Fidus Investment Corporation (FDUS) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Fidus Investment Corporation Third 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 be given at that time. [Operator Instructions]. As a reminder this conference call is being recorded. I would now like to introduce your host for today’s conference, Ed McGregor of LHA. Please go ahead.

Thank you Ashley and good morning everyone and thank you for joining us for Fidus Investment Corporation’s Third Quarter 2015 Earnings Conference call. With me this morning are Ed Ross, Fidus Investment Corporation 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 releases 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, November 6, 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?

Thank you Ed and good morning everyone and welcome to our third quarter 2015 earnings call. I will start our call by highlighting our results for the second quarter followed by a discussion of our investment activity and the performance of our investment portfolio, and Shelby will go into more detail about our financial results and liquidity position. After that, we will open the call for questions. Our investment portfolio continued to deliver solid results during the third quarter. On a year-over-year basis, we grew our adjusted net investment income by 21% while covering our regular quarterly dividend. As of September 30th 2015, our net asset value was $246.3 million dollars or $15.12 per share. We believe this quarter's results are a good illustration of the quality of our portfolio, our underwriting discipline and all in all we are proud of our performance for the quarter. From an operating perspective, we generated net investment income of $7.1 million or $0.43 per share for the third quarter. While adjusted net investment income which we define as net investment income excluding any capital gains in its infinity attributable to realize and unrealized gains and losses was $6.7 million or $0.41 per share. On September 25th 2015, we paid a regular quarterly dividend of $0.39 per share to stockholders of record on September 17th 2015. As of September 30th, we had an outstanding balance of spillover income or taxable income in excess of distributions of roughly $14.4 million. For the fourth quarter of 2015, Board of Directors has declared a regular quarterly dividend of 40$0.39 per share which is payable on December 18th 2015 to stockholders of record on December 4th 2015. In addition, the Board of Directors has declared a special cash dividend of $0.04 per share payable on December 11th 2015 to stockholders of record as a November 27th 2015. During the third quarter, we remain true to our investment strategy. We are patient and disciplined investors that are up quality over quantity and focus on companies that operate in industries we know well that generate excess free cash flow for both debt service and growth and that have strong defensible market positions and positive long term outlooks. In addition, the amount of capital we invest in any given quarter has in the past and will continue to vacillate as a result of the timing and frequency of deal closings, particularly when the majority of the deals are being driven by M&A activity. For example this quarter we invested a total of $12.2 million in contrast to the $28.3 million dollars we invested during the second quarter and the $39.6 million we invested during the first quarter of this year. Of the $12.2 million dollars we invested during the third quarter, 4.2 million consisted of additional investments in five existing portfolio companies. The remaining 8 million was invested in subordinate notes and common equity of a new portfolio company, Vanguard Dealer Services L.L.C. a provider and administrator of finance and insurance products to automobiles dealerships. Also as reported in our third quarter press release, subsequent to quarter end we invested $21.8 million which included two new portfolio company investments. We invested $8.5 million in subordinate notes with the royalty the right agreement of inthinc Technology Solutions, Inc. a provider of vehicle telematics solutions to large enterprise fleet operators. And we invested $8.3 million in subordinated notes of Cavallo Bus Lines Holdings, LLC, a large motor coach operator based in the Midwest that provides charter bus services to clients primarily in the education, athletic and tour end markets. Turning to proceeds from repayments and realizations, we have received $4.1 million in the third quarter which included recognition of a $1.6 million gain related to our investment in Westminster Cracker Company. For the fourth quarter of 2015, we currently expect to see an increase and repayments and realizations in line with repayment levels in the first two quarters of 2015. The fair market value of our investment portfolio of September 30th, 2015 was approximately $428 million dollars, equal to approximately 99% of cost. We ended the quarter with debt equity investments in 48 portfolio companies with equity positions and roughly 83% of them. The breakdown on a fair value basis between debt and equity remained fairly stable with 88% in debt and 12% in equity investments, providing us with high levels of current income from our debt investments and the opportunity for 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 third quarter, these metrics remain strong and in line with prior periods. First, we track the portfolios, weighted average investment rating based on our internal system. Under our methodology, a rating of one is outperformed and a rating of five is an expected loss. As of September 30th, the weighted average investment rating for the portfolio was two on a fair value bases in line with prior periods. Another metric we track is the credible performance of the portfolio which is measured by our portfolio companies combined ratio of total net debt to Fidus’ debt investments with total EBITDA. For the third quarter, this ratio was 3 times compared to 3.5 times 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 obligation stats. In the third quarter, this metric was 3.5 times compared to 3.4 times for the same quarter last year. The soundness of these metrics reflects our philosophy of maintaining significant cushions to our bars enterprise value in support of our capital preservation and income goals. As of September 30th, our debt investments in Paramount building solutions LLC remained our only investment on nonaccrual and represented approximately 1% of our investment portfolio on a cost basis. Turning to our discussion of market conditions, we continue to see solid M&A activity and believe our target lower middle market remains relatively healthy overall. The same fundamentals are in place for most business segments although energy remains weak and certain industrial segments plus those that are more dependent on China and foreign markets have seen recent softness. With the slow growth economy and pockets of uncertainty as a backdrop, we continue to selectively focus on businesses that we believe will perform well over the long term and that are more defensive in nature. Our focus remains on deal quality not quantity. We have managed and will continue to manage the business for the long term maintaining a cautious and deliberate approach to investing. Our goal remains to grow and further diversify our investment portfolio with an acute focus on generating attractive risk adjusted returns and capital preservation. Our relationships, our industry knowledge and our ability to offer flexible capital solutions continue to provide a strong competitive foundation and position us to deliver stable and growing dividends over the long term. 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 will review our third 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 Q2 2015. Total investment income was 13.6 million for the three months ended September 30, 2015, a 0.8 million increase over Q2 2015. Interest income increased by $0.6 million related to higher average assets under management. A 0.3 million increase in dividend income, primarily related to two distributions from equity investment, was offset by a 0.2 million reduction in fee income due to fewer new investments in Q3. Total expenses were 6.5 million for the third quarter, approximately 0.3 million lower than the prior quarter. Interest expense increased by 0.1 million and the base management fee increase by roughly 0.1 million which were offset by a 0.3 million reversal of accrued capital gains fees and a 0.2 million decrease in G&A expenses. Interest expense includes the interest paid on Fidus' SBA debentures and line of credit as well as any commitment and unused line fees. As of September 30th, 2015, the weighted average interest rate on our outstanding debt was 4.2%. The third quarter is generally a lighter quarter for routine G&A expenses. In the fourth quarter, we will incur annual excise tax expense which I would expect to be slightly above excise tax expense in 2014. Net investment income or NII for the three months ended September 30th 2015 was 7.1 million or $0.43 per share versus $0.37 cents per share in Q2 2015. Adjusted NII was $0.41 in Q3 versus $0.38 per share in Q2. The quarter over quarter increase and adjusted NII was driven by higher interest and dividend income and fewer G&A expenses in Q3. 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 investment. A reconciliation of NII to adjusted NII can be found in our earnings press release that was issued yesterday afternoon and also posted on the Investor Relations page of our website. For the three months ended September 30, 2015 Fidus had1.6 million of net realized gains primarily related to a distribution from Westminster Cracker Company from the sale of its operating subsidiary. Net realized gains were offset by 3.2 million of unrealized depreciation resulting in 1.6 million of net loss on investments. Our net asset value as of September 30th 2015 was $15.12 per share which reflects payment of the $0.39 per share regular dividend in September. Turning now to portfolio statistics. As of September 30, our total investment portfolio had a fair value of 428.2 million. Consistent with our debt-oriented investment strategy, our portfolio on a cost basis was comprised of approximately 69% subordinated debt, 20% senior secured loan, and 11% equity and warrant security. Our average portfolio company investment on a cost basis was 9 million at the end of the third quarter. We have equity investments in approximately 83% of our portfolio companies with an average fully diluted equity ownership of 7.8%. Weighted average effective yield on debt investments was 13.4% as of September 30th. The weighted average yield is computed using the effected interest rates for debt investments and cost including the accretion of original issue discount and loan origination fees but excluding investments non-accrual if any. Now I would like to briefly discuss our available liquidity. As of September 30th, our liquidity and capital resources included cash and cash equivalents of 17.7 million unfunded SBA commitments of 34.8 million and 35.5 million of availability on our line of credit, resulting in a total of 88 million of liquidity. Subsequent to quarter end, we borrowed 7 million of SBA debentures which we utilized along as available cash to fund new investments. Our liquidity is now close to 66 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 will now turn the call back over to Ashley for Q&A. Ashley?

