Fidus Investment Corporation (FDUS) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Fidus Investment Second Quarter 2017 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 call is being recorded. I would now like to introduce your host for today's conference Mr. Ed McGregor with LHA. Sir, you may begin.

Thank you, Kaily, and good morning, everyone. Thanking you for joining us today for Fidus Investment Corporation's second quarter 2017 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 5, 2017, these estimates 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 the 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 like to turn the call over to Ed Ross. Ed?

Thank you, Ed, and good morning, everyone. Welcome to our second quarter 2017 earnings call. I will start our call by commenting on our activities and the results for the second quarter. And then provide some comments about investment activity in the performance of our investment portfolio before offering our views about the remainder of 2017. Shelby will go into more detail about our second quarter financial results and liquidity position. After that, we will open the call for questions. As announced in June, Fidus completed a common stock offering the rate net proceeds of $32.3 million for the Company at an offering price well above NAV. In line with our approach of managing the business for the long-term we offering further strengthen our balance sheet and provide incremental equity capital to launch a third SBIC license, subject SBA approval and continue to make holding company investments. Turning to our second quarter highlights, I'm pleased to report solid second quarter results as net investment income increased to $9 million or $0.39 per share and our adjusted net investment income which we define as net investment income excluding any capital gains incentive fee attributable to realize and unrealized gains and losses rose 12.2% percent to $9.2 million or $0.40 per share. Our portfolio of debt and equity investments continued to perform well in the quarter. Adding to a steady record of performance that's been driven by our focus on investing in companies that have positive long-term outlooks, strong yet defensible market positions, operate in industries we know well and generate excess free cash flow for debt service and growth. As of June 30, 2017, our net asset value was $388.4 million or $15.87 per share, up $0.07 on a per share basis from Q1 2017. On June 23, 2017, Fidus paid a regular quarterly dividend of $0.39 per share. At June 30, estimated spillover income or taxable income in excess of distributions was $12.7 million or $0.52 per share. For the third quarter of 2017, the Board of Directors has declared a regular quarterly dividend of $0.39 per share which is payable on September 22, 2017 to stockholders of record on September 08, 2017. In the second quarter of 2017, we invested $32.1 million in debt and equity securities. Of this amount $23.5 million was channeled to two new portfolio company investments. Let me briefly recap each of our new portfolio company investments. We invested $12 million in subordinated notes and warrants of Midwest Transit Equipment, Inc., a leading distributor of school and commercial buses and related maintenance and repair services. $11.5 million in subordinated notes and common equity of NGT Acquisition Holdings, LLC doing business with Techniks Industries, a market leader in the fragmented cutting tools and tool holders market. In addition, we invested $8.6 million of capital and existing portfolio companies, including $6.4 million in an add-on to our subordinated notes and common equity of Pugh Lubricants, $1.5 million in an add-on to our senior secured loan of Plymouth Rock Energy, $0.4 million of new preferred equity of FDS Avionics Corp. doing business as Flight Display Systems, $0.2 million in a draw on our senior secured revolving loan to inflection, and $0.1 million in an add-on to our common equity of US GreenFiber. From a repayments and realization perspective, we had a less active quarter relative to the investments we made. Proceeds totaled $19 million including the following exits of portfolio company investments. We received $0.9 million from the sale of our equity investment and in Anatrace Products resulting in a realized gain of $0.9 million. We received payment in full of $6.4 million on our debt investment in inthinc Technology Solutions and we received $7.6 million on our debt investment in FTH Acquisition Corp and relinquished our preferred activity in FTH for no consideration resulting in an aggregate realized loss of $1.3 million. Regarding our exit of FTH Acquisition Corp, we wait a number of variables including our overall return and the resources involved in monitoring the investment and made a conscious decision from a long-term risk management perspective that this was the right thing to do even though we had to exit at a discount. As reported in our second quarter press release, subsequent to the quarter end, we have had an active start to the quarter. On July 13, 2017 we exited our equity investment in EBL, LLC for realized gain of approximately $2.2 million. Concurrently, we invested $10 million in subordinated notes and a new common equity investment in EBL, LLC. On July 14, 2017, we exited our debt investment in Anatrace Products, LLC. July 18, we invested $10.2 million in senior secured loans of Tile Redi, LLC, a leading manufacturer and marketer of bathroom products for use in tiled showers. The company serves both "do-it-yourselfers" and commercial end users throughout the U.S., primarily selling into the home remodeling and renovation end markets. On July 21, 2017, we invested $12.8 million in subordinated notes and common equity of Marco Group International OpCo, LLC, a manufacturer and distributor of surface preparation equipment, parts and supplies to industrial contractors primarily in the downstream energy, infrastructure and industrial markets. On July 28, 2017, we invested $7.8 million in subordinated notes, preferred equity and common equity of ControlScan, Inc., a leading provider of payments security, managed firewall and managed network solutions and one of the nation's foremost PCI compliance companies. Fair market value of our investment portfolio at June 30, 2017 was approximately $553.3 million equal to approximately 104% of cost. We ended the quarter with debt and equity investments in 55 active portfolio companies. The breakdown on a fair value basis between debt and equity remained fairly stable with 84% in debt and 16% in equity investments, providing us with high levels of current recurring income from our debt investments and the continued opportunity to realize capital gains from our equity related investments. In terms of portfolio performance, we tracked several quality measures on a quarterly basis to help us monitor the overall stability, quality, and performance of our investment portfolios. In the second quarter of these metrics remained strong and in line with prior periods. First, we tracked the portfolio's weighted-average investment rating based on our internal systems. Under our methodology a rating of one is outperformed and a rating of five is an expected loss. As of June 30, the weighted-average investment rating for the portfolio was two on a fair value basis in line with prior periods. Another metric we track is the credit performance of the portfolio, which is measured by our portfolio company's combined ratio of total net debt through Fidus' debt investments to total EBITDA. For the second quarter, this ratio was 3.5 times compared to 3.1 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 have in aggregate to meet their debt service obligations to us. In the second quarter, this metric was 3.6 times compared to 3.6 times for the same quarter last year. The soundness of these metrics reflect our philosophy of maintaining significant cushions to our borrowers enterprise value in and support of our capital preservation and income goals. As of June 30, one of our investments, Restaurant Finance Company, LLC remained on non-accrual status and we continue to engage an active discussion with regard to this situation. As we look to the second half of 2017, we see a relatively healthy market environment for us at this point. Economy is expected to maintain its slow, but steady pace of growth and M&A activity looks to remain active with competition for deals in our target lower middle market ever present, but manageable. The flip side of this of course is that we may also experience active level of repayments and realizations in the second half of 2017. As we have several companies evaluating strategic and financing alternatives. Overall, we feel good about the opportunities the market is providing us and remain focused on making new investments in our cautious defensive and deliberate manner. As always we rely on our core strengths including our relationships or industry knowledge and our ability to off flexible capital solutions. Equipped with ample liquidity, we will look to grow and further diversify our investment portfolio while maintaining in acute focus and generating attractive risk adjusted returns and capital preservation. Now turn the call over to Shelby to provide some details on our financial and operating results. Shelby.

