Fidus Investment Corporation (FDUS) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to Fidus Investment Corporation's First Quarter 2016 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 is being recorded. I would now like to introduce your host for today’s conference, Mr. John Heilshorn of LHA. Sir you may begin.

Thank you, Chelsea, and good morning everyone. Thank you for joining us for Fidus Investment Corporation’s first quarter 2016 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 located at www.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 press release. 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 upon estimates, assumptions, and projections as of today, May 6, 2016, 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 that 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 like to now turn the call over to Ed Ross. Ed, good morning.

Good morning, John, and thank you and good morning everyone. Welcome to our first quarter 2016 earnings call. I will start today’s call by reviewing our first quarter results followed by comments about our investment activity in the quarter, the performance of our investment portfolio, and our views about deal flow for the rest of 2016. Then Shelby will go into more detail about our financial results and liquidity position. After that, we will open the call for questions. Our first quarter results were solid. Total investment income rose 14.4% year-over-year to $14.7 million and was largely driven by 12.8% increase in total interest income. Our net investment income rose 13.7% to $7.1 million or $0.43 per share versus last year’s first quarter. And our adjusted net investment income which we define as net investment income excluding any capital gains incentive fee attributable to realized and unrealized gains and losses was $7.2 million or $0.44 per share. As of March 31, 2016, our net asset value was $248.7 million or $15.25 per share. On March 25, 2016, Fidus paid a regular quarterly dividend of $0.39 per share. As of March 31, 2016, estimated spillover income or taxable income in excess of distributions was $16.1 million or $0.99 per share. For the second quarter of 2016, the Board of Directors has declared a regular quarterly dividend of $0.39 per share which is payable on June 24, 2016, to stockholders of record on June 10, 2016. From an investment perspective, the first quarter was relatively robust. We invested a total of $42.3 million in debt and equity securities in the quarter of which $36.5 million was spread among three new portfolio companies. The new portfolio company investments came from deals held over from the fourth quarter pipeline. Each quarter, we typically have some add-on investments in our portfolio companies and this quarter we invested a total of $5.8 million in existing portfolio companies, of which $4.5 million was to support an acquisition made by Worldwide Express Operations, LLC a transportation services company. The new portfolio of company investments we closed in the first quarter operate in end markets we know well, in our businesses that are niche market leaders, strong cash flow generators, and consistent with our underwriting principles. Briefly summarizing these activities, we invested $10.5 million in subordinated notes and common equity of OMC Investors, LLC, doing business as Ohio Medical Corporation, a manufacturer and distributer of medical suction and medical therapy or oxygen therapy products and source equipment; $13.9 million in subordinated notes from common equity of Thermoforming Technology Group LLC, a designer and manufacturer of thermoforming equipment, tooling, and aftermarket parts; and $12.1 million in subordinated notes and common equity of Hub Acquisition Sub, LLC, doing business as Hub Pen, a supplier and decorator of promotional writing instruments. We also had a relatively active quarter in terms of repayments and realizations. We received proceeds of $31.6 million in the period which included the full exit of investments in three portfolio companies Continental Anesthesia LLC, Stagnito Partners, LLC, and X5 Opco, LLC, as well as the payoff our debt investments in Channel Technologies Group, LLC. Turning to our portfolio metrics, the fair market value of our investment portfolio at March 31, 2016, was approximately $456 million equal to 99% of cost. We ended the first quarter with debt and equity investments in 53 portfolio companies and with equity positions in roughly 85% of them. The breakdown on a fair value basis between debt and equity remain fairly stable with 87% in debt and 13% in equity investments, providing us with high levels of current income from our debt investments and the continued 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 first 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 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 2.1 on a fair value basis as compared to 2.0 in the prior period. Another metric we track is the credit performance of the portfolio which is measured by portfolio companies combined ratio of total net debt through Fidus' debt investments to total EBITDA. For the first quarter, this ratio was 2.9 times compared to 3.1 times for the same quarter last year. The third measure we track is the combined ratio of our portfolio companies total EBTIDA to total cash interest expense, which inductive of the cushion of portfolio companies have in aggregate to meet their debt service obligations to us. In the first quarter this metric was 3.5 times compared to 3.3 times for the same quarter of last year. The strength and stability of these metrics reflect our philosophy of maintaining significant cushions to our borrowers' enterprise value a critical determinant to our capital preservation and income goals. As of March 31, our debt investments in on Portfolio Company were on non-accrual status which represented 1% of the current portfolio cost. While we continued to pleased with the construct of our investment portfolio and the vast majority of our investment -- portfolio investments continue to perform well our one energy services related portfolio company Cheniere saw meaningful decline in the value of our second lean loan during the first quarter as the risk of this investment has increased due to difficult industry conditions. As a reminder, Cheniere is an Oilfield Services Company focused on the Texas and Louisiana markets that operate in some of the lowest breakeven basins in North America, the Eagle Ford and the Permian and has an extensive asset base. Company