Hi everybody. Just going to back to one of the comments you made at on elevated repayments and realizations in Q4, may it sounds like you are along in the process or rather some companies, along in the process of potential M&A and so anything like that, any more color you can give us on then plus, are these newer or older vintage companies, so if we see a realization of on all the company, we wouldn’t necessarily expect the prepayment penalty or accelerated amortization but a newer one, we would and that could move things random and any color you can give us on that that would be great.

Sure. That’s a great question, Robert. I think, it’s all the repayments, as I look at third quarter, I think it was lighter than usual for us, now the portfolio is pretty mature. As I look forward and the numbers were in the 20s and the mid-20s in Q1 and Q2 that is our expectations at this point but as you know, it’s hard to predict, very hard to predict, no different in the origination side. These deals will all take a life of their own. When I think about the vintage, I think there is potentially an older and potentially a more recent one that may come fruitarian. So I think, hopeful that’s helpful to you.

Yes it is. If I could then just kind of follow up on now, just the other kind, with the multiples being high, I mean is that one of your hesitations in doing some of these deals. You say you are seeing good flow right now. Are the [indiscernible] looking to push leverage levels high multiple if they want to maintain return I think more or less they should do it and does that the quality issue that’s may be making you hesitant to do some of these deals when you are seeing a pretty active flow?