Thank you, Ed, and good morning, everyone. I'll review our second quarter results in more detail and close with comments on our liquidity position. Please note I will be providing comparative commentary versus the prior quarter Q1, 2017. Total investment income was $17.3 million for the three months ended June 30 2017, a $1.1 million increase over Q1. Interest income increased $5.6 million primarily related to more assets under management. Fee income increased $5.6 due to investment activity and approximately $0.5 million of fees related to the exit of our debt investments inthinc Technology Solutions. Dividend income in Q2 was $0.6 million a decrease of $1 million from Q1. Total expenses including income tax provision were $8.3 million for the second quarter consistent with Q1. Interest expense decreased by $0.1 million, G&A expenses decreased by $0.1, base management and income incentive fees increased by a total of roughly $0.4 million and a crude capital gains incentive fees decreased by $0.1 million. Interest expense includes the interest paid on Fidus's SBA debentures and line of credit as well as any commitment fees. As of June 30, 2017 the weighted average interest rate on our outstanding debt was 3.7% versus 3.9% in Q1. As of June 30 we had $217.3 million of debt outstanding. Net investment or NII for the three months ended June 30, 2017 was $9 million or $0.39 per share versus $0.35 per share in Q1 2017. Adjusted NII was $0.40 per share in Q2 versus $0.37 per share in Q1. Adjusted NII is defined as net investment income excluding any capital gains incentive fees 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 June 30, 2017 Fidus had $0.4 million of net realized losses primarily related to the exit of our debt and equity investment in FTH Acquisition Corp., a $1.3 million realized loss on FTH was partially offset by a $0.9 realized gain on the exit of our equity investment in Anatrace Products. Our net asset value at June 30, 2017 was $15.87 per share which reflects payment of the $0.39 per share regular dividend in June. Turning now to portfolio statistics, as of June 31, our total investment portfolio had a fair value of $553.3 million. Consistent with our debt oriented investment strategy our portfolio on a cost basis was comprised of approximately of 73% subordinated debt, 16% senior secured loans and 11% equity securities. Our average portfolio company investment on a cost basis was $9.7 million at the end of the second quarter, which excludes five investments in portfolio companies with further operations earnings the process of winding down. We have equity investment in approximately 86.7% of our portfolio with average fully diluted equity ownership of 7.3%. Weighted average effective yield on debt investments was 13% as of June 31. The weighted average yield is computed using the effective interest rates for debt investment at costs including the accretion of original issue discounts and loan origination fees, but excluding investments on non-accrual, if any. Now I'd like to briefly discuss our available liquidity. On June 20, we issued 1.75 million shares at a price of $16.80 per share above NAV and follow on offering with an additional 263,000 shares from the over-allotment issued on June 29, rising total net proceeds of $32.3 million. Also in Q2, SBA approved an additional $25 million commitment for incremental debentures and Fidus Mezzanine Capital to our second SBIC fund. As of June 30, our liquidity and capital resources included cash of $50.8 million, unfunded SBA commitments of $58 million and $50 million of availability on our line of credit resulting in total liquidity of $158.8 million. As Ed discussed, we have had an active start to the third quarter with the number of subsequent events which were funded with available cash and new proceeds from the equity offering. Taking into account subsequent events, our liquidity is currently $131.8 million which includes $23.8 million of cash. Approximately $18.6 million of cash is currently held at Fidus Mezzanine Capital or FMC, our SBIC fund which is in the process of winding down. At the end of August, we expect to use excess cash at FMC to pay down additional SBA debentures with interest rates ranging from 5.3% to 6.4% and maturing days ranging from September 2018 to March 2019. Now, I will turn the call back to Ed for concluding comments. Ed.