projections a blue-chip customer base, a revenue stream that is diversified by hydrocarbon, meaning it serves both the oil and natural gas markets, and a strong management team that is highly experienced have been operated through multiple downturns in the past. As with all of our companies we are very active in this situation working in tandem with management and our other capital structure participants on a long-term path forward. Given the uncertainty surrounding the situation, we are putting this loan on non-accrual for the second quarter. Our view is that we have a very well run company as well as a well positioned one that offer industry conditions. So we are working hard with various constituents to provide the company runway to weather this difficult period. As a reminder, our portfolio is deliberately structured with the goal of providing high levels of current income from our debt investments and capital gains from our equity related investments. We believe that creating a high quality equity portfolio can not only generated attractive risk adjusted returns but also provide a reasonable margin of safety and stability for Fidus. In the first quarter of 2016 our equity portfolio performed well with greater unrealized gains then unrealized losses. Regarding market dynamics, it’s been a mixed bag. Q1 represented a period of limited actionable deal flow for the market and Fidus was no exception. Concerns regarding the U.S. in global economy, coupled with financial market volatility, reduced the volume of high quality deals in the pipeline during the later part of Q4 and during Q1. Because our investment decisions will always be driven by quality and capital preservation considerations, and informed by our cautious and deliberate approach, for these reasons is likely that we will have limited investment activity in the second quarter. However, M&A pipelines are building in a meaningful manner suggesting a more active market for the second half of the year. Of course a more active market may also give rise to a greater level of repayments and realization which may dampen portfolio growth for the year. As we continue to evaluate opportunities, we will remain focused on what we view to be our competitive advantages such as our relationships, our industry knowledge, and our ability to offer flexible capital solutions. We believe these advantages enable us to identify and partner with companies that offer strong cash flow characteristics and enduring business models and can perform well over the long-term. As always, we will be investing in managing the business for the long-term, with the goal of growing and further diversifying our investment portfolio, while maintaining acute focus on generating attractive risk adjusted returns and capital preservation. 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. Please note I will be providing comparative commentary versus the prior quarter Q4 2015. Total investment income was $14.7 million for the three months ended March 31, 2016, a $0.4 million decrease from Q4 of 2015. Interest income decreased by $0.4 million related to lower average assets under management given repayments that occurred earlier in the quarter and new investments closing later in the quarter. A $0.1 million decrease in fee income due to more investment activity in Q4, including a prepayment fee of $0.4 million, was offset by a $0.1 million increase in dividend income primarily related to three distributions from equity investments received in Q1. Despite the slight decrease in fee income versus Q4, we recognized higher than average fee income in Q1 given investment activity and approximately $0.4 million in prepayment and amendment fee. Total expenses including tax provision were $7.6 million for the first quarter approximately $0.3 million lower than the prior quarter primarily related to excise tax that was incurred in Q4. Interest expense was in line with the prior quarter, G&A expenses increased by $0.1 million, and base management and incentive fees decreased by roughly $0.1 million. Interest expense includes the interest paid on Fidus' SBA debentures and line of credit as well as any commitment in unused line fees. As of March 31, 2016, the weighted average interest rate on our outstanding debt was 4.1%. As of March 31, we had $225 million of debt outstanding. In accordance with new accounting standards please note that unamortized deferred financing cost represented as an offset to the corresponding debt liabilities on the balance sheet. Footnote 6 to our financial statements highlights the debt outstanding as well as the unamortized deferred financing costs. Net investment income or NII for the three months ended March 31, 2016, was $7.1 million or $0.43 per share versus $0.44 per share in Q4 2015. Adjusted NII was $0.44 per share in Q1 versus $0.45 per share in Q4. Adjusted NII is defined as net investment income excluding any capital gains incentive fee expense a 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, 2016, Fidus had $0.3 million of realized losses primarily related to the sale of our warrants in Continental Anesthesia Management, LLC. Realized losses were offset by $0.8 million of net unrealized depreciation on investments. Our net asset value as of March 31, 2016, was $15.25 per share which reflects payment of the $0.39 per share regular dividend in March. Turning now to portfolio statistics. As of March 31, our total investment portfolio had a fair value of $455.7 million. Consistent with our debt oriented investment strategy, our portfolio on a cost basis was comprised of approximately 75% subordinated debt, 14% senior secured loans, and 11% equity securities. Our average portfolio company investment on a cost basis was $9.2 million at the end of the first quarter which excludes three investments in portfolio companies that sold their operations are in the process of winding down. We have equity investments in approximately 85% of our portfolio companies with an average fully diluted equity ownership of 7.4%. Weighted average effective yield on debt investments was 13.3% 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 non-accruals if any. Now I’d like to briefly discuss our available liquidity. As of March 31, our liquidity and capital resources included cash and cash equivalents of $13 million, unfunded SBA commitments of $11 million, and $39 million of availability on our line of credit resulting in a total of $63 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 Chelsea for Q&A. Chelsea?