That’s a great question, Robert. I think from a quality perspective, obviously I will talk about deal flow here and then actually what we have been doing. Many deal flow has been pretty good this year. I will tell you it’s dropped a little bit over the last two months but I think that’s more temporary nature with all the stock market volatility and the concerns about the industrial economy, I think people have slowed down just a little bit here to take a breather but if I look at our portfolio, the portfolio continues to perform pretty well and so we are not seeing any major pockets of problems or uncertainty. From a quality perspective, I will also say that the quality of the deal flow is probably come down just a little bit. What I mean by that may be more cyclical opportunities or just tougher opportunities which quite frankly we're probably shying away from at the moment. So that's been a little bit of our strategy and then the other thing is back to that comments I made in the prepared remarks which is the time of these transactions is very-very hard to predict. We're very busy right now but we've been busy on several deals since June and they're just slow coming to fruition. So it's just very hard to predict that. What happened in Q3 in terms of a little lighter investment pace was more of a function of timing of deals in my opinion than it was as being overly cautious.

Got it. Thank you very much.

Thank you. Our next question comes from Vernon Plack of BB&T Capital Markets, your line is open.

Thanks and is there change to the competitive landscape here over the last past 90 days?

Great question. I don't think so. As I think about it, I guess the one thing I'd say and that we've really seen over the past year banks are less aggressive today from a cash flow lending perspective. That's a good thing for us that means we're partnering with them on probably more situations. I think the type of capital that we provide in the larger side of our, $10 million to $20 million EBITDA business, there's plenty of competition. When you drop down I think there's less and that's a place where we've obviously been active over the years and continue to be very active. But one thing I would say in line with competition is pricing and I think I mentioned last quarter if I'm not mistaken is that I think pricing is at a minimum stabilized and quite frankly I think it's improved a little bit over the last six to nine months. So maybe that gives you a little bit indication on the pricing on the competition side. I do think it's for sure stabilized and probably gotten a little bit better over the past six to twelve months.

Okay and as you look at how your portfolio companies, how they have been performing. What are your biggest concerns right now?

That's a great question as well. We're seeing in the portfolio today is as a whole is revenue growth and quite frankly EBITDA growth when you look at things in the aggregate. So I think that's a very positive thing and I like the fact that the weighted average leverage of our debt portfolio is three times. So feel very good about the position that we are in. Having said that and you've heard me say this before we always have a few that are exceeding expectations and a few that are underperforming. And so those ones that are underperforming the key for us is a couple of, one is just the underwriting that we underwrite and really solid businesses that can weather that any storm that comes up including an economic recession or in another event. That's the goal that's what we're trying to do because not only these businesses are just going to go straight line up as you well know. So the key for us is weathering those storms and working with companies to make sure we can come out with a positive long term outcome and so that we spent a lot of time on that quite frankly in terms of managing the portfolio and that's our job I think and that's what we're continuing to do. Energy is obviously is one where that’s a tough sector right now but I think the good news at least from my perspective I sit here today our one material investment in that sector is a very solid company that operates in a tough industry but it's got a very solid and strong asset base and a great management team and we feel good about that investment haven't said that it's a it's a tough sector.

Okay that's great, that's very helpful. Thank you.

Thank you our next question comes from Bryce Rowe of Baird. Your line is open.

Thanks, good morning Ed and Shelby. I think, I have seen this in the last couple quarters and I am sure the, if the stock price has been this frustrating for you with that trading at a discount to NAV but any updated thoughts on the potential for stock repurchases. I know you've got the plant outstanding there but with the stock kind of languish even more so now it is looking more attractive to use at that repurchase plan.

Sure. I guess to be clear we do have availability under our line of credit. So we have flexibility to buy backs some shares. We don't have a plan in place at this point. Having said that as you would expect we spent a lot of time on this at the board meeting, I don't have an update for you which says okay it's imminent, we're getting ready to do it but frankly we're hopeful that things improve a little bit but it's a very real conversation for us at the board level. I will tell you there's other considerations to take into account, no different than a line of credit and the flexibility we have there but also the fact that as you look at our asset base or equity asset base, some of it is the holding company, clearly a good part of it but a good part of it’s also on our SBIC plans. So we're managing a variety of things there and I would say at the levels we're at today we're not quite ready to pull the trigger on that but recognize that it's something that we're talking about the things for some reason get worse which we hoping don’t. Then we'll probably get on the plan.

Great. That’s helpful. Thanks Ed. Have a good one.

Thanks you too. Good talking to you.

Thank you that ends our Q&A session for today. I'd like to turn the call back over to Mr. Ed Ross for any final remarks.

Thank you, Ashley and thank you everyone for joining us this morning. We look forward to speaking with you on our fourth quarter call in early March. Have a great day and a great weekend.

Ladies and gentlemen thank you participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a wonderful day.