Thanks Shelby. As always, I would like to thank our team and our 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 to Kaily for Q&A. Kaily?

[Operator Instructions] Our first question comes from the line of Leslie Vandegrift with Raymond James. Your line is open.

Good morning and thank you for taking the questions.

Good morning, Leslie.

Thank you. I just had a couple quick ones. I know you discussed just and as well as Shelby about the using the deployments already in third quarter, but whether you have an outlook for the timing on the remainder of that new equity raise being used? Do you think the third quarter is going to be fast based all the way through or is some of that going into the fourth?

Great question, Leslie. I wish I knew. I guess what I would say is it's a relatively healthy market. As we sit here today, we're working hard with the portfolio. We're also working on with some potential new investment opportunities. I think the thing that I would mention here is that given is the healthy M&A market, we do have several companies that are at least looking at strategic alternatives and financing alternatives. And so our current expectation is maybe slow growth, but we are going to have some repayments. And if we look at the full-year, there is a scenario where we don't see incremental growth over June where repayments could match our new investments. And so it's hard to tell at this point. Both new investments and repayments are very unpredictable and - so that would be my answer. I think we're taking a cautious approach to growth right now.

And I would just add from a cash management perspective. We'll be able to utilize the cash from the equity offering, but has Ed kind of mentioned, we will have some repayments and to the extent we have repayments that come in FMC our SBIC fund. That w I'll be ideal cash, so we can pay down debentures prior to September 1 and March 1 kind of be in the semiannual payment days. We will have some lumpiness with cash management just as we give repayments in our SBA fund.

Okay. Perfect. Thank you. And then on restaurant finance, the only non-accrual right now had a slight mark down again this quarter and I know you said that you are still in active discussions with them. Is there any more detail on the update there?