Thank you. [Operator Instructions] And our first question comes from the line of Robert Dodd with Raymond James. Your line is now open.

Robert, you there?

I’m sorry; our first question comes from Bryce Rowe with Robert W. Baird.

Thanks, good morning Ed and Shelby.

Good morning.

Good morning, Bryce. How are you?

I’m good. I’m good and I appreciate the discussion around Cheniere, I was going to ask about that. But I think you covered that fine, wanted to ask about Inflexion as well we start pretty material mark lower there and just wanted to get any kind of update you might have is that kind of a candidate now for non-accrual, any color there would be helpful. Thanks.

Sure. So Inflexion is a business information service business focused on the healthcare end markets it’s a smaller business that has exhibited some recent volatility and so the decline in the equity valuation and debt valuation reflects an increase in the risk of our debt and equity investments in this company. So I think where we added value is kind of tells you there is some the real risk here. We’re working, we’re active in this situation as well, we got a support of ownership group but it’s clearly there is some events that increased the risk here.

Okay. That’s helpful. And just kind of shifting gears just wanted to ask about the SBA, not much increase in the SBA debentures from December quarter but clearly approaching that $225 million cap from a commitment perspective, have you guys started discussion with the SBA for additional commitments beyond what you got now?

Sure. Let me take the first part of it just so we had some realizations call it mixed quarter multiple and so when we have that and we generate obviously cash proceeds from those realizations. We utilized that cash first and so we then made a couple investments and then that add-on investment the Worldwide that we referenced about Worldwide all that was in March. So we utilized kept the cash that was in the existing SBIC funds first. And moving to your probably more pertinent question, we have not approached the SBA at this juncture. I think we talked a little bit about this in the last call but we are focused on maintaining a healthy liquidity position as a holding company, we’re pretty well invested there right now and so we are kind of taking a cautious and deliberate approach from that perspective. We do think it’s a great long-term thing for Fidus and for BDCs in general quite honestly but we have not approached the SBA yet.

Okay, that’s great. Thanks.

Okay. Nice talking to you, Bryce.

Thank you. And our next question comes from the line of Robert Dodd with Raymond James. Your line is now open.

Hi guys. I guess headphone [ph] had something. I appreciate you guys taking the questions. Just quick and I don’t know if somebody just asked this, because I was having some issues. On Cheniere the non-accrual that would be about $600,000 round numbers in interest income a quarter; is that correct. Are there any other fees associated with that regular in terms of amortizing into the income stream or is that the kind of ballpark number?

That’s the right ballpark.

Okay. Got it, thank you. Then just looking at the kind of indications I mean a soft Q2 which after a very strong Q1 is not surprising to me. When you talk about the full-year, can you give us any very rough kind of gut feel frankly because it’s very hard to predict. Are we going to be looking something in the range of 2015 or more like the record high deployments you’ve had for year 150, lows have been sub-100. But I mean can you give us any ballpark where you think that may shake out, I mean I’m not going to hold you to it but any kind of color would be great.

As you know it’s -- that’s a tough question to answer but I’ll try to give you some more color here. What we’re seeing is not just deal flow because deal flow has been okay but we use the term actionable but quality and there is not a lot of recap activity right now. So M&A transactions are volatile and some of them just don’t happen, right. So it’s been a interesting quarter and I think it’s all driven by the volatility that started in really Q4 and then in Q1 as we all know is extremely volatile in financial markets and those folks that could wait had a company that wanted to sell but could wait they have done so right. They weren’t going to enter the market during those periods and so that’s changed remarkably in 60 days with some amazing amount of change in the financial markets as well as just the concerns of recessions around the corner or coming the next day. That’s kind of gone away and that’s a good thing and so what we’re seeing is M&A banks if you will are pretty busy right now both with existing opportunities that they’re taking to market or they’re pitching quite a bit. So we’re expecting a pretty active M&A market in the second half of the year but that obviously assuming that there aren’t any disruptions to that meaning more financial market volatility or truly events that impact the economy. So that’s about what I can tell you, I think and we’re also when we look at our portfolio, some of the comments comes from that aspect where there are certain companies that are looking to monetize or certain owners are looking to monetize their investments and so that kind of lends creams to my comments about the M&A community being pretty active right now.

