deals might changing hands and you might be getting taken out. So can you give us an idea of just qualitatively about what your feelings are there?

Absolutely, it’s a great question Robert. I think we’re hoping that this will be a good year from an investment perspective and a very solid vintage and the outlook for that is we see here today is good. But having said that, what comes with that and I think you know this pretty well is that we probably – we have some companies that are right for realization in our portfolio. Last year we had about $62 million of repayments and I think we would expect for a increase in that number this year. I guess, year to-date we’ve had $40 million. I don’t think we expect a crazy numbers but I would expect an increase over and above last year. Its hard to predict as you well know but that’s what we would expect at this point, probably more towards the end of the year though.

Got it. Great. Thanks. And then also on kind of the other dynamic in that obviously I mean a lot of money potentially chasing deal et cetera, on pricing both, but you’ve seen some yield compression, what do you think the potential is for to expand a little bit on refinancing, obviously if while a company finances that you don’t get the equity gain. If you’ve got an equity position and a portfolio company on other hand and they do get sold your realized versus unrealized dynamic shift a little bit. So, you’re expecting there’s going to more of the account [ph] like sale kind of activity as you saw with connector in the second quarter or something more on the refinancing side given what we’re seeing some of that as well.

Sure, sure. I think it’s a great question as well and I wish I could predict it, but I would tell you I think there is –its primarily going to be driven M&A activity, but we do have several or more than a couple of companies in our portfolio that could be refinanced. The strategy of those individual portfolio companies were to lower their cost of financings, not make acquisitions what have you. So, I think there’s will balance, but I think a majority of the repayments will come from M&A activity this year. It could be wrong. It’s really hard to predict, but that’s what I would expect at this point.

Got it. Thank you. One final one if I can hand you on kind of this allied issue. Your take conservative, I want to say over conservative, but appropriately conservative approach in the market. I think you don’t chase structures and the term we’ve heard is, again, obviously these key firms are willing to pay greater and greater multiples to some of these companies and obviously they prefer to level that up a pretty good deal maybe to the point that you’re not willing to do the deal, this kind of touches on some of your comments on in the prepared remarks, but what’s the risk that the market as we gets potentially more aggressive, since it gets away from you in terms of what you’re willing on the risk appetite front?

Obviously, a great question, Robert. I think from my perspective a couple of things, one is, we’re very much look at opportunities and look at the market on a risk adjusted return basis, and we are not volume players as I think you just iterated. I think as we move forward our primary focus is focusing on the quality of the underlying companies and the quality of those assets that we’re putting on our books. And so – if a company is a truly very high quality company, heavy trading, whether it’s seven or 10 times EBITDA and that had sustainable cash flows we are willing to increase leverage over and above where our current portfolio is leverage, because we’re looking at that on a risk adjusted return basis. Let’s we went all the way to five times, which we will do on occasion, but typically when a company is, the equity values at eight, nine, 10 times. And we see sustainability in those cash flows and very strong credit metrics. So it really comes down to what’s the quality of the underlying company. So when I think above do we get just the market move away from our strategy, I don’t think so. I do think we have the ability to move up and down in terms of size of company, as well as finding pockets to where we have real expertise and are willing to take risk adjusted returns whether it’s at lower leverage points or high leverage points. So, it doesn’t concern me too much at this point.

Got it. Thank you.

Absolutely. Thank you.

Thank you. And our next question comes from the line of Bryce Rowe with Robert W. Baird. Your line is open. Please go ahead.

Thanks. Good morning, Ed and Shelby.

Good morning, Bryce.

Robert covered us the topic, right. I wanted to ask about – did want to ask about capital raising process in terms of all to get the ATM in place and you start to use it. So, maybe you could just talk about your strategy or your preference from a capital raising perspective as we move forward. I know you still have availability on the – from an SBA debenture perspective, this availability within the credit facility? Thanks.

That’s a great question. You want to talk about what we’ve done to-date. What we’ve been doing and then I’ll join in gaps.