Not that I think is appropriate to share. I would say we're very active in this situation. The valuation reflects the increase in the risk profile relative to last quarter. It's a dynamic situation is what I would say and so we're continuing to work with the company and try to optimize the outcome for all parties and particularly U.S.

Perfect. Thank you. I know sometimes you can't give us a more detail on those. But the last question just for a modeling issue is delivering income as of June 30?

I'm sorry, one more time.

Spillover income as of June 30, do you guys have that number?

So it's $0.52 per share or about $12.7 million.

Perfect. Thank you. I appreciate it. You guys have a good day.

Thanks, you too. Good talking to you.

Thank you. Our next question comes from the line of Bryce Rowe with Baird. Your line is open.

Thanks. Good morning Ed and Shelby.

Good morning, Bryce.

Good morning.

Ed, I was wondering if maybe you could touch on the Pinnergy write-up in that one equity tranche?

Sure, as you know the Energy sector for a solid 24 months was dismal just overall. There has been an increase in activity levels, it really since call to middle of last year or third quarter of last year. And Pinnergy is benefited from that increase in activity levels and I would say is performing maybe better than the sector, that's what I hear from some of the people call it third-party valuation folks and whatnot. So I think we're - as we've stated in the past, Pinnergy has - got a strong asset base in the blue-chip customer base and in our opinions well positioned in that sector albeit it was horrible for a while as we all know. So there's been - it's been a nice kind of pick up if you will and overall activity for the company, since again mid last year or third quarter of last year.

Okay, that's helpful. And then Shelby just wanted to clarify the upcoming repayments investigated debentures. It looks to be about $32 million and I just didn't hear it clearly, but are you using cash within the - within that SBIC subsidiary to repay or cash from the holding company?

We'll be using cash from within the SBA subsidiary to repay. And so the point I was trying to make is that currently, we have about $18.6 million within that subsidiary - used for operating expenses, distributions to the holding company and repayment of debt and so my hope would be that we would be able to repay at least $12 million, if not potentially a little more comes September 1.

Okay. That's helpful. Thank you.

Any in our repayments will impact some from cash - from within that fund.

Right, right. Okay, and so if you already get some level of repayments over the course of this quarter, would you potentially try to pay down that next tranche to be add outstanding or will you wait until I guess next period six months later to potentially prepay that?

Yes, unfortunately that's a timing challenge, just depending on the timing of when we got a repayment. So if we got a repayment in August, I would prepare a by September 1. If we got a prepayment any time after September, I would wait until March, just because from an interest perspective. There is no benefit of repaying until March.

Okay, got it. Thank you.

Thank you. Good talking to you Bryce.

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

Yes, just to piggyback on Bryce's question there a little bit. It's roughly $32 million you said and I'm kind of curious like, what is the go-to rate and if we look beyond just this quarter, let's say the next 12 to 18 months. Should we expect that whole $32 million to go and what's the - I guess overall - I think you were going faster, but I think you said 5.6% to 6.2%. So you're going from something like near 6% rate and what's the go-to rate on that?

Yes, for me to step back and kind of clarify because there are a lot of moving pieces and I was trying to kind of highlight given we've had a fair amount of subsequent event activity. As of today we sit on about $23.8 million of cash in total and of that $23.8 million about $18.6 million is within the Fidus Mezzanine Capital or SBIC fund. And so that's the available cash that we would look to use the pay down SBA debentures

Okay.

So we've got about $11.5 million of debentures with the maturity date of September of 2018 and those debentures have an average interest rate of about 6.4%, so those would be the first debentures that we would look to pay down. To the extent, we have additional excess cash that we could use to pay down debentures prior to September 1. We would pay down the next tranche which has interest rates of 5.3%. So that's where - with some combination of debentures with 6.4%, hopefully a little bit with 5.3% and maturity days of September 2018 and potentially same with March of 2019.

And your go through rate would be somewhere around 4, right?

For new debentures, yes.

Yes, okay. All right.

So the good news is the debentures within our first fund which is our outlook funds, that mature have the higher interest rates and so we're getting to pay down as you kind of saw in Q1, some of the interest with higher interest rates and that's helping bringing down our weighted average cost of debt.