Very helpful color and kind of bridging that if the M&A activity does pick up, I mean you’ve got $60 million between equity warrants exactly you got pretty substantial portfolio on that side of the business. So obviously doesn’t generate income, can generate gains and it’s got a good track record there. What are your thoughts on do you think there is going to be an increase in equity realizations this year or any color there?

I would say that that clearly there is a decent chance of that happening. You know homeruns I’m not suggesting that but we definitely have some portfolio companies that are thinking about selling or preparing books to go into the market and hopefully the outcomes will be positive and we will inherit some gains. So that’s the hope, so yes that’s the possibility.

Perfect, perfect. One final one if I can on the professional fees obviously those ticked up activity was high in Q1 and obviously you’re in discussions with Cheniere I presume. So I mean is that related to those issues or is there anything else we should -- that's going on in the professional fees?

The professional fees in Q1 really tick out just because of all the year- end audit works, I mean that’s the primary driver and you’ll probably see that every first quarter. So I sound rare of thinking about professional fees on average for a year they’re kind of $4 million give or take. So call it $900,000 to $1.1 million depending on the quarter with Q1 probably being the highest quarter and then Q3 being the lightest.

Okay. Got it, thank you.

Absolutely. Good talking to you, Robert.

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

Most of mine have been asked and answered but I guess just would you characterize the issues with Inflexion as economically related or is it in idiosyncratic circumstance of the company?

Yes it’s more just at the portfolio company; I don’t think there is any economic issue surrounding that. I think there is just some events whether think they can control or not control if you will and so I -- it’s fundamentally a very sound company but it had some negative events but the company and the ownership group are working through right now, so clearly not an economically driven issue.

Okay. And the issues in the energy sector are obvious and it will be what it will be but I’m wondering are you just in kind of the export sensitive manufacturing sectors are you seeing any stress on cash flows or coverage of the portfolio companies?

No, it’s a great question, Chris. We have seen actually as a portfolio slow growth from both revenue perspective as well as an EBITDA perspective. And I’m -- we’re not seeing anything systemic if you will. The clearly energy is an issue and then we do have one portfolio company that is pretty well diversified on end market basis but steel for instance is one of their end markets and that’s down clearly. But that company overall is doing fine. So I -- but we’re not seeing anything right now that is systemic from an -- a slowdown in the economy or what have you, it really feels pretty stable at the moment.

Okay. All right. That’s it from me. Thank you.

Thank you, Chris. Good talking to you.

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

Thanks very much and Ed and Shelby I would ask a similar question perhaps in a little bit different manner. I know that looking at we’re trying to get a sense for growth in the portfolio, I know looking at 2015 there was about $42 million in net growth. I’m getting a sense that we probably won’t see that level of net growth for 2016 and just trying to get a sense for will we see growth, do you think that we’ll see growth in the portfolio from now until the end of the year?

I think it will -- I think the answer is it’s a very tough question to answer.

Of course, of course.

But let me -- both originations and prepayments are impossible to predict from my perspective. But the -- I think we will see growth but I think it will be modest. So I would expect it to be less than last year from a portfolio growth perspective, as I sit here today. But as we mentioned earlier, we do have some companies valuating strategic alternatives which we hope will be a good thing for us. And then we do expect a pretty active M&A market in the second half of the year which hopefully we’ll participate on both into that both from a new investment side as well as realization side. So as far as gut is it’s more modest than last year at this point in time.

Okay. Well that’s helpful and in terms of I’ll ask another technical question as it relates to Cheniere. Just trying wonder where you are in the process of resolving if I can use that word this situation well is this something that with your partners you think will be -- there will be some resolution to this for the next couple of quarters?

I would hope so. I would hope so but at the same time, I would tell you that it’s kind of at the process if you will are just kind of where we stand is at the very early stage of things. And so but I don’t think there is any reason that it should go on for a long period of time. So hopefully it’s not two quarters or six months that long time. You never know, you never know there is just last year the company had positive event that was very good thing for the company, I think the conditions in the industry in the first quarter that are well publicized created issues and so there is a need for discussions at a minimum at this point in time so.

Well, Ed, will they be cash flow positive this year?

That would be our estimation yes.

Thank you. [Operator Instructions]. And I’m showing no further questions at this time. I would now like to hand the call back to Mr. Ed Ross for closing remarks.

Thank you, Chelsea, and thank you everyone for joining us this morning. We look forward to speaking with you on our second quarter call in early August this 2016. Have a great day and a great weekend.

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