Yes. From a current liquidity position as Ed mentioned we has some subsequent events that brought in some more cash, and so, as we stand today we don’t have anything outstanding on our line of credit. So as you refer to we do have the SBA debentures, which is kind of been the primary source of capital that we’ve used for investment to the extent. The investments are SBIC eligible. As back stop, we’ve got the line of credit that we have truly used as a revolver. And from an ATM perspective we have kind of year to-date in 2015, done a gross proceeds of about $1.8 million and since we loss the program, we’ve done net proceeds of $4.6. So kind of some modest equity raises there that’s kind of helped us to manage our outstanding debt. So, given where we stand now was close to $120 million of liquidity. We’re fairly well positioned for kind of near term investment activity.

Yes. And I don’t think I would add there is just I do feel like that the ATM program is something that we see as attractive. We haven’t said that that activity level for us has been really very pretty modest and I don’t think we expect any major change in that as we move forward.

Okay. That’s helpful. Again, my questions have already asked and answered. Thank you guys, appreciated

Thank you.

Thank you. And our next question comes from the line of Chris Kotowski with Oppenheimer. Your line is open. Please go ahead.

Yes. Those guys covered most of what I had to, but that’s it. I may have misheard you, but did you say that your portfolio – I thought I heard you say that the portfolio today was flat with December 31, 2014. Did you mean March 31?

No. We meant December. How you’re doing Chris? Hope you well?

I’m good.

So, we’ve had $40 million, so approximately $40 of new investment activity here in 2015. But with the connect realization which was both a debt and an equity realization we’ve had $40 or approximately $40 million of realizations.

Okay.

All flat with yearend as we sit here today. That’s exactly right.

Okay. And then, I’m wondering just with the turmoil and currency markets and it has to put pressure on any kind of manufacturing based export oriented companies, I’m wondering are you seeing stress on cash flows of any companies like that in your portfolio?

It’s good question. I got to think here for a second. It’s a very good question. I will tell you, I don’t think so. Most of our businesses that we invest in are obvious U.S. Domicile and as I think through the portfolio here I don’t think we are experiencing anything. It really negative momentum if you will or negative trends, due to currency markets in our portfolio. I really can’t think of one right now. It could be wrong but I just can’t take it one.

Okay.

Its pretty good stability and I will tell you the overall portfolio as it has actually for a while is continuing to be what I would call a slow growth mode and we feel very good about the overall quality of the portfolio and the underlying portfolio companies for that matter.

Okay. That’s it from me. Thank you.

Thank you. Appreciate it.

Thank you. And our next question comes from the line of Vernon Plack with BB&T Capital Markets. Your line is open. Please go ahead.

Thanks very much. And just one follow-up, are you considering any alternative investment strategies, in other words something that will fall into that 30% non-qualified bucket?

It’s a very good question. And I will tell you or we thinking about things and looking into what I would say small degree, I’d say, yes. But what we’re doing right now, rightly or wrongly, quite frankly is sticking to the strategy and what we’re kind of build to do which is to originate what I would call very high quality debt and equity investments in lower middle market companies. So, we do look at larger companies from time-to-time for sure and I know they are a lot of strategic initiatives going on in the BDC spectrum if you will. But right now, I wouldn’t expect any measure change from us any time soon. I think we feel very good about the strategy we’re executing on, and I do think we’re going to maintain what I would call a very deliberate investment pace and really it’s going to be lumpy to this. We’re continuing to really look for what we considered to be the best companies that we can invest in and kind of focusing on quality rather than quantity.

Okay. So, we should -- and one something changes, should just be a business as usual for you?

I think that’s right. I think that’s exactly right.

I’ll take that as very good news. Thanks.

Okay.

Thank you. And I’m showing no further questions at this time. And I will like to turn the call back to Mr. Ed Ross for any further remarks.

Thank you, Michelle. And thank you everyone for joining us this morning. We look forward to speaking with you on our first quarter call. I guess that will be in early August. Have a great day and a great weekend. Thank you again.

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