Okay. And then kind of just a bigger picture question for Ed I guess. I mean the large care private equity companies that we follow have been raising record pools of capital, and I'm wondering about the sponsors in your space is - are they also raising funds now that are bigger than the ones before or is there more capital available for transactions or less in the next couple years?

Chris, I think they are taking advantage of the opportunity and raising more capital. I don't know that is changing the market environment if you will. Lower middle market had plenty of cash to pursue high quality situations for quite a while now. And what we're seeing in the market is a continuation of that thing, so valuations are at high levels and maybe close to peak levels currently and our expectation is for that to continue. But again for only that what I would call the highest quality opportunities out there. So I think it's a good thing for our market overall. There is a high degree of interest in the buyout world if you will in our market and there's a fair bit of capital out there and we're looking to try to support folks as they make acquisitions in situations that we think are really high caliber. So I think it's a real positive.

All right. That's it for me. Thank you.

Thank you. Good talking to you Chris.

Take care.

Thank you. And our next question comes from the line of Ryan Lynch with KBW. Your line is open.

Good morning. Thank you for taking my questions. Just have a couple for me and most of mine have been asked and answered. Just one question on EBL. That was obviously a good investment that you guys had. You guys had a nice gain in your equity investments this quarter. Can you talk about why that company was able to have such success as well as you guys also reinvested $10 million into the sub notes of that company again? And so I just wondered what was your thought process behind reinvesting in a company which has obviously been successful, but it's also a company in the retail industry which is obviously facing some major headwinds for various reasons. So can you just talk about why you guys decided to reinvest in a company that had been successful, but also is in a really tough industry right now?

Sure. It's a great question, Ryan. And it's an issue we clearly discussed - for a long time quite frankly. But we've been in that - we first invested in that business, I think in 2012. So we've watched it, gone to Board meetings for a long period of time and we've had consistent call it financial success and operational success throughout that period. So it's a very high quality company. It's focused on more urban markets if you will on the Northeast. They sell a lot of shoes if you will. So it's a Nike and Adidas and others, and then other branded apparel if you will focus on the urban marketplace. They have great relationships with the suppliers in particular Nike and Adidas. And the overall business is interestingly more of a cash business and less susceptible to e-Commerce, which is a concern of ours as we invest going forward. It's an opportunity in some cases, but it's a concern in that sector that you're talking about. And so it's one that's somewhat insulated at least currently from the e-Commerce competition and so we view it's a company that has a very good unit economics, high free cash flow and has opportunity to grow. So with a balanced growth and debt repayment, we like the debt play and we like the equity investment again as well. So it's differentiated from our perspective.

Okay, got it. And then just one more when you - and I'm going to ask you to - if you can generalize, when you guys go out and are making subordinated debt investments, what is your ability to control? How the pricing is structured on those investments via fixed versus floating? I mean obviously the majority of portfolio is fixed rate investments, which matches the liability structure of your balance sheet. But I'm just wondering do you guys have the ability to structure subordinate debt invest that you make as floating rate and you guys have any desire to do that more often in the future, given where rates have been and where they feel like they're going?

Sure. It's a great question and a tough question, Ryan. I would tell you that in some cases, we do have the ability to structure floating rate deals. We did invest in a senior secured loan here in July and that was floating rate. But I would say a large majority of most subordinated debt or restructuring was second liens. But the most second lien loans in our marketplace are fixed. I do think we have the ability to do - in some cases opportunistically it could structure with floating rates. I think you'd have to start a little lower and basically sell that we think that the rates will rise over time and so we're trying to insulate ourselves. We've thought about doing that in some cases and we do think about it is just at the moment we're I guess restructured the deals the way we have - it's what we could get away with if you will for a lack of a better term as well as what we thought was prudent.

Okay. That's great color. That's all the questions for me. Thank you for taking them.

Absolutely, good talking to you Ryan.

Thank you. And I'm showing no further questions at this time. I'd like to turn the call back to Mr. Ross for closing remarks.

Thank you, Kaily and thank you everyone for joining us this morning. We look forward to speaking with you on our third quarter call in early November, 2017. 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 wonderful day.